Recent BAP Decision on Preclusion

Recently, the Bankruptcy Appellate Panel for the First Circuit (“BAP”) considered the preclusionary effect of a state court default judgment against a debtor for breach of a settlement agreement. In Gray v. Tacason, No. 15-003 (B.A.P. 1st Cir. Sept. 25, 2015), the BAP held that the state court had made specific findings on all of the elements a creditor must prove under 11 U.S.C. § 523(a)(6) and affirmed the Bankruptcy Court for the District of New Hampshire’s grant of summary judgment in favor of the creditor.

The state court judgment resulted from litigation over a breach of settlement complaint brought by the creditor against the debtor (“2009 Litigation”). The debtor failed to comply with several court orders in the 2009 Litigation, resulting in a finding of contempt and entry of a default judgment against the debtor in the 2009 Litigation as a sanction (“Contempt Judgment”). The state court determined specific damages after a separate evidentiary hearing (“Damages Order”).

Following the debtor’s bankruptcy petition in June 2012, the creditor filed a complaint that included a count to except the debt arising from the Contempt Judgment and Damages Order from discharge pursuant to § 523(a)(6). Thereafter, the creditor filed a motion for summary judgment asserting that the state court’s findings in the Contempt Judgment conclusively established the elements required by § 523(a)(6), thus precluding the debtor from relitigating those issues. The bankruptcy court granted the creditor’s motion for summary judgment, and the debtor appealed.

The BAP addressed and dismissed three issues raised by the debtor on appeal. First, it found that the relevant issues were previously litigated despite the entry of a default judgment. While default judgments do not generally have preclusive effect, a party’s active or substantial participation in the matter creates an exception to that general rule. Additionally, issue preclusion may apply when a default judgment is entered as a contempt sanction. The record reflects that the debtor actively participated in the litigation and the default judgment resulted from her contemptuous conduct in the litigation.

Second, the BAP held that although a contempt sanction is not per se nondischargeable, the state court made sufficient findings of fact to establish the debtor’s willful and malicious conduct as required under § 523(a)(6). The state court’s findings established that injury to the creditor was substantially likely to occur as a result of the debtor’s actions, satisfying the willfulness requirement, and the debtor ignored court orders intentionally, without justification, satisfying the malice requirement.

Third, there was a sufficient causal connection between the debtor’s willful and malicious conduct, as established in the Contempt Judgment, and the amount awarded in the Damages Order. The Damages Order was designed to compensate for injuries resulting from the debtor’s contemptuous conduct. Thus, the debt arose from a monetary sanction for contempt rather than a pre-existing debt owed to the creditor.

The full text of the opinion may be found here.

Contributed by W. Alexander McGee.