BUKE, LLC v. Eastburg et al

UNITED STATES BANKRUPTCY COURT
DISTRICT OF NEW MEXICO
In re: 	RANDALL SCOTT EASTBURG and 	No. 7-10-10131 JA
LISA SUE EASTBURG,
Debtors.
BUKE, LLC, A New Mexico limited liability company,
Plaintiff,
v. 	Adversary No. 10-1024 J
RANDALL SCOTT EASTBURG and
LISA SUE EASTBURG,
Defendants.
MEMORANDUM OPINION
The Court is faced with the conundrum of how the discharge injunction under 11 U.S.C.
§ 524, which arises upon the entry of a debtor’s discharge, affects pending pre-petition state
court litigation that includes claims arising out of the same conduct, transactions and occurrences
as those at issue in this timely-filed adversary proceeding to determine the dischargeability of
certain debts under 11 U.S.C. § 523. The parties have stipulated, and the Court agrees, that the
automatic stay terminated upon the entry of the Debtors’ discharge on April 21, 2010. See Case
No. 10-10131 JA (Docket No. 43 – Discharge of Debtor Lisa Sue Eastburg and Randall Scott
Eastburg; Docket No. 79 - Stipulated Order Regarding Automatic Stay). The issues before the
Court are whether the discharge injunction or the Court’s exclusive jurisdiction to determine
whether a debt is excepted from the discharge prevents Plaintiff from pursuing any or all of the
claims raised in its state court action when no determination has yet been made by this Court as
to the dischargeability of any debts.
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Plaintiff BUKE, LLC (“BUKE”) asserts that the discharge injunction does not prevent it
from proceeding against the Defendants in the state court action as to all claims raised in that
action. BUKE reasons that because its state court claims against Defendants are based on the
same conduct upon which its claims of non-dischargeability in this adversary proceeding are
based, and because no determination of dischargeability of the debt at issue in the state court
action has yet been made, the state court has concurrent jurisdiction to determine to determine
the validity and the amount of that debt. Consequently, BUKE believes it can continue to pursue
its causes of action simultaneously in state court and in this adversary proceeding. Alternatively,
if the Court were to determine that the discharge injunction applies to prosecution of its claims
against Defendants in the state court action, BUKE argues that the Court can and should modify
the discharge injunction to permit BUKE to proceed against the Defendants in the state court
action.
Defendants counter that the discharge injunction enjoins BUKE from prosecuting its state
court action against them, reasoning that the adjudication of all causes of action against them that
have not been discharged due to this pending adversary proceeding court falls within the
exclusive jurisdiction of the bankruptcy court, and that any debt associated with any other state
court causes of action against them has been discharged. Finally, Defendants assert that this
Court does not have the power to modify the discharge injunction to allow BUKE to pursue its
claims against the Defendants in the state court action.
After consideration of the arguments of counsel, the relevant case law, and the applicable
sections of the Bankruptcy Code, the Court finds that upon the timely filing of a complaint
objecting to the dischargeability of a debt, the discharge injunction does not apply with respect to
that debt until the Court makes a determination of the dischargeability of the debt. Bankruptcy
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courts and state courts have concurrent jurisdiction over causes of action under applicable
nonbankruptcy law to establish the debt. The bankruptcy court has exclusive jurisdiction to
determine whether such debt should be excepted from the discharge. Based on the Court’s
determination of the scope of the discharge injunction, it need not consider whether it has the
power to modify the discharge injunction.1
UNDISPUTED FACTS
1. 	On January 15, 2010 (the “Petition Date”), Defendants commenced a voluntary
case under Chapter 7 of the Bankruptcy Code, entitled In re Randall Scott Eastburg and Lisa Sue
Eastburg, United States Bankruptcy Court, District of New Mexico, Case No. 7-10-10131 JA
(the “Bankruptcy Case”).
2. 	On the Petition Date, an action was pending in the Second Judicial District Court,
State of New Mexico captioned, BUKE, LLC, Plaintiff, v. Cross Country Auto Sales, LLC, and
other Defendants including Defendants Randall Scott Eastburg and Lisa Sue Eastburg, Case No.
CV 2009 07479 (the “State Court Action”). The State Court Action remains pending.
3. 	The complaint in the State Court Action includes the following counts: 	a)
Accounting; b) Conversion; c) Civil Conspiracy; d) Breach of Fiduciary Duty; e) Usurpation of
Corporate Opportunity; f) Unfair Competition; g) Interference with Contractual Relationship;
and h) Racketeering. See Memorandum Brief Regarding Automatic Stay, Discharge Injunction
and Issues Related to 11 U.S.C. § 523 (Docket No. 33) (“BUKE Memorandum”), p.2, ¶ 2;
Defendant’s Memorandum Brief on Automatic Stay, Discharge Injunction and § 523 Actions
(Docket No. 25) (“Eastburg Memorandum”), p.1, ¶ 2.
