ARCHER v. WARNER
In 1991, Leonard and Arlene Warner sold the Warner Manufacturing Company to Elliott and Carol Archer. Subsequently, the Archers sued the Warners for fraud connected with the sale. In settling the lawsuit, the Archers executed releases except for obligations under a $100,000 promissory note and then voluntarily dismissed the lawsuit. After the Warners failed to make the first payment on the promissory note, the Archers sued in state court. The Warners filed for bankruptcy, and the Bankruptcy Court ordered liquidation under Chapter 7. The Archers then brought a claim asking the Bankruptcy Court to find the $100,000 debt nondischargeable and to order the Warners to pay the sum. The Bankruptcy Code provides that a debt shall not be dischargeable in bankruptcy "to the extent" it is "for money...obtained by...false pretenses, a false representation, or actual fraud." The Bankruptcy Court denied the Archers' claim. The District Court and the Court of Appeals affirmed.
Does the Bankruptcy Code cover a debt embodied in a settlement agreement that settled a creditor's earlier claim "for money...obtained by...fraud?"
Legal provision: Bankruptcy Code, Bankruptcy Act or Rules, or Bankruptcy Reform Act of 1978
Yes. In a 7-2 opinion delivered by Justice Stephen G. Breyer, the Court held that a debt for money promised in a settlement agreement accompanied by the release of underlying tort claims can amount to a debt for money obtained by fraud, within the nondischargeability statute's terms. "We conclude that the Archers' settlement agreement and releases may have worked a kind of novation, but that fact does not bar the Archers from showing that the settlement debt arose out of 'false pretences, a false representation, or actual fraud,' and consequently is nondischargeable," wrote Justice Breyer. Justice Clarence Thomas, with whom Justice John Paul Stevens joined, dissented.
Argument of Craig Goldblatt
Chief Justice Rehnquist: We'll hear argument first this morning in Number 01-1418, A. Elliott Archer versus Arlene L. Warner.
Mr. Goldblatt: Mr. Chief Justice, and may it please the Court:
An individual debtor at the end of a bankruptcy case will typically receive a discharge of that debtor's pre-bankruptcy debts.
That discharge, however, is subject to a number of statutory exceptions, each exception reflecting a congressional judgment that a particular category of debt be paid notwithstanding the prior bankruptcy.
Those exceptions include not only debts for money obtained by fraud, debts for injuries caused by drunk driving, and amounts due for alimony and child support.
With respect to the fraud exception at issue here, under the Bankruptcy Code and this Court's cases, a debt is nondischargeable in bankruptcy if the creditor can establish that the underlying debt arises out of an act of fraud.
The question presented in this case is whether a debt that would otherwise be nondischargeable for that reason becomes dischargeable if the parties enter into a settlement agreement that resolves the amount of the debt.
The court of appeals said that a settlement did have that effect, emphasizing that the effect of a settlement was to trade a fraud claim for a contract action that would be discharged in bankruptcy.
Justice Kennedy: Is it your understanding that if the Fourth Circuit were correct and were to be affirmed in this case, that its rule would be the generally prevailing rule in all of the States, or would certain States differ on whether or not there was, in effect, a novation when there was a settlement agreement?
Would we have to go State-by-State?
Mr. Goldblatt: No, Your Honor.
The question of dischargeability is a question of Federal law.
That is how each of the courts of appeals that have addressed the question has treated it.
Indeed, this Court, in Grogan versus Garner, has emphasized that the construction of section 523(a) of the Bankruptcy Code is a question of Federal law.
Justice Kennedy: Well, my... my question, perhaps, was not as clear as it ought to have been.
The Fourth Circuit placed substantial reliance on the fact that this was a novation under State law, that there was a new debt created superseding the old, et cetera, and my question is whether or not... if we affirm its judgment, that we will find in almost every other State a settlement is also a novation, or will the rule vary from State to State, and if it does vary from State to State, will the Fourth Circuit rule from this particular State be the majority rule or minority?
Mr. Goldblatt: Your Honor, the court of appeals did, indeed, say that the... the settlement effected a novation.
That is a common rule.
I'm unaware of any jurisdiction in which that... that wouldn't be the principle.
The question, nevertheless, before this Court is the effect as a matter of Federal bankruptcy law of that settlement.
Justice Kennedy: I'm... I'm well aware of that, but what I'm just asking is... this case came from South Carolina, was it?
Mr. Goldblatt: From North Carolina, Your Honor.
Justice Kennedy: Oh, from North Carolina.
Mr. Goldblatt: Yes.
Justice Kennedy: Is the North Carolina rule about novations and settlements the majority rule for most of the States?
In most States, would this be called a novation?
Mr. Goldblatt: Yes, Your Honor.
I'm unaware of any jurisdiction in which a settlement doesn't effect novation.
When the parties to a dispute settle that dispute, it is commonly the case that... indeed, in every jurisdiction of which I'm aware, following that settlement, the... the creditor or the plaintiff is unable to bring a new lawsuit for fraud.
Rather, the party is left to enforce the... the settlement.
Justice Ginsburg: Mr. Goldblatt, I take it you're saying, yeah, a novation is fine with you.
No longer do they have the original claim.
They have substituted for it, what the claim is, the amount of the settlement.
The... what was it, immediate payment of X dollars?
Was it 2,000?
Mr. Goldblatt: It was an immediate payment of $200,000 and a promissory note for $100,000.
Justice Ginsburg: And that's... that's what they... they say is the basis of their claim in bankruptcy.
They think... they know they can't go back to the original claim.
To that extent, it's a novation.
That's not disputed.
But there is one element of the background of this case perhaps you can clarify for me.
It's odd that Leonard Warner stipulated that this was a nondischargeable debt, but his wife, who's in the bankruptcy with him, says yes, it is dischargeable.
What is the effect of the stipulation by Leonard Warner that this debt is nondischargeable?
Mr. Goldblatt: Your Honor, Leonard Warner stipulates that the debt is nondischargeable as to him.
With respect to Mrs. Warner, it would remain our burden in bankruptcy to show that... that there is an act of fraud that is properly attributable to her, either because she committed it herself or by some principle of agency that it is nondischargeable because of her, so I... I don't believe that the... the stipulation by its terms is... is dispositive on the question of whether it is nondischargeable as... as to her.
Justice Ginsburg: But does that mean that... let's say the Fourth Circuit is affirmed, that you could still, post-bankruptcy, go after Mr. Warner because he stipulated that the debt as to him was nondischargeable?
Mr. Goldblatt: I... I believe that... that's a final and unappealable order at this point, and yes, that's right, of course.
Petitioners assert that they have the right as a matter of Federal bankruptcy law also to continue to recover on this debt as against Mrs. Warner, who also is an obligor on the promissory note.
On the essential point that, Justice Ginsburg, you were making with respect to the holding below, the description you offered is... is exactly right.
It is true that there is a novation.
It is true that the underlying claim of fraud has been released, but just... that was equally true in this Court's decision in Brown versus Felsen.
In Brown, the parties to a State court litigation resolved that litigation by agreeing to the entry of a consent judgment.
It was as equally true there, as it is here, that the parties who had been... whose litigation had ended in the consent judgment were barred, in that case by the preclusive effect of the consent judgment, here by the binding effect of the settlement, from bringing a new suit claiming fraud.
All they could do was enforce the consent judgment.
