United States Court of Appeals
For the First Circuit
No. 00-9010
IN RE: ROBERT T. SPIGEL
Debtor
GLENN MCCRORY & ANN MCCRORY,
Plaintiffs, Appellants,
v.
ROBERT T. SPIGEL,
Defendant, Appellee.
APPEAL FROM THE BANKRUPTCY APPELLATE PANEL
OF THE FIRST CIRCUIT
Before
Lynch, Circuit Judge,
Bownes, Senior Circuit Judge,
and Lipez, Circuit Judge.
James A. Currier for Appellants.
Marty C. Marran for Appellee.
August 13, 2001
LIPEZ, Circuit Judge. Glenn and Ann McCrory appeal from
the judgment of the Bankruptcy Appellate Panel (BAP) reversing the
bankruptcy court and holding that the debt owed them by Robert Spigel
as a result of a Rhode Island Superior Court judgment was not exempt
from discharge pursuant to 11 U.S.C. § 523(a)(2)(A). The McCrorys
claim that the collateral estoppel effect of the Superior Court
judgment creating the debt establishes that Spigel committed fraud in
a transaction related to that debt, and hence that debt should be
exempt from discharge. The BAP disagreed, concluding that the Superior
Court did not find that Spigel engaged in fraud, thereby precluding
reliance on collateral estoppel. We disagree with the BAP's analysis
because the Superior Court judgment reflected findings that Spigel
engaged in fraudulent conduct. However, that judgment did not
establish a sufficient link between Spigel's fraudulent conduct and the
debt Spigel owes the McCrorys to allow an exception to discharge under
§ 523(a)(2)(A) on the basis of collateral estoppel. Consequently, we
affirm for a different reason.
I.
The facts in this case are drawn from the judgment and record
of the Rhode Island Superior Court. The McCrorys are owners of an
unincorporated business, Frenchtown Auto Sales, that services and sells
automobiles in North Kingstown, Rhode Island. At some point prior to
the events at issue here, the McCrorys entered into a verbal agreement
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with Spigel concerning Frenchtown's business. First, the McCrorys
wanted an independent contractor to perform all of their service work.
Spigel formed a corporation called A Smiling Mr. Bob Enterprises, Inc.
(Smiling Mr. Bob), and the McCrorys agreed to have that corporation
service automobiles at the Frenchtown lot. Second, the McCrorys hired
Spigel individually as a sales agent. Under Rhode Island law, an
individual can only sell six cars per year. To sell more, a special
license is required. Spigel did not have the requisite license, so the
McCrorys extended to him the authority to use their license to sell and
buy cars, provided that Spigel did so either at auctions or on the
Frenchtown lot.
The transaction that underlies the debt at issue here began
when Spigel received a phone call from a nephew who sold cars in New
York. This nephew had three cars with New Jersey titles that he wished
Spigel to sell for him. Spigel took delivery of the cars and sold all
three, one to Tarbox Motors and two to Apollo Auto Sales. Both buyers
were Rhode Island dealers. Spigel used the McCrorys' license number to
authorize all three sales, even though none of the sales were conducted
in accordance with the limited grant of authority given to him by the
McCrorys. The sales did not occur at auction or on the Frenchtown lot.
Although Spigel claimed that he had called an unidentified
police officer to run the cars' vehicle identification numbers (VIN's)
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to ensure their legitimacy, the cars were, in fact, stolen.1 Apollo
discovered this problem soon after the sale, when it performed its own
check of the VIN's. Informed of the problem, Spigel refunded the
purchase price of both cars and then called Tarbox to stop any sale of
the car he had sold them. Spigel did not, however, refund the purchase
price to Tarbox or take any other action to reimburse Tarbox,
apparently lacking the funds to do so. Tarbox submitted a claim to its
insurer for the loss associated with the stolen car. The insurer paid
the claim and then, rather than suing Spigel for the loss, proceeded
before the Rhode Island Motor Vehicles Dealers Commission to get
reimbursement from the McCrorys through Spigel's use of the McCrorys'
license to sell a stolen car. Before the commission contacted them
concerning this complaint, the McCrorys had not known of Spigel's sales
to Tarbox and Apollo. The McCrorys claimed, in their defense, that
Spigel had acted on his own. The commission rejected this defense and
ordered the McCrorys to reimburse Tarbox's insurer the $18,000 purchase
price that Tarbox had paid Spigel for the car.2
After working out an arrangement to pay Tarbox's insurer, the
McCrorys instituted an action against Spigel in the Rhode Island
1 At some point following the events described here, Spigel's
nephew was incarcerated. It is not clear from this record whether that
incarceration was related to the sale of the stolen vehicles.
