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News Room

Consumer Bankruptcy

Proposal #5: Procedural Issues In Exceptions To Discharge

a) Authorization to Enter Money Judgments in Nondischargeability Actions

Section 523 of the Bankruptcy Code generally authorizes bankruptcy courts to determine whether certain debts are excepted from a debtor's discharge. Subsection (d) authorizes the court in limited circumstances to "grant judgment in favor of the debtor for the costs of, and a reasonable attorney's fee for, the proceeding" when the debtor prevails, but does not specifically authorize the bankruptcy court to enter a money judgment on the underlying debt when the creditor prevails and the court determines that the debt is not dischargeable.

The Recommendation

Bankruptcy courts should be specifically authorized to enter money judgments for nondischargeable debts.

Reasons for the Change

Establishing the existence and extent of the underlying debt is an essential component of finding that a debt is nondischargeable, [ FN: Cowen v. Kennedy (In re Kennedy), 108 F.3d 1015 (9th Cir. 1997), citingIn re Devitt, 126 B.R. 212, 215 (Bankr. D. Md.1991).] and more generally to assessing the scope of the debtor’s discharge. It is least expensive for the parties and most judicially efficient to litigate the entire matter in one forum; to require that the exact extent of the debt be determined in a separate state court proceeding creates wasteful duplication.

This view is consistent with the holdings of several circuit courts of appeals, most recently that of the 9th Circuit, which found that a bankruptcy court acted within its jurisdiction "to hear and determine . . . all core proceedings" [ FN: 28 U.S.C. §157(b)(1).] in entering a money judgment in a nondischargeability action. [ FN: Cowen v. Kennedy (In re Kennedy), 108 F.3d 1015 (9th Cir. 1997) (noting that this result was consistent with results reached in Second, Fifth, Sixth and 7th Circuits), citingIn re McLaren, 3 F.3d 958, 965 (6th Cir. 1993) ( "squarely holding " that bankruptcy courts have jurisdiction to enter money judgment in adversary proceeding in section 523(a)(2)(A) action, which is "core proceeding" under U.S.C. §157(b)(2)(B) );In re Hallahan, 936 F.2d 1496 (7th Cir. 1991)(recognizing that bankruptcy court has jurisdiction to enter money judgment for amount of creditor's claim excepted from discharge);In re Porges, 44 F.3d 159 (2d Cir. 1995)(affirming jurisdiction for entry of monetary judgment in core proceeding) ;In re Vickers, 546 F.2d 1149 (5th Cir. 1977)(Bankruptcy Act of 1898 authorized entry of monetary judgment in nondischargeability action).]

The lack of specific statutory authority has troubled some courts and has led them to decline to enter money judgments due to the absence of statutory authority. [ FN: See, e.g,In re Thrall, 196 B.R. 959 (Bankr. D. Colo. 1996);In re Hooper, 112 B.R. 1009 (Bankr. 9th Cir. 1990);In re Barrows, 182 B.R. 640 (Bankr. D.N.H. 1994);In re Marlar, 142 B.R. 792 (Bankr. E.D. Ark. 1992).] Although courts acknowledge that "many, if not most," bankruptcy courts routinely enter money judgments against a debtor for a nondischargeable debt, bankruptcy courts no longer have the statutory authorization to do so as they did under the Bankruptcy Act of 1898. [ FN: Thrall, 196 B.R. at 962.]

The problem is compounded by concerns about a debtor’s entitlement to a jury trial under the Seventh Amendment. Courts that believe a debtor has a right to a jury trial on the underlying debt will not enter a money judgment. In addition, courts have suggested that bankruptcy courts’ jurisdictional grant falls short of encompassing this noncore proceeding, which would be analogous to the adjudication of a prepetition claim found to be outside of the constitutional purview of a non-Article III tribunal in Northern Pipeline Constr. Co. v. Marathon Pipe Line Co. [ FN: 458 U.S. 50 (1982).]

The recommended amendment to section 523 would provide specific authority to bank ruptcy courts to issue money judgments in connection with dischargeability complaints. The Commission's recommendation that bankruptcy judges be appointed under Article III of the Constitution should alleviate any lingering concerns and facilitate the use of jury trials in dischargeability cases to the extent necessary.