Nevertheless, this Court held in a unanimous opinion in Brown versus Felsen that in bankruptcy, the creditor nevertheless had the right to seek to establish that the underlying debt arises out of an act of fraud, and the... the reason this Court--
Justice Stevens: Well, of course, there it wasn't just the underlying debt.
It was trying to find out what the judgment actually decided.
They were... they were able to go beyond the terms of the judgment to determine what the judgment actually resolved.
I'm not quite sure it's exactly parallel--
Mr. Goldblatt: --Well, yes, Justice Stevens, that's right, and here what... what petitioners seek to do is go behind the settlement agreement--
Justice Stevens: --Yes.
Mr. Goldblatt: --and see what the settlement actually resolved.
Justice Stevens: Supposing the settlement... they had gone along with the settlement, and then they came up with a... a third proposal where the debtor said, I'm not sure I'm going to be able to meet my obligations, but I've got another proposal, we'll go in the joint venture to do something else and we'll release the contract claim and substitute a third, could you go... still continue to go behind to find out what the original source of the debt was?
Mr. Goldblatt: Yes.
Yes, Your Honor.
Justice Stevens: So even if, say, they had five or six different transactions, each of which purported to be a complete substitute for the deal they had just been unable to... you can always go... say, Well, the whole thing started because you cheated me out of something?
Mr. Goldblatt: Well... well, for each particular debt that one asserts is nondischargeable, the creditor bears the burden of proving in bankruptcy that that debt arises out of an act of fraud.
Justice Stevens: Directly or indirectly out of.
Mr. Goldblatt: That's right, but nevertheless, under Brown versus Felsen, that is the creditor's--
Justice Scalia: Suppose I have an indebtedness.
I'm running a business and I have one indebtedness, and in order to cover the payments for that indebtedness, I incur a second indebtedness which I otherwise would not have incurred, is that traceable to fraud?
Mr. Goldblatt: --If the original indebtedness arises out of an act of fraud, Justice Scalia, then... then yes, it is all debt--
Justice Scalia: Anything that happens later is... that... that wouldn't have happened but for the original indebtedness is, within the terms of the Bankruptcy Act, traceable to the fraud?
Mr. Goldblatt: --Justice Scalia, we... we certainly acknowledge that there must be some principle of, say, proximate causation.
Justice Scalia: Exactly, and that's all we're talking about here, isn't... isn't it?
How... how... you know, how far down the line do we carry traceable to, and does a novation end the traceability, but you... you have to acknowledge it has to end somewhere.
Mr. Goldblatt: There certainly is a principle of proximate causation.
You... you need to show that there is a direct connection between the act of fraud--
Justice Breyer: Wait, but what about... I mean, this doesn't make too much sense to me.
You say, A owes B $100,000 because of a fraud that A committed against B, so they settle it, and they say, our settlement arrangement is the following.
We enter into a new business called Macy's Department Store, and many years later there's another debt between the partners arising out of buying furniture for Macy's that has nothing to do with fraud, and now you're saying that that debt's going to be never dischargeable because the cause of Macy's was the fraud?
Mr. Goldblatt: --No, Justice Breyer, I'm not suggesting that there is never a point in which the causation becomes too tenuous that you can't prove that the debt that one is contending is--
Justice Breyer: No, I... absolutely.
Macy's would never have been created but for the debt, no doubt about that.
Mr. Goldblatt: --But not... not only is... is the principle of--
Justice Breyer: They never would have had this furniture argument but for the debt.
Chief Justice Rehnquist: Well, you're talking not just about cause, but proximate cause.
Mr. Goldblatt: --Exactly.
It's not just a question of but-for causation, but as in common law, proximate causation.
Justice Breyer: And what does that mean, proximate cause, then?
What's the difference between this case and Macy's?
Mr. Goldblatt: Your Honor, here, all that happened is that the... the form of the debt changed.
The parties entered into a settlement agreement in which they changed the debt from an unliquidated cause of action for fraud into a liquidated promissory note.
Justice Scalia: In... in connection with that, one side said to the other, I don't care whether this has come out of fraud or not.
Regardless of whether it came out of fraud, I'm going to give you this money, and we'll be quits.
Why isn't that enough to terminate the proximity, because the averment of both parties is, never mind fraud, it doesn't have anything to do with fraud, we're going to settle this.
Whether there was fraud or whether there wasn't fraud, you get the money.
Mr. Goldblatt: That... that's right, Your Honor, and all a creditor seeks to do in showing a debt as nondischargeable is seeks to enforce the debtor's promise to pay the amount of money given in that settlement.
Justice Scalia: That's true, but... but here it was... there was no acknowledgement of the fraud.
It was given with the averment that this debt does not hinge upon fraud.
This debt is just to settle this controversy between us whether there was fraud or whether there wasn't fraud.
Mr. Goldblatt: That's--
Justice Scalia: Why isn't that enough to terminate the proximity necessary for... for nondischargeability in bankruptcy?
Mr. Goldblatt: --Just a couple of... of answers.
First, it... it doesn't terminate the proximity any more than the consent judgment in Brown versus Felsen might have terminated the proximity in that case.
It's, of course, true that a... a consent judgment operates as a... extinguishes the prior cause of action and the claims merge into the consent judgment.
Nevertheless, this Court said in Brown versus Felsen that notwithstanding the preclusive effect of that judgment, a creditor has the right in bankruptcy to establish that the debt is traceable to fraud, and what it said is--
Justice Scalia: But doesn't a consent judgment always, at... always hinge upon the existence of a cause of action?
Mr. Goldblatt: --Presumably yes, Your Honor, and--
Justice Scalia: Whereas a settlement doesn't.
Mr. Goldblatt: --That's right, and unless the creditor can prove in bankruptcy that the debt that's now reflected in... in the settlement agreement is traceable to an act of fraud, the creditor will lose the nondischargeability action, and the only question is whether the creditor should have the opportunity to establish in bankruptcy that there is, in fact, an act of fraud that... that is reflected in and resolved by the consent judgment.
The consent judgment says expressly... it doesn't say there's no fraud.
It says that this is a compromise of disputed claims, and in exchange for the release, what the creditor got was a clear carve-out from that release for the right to enforce the $100,000 of debt that's reflected in the promissory note.
Justice Scalia: It doesn't say there's no fraud, but it does say that this indebtedness has nothing to do with whether or not there was fraud.
Whether or not there was fraud--
Mr. Goldblatt: That's right.
Justice Scalia: --this indebtedness exists.
It seems to me it severs the connection between the fraud and the indebtedness.
Mr. Goldblatt: --But it is completely silent on the question of whether fraud had occurred, just as the consent judgment in Brown v. Felsen was completely silent on the question whether that debt arose out of contract or fraud.
In Brown, this Court said that the creditor has the opportunity to look behind the fraud... to look behind the settlement to determine whether or not it was for fraud, and there... there's no difference here.
Justice Souter: Would there be... would there be a difference if the settlement had expressly said, we stipulate that there was no fraud leading to the creation of the debt of... for which this in effect is a... a novation?
Mr. Goldblatt: --Justice Souter--
Justice Souter: Would that make a difference?
Mr. Goldblatt: --Justice Souter, that would be a much harder case for reasons we set out in... in our briefs.
We contend as a matter of bankruptcy policy there are reasons why such an agreement shouldn't be enforced, but that would certainly be a much more difficult case than this one.
