DISCHARGE OF FLSA JUDGMENTS UNDER BANKRUPTCY

Written By: Kunal Phatangare

Updated: September 20, 2023

QUESTION PRESENTED

Whether debtors undergoing bankruptcy proceedings are entitled to seek discharge of judgments under the Fair Labor Standards Act (FLSA)?

BRIEF ANSWER

Yes, the Judgments awarded under FLSA may be dischargeable under the Bankruptcy Code. However, the issues which have been litigated and decided in the earlier matter may not be relitigated in accordance with the applicable rule of collateral estoppel. It is pertinent to note that for a debt to be not discharged under §523(a)(6) of the Bankruptcy Code, the debtor must have acted willfully and maliciously. As long as the debtor is able to establish that his actions are in the ordinary course of business and not undertaken to willfully and maliciously injure the interest of the plaintiff, such debts may be discharged under the Bankruptcy Code.The court has rightly explained the application of the aforementioned principle in In re Al-Naji, 521 B.R. 65 (Bankr. W.D.N.Y. 2014)

“On January 10, 2012, Mohammad Al–Naji secured a judgment against the debtor for $83,671.16. The text of that judgment recites that this sum represents damages “for defendants' willful failure to pay wages pursuant to New York Labor Law §198(1–a),” together with attorney's fees and disbursements. The state court's finding of willfulness is binding in the present proceeding. However, for nondischargeability, section 523(a)(6) requires an injury that is not only willful, but also malicious. Here, the evidence at trial established the insolvency of United States Wholesale Sign Co., Inc. Although Tarek Al–Naji may have willfully chosen to pay other creditors to the detriment of his cousin, the corporation's lack of resources provides a non-malicious explanation for the failure to make payment. When resources are insufficient to allow payment of all creditors, the non-payment of any particular creditor will serve as evidence not of malice, but of the reality that someone will be left unpaid. In such circumstances, a corporation might reasonably defer the payment of insider claims. By a preponderance of evidence, therefore, the creditor fails to establish the necessary intent for a determination of non-dischargeability under 11 U.S.C. §523(a)(6).”

ANALYSIS To promote the ‘fresh start’ policy of the Bankruptcy Code, courts narrowly construe the exceptions to dischargeability enumerated in §523(a)(6). In order to establish that a debt should not be discharged under Section 523(a)(6), a plaintiff must establish the following three elements to succeed.

1. The debtor acted willfully.
2. The debtor acted maliciously.
3. The debtor's willful and malicious actions caused injury to the plaintiff or the plaintiff's property.

What does ‘willfully’ mean under §523(a)(6)?

The term 'willfully' has not been defined under the bankruptcy code. The Supreme Court has observed that ‘willful’ in §523(a)(6) means ‘deliberate or intentional.’ The Supreme Court also noted that the kind of intent necessary in construing this section is similar to that of intentional torts, which generally requires that the actor intend ‘the consequences of an act,’ not simply ‘the act itself.’

What does ‘maliciously’ mean under §523(a)(6)?

The term ‘maliciously’ has also not been defined under the bankruptcy code. The Second Circuit has concluded that the term “malicious” in the context of §523 means ‘wrongful and without just cause or excuse, even in the absence of personal hatred, spite, or ill-will.’ Court noted that malice may also be implied from ‘the acts and conduct of the debtor in the context of the surrounding circumstances.’ It was also noted that a court may find malice ‘when anyone of reasonable intelligence knows that the act in question is contrary to commonly accepted duties in the ordinary relationships among people, and injurious to another.’ Malice is not the same as willfulness. The terms ‘willful’ and ‘malicious’ are separate elements with distinct meanings, and both must be satisfied by a preponderance of evidence. A key component of a finding of malice for purposes of Section 523(a)(6) is that the conduct at issue transcends ordinary norms of commercial behavior. Whether circumstances are sufficiently aggravating to support a finding of malice is a fact-specific determination made on a case-by-case basis. A court should look to the totality of the circumstances to determine malice.

Standard of Proof:

The Supreme Court has stated that the standard of proof for the dischargeability exceptions in §523(a) is the ordinary preponderance-of-the-evidence.

