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Connecticut District Court Affirms Ruling that Collateral Estoppel Effect of California Judgments for Fraud Established Them as Non-Dischargeable Fraud Debts in Bankruptcy

Posted by Irve Goldman
April 23, 2014

Debts based on fraud are not dischargeable in bankruptcy, but to achieve that result the aggrieved creditor must ordinarily commence a non-dischargeability action and prove the fraud.  However, when an action for fraud is litigated to judgment before the defendant files for bankruptcy, the fraud judgment will typically preclude the debtor from relitigating the fraud in bankruptcy court based on the doctrine of collateral estoppel.  

Occasionally, however, the debtor will argue that one element or another of the fraud claim that was used to procure the pre-bankruptcy judgment does not comport with what is required under the Bankruptcy Code to prevent the debtor from discharging the fraud debt.  Such was the case in In re Vincent Andrews Management Corp., Civ. No. 3:08 MC 132 (AWT) (D. Conn. Mar. 26, 2014).

In Andrews, the debtors argued that one of the required elements to discharge a debt for fraud – justifiable reliance – was not properly found in an action for fraud that was litigated to judgment against them in California because the standard used there was more lenient than what would be required to except the debt from discharge under the Bankruptcy Code.  The Bankruptcy Court rejected that argument and its decision was recently affirmed by the District Court on appeal.

In Andrews, horseracing legends Laffit Pincay and Christopher McCarron sued their former business managers and investment advisors. Vincent and Robert Andrews for fraud and the Andrews later filed for bankruptcy. In the suit, the jockeys claimed that the Andrews represented they would take as a fee no more than a certain percentage of the earnings derived   from partnership investments they made for the jockeys, but that they actually received much more by investing in those partnerships themselves without disclosing it.  The evidence at trial was that plaintiffs received written disclosures which advised of the Andrews’ personal investments in the partnerships, but were told they did not have to read them.  Evidence was also presented that the plaintiffs were not well-educated, in contrast to the highly educated and sophisticated background of the debtors.

The plaintiffs sued the Andrews for fraud and RICO in California District Court in 1989, got judgments in 1992 and went through a series of appeals to the Ninth Circuit which culminated in final judgments for fraud in 2005.  In the Andrews’ individual bankruptcy proceedings, the plaintiffs claimed that the fraud judgments were entitled to collateral estoppel effect on the claim of non-dischargeability, which was challenged by the Andrews on the basis that the element of justifiable reliance was not actually found in the California action.   

The challenge was on the basis that the underlying jury verdicts in California made findings that the plaintiffs were justified in relying on fraudulent representations even though the statements claimed to be fraudulent were disclosed in documents provided to plaintiffs but never read.  More particularly, the debtors claimed that such a finding could not have been based on the standard of justifiable reliance for actions to except a debt from discharge for fraud because that standard requires a plaintiff to use his senses and make a cursory examination or investigation in processing an allegedly fraudulent statement.

In affirming the bankruptcy court’s ruling, the district court emphasized that under the U.S. Supreme Court’s decision in Field v. Mans and pertinent Ninth Circuit authority, there is not a single, “reasonable man” standard for justifiable reliance that in all cases requires investigation or use of one’s senses in evaluating a statement, but it is a more subjective standard that takes into account the knowledge and relationship of the parties and will not necessarily be negated by a failure to investigate or read written disclosures when the circumstances would not require doing so.

The district court, as did the bankruptcy court, reviewed the jury instructions and jury verdict to determine whether collateral estoppel should apply to the element of justifiable reliance (which was the only element in issue).  The district court, like the bankruptcy court, also found that the jury was properly instructed on the element of justifiable reliance under California law, which was the same standard required to except fraud debts from discharge under section 523(a)(2)(A), and answered affirmatively to the specific jury interrogatory asking if the plaintiffs were justified in relying on the fraudulent representations.

The district court specifically rejected the Andrews’ argument that the jury was misled into applying a more lenient standard for justifiable reliance by other jury instructions on a related intentional concealment claim and the Andrews’ statute of limitations defense.  These other instructions were to the effect that the plaintiffs were under no duty of inquiry concerning the fraudulent representations and concealment if there was a fiduciary relationship between the parties, leading the Andrews to argue that the jury was misled into believing that if they found a fiduciary relationship between the parties, they could find justifiable reliance without any duty of inquiry by the plaintiffs. 

The district court held that this argument was untimely and inappropriate because it should have been raised with the trial court in California and on appeal to the Ninth Circuit, but was not.  In effect, the district ruled that the Andrews could not raise that argument in the context of non-dischargeability proceedings if it was not raised in the non-bankruptcy action in which a final judgment was rendered.  The district court added that there is a presumption that a jury will properly apply the instructions they are given and that nothing in the record provided a basis for disturbing that presumption.

 

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