Justice Souter: But your argument here is we don't really have get to bankruptcy policy.
There simply has not been an agreement which eliminates the fraudulent character of the debt.
Is that basically it?
Mr. Goldblatt: That's... that's exactly right, Justice Souter.
The way this works in bankruptcy is that when the creditor files for bankruptcy with this promissory note outstanding for a hundred-and-some-thousand dollars, the creditor comes into bankruptcy and files a proof of claim saying, I have a claim of a hundred-and-somethousand dollars, and I'm entitled to my pro rata distribution on that hundred-and-some-thousand dollars.
The proof of claim is on page 82 of the joint appendix.
No one's contending that the release bars the creditor from seeking recovery on the amount of that debt.
The only question is whether they can receive recovery in the full amount of the debt by showing it's nondischargeable, or whether they're limited to simply the cents on the dollar that the claim will pay in bankruptcy, because the text of the Bankruptcy Code makes clear that the form of the debt doesn't matter, that a debt... that under section 523, a debt can take any number of different... under... I'm sorry.
Under section 523 of the Bankruptcy Code, any debt, the code says, is nondischargeable if it's traceable to an act of fraud, and the code defines debt very broadly to include debts that are liquidated, unliquidated, reduced to judgment, et cetera.
It's quite clear the form of the debt doesn't matter, unless--
Justice Scalia: But the traceability does, and that's what we're talking about here, how traceable is traceable.
Mr. Goldblatt: --That's right, Justice Scalia, and with respect to that question there is... there is no difference between a consent judgment that is a final adjudication of the claims between the parties and a settlement agreement, both of which are equally preclusive, both of which are equally silent on the question of whether fraud occurred.
Unless the Court has further questions, I'll reserve the balance of my time.
Argument of Lisa Schiavo Blatt
Chief Justice Rehnquist: Thank you, Mr. Goldblatt.
Ms. Blatt, we'll hear from you.
Ms Blatt: Thank you, Mr. Chief Justice, and may it please the Court:
When a creditor settles a fraud claim without resolving the disputed issue of fraud, the creditor has the right to enforce the settlement debt for the full amount in bankruptcy by filing a proof of claim and by establishing fraud in response to the defense of dischargeability.
That conclusion is confirmed by Brown, which held that a creditor who settles a fraud claim by consent judgment may establish fraud in response to a bankruptcy--
Justice Stevens: But the real inquiry in Brown, as I read it, is can we go behind a judgment to see what was actually determined by the judgment.
It wasn't any emphasis on the settlement aspect of it, as I read the opinion.
Ms Blatt: --Right.
Justice Stevens: And I guess the holding is, yes, you may go behind a judgment to see what was decided, and that seems to me a little different from going behind a settlement.
Chief Justice Rehnquist: Well, didn't Brown decide two separate issues?
Ms Blatt: The Court in Brown did two things.
The court... the question of fraud was not litigated in Brown because the case was settled, and the Court mentioned in its last footnote that there would be a different situation if the question of fraud was actually litigated.
The question before the bankruptcy court in Brown is whether the money owed under that consent judgment was money obtained by fraud.
So, too, the exact same question is relevant here.
Justice Ginsburg: It didn't look to what the Court had decided, but what the claim was about, but here we have something in addition.
There is a judicial order.
There was a complaint filed, and it was dismissed as part of the settlement.
That complaint in the court action was dismissed with prejudice.
What effect should that have?
Ms Blatt: Not... a dismissal with prejudice following a settlement.
As this Court stated in Lawlor versus National Screen Service, it's cited in the reply brief at page 9, is that it has... does not have preclusive effect on the disputed issue unless the judgment is accompanied by specific findings on the disputed issue, and that's the classic requirement for issue preclusion or collateral estoppel, that the matter be actually litigated.
Justice Scalia: We're not talking issue preclusion, just... just as far as whether it suffices to terminate the traceability.
That... that isn't necessarily coextensive with... with whether there was issue preclusion.
Ms Blatt: No, the... the dismissal with prejudice doesn't impair the creditor's right to walk into court and sue to enforce the settlement debt, including the right to try to get the full amount of the settlement debt in bankruptcy, and on this issue of traceability, it... it is not only identical to Brown, but the code by its express terms disclaims any distinction between a liquidated debt and an unliquidated debt.
The settlement in Brown and the settlement here converts an unliquidated fraud claim into a liquidated claim to collect on the settlement debt.
Justice Stevens: May I... would you just clear up one thing for me?
Say the fraud claim was for $300,000 and the contract was... the novation was $200,000, in the bankruptcy court do you contend they can get the full 300 or just the 200?
Ms Blatt: No.
Under... under... he would be... the... the creditor would be bound by the settlement agreement under principles of State law that the amount of his debt would only be the $200,000.
Justice Scalia: It seems like a strange result, doesn't it?
Justice Stevens: I don't understand that.
Why shouldn't he--
Justice Scalia: --You conduct this big inquiry and find out that the guy's been defrauded of $300, and then that the settlement agreement really covers up a fraud and you say, Well, but you know, a deal's a deal.
Even though you defrauded him of it and the whole thing's traceable to fraud, we're only going to give you $200,000.
That's very strange.
Ms Blatt: I'm sorry, are you talking about the settlement agreement itself was procured by fraud?
Justice Scalia: No, no, no, no.
No, the settlement agreement was just an arm's-length agreement, but if you find that, in fact, the debt underlying that... that agreement was fraudulently obtained, having gone through all the trouble of determining that fact, why don't you make the guy cough up all the money that he got by fraud?
Ms Blatt: The Court... The Court addressed this very issue in Brown.
The creditor there did not get a fraud judgment for exemplary damages and special... special damages under State law.
He was limited to, in bankruptcy, of just seeking this settlement debt, and what the bankruptcy code does is, it gives the creditor a statutory right to render that settlement debt nondischargeable if fraud can be... can be shown.
You don't... and there's another way of looking at it, too.
Justice Kennedy: But... but what's the policy reason behind that.
I mean, if... if what we're concerned about is vindicating the Federal policy that the... the Bankruptcy Code protects only honest debtors and not dishonest debtors, why not give them the whole $300,000?
I mean, I... I know Brown didn't do that, but why didn't it do that?
Ms Blatt: --The Court in Grogan... it's because of two issues, Justice Kennedy.
Under State... State law determines the amount of the debt that is owed, and there's just no question, at least I don't think that the creditor could make an argument that he's owed any more than $300,000.
He can't relitigate and try to get up to $600,000.
That's just governed by State law.
Justice Kennedy: Well, the Fourth... the Fourth Circuit says State law says that this is a novation, too, so... and you're... you don't want us to be bound by that interpretation of State law.
Ms Blatt: The... again, this Court in Grogan versus Carter said that State law determines the amount of the debt, and I just don't think the creditor would have a good faith argument that he could go beyond the settlement agreement, but on the question of nondischargeability, what the creditor is trying to do is collect the entire amount of the debt by... by showing fraud, and we think applying Brown--
Justice Souter: What their main argument, I think, on the other side is, you get a debt, that's what it is, a debt for money obtained by fraud, and this is not a debt for money obtained by fraud, this is a debt for money owed under a settlement agreement.
Now, the virtue of that is, it's a bright line, and what we're saying, I think, in the negative... the negative of it is that if you depart from that, well there's no end to it.
