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#2189 signed 1-11-96



IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS



In Re:

HARRY LEE WEATHERFORD,

MARY OLIVIA WEATHERFORD,

DEBTOR(S)

NO. 93-40901-7

CHAPTER 7

TERRY AND DARLENE DUDLEY, CONSTANCE D. WISE, BRUCE R. HIDAY, AND ALL OTHERS SIMILARLY SITUATED,

PLAINTIFF(S),

v.

HARRY LEE WEATHERFORD,

MARY OLIVIA WEATHERFORD,

DEFENDANT(S)

ADV. NO. 93-7135

MEMORANDUM OF DECISION

This proceeding is before the Court on the plaintiffs' motion for summary judgment and the defendants' motion for partial summary judgment. The plaintiffs appear by counsel Richard N. Bell and Irwin B. Levin of Cohen & Malad, and Todd W. Ruskamp and Jamie M. Clark of Shook, Hardy & Bacon. The defendant-debtors appear by counsel Eric C. Rajala and Robert D. Berger. The issue presented is whether issue preclusion prevents the debtors from litigating before this Court the dischargeability of a judgment the plaintiffs obtained against them in the United States District Court for the Southern District of Indiana. The Court has reviewed the relevant pleadings and is now ready to rule.

FACTS

The relevant facts are not in dispute. The plaintiffs obtained a summary judgment against the debtors in a class action suit for securities fraud under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, and under the Indiana Securities Act. The plaintiffs' claims were based on the debtors' involvement in the sale of stock in a company called Ski World, Inc. The debtors were officers and directors of the company. The federal district court judge concluded a number of prospectuses for Ski World's stock offerings contained a number of omissions and misstatements of material fact, and that the debtors participated in those omissions and misstatements with "scienter," the intent to deceive, manipulate, or defraud. The judge did state that scienter can include a reckless disregard for the truth. For many of the omissions, though, the judge said the debtors knew the omitted facts, thus indicating they had acted intentionally by omitting them. For others, he said the debtors either knew or could easily have discovered the omitted facts, thus indicating they may have acted only with reckless disregard by omitting them. Specifically, the judge ruled the debtors acted intentionally by omitting from the prospectuses the following facts: (1) all previous companies they had owned had failed to succeed or return any money to investors; (2) the SEC had determined the stock offering contained a fraudulent or manipulative device; (3) the debtors owned stock which gave them 3 to 1 voting rights and control of Ski World; (4) salesmen had to pay a fee to be allowed to sell Ski World stock; (5) Ski World engaged in hundreds of thousands of dollars worth of related-party transactions with other companies controlled by the debtors; (6) the fees for the law firm that prepared the prospectuses were contingent on the offering reaching certain milestones, including some based on the amount of stock sold; (7) due to fraudulent conduct, another company controlled by the debtors and involved in a stock offering was enjoined by the Missouri Securities Division from selling stock; (8) Ski World paid substantial amounts of money to send its top salesmen and its management to Hawaii, Las Vegas, and on a Caribbean cruise; and (9) a major segment of Ski World's business had closed showing losses between $750,000 and $1 million. Indiana law required only negligence, which of course had been established since the more difficult standard of scienter had been met.

For purposes of their federal claims, the district judge concluded the plaintiffs had established reliance on the omissions by showing: (1) the omissions were material, that is, a reasonable investor might have considered them important in making the decision to buy the stock, and (2) the debtors had a duty to disclose the omitted information. He spoke of these facts as creating a "presumption" of reliance; earlier in the case, he had ruled the debtors could present evidence to try to rebut this presumption. Under Indiana law, the judge determined the plaintiffs did not have to "provide positive proof of reliance."

Finally, the judge ruled that by showing the debtors' omissions and misstatements touched upon the reasons for the investment's decline in value, the plaintiffs had shown the omissions and misstatements proximately caused the plaintiffs' investments in the stock to lose money.

