The Ninth Circuit Court of Appeals held in Muegler v. Bening, 413 F.3d 980 (9th Cir. 2005) that collateral estoppel can be used to prevent a debtor from re-litigating the issue of fraud in a nondischargeability action in bankruptcy court. In Muegler, a federal district court found the debtor guilty of intentional fraud under Missouri law and awarded the creditor compensatory and punitive damages. After the debtor filed bankruptcy, the judgment creditor filed a complaint in the bankruptcy court asserting that its debt was nondischargeable under 11 U.S.C. § 523(a)(2)(A) because it was procured by the debtor’s fraud. The creditor further argued that the debtor was collaterally estopped from re-litigating the issue of fraud in the bankruptcy court. After applying Missouri collateral estoppel law, the Ninth Circuit agreed.

Under Missouri law, as in many states, collateral estoppel will prevent re-litigation of an issue when:

  1. the issues in both actions are identical,
  2. the prior action resulted in a judgment on the merits,
  3. the party against whom collateral estoppel is asserted was a party or in privity
    with a party to the prior action, and
  4. the party against whom collateral estoppel is asserted had a full and fair
    opportunity to litigate the issue in the prior action.

The debtor argued that the issues were not identical because fraud under § 523(a)(2) requires that the debtor receive a direct or indirect benefit from his misrepresentations, whereas this was not a requirement under Missouri law. Based on the Supreme Court’s opinion in Cohen v. de la Cruz, 523 U.S. 213 (1998), the Ninth Circuit rejected that argument and held that the existence of a fraud judgment is sufficient for a debt to be nondischargeable under § 523(a)(2)(A), regardless of any benefit to the debtor.

The debtor also argued that there was no identity of issues because the punitive damages award for fraud only required a finding of "evil motive, reckless indifference or constructive knowledge" under Missouri law, rather than "willful and malicious" injury as required under § 523(a)(6). The Ninth Circuit held that if an award of compensatory and punitive damages are based on the same conduct, then the punitive damages will be nondischargeable if the compensatory damages award is found to be nondischargeable.

In addition, the Debtor argued that because discovery and trial sanctions were imposed on him, he did not have a full and fair opportunity to litigate his case, and the judgment was essentially a default judgment rather than a judgment on the merits. The Ninth Circuit held that, because the Debtor filed an answer, thereby requiring proof of the matters not admitted in the pleadings, the resulting judgment was on the merits. Further, the Court held that the Debtor had a fair opportunity to litigate because the relevant procedural opportunities are those available at the beginning of the case, not those lost due to the Debtor’s abuse of the discovery process. Having determined that all requirements were met, the Ninth Circuit held that the debtor was collaterally estopped from re-litigating the issue of fraud in bankruptcy court.