2 The record does not reveal the precise basis of the
commission's ruling.
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Superior Court. In due course, the McCrorys filed a motion for summary
judgment seeking to ground the liability of Spigel on a theory of
equitable indemnification. Although the Superior Court found that both
Spigel and the McCrorys were liable to Tarbox, it also concluded that
Spigel had, through a transaction that failed to "bear any indicia of
legitimacy," been entirely at fault in causing Tarbox's loss. The
court noted the cars' illicit background and Spigel's unauthorized use
of the McCrorys' Rhode Island auto sales license. The cars' New Jersey
titles had obvious misspellings and two of the titles, though "with two
different previous owners," had the same control number.3 Spigel also
listed Frenchtown on the back of the titles as the buyers of the
vehicles, even though Frenchtown had no involvement at all with the
cars. Moreover, Spigel created a new Bill of Sale designed to further
the false impression that he was acting as agent for Frenchtown. This
Bill of Sale bore the heading "Specializing in high quality one owner
reconditioned vehicles. You just made a great deal. A Smiling Mr. Bob
Enterprises, Incorporated d/b/a Frenchtown Auto Sales."4 In contrast
to the opprobrium it directed at Spigel, the court found that the
3 Spigel claimed that he had not noticed the similar control
numbers because he had not had the titles at the same time.
4 The McCrorys did not see this Bill of Sale until it was shown
to them by the State Police as part of its investigation into the
Tarbox sale.
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McCrorys were blameless. Consequently, the court ordered Spigel to
indemnify the McCrorys for the money they paid to Tarbox's insurer.
Spigel appealed to the Rhode Island Supreme Court. During
the pendency of that appeal, Spigel filed for bankruptcy. The McCrorys
responded with the present adversary proceeding, seeking to have the
debt created by the Superior Court judgment deemed nondischargeable
pursuant to 11 U.S.C. § 523(a)(2)(A). The bankruptcy court stayed the
proceeding pending the Rhode Island Supreme Court's decision. Shortly
after the Supreme Court affirmed, Spigel and the McCrorys filed cross-
motions for summary judgment in the bankruptcy court, agreeing that the
court should take judicial notice of the decision and record in the
Rhode Island courts. In a terse order, the bankruptcy court granted
the McCrorys' motion and denied Spigel's, thereby ruling that Spigel's
debt to the McCrorys was nondischargeable. Spigel appealed to the BAP,
which reversed and ordered judgment in favor of Spigel. The McCrorys
now appeal.
II.
A motion for summary judgment in an adversary proceeding
under § 523(a)(2)(A) to have a debt declared nondischargeable is
governed by the same standards applicable to motions under Fed. R. Civ.
P. 56. Fed. R. Bankr. P. 7056. In reviewing the application of those
standards by the bankruptcy court, we apply "the same regimen that the
intermediate appellate tribunal must use, [while] exhibit[ing] no
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particular deference to the conclusions of that tribunal (be it the
district court or the BAP)." In re Healthco Int'l, Inc., 132 F.3d 104,
107 (1st Cir. 1997). Consequently, we review the grant of summary
judgment de novo. Stoehr v. Mohamed, 244 F.3d 206, 208 (1st Cir.
2001); In Re I Don't Trust, 143 F.3d 1, 3 (1st Cir. 1998) ("In an
appeal from a bankruptcy court decision, this court--like the district
court or the bankruptcy appellate panel--affords de novo review to the
bankruptcy court's conclusions of law."). Under the familiar summary
judgment standards, we must "determine whether 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
judgment as a matter of law." Century 21 Balfour Real Estate v. Menna,
16 F.3d 7, 9 (1st Cir. 1994) (quotations and citations omitted).
Although we view the evidence in the light most favorable to the
nonmovant, "[a]s to any essential factual element of its claim on which
the nonmovant would bear the burden of proof at trial, its failure to
come forward with sufficient evidence to generate a trialworthy issue
warrants summary judgment to the moving party." Id. (quoting Ralar
Distribs., Inc. v. Rubbermaid, Inc., 4 F.3d 62, 67 (1st Cir. 1993))
(alteration in original).
III.
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The Bankruptcy Code offers debtors, through discharge, "a new
opportunity in life and a clear field for future effort, unhampered by
the pressure and discouragement of preexisting debt." Local Loan Co.
v. Hunt, 292 U.S. 234, 244 (1934). "By seeking discharge, however,
[the debtor] place[s] the rectitude of his prior dealings squarely in
issue, for as the Court has noted, the Act limits th[e] opportunity
[for discharge] to the 'honest but unfortunate debtor.'" Brown v.