DISCUSSION AND CONCLUSIONS

Federal Rule of Civil Procedure 56, governing grants of summary judgment, is made applicable to bankruptcy proceedings by Federal Rule of Bankruptcy Procedure 7056. Rule 56 provides that this Court must grant summary judgment "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." In considering a motion for summary judgment, the Court must examine all the evidence in the light most favorable to the party against whom summary judgment is sought. Summary judgment is inappropriate if an inference can be deduced from the facts which would allow the nonmovant to prevail. The court must consider factual inferences tending to show triable issues in the light most favorable to the existence of those issues. Where different ultimate inferences may properly be drawn, summary judgment should be denied. United States v. O'Block, 788 F.2d 1433, 1435 (10th Cir. 1986).

The Court believes there are no genuine issues of material fact. Consequently, under Rule 56, the plaintiffs are entitled to summary judgment if, as a matter of law, issue preclusion applies to the district court judgment and that judgment is based on the kind of fraud which renders a debt nondischargeable under 11 U.S.C.A. §523(a)(2)(A). Issue preclusion applies if: (1) the issue to be precluded here is the same as that involved in the prior action; (2) the issue was actually litigated by the parties in the prior action; and (3) the prior determination of the issue was necessary to the resulting final judgment. In re Wallace, 840 F.2d 762, 765 (10th Cir. 1988).

The debtors raise a number of objections to the application of issue preclusion (or collateral estoppel). Initially, they contend that in the case in the Southern District of Indiana, the plaintiffs mailed their motion for summary judgment to a post office box the debtors no longer used, rather than to their home. As a result, the debtors contend, they failed to respond to the motion because they did not receive it, and the District Court entered the judgment against them by default. There is no question the debtors were properly served with the summons and petition in the Southern District of Indiana. Several attorneys represented them in the suit at different times, although they were without counsel when the summary judgment was entered. The debtors contend they orally notified the court and the plaintiffs' counsel that they wanted to receive their correspondence at their home. This allegation is disputed. In any event, the debtors contend that their failure to receive and respond to the summary judgment motion means none of the issues resolved by the granting of that motion was actually litigated.

While recognizing that this Court cannot rule on a motion for relief from the judgment pursuant to Federal Rule of Civil Procedure 60(b), the debtors nevertheless seek by indirection what the Court cannot give them directly, namely, a ruling that the district court judgment is not a valid and enforceable final judgment because they did not receive notice of the summary judgment motion. There is no question that the federal court in Indiana had jurisdiction over the persons of the debtors and of the subject matter of the plaintiffs' lawsuit. This adversary proceeding was brought within six months of the rendering of the summary judgment. At least at that time, the debtors could have sought relief from that court under Rule 60(b) on the ground of lack of notice of the motion. Their argument here can only be considered an equitable collateral attack on the judgment, and they are not entitled to relief under the circumstances. See Winfield Associates v. Stonecipher, 429 F.2d 1087, 1090-91 (10th Cir. 1970).

The debtors also question whether the issues decided by the district court are the same as those required to make their debts to the plaintiffs nondischargeable. Ordinarily, this Court has considered the elements of §523(a)(2)(A) to be: (1) the debtors knowingly committed actual fraud, false representations or false pretenses, (2) the debtors intended to deceive the plaintiffs, (3) the plaintiffs reasonably relied upon the debtors' conduct, and (4) that reliance proximately caused damage to the plaintiffs. In re Tam, 136 B.R. 281, 286 (Bkrtcy.D.Kan. 1992). Recently, the United States Supreme Court has altered this view by deciding the injured party's reliance need not be reasonable, but only "justifiable." See Field v. Mans, ___ U.S. ___, 116 S.Ct. 437, ___ L.Ed.2d ___ (1995). However, in reaching this conclusion, the Supreme Court indicated Congress' use of the phrase "actual fraud" in §523(a)(2)(A) incorporated the settled common-law meaning of those words. Slip op. at 10. Under §10(b) and Rule 10b-5, the common law has developed somewhat different elements for fraud than those used in other areas, at least where a failure to disclose information is involved. The first two elements remain the same, but the third and fourth are changed. In Affiliated Ute Citizens v. United States, 406 U.S. 128, 152-54 (1972), the Supreme Court ruled that positive proof of reliance is not required in cases primarily involving a failure to disclose, but instead causation in fact is shown by establishing the defendant had a duty to disclose and the withheld information was material in the sense that a reasonable investor might have considered it important in making an investment decision. Later decisions have indicated the defendant may try to defeat such a showing of reliance by, for example, attacking materiality directly or showing the plaintiff made the investment despite knowing of the misrepresentation or omission. See Blackie v. Barrack, 524 F.2d 891, 906-07 (9th Cir. 1975). To establish that the defendant's wrongdoing proximately caused his or her damages, an investor is not required to prove that the wrongdoing was the sole cause of the decline in the value of the investment, merely that it "touched upon the reasons" for the decline. Marbury Management v. Kohn, 629 F.2d 705, 708 (2d Cir. 1980).