You have a settlement agreement, and no matter how long you go into the future, whatever it is, that... whatever it says you're supposed to do in that settlement agreement, it is.
Use the words proximate cause, use whatever they want, but it is a debt.
Where it comes from is the fraud.
That's where the source of the debt is, no matter what it says in that settlement agreement, and there's just no stopping place, no way to look into it, no attenuation forever, et cetera, so that's what I'd like you to here address.
Ms Blatt: --Well, this Court already crossed that bridge in Brown.
Justice Souter: Well, all right, so then maybe Brown was wrong.
Ms Blatt: But the second point is that--
Justice Souter: Maybe it was wrong.
Ms Blatt: --Whatever the limits of the traceability point, which this Court addressed in a separate decision, Cohen versus de la Cruz, which dealt with the traceability aspects--
Justice Breyer: There is no traceability.
There's never a problem.
Underlying this was the fraud.
Whatever it says in that settlement agreement is based on fraud.
Ms Blatt: --The code itself says that any enforceability obligation, whether or not it's liquidated or unliquidated or appears in a judgment, if you can prove that there has been a fraudulent acquisition of money, the resulting debt is nondischargeable, and that is--
Justice O'Connor: Ms. Blatt, what is your... what is the Government's position if the parties had expressly dealt with it in the settlement agreement?
Ms Blatt: --We think the right would be subject to waiver.
We don't think... we don't see anything in the code that would be--
Justice O'Connor: So you don't agree with petitioner's counsel that it's a harder case, but wouldn't give it up?
Ms Blatt: --We think the right can be waived.
What we do think, though--
Justice O'Connor: All right, now, the language in this particular settlement agreement gave up claims arising out of or relating to the matter of the State court litigation.
Was that not a waiver of this claim?
Ms Blatt: --No, it certainly wasn't a waiver of the right to collect on the debt, and in fact there's an express preservation of not only the right to collect all the obligations under the promissory note, but to collect the amounts under the settlement agreement, and we think to apply a contrary rule, the rule that the court below applied, would be unsound for three reasons.
It would force creditors and parties trying to settle a case to start negotiating over bankruptcy contingencies that are purely hypothetical, may never happen, and are entirely extraneous to the settlement.
The rule adopted by Brown also, our second point, is that it reflects the common sense and ordinary understanding that settlements preserve the creditor's right to enforce the settlement agreement and the statutory right to prove fraud to render the debt enforceable, notwithstanding bankruptcy, and that has been the premise of hundreds, if not thousands of settlement agreements entered into by the Government that do not refer to bankruptcy contingencies.
Third, to hold that those settlement agreements waive the creditor's rights in bankruptcy would render debts dischargeable even where the debtor committed fraud, and that result would undermine congressional policy to favor the rights of innocent victims of fraud over the perpetrators of fraud.
Justice Stevens: But you do agree that some fraud claims could be waived as far as the dischargeability, because you wrote the rights settlement agreement.
Ms Blatt: Yes, if there was an affirmative manifestation of an intent.
Justice Stevens: Why isn't that inconsistent with the statutory policy, just as this case would be?
Ms Blatt: Because there is a background presumption, Justice Stevens, that rights are subject to waiver, and so if there's an intentional relinquishment of a Federal statutory right, then a court can give that effect, but not only is there silence on that issue in this case, there is an express reservation of the right to enforce the settlement agreement, and--
Justice Stevens: To enforce the settlement agreement.
Ms Blatt: --Yes, and that includes--
Justice Stevens: But that's not a reservation of the right to sue for fraud.
Ms Blatt: --They're not suing for fraud.
They're suing to collect on the settlement agreement for the full amount in bankruptcy.
By asking the bankruptcy court, not only by filing the proof of claim, but to render the debt survivable and enforceable in bankruptcy.
It's no different than the settlement judgment in... in Brown.
Argument of Donald B. Ayer
Chief Justice Rehnquist: Thank you, Ms. Blatt.
Mr. Ayer, we'll hear from you.
Mr. Ayer: Thank you, Mr. Chief Justice, and may it please the Court:
I would like to make four points this morning.
The first one, to pick up on what Justice O'Connor said, I think there's a fundamental misconception in the question as it's presented and as it was described by Mr. Goldblatt this morning, and this conception is that what we're dealing with here is a categorical rule that says that whenever you have a settlement, because it's a contract, it bars any further pursuit of a nondischarge claim.
That is completely inconsistent with the holdings of the court below, all of which looked specifically at the language of the release and concluded that what had specifically been released was the right to pursue the claim under 523.
Chief Justice Rehnquist: This would have been a release in State court proceedings?
Mr. Ayer: --Correct, Your Honor, and... and that leads to the second point, which is that what is at issue here really is the interpretation of the language, the specific language--
Justice Ginsburg: There's no language about 523, which you just said--
Mr. Ayer: --That's correct, Your Honor.
Justice Ginsburg: --this is a standard settlement.
It's a compromise.
Neither side is admitting anything.
One side is not admitting fraud, and the other side isn't saying we've proved fraud.
It's just a zero on there.
Mr. Ayer: Well, Your Honor, I think what you said in terms of the language is certainly correct.
I think the important issue is that this is a settlement and, indeed, there is also a... a voluntary dismissal with prejudice in a State court case.
I would submit the proper analysis of that is to interpret the settlement under State law and then ask the question, is there some problem with Federal bankruptcy law that requires you to somehow override what's been agreed to or what's been done in State court.
Justice Souter: But isn't... isn't the problem with approaching it that way... I... at least, I think the problem with approaching it that way is that there is no State law analog to the issue that is being raised here.
In other words, under... under State law, there was a fraud claim, there was a settlement of the fraud claim, but there is no issue under State law about bankruptcy, and that is strictly a... a Federal policy--
Mr. Ayer: Well--
Justice Souter: --and I don't know how we get... we... we look to State law to find out whether there is doubt or not, but I don't know why State law should be a source of an answer to this Federal question, which is peculiarly Federal.
Mr. Ayer: --Well, I... I don't think, Your Honor, that it is the final answer, but it seems to me it's entirely possible for parties in a State court proceeding to enter into a settlement that says, and we hereby specifically release our 523 claim, and had that been--
Justice Souter: They... they might be able to... I mean, I'll assume for the sake of argument that they might be able to do that, but in... in that case, the... the issue here would be resolved, on... on your theory, certainly, by the express agreement with the parties, and they didn't do that, so we've got a case in which they didn't agree on the issue expressly, and I don't see why State law, which doesn't have the issue, is a good place to look for the answer.
Mr. Ayer: --Well, I think... I guess my point, Your Honor, is that the question of whether they expressly agreed to it becomes a question of interpretation, and I would like to get to arguing that they did, in fact, expressly agree to it.
Chief Justice Rehnquist: Well, didn't Brown versus Felsen suggest some discouragement to the idea of anticipatory litigation in State courts of issues that would arise in bankruptcy court?
Mr. Ayer: --I... I think Brown versus Felsen certainly expressed the view that they didn't want to encourage people to have to affirmatively determine fraud in State court when it had been, in fact, been... been... the issue of nondischargeability had been put into the bankruptcy court, but nothing in Brown versus Felsen in any way qualifies the proposition that parties can, in a State court proceeding, resolve, for example, by trial an issue of fraud that would be preclusive under collateral estoppel.
Chief Justice Rehnquist: You say it doesn't qualify the proposition.
It doesn't address the proposition.
