Opinion
No. 02-81018
August 15, 2002
OPINION
This matter is before the Court on three (3) motions for relief from the automatic stay filed by nineteen (19) unsecured creditors ("MOVANTS") holding similar claims against Thomas D. Hiles ("HILES"), one of the Debtors. The MOVANTS have each filed an adversary complaint against HILES seeking a determination that the debts HILES owes to each of them are nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A) and (a)(4). Asserting the same factual allegations, the MOVANTS have also filed suits in state court against HILES and three (3) other defendants based upon state law claims for rescission of certain securities purchases and damages for fraud, breach of fiduciary duty and professional negligence. In addition to modification of the automatic stay to permit the state cases to proceed, the MOVANTS seek to stay the adversary proceedings until the state court cases are concluded.
The individual MOVANTS are Stanley Paul, Mary Vallero, Joanie Vallero, Erik Brown, James Musolf, Jean Musolf, Richard Duff, Dorothy Duff, Marlene Bullock, Janice Swanson, Melvin Landuyt, Connie Landuyt, Tamra Woodley, Betty Reinschmidt, both in her individual capacity and as the personal representative of her deceased husband's estate, Russell Swise, Rosemary Swise, Rita Marks and Dorothy King.
The motions are opposed by HILES and a state court codefendant and one of HILES' creditors, Lincoln Financial Advisors, d.b.a. Lincoln Financial Group ("LINCOLN FINANCIAL"), who seek to have the nondischargeability complaints tried first, in bankruptcy court, with the state court cases stayed until their conclusion.
BACKGROUND
HILES worked as a securities salesman and investment advisor since 1991, doing business under the name Hiles Associates. He maintained an affiliation with LINCOLN FINANCIAL, Vernon Shiflett ("SHIFLETT") and Midwest Financial ("MIDWEST"). Basing their complaints upon their purchase of certain unregistered securities, the MOVANTS describe LINCOLN FINANCIAL as HILES' "broker/dealer" and allege that LINCOLN FINANCIAL held HILES out as its financial advisor/securities salesperson and that SHIFLETT and MIDWEST were HILES' "contacts" for selling those securities and received referral commissions from the sales. The multi-count state court complaints allege violations of the Illinois Securities Law of 1953, ( 815 ILCS 5/1 et seq.), violations of the Illinois Consumer Fraud and Deceptive Business Practices Act, ( 815 ILCS 505/1 et seq.), common law fraud and professional negligence. Each complaint contains a jury demand.
Prior to HILES' bankruptcy, six (6) separate lawsuits were filed in state court against HILES, LINCOLN FINANCIAL, MIDWEST and SHIFLETT, the first on October 17, 2000. The automatic stay was modified or annulled, to permit the postpetition commencement of additional, similar lawsuits. Most of the state court suits have been consolidated for discovery.
Since the bankruptcy filing, four (4) adversary complaints have been filed against HILES seeking a determination of nondischargeability under 11 U.S.C. § 523(a). The aggregate number of Plaintiffs in the four (4) adversaries is twenty-three (23), all but two of whom are also a Plaintiff in one of the state court cases. Each of the adversary complaints alleges two alternative grounds for relief, under Section 523(a)(2)(A), that HILES used false pretenses, a false representation or actual fraud with respect to his sale of unregistered securities to the Plaintiffs and, under Section 523(a)(4), that HILES committed fraud or defalcation while acting in a fiduciary capacity with respect to those sales. The aggregate investment amounts alleged to have been lost by the twenty-three (23) Plaintiffs is in excess of $1,000,000. The prayer for relief in each adversary complaint requests that the state court causes of action be permitted to be litigated to conclusion, in state court, before the bankruptcy court then takes up the issue of nondischargeability.
Carl Peters and Donna Peters, Plaintiffs in Adv. No. 02-8128, have not filed a complaint in state court, but have indicated an intention to do so. James Nichols and Anita Nichols have filed both a state court complaint and a complaint to determine dischargeability, but have not moved for stay relief.