Although they at one time preserved the reliance issue for trial, the debtors lost their chance to prove nonreliance by failing to respond to the plaintiffs' summary judgment motion. The district judge's findings of materiality and a duty to disclose establish the requisite reliance on the debtors' omissions. The judge's determination that the omissions all touched upon the reasons for the plaintiffs' losses on their investments in Ski World establishes the requisite proximate cause.

The debtors suggest that the "presumption" of reliance the district court referred to and applied means the burden of proof was different in the Indiana suit than it is before this Court under §523(a)(2)(A). This is incorrect. By incorporating the common law definition of fraud in §523(a)(2)(A), Congress also incorporated the common law modifications which the courts apply to that definition in the context of securities fraud under §10(b) and Rule 10b-5. Thus, the elements of proof themselves, not the burden of proof, are modified in this context. While this special version of fraud differs from the standard version, it nevertheless falls squarely within §523(a)(2)(A) because in the area of securities fraud, it constitutes the common-law definition of the words "actual fraud" used in that section. A summary judgment is a ruling on the merits, and issues thus resolved have been "actually litigated" for purposes of issue preclusion. See 18 Wright, Miller & Cooper, Fed. Prac. & Pro. Jurisdiction §4444 (1981). Consequently, the debtors' obligation to the plaintiffs is nondischargeable.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule 7052 of the Federal Rules of Bankruptcy Procedure and Rule 52(a) of the Federal Rules of Civil Procedure. A judgment based on this ruling will be entered on a separate document as required by FRBP 9021 and FRCP 58.

Dated at Topeka, Kansas, this ____ day of January, 1996.













_________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS





In Re: )

)

HARRY LEE WEATHERFORD, ) NO. 93-40901-7

MARY OLIVIA WEATHERFORD, ) CHAPTER 7

)

DEBTOR(S). )

)

TERRY AND DARLENE DUDLEY, )

CONSTANCE D. WISE, BRUCE R. )

HIDAY, AND ALL OTHERS )

SIMILARLY SITUATED, )

PLAINTIFF(S), )

v. ) ADV. NO. 93-7135

)

HARRY LEE WEATHERFORD, )

MARY OLIVIA WEATHERFORD, )

)

DEFENDANT(S). )

JUDGMENT ON DECISION

This proceeding was before the Court on the plaintiffs' motion for summary judgment and the defendants' motion for partial summary judgment. The plaintiffs appeared by counsel Richard N. Bell and Irwin B. Levin of Cohen & Malad, and Todd W. Ruskamp and Jamie M. Clark of Shook, Hardy & Bacon. The defendant-debtors appeared by counsel Eric C. Rajala and Robert D. Berger. The issue presented was whether issue preclusion prevented the debtors from litigating before this Court the dischargeability of a judgment the plaintiffs obtained against them in the United States District Court for the Southern District of Indiana.

The Court has now issued its Memorandum of Decision resolving that issue. For the reasons stated therein, judgment is hereby entered granting the plaintiffs' motion for summary judgment. Their judgment against the debtors is hereby declared to be nondischargeable under 11 U.S.C.A. §523(a)(2)(A).

IT IS SO ORDERED.

Dated at Topeka, Kansas, this _____ day of January, 1996.













__________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE

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