Res judicata limits the ability of a debtor in a second chapter 11 case to object to a claim allowed in a prior bankruptcy, the Fifth Circuit said.

A company and its individual owner were in parallel chapter 11 cases. The two debtors proposed and confirmed a joint plan.

The plan allowed the claim of a secured creditor for $1.8 million (rounded off). The plan called for the claim to accrue 5% interest and to be paid in 59 equal installments, with a so-called balloon payment in the 60th month.

After the 38th payment, the company filed in chapter 11 again and stopped making payments under the plan from the prior case. In the new case, the lender filed a proof of claim for $1.3 million (rounded off).

The corporate debtor objected to the $1.3 million claim, contending that most of the original $1.8 million claim was owing solely by the owner. Bankruptcy Judge Ronald B. King overruled the objection, holding that the objection was barred by res judicata, among other theories.

The district court affirmed, and so did Circuit Judge Edith Brown Clement in an opinion on November 15.

First, Judge Clement dealt with the bankruptcy court’s subject matter jurisdiction.

The corporate debtor argued that most of the debt was owed only by the individual, thus giving the bankruptcy court no subject matter jurisdiction to rule on the allowance of a debt owed by a non-debtor.

“[W]hether the bankruptcy court’s allowance of [the lender’s] claim was proper is an entirely different question from whether it had the jurisdiction to do so,” Judge Clement said. She held that the “propriety of the bankruptcy court’s determination to allow or disallow a claim against the debtor’s estate is simply not a jurisdictional inquiry.” [Emphasis in original.]

Next, Judge Clement analyzed whether the requisites of res judicata were satisfied.

There was no dispute about three elements: (1) The lender and the debtor were both parties in the first bankruptcy; (2) confirmation in the first bankruptcy was final; and (3) the bankruptcy court had jurisdiction in the first bankruptcy.

The debtor disputed the fourth element: whether the objection in the second bankruptcy arose out of the same transaction that underlay the prior bankruptcy.

The Fifth Circuit employs a “transactional test,” Judge Clement said. Citing Nilsen v. City of Moss Point, 701 F.2d 556, 560 (5th Cir. 1983) (en banc), she asked whether the two actions were based on the “same nucleus of operative facts.”

In the case on appeal, Judge Clement inquired as to “whether the transactions at the heart of [the debtor’s] claim objection in the second bankruptcy were the source of [the lender’s] claim in the first bankruptcy.” In other words, was the claim objection in the second bankruptcy “based on the same transaction or series of transactions that gave rise to the terms of the [chapter 11 plan in the first bankruptcy] as it relates to the amount of [the lender’s] claim”?

Judge Clement held “that it is,” because the objection in the second case “depends entirely on” the subject matter “that formed the basis” for the lender’s claim in the first bankruptcy.

Even if all four elements were present, Judge Clement said that res judicata would not apply unless the debtor “could have or should have” raised the claim in the first bankruptcy.

Since the claim objection in the second bankruptcy was “undeniably a question” about the propriety of the claim in the first bankruptcy, Judge Clement said the debtor could have raised the objection in the first bankruptcy. Consequently, she said, the debtor was precluded from contending that the claim had been allowed “for the wrong amount.

Judge Clement raised a caveat. Res judicata did not prevent the debtor “from maintaining any claim objection in the second bankruptcy.” [Emphasis in original.] The doctrine only barred “a claim objection that is premised, in part or in whole, on the impropriety of [the lender’s] claim from the” plan in the first bankruptcy. 

The claim had been reduced between the first and second bankruptcies, raising the question of whether the allowance of the claim in the second bankruptcy for $1.3 million was the correct amount. That issue, Judge Clement said, was “merely a factual determination reviewed for clear error.”

Examining the evidence and the bankruptcy judge’s findings in the second bankruptcy, Judge Clement found no clear error and affirmed.