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#2142 aff'd 2-28-96 (D.Kan.) (Crow, J.)

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS

In Re:

RAYMOND PAUL SCHWARTEN,

SUSAN RENE SCHWARTEN,

DEBTOR(S)

CHAPTER 7

NO. 92-42199-7

MARK TWAIN KANSAS CITY BANK,

PLAINTIFF(S),

v.

RAYMOND PAUL SCHWARTEN, SUSAN RENE SCHWARTEN,

DEFENDANT(S)

ADV. NO. 93-7029

MEMORANDUM OF DECISION

This adversary proceeding is before the Court on a motion for summary judgment filed by Mark Twain Kansas City Bank (Mark Twain). Before the debtors filed for bankruptcy, Mark Twain obtained a partial summary judgment against them in a state court in Jackson County, Missouri. Mark Twain now contends that, through collateral estoppel, this partial judgment establishes that it holds a claim against the debtors that is nondischargeable under 11 U.S.C.A. §523(a)(2)(A) and (B). The debtors oppose the motion. Mark Twain is represented by Neil S. Sader and Gregory M. Garvin of Brown, Nachman & Sader, P.C., of Kansas City, Missouri. The debtors are represented by Robert N. Calbi of Kansas City, Missouri, and Robert L. Lundblad of Kansas City, Kansas.

FACTS

The motion for partial summary judgment which Mark Twain submitted to the state court alleged the following to be undisputed facts. In early 1990, the debtors were involved in a corporation called Sonic Technologies, Inc. (Sonic). Mrs. Schwarten was a stockholder and president, and Mr. Schwarten was the chief executive officer and in charge of the company's day-to-day operations. On Sonic's behalf, they negotiated an agreement with a company called Franklin Environmental Services, Inc. (Franklin), and a company called U.S.D.C. In return for $10,000 paid to Sonic, Franklin received an option to join in a new corporation that would be formed as a joint venture with Sonic and U.S.D.C. If it exercised the option, Franklin was to pay Sonic another $50,000; Sonic would also receive some stock in the new corporation and certain prepaid license rights. Franklin had until sometime in April to exercise the option, and it ultimately chose not to do so.

Around the same time, Sonic was applying to Mark Twain for a loan. About a week after reaching the option agreement with Franklin, in a February 1990 monthly statement of income for Sonic which they submitted to the bank, the Schwartens included the $50,000 which Franklin would not actually owe until it exercised the option. About the same time, the Schwartens reported that Sonic, Franklin, and U.S.D.C. had agreed to form the new corporation for the joint venture, and that Sonic would receive stock in that corporation, the prepaid license rights, and the $50,000 from Franklin as a result of the deal.(1) These representations overstated Sonic's net income by more than 150% and exaggerated its prospects for future success. As the Schwartens knew it would, Mark Twain relied on this information in deciding to provide Sonic a $100,000 line of credit. On March 8, as Sonic's president, Mrs. Schwarten signed the line of credit agreement, a promissory note, and a security agreement. The note was due on demand or in June 1990. Both the Schwartens personally guaranteed the line of credit. On March 12, Sonic borrowed $94,249.79 on the line.

Sonic failed to pay the note when due, and in August, Mark Twain made demand for payment on the note and on the Schwartens' guarantees. It then filed suit in state court in September 1990. Among other things, the bank sought judgment against Sonic and the Schwartens for fraud or misrepresentation. In 1992, it sought partial summary judgment on certain issues, including its claims that Sonic and the Schwartens had defrauded it. In September, the state court issued an order granting, among other things, "[j]udgment against both Sonic Technology and the Schwartens for their fraud in inducing the bank to extend a line of credit." Later, the court made this partial summary judgment a final order. The Schwartens have appealed the judgment.

Mark Twain now seeks summary judgment on the ground the state court judgment against the Schwartens for fraud is nondischargeable. The Schwartens contest only minor points concerning the facts as stated above. They contend the bank made claims against them for "misrepresentation," not fraud, apparently deny that Mr. Schwarten was an officer of Sonic at the time he guaranteed its debt to the bank, and note that the state court did not dispose of the bank's claim for "Recovery of Security" against Sonic. Then, in the course of making their arguments in their brief, they seem to contend that Mrs. Schwarten did not sign any of the documents which contained the alleged misrepresentations, and so could not be liable for any written misrepresentations. As will be explained below, the Court concludes none of these assertions raises a genuine issue of material fact that would preclude granting Mark Twain's motion.

