Res Judicata Revisited by the Fifth Circuit

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Jun 2000

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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.

<h3>Claim Preclusion in Professional Fee Matters</h3>

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Intelogic Trace, 200 F.3d 382 (5th Cir. 2000)</a>, 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.<a href="#1" name="1a">1</a> 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.<a href="#2" name="2a">2</a> 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.<a href="#3" name="3a">3</a> The critical issue in this determination is whether the two actions under consideration are
based on "the same nucleus of operative facts."<a href="#4" name="4a">4</a> 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.<a href="#5" name="5a">5</a> 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.<a href="#6" name="6a">6</a> 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.<a href="#7" name="7a">7</a>

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.<a href="#8" name="8a">8</a> 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.<a href="#9" name="9a">9</a> Therefore, the court concluded that the trustee's claims against the accountants were barred
by res judicata.<a href="#10" name="10a">10</a>

<h3>Claim Preclusion in Plan Confirmation Matters</h3>

The Intelogic case dealt with the res judicata effect of a professional fee application order. In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
of Applewood Chair Co., 203 F.3d 914 (5th Cir. 2000)</a>, the Fifth Circuit reviewed the scope of its prior
decision in Republic Supply<a href="#11" name="11a">11</a> 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.<a href="#12" name="12a">12</a> The
court did so even though it assumed that the bankruptcy court did not have subject matter jurisdiction to
release the guaranty.<a href="#13" name="13a">13</a>

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.<a href="#14" name="14a">14</a> 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,<a href="#15" name="15a">15</a> 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.<a href="#16" name="16a">16</a> The bank's claims were disclosed and treated in the
confirmation plan.<a href="#17" name="17a">17</a> 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.<a href="#18" name="18a">18</a>

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.<a href="#19" name="19a">19</a> The absence of a prior related adversary proceeding does not prevent application of res
judicata.<a href="#20" name="20a">20</a>

Res judicata in the context of plan confirmation is, however, "a double-edged sword."<a href="#21" name="21a">21</a> 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.<a href="#22" name="22a">22</a>

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,<a href="#23" name="23a">23</a> 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.<a href="#24" name="24a">24</a>

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.<a href="#25" name="25a">25</a> 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.<a href="#26" name="26a">26</a>

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.<a href="#27" name="27a">27</a>

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.<a href="#28" name="28a">28</a>

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.<a href="#29" name="29a">29</a> 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.<a href="#30" name="30a">30</a> 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."<a href="#31" name="31a">31</a> Therefore, the court
concluded that the confirmation of the debtor's plan extinguished the creditor's lien.<a href="#32" name="32a">32</a>

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.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> 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." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Brenner, 189 B.R. 121, 128 (Bankr. N.D. Ohio 1995)</a>; accord, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Sanders, 243 B.R. 326, 331 (Bankr. N.D. Ohio 2000)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 386</a>, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. City of Moss Point, Miss., 701 F.2d 556, 559 (5th Cir. 1983) (en banc)</a>, quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Birmingham News Col., 608 F.2d 1049, 1052 (5th Cir. 1979)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 386</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 702 F.2d at 560</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Power Partners v. General Elec. Co., 20 F.3d 663, 665 (5th Cir. 1994)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Howe, 913 F.2d 1138, 1144 (5th Cir. 1990)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 386 n.3</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 388</a>, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 913 F.2d at 1145</a>, and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Enterprises Inc. v. Commercial State Bank, 864 F.2d 36, 38 (5th Cir. 1989)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 389</a>; see, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 913 F.2d at 1147</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. FDIC, 977 F.2d 166, 174 (5th Cir. 1992)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 389</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 200 F.3d at 390</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> Id. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 1054</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 1051 n.6</a>. Accord, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re NCC Inc. 213 B.R. 487 (E.D. La. 1997)</a>, aff'd., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d 1160
(5th Cir. 1998)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. MacDonald Moving Services Inc. 124 F.3d 82, 89 (2d Cir. 1997)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Barton, 107 F.3d 685, 691 (9th Cir. 1995)</a>. In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Chair Co., 203 F.3d at 919-20</a>, 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. <a href="#13a">Return to article</a>

<a name="14">14</a> Bankruptcy Code §1141. <a href="#14a">Return to article</a>

<a name="15">15</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 913 F.2d at 1138</a>. <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 913 F.2d at 1144-45</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 1146</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 1147</a>; accord, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Corp. v. State Street Bank and Trust Co., 948 F.2d 869 (2nd Cir. 1991)</a>. <a href="#18a">Return to article</a>

<a name="19">19</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. FDIC, 977 F.2d 166 (5th Cir. 1992)</a>. <a href="#19a">Return to article</a>

<a name="20">20</a> Accord, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra</a>; see, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Baudoin, 981 F.2d 736 (5th Cir. 1993)</a> (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). <a href="#20a">Return to article</a>

<a name="21">21</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Depew, 115 B.R. 965, 973 (Bankr. N.D. Ind. 1989)</a>. <a href="#21a">Return to article</a>

<a name="22">22</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 243 B.R. at 331</a>. <a href="#22a">Return to article</a>

<a name="23">23</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Burton Securities S.A., 202 B.R. 411 (S.D. Tex. 1996)</a>. <a href="#23a">Return to article</a>

<a name="24">24</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 414-15</a>. <a href="#24a">Return to article</a>

<a name="25">25</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 415</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#26a">Return to article</a>

<a name="27">27</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#27a">Return to article</a>

<a name="28">28</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 418-19</a>. <a href="#28a">Return to article</a>

<a name="29">29</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Timm, 502 U.S. 410, 417 (1992)</a>. <a href="#29a">Return to article</a>

<a name="30">30</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Securities, supra, 202 B.R. at 420</a>, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Penrod, 50 F.3d 459, 462 (7th Cir. 1995)</a>. <a href="#30a">Return to article</a>

<a name="31">31</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Securities, supra, 202 B.R. at 410</a>, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 50 F.3d at 462-63</a>, and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Be-Mac Transport Co. Inc., 83 F.3d 1020, 1025-26 (8th Cir. 1996)</a>. <a href="#31a">Return to article</a>

<a name="32">32</a> "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. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Chattanooga Wholesale Antiques Inc., 930 F.2d 458, 462-63 (6th Cir. 1991)</a>."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Alliance Operating Corp., 173 B.R. 326, 330 (E.D. La. 1994)</a>, aff'd, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d 1174 (5th Cir. 1995)</a>; accord, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Wrenn Ins. Agency of Missouri Inc., 178 B.R. 792, 796-97 (Bankr. W.D. Mo. 1995)</a>. <a href="#32a">Return to article</a>

Journal Authors

Rudy J. Cerone

Journal Date

Thursday, June 1, 2000 - 12:00