Finality in Cash Collateral Orders Its Not Over Until Its Over

Journal Issue

Feb 2006

Column Name

Practice & Procedure

Citation

ABI Journal, Vol. XXV, No. 1, p. 30, February 2006

Bankruptcy Code

502

Topic Tags

Administrative Expense Claims

Journal HTML Content

In a series of opinions issued by the U.S.
Bankruptcy Court for the Eastern District of Arkansas in the chapter
11 of Hoffinger Industries Inc. (the debtor),2
J.M. Capital Finance Ltd. went from being a secured
creditor—which, in exchange for its consent for the debtor to
use its cash collateral, received a superpriority administrative
expense and replacement liens—to a creditor whose pre-petition
secured claim was disallowed and recharacterized as equity (and to the
extent that JM Capital had any claim, it was subordinated under
§510(c) of the Bankruptcy Code.) This column is not intended to
address the equitable subordination or recharacterization aspect of
the bankruptcy court’s opinions; rather, it will address the
court’s analysis in “reconsidering” the cash
collateral order that granted JM Capital (at least that’s what it
thought) an allowed secured claim with a superpriority administrative
expense and adequate protection liens, and ways that a secured
creditor may be able to protect itself from an attack. Brief
Background JM Capital and the debtor were related entities by
which each entity shared, albeit indirectly, some of the same
equity-holders. JM Capital’s principal business activity
“was to provide financing to the
debtor.”3 JM Capital and the debtor
collectively represented that JM Capital had lent the debtor $10
million pre-petition, which was secured by liens on certain
collateral. The debtor filed for chapter 11 on Sept. 13, 2001, as a
result of a $13.5 million personal-injury judgment in favor of Leesa
Bunch.4 Shortly after the filing, the debtor
filed a motion requesting authorization to use cash collateral and to
obtain secured debt. The debtor sought to enter into a $10 million line
of credit with another related entity, C.M.A. Corp. JM Capital agreed
to subordinate its $10 million pre-petition loan and to permit the use
of its cash collateral on the condition that it received replacement
liens and a superpriority administrative expense
claim.5 The court entered an order
authorizing the debtor to obtain the $10 million line of credit,
authorizing the debtor to use cash collateral, subordinating JM
Capital’s pre-petition liens and granting JM Capital a
superpriority administrative expense claim and replacement liens. The
order included a provision that required the debtor to assert any
cause of action or defense against JM Capital within 90 days after the
entry of the order, and provided that if the debtor failed to pursue
any cause of action within that 90-day window, “the
creditors’ committee or other party in interest may assert or
otherwise pursue the JM causes of action within 120 days following the
entry of the final order... granting the motion and approving the use
of cash collateral pursuant to this
agreement.”6 The opinions do not state
whether the cash collateral order expressly allowed the claim as a
secured claim. Ms. Bunch and McMasker Enterprises Inc. (the
plaintiffs) did not assert any claims or defenses against JM Capital
within the 120-day window. Rather, on Aug. 6, 2004, almost three years
after entry of the cash-collateral order, the plaintiffs filed a
complaint against JM Capital requesting the court to, among other
things, (1) reconsider the liens granted as adequate protection to JM
Capital in the Nov. 21, 2001, cash-collateral order, (2) disallow JM
Capital’s claim or reclassify the claim as equity, and (3)
equitably subordinate JM Capital’s claims to the claims of all
other creditors of the debtor. JM Capital responded by filing a
motion for summary judgment.7 JM Capital
argued that since the plaintiffs did not bring their action within the
120-day window as provided by the cash-collateral order, the
plaintiffs were now barred by the doctrine of res judicata.
Additionally, it argued that the plaintiffs were time-barred by the
one-year limitation period under Rule 60(b) of the Federal Rules of
Civil Procedure (Federal Rules), and to the extent that the one-year
limitation did not apply, the plaintiffs failed to bring their action
within a reasonable time.8 The court
denied JM Capital’s motion for summary judgment. The court held
that the 90-day and 120-day windows established in the cash-collateral
order did not prevent creditors from bringing their own causes of action
against JM Capital; rather, the time limitations only prevented the
debtor and creditors from bringing causes of action belonging to the
debtor.9 Since the plaintiffs were bringing
their own causes of action (equitable subordination and
recharacterization), the plaintiffs were not barred by the doctrine of