After the debtors filed their brief, Mark Twain filed a reply. The debtors have filed a motion to strike the response on the ground the pretrial order in this proceeding allowed for a summary judgment motion and a response but no further pleadings. The Court finds that it can resolve the motion without considering the reply brief, so the motion to strike is denied as moot.

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. FRCP 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 question in this case is whether the state court's judgment collaterally estops the debtors from relitigating whether they defrauded Mark Twain. Although the parties have discussed the matter in terms of "collateral estoppel," the Tenth Circuit, along with other federal courts, has followed the lead of the Supreme Court and instead calls the concept "issue preclusion"; the related concept formerly called "res judicata" is called "claim preclusion." Carter v. City of Emporia, 815 F.2d 617, 619 n. 2 (10th Cir. 1987); see also 18 Wright, Miller & Cooper, Fed. Prac. & Pro.: Jurisdiction, §4402 (1981) (discussing and explaining changing terminology, and citing cases). "Claim preclusion" refers to the doctrine that forbids litigating in a later suit claims that were or should have been litigated in a prior suit; "issue preclusion" refers to the doctrine that forbids relitigating in a later suit issues that were adequately litigated in a prior suit. 18 Wright, Miller & Cooper, Fed. Prac. & Pro.: Jurisdiction, §4402; Hybert v. Shearson Lehman/American Express, Inc., 688 F.Supp. 320, 325 (N.D.Ill. 1988).

The requirements of issue preclusion (or collateral estoppel) are:

(1) the issue to be precluded is the same as that involved in the prior state action, (2) the issue was actually litigated by the parties in the prior action, and (3) the state court's determination of the issue was necessary to the resulting final and valid judgment.

In re Tam, 136 B.R. 281, 285 (Bankr.D.Kan. 1992). Mark Twain now asks the Court to conclude that the debtors' liability to the bank for fraud, under the state court's judgment, is nondischargeable under 11 U.S.C.A. §523(a)(2)(A) or (B). Those subsections provide that debtors may not discharge 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;

(B) use of a statement in writing--

(i) that is materially false;

(ii) respecting the debtor's or an insider's financial condition;

(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive.

Without citing any authority, the debtors assert that subsection A applies only to alleged oral misrepresentations and that subsection B applies to alleged written misrepresentations. This is simply wrong. Instead, subsection A applies not only to oral misrepresentations, but to all written misrepresentations as well, except for the subcategory of written misrepresentations which were included in a statement respecting the debtor's or an insider's financial condition. See In re Novak 97 B.R. 47, 56-58 (Bankr. D. Kan. 1987) (finding §523(a)(2)(A) violated by combination of written and oral statements). Mark Twain asserted two misrepresentations in the state court, and now argues that one is covered by subsection A and the other by subsection B.

The debtors argue that the state court's judgment contained no findings of fact and therefore cannot preclude them from litigating any issues. However, the state court granted summary judgment, which means that it concluded there were no disputed facts. Instead, the parties' pleadings stated the facts that supported the court's judgment. Mark Twain has submitted a copy of the motion for summary judgment that it filed in the state court, and the debtors have not specified any facts stated in the motion which they controverted before summary judgment was granted. Consequently, the absence of findings of fact from the state court's judgment has no effect on this Court's consideration of issue or claim preclusion.

The state court's order does not indicate whether it concluded the debtors were liable for only one of the misrepresentations alleged or for both. Clearly, the court decided they were liable for at least one. Mark Twain asserted that it relied on each misrepresentation in deciding to extend the line of credit to Sonic. It now contends: (1) the misrepresentation about the formation of the joint venture violated subsection A of §523(a)(2), and (2) the misrepresentation of Sonic's income was contained in a financial statement and violated subsection B.

To prevent a claim from being discharged under 11 U.S.C. §523(a)(2)(A), the creditor must prove the following:

1) the debtor made a representation;

2) the debtor knew the representation was false when made;

3) the debtor made the representation with the purpose and intent of deceiving the plaintiff;

4) the plaintiff reasonably relied on the representation; and

5) the plaintiff suffered a loss as a proximate result of the representation.

In re Pressgrove, 147 B.R. 244, 246-47 (Bankr.D.Kan. 1992). "False pretenses" and "false representations" are kinds of "fraud." 3 Collier on Bankruptcy ¶¶523.08[4] and [5] (15th ed. 1994); see also 5 Wright & Miller, Fed. Prac. & Pro.: Civil 2d, §1297 at 584-89 (1990) (stating textbook elements of fraud). The facts that Mark Twain alleged in its state court motion for summary judgment alleged facts sufficient to satisfy these requirements with respect to the formation of the joint venture. The debtors have not shown that they challenged any of the asserted facts before the state court.

