Bankruptcy Judge Robert E. Grossman of the United States Bankruptcy Court of the Eastern District of New York recently issued a decision holding that an award of treble damages in a prepetition arbitration for a willful violation of state law did not mean that such debt would be automatically excepted from discharge under Section 523(a)(2)(A) of title 11 of the United States Code (the “Bankruptcy Code”).
The adversary proceeding, Robert Miner and Laurie Miner v. Barry Mines, stemmed from a prepetition agreement between the debtor, Barry Mines (the “Debtor”) and judgment creditors, the Miners. The Debtor owned and operated companies wherein the Debtor would advertise opportunities for individuals to create and operate their own boating magazines. The Miners entered into an operating agreement (the “Agreement”) with the Debtor and his companies. In 2017, the Miners sent the Debtor a notice of demand for arbitration wherein the Miners were to assert claims against the Debtor for violations of the Agreement, fraud based claims and punitive damages in the form of treble damages based on the Debtor’s alleged willful conduct. The dispute was arbitrated and the arbitrator ultimately found in favor of the Miners. In or around 2018, a judgment was entered by the Suffolk County Supreme Court in the sum of $162,448.37 (the “Judgment”) which confirmed the arbitration award and added costs and interest. The Judgment was final and non-appealable. A year later, the Debtor filed for relief under chapter 7. The Miners filed a claim in the Debtor’s case based on the Judgment.
The Miners also commenced an adversary proceeding under Section 523(a)(2)(A) alleging that the arbitration award was entitled to collateral estoppel as related to nondischargeability because the arbitrator had granted treble damages which required a finding of fraud based conduct in violation of respective Virginia consumer protection laws. The Debtor filed an answer to the Miners’ complaint and the Miners subsequently moved for summary judgment re-asserting the collateral estoppel argument. The Debtor filed a motion to dismiss the Miners’ case asserting that the arbitrator did not make any determination that the Debtor committed fraud. Judge Grossman denied both the Miners’ motion for summary judgment and the Debtor’s motion to dismiss and directed that the matter proceed to trial.
At trial Judge Grossman examined the applicability of collateral estoppel as related to the Miners’ Section 523(a)(2)(A) claim, which excepts from discharge any debt “to the extent obtained by false pretenses, or actual fraud.” 11 U.S.C. §523(a)(2)(A). Judge Grossman cited applicable New York law for the elements required to establish that a debt was obtained by false pretenses, false representation and actual fraud.
For false pretenses a movant must show: (1) an implied misrepresentation or conduct by the defendants; (2) promoted knowingly and willingly by the defendants; (3) creating a contrived and misleading understanding of the transaction on the part of the plaintiffs; (4) which wrongfully induced the plaintiffs to advance money, property or credit to the defendant. A false pretense occurs when there is conscious deceptive or misleading conduct designed to obtain or deprive another of property. To establish false representation, the movant must show that: (1) the defendant made a false or misleading statement; (2) with intent to deceive; (3) in order for the plaintiff to turn over money or property to the defendant. With respect to fraud under Section 523(a)(2)(A) one must show that: (1) the debtor made a false representation; (2) that at the time made, the debtor knew the statement was false; (3) the misrepresentation was made with an intent to deceive; (4) that the creditor reasonably relied on that misrepresentation; and (5) that the creditor was damaged as a result of the misrepresentation. Judge Grossman looked to the Supreme Court’s decision in Husky International, Husky Int’l Elecs., Inc. v. Ritz, 136 S. Ct. 1581, 1586 (2016), noting that the term “actual fraud” encompasses fraudulent conveyance schemes, even when such schemes do not involve a false representation.
The Miners’ position, which Judge Grossman found unpersuasive, was that the arbitration award should be given a preclusive effect on the issue of nondischargeability under Section 523(a)(2)(A) based on collateral estoppel. The Miners believed that through the arbitrator’s treble damage award under applicable Virginia consumer protection laws, willfulness was implicated and such a finding was premised on fraudulent conduct which necessarily implied a finding of willful fraud that would satisfy the elements of Section 523(a)(2)(A). Because the Judgment was entered in the Supreme Court of Suffolk County, New York law would apply in examining the collateral estoppel doctrine.
Citing to the Second Circuit opinion, Evans v. Ottimo, 469 F.3d 278, 282 (2d Cir. 2006), under applicable New York law, collateral estoppel is applied as a two step test which requires “(1) the identical issue necessarily was decided in the prior action and is decisive of the present action, and (2) the party to be precluded from relitigating the issue had a full and fair opportunity to litigate the issue in the prior action.” In the case, the Debtor had a full and fair opportunity to litigate the arbitration award, the Debtor participated in the arbitration and was represented by counsel. The second prong of the collateral estoppel analysis was met. The Court held that the identity prong of the first prong was not met as all the necessary elements of Section 523(a) had not been proven by a preponderance of the evidence. The arbitration award was devoid of any specific factual findings and did not reference any specific statute or legal principal on which it had been based. In reviewing pleadings submitted by the parties in the arbitration, none of the arbitration materials indicated that the award of trebled damages was necessarily based on a finding of false pretenses, false representation or actual fraud under applicable Virginia consumer protection laws. The Court found that the Miners’ arbitration claims were “painted in a broad-brush stroke over the entirety” of applicable Virginia consumer protection laws and that the Court would have no way of determining whether the Debtor’s “willfulness” related to a false representation by the Debtor, false pretenses, actual fraud or just was related to a willful breach of the Agreement. Judge Grossman refused to find that liability determined by the arbitration award involved findings that would be identical to the elements of Section 523(a)(2)(A), thus declaring that the debt would be discharged, ruling in favor of the Debtor.
This recent opinion emphasizes the challenges that can arise for litigants thrown into bankruptcy, despite obtaining favorable results in other courts. While prior judgements obtained either by way of trial or arbitration may give judgment creditors a sense of relief, once a debtor files bankruptcy, it is up to the bankruptcy court and the judges therein to determine whether such debts will survive or be discharged.