Felsen, 442 U.S. 127, 128 (1979) (quoting Local Loan Co., 292 U.S. at
244). Nevertheless, the Bankruptcy Code does not condition discharge
upon a generalized determination of the moral character of the debtor.
Instead, it specifies the types of debts that the Code deems exempt
from discharge. See, e.g., 11 U.S.C. § 523(a). Moreover,
"[e]xceptions to discharge are narrowly construed . . . and the
claimant must show that its claim comes squarely within an exception
enumerated in Bankruptcy Code § 523(a)." Century 21 Balfour Real
Estate, 16 F.3d at 9.
A. The scope of the exception to discharge.
As the party seeking to prevent Spigel from discharging his
debt to them, the McCrorys bear this burden to show that Spigel's debt
comes squarely within an exemption from discharge. They focus their
argument solely on 11 U.S.C. § 523(a)(2)(A), which exempts from
discharge a debt "for money, property, services, or an extension,
renewal, or refinancing of credit, to the extent obtained by--false
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pretenses, a false representation, or actual fraud, other than a
statement respecting the debtor's or an insider's financial condition."
11 U.S.C. § 523(a)(2)(A). Applying this language, we have said that
the statutory language does not "remotely suggest that
nondischargeability attaches to any claim other than one which arises
as a direct result of the debtor's misrepresentations or malice."
Century 21 Balfour Real Estate, 16 F.3d at 10.5 Thus, in order to
establish that a debt is nondischargeable because obtained by "false
pretenses, a false representation, or actual fraud," we have held that
a creditor must show that 1) the debtor made a knowingly false
representation or one made in reckless disregard of the truth, 2) the
debtor intended to deceive, 3) the debtor intended to induce the
creditor to rely upon the false statement, 4) the creditor actually
relied upon the misrepresentation, 5) the creditor's reliance was
justifiable,6 and 6) the reliance upon the false statement caused
5 In Century 21 Balfour Real Estate, the debt was created
through a crossclaim for equitable indemnification between the creditor
and the debtor, both of whom were named as defendants in an action
alleging fraud against the debtor and negligence against the creditor.
Id. at 8. Both defendants were held liable, after which the crossclaim
was allowed "because [the creditor's] mere negligence made it less
culpable than [the debtor], whose conduct had been found fraudulent."
Id.
6 As originally formulated in this circuit, a creditor's
reliance had to be reasonable. Commerce Bank & Trust Co. v. Burgess,
955 F.2d 134, 140 (1st Cir. 1992); Century 21 Balfour Real Estate, 16
F.3d at 10. The Supreme Court, however, has since overruled this
formulation and, drawing from the Restatement (Second) of Torts, held
that a creditor's reliance need only be justifiable. Field v. Mans,
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damage. Palmacci v. Umpierrez, 121 F.3d 781, 786 (1st Cir. 1997).
Though the first two elements of the Palmacci test describe the conduct
and scienter required to show fraudulent conduct generally, the last
four embody the requirement that the claim of the creditor arguing
nondischargeability in an adversary proceeding must arise as a direct
result of the debtor's fraud.7
Reading the statute to require such a direct link is
supported by the legislative history. Prior to 1984, some courts had
interpreted § 523(a)(2)(A) as preventing the discharge of an entire
516 U.S. 59, 70-71 (1995).
7 We note that the Seventh Circuit has recently called into
question whether the Palmacci test should properly be considered the
exclusive test to determine nondischargeability under § 523(a)(2)(A).
In McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000), that court
noted that Palmacci and similar cases have adopted a test that focuses
solely upon false representations as the total universe of fraud under
§ 523(a)(2)(A), in large part because false representations were the
only fraud before those courts. Id. at 892. § 523(a)(2)(A), however,
explicitly lists both "actual fraud" and "false representations" as
grounds for denying a discharge, a distinction in the statutory
language that the McClellan court relied upon to hold that "actual
fraud" encompasses more than misrepresentations. Id. at 892-93; see
also Mellon Bank N.A. v. Vitanovich, 259 B.R. 873, 876 (B.A.P. 6th Cir.
2001) (adopting McClellan's definition of actual fraud to evaluate
nondischargeability of a debt created by a check kiting scheme).
Though there are differences between McClellan and Palmacci–the most
significant of which concerns whether reliance is required--we do not
decide whether we would adopt the Seventh Circuit's reasoning.
