FOR THE NORTHERN DISTRICT OF CALIFORNIA
MARTIN LEVY, No. 1-82-00958
v. A.P. No. 1-88-0049
BANK OF THE ORIENT,
Memorandum of Decision
There are no disputed issues of fact in this case. When the debtor filed his Chapter 7 petition in 1982,
he was a defendant in a state court suit brought by Bank of the Orient; this debt was duly scheduled.
Two years later, long after the debtor's discharge was entered, a codefendant in the state court action filed
a cross-complaint against First Interstate Bank, which had also been scheduled as a creditor in the
bankruptcy as to an unrelated debt. First Interstate then filed a cross-complaint against the debtor for
indemnity. The propriety of this cross-complaint is the central issue here.
Instead of ignoring the cross-complaint or immediately seeking the protection of the bankruptcy court,
the debtor, in pro per, filed an answer to the cross-complaint raising his discharge as a defense.
Thereafter, through inadvertence the debtor allowed the state court action to proceed to trial in his
absence. At trial, First Interstate filed an amended cross-complaint against the debtor and obtained a
judgment on it. The state court made a finding that the debt was not discharged. Since Bank of the Orient
had been assigned First Interstate's rights pursuant to a settlement before the trial, it is the real party in
interest here. The debtor brought this adversary proceeding when Bank of the Orient took steps to
enforce the judgment.
At first impression it seemed that the state court judgment, although clearly erroneous in its finding
that the debt sued upon was not discharged, was valid and binding upon this court. 28 U.S.C. section
1334(b) provides that the district courts (and hence the bankruptcy courts) have original but not exclusive
jurisdiction over all civil proceedings arising under the Bankruptcy Code. The advisory committee note
to Bankruptcy Rule 4007 specifically states that jurisdiction over dischargeability issues, except those
covered by section 523(c) of the Bankruptcy Code, is held concurrently by the bankruptcy court and any
appropriate nonbankruptcy forum. On the face of it then, once the debtor placed the issue of
dischargeability before the state court that court had jurisdiction to decide the issue.
However, validating the state court judgment is troublesome because of the language and intent of
section 524(a) of the Bankruptcy Code. Section 524(a) was designed and intended by Congress to
eliminate historical circumvention of bankruptcy law through state court proceedings. In the old days,
creditors would sue the debtor on a discharged debt in state court and, when the debtor through
ignorance, inadvertence, or inability to afford counsel failed to plead the discharge as an affirmative
defense,the discharge would be deemed waived and the debtor was subject to an enforceable judgment.
Section 524(a) was designed to void any judgment obtained before or after the discharge without requiring
the debtor to take any action at all
. 3 Collier on Bankruptcy
(15th Ed.), section 524.01, p. 524-9.
If section 524(a) was designed to protect the debtor from inadvertently losing the benefits of his
discharge, it is difficult for the Court to find that the debtor here inadvertently turned a void action into
a valid one by answering it. Moreover, it does not matter for jurisdictional purposes whether the issue
of dischargeability is raised by affirmative defense or by allegation 1in the complaint. Therefore,
if the law is as urged by the Bank of the Orient, then a creditor can sue the debtor after discharge, allege
that the debt was not discharged, and when the debtor defaults obtain a valid judgment. This is exactly
what section 524(a) was meant to eliminate.
Nor does the Court think that 28 U.S.C. section 1738 requires it to blindly allow enforcement of a
default judgment it knows to be erroneous. While that statute does require the bankruptcy court to give
full faith and credit to state court decisions, the Court believes that the proper rule of law was stated by
Circuit Judge Gibbons in his concurring opinion in Matter of McMillan
(3rd Cir. 1978) 579 F.2d 289, 294:
[W]e should admit an exception to the federal duty
to recognize state court judgments imposed by sec-
tion 1738. When congress expressly identifies an
abuse, when it has the constitutional power to cor-
rect it, and when as here it exercises that power,
then the courts should give the congressional act
its full effect.
This Court can give full effect to the debtor's rights under section 524(a) of the Bankruptcy Code only
be reviewing the merits of the judgment rendered by the state court in the absence of the debtor. For the
reasons stated above, the Court finds that it has the power and the obligation to do so.
The state court judgment cannot withstand scrutiny on the merits. It is based solely on Matter of
Frenville Co., Inc.
(3rd Cir.1984) 744 F.2d 332, which has been universally criticized and is not followed
outside the Third Circuit. Grady v. A.H. Robbins Co., Inc.
(4th Cir.1988) 839 F.2d 198, 201; In re
(2nd Cir.1985) 765 F.2d 343, 348n.4. In In re Christian Life Center
821 F.2d 1370, 1374, the Ninth Circuit implicitly rejected Frenville
. See In re Anfesco Industries, Inc.
(Bkrtcy.E.D.N.Y.1988) 81 B.R. 777, 782.
The undisputed fact is that First Interstate had actual notice of the bankruptcy in a timely manner. This
rendered any debt owed to it, and not merely those scheduled, discharged unless a timely complaint was
filed in this court pursuant to section 523(c) of the Code. In re Rickets
(9th Cir.B.A.P.1987) 80 B.R. 495,
498; In re Braun
(Bkrtcy.D.Ore.1986) 84 B.R. 192, 194.
For the above reasons, the Court finds that the debt sued upon was discharged and the judgment is
void pursuant to section 524(a)(1) of the Bankruptcy Code. A permanentinjunction shall issue prohibiting
any attempt to enforce the judgment. Each side shall bear its own costs and attorneys' fees.
Counsel for the debtor shall submit an appropriate form of judgment.
Dated: June 22, 1988 _______________________
U.S. Bankruptcy Judge
1. Because the Court finds that it may look behind the state court judgment, it need not deal with the
issues raised by the debtor pleading the discharge as an affirmative defense in answer to the
cross-complaint. However, the Court does note that the state court judgment was rendered on an
amended cross-complaint filed at the trial and in the absence of the debtor. The debtor therefore never
even saw, let alone responded to, the complaint upon which the judgment was rendered. There is a
resolution of this matter which preserves the protections of section 524(a) without depriving the state
court of its concurrent jurisdiction. There is an important exception to the applicability of the doctrines
of res judicata and collateral estoppel; they are generally not binding upon the bankruptcy court in
dischargeability cases. In re Daley
(9th Cir.1985) 776 F.2d 834, 839; In re Comer
(9th Cir.1984) 723
F.2d 737, 740; In re Houtman
(9th Cir.1978) 568 F.2d 651, 653; In re Harck
(9th Cir.B.A.P.1987) 70
B.R. 118, 121. While those cases dealt generally with state court default judgments taken before
bankruptcy and relating to issues under sections 523(a)(2), (4), and (6) of the Code, there is no reason
to limit their holdings to only those types of discharge cases or to cases commenced before the bankruptcy
when to do so would thwart the congressional intent manifest in section 524(a) to protect the debtor from
inadvertent and unmeritorious loss of his discharge rights. See, e.g., In re Williams
3 B.R. 401, in which the bankruptcy court declined to give res judicata effect to a state court judgment
that a debt was nondischargeable under section 523(a)(5). Accordingly, the Court finds that while
principles of res judicata may apply when both sides have fully argued a dischargeability case to the state
court, they do not preclude a different result in the bankruptcy court where the state court judgment was
rendered in the absence of the d