Opinion
Case No. 06-26574-svk, Adversary No. 07-2082.
May 14, 2008
DECISION AND ORDER GRANTING DEBTORS' MOTION TO VACATE ORDER DENYING DISCHARGE
After a hearing held on October 17, 2007 on the Plaintiff-Trustee's Motion for Default Judgment, which the Debtors did not attend, on October 22, 2007, this Court entered an Order denying the Debtors' Discharge under 11 U.S.C. § 727(a)(2). Subsequently, on the Trustee's Motion for Turnover of Property and Nondischargeable Judgment, on February 14, 2008, the Court entered an Order requiring the Debtors to pay $3,000 to the Trustee for unauthorized post-petition sale of some playground equipment; the Court denied the Trustee's requests for turnover of other assets, and expressly refused to find that the Debtors' case had been converted from Chapter 13 to Chapter 7 in bad faith. On April 29, 2008, the Court took under advisement the Trustee's Motion for Default Judgment against Cherie and Lyndon Sims, arising out of the purchase of the same playground equipment. Meanwhile, the Debtors filed a letter on March 25, 2008 that the Court construed as a Motion to Vacate the Order Denying Discharge. A hearing was held to address the Motion on April 30, 2008 and the Court considered the arguments of the Debtors and the Chapter 7 Trustee.
The process for obtaining relief from a judgment or order is governed by Federal Rule of Bankruptcy Procedure 9024 which incorporates Federal Rule of Civil Procedure 60(b). Once a default judgment has been entered, the court may set aside the judgment pursuant to Rule 60(b)(1) if a motion is made within a reasonable time and in no event more than one year from entry of the judgment. In re Rosillo, 2007 Bankr. LEXIS 2620 (Bankr. S.D.N.Y. July 31, 2007); Frost v. Subramanian (In re Subramanian), 2005 Bankr. LEXIS 3192 (Bankr. D.N.J. Sept. 13, 2005); In re Archer, 264 B.R. 165 (Bankr. E.D. Va. 2001). There are six reasons for granting relief from judgment set forth in Rule 60(b): (1) mistake, inadvertence, surprise, or excusable neglect; (2) newly discovered evidence which by due diligence could not have been discovered in time to move for a new trial; (3) fraud or other misconduct of an adverse party; (4) the judgment is void; (5) the judgment has been satisfied, released, or discharged; or (6) any other reason justifying relief from the operation of the judgment. Sanders v. Progressive Cas. Ins. Co. (In re Sanders), 2007 Bankr. LEXIS 4269 (B.A.P. 9th Cir. Dec. 13, 2007).
This case involves the Debtors' claim of excusable neglect in failing to appear at the hearing on the Motion for Default Judgment. The Debtors' attorney had withdrawn from their representation in the midst of this case, and they attempted to represent themselves. They testified at prior proceedings that in addition to the bankruptcy case, which was converted from Chapter 13 to Chapter 7 when they were evicted from and locked out of their business premises, they were facing thousands of dollars in tax liens and were involved in a divorce. Mrs. Smith testified that she was taking prescription narcotics for a painful neuralgia condition. Her house was being foreclosed, and at one time, the post office stopped delivering the mail to the house, due to the foreclosure. Mrs. Smith had appeared at several hearings, but did not appear at the default hearing; she represented that she did not receive the notice of the hearing. Mr. Smith stated that he was receiving so many communications from the Bankruptcy Court, Trustee and Divorce Court, that after his attorney resigned, he did not understand the necessity of appearing at the various hearings. The Debtors contend that if they had appeared at the hearing on the Motion for Default Judgment, they could have explained to the satisfaction of the Court that they did not knowingly and intentionally make false oaths in their bankruptcy case.