McClellan is consistent with our existing precedent in that it also
requires a direct link between the alleged fraud and the creation of
the debt. McClellan, 217 F.3d at 894-95 (noting that the actual fraud
denied discharge under § 523(a)(2)(A), as opposed to constructive
fraud, requires a showing that the fraud created the debt); see also,
e.g., Century 21 Balfour Real Estate, 16 F.3d at 10.
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debt even though the fraudulent conduct of the debtor was directly
related only to a part of that debt. See, e.g., Birmingham Trust Nat'l
Bank v. Case, 755 F.2d 1474, 1477 (11th Cir. 1985) (holding that
debtor's misrepresentations regarding ownership of collateral caused
entire debt, rather than just the value of the collateral, to be
nondischargeable). Congress responded by adding "to the extent
obtained by" to § 523(a)(2), Pub. L. 98-353 § 454(a)(1)(B), a change
that other courts have interpreted as "expressly limit[ing] the
exception to discharge to the extent that [the debt] was actually
obtained by the fraudulent conduct." Muleshoe State Bank v. Black, 77
B.R. 91, 92 (N.D. Texas 1987); see also Nova Home Health Servs., Inc.
v. Casagrande, 143 B.R. 893, 899 n.6 (Bankr. W.D.Mo. 1992). Thus, in
order to prevail in the adversary proceeding, the McCrorys must show
that the debt Spigel owes to them "arises as a direct result of the
debtor's misrepresentations or malice." Century 21 Balfour Real
Estate, 16 F.3d at 10.
B. The relationship between the debt and the fraudulent conduct.
In seeking to demonstrate that Spigel's debt is
nondischargeable, the McCrorys rely exclusively upon the collateral
estoppel effect of the judgment in the Rhode Island Superior Court that
created the debt. The ordinary rules of collateral estoppel and res
judicata apply in most actions in the bankruptcy court, including
adversary proceedings under § 523(a) to except debts from discharge.
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FDIC v. Shearson-American Express, Inc., 996 F.2d 493, 497 (1st Cir.
1993); Grogan v. Garner, 498 U.S. 279, 284 n.11 (1991). But see Brown,
442 U.S. at 138 (casting doubt upon the applicability of res judicata
in § 523(a) actions). We look to state law to determine the preclusive
effect of a prior state court judgment. New Hampshire Motor Transp.
Ass'n v. Town of Plaistow, 67 F.3d 326, 328 (1st Cir. 1995). Under
Rhode Island law, for collateral estoppel, or issue preclusion, to
apply, there must be "an identity of issues; the prior proceeding must
have resulted in a final judgment on the merits; and the party against
whom collateral estoppel is sought must be the same as or in privity
with the party in the prior proceeding." Commercial Union Ins. Co. v.
Pelchat, 727 A.2d 676, 680 (R.I. 1999) (quoting State v. Chase, 588
A.2d 120, 122 (R.I. 1991)); see also Casco Indem. Co. v. O'Conner, 755
A.2d 779, 782 (R.I. 2000). The first of these requirements, the
identity of issues in both actions, creates the controversy in this
case.
Both the BAP and the McCrorys focus their attention on the
question of whether the Superior Court judgment established any fraud.
In reversing the bankruptcy court, the BAP concluded that
the essential elements of an exception to
discharge under Section 523(a)(2)(A), false
representations, false pretenses, or actual
fraud, were not plead, litigated in, or
determined by the state court. The McCrorys'
state court complaint does not mention fraud,
false representations, false pretenses,
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misrepresentation or deceit as a basis for
indemnification. Moreover, neither party, in the
summary judgment pleadings and in oral argument
before the state court, argued fraud. . . . The
judgment of the state court established the
debtor's liability under equitable
indemnification principles, not fraud.
Consequently, the BAP found that "neither res judicata or collateral
estoppel was appropriate in this case."
We have reservations about this analysis and its close
attention to the labels describing the legal theories underlying the
Superior Court judgment. Indeed, the McCrorys point to the Superior
Court's declaration that the transaction between Spigel and Tarbox bore
"no indicia of legitimacy" as a demonstration that they proved in the
state court that Spigel engaged in fraud. We agree. The Superior
Court found that Spigel held himself out during the sale to Tarbox as
an agent of Frenchtown and provided a New Jersey title for the car he
sold to Tarbox indicating that Frenchtown had been a buyer of the car.
Both of these statements were patently false. Spigel himself
acknowledged that his authority to act as an agent for Frenchtown
extended only to selling cars at auction or off the Frenchtown lot.