1 The parties also concede that modification of the discharge injunction is no longer at issue. See Memorandum
Brief Regarding Automatic Stay, Discharge Injunction and Issues Related to 11 U.S.C. § 523 (Docket No. 33), page
9 (“. . . there is no need for modification of the discharge injunction.”); Defendants’ Reply to BUKE, LLC’s
Memorandum Brief on Automatic Stay, Discharge Injunction and § 523 Actions (“Defendants’ Reply Brief”), p.6.
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5. 	On March 3, 2010, BUKE filed this adversary proceeding objecting to the
dischargeability of certain alleged debts of the Defendants pursuant to 11 U.S.C. §523(a)(2) and
(a)(4) on theories of Conversion, Breach of Fiduciary Duty, Civil Conspiracy, and Violation of
the New Mexico Racketeering Act. See Docket No. 1.
6. 	On the same date, BUKE filed a motion for relief from the automatic stay in the
Bankruptcy Case (“Stay Motion”) and the Debtors filed a timely objection. See Bankruptcy
Case, Docket No. 19 and Docket No. 31. In the Stay Motion, BUKE requested that the Court
modify the automatic stay to allow BUKE to proceed against the Debtors in the State Court
Action.
7. 	The Stay Motion also sought modification of the stay to allow BUKE to make
adjustment to the capital accounts and membership interest of the Debtors. The request for relief
from stay regarding adjustments to capital accounts and membership interests has been resolved
by an agreed order entered May 24, 2010. 	See Bankruptcy Case, Docket No. 56.
8. 	The Debtors were granted a discharge under 11 U.S.C. §727(a) by an order
entered April 21, 2010. See Bankruptcy Case, Docket No. 43.
9. 	On May 19, 2010, BUKE filed an Amended Verified Complaint to Determine
Non-Dischargeability of Debts, for Judgment on the Debts, for Declaratory Judgment, and for
Modification of the § 524 Discharge Injunction (“Amended Complaint”). 	See Docket No. 16.
The Amended Complaint added the following counts: 1) a count for declaratory judgment
asking the Court to determine that the discharge injunction does not apply to the claims pending
in this adversary proceeding or to the claims raised in the State Action; and 2) an alternative
count requesting the Court to modify the discharge injunction. Id.
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10. 	On July 19, 2010 BUKE and the Defendants stipulated that the automatic stay
terminated upon the entry of the Debtors’ discharge, rendering BUKE’s Stay Motion moot. See
Bankruptcy Case, Docket No. 79.
DISCUSSION
The issue before the Court, at its core, is whether BUKE’s claims against Defendants in
the State Court Action can be litigated in that action or whether they must be litigated in this
adversary proceeding. BUKE contends that it is free to prosecute its claims against Defendants
in the State Court Action because the automatic stay terminated and the discharge injunction is
inapplicable until a determination of dischargeability has been made. Defendants assert that
because the bankruptcy court has exclusive jurisdiction to determine dischargeability issues, this
Court has exclusive jurisdiction to determine BUKE’s claims against them asserted in the State
Court Action. BUKE counters that the State Court has concurrent jurisdiction to determine the
amount and validity of its claims against the Defendants, and, once that determination has been
made, the Bankruptcy Court determines whether such claims are dischargeable.
Termination of the Automatic Stay
The parties agree that the stay terminated upon the entry of the order discharging the
Defendants in their Bankruptcy Case, and that the discharge injunction does not apply to a debt
when a timely objection to dischargeability of the debt is made under 11 U.S.C. § 523(a)(2), (4)
or (6) unless and until the bankruptcy court determines that the debt is discharged. The Court
agrees that the parties’ stipulation is a correct application of the law.
Bankruptcy Code § 362(c)(2)(C) provides that, except as to property of the estate, the
automatic stay terminates in an individual debtor chapter 7 case when the discharge is granted or
denied under 11 U.S.C. § 707(b). Defendants were granted a discharge under 11 U.S.C. §727(a)
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by an order entered April 21, 2010. See Bankruptcy Case, Docket No. 43. Consequently, the
stay terminated with respect to prosecution of claims against the Defendants.2
Applicability of the Discharge Injunction
Bankruptcy Code §§ 523(a) and (c) and (d) contemplate that a debt is not discharged if a
timely complaint is filed objecting to discharge of the debt under 11 U.S.C. § 523(a)(2), (4) or
(6) unless and until the court denies the objection.3 Here, because there has been no
determination of the dischargeability of the debt that BUKE seeks in this adversary proceeding to
except from the discharge, the discharge injunction is not yet applicable to that debt.
