Res Judicata Revisited by the Fifth Circuit

Res Judicata Revisited by the Fifth Circuit

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Debtors and creditors in a bankruptcy case are well advised to be vigilant in the protection of the vitality and integrity of their claims against one another and against third parties. Two recent Fifth Circuit cases provide fresh guidance about the res judicata effect of bankruptcy court orders on later asserted claims.

Claim Preclusion in Professional Fee Matters

In Matter of Intelogic Trace, 200 F.3d 382 (5th Cir. 2000), the court reaffirmed the long-standing axiom that he who stands mute while his rights are being affected during the course of a bankruptcy case later will regret that silence. Intelogic involved the issue of whether a post-confirmation final fee order for a debtor's accountants is res judicata to a later suit filed by the debtor's successor chapter 7 trustee for alleged malpractice committed by those accountants during the earlier chapter 11 case.1 Basing its decision on well-established Fifth Circuit precedent, the court held that res judicata barred the suit.

The court first restated the Fifth Circuit test for determining whether a claim is barred by the doctrine of res judicata, which requires that (1) the parties must be identical in both suits; (2) the prior judgment must have been rendered by a court of competent jurisdiction; (3) there must have been a final judgment on the merits; and (4) the same cause of action must be involved in both cases.2 The parties did not dispute the satisfaction of the first three elements, requiring the court to address only the fourth in more depth.

To determine whether the chapter 11 fee application hearing and the later malpractice suit involved the same cause of action, the court applied the "transactional test" set forth in the Restatement (Second) of Judgments.3 The critical issue in this determination is whether the two actions under consideration are based on "the same nucleus of operative facts."4 The court noted that Comment C to §24 of the restatement states that, even though a number of different legal theories may result in liability for a given episode, that does not create multiple transactions and hence multiple claims.5 The focus, therefore, is on the operative facts, not on how many creative legal theories a plaintiff's lawyer can throw at the wall to attempt to stick the defendant with liability arising from one set of facts.

The court went on to note that, even if the two actions are the same under the transactional test, res judicata still would not bar the later action unless the claimant could have and should have brought its later-asserted claims in the earlier proceedings.6 The key issue in that determination is whether the claimant had a "sufficient general awareness of the real potential for claims" against the defendant at the time of the earlier proceeding.7

The court then considered whether the bankruptcy procedures applicable to the earlier fee hearing afforded an opportunity to litigate the malpractice claims, i.e., whether the malpractice issues "could have" been litigated in connection with the fee hearing.8 The court concluded in the affirmative. If the debtor had included with its objection to the fee application a claim for affirmative relief on account of the alleged malpractice, the matter would have been converted to an adversary proceeding pursuant to Rule 3007. In addition, Rule 9014 provides that the court may direct the application of any adversary proceeding rules at any stage of a contested matter. Thus, because a bankruptcy claimant is afforded the opportunity to conduct discovery, further develop a case, etc., even in the context of a contested matter, there exists a sufficient opportunity to litigate to meet the "could-have-litigated" requirement in connection with the prior proceeding.9 Therefore, the court concluded that the trustee's claims against the accountants were barred by res judicata.10

Claim Preclusion in Plan Confirmation Matters

The Intelogic case dealt with the res judicata effect of a professional fee application order. In Matter of Applewood Chair Co., 203 F.3d 914 (5th Cir. 2000), the Fifth Circuit reviewed the scope of its prior decision in Republic Supply11 regarding the extent that a plan confirmation order can present a res judicata bar to the later assertion of claims by creditors against third parties. Republic Supply involved a confirmed chapter 11 plan that contained a provision expressly releasing any claims the creditor had against a third party, the guarantor of the creditor's claim against the debtor. The creditor neither objected to the release provision nor appealed the confirmation order. The Fifth Circuit held that the creditor's subsequent suit against the guarantor on the guaranty was barred by the res judicata effect of the confirmation order.12 The court did so even though it assumed that the bankruptcy court did not have subject matter jurisdiction to release the guaranty.13

It is axiomatic that a confirmed chapter 11 plan of reorganization is binding upon the debtor, all creditors and all parties-in-interest in the case.14 However, the extent to which questions that could have been raised pertaining to such plan are later barred by res judicata is the subject of much interpretation in the case law. For example, in In re Howe,15 the debtors objected to the claims of their major secured bank creditor and instituted an adversary proceeding in an attempt to have the bank's mortgage declared null and void, contending that the interest rate charged was usurious. A plan of reorganization ultimately was confirmed that treated the bank's claim as an allowed partially secured, partially unsecured claim. After the debtors defaulted in payments to the bank under the plan, the debtors filed a lender liability suit against the bank based on the same loan transaction which was addressed as a partially secured claim in the confirmed plan. The issue before the Fifth Circuit was whether the plan confirmation order was res judicata to the lender liability claims.

