Court Opinion

ID: 9647166
Source: CourtListenerOpinion
Date Created: 2023-08-23 13:25:26.342522+00
Date Added: 2024-06-11T18:11:46.097641
License: Public Domain

OPINION
The Debtor, Frank P. Francis, has appealed the bankruptcy court’s grant of summary judgment in favor of the Plaintiffs (Schory) in a nondischargeability action under § 523(a)(2)(A). The bankruptcy court determined that due to several prior state court decisions, collateral estoppel barred Francis from relitigating whether his debt resulted from his fraud. The Ohio Supreme Court had previously held that a letter in which Francis admitted that he had fraudulently misappropriated funds from Schory was substantially true. The bankruptcy court further determined that a prepetition settlement agreement between the parties did not operate as a novation which extinguished Scho-ry’s fraud claim for purposes of § 523(a)(2)(A).
The issue of novation in the context of § 523(a)(2)(A) is a novel issue in the Sixth Circuit. The Panel finds the reasoning of United States v. Spicer, 57 F.3d 1152 (D.C.Cir.1995) persuasive, and holds that a general release as part of a tort settlement does not constitute a novation which extinguishes a creditor’s fraud claim in the con*387text of § 523(a)(2)(A). Furthermore, the bankruptcy court properly applied collateral estoppel. Accordingly, the Panel affirms the bankruptcy court’s order finding that the debt is nondisehargeable.
I.ISSUES ON APPEAL
There are two issues on appeal. The first is whether the bankruptcy court erred in granting summary judgment on the basis of collateral estoppel. The second is whether the parties’ prepetition settlement agreement operates as a novation that extinguishes Sehory’s nondischargeability claim under § 523(a)(2)(A), which did not exist at the time of the prepetition settlement agreement.
II.JURISDICTION AND STANDARD OF REVIEW
The Bankruptcy Appellate Panel of the Sixth Circuit has jurisdiction to decide this appeal. The United States District Court for the Northern District of Ohio has authorized appeals to the BAP. A “final order” of a bankruptcy court may be appealed by right under 28 U.S.C. § 158(a)(1). For purposes of appeal, an order is final if it “ends the litigation on the merits and leaves nothing for the court to do but execute the judgment.” Midland Asphalt Corp. v. United States, 489 U.S. 794, 798, 109 S.Ct. 1494, 1497, 103 L.Ed.2d 879 (1989) (citations omitted).
Conclusions of law are reviewed de novo. Nicholson v. Isaacman (In re Isaacman), 26 F.3d 629 (6th Cir.1994). Determinations regarding summary judgment are reviewed de novo. Myers v. IRS (In re Myers), 216 B.R. 402 (6th Cir. BAP 1998). “De novo review requires the Panel to review questions of law independent of the bankruptcy court’s determination.” First Union Mortgage Corp. v. Eubanks (In re Eubanks), 219 B.R. 468, 469 (6th Cir. BAP 1998) (citing In re Schaffrath, 214 B.R. 153, 154 (6th Cir. BAP 1997)).
III.FACTS
In 1987, Francis and Sehory formed a partnership which ultimately resulted in litigation between the two parties. Sehory filed a lawsuit against Francis alleging fraud, misrepresentation, and misappropriation of funds. Francis filed counterclaims. On March 14, 1991, the parties reached a settlement. Pursuant to the settlement agreement, Francis signed a cognovit note for $130,000 secured by a mortgage on Francis’s real property. The parties agreed to release each other from all claims relating to the litigation.
Ultimately, Francis defaulted on the cog-novit note and Sehory filed a foreclosure action against the real property securing the note. The parties eventually entered into an amended settlement agreement on March 2, 1991. The following letter dated May 1, 1991, was attached to the settlement agreement:
Dear Bob:
I am sincerely sorry for all the grief and aggravation I have caused you and your family. I acknowledge by this letter that I fraudulently misappropriated the sum of $370,000 from the Arlington General Partnership on the Arlington Road and Whipple Avenue Projects. This was done by knowingly misrepresenting the construction expenses of Francis General Construction, Inc. I regret any problems which I may have caused your family and your business. I also apologize for filing the counterclaim and calling the police.
Very truly yours, /s/
Frank P. Francis, Individually and as /s/
Frank P. Francis, President
Francis General Construction, Inc.
Francis defaulted on the amended settlement agreement, and Sehory again filed a foreclosure action. Francis filed a counterclaim asserting that he had been coerced into signing the letter and that Sehory had defamed him by showing the letter to others.