Competing Considerations

Without Article III status, some commentators might be concerned that a statutory authorization of this ability might yield another constitutional crisis.

b) Issue Preclusive Effect of True Defaults

Since Congress amended the Bankruptcy Act of 1898 in 1970, the issue of nondischargeability has been a federal matter governed by federal bankruptcy law. [ FN: Grogan v. Garner, 498 U.S. 279, 284 (1991), citing S.Rep. No. 91 - 1173, pp. 2 - 3 (1970); H.R.Rep. No. 91 - 1502, p. 1 (1970), U.S.Code Cong. & Admin.News 1970, p. 4156.] To protect parties from relitigating an identical issue and to promote judicial economy by preventing needless litigation, [ FN: Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979). ] the judicial doctrine of issue preclusion applies in section 523(a) nondischargeability proceedings. [ FN: Grogan v. Garner, 498 U.S. 279, 285, n. 11 (1991).] Issue preclusion relieves parties of the cost and vexation of multiple lawsuits,conserves judicial resources, and, by preventing inconsistent decisions, encourages reliance on adjudication. [ FN: Montana v. United States, 440 U.S. 147 (1979).]

Federal common law generally requires at least that the issue to be precluded was actually litigated and that determination of the issue was essential to the final judgment. [ FN: See, e.g., Allen v. McCurry, 449 U.S. 90, 94 (1980), citing Montana v. United States, 440 U.S. 147, 153 (1979); Klingman v. Levinson 831 F.2d 1292, 1295 (7th Cir. 1987).] Because the "actual litigation" requirement is one of the fundamental pillars of this doctrine, a true default judgment in a prior federal action does not preclude litigation of an issue in subsequent actions. Accordingly, a federal default judgment does not preclude litigation of a question of fraud or the like in a subsequent nondischargeability proceeding. This is consistent with the general rule on issue preclusion set forth in the Restatement (Second) of Judgments:

When an issue of fact or law is actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment, the determination is conclusive in a subsequent action between the parties, whether on the same or a different claim. [ FN: Restatement (Second) of Judgments §27 (1982).]

To determine whether a previous judgment precludes subsequent litigation, one looks to where the prior court action took place and the rules of preclusion that court would have used. [ FN: See, e.g., Marrese v. American Academy of Orthopaedic Surgeons, 470 U.S. 373 (1985).] If a state court conducted the prior litigation, under 28 U.S.C. § 1738, federal courts give such judicial proceedings "the same full faith and credit . . . as they have by law or usage in the courts of such State . . . from which they are taken." [ FN: 28 U.S.C. §1738. Matsushita Elec. Indus. Co., Ltd. v. Epstein, 116 S.Ct. 873, 877 (1996). The Full Faith and Credit Clause of the United States Constitution, Article IV, section 1, applies only to state recognition of other states ’ judgments. ] Yet, section 1738 is inapplicable if the prior action was so deficient that it violates due process. [ FN: It ordinarily is a violation of due process for a judgment to be binding on a litigant who was not a party or a privy and therefore has never had an opportunity to be heard. Parklane Hosiery Co. v. Shore, 439 U.S. 322, 327 n. 7 (1979), citing Blonder - Tongue Laboratories Inc. v. University of Illinois Foundation, 402 U.S. 313, 329 (1971). Applying a slightly broader exception than the due process standard, the Supreme Court also has "previously recognized that the judicially created doctrine of collateral estoppel does not apply when the party against whom the earlier decision is asserted did not have a ‘full and fair ’ opportunity to litigate. " Kremer v. Chemical Construction, 456 U.S. 461, 480- 481 (1982). "Redetermination is warranted if there is reason to doubt the quality, extensiveness, or fairness of procedures followed in prior litigation. " Id., citing Montana v. United States, 440 U.S. 147, 164 (1979).] In addition, section 1738 does not apply ifanother statute clearly manifests Congressional intention to provide an exception. [ FN: For example, the first habeas corpus statute rendered state court proceedings null and void that were inconsistent with the decision of a federal habeas court. Allen v. McCurry, 449 U.S. 90, 98 n.12 (1980), quoting Act of Feb. 5, 1867, ch. 28., s 1, 14 Stat. 385, 386, codified as amended at 28 U.S.C. §2254 (1994).]

