Preclusive Effect of Pre-Petition State Court Judgments in Nondischargeability Proceedings

(Excerpt) A central purpose of the Bankruptcy Code is to provide a “fresh start” for the “honest but unfortunate debtor.” Subject to various exceptions, section 727 of the Bankruptcy Code provides that the court shall grant the debtor a discharge, which permanently enjoins the debtor’s creditors from attempting to collect any prepetition debts. This “fresh start” policy is not absolute, however, and section 523 of the Bankruptcy Code lists various types of debts that are nondischargeable. Under section 523(a)(2), (4), and (6), a debtor will not be discharged from debts which are “(2) . . . obtained by-- (A) false pretenses, a false representation or actual fraud . . .” and “(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny . . .” and “(6) for willful and malicious injury by the debtor to another entity or to the property of another entity[.]” Yet, the types of debts specified in section 523(a)(2), (4), and (6) will be automatically discharged unless the creditor obtains a judgment from a bankruptcy court that the debt is nondischargeable. Nondischargeability actions are adversary proceedings and often involve legal issues that have previously been litigated by the parties. Therefore, to avoid re-litigating matters already decided prior to bankruptcy, a party, often the creditor, may seek to apply collateral estoppel. Collateral estoppel “treats as final only those questions actually and necessarily decided in a prior suit[,]” and prevents parties from re-litigating matters already subject to a judicial decision. Bankruptcy courts have split as to whether collateral estoppel applies in a nondischargeability action if the prior court issued a consent or default judgment