Patel v. MS Int'l

PRAMOD PATEL and ANKIT SHAH Appellants, v. MS International, Inc., Appellee.

No. 20-cv-06234

United States District Court, N.D. Illinois, Eastern Division

September 24, 2021

MEMORANDUM OPINION AND ORDER

John Robert Blakey United States District Judge.

Debtors Pramod Patel (Patel) and Ankit Shah (Shah) (collectively Appellants) seek review of the United States Bankruptcy Court's decision on summary judgment that Appellants' actual fraud precluded the discharge, under 11 U.S.C. § 523(a)(2)(A), of a debt stemming from a California district court default judgment in favor of Appellee MS International Inc. (MSI). Appellants appeal the bankruptcy court's summary judgment ruling and its denial of their motion to reconsider.^[1] For the reasons set forth below, the Court affirms.

I. Background

A. The California Action

MSI distributes flooring, tile and hardscape products nationwide from its California headquarters. Bankr. R., [53] at 2.^[2] Appellants worked for MSI in various customer service and sales capacities from 2013 to 2017. Id. In 2018, MSI sued Appellants in the United States District Court for the Central District of California (“California court”), alleging that they stole MSI's trade secrets and used the stolen information at their new jobs with an MSI competitor, Century Marble and Granite. See MSI Int'l, Inc. v. Patel, No. 18-cv-00152 (C.D. Cal.) (“California Action”).^[3] MSI brought six claims against Patel and Shah pursuant to federal and state law: (1) misappropriation of trade secrets in violation of 18 U.S.C. § 1836(b); (2) violation of California Penal Code § 502; (3) violation of California Penal Code § 496; (4) violation of the Federal Computer Fraud and Abuse Act, 18 U.S.C. § 1030; (5) fraud and deceit in violation of California Civil Code §§ 1709, 1710; and (6) Unfair Competition under Business & Professions Code §§ 17200, et seq. Cal. R..[1].

Appellants moved to dismiss the California Action on jurisdictional grounds, which the court denied. Cal. R. [14], [24]. Appellants then actively participated in the California Action: they filed a joint Rule 26(f) discovery plan, id. [21]; served initial disclosures (albeit late), id. [60] at 4-5; stipulated to a protective order, id. [23]; and filed attorney appearances, id. [28]. They did not, however, answer the complaint or respond to other discovery requests. Id. [60] at 4. As a result, and at MSI's request, the clerk entered default on June 5, 2018. Id. [31]. On August 31, Appellants- having still not answered the complaint-moved to vacate the entry of default, id. [36], and MSI moved for default judgment, id.[40].

On December 17, 2018, the California court denied the motion to vacate and granted default judgment against Appellants, jointly and severally, as to all counts except Count IV^[4] and awarded $2, 210, 238.30 in damages, attorneys' fees, and costs (hereinafter, “California default judgment”). Id. [60]. The California court awarded the damages based upon the federal and state law claims after requiring MSI to submit additional evidence to demonstrate that Appellants' conduct caused MSI's alleged damages. Id. [60] at 27-32.

B. The Bankruptcy Proceedings

Four months after the California court issued its default judgment, Appellants each filed for Chapter 7 bankruptcy protection in the United States Bankruptcy Court for the Northern District of Illinois. Nos. 19-BR-08032 (Bankr. N.D. Ill.) (Shah); 19-BR-08037 (Bankr. N.D. Ill.) (Patel). Soon after, MSI filed adversary complaints in the bankruptcy proceedings objecting to the discharge of the judgment debt from the California Action pursuant to § 523(a)(2)(A) of the Bankruptcy Code, Nos. 19-AP-0740, 19-AP-0741 (Bankr. N.D. Ill.)., ^[5] which provides that a debtor may not discharge debts for money that was “obtained by false pretenses, a false representation, or actual fraud.” 11 U.S.C. § 523(a)(2)(A).

MSI then filed a motion for summary judgment arguing that, under the doctrine of issue preclusion, the California default judgment precluded further consideration of whether the California judgment debt constituted money obtained by “false pretenses, a false representation, or actual fraud.” Bankr. R. [1] ¶ 33 (quoting 11 U.S.C. § 523(a)(2)(A)).

The Bankruptcy Court-applying the federal rule governing issue preclusion- agreed with MSI that the Appellants were estopped from relitigating issues decided in the California default judgment. Bankr. R. [53] at 4-6.