res judicata.10 Additionally, the
court held that it could reconsider JM Capital’s claim, even if
previously allowed by a final order, for cause under §502(j) of
the Code, and as a result, the court disallowed the secured claim and
recharacterized the $10 million “loan” as
equity.11 Res Judicata Not
Applied to the Cash Collateral Order The court recognized that
the Eighth Circuit employs a three-element test to determine whether
res judicata applies to a given cause of
action.12 The elements in the Eighth Circuit
are as follows: 1. a court of competent jurisdiction rendered the
prior judgment; 2. the prior judgment was a final judgment on the
merits; and 3. both cases involve the same cause of action and the
same parties. The bankruptcy court easily concluded that the first
element was met, since the cash-collateral order was entered by the
court. Second, the court assumed without deciding that the
cash-collateral order was a final order on the merits, even though the
order was titled “Final Order Authorizing Debtor to Use Cash
Collateral Order....” The court, however, held that the third
element was not met. In other words, the hearing on cash collateral
and the trial on recharacterization/equitable subordination and
objection to claim did not involve the same cause of action and the
same parties.13 The court explained that
“if a case arises out of the same nucleus of operative fact, or
is based upon the same factual predicate, as a former action...the two
cases are really the same ‘claim’ or ‘cause of
action’ for purposes of res
judicata.”14 The court then
recognized that the factual predicate of a cash-collateral hearing is
whether the debtor should be authorized to use cash collateral. The
court explained that a hearing on authority to use cash collateral is
brought before a court immediately after the filing of the petition,
and creditors do not understand the financing relationships between
the debtor and its financiers. At a cash-collateral hearing, the court
is not called upon to examine the credit history of the debtor, but
whether, and to what extent, the debtor can use cash
collateral.15 Section 502(j) and Rule
9024 The court also held that it could reconsider any allowed
claim for cause, and then disallow that claim according to the
equities of the case. Although cause is not defined by the Code, the
court equated a §502(j) motion with a motion for relief from
judgment under Federal Rule 60(b), which is incorporated into the
bankruptcy arena by Bankruptcy Rule 9024. However, as the court noted,
some courts apply the standards outlined in Federal Rule 60(b) for
relieving a party from a judgment only when the claim was actually
litigated.16 A bankruptcy court in the
Eighth Circuit can reconsider a claim allowed or disallowed without a
contest under §502(j) of the Code by considering “whether
delay would prejudice the debtors or other creditors, the reason for
the delay and its length and impact on efficient court administration,
whether the creditor acted in good faith, whether clients should be
penalized for counsel’s mistake or neglect, and whether
claimants have a meritorious
claim.”17 The court concluded that it
could reconsider JM Capital’s secured claim under the
less-stringent “without a contest” standard of §502(j)
to the extent that the claim was actually allowed by the cash
collateral order. First, it appeared to the court that JM Capital did
not actually have a fully secured claim. Second, and probably more
important to the court, any debt funded by JM Capital to the debtor
was used to pay interest on equity and, in effect, decreased its
ability to pay large judgments, such as Ms. Bunch’s
judgment.18 The court also found that the
plaintiffs had acted in good faith, and since no distributions had
been made by the debtor, nobody would be prejudiced. Thus, the court
reconsidered JM Capital’s claim and held that it did not have a
claim as a secured creditor, or as a creditor at
all.19 A Look at the Code and
Rules The U.S. Supreme Court first formulated the res
judicata doctrine in Cromwell v. County of Sac, 94 U.S.
351, 352, 24 L.Ed. 195 (1876): [T]he judgment, if rendered on the
merits, constitutes an absolute bar to a subsequent action. It is a
finality as to the claim or demand in controversy, concluding parties
and those in privity with them, not only as to every matter which was
offered and received to sustain or defeat the claim or demand, but as
to any other admissible matter which might have been offered for that
purpose. The policy behind the res judicata doctrine is that
“[a]ll facts, allegations and legal theories which support a
particular claim, as well as all possible remedies and defenses, must
be presented in one action or are
lost.”20 Indeed, res judicata

