Sixth Circuit Decision Illustrates How Debtors are Often Unable to Discharge Judgment Debts for Business Tort Claims in Bankruptcy

businessmen looking out a window with a trend line overlayDue to the economic repercussions of COVID-19, businesses are increasingly viewing bankruptcy as an option in light of their vanishing profits and high debt loads.  Accordingly, economists expect a spike in corporate and individual bankruptcies.  But, how does bankruptcy affect a company's liability (or potential liability) for certain business torts?

The Sixth Circuit added to an already ample body of case law when it recently held that the doctrine of collateral estoppel applies to prohibit debtors from litigating whether judgment debts for certain business tort claims can be discharged through bankruptcy.  Based on this framework from the Sixth Circuit, and other existing authority, businesses contemplating legal action for intentional torts like misappropriation of trade secrets, tortious interference, and fraud should not necessarily shy away from litigation due to a debtor's looming or threatened bankruptcy.  Likewise, businesses considering bankruptcy protection should be mindful of any judgment debts that courts routinely find nondischargeable under the Bankruptcy Code.

A.  Certain Debts Cannot be Discharged Under the Bankruptcy Code

The United States Bankruptcy Code, specifically 11 U.S.C § 523(a), carves out several types of debts that a debtor, whether a corporation or individual, cannot discharge through Chapter 7 or Chapter 11 bankruptcy.  Included among these nondischargeable debts are the kind of judgment debts often incurred on business tort claims, such as misappropriation of trade secrets, tortious interference, infringement, fraud, and in some instances, a knowing breach of contract.  In particular, §§ 523(a)(2), 523(a)(4), 523(a)(6) prohibit discharge of debts incurred by fraud or false pretenses, fraud or defalcation while acting as a fiduciary, and debts for "willful and malicious injury," respectively.  A judgment creditor must file an objection in the debtor’s bankruptcy action to establish a judgment debt is nondischargeable pursuant to §§ 523(a)(2), (4) and (6).  Significantly, obtaining a judgment on a claim for fraud or intentional torts like tortious interference often means that the court in the prior action already determined that a debtor committed fraud or inflicted a willful and malicious injury.  Accordingly, when a judgment debtor enters bankruptcy, creditors often seek a ruling (typically through filing a dispositive motion) that the judgment debt is nondischargeable pursuant to the doctrine of collateral estoppel, which precludes relitigation of issues of fact or law actually litigated and decided in a prior action.

B.  The Sixth Circuit Applied Collateral Estoppel to Find a Judgment Debt for Tortious Interference Nondischargeable Pursuant to 11 U.S.C § 523(a)(6)

On May 4, 2020, the Sixth Circuit affirmed a bankruptcy court's finding that judgment debts due to liability on business tort claims were nondischargeable under the doctrine of collateral estoppel.  CMCO Mortg., LLC v. Hill, 957 F.3d 704 (6th Cir. 2020).  In CMCO, Aaron Hill (the judgment debtor) appealed a bankruptcy court decision that found a $3 million judgment nondischargeable under § 523(a)(6) (prohibiting discharge of debts for willful and malicious injury).  Hill, a bank executive, incurred the judgment debt in a Kentucky state lawsuit brought by his former employer, CMCO Mortgage, for claims of tortious interference and misappropriation of trade secrets.  Under Kentucky law, a claim of tortious interference with a business advantage requires that the claimant establish the defendant intentionally interfered with the advantage and that the defendant had an improper motive in so interfering.  In other words, tortious interference with a business advantage (like the other varieties of tortious interference claims) requires the defendant "show malice or some significantly wrongful conduct."  Natl. Collegiate Athletic Ass'n v. Hornung, 754 S.W.2d 855, 859 (Ky.1988).  After Hill entered bankruptcy, CMCO moved for summary judgment and argued that the question of whether Hill intentionally interfered with an improper motive is identical to the question of whether the judgment debt is for a willful and malicious injury, as § 523(a)(6) requires for a debt to be nondischargeable.  Accordingly, CMCO argued, when the Kentucky court found Hill liable for tortious interference, it also necessarily determined Hill’s resulting judgment debt was for a willful and malicious injury, and collateral estoppel therefore barred Hill from litigating the issue again in bankruptcy.  The bankruptcy court agreed with CMCO and applied the doctrine of collateral estoppel, finding Hill’s judgment debt to be nondischargeable under § 523(a)(6).  The Sixth Circuit affirmed - holding that the Kentucky court’s determination of Hill’s intent and improper motive, which was required for liability on the tortious interference claim, was identical to the determination of whether Hill’s judgment debt is for a willful and malicious injury.  Therefore, the Sixth Circuit held that the bankruptcy court properly applied collateral estoppel based on the Kentucky's court’s finding of liability to hold Hill’s judgment debt nondischargeable under § 523(a)(6).