The court had no hesitation in finding that res judicata applied. The loan transaction at the heart of the lender liability suit also was the source of the bank's claim against the debtors' estate. The debtors merely asserted in the lender liability suit new theories of liability based on the same nucleus of operative facts that gave rise to the bank's claim in the bankruptcy.16 The bank's claims were disclosed and treated in the confirmation plan.17 The court held that because the debtor had a full opportunity to contest the bank's claim in the adversary proceeding filed pre-confirmation which was, in effect, settled by confirmation of the plan, the debtors could not collaterally attack the confirmation order in the lender-liability action based on the same loan transaction.18

However, even if the debtor does not bring a pre-confirmation adversary proceeding against the creditor related to the issue pursued post-confirmation, the confirmation order still may act as a res judicata bar to a later suit.19 The absence of a prior related adversary proceeding does not prevent application of res judicata.20

Res judicata in the context of plan confirmation is, however, "a double-edged sword."21 While it can be used to cut off a debtor's claims against a creditor, it also can be used to cut off the creditor's claims against the debtor and even against a non-debtor third party. As is often the case in bankruptcy, a lack of vigilance can be hazardous to a creditor's financial health.22

The order confirming a plan, and a plan itself, can have the effect of barring or altering the nature of a creditor's claim against the debtor and/or the debtor's property. For example, in Burton Securities,23 the debtor owned a gambling vessel that was operated by the creditor under a management agreement. Other creditors provided various necessities to the vessel. The creditor commenced a lawsuit in district court to foreclose a maritime lien. Thereafter, the debtor filed a chapter 11 proceeding, the creditor's district court lawsuit was transferred to bankruptcy court and the debtor filed an objection to the creditor's claim.24

While that objection to the claim was pending, the bankruptcy court confirmed the debtor's plan, which set forth the order of payment for each creditor's claim. After confirmation of the plan, the bankruptcy court ruled on the debtor's objection to the creditor's claim.25 Thereafter, the liquidating trustee appointed under the plan filed a motion with the bankruptcy court seeking an order of distribution to creditors. The bankruptcy court entered an order requiring the trustee to make distributions accordingly to the priorities set forth in the plan. The court held that the creditor's claim had to be dealt with in accordance with the terms of the plan and could not be elevated above its treatment as would be the case if the creditor were treated as secured.26

On appeal to the district court, the creditor contended that the bankruptcy court erred in recognizing the priority of payments set forth in the confirmed plan. It also argued that its secured claim, as recognized in the claims objection order, "passed through" the bankruptcy unaffected by the confirmed plan.27

The district court rejected the creditor's appeal on a number of grounds. It held that under Eubanks, Republic Supply and other precedents, once a bankruptcy plan is confirmed it is binding on all parties, and that questions that could have been raised pertaining to the plan are entitled to res judicata effect. Since the creditor did not appeal the plan confirmation order, that order is a final and binding judgment barring the creditor from challenging the distribution scheme set forth in the plan.28

The district court then addressed the creditor's contention that its secured claim passed through the bankruptcy unaffected by the plan confirmation order. The court first noted the well-established principle of bankruptcy law that liens pass through bankruptcy proceedings unaffected.29 That principle cannot be taken literally, however. It cannot be applied where there is a confirmed chapter 11 plan of reorganization that deals with the lien.30 Moreover, "confirmation of a chapter 11 plan of reorganization extinguishes a creditor's lien where the plan provides for payment of the creditor's claim, but makes no provision for preservation of the lien, and the creditor participated in the bankruptcy proceedings."31 Therefore, the court concluded that the confirmation of the debtor's plan extinguished the creditor's lien.32

While the Fifth Circuit broke no new ground in Intelogic and Applewood Chair, it applied long-standing jurisprudential rules on res judicata that practitioners are well-advised to know when seeking to protect claims against other parties.