Applying section 1738, the Sixth and 9th Circuit Courts of Appeals recently determined that the issues of fraud and defalcation were decided conclusively in prior state court default judgments because Florida and California law, which governed the prior proceedings in those cases, did not require issues to be actually litigated for issue preclusion purposes. [ FN: See, e.g., Bay Area Factors v. Calvert, 105 F.3d 315 (6th Cir. 1997) (precluding relitigation of fraud after California court default judgment that contained no specific findings of fraud); Gayden v. Nourbakhsh, 67 F.3d 798 (9th Cir. 1995) (precluding relitigation of fraud after Florida court default judgment that contained finding of fraud). But see Stephen J. Burbank, "Full Faith and Credit and Federal Common Law: A General Approach, 71 Cornell L. Rev. 733, 737 (1986) ( "Once one recognizes that the full faith and credit statute states or chooses only a domestic referent and not domestic state preclusion law, it is not apparent why a general approach to federal common law should not also accommodate problems concerning the preclusive effects of state judicial proceedings ").] The courts did not appear to consider whether Florida and California courts should have applied federal preclusion doctrine when determining the issue preclusive effect on subsequent nondischargeability litigation. Therefore, although no evidence on fraud or defalcation was presented in the state court hearings on fraud or defalcation, these debts were deemed to be nondischargeable in subsequent bankruptcy cases without any litigation on the merits.

The Recommendation

For complaints to establish nondischargeability on grounds set forth in section 523(c), the Bankruptcy Code should clarify that issues that were not actually litigated and necessary to a prior judgment shall not be given preclusive effect.

Reasons for the Change

Bankruptcy affords a broad discharge and a fresh start to honest but unfortunate debtors. [ FN: See Local Loan Co. v. Hunt, 292 U.S. 695 (1934); Goldberg v. Scarlata, 979 F.2d 521 (7th Cir. 1992). Creditors therefore are expected to prove each element of an exception to discharge by a preponderance of the evidence. Grogan v. Garner 498 U.S. 279 (1991).] Section 523 of the Bankruptcy Code specifically enumerates exceptions, which are to be construed narrowly, [ FN: See, e.g., Schweig v. Hunter, 780 F.2d 1577, 1579 (11th Cir. 1986); Manufacturer ’s Hanover Trust Company v. Ward , 857 F.2d 1082, 1083 (6th Cir. 1988).] for debts that should not be discharged in bankruptcy for public policyreasons, presumably because they involve "moral turpitude" or intentional wrongdoing. [ FN: See Thul v. Ophaug, 827 F.2d 340 (8th Cir. 1987). Some exceptions to discharge, such as those for certain taxes and alimony, are justified by other public policy reasons, e.g., to protect the public fisc. Because these exceptions do not expressly require litigation in the bankruptcy court and are of a different nature, they are not amenable to being the subject of issue preclusion problems.] As a general matter, Congress delegated to federal courts the determination of the dischargeability of debt in bankruptcy. [ FN: Brown v. Felsen, 442 U.S. 127, 138 (1979).] Thus, while a bankruptcy court defers to prior state court judgments when the issues relevant to dischargeability have been litigated fully, there is an insufficient basis on which to make a debt nondischargeable if the issue was never litigated at all. In instances of true default judgments, completely forgoing litigation of the grounds for nondischargeability is inconsistent with the exclusive jurisdiction of the district and bankruptcy courts over dischargeability actions. Issue preclusion in this context should bar re-litigation -- not initial litigation -- of issues that were actually litigated and decided in a previous action, as federal issue preclusion doctrine generally demands. [ FN: Gober v. Terra + Corp., 100 F.3d 1195, 1199 n. 2 (5th Cir. 1996), citing Restatement (Second) of Judgments, Introductory Note to ch. 1 (1982).]