By order entered July 31, 2002, this Court also allowed eleven (11) additional individual investors to proceed with arbitration before the National Association of Securities Dealers in Florida. The arbitration was commenced prepetition against Lincoln Financial Advisors Corporation and the Lincoln National Life Insurance Company. HILES was only brought in as third-party respondent by LINCOLN FINANCIAL. The eleven (11) claimants are alleged to have invested an aggregate amount of $371,000 in unregistered securities. None of the eleven (11) arbitration claimants filed an adversary complaint for nondischarge-ability against HILES, and the deadline for such complaints has expired.
This Court also previously annulled the automatic stay to retroactively validate the postpetition suits filed by Mary Vallero and Joanie Vallero, which had been removed to federal court by LINCOLN FINANCIAL. Subsequent to this Court's annulment order, the district court remanded those cases back to the state court.
At the preliminary hearing, the motions for relief from automatic stay were granted, in part, only to the extent necessary to permit the MOVANTS to serve notices of rescission and to file state court lawsuits against HILES and effect service of process. Having been advised of the likelihood that the adversary complaints would be filed, the Court reserved the issue of whether the automatic stay would be modified to permit the state court suits to proceed on their merits. The MOVANTS now all stand on the same footing, each with a pending action filed in state court against HILES, LINCOLN FINANCIAL, SHIFLETT and MIDWEST, and each with a nondischargeability complaint pending in bankruptcy court against HILES seeking a determination of nondischargeability under Sections 523(a)(2)(A) and (a)(4).
The three (3) motions for stay relief were taken under advisement by the Court at a hearing conducted on June 21, 2002, with briefs to be submitted thereafter. The discharge order was entered on June 24, 2002. Although the parties do not address in their briefs the effect of discharge, that event is critical to a proper resolution of the matter before the Court.
ANALYSIS
The automatic stay is a temporary restraint. Section 362(c) of the Bankruptcy Code, with certain exceptions not applicable here, after setting forth a separate rule with respect to acts against property of the estate, provides as follows:
(2) the stay of any other act under subsection (a) of this section continues until the earliest of —
(A) the time the case is closed;
(B) the time the case is dismissed; or
(C) if the case is a case under chapter 7 of this title concerning an individual or a case under chapter 9, 11, 12, or 13 of this title, the time a discharge is granted or denied.
11 U.S.C. § 362(c)(2). Since the state court suits are not acts against property of the estate, the automatic stay applicable to those suits terminated upon entry of the discharge order on June 24, 2002, pursuant to subsection (2)(C).
Once the debtor receives a discharge, the stay is replaced by a permanent injunction under Section 524(a), except as to debts found to be nondischargeable under Section 523, which provides, in relevant part, as follows:
(a) A discharge in a case under this title —
. . .
(2) operates as an injunction against the commencement or continuation of an action . . . to collect, recover or offset any such debt as a personal liability of the debtor. . . .
11 U.S.C. § 524(a)(2). In addition, with an exception not applicable here, Section 524(e) provides that "discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." 11 U.S.C. § 524(e). It has been made abundantly clear by the Seventh Circuit, construing Section 524(a)(2) together with Section 524(e), that the discharge injunction prevents suits from continuing only with respect to the personal liability of the debtor and that it does not preclude a determination of the debtor's liability on the basis of which indemnification would be owed by another party. Hawxhurst v. Pettibone Corp., 40 F.3d 175 (7th Cir. 1994); In re Hendrix, 986 F.2d 195 (7th Cir. 1993); In re Shondel, 950 F.2d 1301 (7th Cir. 1991). The application of this principle to the state court suits follows plainly from the fact that the liability of HILES' codefendants is largely dependent upon a determination of HILES' own liability.
In its Supplemental Brief filed July 12, 2002, LINCOLN FINANCIAL asserts that the bankruptcy court has jurisdiction to adjudicate the claims pending in state court and that "the equities in the matter dictate that it take that jurisdiction." Just how, or on what basis, this Court should go about that is left to the reader's imagination. The MOVANTS' claims against HILES' codefendants are not and have never been before this Court. Nor would it be permissible for those state law claims to be joined in the pending adversaries against HILES.
Those claims, involving third parties, have no effect upon the administration of the bankruptcy estate and are claims over which the bankruptcy court does not have even "related to" jurisdiction. See In re Bass, 171 F.3d 1016 (5th Cir. 1999); In re ACI-HDT Supply Co., 205 B.R. 231 (9th Cir.BAP 1997); In re Marvin Johnson's Auto Service, Inc., 192 B.R. 1008, 1019-20 (Bankr.N.D.Ala. 1996); In re Houghton, 164 B.R. 146 (Bankr.W.D.Wash. 1994).