The Ohio Court of Common Pleas granted summary judgment in favor of Sehory on all of Francis’s claims. Francis appealed to the Ohio Court of Appeals, which affirmed the trial court’s decision that there was no defamation because the admissions in the letter were “substantially true.” Francis appealed *388to the Ohio Supreme Court, which affirmed the judgment of the Court of Appeals on the basis that truth is an absolute defense to defamation and the letter was true. Ed Schory & Sons. v. Francis, 75 Ohio St.3d 433, 662 N.E.2d 1074 (Ohio 1996).
On May 30, 1997, Francis filed a petition under Chapter 7 of the Bankruptcy Code. Schory filed an adversary proceeding for a determination that the debt is nondischargeable under 11 U.S.C. §§ 523(a)(2)(A) and (a)(4). The bankruptcy court applied estoppel and determined that the debt was nondischargeable under § 523(a)(2)(A) based on Francis’s admissions in his letter of May 1,1991. Francis appealed.
IV. DISCUSSION

A. The bankruptcy court properly collateral estoppel in determining that the debt is nondischargeable under § 523(a)(2)(A) due to Francis’s fraud.

The bankruptcy court held that the of collateral estoppel bound the court to follow findings of the state courts that admission of fraud was substantially true. Therefore, the bankruptcy court granted summary judgment, holding the debt nondischargeable under § 523(a)(2)(A).
Collateral estoppel requires “that ‘the of a factual or legal issue in a judgement is conclusive in subsequent if it was “actually litigated and and the determination was essential to the judgment.’ ” Corzin v. Fordu (In re Fordu), 209 B.R. 854, 862 (6th Cir. BAP 1997) (quoting Shelar v. Shelar, 910 F.Supp. 1307, 1312 (N.D.Ohio 1995)). The Sixth has held that the application of collateral estoppel in a nondischargeability action upon whether the applicable state law would give collateral estoppel effect to the judgment. Bay Area Factors v. Calvert (In re Calvert), 105 F.3d 315 (6th Cir.1997).
In order to successfully assert estoppel under Ohio law, a party must plead and prove the following elements: (1) the party against whom estoppel is sought was a party or in privity with a party to the prior action; (2) there was a final judgment on the merits in the previous case after a full and fair opportunity to litigate the issue; (3) the issue must have been admitted or actually tried and decided and must be necessary to the final judgment; and (4) the issue must have been identical to the issue involved in the prior suit. See Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326, 99 S.Ct. 645, 649, 58 L.Ed.2d 552 (1979).
The first element is clearly met in this case, as the adversary proceeding involved the same parties as the state court litigation.
The bankruptcy court also properly determined that the second element is met. “In Ohio, a grant of summary judgment ‘a final determination of the rights of the parties in an action and hence comes within the definition of a judgment as set forth in Ohio Revised Code Section 2323.01. (Repealed; see now Civ. R. 54).’ ” (Bankruptcy Court Mem. Of Decision 3/17/98 at 8) (citing Priester v. State Foundry Co., 172 Ohio St. 28, 173 N.E.2d 136 (Ohio 1961)).
The bankruptcy court also properly found that the third element is met, stating:
Both the Ohio Court of Appeals and the Ohio Supreme Court affirmed the trial court’s granting of summary judgment in favor of Schory by holding that the trial court did not err in finding the letter was “substantially true” and was, thus, a defense to any libel claims asserted by the Debtor. Under these the “actually litigated” requirement for the application of collateral estoppel is met and the state court judgment and its appellate affirmances that the Debtor committed a fraud upon Schory through the misappropriation of partnership funds is entitled to collateral estoppel effect under Ohio law.
(Mem. Of Decision 3/17/98 at 8-9.) The state court actually decided the issue of the truth of the letter. Furthermore, the finding that the letter was true was essential to the as it was the basis for granting judgment.
The fourth element requires that the issues be identical.
*389If the same facts or evidence would sustain both, the two actions are considered the same within the rule that the judgment in the former is a bar to the subsequent action. If, however, the two actions rest upon different facts, or if different proofs would be required to sustain the two actions, a judgment in one is no bar to the maintenance of the other.
Monahan v. Eagle Picker Indus., 21 Ohio App.3d 179, 486 N.E.2d 1165, 1168 (1984) (citing Norwood v. McDonald, 142 Ohio St. 299, 27 O.O. 240, 52 N.E.2d 67 (1943) (internal citations omitted)).
