In Re: Michael Rodger Brown

Background

Jennifer Brown appealed a Bankruptcy Court order concerning her contingent claim for an equitable distribution of approximately $12.75 million in marital assets that two accounting firms could not account for. Michael Rodger Brown filed for Chapter 7 bankruptcy while the parties’ state-court divorce action was pending.

The Bankruptcy Court granted Jennifer relief from the bankruptcy stay so she could continue the divorce action. It allowed the state court to determine the parties’ rights regarding marital property, but retained review and approval over any distribution of bankruptcy-estate property or determination of title to estate assets.

During the divorce action, Jennifer and Michael entered into a so-ordered term sheet. It provided that Michael would pay Jennifer $2.5 million as her share of equitable distribution from his post-petition earnings, rather than from the marital or bankruptcy estate. The state court later incorporated the term sheet into the parties’ final judgment of divorce. The judgment stated that the term sheet survived and was not merged into the judgment.

After the divorce judgment, Michael asked the Bankruptcy Court to approve the term sheet and to expunge Jennifer’s bankruptcy claim. The Bankruptcy Court declined to approve the term sheet under Federal Rule of Bankruptcy Procedure 9019 because the payment did not come from the bankruptcy estate, and it denied that approval request as moot. The Bankruptcy Court also expunged Jennifer’s claim, finding that claim-preclusion principles barred it because the claim had been settled in the divorce action.

Arguments on appeal

Jennifer argued that the term sheet did not waive a claim to an equitable share of concealed assets that a bankruptcy trustee might later discover. She also argued that the term sheet did not specifically release her claims, was not the parties’ entire agreement, and should not have preclusive effect. In addition, she argued that Michael fraudulently concealed marital assets and that this fraud prevented the divorce judgment from barring her bankruptcy claim.

District Court’s analysis

The District Court applied New York claim-preclusion law. Claim preclusion, sometimes called res judicata, generally prevents a party from relitigating claims that were decided, or could have been decided, in an earlier action. The court explained that New York law gives a final divorce judgment preclusive effect over material issues that were litigated or could have been litigated in the divorce action.

The court held that the final judgment of divorce was a final judgment on the merits involving the same parties. Because the judgment incorporated the term sheet, it also had preclusive effect for matters covered by that agreement. The court concluded that the term sheet’s reference to Jennifer’s “share of equitable distribution,” together with New York law requiring equitable-distribution issues to be resolved before a divorce judgment becomes final, showed that the parties had settled the equitable-distribution issues entirely.

The court further reasoned that Jennifer had obtained relief from the bankruptcy stay specifically to litigate equitable distribution in the divorce action. She also knew about the possibility of unaccounted-for marital assets because the state court had appointed an accounting firm to investigate them and she had retained her own accounting firm to review that work. The court concluded that any claim involving those assets was resolved, or could have been raised, in the divorce action.

The court rejected Jennifer’s fraudulent-inducement argument. It noted that neither it nor the Bankruptcy Court had decided whether Michael actually concealed assets. But the court held that Jennifer knew before signing the term sheet that unaccounted-for assets might exist, and she confirmed during the state-court hearing that she had sufficient financial information to enter into the agreement. The court also noted that she was represented by counsel and that the term sheet had been extensively negotiated.

Because claim preclusion supplied a complete defense to Jennifer’s claim, the District Court held that the Bankruptcy Court correctly expunged it under 11 U.S.C. § 502(b)(1), which allows a bankruptcy claim to be disallowed when it is unenforceable under applicable nonbankruptcy law.

Disposition

The District Court affirmed the Bankruptcy Court’s April 27, 2020 order. It also denied Jennifer’s request for oral argument because the briefs and record adequately presented the facts and legal arguments. The District Court remanded the case for further proceedings consistent with the opinion.