Permitting default judgments to be preclusive in discharge litigation has yielded substantial disparities. This problem is illustrated by comparing three appellate cases in the 9th Circuit: As mentioned previously, in In re Nourbakhsh, the 9th Circuit held a debt nondischargeable based on a Florida court default judgment. However, in In re Davis, after a district court gave preclusive effect to an Arizona default judgment, the 9th Circuit reversed the district court because Arizona law required actual litigation as a prerequisite to issue preclusion. [ FN: 1996 WL 733174 (9th Cir., Dec. 16. 1994) ( unpublished disposition).] Because the prior judgment at issue in Silva v. Smith’s Pacific Shrimp had been in federal court based on diversity jurisdiction, a judgment based on an unopposed motion for summary judgment did not satisfy the requirements for issue preclusion. [ FN: 190 B.R. 889 (Bankr. 9th Cir. 1995) (unopposed motion for summary judgment in Washington case does not prevent subsequent litigation).] Thus, the geographic location of a prior default judgment has become determinative of whether the debtor will have the opportunity to litigate a federal cause of action, the nondischargeability of an otherwise dischargeable claim.

Both the history history of the procedures set forth in section 523(c) and longstanding concerns about debtor-creditor relations justify the apprehension of judges, scholars, and practitioners about the problem of reliance on default judgments. Under the Bankruptcy Act of 1898, creditors would bring state court actions post-bankruptcy alleging fraud on prepetition debts due to mistakes on financial statements. Debtors failed to defend themselves in these actions because of "an inability to retain an attorney due to lack of funds" or because of amistaken reliance on a bankruptcy discharge. [ FN: H.R. Rep. 91-1502, 91st Cong., 2d Sess. at 1 (1970).] This practice significantly undermined the bankruptcy process and the scope of the discharge. [ FN: Id. at 3 .] Thus, in 1970, Congress amended the Bankruptcy Act of 1898 to make the discharge automatic rather than an affirmative defense and to require creditors to file and litigate certain nondischargeability actions in the context of the bankruptcy itself. [ FN: "The 1970 amendments took jurisdiction over certain dischargeability exceptions, including the exceptions for fraud, away from the state courts and vested jurisdiction exclusively in the bankruptcy courts. " Grogan v. Garner, 498 U.S. 279 284, n. 10 (1991), citing Brown v. Felsen, 442 U.S. at 135 - 136; S.Rep. No. 91 - 1173, pp. 2 - 3 (1970); H.R.Rep. No. 91 - 1502, p. 1 (1970), U.S.Code Cong. & Admin.News 1970, p. 4156.] Congress also sought to further the bankruptcy judges’ expertise in analyzing exceptions to discharge. [ FN: H.R. Rep. 91-1502, 91st Cong., 2d Sess. at 2 (1970). See generally Jon T. Alexander, Comment, "Issue Preclusion, Full Faith and Credit, and Default Judgments: A Dilemma For the Bankruptcy Courts, " 44 U.C.L.A. L. Rev. 159, 173 (1996).] The current situation presents the opportunity for a new twist on the Bankruptcy Act problem. Now, state court actions, which almost invariably include a fraud count, are commenced before the debtor has filed a bankruptcy petition and the debtor fails to respond, often due either to misunderstanding or to a lack of financial resources to hire an attorney. [ FN: "I cannot help but believe that the broad reading of the ‘actually litigated ’ requirement is a trap for unwary and innocent debtors that cannot afford counsel. I suspect that many of these debtors do not contest liability because they admit that they owe the money (albeit not because of any fraud). " Letter from Hon. Edward D. Jellen, Chief Judge U.S. Bankr. Ct. N.D. Cal., page 2, February 5, 1997.] This has a particularly harsh effect on pro se debtors. [ FN: See memorandum from Wayne Johnson, July 25, 1996 Re: Consumer Bankruptcy Issues, page 3.]