Mr. Ayer: Correct.
Justice Ginsburg: Suppose--
Mr. Ayer: But it does, Your Honor, address it in the sense, and then Grogan confirms that collateral estoppel does apply, so that if you have a State proceeding--
Justice Ginsburg: --There's... there's no collateral estoppel here.
That argument absolutely dumbfounded me, frankly, because for collateral estoppel, issue preclusion, you must have raised, actually litigated, there must be a court determination of the issue, and that determination must be essential to the judgment.
You don't have any actual litigation here, so I don't know how you can--
Mr. Ayer: --Your Honor, under this Court's Matsushita decision, it is perfectly clear that in order to determine whether there's issue preclusion, you have to look at the State law in the State where the judgment is entered, and... and the State law, as we indicate in our brief, in North Carolina is that if you have a voluntary dismissal with prejudice under the Miller Building case, under the Barnes case, that voluntary dismissal with prejudice resolves the issues that were put in issue--
Justice Ginsburg: --The only decision that you cite from the North Carolina supreme court says, we go down the line with what is the standard understanding of issue preclusion, actually litigated, decided, and essential to the judgment.
Mr. Ayer: --Your Honor, I--
Justice Ginsburg: That's what the North Carolina supreme court said.
Mr. Ayer: --I disagree, Your Honor.
The... the Thomas McInnis case that you're referring to is a case where what actually happened with regard to the issue of whether prejudgment interest was available was that a husband, in litigating that issue, in fact, failed to timely raise it, and when he failed to timely raise it, the wife was subsequently collaterally estopped from pursuing it.
There's one sentence in the Thomas McInnis case that says, we apply the usual principles of collateral estoppel.
There are multiple cases, Your Honor, in North Carolina that are entirely clear that the rule is that if you have a voluntary dismissal with prejudice, that voluntary dismissal is determinative as though the matter, and this of... almost a quote, as though--
Justice Ginsburg: Well, that would certainly run entirely against the stream, and it would run against the Restatement of Judgments, which you cite, and that says you must manifest... yes, parties can make a stipulation finding.
They can do it in a consent judgment just as they can in the settlement, but they have to make that manifest.
Mr. Ayer: --Right.
Justice Ginsburg: The court does not infer that an issue that was never litigated was, in fact, decided.
Mr. Ayer: I guess what... what I would like to suggest to... to the Court is that what we do have here is a settlement of a State court litigation followed by a voluntary dismissal with prejudice, that the effect of that, of those acts, including the language, because that's what the courts here... all three of these courts focus specifically on the precise language, and they concluded that that language was a waiver.
I would submit that was--
Justice Souter: Well, if they concluded that it's a waiver of claim, and we don't have any... I presume no one has a problem with that.
The question is whether there is... is a waiver on the disputed fact issue, and... and my... my question to you is, you... you refer to the myriad State law cases that hold in your favor.
Is it clear that those are cases on issue preclusion--
Mr. Ayer: --Yes, Your Honor.
Justice Souter: --as opposed to claim preclusion--
Mr. Ayer: Yes, Your Honor--
Justice Souter: --or res judicata?
Mr. Ayer: --The... the Miller Building case and the Barnes case, both of those cases involved collateral estoppel.
It was invoked by a new party, and it was clearly based upon the fact that the... that the matter had been... in one case, it was a voluntary stipulation with prejudice.
The other was a voluntary--
Justice Souter: Well, was it a stipulation that... that expressly addressed the... the fact issue?
Mr. Ayer: --I don't believe you can tell from the opinion, and that's not, certainly, what they rely on.
The principle that is stated in those cases in a... in a categorical way, and I can... I can read it to the Court, is that... let's see.
Justice Ginsburg: May I read you the language from McInnis, which is the North Carolina supreme court?
It was not just simply a statement that, we recognize issue preclusion in its traditional guise.
It was, issue preclusion does not apply unless, quote, the prior suit resulted in a judgment on the merits, identical issues are involved, the issue was actually litigated, the issue was actually determined.
Unknown Speaker: Now, you're asking us to reject that as the law of the... North--
Justice Ginsburg: Carolina.
Mr. Ayer: Well, I... I think, Your Honor, there are... there are many Federal court cases that recognize that a matter which is not actually litigated in the sense that it went to trial and was determined after a trial or a fact-finding.
If the parties intend for a settlement agreement to be preclusive, and that is incorporated into a judgment, that will have collateral estoppel effect, and that's what happened--
Chief Justice Rehnquist: Well, are you relying on... I thought you were relying on North Carolina law.
Mr. Ayer: --We are.
I'm simply trying to point out that the notion that there is some sweeping, overarching general law that says it always must be actually litigated, that that, in fact, is not correct.
Justice Ginsburg: No, I... no, no, we made it plain, and I don't think there's any question here that the parties can stipulate, and the stipulation will have... will have the same effect as a finding, but, as the Restatement of Judgments points out, that must be made manifest.
You don't imply it from words that don't say, and we stipulate that this claim is going to be dischargeable in bankruptcy.
Mr. Ayer: Well, what... let me suggest to the Court a... a way in which this was clear.
First of all, I... I do really want to emphasize that... that all three of the opinions of the court below, none of them adopt this sort of categorical, it's a contract, therefore the right is waived approach.
That is not the issue in any of these cases.
They all look at the specific language, and they reason to the conclusion.
The... the court of appeals, for example, specifically said that, quote, a--
Unknown Speaker: Where are you quoting from, Mr. Ayer?
Chief Justice Rehnquist: What page?
Mr. Ayer: --Let's see, here.
Page 10a of the... of the appendix.
Chief Justice Rehnquist: Thank you.
Mr. Ayer: The petition appendix.
They said, in invoking the novation concept, it's necessary--
Chief Justice Rehnquist: Whereabouts on the page are you?
Mr. Ayer: --It's actually... I'm sorry, Your Honor, it's... it's 9a.
If you look at the end of the first paragraph, under the novation theory, courts need only address... wait a minute.
I'm sorry, the top of the page on 9a.
When following the novation theory, the terms of the settlement should be examined to determine whether the nondischargeability claims were released.
The rest of that page is an examination of the terms, and if you look over onto the next page, 10a, they quote the West case, which says, a promissory note does not discharge the underlying obligation unless the parties expressly release and substitute the new.
That is what these cases are all about, all three of them, and the question of whether the settlement released the claim is a question, I would submit, in the first instance... not in the last instance, but in the first instance, it's a question of State law, and--
Justice Ginsburg: I think there's no dispute that the settlement released the claim.
There's no dispute that there was a novation here.
There's no dispute that they no longer have the original fraud claim.
They have a claim only on the promissory note that they got as a result of the settlement, so it... they're... they're not claiming, oh, we can go back to the day we filed our fraud complaint.
They're saying, we have a debt here, a promissory note, and that is the sum total of what we can claim.
Mr. Ayer: --Right, but Your Honor, the... the holding of all the courts below went beyond what Your Honor is saying.
Justice Ginsburg: The words that you read--
Mr. Ayer: Well--
Justice Ginsburg: --are simply supportive of that--
Mr. Ayer: --let me... let me--
Justice Ginsburg: --but you can't... you can't get anything more than the amount of the promissory note that results from the settlement.
Mr. Ayer: --Well, let me refer the Court, for example, to 35a of the petition appendix, where it is stated that, quote, by including in the release future claims--
Chief Justice Rehnquist: What... what is this from, this is the opinion of the bankruptcy court?
