Monday, November 29, 2021

FYI: 5th Cir Rejects Borrower's Bankruptcy Claim Objection as Barred by Res Judicata

The U.S. Court of Appeals for the Fifth Circuit recently rejected a borrower's objections to a bankruptcy court's jurisdiction, and held that the doctrine of res judicata barred the borrower's claim objection as it was ultimately based on the alleged impropriety of the creditor's claim from a prior bankruptcy.


A copy of the opinion is available at:  Link to Opinion


Two married individuals ("husband" and "wife") who owned a construction company ("Construction Company") filed separate voluntary Chapter 11 petitions for bankruptcy in 2014.


In 2015, husband and Construction Company filed an amended "joint" plan of reorganization. This plan set out the amounts Construction Company owed to its creditors, including the amount owed to a secured creditor ("Secured Creditor") on five promissory notes that were rolled into one note prior to the bankruptcy petitions.


The plan, which had an effective date of November 8, 2015, provided that Secured Creditor would have an Allowed Secured claim in the amount of $1,812,472.43. The Plan was signed by husband on behalf of himself and Construction Company and no objection was filed. The Plan was confirmed by the bankruptcy court and the order was not appealed by either party.


Construction Company, after making thirty-eight of the 60 payments required by the plan, stopped making payments in January 2019 when it again filed for bankruptcy.


In the second bankruptcy action, Secured Creditor filed a proof of claim in the amount of $1,333,695.84. Construction Company filed an objection to this claim and the bankruptcy court held a hearing on the dispute. Construction Company argued that the Secured Creditor's claim amount was incorrect because it was based on an incorrect claim amount in the 2015 Plan and it failed to account for certain payments made by Construction Company.


Secured Creditor pointed out that Construction Company failed to object to Secured Creditor's claim in the 2015 plan or otherwise seek appeal after the bankruptcy court confirmed the Plan.


The bankruptcy court overruled Construction Company's objection and allowed Secured Creditor's claim reasoning that neither husband nor Construction Company objected to or disputed the claim amount in the plan.  The bankruptcy court found that the doctrines of res judicata, judicial estoppel, and judicial admission barred Construction Company's claim objection to the extent it was premised on the impropriety of Secured Creditor's claim in the 2015 Plan.


Construction Company filed an appeal in the district court. The district court affirmed the judgment of the bankruptcy court and dismissed the appeal.  Construction Company then appealed to the Fifth Circuit. 


In its appeal, Construction Company asserted three arguments as to why the bankruptcy court erred.


First, Construction Company argued that the bankruptcy court lacked subject matter jurisdiction to allow Secured Creditor's claim in the second bankruptcy action.


Construction Company reasoned that Construction Company was not liable for the full claim amount since husband and wife were individually liable for some of the promissory notes on which the Plan directed Construction Company to make payments on. Thus, Construction Company argued, neither the Plan nor the promissory notes shifted liability for all the debt from husband and wife to Construction Company. Construction Company further argued that the Plan did not authorize the bankruptcy court to allow Secured Creditor's claim as to the entire amount owed and thus the court lacked subject matter jurisdiction to allow the same.


The Fifth Circuit disagreed, ruling that "[b]ankruptcy judges may hear and enter final judgments in 'all core proceedings arising under title 11, or arising in a case under title 11." Stern v. Marshal, 564 U.S. 462, 474, (2011) (quoting 28 U.S.C. 157(b)(1)). Included in the meaning of core proceedings is the "allowance or disallowance of claims against the estate." 28 U.S.C. 157(b)(2)(B). In determining whether and to what extent Secured Creditor had a claim against Construction Company, the bankruptcy court allowed a claim against an estate which is an action that falls within the bankruptcy court's jurisdiction pursuant to 157(b)(1) and (2)(B).


The Fifth Circuit further held that propriety of the bankruptcy's determination to allow or disallow the claim against debtor's estate was not a jurisdictional inquiry, and thus the bankruptcy court did not lack subject matter jurisdiction.


Next, Construction Company argued that the district court erred in affirming the bankruptcy court's order determining that res judicata barred Construction Company from objecting to Secured Creditor's claim.


The Fifth Circuit again disagreed, ruling that Construction Company's objection was barred because the claim in the second bankruptcy as it related to Secured Creditor's claim in the 2015 Plan being for the right amount, arose out of the same transaction that was the subject of the 2015 Plan and Construction Company could have made its arguments in the first proceeding, but it did not.


The Appellate Court relied on its opinions in Eubanks and Howe in determining what constitutes an identity of claims for res judicata purposes. In Eubanks, the Court held that because the debtor's liability suit "put[] into issue the same facts which would determine, inter alia, the treatment and amount of the debt owed to [the bank]," there was an identity of claims between the confirmation order and the debtor's lender liability action. Eubanks v. F.D.I.C., 977 F.2d 166, 172-173 (5th Cir. 1992). In Howe, the Court found that a debtors' lender liability claims were barred by res judicata by a plan of reorganization because "[t]he loan transaction at the heart of the [lender liability] litigation was also the source of [the creditor's] claim against the estate." In re Howe, 913 F.2d 1138, 1144 (5th Cir. 1990).


The Fifth Circuit determined the answer hinged on whether the transactions at the heart of Construction Company's claim objection in the second bankruptcy were the source of Secured Creditor's claim in the first bankruptcy.


Here, the Appellate Court found that Construction Company's claim objection arose out of the subject matter that formed the basis of Secured Creditor's claim in the first action, i.e. the amounts Construction Company owed to Secured Creditor on the underlying promissory notes.  Because the claim objection arose out of the same transaction that was the subject of the 2015 Plan and since Construction Company could have raised an objection in the first proceeding, the Fifth Circuit ruled that the lower court was correct in finding the objection barred by res judicata.


Finally, the Fifth Circuit held that the lower court did not clearly err in allowing the amount of Secured Creditor's claim based on the ledger and witness presented by Secured Creditor at the hearing, and the fact that any payments not accounted for in the claim were payments made after the petition and were accounted for in the latest running of the balance.


Thus, the Fifth Circuit affirmed the judgment of the bankruptcy court.




Ralph T. Wutscher
Maurice Wutscher LLP
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