Bankruptcy courts already are permitted in some contexts to look to prior judgments and then to make independent decisions about the nature or character of those judgments. For example, in determining whether a domestic relations obligation is characterized as support or a property settlement, bankruptcy courts are not bound by the state court’s characterization and must make an independent determination. The instant proposal does not require an intrusive inquiry; it merely permits bankruptcy courts to determine whether a dispute was, in fact, actually litigated in a previous action.

The writings of Professor Stephen Burbank, a noted federal courts scholar, suggest that this recommendation would not be inconsistent with the full faith and credit statute: "There is a federal interest in ensuring that legal rules used in the process by which rights under federal substantive law are recognized and enforced are not inimical to a particular scheme of federal substantive rights. This interest exists whether federal or state law provides the process and however the rules are characterized. In the case of litigation in the federal courts, the existence of the interests suffices, under traditional federal common law analysis, to trigger the conclusion thatfederal law governs." [ FN: Stephen J. Burbank, "Full Faith and Credit and Federal Common Law: A General Approach, 71 Cornell L. Rev. 733, 737 (1986) (concluding that contrary to Supreme Court ’s interpretation, Full Faith and Credit statute does not choose domestic preclusion law of rendering state, but rather it requires application in interjurisdictional cases of law that courts of rendering state should apply ). "Under traditional federal common law analysis a court must still be alert to the possibility that application of state law, borrowed as federal law, will thwart the purposes of, or otherwise interfere with, federal substantive law. In that event, the offending state law rule is displaced, because federal sources require otherwise than that it apply. " Id., at 811.]

The primary concern of this proposal is "true" or "ordinary" defaults, not situations where a debtor may have participated substantially and extensively in a prior adversary proceeding but then managed to force entry of a default rather than a litigated judgment. As such, this proposal is not intended to affect courts’ determinations of what is "actually litigated" for issue preclusion purposes. [ FN: Pahlavi v. Ansari, 113 F.3d 17 (4th Cir. 1997) (although default judgment ultimately entered, issue of defalcation actually litigated); Gober v. Terra+ Corp., 100 F.3d 1195 (5th Cir. 1996) (parties actively litigated for two years before debtor failed to attend hearing that yielded default judgment, which satisfied Texas ’ requirement that issue be actually litigated and essential to judgment); Bush v. Balfour Beatty Bahamas, Ltd., 62 F.3d 1319 (11th Cir. 1995);In re Daily, 47 F.3d 365, 368 - 69 (9th Cir.1995) (party who deliberately precludes resolution of factual issues through normal adjudicative procedures may be bound, in subsequent, related proceedings involving same parties and issues, by prior judicial determination reached without completion of usual process of adjudication). ]

Competing Considerations

This proposal furthers the Congressional policy that only certain debts are excepted from discharge. However, some people might argue that this policy should not trump the policy to accord full faith and credit to state court judgments.

Some might argue that bankruptcy law must incorporate as much of state law as possible, and thus failure to apply state law preclusion standards, even in actions that are exclusively federal bankruptcy actions, is inappropriate. However, state courts might use federal preclusion standards themselves if they were to determine the preclusive effect of their judgments on federal bankruptcy nondischargeability actions.

c) Vicarious Liability

Bankruptcy nondischargeability is based principally on the debtor's individual culpable conduct. This is especially true of the more frequently-litigated categories of nondischargeable debts in section 523(a) that contain an express or inherent intent requirement, e.g., those for fraud, defalcation, and willful and malicious injury. Although section 523(a) contains a long list of exceptions to discharge, debts presumptively are dischargeable and these exceptions to discharge are narrowly construed. A creditor bears the burden to prove each element of an exception todischarge by a preponderance of the evidence. [ FN: Grogan v. Garner, 498 U.S. 279 (1991) .] Imputing liability to an innocent actor is inconsistent with the underlying goals of the nondischargeability provisions. Because spouses have no formal agency relationship, it is even more inappropriate to permit one spouse’s intent to be imputed to another for purposes of nondischargeability.

The Recommendation

Section 523(c) should be amended such that intentional action by a wrongdoer who is not the debtor cannot be imputed to the debtor.