Applicability of Doctrine of Collateral Estoppel:

The Supreme Court has confirmed that the doctrine of collateral estoppel may be invoked in Section 523 actions. The Court noted, “collateral estoppel principles do indeed apply in discharge exception proceedings pursuant to § 523(a).” The Supreme Court also determined that “the ordinary preponderance standard governs the applicability of all the discharge exceptions.” Therefore, a Bankruptcy Court could properly give collateral estoppel effect to those elements of claim that are identical to the elements required for discharge and which were actually litigated and determined in the prior action. Courts recognize that the application of the collateral estoppel doctrine differs based on the forum in which the first judgment was entered.

The Federal Collateral Estoppel Rule:

Federal principles of collateral estoppel, which we apply to establish the preclusive effect of a prior federal judgment, require the following four elements. An identical issue was raised in a previous proceeding. The issue was actually litigated and decided in the previous proceeding. The party had a full and fair opportunity to litigate the issue. Resolution of the issue was necessary to support a valid and final judgment on the merits.

Applicability of Federal Rule of Collateral Estoppel to Default Judgments:

The majority view is that collateral estoppel based on default judgments is undesirable. An exception to this general rule may be found where the defendant has abused the litigation process. The Second Circuit has also noted, “Several other circuits have allowed a default judgment entered as a procedural sanction to be accorded preclusive effect in a subsequent action if the sanctioned party's abuse of the litigation process is of sufficiently outrageous severity.” At the same time, a full trial on the merits is not a prerequisite for collateral estoppel to apply. Rather, preclusion is appropriate where “the issue was raised by the pleadings or otherwise placed in issue and actually determined in the prior proceeding.”

CONCLUSION

In the context of bankruptcy, a judgment resulting from Fair Labor Standards Act (FLSA) violations may potentially be discharged, provided that the aforementioned elements under Section 523(a)(6) of the Bankruptcy Code are met. While judgments under the FLSA are not automatically exempted from discharge in bankruptcy, there is a possibility to create an exception if it can be proven that the debtor's conduct was willful and malicious. However, it is important to recognize that the doctrine of collateral estoppel prevents the re-litigation of issues already decided in the FLSA matter.

REFERENCES:

Cocoletzi v. Orly (In re Orly), 2016 WL 4376947, at *3 (Bankr. S.D.N.Y. Aug. 10, 2016)

In re Qiao Lin, 576 B.R. 32 (Bankr. E.D.N.Y. 2017)

Kawaauhau v. Geiger, 523 U.S. 57, 61, n.3, 118 S.Ct. 974, 140 L.Ed.2d 90 (1998)

Ball v. A.O. Smith Corp., 451 F.3d 66, 69 (2d Cir. 2006) (quoting In re Stelluti, 94 F.3d at 87)

Yash Raj Films (USA) Inc. v. Akhtar (In re Akhtar), 368 B.R. 120, 130–31 (Bankr. E.D.N.Y. 2007)

In re Orly, 2016 WL 4376947, at *3

In re Stelluti, 94 F.3d 84 (2d Cir. 1996)

Forrest v. Bressler (In re Bressler), 387 B.R. 446, 455 (Bankr. S.D.N.Y. 2008).

Grogan v. Garner, 498 U.S. 279, 291, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991)

Grogan, 498 U.S. at 284 n.11, 111 S.Ct. 654

See Indo–Med Commodities, Inc. v. Wisell (In re Wisell), 494 B.R. 23, 29 (Bankr. E.D.N.Y. 2011) (citing Grogan).

Ball, 451 F.3d at 69 (quoting Purdy v. Zeldes, 337 F.3d 253, 258 & n.5 (2d Cir. 2003))

Artmatic USA Cosmetics v. Maybelline Co., 906 F.Supp. 850, 856 (E.D.N.Y. 1995) (citing cases)

In re Ferrandina, 533 B.R. at 23 n.13

In re Adler, Coleman, 205 Fed.Appx. at 857 n.1

Dolan v. Roth, 325 F.Supp.2d 122, 133 (N.D.N.Y. 2004)