To prevent its claim from being discharged under §523(a)(2)(B) under the circumstances of this case, Mark Twain would have to prove that, with the intent to deceive, the debtors presented or caused to be presented a written statement respecting Sonic's financial condition that was materially false and on which Mark Twain reasonably relied. Mark Twain's state court motion for summary judgment alleged facts sufficient to satisfy these requirements with respect to the monthly statement of income which the debtors gave it in order to obtain the line of credit for Sonic. Again, the debtors have not shown that they challenged any of the asserted facts before the state court.

Mark Twain's statement of facts in its state court summary judgment motion indicated that both the Schwartens participated in both fraudulent acts. The state court's judgment states that both of them are liable for fraud. The debtors apparently failed to contest the facts on the ground that either of them was not a participant. Their attempts now to claim that one of them did not participate come too late.

Since Mark Twain alleged facts sufficient to satisfy the requirements of either §523(a)(2)(A) or (B), the debtors' alleged false representations both led the bank to extend the line of credit, and the state court necessarily concluded the debtors had commited at least one of the two fraudulent acts alleged, the state court's judgment would be nondischargeable under at least one of the two subsections. Nevertheless, the debtors make two more arguments to try to defeat summary judgment on the dischargeability issue. First, they contend this Court should not decide the issue because they have appealed the state court judgment. However, the Court believes it is appropriate to rule that so long as it is upheld on appeal, the state court's judgment will be nondischargeable. Second, the debtors argue that, in effect, Mark Twain has no claim against them until the state court rules on its claim for recovery of its collateral. This argument, though, concerns only the ultimate amount the bank is entitled to recover from the debtors. The "debt" which is made nondischargeable under §523(a) is defined by §101(12) to be a "liability on a claim" and "claim" is defined by §101(5) to include a "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured." Certainly, Mark Twain has a right to payment from the debtors based on their guarantees of Sonic's debt. These obligations are the ones that will not be extinguished in bankruptcy. If the obligations are paid through the sale of the bank's collateral or its allegedly improper dealing with its collateral, the obligations may be extinguished in the state court through state law; that possibility is not this Court's concern. Whatever amount the state court determines the debtors owe to Mark Twain based on the fraudulent acts is nondischargeable.

For these reasons, the Court concludes the state court's summary judgment based on either the misrepresentation of the formation of the joint venture or of Sonic's income precludes the debtors from litigating before this Court whether those actions are covered by §523(a)(2)(A) or (B). Unless that judgment is reversed or vacated on appeal, the debtors' obligations under it will be nondischargeable.

The foregoing constitutes 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 May, 1995.













_________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE













IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS











In Re: )

)

RAYMOND PAUL SCHWARTEN, ) NO. 92-42199-7

SUSAN RENE SCHWARTEN, ) CHAPTER 7

)

DEBTOR(S). )

)

MARK TWAIN KANSAS CITY BANK, )

)

PLAINTIFF(S), )

v. ) ADV. NO. 93-7029

)

RAYMOND PAUL SCHWARTEN, )

SUSAN RENE SCHWARTEN, )

)

DEFENDANT(S). )

JUDGMENT ON DECISION

This adversary proceeding was before the Court on a motion for summary judgment filed by Mark Twain Kansas City Bank (Mark Twain). Before the debtors filed for bankruptcy, Mark Twain obtained a partial summary judgment against them in a state court in Jackson County, Missouri. Mark Twain contended that, through collateral estoppel, this partial judgment established that it holds a claim against the debtors that is nondischargeable under 11 U.S.C.A. §523(a)(2)(A) and (B). Mark Twain was represented by Neil S. Sader and Gregory M. Garvin of Brown, Nachman & Sader, P.C., of Kansas City, Missouri. The debtors were represented by Robert N. Calbi of Kansas City, Missouri, and Robert L. Lundblad of Kansas City, Kansas.

The Court has considered the issues and rendered its Memorandum of Decision. For the reasons stated therein, judgment is hereby entered declaring that the debtors' obligations to Mark Twain under the state court's summary judgment will be nondischargeable under §523(a)(2)(A) or (B), unless that judgment is reversed or vacated on appeal.

IT IS SO ORDERED.

Dated at Topeka, Kansas, this _____ day of May, 1995.













__________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE

1. It is not clear whether Mark Twain asserted that the debtors indicated that Sonic would receive another $50,000 in addition to the $50,000 reported as already received, but this discrepancy will have no impact on the Court's ruling.

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