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Dispute Over Discharge of Debt in Chapter 7 Bankruptcy Addresses Treatment of State Judgments by Federal Courts

sparkyface from morguefile.comA federal district court upheld a bankruptcy court’s order holding a debt to be nondischargeable in a Chapter 7 case. In re Kurtz, No. CV 12-07175, order (C.D. Cal., Jul. 10, 2013). The case dealt with a judgment against the debtor based on an arbitrator’s decision in a California state lawsuit. The judgment creditor sought to have the debt declared nondischargeable under a provision of the Bankruptcy Code preventing discharge of debts that result from “defalcation while acting in a fiduciary capacity.” 11 U.S.C. § 523(a)(4). The district court affirmed the judgment for the creditor, and reviewed the standards for determining whether a federal court can review issues related to a state court judgment.

The creditor, 3H Corporation, entered into a contract in August 2005 with Integrated Technologies Consulting, Inc. (ITC). The debtor was president of ITC at the time, and signed the contract in such capacity. The contract provided that the parties would create a bank account exclusively for activities under the contract. After a dispute developed between 3H and ITC in October 2008, ITC moved the money to a different bank account, giving notice to 3H. 3H sued ITC, and the debtor individually, the following month for breach of contract, breach of fiduciary duty, and other claims. The parties agreed to submit the matter to arbitration. After a seven-day proceeding that took place between October 2010 and February 2011, an arbitrator issued a decision finding the debtor personally liable and awarded both compensatory and punitive damages to 3H. A Los Angeles court confirmed the award in October 2011.

The debtor filed for Chapter 13 bankruptcy in June 2011, converting the case to Chapter 7 a month later. 3H intervened, seeking a determination as to the arbitration award’s dischargeability. It claimed that the debt resulted from the debtor’s “defalcation while acting in a fiduciary capacity,” and that the arbitrator had established that the debtor committed defalcation. The doctrine of issue preclusion, or collateral estoppel, 3H argued, supported its motion for summary judgment. This doctrine prevents a party from relitigating an issue that a court has already decided.

The debtor appealed to the district court after the bankruptcy court granted 3H’s motion. He sought, in part, to address whether the court could reconsider the arbitrator’s decision regarding defalcation. The district court accepted one of 3H’s two arguments in support of the arbitration judgment. 3H argued that the Rooker-Feldman doctrine, which “prohibits federal district courts from hearing cases that constitute appeals of state court judgments,” should apply, but the court disagreed. Kurtz, order at 4, citing Exxon Mobil Corp. v. Saudi Basic Industries Corp., 544 U.S. 280, 291-2 (2005). That doctrine only applies, the court held, to claims that seek direct review of a state court judgment, whereas this case was primarily about bankruptcy law. The debtor still could not seek review of the arbitration award, however, due to issue preclusion. The court held that the bankruptcy court properly applied issue preclusion in reviewing the arbitrator’s order.

The bankruptcy system offers a chance for relief to people whose income is insufficient to service their debts. For the past sixteen years, bankruptcy attorney Devin Sawdayi has handled Chapter 7 liquidation cases and Chapter 13 restructuring cases for debtors in the Los Angeles area, helping them manage their debts and get back on their feet with dignity and respect. Contact us today online or at (310) 475-9399 to schedule a free and confidential to discuss your case.

More Blog Posts:

California Bankruptcy Court Rules on Discharge of Debt Allegedly Incurred Through Fraud, Los Angeles Bankruptcy Lawyer Blawg, September 7, 2013

Supreme Court Rules on Meaning of “Defalcation” in Statutory Provision for Nondischargeable Debts in Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, July 30, 2013

Payroll Debts Ruled Nondischargeable in Chapter 7 Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, July 23, 2013

Photo credit: sparkyface from morguefile.com.