1 Colloquially stated, that rule is: If you snooze, you lose. "Simply put, creditors who sleep on their rights through the confirmation process do so at their own peril." In re Brenner, 189 B.R. 121, 128 (Bankr. N.D. Ohio 1995); accord, In re Sanders, 243 B.R. 326, 331 (Bankr. N.D. Ohio 2000). Return to article

2 Intelogic, supra, 200 F.3d at 386, citing Nilsen v. City of Moss Point, Miss., 701 F.2d 556, 559 (5th Cir. 1983) (en banc), quoting Kemp v. Birmingham News Col., 608 F.2d 1049, 1052 (5th Cir. 1979). Return to article

3 Intelogic, supra, 200 F.3d at 386; Nilsen, supra, 702 F.2d at 560. Return to article

4 Agrilectric Power Partners v. General Elec. Co., 20 F.3d 663, 665 (5th Cir. 1994); In re Howe, 913 F.2d 1138, 1144 (5th Cir. 1990). Return to article

5 Intelogic, supra, 200 F.3d at 386 n.3. Return to article

6 Intelogic, supra, 200 F.3d at 388, citing Howe, supra, 913 F.2d at 1145, and D-1 Enterprises Inc. v. Commercial State Bank, 864 F.2d 36, 38 (5th Cir. 1989). Return to article

7 Intelogic, supra, 200 F.3d at 389; see, also, Howe, supra, 913 F.2d at 1147; Eubanks v. FDIC, 977 F.2d 166, 174 (5th Cir. 1992). Return to article

8 Intelogic, supra, 200 F.3d at 389. Return to article

9 Intelogic, supra, 200 F.3d at 390. Return to article

10 Id. Return to article

11 Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987). Return to article

12 Id. at 1054. Return to article

13 Id. at 1051 n.6. Accord, In re NCC Inc. 213 B.R. 487 (E.D. La. 1997), aff'd., 162 F.3d 1160 (5th Cir. 1998); Corbett v. MacDonald Moving Services Inc. 124 F.3d 82, 89 (2d Cir. 1997); Trulis v. Barton, 107 F.3d 685, 691 (9th Cir. 1995). In Applewood Chair Co., 203 F.3d at 919-20, the court declined to extend the holding of Republic Supply to situations where a plan of reorganization does not contain a specific discharge of the indebtedness of a third party. Return to article

14 Bankruptcy Code §1141. Return to article

15 Howe, supra, 913 F.2d at 1138. Return to article

16 Howe, supra, 913 F.2d at 1144-45. Return to article

17 Id. at 1146. Return to article

18 Id. at 1147; accord, Sure-Snap Corp. v. State Street Bank and Trust Co., 948 F.2d 869 (2nd Cir. 1991). Return to article

19 Eubanks v. FDIC, 977 F.2d 166 (5th Cir. 1992). Return to article

20 Accord, Sure-Snap, supra; see, also, Matter of Baudoin, 981 F.2d 736 (5th Cir. 1993) (res judicata, based on the bankruptcy court's allowing creditor's proof of claim in a chapter 7 case, and authorizing and confirming the sale of the debtor's mortgaged property to the creditor, precluded the debtor's later lender liability action against the creditor based on the same loan transaction as the one at issue in the chapter 7 case). Return to article

21 Matter of Depew, 115 B.R. 965, 973 (Bankr. N.D. Ind. 1989). Return to article

22 Sanders, supra, 243 B.R. at 331. Return to article

23 In re Burton Securities S.A., 202 B.R. 411 (S.D. Tex. 1996). Return to article

24 Id. at 414-15. Return to article

25 Id. at 415. Return to article

26 Id. Return to article

27 Id. Return to article

28 Id. at 418-19. Return to article

29 Dewsnup v. Timm, 502 U.S. 410, 417 (1992). Return to article

30 Burton Securities, supra, 202 B.R. at 420, citing Matter of Penrod, 50 F.3d 459, 462 (7th Cir. 1995). Return to article

31 Burton Securities, supra, 202 B.R. at 410, citing Penrod, supra, 50 F.3d at 462-63, and In re Be-Mac Transport Co. Inc., 83 F.3d 1020, 1025-26 (8th Cir. 1996). Return to article

32 "Res judicata applies even when the plan mistakenly characterizes a claim or provides that a creditor should receive less than the amount to which it is legally entitled. In re Chattanooga Wholesale Antiques Inc., 930 F.2d 458, 462-63 (6th Cir. 1991)." Matter of Alliance Operating Corp., 173 B.R. 326, 330 (E.D. La. 1994), aff'd, 60 F.3d 1174 (5th Cir. 1995); accord, In re Wrenn Ins. Agency of Missouri Inc., 178 B.R. 792, 796-97 (Bankr. W.D. Mo. 1995). Return to article

Journal Date: 
Thursday, June 1, 2000