is designed to prevent the relitigation of issues that already have or
could have been litigated.21 Res
judicata applies equally in bankruptcy courts as it does in other
civil cases.22 However, §502(j) of the
Code creates a narrow exception to the common law
principle.23 Under §502(j), a court may
reconsider a claim that has been allowed or disallowed for cause.
Thereafter, a court may enter an order allowing or disallowing a claim
based on the equities of the case.24 Res
judicata therefore should apply to orders allowing or disallowing
claims, at least to the extent that there is no reason to revisit the
issues under §502(j), Bankruptcy Rule 9024 and Federal Rule
60(b).25 Since “cause” is not
defined by the Code, many courts have adopted the standards set forth
in Federal Rule 60(b) for motions to reconsider filed after 10 days
after entry of the order to determine whether cause exists to
reconsider the claim.26 Under this approach, a
court may reconsider an order allowing or disallowing a claim for the
following reasons: 1. mistake, inadvertence, surprise or excusable
neglect; 2. newly discovered evidence that by due diligence could
not have been discovered in time to move for a new trial under Rule
59(b); 3. fraud (whether...denominated in-trinsic or extrinsic),
misrepresentation 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 reasons justifying relief from the
operation of the judgment. Although Federal Rule 60(b) requires a
motion to be filed within a reasonable time, the Rule requires a
motion based on paragraphs 1, 2 and 3 above to be filed no later than
one year after entry of the order. Bankruptcy Rule 9024 does not
require “a motion...for reconsideration of an order allowing or
disallowing a claim against the estate entered without a contest”
to be filed within the one-year limitation. Conversely, an order
allowing or disallowing a claim entered after a contested hearing must
be brought within one year after entry of the order. Thus, if cause
does not exist under §502(j)—and as a result, there are no
Rule 60(b) grounds—and the elements for res judicata are
met, a party in interest should be barred from relitigating an order
allowing a secured claim. Conclusion In light of these
three opinions issued in Hoffinger Industries, what steps can a
secured creditor consenting to the use of its cash collateral do to
protect itself from an attack by a party in
interest?27 First of all, if grounds exist
under §502(j) and Bankruptcy Rule 9024 to vacate an order
allowing a claim, res judicata will not
apply.28 Second, the Bankruptcy Rules and
Code may provide the answer to the question. Under Bankruptcy Rule
9014, motions to prohibit, condition or use cash collateral are
contested matters,29 and thus the one-year
limitation under Bankruptcy Rule 9024 and Federal Rule 60(b) should
apply to a cash-collateral order. When obtaining an allowed secured
claim through the cash-collateral process then, the secured creditor
may consider requiring the debtor to (a) serve the motion for
authorization to use cash collateral on all creditors, (b) include a
provision in the notice of motion that the secured creditor will put on
evidence establishing its secured claim, and that the debtor and
secured creditor will request the court to make a final adjudication
on the merits concerning its claim, and (c) serve all creditors with a
proposed order incorporating those
provisions.30 In the notice and proposed
order, counsel should also consider including a limitations window
similar to the window in the Hoffinger Industries