This conclusion, however, does not end the inquiry. Prosecution of a cause of action
against a debtor in state court after the entry of the discharge injunction to collect a debt as a
personal liability of the debtor is outside the scope of the discharge injunction4 only if there
exists the required nexus between prosecution of the cause of action in state court and the
2 See In re Hiles, 2002 WL 32709406, at*4 (Bankr.C.D.Ill. Aug. 15, 2002)(“Pending motions for relief from the
automatic stay that are preempted by termination of the stay by operation of law pursuant to Section 362(c) are moot
and should be dismissed.”)(citing Madison Nat’l Bank v. Chiapelli, 131 B.R. 354 (E.D.Mich.1991)).
3See, e.g., In re Redburn, 193 B.R. 249, 261 (Bankr.W.D.Mich. 1996)(stating that “[t]he proper conclusion is that a
debt (in this case, a noncontingent liquidated debt) is not discharged until after the trial in the chapter 7 proceeding
when the bankruptcy court holds the debt to be dischargeable. It is at this time when any state court judgment is
voided, pursuant to § 524(a)(1), and the discharge injunction becomes effective, under § 524(a)(2).”); In re Mitchell,
255 B.R. 345 (Bankr. D.Mass. 2000)(relying on the reasoning in Redburn to conclude that the debtors exceeded the
eligibility limits for Chapter 13 relief where debt from prior case had not been discharged); In re Gray, 2000 WL
34239244, at *5 (W.D. Wis. Apr. 12, 2000)(stating that [t]he discharge order did not discharge the debts that
creditors-appellees contested in their dischargeability complaint[ ]” and holding further that “[b]ecause the
automatic stay of creditors-appellees’ state court suit was not converted into an injunction, the bankruptcy judge did
not violate the § 524(a) statutory injunction by granting . . . relief from the stay to pursue their claims.”); In re
Massa, 217 B.R. 412, 421 (Bankr. W.D.N.Y. 1988)(reasoning that because § 523 was in play, no determination had
been made as to whether the claim was discharged, so that further proceedings to collect the claim and have the
issue of dischargeability determined did not violate the discharge injunction). But cf. In re Edler, 416 B.R. 147, 152
(Bankr. E.D.Pa. 2009)(suggesting that “unless [creditor] prevails in the pending § 523(a) dischargeability
proceeding, resumption of his litigation against the Debtor in state court would run afoul of the discharge
injunction” and stating further that, where the stay terminates upon the entry of the discharge, “creditors typically
forbear from resuming collection activity until resolution of a pending dischargeability proceeding in bankruptcy
court, especially proceedings based on § 523(a)(4) or (6), over which the bankruptcy court has exclusive
jurisdiction.”).
4 Bankruptcy Code §524(a)(2) provides:
[the discharge injunction] operates as an injunction against the commencement or continuation of an action,
the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the
debtor, whether or not discharge of such debt is waived;
11 U.S.C. §524(a)(2)
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determination in bankruptcy court of the non-dischargeability of the debt. Otherwise, there
would be no limit on what claims could be prosecuted in state court while a non-dischargeability
action is pending. 	The scope of claims against a debtor that a plaintiff may pursue once the
discharge is entered depends on whether the following requirements are met: 1) the cause of
action to establish the debt and a claim of non-dischargeability in a pending adversary
proceeding are based on the same conduct, transactions and occurrences; 2) the non-
dischargeable character of the debt is at issue in the adversary proceeding; and 3) the creditor is
prosecuting the cause of action in state court for the purpose of applying collateral estoppel to
avoid relitigating the validity and extent of the debt in the adversary proceeding.5 Provided these
three requirements are met, prosecution of a cause of action against the debtor in state court after
the debtor is granted a discharge, in furtherance of the collection, recovery, or offset of any debt
as a personal liability of the debtor, does not violate the discharge injunction.
These requirements are consistent with the protection afforded by the discharge
injunction, the purpose of which is to afford the debtor with a financial fresh start,6 and the
5When the elements of the underlying cause of action satisfy all required elements under a subsection of 11 U.S.C. §
523, a debt arising from a state law cause of action can support a non-dischargeability claim. See, e.g., In re Lopez,
2010 WL 1735503 (9 th Cir. Apr. 29, 2010)(applying collateral estoppel to state court judgment based on
misappropriation of trade secrets under California Civil Code §3426.1 in order to hold the debt non-dischargeable
under 11 U.S.C. § 523(a)(6)); In re Porter, 539 F.3d 889 (8 th Cir. 2008)(judgment against debtor arising from state
employment retaliation case was entitled to collateral estoppel effect to support non-dischargeability action for
willful and malicious injury under 11 U.S.C. § 523(a)(6)); In re Duncan, 448 F.3d 725 (4 th Cir. 2006)(finding that
wrongful death judgment was not entitled to collateral estoppel effect, but remanding case to bankruptcy court for
determination of whether the debt was non-dischargeable under 11 U.S.C. § 523(a)(6)). See also In re Wallace, 840
F.2d 762, 765 (10 th Cir. 1998)(stating that “collateral estoppel is binding on the bankruptcy court and precludes
relitigation of factual issues if (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” (citations omitted) and concluding that collateral estoppel
applied to preclude relitigation of a state court determination of embezzlement under state law in a non-
dischargeability action under 11 U.S.C. §523(a)(4)).