Though the liability of LINCOLN FINANCIAL, SHIFLETT, and MIDWEST is, in large part, derivatively based on HILES' liability under state law, the MOVANTS' present ability to pursue those claims is not affected by their pending nondischargeability claims against HILES under bankruptcy law. Those nondischargeability determinations, based upon the application of Sections 523(a)(2)(A) and (a)(4), are ones over which the bankruptcy court has exclusive jurisdiction. Rein v. Providian Financial Corp., 270 F.3d 895, 904 (9th Cir. 2001). Until the determination is made by this Court, it remains an open question as to whether the MOVANTS' claims against HILES are discharged or not. See In re Schultz, 251 B.R. 823, 830 (Bankr.E.D.Tex. 2000) (so long as a possibility remains that a debt could be declared nondischargeable, permanent applicability of discharge injunction could not be determined).
Since the automatic stay is no longer in effect, and based upon the clear authority from the Seventh Circuit as to the scope of the discharge injunction, this Court holds that the MOVANTS' state court suits are neither stayed nor enjoined in any respect as to the claims against LINCOLN FINANCIAL, SHIFLETT and MIDWEST. As to the state law claims against HILES with respect to which a determination of his liability is a prerequisite to recovery from one or more of the nondebtor codefendants, the suits are neither stayed nor enjoined as to a determination of such liability. Collection of any judgment as a personal liability of HILES is, of course, subject to a determination under Section 523 by this Court.
What then is to be done with the pending adversary proceedings, particularly in light of the fact that the bankruptcy court has exclusive jurisdiction to determine dischargeability under Sections 523(a)(2) and (4)? One option is to stay the adversary proceedings until conclusion of the state court suits. Given the similarity between the state claims and the adversary claims, application of the doctrine of collateral estoppel will likely permit the adversaries to proceed to judgment without a trial or with an abbreviated one. See, Grogan v. Garner, 498 U.S. 279, 284, 111 S.Ct. 654, 658, 112 L.Ed.2d 755, n. 11 (1991) (clarifying that collateral estoppel principles apply in nondischargeability cases.)
A second option is to allow the adversary proceedings to go forward on a parallel track with the state court suits. Parallel proceedings are ordinarily discouraged for reasons of judicial economy, and unfairness to the litigants, whose expenditure of time, energy and resources would be doubled. The issue of whether the adversaries should proceed or wait is not necessary to a proper disposition of the motions before the Court. Therefore, the Court will leave that issue for another day, to be taken up between the Plaintiffs and HILES at the appropriate juncture in the adversary cases themselves.
In their briefs, the parties (including LINCOLN FINANCIAL) address the issue of whether the adversaries should proceed. As indicated, this issue must be addressed as part of the adversary cases, to which LINCOLN FINANCIAL is not a party. The MOVANTS have previously challenged LINCOLN FINANCIAL'S standing, and this Court considers it important to maintain the separateness of the adversary cases from HILES' main bankruptcy case.
Pending motions for relief from the automatic stay that are preempted by termination of the stay by operation of law pursuant to Section 362(c) are moot and should be dismissed. Madison National Bank v. Chiapelli, 131 B.R. 354 (E.D.Mich. 1991). Since the automatic stay terminated with entry of the discharge order on June 24, 2002, the pending motions for relief from the automatic stay are moot and will be dismissed by separate Order. This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052.
ORDER
For the reasons stated in an Opinion filed this day, IT IS HEREBY ORDERED that the Motions for Relief from the Automatic Stay filed by Stanley Paul, Mary Vallero, Joanie Vallero, Erik Brown, James Musolf, Jean Musolf, Richard Duff, Dorothy Duff, Marlene Bullock, Janice Swanson, Melvin Landuyt, Connie Landuyt, Tamra Woodley, Betty Reinschmidt, individually and in her capacity as personal representative of her deceased husband's estate, Russell Swise, Rosemary Swise, Rita Marks and Dorothy King, should be and hereby are dismissed as moot.