When the Ohio courts addressed the defamation issue, they found that Francis’s admission of fraud was true. The elements required to prove fraud under Ohio law are:
(a) representation or, when there is a duty to disclose, concealment of a fact, (b) which is material to the transaction at hand, (c) made falsely, with knowledge of its falsity, or with such utter disregard and recklessness as to whether it is true or false that knowledge may be inferred, (d) with the intent of misleading another into relying upon it, (e) justifiable reliance upon the representation or concealment, and (f) a resulting injury proximately caused by the reliance.
Gaines v. Preterm-Cleveland, Inc., 33 Ohio St.3d 54, 514 N.E.2d 709, 712 (Ohio 1987).
In order to make the determination that Francis’s admission was true, the Ohio courts necessarily had to consider the elements of fraud. The bankruptcy court properly noted, “Although the state courts were not presented with a fraud claim, by finding that the contents of the May 1,1991, letter were true, these courts did determine that the Debtor committed a fraud upon Schory.” (Mem. Of Decision 3/17/98 at 12.) Accordingly, if the elements of fraud under Ohio law are the same as the elements required under § 523(a)(2)(A), the bankruptcy court was bound by the Ohio court’s determination that Francis committed fraud.
Section 523(a)(2)(A) provides:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—
(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition[.]
11 U.S.C. § 523(a)(2)(A).
A finding of fraud under § 523(a)(2)(A) requires proof of the following elements:
(1) the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiably relied on the false representation; and (4) its reliance was the proximate cause of loss.
Rembert v. AT & T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277, 280-81 (6th Cir.1998).
The Panel concludes that the bankruptcy court properly found “that the elements of a dischargeability claim under 11 U.S.C. § 523(a)(2)(A) are virtually identical to the elements of a fraud claim in Ohio.” (Mem. Of Decision 3/17/98 at 11.) Therefore, the bankruptcy court correctly applied collateral es-toppel in this ease.

B. The bankruptcy court properly found that the parties’ prepetition settlement agreement was not a novation which extinguished Schory’s subsequent nondischargeability claim under § 523(a)(2).

The question whether execution of a promissory note extinguishes a prior cause of action has been debated for almost 50 years, resulting in a substantial case history. In 1949, the Seventh Circuit held,
The general rule is that a promissory note is but the evidence of indebtedness and does not discharge the debt for which it was given.... But if it is shown that the note, by express agreement, is given and received, as payment or waiver of the antecedent tort action, and if the agreement is *390that the note operates to discharge the original obligation and substitute a new one therefor-in other words, that it is taken in payment of the debt then the original debt is fully satisfied by acceptance of the note.
Maryland Casualty Co. v. Cushing, 171 F.2d 257, 258-59 (7th Cir.1948) (internal citations omitted.)
Later, the Eleventh Circuit considered the issue in Greenberg v. Schools, 711 F.2d 152 (11th Cir.1983), holding, “a debt which originates from the debtor’s fraud should not be discharged simply because the debtor entered into a settlement agreement.” Id. at 156.
In re West, 22 F.3d 775 (7th Cir.1994), held that a general release included a release of a nondischargeability claim in bankruptcy, stating, “even if the obligation arising from Ms. West’s embezzlement would have been non-dischargeable due to its fraudulent nature, no allegations of fraud surround the note, and the note substituted a contractual obligation for a tortious one.... Thus, pursuant to Maryland Casualty, dischargeability turns on the note, rather than the super-ceded obligation.” Id. at 777.
On the other hand, United States v. Spicer, 57 F.3d 1152 (D.C.Cir.1995), declined to follow West and Maryland Casualty because “it improperly elevates legal forrii over substance” to allow a debtor to discharge a debt based on fraud. Id. at 1155. The court rejected the argument that a settlement extinguishes a nondischargeability claim “because it is contrary to the public policy embodied in § 523(a)(2)(A) of preventing fraudulent debtors from escaping their obligations at the expense of innocent defrauded creditors.” Id. The court found that it was more appropriate to “inquire into the factual circumstances behind the settlement agreement to ascertain whether ... the debt ... was derived from the alleged fraudulent conduct....” Id. (quoting Greenberg, 711 F.2d at 156). The court stated, “We cannot agree with a rule under which, through the alchemy of a settlement agreement, a fraudulent debtor may transform himself into a nonfraudulent one, and thereby immunize himself from the strictures of § 523(a)(2)(A).” Id.
The Sixth Circuit has not yet ruled on the issue of novation in the context of § 523(a)(2)(A). The Panel holds that a general release as part of a settlement of a tort claim does not serve as a novation allowing a debt incurred by fraud to be discharged in bankruptcy. In the context of this case, the Panel agrees with Spicer and rejects Wesi for several reasons.