cash-collateral order. Additionally, counsel should include in the
notice and proposed order that the final order authorizing the use of
cash collateral will not only bar any subsequent litigation on causes
of action belonging to the debtor, but the order will also bar any
causes of action belonging to parties in interest that fail to act
within the limitations period established by the order. Finally, the
secured creditor should file, prior to the final cash-collateral
hearing, a proof of claim evidencing its secured status along with
supporting documentation such as promissory notes, mortgages, security
agreements and evidence of perfection of lien. These steps will help
the creditor contend in subsequent litigation that the order allowing
its secured claim is a final order protected by res
judicata. Even if no objections to the motion are filed, res
judicata should still apply since the secured creditor put on
evidence of its secured claim, the court entered a final order on the
merits, a court of competent jurisdiction rendered the opinion, and
both cases involve the same cause of action and the same parties. As
stated above, res judicata is designed to prevent the
relitigation of issues that already have or could have been litigated.
If a party in interest fails to object to the allowance of the secured
creditor’s claim under the cash-collateral order, res judicata
should apply since the party in interest will have had an opportunity
to object—unless, of course, a court revisits the issue under
the limited grounds authorized by §502(j), Bankruptcy Rule 9024
or Federal Rule 60(b). n<hr>Footnotes1 Mr. Misken began
representing Hoffinger Industries Inc. in its chapter 11 in August
2004. Mr. Misken did not participate in the cash collateral hearing or
the adversary proceeding discussed in this article. 2 Bunch v.
JM Capital Fin. Ltd. (In re Hoffinger Indus. Inc), 321 B.R.
515 (Bankr. E.D. Ark. 2005) (Hoffinger I); Bunch v. JM Capital Fin.
Ltd. (In re Hoffinger Indus. Inc.), 323 B.R. 681 (Bankr. E.D.
Ark. 2005) (Hoffinger II); Bunch v. JM Capital Fin. Ltd. (In
re Hoffinger Indus. Inc.), 327 B.R. 389 (Bankr. E.D. Ark. 2005)
(Hoffinger III). 3 Hoffinger III, 327
B.R. at 401. 4 Id. at 394. 5 Id. at
406. 6 Hoffinger I, 321 B.R. at 517. “JM causes
of action” was defined in the order as “any and all
defenses, affirmative defenses, counterclaims, causes of action,
rights of set-off the debtor may have against JM or any other
objections to the claims or liens of JM whether pre-petition or
post-petition, including but not limited to any claims or rights under
§§547, 548, 549, 550 and 553....” 7 JM Capital
previously filed a motion to dismiss based on the same theories, and
the court denied the motion. In the motion for summary judgment, JM
Capital sought, as an alternative, for the court to reconsider its
previous denial of JM Capital’s motion to dismiss. 8

Id. 9 Hoffinger I, 321 B.R. at 517. 10
Id. at 520. 11 Hoffinger III, 327 B.R. at
411-12. 12 Hoffinger I, 321 B.R. at 518 (citing Canady
v. Allstate Ins. Co., 282 F.3d 1005, 1014 (8th Cir. 2002)).

13 Id. at 518. 14 Id. at 519 (citing
Ruple v. City of Vermillion S.D., 714 F.2d 860, 861 (8th Cir.
1983)). 15 The court also pointed out that JM Capital did not file
a proof of claim until after the 120-period in the cash collateral
order expired. As a result, even if the plaintiffs wanted to object to
the validity of JM Capital’s claim within the 120-day window,
they were unable to do so. In other words, “[w]ithout the claim,
the present adversary proceeding and the earlier cash-collateral
hearing could not have been based on the same factual predicate.”
Therefore, the cash-collateral order was not res judicata to the
plaintiffs’ equitable subordination or recharacterization causes
of action. The court did not state whether the debtor listed JM
Capital on its schedules with a $10 million secured claim. Under
Bankruptcy Rule 3003(b)(1), the debtor’s schedules
“constitute prima facie evidence of the validity and
amount of the claims of creditors, unless they are scheduled as
disputed, contingent or unliquidated.” 16 Hoffinger
III, 327 B.R. at 411 (citing In re Gomez, 250 B.R.
397, 400 (M.D. Fla. 1999)). 17 Id. (citing Kirwan v.
Vanderwerf (In re Kirwan), 164 F.3d 1175, 1177 (8th
Cir. 1999)). 18 Hoffinger III, 327 B.R. at 412.

