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In re Brown

argued: October 15, 1991.



Before: Sloviter, Chief Judge, Cowen and Weis, Circuit Judges

Author: Weis


WEIS, Circuit Judge.

In this appeal we decide that a bankruptcy judge was required to give preclusive effect to a state court summary judgment on liability in a mortgage foreclosure proceeding. Furthermore, because the amount due is yet to be determined, the bankruptcy judge should permit the state court proceedings to continue. Because it appears that the bankruptcy judge's denial of the mortgagor's motion to dismiss the Chapter 11 petition here was influenced by a misunderstanding of issue preclusion, we believe that the case should be remanded for further consideration. Accordingly, we will reverse the district court order dismissing the petition.

This opinion discusses two interrelated bankruptcy cases, the first by a corporation, the second by an individual who had owned an interest in that company. The debtor here, Rosemary Brown, filed a petition for reorganization under Chapter 11 as the result of earlier financial difficulties, and subsequent bankruptcy proceedings, encountered by Repro Supply Corporation. Rosemary Brown and her husband, Gary, each owned fifty percent of the stock of that company.

Although successful for a time, Repro became unable to pay loans it had received from First Jersey National Bank and, filed for Chapter 11 protection in 1986. The bankruptcy court entered a cash collateral order in which Gary Brown waived any claims he might have against the bank and agreed that he and his wife Rosemary would give the bank mortgages on three properties that they jointly owned. This arrangement was negotiated so that the bank would continue financing Repro during the reorganization process.

On June 8, 1987, the Browns executed three mortgages that stated that they were given pursuant to the bankruptcy court's cash collateral order. Soon thereafter, the bank stopped advancing funds to Repro and the corporation was unable to reorganize.

On July 17, 1987, Gary Brown agreed to give the bank possession of Repro's collateral and began liquidating the corporation's assets. On September 16, 1987, the bankruptcy court issued an order stating that the bank was deemed to be in possession of all Repro's collateral subject to liens and directed the bank to liquidate the debtor's estate in a commercially reasonable manner.

Rosemary and Gary Brown sold some of Repro's assets in the months following, but with limited success. The bank then put up Repro's inventory and equipment for auction. The results were far below expectations, leaving a balance due on Repro's loans of approximately $1 million.

In 1988, the bank filed suit in the Superior Court of New Jersey to foreclose on two of the mortgages given by Rosemary and Gary Brown. The Browns counterclaimed, asserting breach of contract, breach of the duty of good faith, negligence, and promissory estoppel. The state court entered summary judgment in favor of the bank, struck the Browns' affirmative defenses and counterclaims, and directed the bank to submit affidavits as well as the mortgages so the amount due could be determined.

In response to a motion filed by the Browns, the state court reconsidered the summary judgment, but reaffirmed its previous ruling. Soon thereafter, the bank submitted a certification of the amount due. The Browns requested a hearing on that issue, in part because of an assertion that the bank did not adequately account for the proceeds of the Repro collateral liquidation.

On October 10, 1989, before a hearing could be held in the state court, Rosemary, but not Gary, Brown filed a Chapter 11 petition on her own behalf. The bank filed a motion to dismiss alleging that Rosemary's Chapter 11 petition had been filed in bad faith as demonstrated by her lack of an existing business, her lack of assets other than the mortgaged properties, her lack of a reasonable prospect of reorganizing, and her husband Gary's failure to join in the petition.

After a hearing, the bankruptcy judge (not the one to whom the Repro case had been assigned) denied the bank's motion and announced his intention to adjudicate certain matters that had already been considered by the state court, such as whether the mortgages were valid or procured by fraud. He also expressed concern about whether the sale of Repro's assets had been conducted in a proper manner.

On appeal, the district court considered the denial of the bank's motion to be interlocutory and declined to consider the merits. We reversed, concluding that the bankruptcy judge's determination was final. In re Brown, 916 F.2d 120 (3d Cir. 1990).

On remand, the district court reversed the bankruptcy judge's order after determining that the "record [did] not support a finding that the debtor had a reasonable likelihood of rehabilitation" and, in the alternative, that Rosemary had filed her Chapter 11 in bad faith. In addition, the district court concluded that the bankruptcy judge exceeded his authority when he permitted the bankruptcy case to continue so that he could review the state court decision. The district court also held that an individual debtor could not utilize the provisions of Chapter 11, that option being available only to business entities.

Rosemary Brown appealed to this Court. She points out that after the district court filed its order, the Supreme Court held that individual nonbusiness debtors may file under Chapter 11. She also contends that the district court erred in its findings that she did not have a reasonable likelihood of rehabilitation and that her filing under Chapter 11 was in bad faith.

The bank argues that the doctrine of issue preclusion bars re-litigation of the issues decided in the state court and that the bankruptcy court did not apply the appropriate standard in denying the bank's motion to dismiss the petition.


In an appeal from an order of a bankruptcy judge, a district court applies the clearly erroneous test to factual findings and plenary review to questions of law. Mixed questions of law and fact must be divided into their respective components and the appropriate test applied. We use the same standards. Universal Minerals, Inc. v. C.A. Hughes & Co., 669 F.2d 98, 101-03 (3d Cir. 1981). In that sense, our review duplicates that of the ...

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