Mr. Ayer: --This is the opinion of the bankruptcy court.
I'm just trying to... this was the consistent analysis in all of these courts.
By including in the release future claims, the court concludes that the plaintiffs effectively released and extinguished the dischargeability claim which they now seek to assert.
Justice Breyer: Well, that's a new, different issue than we granted, isn't it?
I mean, that's... the question, I take it, is, we're assuming there's a novation, there's a settlement, and fine, and that settlement says, I promise to pay $200,000, so it's a debt.
It's a debt for money, and the question is, is it a debt for money obtained by actual fraud?
Mr. Ayer: Well--
Justice Breyer: If so, how do we characterize that debt?
Mr. Ayer: --I--
Justice Breyer: You're saying it was, but it was released.
I... I don't see that we reach that.
Mr. Ayer: --Well, whether... whether this is a different issue than you granted, I guess... I... I agree that the question as it was presented in the petition--
Justice Breyer: Yes.
Mr. Ayer: --is most easily read as this broad, blanket rule.
That is not--
Justice Breyer: Well, I... I would assume that the text and the wording here that you're relying on, and the rule of the State about a novation and so forth, are... are prevalent, not universal, but are... are the standard form of... of settlement and release in almost every State, and apparently the novation rule is standard as well, so the... the result that you're asking us to reach is that this also forecloses any Federal characterization of this as being a debt incurred by fraud, and... and that's a very sweeping statement, and a very sweeping rule.
Mr. Ayer: --Well, I... I think... I think there is... I think the ultimate question, and the last question and the fourth question I'm hoping to get to, and I will get to now, is the question of, if... if you agree with me for purposes of argument that initially, you look to see what the State settlement does and, indeed, here also what the effect under State law of the voluntary discharge with prejudice is... voluntary dismissal with prejudice is, and... and you see, as these courts below held, that the effect is, in fact, to give up the right, then the question is, is there something about Federal bankruptcy law or policy that prevents parties from voluntarily agreeing to do that?
Justice Ginsburg: May I go back just one step?
Suppose this settlement had been entered as a consent judgment, just as was the case in Brown against Felsen, what then?
Mr. Ayer: I think it would depend, Your Honor, what was in the consent judgment.
Justice Ginsburg: Nothing.
The Court just enters... there's... the parties' settlement is incorporated in the consent judgment.
Mr. Ayer: I... I think it would become a question of whether, under the laws of the place where the consent judgment is entered, the fact that there's a settlement that is somehow appended to that order, if it's appended, whether that becomes limiting or defining of the terms of what's agreed to.
If all you have... I would agree with this.
If all you have--
Justice Ginsburg: Wasn't... in... in Brown against Felsen, there wasn't... the settlement was not on the record?
Mr. Ayer: --There's... there's no discussion, Your Honor.
In fact, what's pretty clear in Brown versus Felsen, and the critical difference between Brown and this case is that there was no... there was no kind of any release of a fraud claim.
You simply had the settlement, and the... the creditor got paid, and... and nobody had yet proven affirmatively that there was fraud.
What this Court said is, on those facts, you get to come in and prove fraud.
Justice Breyer: Okay, so you're... you're then conceding the following, is that right, that if, in fact, I owe you $300,000 because I cheated you by fraud, we then enter into a settlement which might be approved by the court, assume it is, and what that settlement says is, in light of what you claim I did to you, cheat you through fraud, I promise to pay $200,000, and you are conceding that that's all there is to the case, that that is nondischargeable?
Mr. Ayer: I... I am at least conceding that there's no waiver of the right to argue--
Justice Breyer: Well, I want to know on my... the facts I just gave you--
Mr. Ayer: --Well, it... it--
Justice Breyer: --in your opinion--
Mr. Ayer: --Your--
Justice Breyer: --is that 200,000 debt nondischargeable?
Mr. Ayer: --If it amounts to a clear concession that there was fraud, yes.
Justice Breyer: No.
What I'm saying is, you have the facts I gave you.
Mr. Ayer: Okay.
Justice Breyer: Remember what they were.
Mr. Ayer: In consideration of--
Justice Breyer: You said it was $300,000 obtained by fraud.
I said, I will settle that by entering into this piece of paper which says, I promise to pay 200.
Mr. Ayer: --I... I would say--
Justice Breyer: Approved by the court.
Mr. Ayer: --I would... I would say that that is non... that is not nondischargeable without affirmatively proving fraud, although you would--
Justice Breyer: There are... there are too many negatives in your statement.
Mr. Ayer: --Well, you--
Justice Breyer: I'm lost.
Unknown Speaker: [Laughter]
Mr. Ayer: --That leaves--
Justice Breyer: I give... remember my example.
I want to say, in your opinion, is that nondischargeable, yes or no?
Mr. Ayer: --It is not non... it is--
It is not clear from the hypothetical that it is nondischargeable, but it is certainly not... you have the opportunity to come into bankruptcy court and prove fraud.
Your... your hypothetical does not establish fraud.
Justice Breyer: Oh, okay, but you're saying you have an opportunity--
Mr. Ayer: Yes.
Justice Breyer: --to prove the fraud?
Mr. Ayer: Absolutely.
Justice Breyer: And your case is different from that in... I gave in which respect?
Mr. Ayer: In the respect--
Justice Breyer: In the release?
Mr. Ayer: --In the respect that our case included language which was interpreted by all three of these courts as a release... under State law as a release of the right to go to bankruptcy court and pursue--
Justice Breyer: Fine, and the reason that's in the question presented is?
Chief Justice Rehnquist: Yes, it isn't in the question presented, that's what I thought.
Mr. Ayer: --The reason it's in the question presented is because it's... it is the holding of the case below.
Chief Justice Rehnquist: Well--
Mr. Ayer: The case below doesn't--
Chief Justice Rehnquist: --the... the question presented, Mr. Ayer, is whether a debt that would otherwise be nondischargeable becomes dischargeable if the parties enter a settlement agreement under which the amount of the debt is... it literally doesn't say anything about fraud or collateral estoppel.
Mr. Ayer: --That's correct, Your Honor.
I guess what I would say is that that question is--
Justice Scalia: You're answering the question.
You just want to answer it, maybe, right?
Mr. Ayer: --Well, that's right.
The answer is maybe, and it depends--
Justice Scalia: Sometimes yes, sometimes no.
Mr. Ayer: --and what it depends upon is, has there been a basis on which to conclude that that right has been given up, and the answer is that no such basis arises simply because there's a settlement contract.
We do not claim that, and neither did any of the courts below.
There... there's nobody here in this courtroom or in this case who says, that's the rule of law.
That you can say it's not the rule of law and everybody will agree with you, but that's not the issue in the case.
Justice Souter: Okay, taking your terms, everybody, I guess, agrees that if the settlement agreement said, we agree, the two parties, that there was no fraud involved in the creation of the debt which this agreement settles, that that would, in fact, be preclusive, that they could not, in fact, prove fraud and... and nondischargeability.
Why is the settlement here like the settlement I just described, because that, as I understand it, is your argument.
There's no legal difference between the settlement we've got here, which says nothing about fraud, and the settlement that I described in which fraud is expressly addressed.
Why are the two alike?