The Supreme Court listed the following factors to determine what sort of neglect will be considered excusable: "danger of prejudice to the debtor, length of the delay and its potential impact on judicial proceedings, the reason for the delay, including whether it was within the reasonable control of the movant, and whether the movant acted in good faith." Pioneer Inv. Serv. Co. v. Brunswick Assoc. Ltd. P'ship, 507 U.S. 380, 394 (in the context of FED. R. BANKR. P. 9006). One bankruptcy court pointed out that "excusable neglect" defined by the Pioneer case "has broad application to bankruptcy practice and procedure." Xuchang Rihetai Human Hair Goods Co., Ltd. v. Hongjun Sun (In re Hongjun Sun), 323 B.R. 561, 564 (Bankr. E.D.N.Y. 2005). In the bankruptcy context, the "[D]ebtors showing of excusable neglect boils down to an assertion that they were understandably ignorant of the rules of bankruptcy procedure. . . ." Id.
Decisions to grant or deny a motion to set aside a default judgment are within the sound discretion of the bankruptcy court. Jones Truck Lines v. Foster's Truck Equip. Sales (In re Jones Truck Lines, Inc.), 63 F.3d 685, 686 (8th Cir. 1995). Since the Debtors' request was made within one year of the entry of the order for default judgment, the Court can construe their letter as a motion under Rule 60(b)(1). As the defaulting party, the Debtors have the burden to show the applicability of Rule 60(b). Iowa Oil Co. v. T Mart, Inc. (In re Iowa Oil Co.), 299 B.R. 555, 560 (Bankr. N.D. Iowa 2003). Generally, a party moving under Rule 60(b) must show that three factors weigh in favor of vacating the default judgment: "(1) whether the non-defaulting party will be prejudiced; (2) whether the defaulting party has a meritorious defense; and (3) whether culpable conduct of the defaulting party led to the default." Info Sys. Networks Corp. v. United States, 994 F.2d 792, 795 (Fed. Cir. 1993); See also In re Wilson, 349 B.R. 831 (Bankr. D. Idaho 2006). Stated another way, the moving party must demonstrate good cause for the default, a meritorious defense to the plaintiff's complaint, and quick action to correct the default. Pretzel Stouffer v. Imperial Adjusters, Inc., 28 F.3d 42, 45 (7th Cir. 1994); United States v. Di Mucci, 879 F.2d 1488, 1495 (7th Cir. 1989); Moglia v. King Marine, Inc. (In re Outboard Marine Corp.), 369 B.R. 353, 360 (Bankr. N.D. Ill. 2007). "Even though Rule 60(b) motions are liberally construed there is a compelling interest in the finality of judgments which should not be lightly disregarded . . . it is the debtor's burden to bring himself within the provisions of Rule 60(b)." Sanders, supra, 2007 Bankr. LEXIS 4269.
Entry of a default judgment prohibits a party from having a case decided on its merits. In light of this, a "Rule 60(b) motion guides the balance between the `overriding judicial goal of deciding cases correctly, on the legal and factual merits, with the interests of both litigants and the courts in the finality of judgments.'" Id. (citing Sallie Mae Serv., L.P. v. Williams (In re Williams), 287 B.R. 787, 793 (B.A.P. 9th Cir. 2002)). It is a "well-established principle that a trial on the merits is favored over default judgment and that close cases should be resolved in favor of the party seeking to set aside default judgment." Info. Sys. Networks Corp. v. United States, 994 F.2d 792, 795 (Fed. Cir. 1993); Zawadski De Bueno v. Bueno Castro, 822 F.2d 416, 420 (3d Cir. 1987); Gross v. Stereo Component Sys., Inc., 700 F.2d 120, 122 (3d Cir. 1983); United Coin Meter Co. v. Seaboard Coastline R.R., 705 F.2d 839, 845 (6th Cir. 1983) ("Judgment by default is a drastic step which should be resorted to only in the most extreme cases."). The Seventh Circuit shares the policy of favoring a trial on the merits and has held that a "default judgment should be used only in extreme situations, or when other less drastic sanctions have proven unavailing." Yong-Qian Sun v. Bd. of Trs., 473 F.3d 799, 811 (7th Cir. 2007) (citing C.K.S. Eng'rs, Inc. v. White Mountain Gypsum Co., 726 F.2d 1202, 1205 (7th Cir. 1984)). The Seventh Circuit classifies the default judgment as a "weapon of last resort, appropriate only when a party willfully disregards pending litigation." C.K.S. Eng'rs, Inc. v. White Mountain Gypsum Co., 726 F.2d at 1204 (district court declined to vacate default where it concluded that defendants "believed that they could ignore this case and throw themselves upon the mercy of the court by contending that their local counsel was incompetent").