C.  Federal Courts Routinely Apply Collateral Estoppel to Find Debts for Intentional Tort Claims Nondischargeable

The exemption from discharge under 11 U.S.C § 523(a)(6) of debts for willful and malicious injuries is the most broad exemption in 11 U.S.C § 523(a) and encompasses the majority of intentional torts.  This has led to development of a large body of case law that addresses whether judgements in prior actions on various intentional tort claims collaterally estop litigation in a subsequent bankruptcy action.  Among this case law, there is ample authority applying the collateral estoppel doctrine where the debtor had prior judgments based on claims for misappropriation of trade secrets, copyright infringement, and tortious interference.  See e.g., Rowe Oil v. McCoy (In re McCoy), 189 B.R. 129, 132 (Bankr. N.D. Ohio 1995) (judgment debtor collaterally estopped from litigating dischargeability of judgment debt for misappropriation of trade secrets); Schnell v. Schnell, No. 14-41478, 2015 Bankr. LEXIS 2461, at *21 (Bankr. E.D. Tex. July 27, 2015) (debtor estopped from litigating dischargeability of judgment debt for copyright infringement); Ice House Am., LLC v. Cardin (In re Cardin), No. 11-52077, 2013 Bankr. LEXIS 503, at *21-25 (Bankr. E.D. Tenn. Jan. 31, 2013) (debtor estopped by judgment for tortious interference with a contract); see also, Jelm v. Malzeke (In re Malzeke), No. 94-3950, 1995 U.S. App. LEXIS 12798, at *3-4 (6th Cir. May 24, 1995) (debtor estopped from litigating whether judgment debt on fraud claim is dischargeable under § 523(a)(2)); Turchin v. Berkowitz (In re Turchin), No. 19-60002, 2020 U.S. App. LEXIS 14427, at *2-3 (9th Cir. May 6, 2020) (same).

It is well settled what is required to show whether an injury is willful and malicious - the "willful" injury requirement as used in § 523(a)(6) is met where an actor intends to cause the injury that is a consequence of the act or believes it is substantially certain to result; and, the "malicious" injury requirement is met where the actor is without just cause or excuse.  Kawaauhau v. Geiger, 523 U.S. 57, 61-62, 118 S. Ct. 974 (1998); Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 463 (6th Cir. 1999); Petralia v. Jercich (In re Jercich), 238 F.3d 1202, 1208 (9th Cir. 2001) (noting that "a debtor must will or desire the harm, or believe that injury is substantially certain to occur as a result of his behavior before a resulting debt will be excepted from discharge under § 523(a)(6).").  Courts in the Fifth, Seventh, Ninth, and Tenth Circuits have read § 523(a)(6) so broadly as to even include judgment debts for breach of contract where the debtor committed a knowing breach of conduct and engaged in tortious conduct such that the breach evinces a malicious intent to cause injury through the breach.  See Petralia, 238 F.3d at 1205-07 (holding that a knowing breach of a contact constitutes a nondischargeable debt under § 523(a)(6) when the breach is accompanied by malicious and willful conduct); Williams v. Int'l Bhd. of Elec. Workers Local 520 (In re Williams), 337 F.3d 504, 510 (5th Cir. 2003); Lockerby v. Sierra, 535 F.3d 1038 (9th Cir. 2008);  Sanders v. Vaughn (In re Sanders), 210 F.3d 390 (10th Cir. 2000).  However, the law regarding dischargeability of debts under § 523(a)(6) for breach of contract is not well settled.  In fact, the Sixth Circuit's two opinions on the issue are in conflict.  Compare Steier v. Best (In re Best), 109 F. App'x 1, 8 (6th Cir. 2004) ("a breach of contract cannot constitute the willful and malicious injury required to trigger § 523(a)(6)"), with Spring Works, Inc. v. Sarff (In re Sarff), 242 B.R. 620, 626 (B.A.P. 6th Cir. 2000)(holding that damages for a breach of contract can be nondischargeable under § 523(a)(6), but that the plaintiff must show "the defendant intended to cause harm by breaching the contract").

As the economic fallout of COVID-19 continues, potential judgment creditors and debtors should be mindful of the discharge exemptions under §§ 523(a)(2), (4), and (especially) (6) when assessing bankruptcy or the implications of bankruptcy on judgment collection and recovery.

About The Author

Augustus Flottman | Faruki Attorney