19 Id. 20 18 Moore’s Federal
Practice-Civil §131.01 (LexisNexis 2005). 21
Id. 22 See, e.g, Katchen v. Landy, 382 U.S. 323, 334,
86 S.Ct. 467, 475, 15 L.Ed.2d 391 (1966) (“the normal rules of
res judicata and collateral estoppel apply to the decisions of
the bankruptcy courts”); 641 Avenue of the Americas Ltd.
P’ship. v. 641 Assocs. Ltd., 189 B.R. 583, 588
(S.D.N.Y. 1995). 23 In re Gomez, 250 B.R. 397, 400
(Bankr. M.D. Fla. 1999) (stating that §502(j) of the Code creates
“a narrow exception to the otherwise unwavering bar which
§1327(a) places upon relitigation of claim allowance after
confirmation”). 24 Bankruptcy Rule 3008 implements
§502(j) of the Code and provides that: [a] party in
interest may move for reconsideration of an order allowing or
disallowing a claim against the estate. The court after notice and a
hearing shall enter an appropriate order. 25 See 4 King,
Lawrence P., Collier on Bankruptcy ¶502.11[3] (15th
ed.rev. 2005) (“to the extent a claim has been allowed or
disallowed pursuant to an adversary proceeding or other contested
litigation process, however, the rules of finality and appeal might
apply and thus review may be available under Bankruptcy Rule 9024 but
not §502(j)”). 26 See, e.g., Above the Belt Inc. v.
Bohannon Roofing Inc., 99 F.R.D. 99, 101 (E.D. Va. 1983). For
motions brought within 10 days after entry of the order, courts look
at Federal Rule 59(a). Under Federal Rule 59(a), a bankruptcy court
may grant a new trial for “any of the reasons for which rehearings
have...been granted in suits in equity in the courts of the United
States.” Although there is no fixed standard that applies to
Federal Rule 59(a) relief, “[t]he general grounds for a new
trial are [among others,] the verdict is against the clear weight of
the evidence...that the trial was not fair, or that substantial errors
occurred in the admission or rejection of evidence....” 12
Moore’s Federal Practice-Civil §59.13. 27 Under
BAPCA, a chapter 11 debtor may file a plan within 120 days after the
entry of the order for relief. The court may extend that time period for
cause, but may not extend the time period beyond 18 months after entry
of the order for relief. Thus, unlike the adversary proceeding in

Hoffinger Industries mentioned above, a creditor
should not be able to attack an allowed claim of a secured creditor
three and a half years after entry of a cash collateral order. 28
See, e.g., In re Firrone, 272 B.R. 213, 217 (Bankr. N.D.
Ill. 2000). 29 Bankruptcy Rule 4001(a)(1) and (b)(1). 30
Bankruptcy Rule 4001 requires a motion to prohibit, condition or use
cash collateral to be served on the creditors’ committee and, if
one has not been appointed, upon all creditors listed on the list of
creditors. See Spartan Mills v. Bank of America Ill., 112
F.3d 1251, 1257 (4th Cir. 1997) (“due process requires that in
order for a proceeding to be accorded finality, notice must be given
that is ‘reasonably calculated, under all the circumstances, to
apprise interested parties of the pendency of the action and afford them
an opportunity to present their objections’”). If the
secured creditor is filing the motion to prohibit or condition the use
of cash collateral, the secured creditor can include the above
mentioned provisions in the motion, notice and order.

Journal Authors

Kenneth Michael Misken

Journal Date

Wednesday, February 1, 2006 - 12:00

Bankruptcy Rule

2006

9024