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Collateral Estoppel Used to Prevent Discharge
Chicago Daily Law Bulletin

The 7th U.S. Circuit Court of Appeals has reversed a ruling by U.S. District Judge Richard L. Young of the Southern District of Indiana.

When John W. Catt II declared bankruptcy, Shirley and Gerald Hash, who had been joint venturers with Catt in a construction project and had obtained a fraud judgment against him in a default proceeding in Indiana state court for $487,045 in damages and $51,000 in punitive damages, sought a ruling from the bankruptcy court that the judgment debt to them was not dischargeable in bankruptcy.

The bankruptcy judge ruled, however, that the Hashes could not use the doctrine of collateral estoppel to make the state court’s finding of fraud binding in the bankruptcy proceeding and that they would have to prove fraud again in the bankruptcy proceeding to defeat discharge.

The Hashes declined to do so, standing on their claim of collateral estoppel, and the district judge ruled that the debt was dischargeable.

The appeals court reversed. The court said the effect of a judgment in subsequent litigation is determined by the law of the jurisdiction that rendered the judgment.

In this case, the appeals court said, while ”one might suppose that findings made in default proceedings would never be given collateral estoppel effect because they are not based on a full and fair hearing,” Indiana is one of a minority of states that allow findings made in default proceedings to collaterally estop, provided that the defaulted party could have appeared and defended if he had wanted to.

”Do these states have a deviant understanding of collateral estoppel, or, worse, are they violating due process? The answer to both questions is no,” the court said.

The appeals court said Catt had an opportunity for a hearing on the issues, and he had no valid basis for believing that the trial would not be held merely because his lawyer was quitting the case. The court said he could have sought a continuance to enable him to hire another lawyer. The appeals court added that it was apparent that Catt was determined to bypass the state-court litigation in the hope that any judgment against him in that suit would be wiped out by a discharge in bankruptcy.

”So the fact that the ‘trial’ which was held in the Indiana state court was a travesty of a trial, lacking as it did an adversary dimension or for that matter the kind of active judicial participation that characterizes the inquisitorial systems of the Continental European judiciaries — the fact that it was no better, really, than a default proceeding — cannot bail Catt out,” the appeals court said.

The appeals court said that while the Indiana proceedings were perfunctory, the bankruptcy judge was bound to accept the judgment entered in state court.

In re John W. Catt II, No. 03-1847. Judge Richard A. Posner wrote the court’s opinion with Chief Judge Joel M. Flaum and Judge Diane P. Wood concurring. Released May 19, 2004.

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