In United States Tr. v. Clark (In re Clark), the court denied the U.S. Trustee's motion for default judgment in a complaint to revoke the discharge on the grounds it was an unduly harsh sanction, particularly when the debtors did not receive actual notice. 2007 Bankr. LEXIS 525 (Bankr. S.D. Iowa Feb. 23, 2007). Even though the U.S. trustee complied with the service requirements of FED. R. BANKR. P. 7004, it did not automatically necessitate that default would be granted. Similar to the Seventh Circuit, the Clark court favored a hearing on the merits and characterized default as a harsh and rare judicial act that should be resorted to in extreme circumstances.
Bankruptcy courts have taken a conservative approach and often refrain from granting default judgment motions, especially when the defendant is the debtor in a bankruptcy case. In re McArthur, 258 B.R. 741 (Bankr. W.D. Ark. 2001). Further, when faced with the choice of upholding denial of a debtor's discharge entered on default judgment or vacating the judgment upon motion of the debtor, some courts apply a relaxed standard. The Second Circuit granted a debtor relief from a default judgment denying her discharge because of counsel's administrative errors. La Barbera v. Grubard, 112 F.2d 738 (2d Cir. 1940). The La Barbera court reopened the final judgment under the rationale that "the bankrupt had not had her day in court on the most vital matter to her of the whole bankruptcy proceedings." 112 F.2d at 738. In In re Trappen, the Court set aside the default judgment under Rule 60(b)(6), upon accepting that the Defendants were unaware of both the filing of the motion for default judgment as well as the hearing on that motion. 2006 Bankr. LEXIS 2845 (Bankr. D. Idaho Sept. 27, 2006). In considering whether the debtors offered a "meritorious defense," the Trappen court noted that since the discovery phase was incomplete, the "merits of the parties' positions is an open question," and accepted the defendants' denial of the allegations as a potential defense. The court further reasoned that the prejudice faced by the defendant if the judgment was upheld would outweigh that of the plaintiff; "if the default is allowed to remain in effect, Defendants will face the Bankruptcy Code's most severe consequence, namely, the denial of a discharge." In re Trappen, 2006 Bankr. LEXIS 2845, at *10 (Bankr. D. Idaho Sept. 27, 2006). Essentially the court was unwilling to deny the discharge "as a procedural matter and not on the merits." Id. La Barbera and Trappen present strong policy arguments in favor of vacating the default judgment here. Given that the denial of discharge is the harshest outcome possible in a bankruptcy case, the prejudice facing the Trustee of having to re-present his case on the merits does not outweigh the prejudice to the Debtors if the Court upholds the denial of their discharge. Mr. Smith provided evidence of such prejudice in the letter he filed with the Court. The Debtors have previously explained the problem with receiving and understanding mail from the Trustee when their house was in foreclosure and they were undergoing a divorce. The Debtors filed their letter requesting reconsideration in a timely and "reasonable amount of time" as it was within one year from the entry of the default judgment as required by Rule 60(b)(1). Following the rationale of Trappen, and considering that the Court has previously ruled that the Debtors did not convert their case in bad faith, the Court accepts the Debtors' denial of the Trustee's allegations as a potentially meritorious defense. The Debtors' omissions in failing to appear at the hearing do not seem to be the product of "willful disregard for the pending litigation," but rather the result of a combination of ignorance of the Bankruptcy Rules, ailing health and personal tumult. Such circumstances are arguably beyond the Debtors' personal culpability. In a close case, the Court should vacate a default judgment in favor of a trial on the merits. See e.g. Info. Sys. Networks Corp. v. United States, 994 F.2d 792. The Debtors carried their burden of proof on the motion. The default judgment against the Debtors shall be reopened to provide them with their "day in court" on the determination of their bankruptcy discharge.
IT IS THEREFORE ORDERED: the Debtors' Motion to Vacate the Order Denying Discharge is granted.
IT IS FURTHER ORDERED: that the trial on the adversary proceeding to deny the Debtors' discharge will be held on June 18, 2008 at 9:30 A.M.