First, West overextended the holding of Maryland Casualty, which was that a novation can only occur through a settlement if it was the parties’ express intention that a contract claim be substituted for the original fraud debt. However, a generally worded release in a tort settlement agreement does not state or suggest any intention by either party to release bankruptcy rights and claims. Indeed, in the present case, nothing in the parties’ agreements suggests either that Francis intended to release his right to claim bankruptcy or that Schory intended to release his bankruptcy nondischargeability claims.
Second, the Spicer holding parallels the law applicable when a creditor claims that a debtor has contractually waived the right to seek a discharge. 11 U.S.C. § 727(a)(10) permits a waiver of the bankruptcy discharge but only if executed postpetition. Further, case law provides that a provision in a pre-petition settlement agreement which waives a party’s right to file bankruptcy is unenforceable as against public policy. See Giaimo v. Detrano (In re Detrano), 222 B.R. 685, 687 (Bkrtcy.E.D.N.Y.1998).
Third, the West holding undermines the settlement of tort claims. If a prepetition general release is sufficient to extinguish a later nondischargeability claim in bankruptcy, a defendant might be motivated to settle a tort claim for any amount and then simply file bankruptcy to seek to discharge the settlement debt. On the other side, a plaintiff, naturally concerned about that strategy, might be less willing to settle the tort claim. The law ought to facilitate settlements, not obstruct them.
*391Fourth, the West holding circumvents the explicit limitation in Bankruptcy Code against the discharge of debts incurred by fraud. Section 523(a)(2)(A) plainly provides that a debt incurred as a result of fraud is nondischargeable in bankruptcy. In the present case, Francis committed a fraud against Schory and has admitted both the fraud and the resulting debt. The settlement did not negate either the fraud, the admission, or the debt.
On several occasions, the Supreme Court has stated that Congress clearly intended fraud debts to be nondischargeable. Most recently the Court stated, “The Bankruptcy Code has long prohibited debtors from discharging liabilities incurred on account of them fraud, embodying a basic policy animating the Code of affording relief only to an ‘honest but unfortunate debtor.’ ” Cohen v. Hilda de la Cruz, — U.S. -, 118 S.Ct. 1212, 1216, 140 L.Ed.2d 341 (1998) (quoting Grogan v. Garner, 498 U.S. 279, 287, 111 S.Ct. 654, 659-60, 112 L.Ed.2d 755 (1991)). See also Brown v. Felsen, 442 U.S. 127, 128, 99 S.Ct. 2205, 2208, 60 L.Ed.2d 767 (1979) (“[A]s the Court has noted, the Act limits [the bankruptcy] opportunity to the ‘honest but unfortunate debtor.’ ” quoting Local Loan Co. v. Hunt, 292 U.S. 234, 244, 54 S.Ct. 695, 699, 78 L.Ed. 1230 (1934)).
The Supreme Court has also concluded, “[I]t is unlikely that Congress ... would have favored the interest in giving perpetrators of fraud a fresh start over the interest in protecting victims of fraud.’ ” Cohen v. Hilda de la Cruz, — U.S. at-, 118 S.Ct. at 1219 (quotingGropan v. Garner, 498 U.S. at 287, 111 S.Ct. at 659-660). Because Spicer recognizes this clear Congressional intent, we choose to follow it.
The Panel also follows Spicer because Brown v. Felsen compels the Spicer result. In Brown v. Felsen, the creditor filed suit alleging both contract and fraud claims against the debtor, but the stipulation and judgment by which the parties later settled did not specifically identify the basis of the liability. The debtor then filed bankruptcy. That filing, the Supreme Court noted, “placed the rectitude of his prior dealings squarely at issue_” Brown, 442 U.S. at 128, 99 S.Ct. at 2208.
In response to the creditor’s claim that the debt was nondischargeable due to the debt- or’s fraud, the debtor asserted that under the doctrine of res judicata, the creditor was precluded from asserting fraud, as the prior stipulated judgment did not include a finding of fraud. After reviewing the policy of repose that underlies the doctrine of res judica-ta, the Court rejected its application in this context, stating:
Because res judicata may govern grounds and defenses not previously litigated, however, it blockades unexplored paths that may lead to truth. For the sake of repose, res judicata shields the fraud and the cheat as well as the honest person. It therefore is to be invoked only after careful inquiry. Petitioner [creditor] contends, and we agree, that here careful inquiry reveals that neither the interests served by res judicata, the process of orderly adjudication in state courts, nor the policies of the Bankruptcy Act would be well served by foreclosing petitioner from submitting additional evidence to prove his case.
Id., 442 U.S. at 132, 99 S.Ct. at 2210. (Emphasis added.)