6 Green v. Welsh, 956 F.2d 30, 33 (2 nd Cir. 1992)(the protection afforded by the discharge injunction furthers a
primary purpose of the Bankruptcy Code, which is to give the debtor the opportunity to make a “financial ‘fresh
start.’”)(quoting In re Jet Florida Systems, Inc. 883 F.2d 970, 972 (11 th Cir. 1989)(per curiam)); In re Laboy, 2010
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inapplicability of the discharge injunction to a debt until it is determined in a pending adversary
proceeding whether the debt is excepted from the discharge.
BUKE’s Amended Complaint includes forty-one general allegations and asserts the
following separate counts based on those general allegations: conversion, breach of fiduciary
duty, civil conspiracy, and violation of the New Mexico Racketeering Act based on fraud,
larceny and embezzlement. The State Court Action includes the following additional counts that
were not specifically pled in the Amended Complaint: accounting, usurpation of corporate
opportunity, unfair competition, and interference with contractual relations. Defendants assert
that only the claims for breach of fiduciary duty and fraud have not been discharged, and that
BUKE’s prosecution of its other causes of action against Defendants in state court would violate
the discharge injunction.
In this adversary proceeding BUKE has timely filed claims contesting the
dischargeability of debt premised on 11 U.S.C. § 523(a)(2)(A) and (a)(4). The causes of action
raised in the State Court Action can establish the debt, and the adversary proceeding will
determine the dischargeable character of the debt under those Code sections. The dischargeable
character of claims for fraud are at issue as the result of BUKE’ non-dischargeability claim under
11 U.S.C. § 523(a)(2)(A). The dischargeable character of claims for breach of fiduciary duty,
embezzlement and larceny are at issue as the result of BUKE’s non-dischargeability claim under
11 U.S.C. § 523(a)(4).
In its brief, BUKE states that it does not seek any damages or recovery against the
Defendants in the State Court Action on its claims for an accounting, interference with
contractual relations and unfair competition. See BUKE Memorandum, p. 2, ¶3 and p. 3, ¶ 8.
WL 427780, at *5 (Bankr. D.Puerto Rico Feb. 2, 2010)(same). See also In re Walker, 927 F2d. 1138, 1141 (10 th
Cir. 1991)(recognizing that the discharge injunction affords the debtor a fresh start in economic life).
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Thus any claim against Defendants for an accounting, interference with contractual relations or
unfair competition is not asserted to establish a debt with respect to which its non-dischargeable
character is at issue in this adversary proceeding, and assertion of such claims against the
Defendants would be subject to the discharge injunction if asserted in furtherance of the
collection, recovery or offset of any debt as a personal liability of the Defendants.7
BUKE characterizes several of its state law claims as non-dischargeable claims under 11
U.S.C. § 523(a)(6). 	For example, BUKE contends that its claims for usurpation of corporate
opportunity (pled in the State Action but not pled in this adversary proceeding) and for civil
conspiracy (pled in both the State Action and this adversary proceeding) are premised on
Defendants’ willful and malicious conduct. Pursuant to 11 U.S.C. § 523(a)(6), debts resulting
from a “debtor’s willful and malicious injury by the debtor to another entity or to the property of
another entity” are non-dischargeable. 11 U.S.C. § 523(a)(6). But the Amended Complaint does
not include a non-dischargeability claim under 11 U.S.C. § 523(a)(6). Thus the claims for
usurpation of corporate opportunity and civil conspiracy are not asserted to establish a debt with
respect to which its non-dischargeable character is at issue in this adversary proceeding.
Consequently, assertion of those claims against the Defendants is subject to the discharge
injunction.8 In addition, even though Defendants stipulated that BUKE’s claim for conversion
has not been discharged, the non-dischargeable character of a claim for conversion requires a
7 See, Hiles, 2002 WL 32709406 at *3 (“[T]he discharge injunction prevents suits from continuing only with
respect to the personal liability of the debtor and that it does not preclude a determination of the debtor’s liability on
the basis of which indemnification would be owed by another party.)(citing Hawxhurst v. Pettibone Corp., 40 F.3d
175 (7 th Cir. 1994)(remaining citations omitted). Even if assertion of a claim for an accounting were subject to the
discharge injunction, the discharge injunction would not preclude the Plaintiff from seeking an accounting as part of
discovery relevant to assertion of a claim that is not subject to the discharge injunction.