From there, the Bankruptcy Court evaluated whether the issues that the California court decided in granting default judgment and MSI's statement of material facts established that Appellants may not discharge their debt to MSI under § 523(a)(2)(A). Id. at 15. MSI cited exclusively to the California Action to support its material facts in support of summary judgment, Bankr. R. [37], and the bankruptcy court ultimately deemed MSI's material facts admitted, because Appellants failed to cite to the record in opposing MSI's statement of facts (relying instead on legal arguments about issue preclusion and impermissibly citing to their unverified answer as factual proof), Bankr. R. [53] at 6-10.

Next, the bankruptcy court considered the definition of actual fraud under § 523(a)(2)(A). It found that the California court's detailed findings with respect to MSI's federal and state law claims established that Appellants committed “actual fraud” through their “fraudulent and deceitful conduct” in “taking [MSI's] information and trade secrets without permission to benefit themselves and Century Marble and Granite” in violation of federal and state law. Bankr. R. [53] at 15. As such, it granted summary judgment for MSI.

Appellants asked the bankruptcy court to reconsider its summary judgment decision, arguing, for the first time, that the bankruptcy court should have applied the state rule on issue preclusion because the California Action's jurisdiction was based on diversity.^[6] Bankr. R. [58] at 5-6. They also argued that, even if the federal rule on issue preclusion applied, it generally does not afford preclusive effect to default judgments and a narrow exception to this general rule did not apply. Id. at 6-8. They also raised two new “due process” arguments regarding the preclusive effect of the California default judgment: (1) their lawyers in the California Action made various errors; and (2) the California court entered default judgment right before their bankruptcy filings, which shows Appellants deliberately chose to forego litigating in the California Action in favor of resolving MSI's claims in a bankruptcy setting. Id. at 8-10. Finally, they also argued that the court erred in deeming MSI's material facts admitted, because Appellants' failure to present evidence to refute MSI's facts arose from MSI's purported refusal to give (and the bankruptcy court's refusal to compel) discovery on those issues. Id. at 4 n.1.

The bankruptcy court denied Appellants' motion to reconsider, finding that the motion asserted only errors of law, which should be raised on appeal. Bankr. R. [64].

Nonetheless, the bankruptcy court also considered Appellants' arguments on their merits and rejected them, holding that: issue preclusion was proper under both the federal rule and the California rule, id. at 3-7; Appellants had adequate recourse under state law for any errors made by their prior attorneys, id. at 3; and Appellants' substantial participation in the California Action belied their argument that they chose to take a default there so they could litigate the issue of fraud in bankruptcy proceedings, id. at 3, 8-9. Finally, it held that, even if issue preclusion did not apply, MSI's statement of materials facts, which Appellants failed to oppose and the court deemed admitted, independently supported summary judgment for MSI. Id. at 7-8.

Appellants now appeal the bankruptcy court's summary judgment decision and denial of their motion to reconsider. Their brief identifies four issues for appeal:

1. Whether the bankruptcy court erred in finding that Appellants' conduct in the California Action warranted an exception to the general rule that default judgments do not trigger issue preclusion.

2. Whether the bankruptcy court erred in giving preclusive effect to the California default judgment given Appellants' prior attorneys' conduct and the timing of the default judgment in relation to the filing of their bankruptcy cases.

3. Whether the bankruptcy court erred when, after denying Appellants' motion to compel discovery, it granted summary judgment because Appellants failed to point to testimony or documentary evidence in their opposition to summary judgment.

4. Whether the bankruptcy court erred in granting MSI's motion for summary judgment and denying Appellants' reconsideration motion.

[19] at 1-2.

II. Standards of Review

This Court has jurisdiction to hear appeals from a bankruptcy court's rulings pursuant to 28 U.S.C. § 158(a). On appeal, this Court reviews de novo a bankruptcy court's legal conclusions as well its final determination to grant summary judgment. See In re Miss. Valley Livestock, Inc., 745 F.3d 299, 302 (7th Cir. 2014). It reviews factual findings for clear error. See id.

Whether the doctrine of issue preclusion can apply in a subsequent action constitutes a legal question that this Court reviews de novo. See Reeves v. Davis, 638 F.3d 549 553 (7th Cir. 2011). But, even if a prior judgment can trigger issue preclusion, a bankruptcy court generally has discretion to decide whether to apply the doctrine, especially where considerations of fairness affect whether it should be applied. See Cohen v. Buci, 103 B.R. 927, 932 (N.D. Ill. 1989) (citing Garza v. Henderson, 779 F.2d 390, 393 (7th Cir. 1985). Thus, once this Court examines...