IN THE last two weeks, 3 clients with state court cases in their late stages based on complaints for very large amounts arising from business transactions sought bankruptcy relief. One already had a judgment for $4.0 million. The other had a tentative judgment after trial where debtor was not represented by counsel, for $800,000, and the third was about to go to trial for a complaint asking for $2.5 million for damages from a failed partnership. The problem with these civil cases for money damages is that there is always an allegation of fraud, conversion of money, breach of fiduciary duty.
If these causes of actions are litigated in a state court case and the state court judge finds that the facts support fraud, conversion of money or breach of fiduciary duty, then a bankruptcy court will defer to the judgment of the state court on these causes of action. So, when defendant decides to seek bankruptcy relief, it is too late to get a bankruptcy discharge of a judgment for money that is based on these 3 causes of action because the bankruptcy code exempts debt arising from fraud, conversion or breach of fiduciary duty. So, when faced with this kind of lawsuit, it is preferable to seriously consider the chances of losing on these 3 causes of action.
If you think you have enough evidence, and by this, I mean documentary evidence, to win on these 3 causes of action such that under the worse situation, there may be a judgment against you for money had and received or a breach of contract for a large amount but you are assured that there will be no findings of fraud, conversion or breach of fiduciary duty, then by all means, defend yourself in state court. If you lose in state court with a simple money judgment for $4.0 million, then certainly, you can still thereafter discharge the $4.0 million judgment in bankruptcy if there is no findings of fraud, conversion or breach of fiduciary duty.
However, if you feel that you have some documentary evidence, but not a whole lot of it that exonerates you from the allegations of fraud, conversion or breach of fiduciary duty, it is preferable and the better part of caution that you litigate the lawsuit in bankruptcy court through and adversary proceeding. It is preferable to litigate these specific issues in bankruptcy court, because bankruptcy law may have a different treatment of the matter. For instance, fiduciary duty is not a cut and dry issue in bankruptcy. Clearly, a bank has a fiduciary duty to keep the money of depositors safe. But is there a fiduciary duty between a majority and minority stockholder that is not dischargeable in bankruptcy? A minority stockholder may allege that the majority stockholder who runs the business defrauded him by breaching his fiduciary duty to the minority stockholder. It is easier to litigate this issue in bankruptcy court because bankruptcy judges are more familiar with the thresholds required to exempt a breach of fiduciary duty from discharge. A state court judge may find there was a breach of fiduciary duty whereas a bankruptcy court may find that there was no fiduciary that existed between the parties that would exempt the debt from discharge.
In the 2nd case aforementioned, client appeared at trial without a lawyer and failed to present her evidence the right way such that no evidence on her part was admitted to support her defense at trial. Without evidence to support her defense, the tentative judgment was for $800,000 including findings of fraud, conversion and breach of fiduciary duty as a majority stockholder. It is still possible to file bankruptcy at this point and try to discharge the judgment because client defended herself without a lawyer at trial. This is similar to a default judgment in state court that can be litigated in bankruptcy court because there was actually no litigation in state court that took place. Not being able to present your evidence at trial is almost the same as a default judgment. But it certainly would have been better to file the bankruptcy before the state court trial and do an adversary proceeding and try the fraud, conversion and breach of fiduciary duty issues in bankruptcy court. Client may lose on the money judgment but may win on these 3 issues, making the debt completely discharged in bankruptcy.
“Thanks be to God for his indescribable gift!” – 2 Corinthians 9:15.
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S Fremont Ave Mailstop 58 Bldg A-1 Suite 1125 Alhambra, CA 91803.