8 Defendants’ argument that because such causes of action are not specifically enumerated in 11 U.S.C. § 523, they
can never support a non-dischargeability claim is incorrect. But because the Amended Complaint does not now
include a non-dischargeability count under 11 U.S.C. § 523(a)(6), BUKE cannot litigate the underlying claims raised
in the State Court Action that might support a non-dischargeability claim under 11 U.S.C. § 523(a)(6) to judgment
and then return to the Bankruptcy Court to determine the non-dischargeable character of the debt (i.e., whether the
debt is non-dischargeable under § 526(a)(6) as a debt for willful or malicious injury).
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non-dischargeability claim under 11 U.S.C. § 523(a)(6). Thus, assertion of that claim against the
Defendants is also subject to the discharge injunction.9 Unless and until the Amended Complaint
in this adversary proceeding is amended further pursuant to Rule 15, Fed.R.Civ.P., made
applicable to adversary proceedings by Rule 7015, Fed.R.Bankr.P., 10 to specifically plead a
non-dischargeability claim under 11 U.S.C. § 523(a)(6), premised on the additional counts raised
in the State Court Action, BUKE has not put those additional causes of action at issue for
purposes of dischargeability and may not prosecute those causes of action in state court.
BUKE asserted a claim against Defendants in both this adversary proceeding and in the
State Court Action under the New Mexico Racketeering Act (“RICO”). The RICO claim
asserted in this adversary proceeding is alleged to arise out of larceny, fraud and embezzlement.
The Court does not have before it Plaintiff’s complaint in the State Court Action. If BUKE has
asserted a RICO claim against Defendants in the State Court Action alleged to arise out of
larceny, fraud and embezzlement based on the same conduct, transactions and occurrences as the
RICO claim asserted in this adversary proceeding, for the purpose of applying collateral estoppel
to avoid relitigating here the validity and extent of the debt established under that claim, then
such prosecution of the claim is not subject to the discharge injunction. The dischargeable
character of the claim is at issue in this adversary proceeding as the result of BUKE’s non-
dischargeability objections under 11 U.S.C. §§ 523(a)(2) and (4).11
9 By the express terms of 11 U.S.C. §524(a)(3) the discharge injunction applies even if it has been waived.
10 In accordance with Rule 15, Fed.R.Civ.P., “a party may amend its pleading only with the opposing party’s written
consent or the court’s leave” which should be freely given “when justice so requires.” Rule 15(a)(2), Fed.R.Civ.P.
Amendments will relate back to the date of the original pleading when “the amendment asserts a claim . . . that arose
out of the conduct, transaction, or occurrence set out -- or attempted to be set out – in the original pleading.” Rule
15(c)(1)(B), Fed.R.Civ.P.
11 See In re Daily, 47 F.3d 365, 367-68 (9th Cir. 1995) (collateral estoppel effect given to issues determined in
connection with a judgment under a racketeering statute, resulting in a determination that the debt was non-
dischargeable under11 U.S.C. § 523(a)(2)); In re Markarian, 228 B.R. 34 (1st Cir. BAP 1998)(collateral estoppel
effect could be given to jury’s finding of actual fraud in RICO action that was subsequently affirmed on appeal on
narrower grounds to determine that the resulting debt was non-dischargeable under11 U.S.C. § 523(a)(2)(A)); In re
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Defendants rely on In re Nemovitz, 142 B.R. 472, 474 (Bankr.M.D.Fla. 1992) for the
proposition that a debt arising from a state law cause of action cannot be non-dischargeable,
including a cause of action under a racketeering statute, because “all actions seeking a
determination of non-dischargeability of a debt must stand or fall on the provisions of § 523 of
the Bankruptcy Code.” Nemovitz, 142 B.R. at 474. The Court agrees that establishing a debt
under state law is not sufficient to establish that the debt is non-dischargeable under 11 U.S.C §
523. The plaintiff must also establish that the acts that gave rise to the debt support a
determination that the debt is excepted from the discharge under 11 U.S.C. § 523(a). 	However,
the debt may be established under state law, whereas the non-dischargeable character of the debt
is determined by the bankruptcy court under 11 U.S.C. § 523(a). See In re McKendry, 40 F.3d
331 (10 th Cir. 1994)(discussed below). See also Cohen v. de la Cruz, 523 U.S. 213, 118 S.Ct.
1212 (1998) (a debt based on conduct that constituted fraud under the New Jersey Consumer
Fraud Act that also satisfies the elements of 11 U.S.C. § 523(a)(2)(A) is non-dischargeable).