Reasons for the Change

This proposal is consistent with the recommendation of Small Business, Partnership, and Single Asset Real Estate Working Group Proposal #8. [ FN: See Memorandum from Stephen H. Case, Elizabeth I. Holland, & George H. Singer dated July 10, 1997 re: Small Business, Partnership and Single Asset Real Estate Working Group Proposal #8: Section 523 & Imputed Conduct or Liability (Partner as Debtor).] Debts are excepted from discharge for public policy reasons to deter intentional conduct and to eliminate the benefits of the debtor’s inappropriate actions. These goals are not implicated when the debtor is not personally culpable and has not reaped a direct benefit from the wrongdoing of another.

Other sources of law impose liability without individual culpability. Under partnership law, partners are mutually liable for partnership debts incurred by any of them in the ordinary course of business. Liability is not premised on the intent of the partners. Likewise, tort law imposes vicarious liability under the doctrine of respondeat superior, again without a showing of intent on the party of the debtor. [ FN:In re Rex, 150 B.R. 505 (Bankr. D. Mass. 1993) (no vicarious liability for section 523(a)(6) action).] Similarly, some state laws make parents responsible for the offenses of their children. [ FN: See, e.g., Deroche v. Miller (In re Miller), 196 B.R. 334, 336 (Bankr. E.D.La. 1996) (refusing to impute liability even though Louisiana Civil Code made parents answerable for offenses or quasi - offenses committed by their children).] By contrast, the plain language of the nondischargeability provisions indicates Congressional intention that many nondischargeability provisions are triggered by the debtor’s intention and the debtor’s activity. For example, section 523(a)(6) makes nondischargeable debts "for willful and malicious injury by the debtor to another entity or to property of another entity." This language has persuaded courts to reject vicarious liability as a basis for nondischargeability under section 523(a)(6). [ FN: Columbia Farms Distribution Inc. v. Maltais, 202 B.R. 807 (Bankr. D. Mass. 1996) (nondischargeability of debt under section 523(a)(6) cannot be grounded on imputation to debtor of acts of another); Deroche v. Miller (In re Miller), 196 B.R. 334, 336 (Bankr. E.D.La. 1996) ( "plain meaning test requires that the debtor must have been the one who caused the willful and malicious injury. Imputed liability is insufficient [for section 523(a)(6)], " thus not applying vicarious liability to debtor for act of her child), citing United States v. Ron Pair Enterprises Inc., 489 U.S. 235, 241 (1989). "The statute is not concerned with liability which, as here, is vicariously imposed upon a debtor under the doctrine of respondeat superior solely by reason of the intentional and malicious conduct of the debtor's agent or servant. "In re Rex, 150 B.R. 505, 506 (Bankr. D. Mass. 1993) (debt not dischargeable under section 523(a)(6) for acts of debtor ’s agent, and finding decisions on point to be consistent with this holding); Giuliano v. Albano (In re Albano), 143 B.R. 323 (Bankr.D.Conn.1992) (rejecting vicarious liability for willful and malicious injury based on actions of bouncer at debtor ’s restaurant because nothing in language or legislative history of section 523(a)(6) suggests that common law notions of vicarious or imputed liability on agency theory are appended to statutory exceptions to discharge).] Likewise, some courts have refused toimpute liability for actions under section 523(a)(2)(A). [ FN: See Neal v. Clark, 95 U.S. 704 (1877)(debt is dischargeable, even if dishonestly incurred, if the debtor did not participate in the dishonest actions); Aetna Casualty and Surety Co. v. Markarian, 208 B.R. 249 (Bankr. 1st Cir. 1997) (portions of judgment debt attributable to codefendants ’ wrongdoing not included in nondischargeable debt under section 523(a)(2)(A)). See also Walker v. Citizens State Bank (In re Walker),726 F.2d 452 , 454 (8th Cir.1984) (fraud cannot be imputed to debtor/principal spouse unless debtor knew or should have known of fraud, or was recklessly indifferent to agent ’s act);] However, many courts have not taken this view, based in part on Supreme Court precedent that pre-dates both the Bankruptcy Code of 1978 and the Bankruptcy Act of 1898, and instead have determined that debts are nondischargeable on account of the innocent debtor’s partner or agent’s action and intent. [ FN: See McIntyre v. Kavanaugh, 242 U.S. 138, 139 (1916) (interpreting predecessor to section 523(a)() that did not include the words "by the debtor ") ; Strang v. Bradner, 114 U.S. 555, 561 (1885) (partners legally obligated for each others ’ misrepresentations, and thus resulting debts will be nondischargeable for all partners, especially when they benefit from "fruits of the fraudulent conduct "); Banc Boston Mortgage Corp. v. Ledford (In re Ledford) , 970 F.2d 1556 (6th Cir. 1992), cert. denied , 507 U.S. 916 (1993) ( fraud can be imputed to innocent partner for purposes of section 523(a)(2)(A) because debtor is liable under Tennessee agency law for actions taken by other partners in ordinary course of business) ; Luce v. First Equipment Leasing Corp. (In re Luce), 960 F.2d 1277 (5th Cir. 1992) (imputing liability under section 523(a)(2)(A), following Strang v. Bradner and prior lower court decisions); Impulsora Del Territorio Sur v. Cecchini (In re Cecchini), 780 F.2d 1440 (9th Cir.1986) ( imputing knowledge and intent of blameworthy partner to innocent debtor - partner on account of partnership law under section 523(a)(6)); Moore v. Gill (In re Gill), 181 B.R. 666 (Bankr. N.D. Ga. 1995); Eppard v. Sestito (In re Sestito), 136 B.R. 602 (Bankr. D. Mass.1992)(excepting from discharge under section 523(a)(2)(A) debt where misrepresentation was made by the debtor's partner); Lail v. Weaver (In re Weaver), 174 B.R. 85 (Bankr. E.D. Tenn.1994) (under Tennessee law, false representation of joint venturers should be imputed to debtor); Oetker v. Bullington (In re Bullington), 167 B.R. 157 (Bankr. W.D. Mo.1994) (nondischargeability for section 523(a)(6) can be based on imputed intent from other partners).] This disparity creates confusion and more litigation in the courts.