The Tarbox sale, however, took place on the Tarbox lot. Moreover, it
is undisputed that Frenchtown had never owned the cars.
However, this showing in the Superior Court action of
fraudulent conduct by Spigel is not identical to the fraud showing
required by § 523(a)(2)(A). The finding of the Rhode Island Superior
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Court that Spigel engaged in fraudulent conduct is, at most, identical
only to the first two elements of the Palmacci test, i.e., that Spigel
made a false statement with an intent to deceive. That finding does
not demonstrate that the McCrorys' claim "arises as a direct result of
the debtor's misrepresentations or malice," Century 21 Balfour Real
Estate, 16 F.3d at 10, as required by the remaining four elements of
Palmacci and the identity of issues element of collateral estoppel. We
explain.
In attempting to recover from Spigel the sum of their
liability to Tarbox, the McCrorys proceeded on a theory of equitable
indemnification, a theory that allows one "exposed to liability solely
as the result of a wrongful act of another . . . to recover from that
party." Muldowney v. Weatherking Prods., Inc., 509 A.2d 441, 443 (R.I.
1986); see also Helgerson v. Mammoth Mart, Inc., 335 A.2d 339, 341
(R.I. 1975) (allowing indemnification "where one person is exposed to
liability by the wrongful act of another in which he does not join").
The McCrorys had to prove three elements for the Superior Court to
resolve that claim in their favor: 1) that they, as the parties seeking
indemnification, are liable to a third party, Tarbox, 2) that the
prospective indemnitor, Spigel, is also liable to that third party, and
3) that as between the two, equity demands that the indemnitor
discharge the obligation. Wilson v. Krasnoff, 560 A.2d 335, 341 (R.I.
1989). The McCrorys satisfied the third element of their equitable
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indemnification claim by proving that Spigel had wronged Tarbox while
they were blameless for that loss. They did not prove, nor were they
required to, that Spigel had intended to harm them. See, e.g., id.
("One situation satisfying this third element is when a potential
indemnitor is at fault and the prospective indemnitee is blameless.").
Because the Superior Court was not asked to find, and did not
find, any wrongdoing by Spigel directed at the McCrorys in the creation
of his indebtedness to them, its judgment simply does not establish
that the claim of the McCrorys is "one which arises as a direct result
of the debtor's misrepresentations or malice." Century 21 Balfour Real
Estate, 16 F.3d at 10. All of Spigel's actions were directed at
Tarbox. There is no finding by the Superior Court that Spigel intended
to induce the McCrorys to rely on his false statements. Indeed, there
was no evidence before that court to support any such findings. Spigel
did not make any statements to the McCrorys at all about the Tarbox
transaction, much less false statements that the McCrorys justifiably
relied upon, with that reliance causing the debt.
All six of the Palmacci elements, however, and thus the
direct link between the fraud and the debt, are arguably present
between Spigel and Tarbox. Thus, if the Superior Court judgment for
equitable indemnification permitted the McCrorys to succeed to Tarbox's
position with respect to the transaction, they might be able to cure
the defect we have identified here. The McCrorys have not shown, as
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they must, that they stand in Tarbox's shoes. It is far from clear
that Rhode Island law permits the McCrorys as equitable indemnitees to
succeed to Tarbox's position; most likely, it does not. Silva v. Home
Indemnity Co., 416 A.2d 664, 668 (R.I. 1980); Hawkins v. Gadoury, 713
A.2d 799, 803 (R.I. 1998) (noting that though statute of limitations in
subrogation action runs from the date of the original injury, equitable
indemnification causes of action accrue upon the discharge from common
liability). Consequently, we conclude that the collateral estoppel
effect of the Superior Court judgment was an insufficient basis for
demonstrating that Spigel's debt was nondischargeable under §
523(a)(2)(A).
IV.
We understand that exceptions to discharge serve both to
punish the debtor and "concomitantly to protect the inculpable
creditor." Century 21 Balfour Real Estate, 16 F.3d at 10. The
McCrorys are inculpable creditors who are not protected by the outcome
here. However, that protective policy must be balanced against the
policy that exceptions to discharge are construed narrowly. Moreover,
the result here is not solely attributable to the strictures of the
Bankruptcy Code. In pursuing their claim under § 523(a)(2)(A), the
McCrorys relied entirely upon the collateral estoppel effect of the
Superior Court judgment instead of supplementing that judgment with
evidence that might have addressed the remaining four elements of
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Palmacci. Thus, they failed to meet their burden under § 523(a)(2)(A),
and Spigel's debt to them must be discharged.
Affirmed.
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