Phillips v. Phillips (In re Phillips)

Phillips v. Phillips (Case No. 13-6019, October 30, 2013)
The BAP affirmed the decision of the bankruptcy court giving collateral estoppel effect to a state court judgment, finding that the debtor had converted assets of various parties and that the resulting liability was nondischargeable pursuant to Section 523(a)(6) of the Bankruptcy Code.
Procedural context:
The debtor appealed from orders of the bankruptcy court awarding judgments against the debtor for intentional conversion of property, for costs of suit, and determining that the judgments were not discharged pursuant to Section 523(a)(6).
Diane Phillips was married to David Phillips, Sr. until his death in May 2010, and is the personal representative of his estate. Defendant, David L. Phillips, Jr. is the son of David L. Phillips, Sr. and the stepson of Diane Phillips. Diane is the sole member and officer of Sheridan Properties, LLC, a Minnesota limited liability company ("Sheridan"). Sheridan and Diane Phillips, in her individual capacity and as the personal representative of the estate of David L. Phillips, Sr. were plaintiffs in the underlying adversary proceeding. Some time after the death of David L. Phillips, Sr., plaintiffs sued defendant, along with his wife and sister, and various entities controlled by them, in a Minnesota state court. While the state court was proceeding, defendant filed for chapter 7. Plaintiffs commenced an adversary proceeding against defendant for a determination of dischargeability of certain debts. The automatic stay prevented the state court case from proceeding against defendant, but the case proceeded against the other defendants in state court. Among other things, the state court found that certain entities were Minnesota entities owned and controlled by defendant, either directly or through ownership interests held by his wife. The state court further found that those entities, acting through defendant, converted assets belonging to plaintiffs. Additional judgments were entered against defendant and in favor of certain individuals and entities in different amounts for conversion of assets. At a pretrial hearing regarding the estoppel effect of the state court's findings, the bankruptcy court ruled that: (1) it would receive into evidence a copy of the state court judgment and decree; (2) collateral estoppel issues under Minnesota law would apply and will be binding as to all non-debtor defendants; and (3) collateral estoppel issues as to ownership of the assets involved in the proceedings will also be binding; and (4) plaintiffs were entitled to introduce evidence as to privity between defendant and his corporations and should privity be established, collateral estoppel would be extended to be binding on the defendant as well. Following an evidentiary hearing, the bankruptcy court found defendant personally liable for the conversions found by the state court, and that the resulting liability was nondischargeable pursuant to Section 523(a)(6). The bankruptcy court further found that the only reason judgment was not entered against defendant personally was that the action was stayed against him by the bankruptcy filing. He had given extensive testimony at the state court trial, and had repeated the same testimony to the bankruptcy court. The evidence had shown that the defendant personally controlled the decisions to take the property and the disposition of it, and that he distributed the proceeds to himself and his corporations knowing that that they had no right in the property or the proceeds. His actions were blatant personal acts of willful and malicious conversion of property which he knew belonged to the plaintiffs. Consequently, the court held that the resulting liability was nondischargeable under Section 523(a)(6). Defendant asserted that the bankruptcy court erred in giving collateral estoppel effect to the state court order that was litigated and issued post-bankruptcy filing and during which defendant was a witness, but not a party. The BAP observed that defendant did not dispute the admissibility of the state court judgment or that the concept of privity was a proper subject for which evidence could be presented. Thus, the appeal was based solely on the bankruptcy court's pretrial ruling that the state court findings as to ownership of the assets was binding on the bankruptcy court. The BAP rejected the defendant's first argument that collateral estoppel, or issue preclusion, should only apply in dischargeability proceedings to bar a party from relitigating discrete issues of fact that were adjudicated in "pre-bankruptcy" litigation. The argument was without support. The defendant's second argument was that collateral estoppel should not apply because he was not a "party" to the state court case. The BAP noted that this argument was based upon an element of Minnesota preclusion law. The court observed that whether a prior Minnesota state court judgment bars defendant's claim of asset ownership is controlled by the full faith and credit statute, 28 U.S.C. 1738. Pursuant to this provision, "a federal court must give to a state-court judgment the same preclusive effect as would be given that judgment under the law of the State in which the judgment was rendered." Under Minnesota law, the BAP observed that collateral estoppel is available where: (1) the issues are identical to those in a prior adjudication; (2) there is a final judgment on the merits; (3) the estopped party was a party or in privity with a party in the previous action; and (4) the estopped party was given a full and fair opportunity to be heard on the adjudicated issues. The BAP noted that the defendant appeared to challenge the third and fourth elements arguing that he was not a party to the state court action. First, the BAP noted that technically, defendant was a "party" to the state court case - the action was simply stayed against him and proceeded to trial only against the other defendants. Second, the court noted that the defendant identified himself only as a "witness" in the state court case. The BAP stated that the reality, however, was that defendant was much more than simply a witness. As a party to the state court case, which had commenced three months prior to the bankruptcy filing, defendant was well aware that the issues involved ownership and conversion of assets. He chose to file bankruptcy to avoid having a personal judgment entered. It was undisputed that defendant testified extensively at the state court trial and was found to be in control of the entities and made the decisions on behalf of the entities, including the decisions to take the property and dispose of it. Quoting the Supreme Court, the BAP stated that "the persons for whose benefit and at whose direction a cause of action is litigated cannot be said to be a stranger to the cause." Defendant further argued that the state court judgment should not be given collateral estoppel effect against him because that violated the automatic stay. Rejecting this argument, the BAP stated that contrary to defendant's characterization, the state court did not enter judgment against him and, therefore, its judgment was not void as a violation of the automatic stay. Finally, the BAP held that the bankruptcy court correctly gave preclusive effect to the state court's determination as to ownership of the assets because a contrary decision by the bankruptcy court would "wholly undermine" the state court's ruling.
Federman, Schermer, and Saldino

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