Concurrent Jurisdiction of State Court to Determine Claims in the State Court Action
Defendants argue that the state court has no jurisdiction to determine any claims pending
against Defendants that have not been discharged because determination of such claims is within
this Court’s exclusive jurisdiction over dischargeability actions. This argument fails. Although
bankruptcy courts have exclusive jurisdiction to determine whether a debt is nondischargeable
under 11 U.S.C. § 523(a)(2), (4) or (6), bankruptcy courts and state courts have concurrent
jurisdiction to adjudicate claims arising under applicable non-bankruptcy law.
Bankruptcy Code § 523(c) provides:
Nix, 92 B.R. 164 (Bankr N.D. Tex.)(collateral estoppel effect given to finding made in connection with a judgment
under a racketeering statute resulting in a determination that the debt was non-dischargeable under11 U.S.C. §
523(a)(2)).
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Except as provided in subsection (a)(3)(B) of this section, the debtor shall be
discharged from a debt of a kind specified in paragraph (2), (4), or (6) of
subsection (a) of this section, unless, on request of the creditor to whom such debt
is owed, and after notice and a hearing, the court determines such debt to be
excepted from discharge under paragraph (2), (4), or (6), as the case may be, of
subsection (a) of this section.
11 U.S.C. § 523(c).12
This provision vests jurisdiction exclusively in the bankruptcy court to determine whether a debt
of the kind specified in 11 U.S.C. § 523(a)(2), (4) or (6) will be excepted from the discharge,13
unless 11 U.S.C. § 523(a)(3)(B) applies.14
Adjudication of claims in state court to establish the validity and extent of a debt arising
under applicable non-bankruptcy law is not within the exclusive jurisdiction of the bankruptcy
court to determine whether a debt will be excepted from the discharge. Bankruptcy courts in
appropriate circumstances can modify the automatic stay to permit state court litigation to
proceed to judgment for the purpose of establishing a debt at issue in a pending non-
dischargeability action so that collateral estoppel may be used to limit what may subsequently be
raised in the non-dischargeability action.15 The automatic stay, like the discharge injunction,
12 The phrase “after notice and a hearing,” which is defined in 11 U.S.C. §102(1), refers to notice and an opportunity
for a hearing before the bankruptcy court.
13 In re Smith, 125 B.R. 630, 631 (Bankr.E.D.Okla. 1991)(noting that “[o]nly those actions based in § 523(a)(2), (4),
and (6) are within the exclusive jurisdiction of the Bankruptcy Court.”); In re Culley, 347 B.R. 115 (10 th Cir. BAP
2006)(unpublished)(stating that “the bankruptcy court correctly concluded that § 523(c) accorded it exclusive
jurisdiction to determine the dischargeability of debts described in § 523(a)(2), (4), (6), and (15), and that the
deadline for these actions had passed.); In re Adamson, 2010 WL 2635631, *2 (Bankr. D. Dist. Col. June 28,
2010)(noting that “Section 523(c)(1) gives the bankruptcy courts exclusive jurisdiction to determine the
dischargeability of debts excepted from discharge under paragraph (2), (4) or (6) of section 523(a).”)(citations
omitted); 4 Collier on Bankruptcy ¶ 523.29 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.). See also Grogan
v Garner, 498 U.S. 279, 284, 111 S.Ct. 654, 657-58, n10 (1991)(“The 1970 amendments took jurisdiction over
certain dischargeability exceptions, including the exceptions for fraud, away from the state courts and vested
jurisdiction exclusively in the bankruptcy courts.”); In re Wallace, 840 F.2d 762, 764 (10 th Cir. 1998) ([T]he
bankruptcy court in a dischargeability action under section 523(a) ultimately determines whether or not a debt is
dischargeable . . .”).
14 Section 523(a)(3)(B), which applies to certain debts that are unscheduled or not timely scheduled, does not apply
here.
15 The stay may be modified because a state court’s adjudication of claims, and the subsequent use of collateral
estoppel to bar relitigation of factual issues decided in state court, is consistent with a bankruptcy court’s exercise of
exclusive jurisdiction over objections to discharge under 11 U.S.C. § 523(a)(2), (3) and (6). See, e.g., In re Burgess,
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does not divest state courts of jurisdiction over a stayed or enjoined action, it prevents state
courts from exercising their jurisdiction. When the stay is modified, the state court may exercise
its concurrent jurisdiction to determine the validity and extent of the debt with respect to which
its dischargeable character is at issue in a pending non-dischargeability action. Similarly,
termination of the stay by operation of the Bankruptcy Code as a result of entry of a discharge
under 11 U.S.C. § 727(a), rather than by modification of the stay by the Court, permits the state
court to exercise such concurrent jurisdiction.