The Court went on to note that the creditor’s nondischargeability claim was not an attack upon the original judgment; rather, it was a new defense to the “bankruptcy which the respondent [debtor] has interposed between petitioner and the sum due him.” Id. Thus, the Court concluded that it was the debtor’s bankruptcy filing, not the creditor’s nondischargeability complaint, that had upset the repose that would otherwise justify treating their earlier stipulated judgment as final.
The Court then rejected the debtor’s argument that a creditor can avoid the application of res judicata and preserve a nondischarge-ability claim simply by bargaining for a preservation of that right in their stipulated judgment. The Court stated, “It makes little sense, however, to resolve a federal dis-chargeability question according to whether or not the parties in the state court waived their right to engage in hypothetical litiga*392tion in an inappropriate forum.” Id., 442 U.S. at 137, 99 S.Ct. at 2212.
Finally, the Court quoted from the legislative history of this discharge exception, which stated that the exception was intended “to exclude beyond peradventure certain liabilities growing out of offenses against good morals.” The Court offered this legislative history as evidence that “Congress intended the fullest possible inquiry ...” Id., 442 U.S. at 138, 99 S.Ct. at 2213 (citing H.R.Rep. No. 1698, 67th Cong., 1st Sess., 3, 6 (1902). See 36 Cong. Rec. 1375 (1903)). The Court then concluded, “[A]ll debts arising out of the conduct specified in § 17 should be excepted from discharge and the mere fact that a conscientious creditor has previously reduced his claim to judgment should not bar further inquiry into the true nature of the debt.” Id., 442 U.S. at 138, 99 S.Ct. at 2213.1
The only difference between Brown v. Fel-sen and this case is that in Brown, the parties’ settlement was incorporated into a judgment, and as a result, .the debtor’s arguments focused on res judicata instead of release. Thus, the question becomes whether the result should be different in the case of a judgment. The court in West distinguished Brown v. Felsen with this single sentence, “A judgment, however, is far removed from a release voluntarily given by a creditor.” 22 F.3d at 778. But this distinction is unsatisfactory on two levels. First, it ignores that the judgment in Brown was a consent judgment, and was thus the functional equivalent of “a release voluntarily given by the creditor.” Second, although the doctrines of release and res judicata are different in significant respects, West offers no explanation as to why those differences are significant in the context of a nondischargeability claim under 523(a)(2) and the Panel cannot find any such explanation.
Indeed, in this case, if the agreement between Schory and Francis had been incorporated into a consent judgment as it was in Brown, then that decision would plainly compel a result for Schory. There is no principled basis on which to conclude that Schory should be barred from the opportunity to prove the true nature of the debt just because the parties elected to keep their settlement agreement private and not to burden the state court with an unnecessary consent judgment. Accordingly, the Panel concludes that under Brown, Schory’s settlement with Francis did not release Schory’s bankruptcy nondischargeability claim.
The Panel rejects the dissent’s arguments that because nothing in the Bankruptcy Code precludes a creditor from a prepetition release of a nondischargeability claim under § 523(a)(2), state law controls the result. The state law result on whether a creditor can release a § 523(a)(2) claim is simply not relevant, because the Congressional mandate in § 523(a)(2) for the nondischargeability of fraud debts is so strong that it trumps any state release law (or res judicata law) that might otherwise apply in favor the debtor.
The Panel also rejects the dissent’s argument that there is no parallel provision in the Code that protects creditors in the way that § 727(a)(10) protects debtors. Rather, we conclude that § 523(a)(2), as interpreted and applied by the Supreme Court, is itself the parallel to § 727(a)(10) that the dissent seeks. Within its context, each section effectively limits to the bankruptcy process the parties’ exercise of their bankruptcy rights, as well as their waivers of those rights. Thus, when Schory and Francis settled and exchanged mutual releases before Francis filed bankruptcy, Francis did not give up his right to seek a discharge of his debts in bankruptcy and Schory did not give up his right to object to the discharge of Francis’s fraud debt under § 523(a)(2) in the event of such a bankruptcy.
Y. CONCLUSION
The bankruptcy court properly applied collateral estoppel to determine that the debt evidenced by the cognovit note is nondis-chargeable. The Panel follows Spicer and holds that a prepetition general settlement agreement does not extinguish a claim for *393bankruptcy nondischargeability. The bankruptcy court’s order holding that the debt is nondischargeable under § 523(a)(2)(A) is AFFIRMED.

. When the Bankruptcy Act was repealed in 1979, § 17 was replaced by § 523 of the Bankruptcy Code.