By Richard D. Trenk, Esq. and Joao F. Magalhaes, Esq.
Insurance carriers litigating fraud claims often look to statutory rights, for example the New Jersey Insurance Fraud Prevention Act, for relief against those who have submitted false claims or otherwise defrauded a carrier. Prevailing carriers may be subsequently confronted with debtor-defendants who attempt to frustrate collection efforts through initiating bankruptcy proceedings, which automatically invokes the jurisdiction of the United States Bankruptcy Court. Carrier-creditors must act quickly to avoid the presumptive discharge of all pre-petition debts pursuant to Title 11 of the United States Code, which is also known as the Bankruptcy Code. Depending upon the type of relief that the creditor seeks, an adversary proceeding must be filed as early as 60 days after the first date set for the meeting of creditors.
Bankruptcy Code section 523 (“Exceptions to discharge”) governs the types of debt that may be excepted from a debtor’s discharge; i.e., the debts that will not be erased as a result of the bankruptcy proceeding. Included within these exceptions, pursuant to section 523(a)(2), are debts in connection with money or other property obtained through, among other acts, false pretenses, false representations, or actual fraud. Whether a claim is non-dischargeable under the Bankruptcy Code is a matter within the sole authority of bankruptcy courts. Notwithstanding, principles of collateral estoppel – the doctrine prohibiting the relitigation of issues that have been adjudicated in a prior lawsuit – apply such that bankruptcy courts can rely upon state court findings for purposes of establishing non-dischargeability under Bankruptcy Code section 523.
For collateral estoppel to applied, it must be shown that a state court’s findings were the types of findings necessary under the subsections of Bankruptcy Code section 523. For instance, in In re Drossel, wherein judgment creditors cross-moved for summary judgment to except a state court judgment under the New Jersey Consumer Fraud Act from discharge pursuant to Bankruptcy Code section 523(a)(2)(A), the United States Bankruptcy Court for the District of New Jersey denied summary judgment because “[t]he state court opinion did not affirmatively articulate, that the Debtor’s violations were the result of his intentional conduct or that they amounted to actual fraud.” As the court further explained:
Here, the underlying state court opinion did not address the crucial elements of actual fraud such as intent, knowledge, and reliance but instead found regulatory violations for which knowledge and intent are not elements. Even though a regulatory violation of the Act has already been determined, whether the Defendant committed actual fraud when entering into the home improvement contract with the Plaintiffs is still an open issue for which Plaintiff must be afforded a “full and fair opportunity” to litigate.
The bankruptcy court’s decision in Drossel was consistent with the Third Circuit’s decision in In re Schlessinger, wherein a judgment creditor pursued non-dischargeability based on a debtor’s diversion of partnership funds. The Third Circuit held that the debtor was not collaterally estopped from denying that the damages award arose from the conduct specified by Bankruptcy Code section 523 because the issue decided in the state court was not identical to a finding that the debtor willfully and maliciously injured the partnership or its property.<a
Thus, an insurance carrier pursuing fraud claims against a defendant must be aware of whether a bankruptcy court would construe the carrier’s judgment as satisfying the elements of fraud mandated under Bankruptcy Code section 523. Carriers must be mindful of these critical points of differentiation, and should consult with a bankruptcy specialist during the pendency of a state court action to ensure that the findings made will suffice to ensure that the resulting judgment will not be nullified by a bankruptcy proceeding. In any event, if a bankruptcy filing does ensue, additional litigation within the bankruptcy court will almost certainly be necessary to determine the non-dischargeability of the debt.
 11 U.S.C. § 341(a); compare Fed. R. Bankr. P. 4004 (requiring that, in a chapter 7 case, objections to a debtor’s discharge under 11 U.S.C. § 727(a)(8) or (a)(9) must be filed no later than 60 days after the first date set for the meeting of creditors under § 341(a)) with Fed. R. Bankr. P. 4007 (providing that a complaint to determine the dischargeability of a particular debt, except under § 523(c), may be filed at any time).
 11 U.S.C. § 523(a)(2)(A).
 Grogan v. Garner, 498 U.S. 279, 284-85 n. 11 (1991).
 In re Leonelli-Spina, 426 Fed.Appx. 122, 125-26 (3d Cir. May 4, 2011) (wherein former client of debtor who had obtained state court judgment against debtor-attorney brought adversary proceeding to except judgment from discharge, holding that state court judgment finding violation of New Jersey Rules of Professional Conduct in withdrawing funds from client trust account, and in turn committing fraud, breach of contract and breach of fiduciary duty, was entitled to issue preclusive effect in non-dischargeability proceeding under 11 U.S.C. § 523(a)(4) because determination that attorney had committed fraud or defalcation while acting in fiduciary capacity was essential to judgment entered in state court lawsuit, and matter was actually litigated to final judgment on merits in proceeding in which parties were identical, and in which attorney, as party against whom preclusion was sought, had full and fair opportunity to defend).
 2007 WL 3375073, at **1, 8 (Bankr. D.N.J. Nov. 7, 2007) (denying dueling motions for summary judgment, and scheduling trial, in part on grounds that plaintiffs’ judgment was not premised upon a finding of actual fraud).
 Id. at *5.
 208 Fed.Appx. 131, 133-34 (3d Cir. Dec. 14, 2006) (explaining that (1) “embezzlement and larceny both require the appropriation or taking of another’s property[,]” and (2) “[n]egligent or reckless acts do not suffice to establish that a resulting injury is ‘willful and malicious.’”).