Mr. Ayer: Well, one reason why, and this... this gets back to my point that I think you have to take a State court settlement under State law first to understand it, this... this settlement, among the other language of releases which we've talked about, also includes language that commits to filing a voluntary dismissal with prejudice.
Now, as I've indicated, in order--
Justice Souter: Well, isn't... isn't that what any neither party settlement does?
Mr. Ayer: --Well, it may or may not, Your Honor, but in this case in North Carolina, under North Carolina law, under Miller Building and Barnes, when you file a voluntary dismissal with prejudice, it is as though the matter were litigated to a conclusion and the plaintiff lost, and--
Justice Souter: I thought that--
--So far as--
Justice Ginsburg: --I thought that was true, certainly true as far as claim preclusion goes.
Mr. Ayer: --Right.
Justice Ginsburg: It's claim-precluded, but you constantly mixed up--
Mr. Ayer: --Well--
Justice Ginsburg: --claim preclusion and issue preclusion--
Mr. Ayer: --Well, Your Honor--
Justice Ginsburg: --and yes, a voluntary dismissal with prejudice is preclusive of that claim.
You can never bring that claim again, but it resolves no issues.
Mr. Ayer: --Well, Your... Your Honor, that... that is the law in many places.
That is not the law in North Carolina, and I simply... I know this Court doesn't spend its time deciding State law issues, but--
Justice Ginsburg: I haven't seen a single North Carolina supreme court decision that so holds, that a voluntary... I thought that North Carolina rules, by the way, were based on the Federal rules with respect to the voluntary dismissal rule.
Isn't that so?
Mr. Ayer: --I... I think the rules are somewhat similar.
I've not studied them to know how precisely parallel they are.
Justice Ginsburg: And... and the voluntary dismissal is claim-preclusive but not issue-preclusive?
Mr. Ayer: Well, let me... let me just quote, because I... I've found it... the language in Miller Building and Barnes is that a voluntary dismissal with prejudice, quote, precludes subsequent litigation to the same extent as if the action had been prosecuted to a final adjudication adverse to the plaintiff.
Justice Souter: All right, Mr. Ayer, let's assume that that particular reason isn't necessarily going to persuade all of us here.
Do you have another reason to say that the agreement, the settlement here should be treated in law by this Court under the Bankruptcy Code just like a settlement that expressly says there wasn't any fraud?
Do you have any other reason?
Mr. Ayer: I think the language of the release is quite clear.
The language of the release talks about releasing any and all rights, including future rights.
Unknown Speaker: Well, but it's a question of Federal law as to whether that includes a nondischargeability claim.
I mean, that's what we're here to talk about, and I think that's--
Mr. Ayer: Well, let me--
Justice Kennedy: --that's going to be the same in every State, which is what I've asked.
The very first question we asked, or I asked, was whether or not this was a rule depends on the... the vagaries of the law of North Carolina or not.
Mr. Ayer: --Well... and let me suggest, Your Honor, that... that in order--
Justice Kennedy: And I would... I would have to agree with what Justice... Justice Ginsburg seems to be indicating, that this... that what you're saying is that there's issue preclusion as to an issue that's never been litigated.
Mr. Ayer: --Well, and the parties--
Justice Kennedy: That's astounding.
Mr. Ayer: --But I think we know under Arizona v. California and other decisions that parties can do that if they in... if they indicate an intention to do it, and the question is, have they done that here.
Justice Scalia: Can I ask... this... this puzzles me.
Is it, indeed, a question of Federal law whether a contract which... which gives up all future rights in connection with this claim includes... whether... whether the contract includes the right to claim nondischargeability?
Mr. Ayer: --No, Your Honor.
Justice Scalia: Is... is that a Federal question or a State question?
Mr. Ayer: I think... I believe it's not, and I really feel--
Justice Scalia: What do you... you think it's a question of State law?
Mr. Ayer: --I believe it's a question of State law.
Justice Scalia: It's a question of Federal law what the consequence--
Mr. Ayer: Correct.
Justice Scalia: --of that State contract is.
Mr. Ayer: Absolutely.
Justice Scalia: Okay.
Mr. Ayer: And let me address, if I could, what I view as the logical way to think about this.
Once you have a State contract that is given meaning under State law, the question is, is that somehow to be modified or overridden in light of Federal bankruptcy policy, and what we have here, on the other side, I think, are two different views.
We have one view of the petitioners that it can never be done, there's no way, bankruptcy policy won't allow it, and the other view of the Government is that, well, you can do it if it's clear enough, and then you get into nice questions of what, I guess, our Federal common law--
Chief Justice Rehnquist: Your view, Mr. Ayer, would simply encourage anticipatory litigation of issues that might arise in bankruptcy, which I think Brown suggests is not a good idea.
Mr. Ayer: --Your Honor, I think all... all our approach does is allow parties to enter into settlements to be given what effect they have.
Chief Justice Rehnquist: Well, but, I... I think here, too, probably there's general agreement.
If in so many words you say in the State court settlement, I waive my right to claim nondischargeability in bankruptcy, probably everybody would say, or a majority would say yes, but you don't have that here.
Mr. Ayer: Well, what it... I mean, I guess the next question would be, what else might be adequate, and do you really want to develop a... a body of Federal law.
Let me, if I could, just point to the arguments on the other side why this should be treated as essentially a Federal override of State law interpretive principles is based first upon citation of a number of express provisions of the Bankruptcy Code which have nothing to do with the subject and, I think, prove the opposite point.
There's a whole section on debtor reaffirmations which set up detailed procedures that the bankruptcy court enforces to make sure that debtors don't get taken advantage of, and they are specific, and they're clear, and the bankruptcy court follows them.
That's an occasion for the bankruptcy court to get involved.
There's the idea that the automatic stay cannot be voluntarily given up.
Again, that's the product of specific language that creates an automatic stay to protect the debtor and has 18 itemized exceptions, specific language.
There... they invoke the preference provisions which let, of course, the bankruptcy court go back into transactions that occur prior to bankruptcy, and look at them on very specific terms set forth in section 547.
They talk about the fraudulent conveyance section does the same thing in a slightly different way, but there are no such provisions whatsoever with regard to waivers of section 523 claims.
Section 523 claims are something that the creditor loses if he does not affirmatively file within 60 days of the first meeting of creditors.
There are no protections with regard to that in the code, and if... if something isn't filed, they disappear.
Indeed, the whole idea that creditors are... that... that the issues with regard to nondischargeability under (a)(2), (a)(4), (a)(6), and (a)(15), are made a matter of exclusive Federal jurisdiction, the reason for that, and your case and Brown talk specifically about that, is because creditors were abusing the process by pursuing them.
This is not a protection for creditors.
This is a... a way of making sure creditors don't come in after bankruptcy and basically put the screws to... to debtors who have gotten a discharge.
What language there is... and we talk about this in both the briefs, I think specific language runs counter to this.
We talked in the briefs about (a)(11) and (a)(19), which specifically mention settlements, and I would submit the better interpretation of that language is to say, in those instances where the language specifically says that any settlement may give rise to a nondischargeable claim, is to allow the bankruptcy court to go back in and look at those facts even if the right to a nondischarge... right to pursue nondischarge was given away.
I think the bottom line is that the arguments on the other side relate to a series... they don't relate to any language of the code, other than the much overbroad idea that it... that it's any debt, and of course that doesn't mean that a party can't be foreclosed from litigating the 523 claim because he's already lost it in State court, so any doesn't mean absolutely every.
