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Bankruptcy Court Cannot Reduce Amount of State Court Judgment, According to California Federal Court

Sergio Roberto Bichara [FreeImages.com Content License (http://www.freeimages.com/license)], via FreeImages.comThe bankruptcy process allows individuals and families to rebuild their finances after they find themselves unable to continue paying their debts with their existing income. Under the federal Bankruptcy Code, bankruptcy judges can make rulings regarding the payment of debts and, at the end of many cases, the discharge of remaining debts. Disputes may arise between a debtor and one or more creditors, which the court may have to resolve. A recent decision by a Los Angeles federal court reviewed a bankruptcy court’s authority to modify the amount of a debt, which is a common topic of dispute. In re Spellman, No. 2:15-cv-00507, opinion (C.D. Cal., Sep. 17, 2015). It held that the bankruptcy court could not modify the debt because it was the result of a state court judgment.

The debtor is the beneficiary of a trust that includes a spendthrift clause limiting his access to the trust proceeds until his 35th birthday in 2017. In early 2007, the debtor hired an attorney to represent him in a lawsuit filed by members of his family disputing money received by the trust. The parties settled the lawsuit in September 2009. The debtor’s attorney, as part of the settlement, sought the removal of the spendthrift clause in order to claim his fee. The debtor claimed that he was unaware until then that the attorney would claim one-third of the trust proceeds, or approximately $200,000. He notified the attorney that he was terminating their attorney-client relationship, but the attorney reportedly continued working on the case until the court approved the settlement. The attorney filed suit against the debtor in December 2009 to collect his unpaid fee.

The debtor and the attorney submitted the case to arbitration. The arbitrator awarded the attorney 33 percent of the trust proceeds. The trustee of the trust obtained an order from the probate court setting aside the removal of the spendthrift provision, but the attorney obtained an order from the superior court confirming the arbitrator’s award and entering a judgment against the debtor for more than $214,000. With the spendthrift clause in place, the debtor was personally liable for the judgment amount. The debtor filed for Chapter 13 bankruptcy in March 2012.

The debtor objected to the attorney’s proof of claim, and the bankruptcy court ruled in his favor. The court reduced the amount owed to the attorney to just under $44,000, an amount it deemed the “reasonable value” of the attorney’s services to the debtor. 11 U.S.C. § 502(b)(4). The court rejected the attorney’s argument that res judicata precluded it from reviewing the state court’s judgment, or that federal law required it to give “full faith and credit” to the judgment. 28 U.S.C. § 1738. The attorney appealed to the district court, which reversed the ruling.

The district court noted that it, like the bankruptcy court, was “troubled” by the attorney’s conduct. Spellman, op. at 7. This was not merely a disputed debt, however. It was a judgment entered by a state court. The district court ruled that California’s preclusion doctrine barred the bankruptcy court from modifying the judgment, regardless of § 502(b)(4).

If you need to speak to a Los Angeles bankruptcy attorney, contact the Law Offices of Devin Sawdayi today online or at (310) 475-939 to schedule a free and confidential consultation. We represent individuals and families in Chapter 7 and Chapter 13 bankruptcy cases, helping them repair their finances with dignity and respect.

More Blog Posts:

Bankruptcy Trustee Files “Clawback” Suits Seeking Return of Allegedly Fraudulent Transfers, Los Angeles Bankruptcy Lawyer Blawg, April 22, 2015

Bankruptcy Court Grants Trustee’s Motion to Deny Discharge in Chapter 7 Case, Los Angeles Bankruptcy Lawyer Blawg, April 8, 2015

Debtors Allowed to Sue Loan Servicer for Charging Unapproved Fees During Chapter 13 Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, December 23, 2014

Photo credit: Sergio Roberto Bichara [FreeImages.com Content License], via FreeImages.com.