How to Draft a Nondischargeable Judgment

The United State District Court in the Southern District Court recently affirmed a bankruptcy court finding that a stipulated judgment issued in California state court did not provide issue preclusion, and was dischargeable despite language to the contrary in the stipulated judgment. [1]

The Parties:

• Cheikes is a non-practicing attorney with a long history of involvement in cross-border motion picture finance
• Wlodarczyk was an intermediary in a transaction

The Facts

• Cheikes was to deposit €300,000 into an escrow account
• A third party would use the escrow money for the issuance of a €50,000,000 standby letter of credit.
• Cheikes refused to release the escrow funds until Wlodarczyk signed a personal and corporate guarantee promising that Cheikes would not lose his initial investment.
• Wlodarczyk signed the guarantee, and Cheikes released the money
• Cheikes was to deposit €300,000 into an escrow account
• A third party would use the escrow money for the issuance of a €50,000,000 standby letter of credit.
• Cheikes refused to release the escrow funds until Wlodarczyk signed a personal and corporate guarantee promising that Cheikes would not lose his initial investment.
• Wlodarczyk signed the guarantee, and Cheikes released the money
• Wlodarczyk ended up filing for Chapter 7 bankruptcy.
• Cheikes filed an adversary complaint for nondischargeability of the debt.
• Cheikes argued that the Stipulated Judgment should be given preclusive effect and that the debt was not dischargeable as a matter of law pursuant to 11 U.S.C. § 523(a)(2)(A).

Language in the Stipulated Judgment

“compromise on the breach of contract (guarantee), conversion and fraud claims filed by Plaintiffs and it is expressly agreed by the Defendants that this Stipulated Judgment is not dischargeable pursuant to 11 U.S. Code § 523 should either of the Defendants file for bankruptcy protection under any section of Title 11 of the United States Codes.”

Holdings on Issue Preclusion

• One element of the test for issue preclusion requires that the issue be “necessarily decided”.
• The Stipulated Judgment failed to include facts in relation to the fraud claim.
• The Stipulated Judgment failed to include express findings of fraud.
• If the stipulation does no more than assess the amount of the judgment without any indication of the facts on which the judgment is based, then there is not a sufficient record on which to base collateral estoppel. In re Berr, 172 B.R. 299, 307 (B.A.P. 9th Cir. 1994)

11 U.S.C. § 523(a)(2)(A) on Nondischargeability

(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;

Standard to Prove Nondischargeability

In order to succeed on a claim of nondischargeability under § 523(a)(2)(A), a creditor must show: “(1) the debtor made . . . representations; (2) that at the time he knew they were false; (3) that he made them with the intention and purpose of deceiving the creditor; (4) that the creditor relied on such representations; and (5) that the creditor sustained the alleged loss and damage as the proximate result of the misrepresentations having been made.”

In re Sabban, 600 F.3d 1219, 1222 (9th Cir. 2010)

Holdings on Nondischargeability

• The guarantee failed to include representations regarding past experience or that he had the financial ability to pay
• Wlodarczyk was not required to provide any disclosures of financial conditions
• The guarantee failed to include representations regarding Wlodarczyk’s financial condition
• Cheikes failed to demonstrate that any alleged falsity in verbal statements were knowing, and that Wlodarczyk had a present intent to deceive Cheikes when he signed the guarantee

Lessons for drafting Stipulated Judgments

• Include facts regarding all fraud claims
• Include express findings of fraud

Lessons for drafting Contracts

• Include all key representations that clients are relying on
• Specific to guarantees or loans:
  • Require representations regarding financial ability to pay
  • Require disclosures of financial condition
  • Require representations and warranties regarding accuracy of disclosures financial ability to pay

Angela Madathil is a Business, M&A, and Deal Attorney and provides legal assistance to buyers and sellers of businesses, as well as business brokers in Nebraska, Missouri, and Kansas.   This can involve contract review and negotiation, due diligence assistance, and post-sale integration.  The Goosmann Law Firm team advises to buyers and sellers of businesses, as well as business brokers throughout the Midwest and has attorneys licensed in Iowa, Kansas, Minnesota, Missouri, Nebraska, South Dakota, and other states.

[1] Cheikes v. Wlodarczyk (In re Wlodarczyk), 19-00062 (S.D. Cal. July 7, 2019)