How to Draft a Judgment to Be Nondischargeable in Bankruptcy

Ordinarily, a settlement agreement making a debt nondischargeable is not enforceable in bankruptcy. Indirectly, a district judge in San Diego described how a stipulated judgment could be drafted before bankruptcy to result in nondischargeability.

Before bankruptcy, the debtor had personally guaranteed a debt of about $300,000 owing by a third party. When the debtor failed to honor the guarantee after the primary obligor defaulted, the creditor sued the debtor in state court, asserting claims for breach of contract, conversion, fraud, and negligence.

The suit was resolved by entry of a stipulated judgment of some $200,000, calling for the debt to be paid in installments. The stipulated judgment declared that the debt would be nondischargeable in bankruptcy. The debtor filed a chapter 7 petition after defaulting on the payments.

The judgment creditor filed an adversary proceeding to declare the debt nondischargeable under Section 523(a)(2)(A) for money obtained by “false pretenses, false representation or actual fraud.”

The creditor filed a motion for summary judgment in bankruptcy court, invoking the doctrine of issue preclusion to render the debt nondischargeable. The bankruptcy judge denied the motion and later held a bench trial. After trial, the bankruptcy judge again ruled that issue preclusion did not render the debt nondischargeable and found that the creditor had failed to adduce facts that made the debt nondischargeable under Section 523(a)(2)(A).

The creditor appealed and lost again in a July 15 decision by District Judge Marilyn L. Huff.

Judge Huff first dealt with issue preclusion under the law of California, the forum state. Among the five requirements in California, the issue must have been actually litigated in the former proceeding. She quoted the stipulated judgment in state court as saying it was a “compromise on the breach of contract (guarantee), conversion and fraud claims.” The judgment went on to say that the parties “expressly agreed” that the debt would be nondischargeable in bankruptcy.

Judge Huff said that the stipulated judgment was not automatically enforceable under its own terms because “such prepetition waivers are unenforceable” under Ninth Circuit precedent. Nonetheless, she said, the judgment would be nondischargeable if it met the requirements for issue preclusion.

Judge Huff said that issue prelusion did not apply because there was no record sufficient “‘to reveal the controlling facts and pinpoint the exact issues litigated in the prior action,’” quoting In re Plyam, 530 B.R. 456, 462 (B.A.P. 9th Cir. 2015). She went on to say that the stipulated judgment recited “no facts in relation to the fraud claim.”

Furthermore, Judge Huff said, the judgment “makes no express finding of fraud.” Instead, the judgment only mentioned fraud in saying that the settlement compromised claims for breach of contract, conversion and fraud.

The facts in the judgment “merely show that [the debtor] owes [the creditor] a debt,” Judge Huff said.

Judge Huff therefore upheld the bankruptcy court’s ruling that issue preclusion did not bar discharge of the debt. The judgment, she said, did “not show that the issue of fraud was necessarily decided because the Stipulated Judgment lacks any substantive reference to the fraud claim or facts supporting the claim.”

Next, Judge Huff analyzed whether the bankruptcy judge committed error in his findings of fact and conclusion of law after trial. The creditor argued, among other things, that the debtor made a false representation by failing to disclose his financial inability to make good on the guarantee.

Judge Huff said that a failure to disclose can be a fraudulent omission leading to nondischargeability under Section 523(a)(2)(A). However, she said there must be a duty to disclose, and a contract “does not include an implicit representation of the debtor’s ability to perform.”

Judge Huff consulted the Restatement of Torts and principles of common law fraud to determine whether the debtor had a duty to disclose. She said the debtor had no duty to disclose because the creditor did not ask him to make representations regarding his financial condition.

Judge Huff found no flaws in the bankruptcy court’s factual findings because the debtor “was under no duty to disclose his financial condition at the time of the guarantee.” She therefore upheld the judgment after trial declaring that the debt was dischargeable.