Whether the partnership is large and diffuse or small, partners may be wholly unaware of their co- partners' ill-intended activities. The "innocent" debtor does not necessarily gain from the inappropriate activity of a partner, when, for example, one partner steals goods entrusted to the partnership, the other partners retain no benefit. Vicarious liability is particularly troubling if it is used to transfer liability between spouses or other social relations because the predicate assumptions for applying vicarious liability are not present in that circumstance. Debtors' involvement in a non-profit-seeking social relationship should not be the sole basis for punishing a debtor for the ill-intentioned act of another.

This proposal seeks to minimize uncertainty and to adopt the trend in more recent bankruptcy court decisions that the creditor bringing a nondischargeability action must prove that the debtor had the requisite intent, whether the debtor is the spouse, the employer, or the principal of a wrongdoing agent. Of course, the fact of partnership or marriage may be factually relevant in litigation over an exception to discharge. To the extent that the debtor's own actions are sufficient to meet the applicable standard of nondischargeability, then the debt caused by those actions may be excepted from discharge. This proposal merely seeks to eliminate an automatic imputation of liability based on the debtor’s status as a spouse or partner.

Competing Considerations

Some might argue that the discharge exceptions reflect competing social policy choices based on the nature of the debt itself, not just protecting the "honest but unfortunate" debtor, thus there may be justifiable reasons to acknowledge vicarious liability in bankruptcy dischargeability litigation for true agency relationships. [ FN: See, e.g., Lawrence Ponoroff, "Vicarious Thrills: The Case for Application of Agency Rules in Bankruptcy Dischargeability Litigation, " 70 Tul. L. Rev. 2515 (1996).] However, even under this approach, spouses in typical consumer nondischargeability cases would not be vicariously liable because spouses do not have a formal agency or partnership relationship.

In imputing a partner's fraud to the debtor, some courts have emphasized that partners have a duty to ensure that partnership affairs are conducted with integrity and the partners accept these obligations by participating in the partnership. In effect, partners are made nondischargeable guarantors for the fraudulent activities of other partners.

 

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