No Issue Preclusion Where Verdict Could Have Been Based on Negligence

Posted by NCBRC - April 9, 2015

The element of “willful and malicious injury” in the discharge exception under section 523(a)(6) could not be established by issue preclusion where the state court judgment could have been based on negligence. Gerard v. Gerard, No. 14-1496 (7th Cir. March 12, 2015). In this case, the debtor, Michael Gerard, sought the financial help of Kevin and Margaret Gerard (the Gerards) to purchase real property. Under their arrangement, the Gerards paid the purchase price of the property and the debtor agreed to pay ongoing expenses and ultimately purchase it in its entirety. In less than one year, after he had made payments in the amount of approximately 5% of the value of the property, it became clear that Michael could not afford to honor his agreement with the Gerards. The Gerards decided to sell the property, but Michael thwarted their efforts by recording a lien (Memorandum of Interest) against the property in which he stated that the Gerards had “acquired title for convenience only.” The Gerards sued Michael in state court for slander of title and breach of contract. The jury found that Michael knew or should have known that the Memorandum of Interest contained falsehood and that the recording of the lien caused the Gerards to be unable to sell the property. When Michael filed chapter 11 bankruptcy the Gerards filed an adversary proceeding seeking to prevent discharge of the judgment debt. The bankruptcy court granted summary judgment in favor of the Gerards based on the findings of the state jury. The district court affirmed.

On appeal, the Seventh Circuit found that the lower courts erroneously applied the doctrine of issue preclusion where the state court judgment did not necessarily establish an element of the exception to discharge in section 523(a)(6). For a creditor to meet his burden of proving that the debtor is not entitled to discharge he must show that the debtor’s actions caused “willful and malicious injury.” The willfulness element is met when the debtor intended the harm rather than merely the conduct causing the harm. Issue preclusion may be used to establish this requirement even where the state court jury is not instructed to find “willful and malicious” conduct so long as the verdict necessarily incorporates that finding. The court found that the state slander of title law permitted the jury to find that Michael filed the Memorandum of Interest when he “knew or should have known” that it contained false information, and that a standard of reasonableness was applied to his knowledge of the truth or falsity of the document.

The court concluded that, while Michael’s conduct might, in fact, meet the more onerous condition required to except it from discharge, that finding could not be based on the state court jury’s verdict. The court reversed and remanded for a finding as to whether Michael’s conduct met the “willful and malicious injury” standard.

Gerard 7th Cir opinion




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