The policies that are invoked are, first, the honest but unfortunate debtor policy, but nobody here, I think, seriously suggests that a party can't give the thing away, give the right away if they want to, and so I think... give the right to pursue the 523 action away by clear enough language.
That seems to be the... the petitioner I think disagrees with me, but other than that, I think the better view is that they can, and I don't think this Court in any of its cases has ever suggested that the honest but unfortunate debtor policy forecloses relying on prior resolutions under State law.
Collateral estoppel certainly applies, and we think settlement language that's clear ought to apply.
They claim that allowing this is some sort of a trap for the unwary.
It would be a trap if the rule were this categorical rule that says, boy, you enter into a settlement contract, you lose your 523 claim.
That's not the issue in the case.
The issue is, does the language here support the... the idea that the... the right to pursue the 523 claim has been given up, and to hold parties to the State law effect of releases that they sign is no trap for the unwary.
That's how we do litigation in this country every day.
Justice Stevens: Mr. Ayer, may I ask you this question: You started out telling us you were going to make four points.
I know what one, two, and four are, but I'm just curious as to what three was.
Mr. Ayer: Three was the State law point.
I... I guess... three was the point that when you look at State law here, the reading of... the fair reading of State law does, indeed, support the State law rulings of all three of the courts below, and point four, of course, is that there's no reason in Federal law to go back and say no, we have to second-guess that.
Justice Kennedy: I... I suppose after this case, no matter which way it goes, you can have an Archer clause in... in the settlement agreement.
I... I've never seen a settlement agreement in which the parties agree that it's going to be nondischargeable.
As a matter of common course, do these clauses appear in contracts, or--
Mr. Ayer: I'm not aware of it, Your Honor.
They certainly can if they want to.
Justice Kennedy: --I know they can.
Chief Justice Rehnquist: Thank you, Mr. Ayer.
Mr. Ayer: Thank you, Your Honor.
Rebuttal of Craig Goldblatt
Chief Justice Rehnquist: Mr. Goldblatt, you have 4 minutes remaining.
Mr. Goldblatt: Okay.
I only have four points.
First, with respect to the State law question of preclusion, we say in our reply brief on pages 7 and 8 that that issue had been waived.
I don't want to belabor that point, but I... I will point out that the brief respondent filed in the court of appeals, which is... which is, of course, in the record here, states State law correctly.
There, on page 29 in the court of appeals respondent said, there is no issue of collateral estoppel in this case because there have never been any evidentiary findings.
We submit that's a correct statement of State law.
None of the North Carolina cases cited by respondent involved a case in which a settlement agreement is given preclusive effect.
Second, with respect to the language of this particular release, it would certainly present a harder case if you had a situation which the release said, we give up all of our rights in bankruptcy, and in the event you file for bankruptcy, we will not make any effort to collect on the debt.
This release is quite far from that, and expressly preserves the right at all points to recover on the amount that was promised in the promissory note, and this Court's opinion in Brown makes clear as a matter of Federal law that what a nondischargeability action is is simply an action to enforce the obligations that were promised as part of the settlement.
Finally, the question of the form of the debt, and whether the form of the debt drove the decision below, there... the Court of appeals certainly does say... and this is in the joint appendix at page 8... I'm sorry, page 9a, footnote 8.
It explains quite clearly that a basis for its decision is the notion that the creditor was substituting the tort claim, the fraud claim for a contract claim and rests its decision on that basis.
The consequence of that decision would be that from the creditor's perspective, if a creditor has an unliquidated claim, and this applies not only to claims for fraud but, say, an injury caused by drunk-driving, any of the categories of nondischargeability, if you have an unliquidated claim and they file for bankruptcy, you can contend its nondischargeable.
If, on the other hand, you've litigated all the way to judgment, under Brown you can say in bankruptcy, even if the judgment doesn't say what it's for, that that's nondischargeable.
It would create an anomalous situation in which the middle category, cases that are resolved in settlement agreements that don't resolve the question of liability, the rights in bankruptcy to show nondischargeability is given up, and because the code makes clear that the form of the debt is irrelevant to persons of dischargeability, and because this Court's decision in Brown versus Felsen is essentially indistinguishable from this case, we submit the decision below should be reversed.
Justice Scalia: It's rather unfortunate, Mr. Goldblatt, that there's nobody in the room to defend the position that I understood was taken by the question presented, namely that a novation... a novation is all you need.
I think that's, at least, an arguable position, but... but nobody... nobody seems to want to--
Mr. Goldblatt: We agree that... that--
Justice Scalia: --discuss the issue on... on which we took the case.
Mr. Goldblatt: --Your Honor, we... we agree, as we say in our reply brief, that the principal basis of the decision below has been abandoned by respondent here, and we believe it's been abandoned because it can't be squared with this Court's decision in Brown versus Felsen, which holds squarely to the contrary.
Chief Justice Rehnquist: Thank--
Justice Ginsburg: --What about the (a)(11) and (a)... the 19, the express provisions for nondischargeability?
Mr. Goldblatt: Your Honor, what Congress was doing in... in sections (a)(11)... I... I see my time has... has run out, but what Congress was doing in (a)(11) and (a)(19) was giving preclusive effect--
Chief Justice Rehnquist: Thank you, Mr. Goldblatt.
The case is submitted.
Argument of Speaker
Mr. Ayer: The opinion of the Court in No. 01-1418 Archer against Warner will be announced by Justice Breyer.
Argument of Justice Breyer
Mr. Breyer: The Bankruptcy Code provides that a debt shall not be dischargeable, and that means the debt survives bankruptcy ”to the extent” it is for money obtained by fraud.
Now, the question in this case is whether, the words that I have just read, can cover a debt under an agreement that settles and releases an earlier fraud claim, and we hold that it can.
The case, in essence, presents the following circumstance: A sues B in state court for money obtained by fraud, A and B then settled the lawsuit.
The settlement agreement provides that A, here said, that B would pay A $300,000, but B paid only $200,000, then B went bankrupt, and A says this remaining $100,000 debt survives bankruptcy because it is for money obtained by fraud.
B says “No it is not, it is not the money obtained by fraud rather it is for money promised in a settlement agreement”.
Now, the lower courts agreed with B; they said this settlement agreement worked a novation, it erased whatever old debt there was for fraud and it substituted a new debt which is really a contract debt and it is that new debt which is not for money obtained by fraud, so it is dischargeable in bankruptcy.
We do not agree with that view.
In our view you do not have to choose one or the other characterization, you do not have to say either for fraud or for contract, the debt could be both a contract related debt, which is embodied in a settlement agreement and it could also and more basically be a debt for money obtained by fraud.
At least, for the settled case itself was about fraud.
This conclusion in our view follows from an earlier Supreme Court case called Brown versus Felsen, there the Court essentially held, as we see it, that the debt embodied in a consent decree could amount to the debt for money obtained by fraud as well wherefore example the case where the consent decree ended was a fraud case.
We cannot find any significant difference between the consent decree in Brown and the settlement agreement here.
In both instances, we would follow Congress's desire that bankruptcy court makes the fullest possible inquiry to ensure that all debts arising out of fraud are accepted from discharge no matter what their form.
For these and other reasons set forth in the opinions, we reverse the Court of Appeals.
We remand for further proceedings.
Justice Thomas has filed a dissenting opinion which Justice Stevens has joined.