The Court finds support for this conclusion in In re McKendry, 40 F.3d 331 (10th Cir.
1994). In McKendry, the Tenth Circuit reversed the bankruptcy court’s determination that the
plaintiff’s non-dischargeability action was time-barred based on the expiration of the state law
statute of limitations on fraud which formed the basis of plaintiff’s claim. McKendry, 40 F.3d at
337. The plaintiff in McKendry had reduced its debt to judgment in state court, establishing both
the existence and the amount of the debt, and later sought a determination of non-
dischargeability from the bankruptcy court, alleging that the debt was procured by fraud.
McKendry pointed out that there are two separate causes of action in bankruptcy court: 1) a
cause of action to establish the debt; and 2) a cause of action to determine whether the debt is
discharged. 40 F.3d at 336 (citing In re Moran, 152 B.R. 493, 495 (Bankr.S.D.Ohio 1993)). The
Tenth Circuit held that, provided the plaintiff establishes the debt through the underlying state
245 B.R. 871, 876 (Bankr D. Colo. 2000) (“While the determination of whether a debt is dischargeable under
section 523(c) is exclusively within the province of the bankruptcy court, the facts which may form the basis for
such a determination may be litigated in state court.) (citations omitted). Williams v. Horowitz (In re Horowitz),
2010 WL 814103, at *5 (Bankr. E.D.N.Y. Mar. 1, 2010) (stay modified to allow the state court action to proceed to
judgment, but enforcement of any judgment remained stayed, with plaintiffs to return to bankruptcy court for
determination of dischargeability based on findings of fact issued in the state court action); In re Milam, 2010 WL
341411 (Bankr. D. Kan. 2010) (same); Mercado v. Fuchs (In re Fuchs), 2006 WL 6543977 (Bankr. N.D. Tex 2006)
(same). Cf. Laurent v. Ambrose (In re St. Laurent), 991 F.2d 672, 676 (11 th Cir. 1993) (use of collateral estoppel to
bar a bankruptcy court from relitigating factual issues previously decided in state court is consistent with the
bankruptcy court’s exercise of exclusive jurisdiction to determine dischargeability).
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court action within the applicable state law statute of limitations, the plaintiff is not precluded by
the state law statute of limitations from bringing a subsequent timely-filed non-dischargeability
action based on fraud in bankruptcy court even if the state law cause of action is premised on a
theory of recovery other than fraud. Id. at 337. The applicable limitations period to establish that
a debt under state law is the applicable state law statute of limitations, whereas the applicable
time limit for dischargeability claims is found in Rule 4007, Fed.R.Bankr.P. 16 See McKendry, 40
F.3d at 336 (supporting its conclusion by reference to Rule 4007(c)).
The bankruptcy court and state court have concurrent jurisdiction over the cause of action
to establish the debt under applicable nonbankruptcy law. The bankruptcy court has exclusive
jurisdiction over the cause of action to determine whether the debt is excepted from the
discharge.
CONCLUSION
After the debtor is granted a discharge, neither the automatic stay nor the discharge
injunction nor the bankruptcy court’s exclusive jurisdiction over dischargeability actions
precludes a plaintiff from prosecuting a cause of action against a debtor in state court in
furtherance of the collection, recovery or offset of any debt as a personal liability of the debtor
provided (1) the cause of action to establish the debt under applicable non-bankruptcy law and a
claim of non-dischargeability are based on the same conduct, transactions and occurrences, 2)
the non-dischargeable character of the debt is at issue in an adversary proceeding, and 3) the
creditor is prosecuting the cause of action in state court for the purpose of applying collateral
estoppel to avoid relitigating in bankruptcy court the validity and extent of the debt in the non-
dischargeability adversary proceeding. Nevertheless, the bankruptcy court may still act as
16 Pursuant to Rule 4007, Fed.R.Bankr.P., complaints objecting to the dischargeability of a particular debt must be
filed “no later than 60 days after the first date set for the meeting of creditors under § 341(a).” Rule 4007(c),
Fed.R.Bankr.P.
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gatekeeper to determine whether those claims are to be litigated in state court or bankruptcy
court. A debtor-defendant may timely remove the claims against the debtor to bankruptcy court
pursuant to 11 U.S.C. §1452(a) and Rule 9027, Fed.R.Bankr.P.,17 and then move under Rule 42,
Fed.R.Bankr. P., to consolidate the removed action with the pending non-dischargeability action.
The plaintiff may then move to remand. 18 In addition, in appropriate circumstances the debtor
may seek an injunction under 11 U.S.C § 105(a) to stay the prosecution of claims in the state
court action.19
Defendants did not timely seek to remove the State Court Action to this Court and have
not requested the Court to stay the State Court Action. Thus, BUKE is not precluded from
17 See Retirement Systems of Alabama v. Merrill Lynch & Co., 209 F.Supp.2d 1257,1264 (M.D. Ala. 2002) (Section
“1452 authorizes a party to remove a particular ‘claim or cause of action’ that touches on the administration of a
bankruptcy estate, but not an entire ‘action’ involving claims and other parties that may have nothing to do with the
bankruptcy.”); Stefanik v. Ovsenik, 2007 WL 2156362, at *2 (M.D.N.C. July 24, 2007) (in an action with multiple
defendants, 28 U.S.C § 1452(a) allows the debtor to remove any claim or cause of action against the debtor); Willett
v. Willett, 1996 WL 910907, at *5 (Bankr. E.D.Va. May 9, 1996)(a portion of a proceeding may be removed if
what is removed is a severable claim or cause of action)(citing Bank of Delaware v. Houghton (In re Straughn, 10
B.R. 28, 29 (Bankr. D.Del. 1980)). In addition, regarding the inapplicability of the “unanimity rule” to removal
under 11 U.S.C. § 1452, which requires all defendants to consent to removal of an action, see Daleske v. Fairfield
Communities, Inc., 17 F.3d 321, 323 (10th Cir. 1994)(unlike 11 U.S.C. § 1441 that permits “‘defendants’ to remove
‘any’ civil action over which the district court has original jurisdiction”, 11 U.S.C. § 1452(a) “allows any ‘party’ to
remove cases within the district court’s bankruptcy jurisdiction”); In re Terry Mfg. Co. Inc., 324 B.R. 147, 151
(Bankr. M.D.Ala. 2005) (the unanimity rule does not apply to removal under 11 U.S.C. §1452); Newby v Enron
Corporation (In re Enron Corp. Sec., Derivative & “ERISA” Litigation), 2004 WL 1237497, at *25 (S.D. Tex
2004) (same). But see Ross v. Thousand Adventures of Iowa, Inc., 178 F.Supp.2d 996, 1001-02 (S.D. Iowa 2001)
(holding that removal based on bankruptcy jurisdiction requires unanimity of defendants)..
18 See Thomson v. Able Supply Co., 179 F. Supp.2d 693 (W.D. Tex 2002) (court considers whether to abstain from
hearing and remand the portion of the claims pending in state court that had been removed to the bankruptcy court
and then transferred to the district court); Broyles v.U.S. Gypsum Co., 266 B.R. 778 (E.D. Tex. 2001)(same).
19 See In re Crocker, 362 B.R. 49, 57 (1st Cir.BAP 2007) (concluding that “the bankruptcy court had the authority
under § 105(a) to stay the state court action and did so to preserve its jurisdiction over the dischargeability issues to
be filed by Debtors in the adversary proceeding within the reopened bankruptcy case.”); In re Birting Fisheries, Inc.,
300 B.R. 489, 497 n.7 (9th Cir.BAP 2003)(noting that the legislative history of 11 U.S.C § 105(a) indicates that §
105 is a statutory exception to the Anti-Injunction Act, 28 U.S.C. §2283, which proscribes a court of the United
States from issuing an injunction to stay state court proceedings); In re AS Management Services, Inc., 2007 WL
2100514, at *5-6 (Bankr. S.D.Fla. July 12, 2007)(using its powers under U.S.C § 105(a) to enjoin the plaintiffs and
their attorneys, agents, and representatives from prosecuting certain claims in a pending state court action that were
also pending in an adversary proceeding in bankruptcy court); Edler, 416 B.R. at 152 (“To the extent that a creditor
might contend that it has the right to proceed in state court after termination of the automatic stay because the
discharge injunction is inapplicable to the debt whose dischargeability is as yet undetermined, it would be within the
bankruptcy court’s power to restrain the creditor from proceeding in state court pending the conclusion of the
dischargeability proceeding.”)(citing 11 U.S.C. § 105).
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pursuing its claims in the State Court Action against Defendants for fraud, breach of fiduciary
duty, and RICO for the purpose of establishing facts pertinent to the non-dischargeability claims
raised and preserved in this adversary proceeding. However, in order to preserve any
dischargeability claim premised on 11 U.S.C. § 523(a)(6), it must seek to further amend its
complaint. 	An order consistent with this Memorandum Opinion will be entered.
__________________________________
ROBERT H. JACOBVITZ
United States Bankruptcy Judge
Date entered on docket: 	August 23, 2010
COPY TO:
William R. Keleher
Attorney for Plaintiff
PO Box 2168
Albuquerque, NM 87103
Chris W. Pierce
Attorney for Defendants
2632 Mesilla St. NE
Albuquerque, NM 87110
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