Opinion ID: 16535
Heading Depth: 2
Heading Rank: 2

Heading: Preclusion Issues

Text: 33 Southmark has already recovered damages of a sort from Coopers, in that the bankruptcy court ordered Coopers to disgorge over $550,000 of the fees it received as court-appointed examiner. The recovery, based on Coopers' failure to disclose its professional relationships with Drexel pursuant to 11 U.S.C. § 328(c), consisted of Drexel-related fees of $55,000, together with treble damages that amount as a penalty, plus reimbursement of Southmark's costs and attorneys fees in prosecuting the motion. Coopers asserts that this recovery, which neither party appealed, provides a basis for either issue or claim preclusion against Southmark's current lawsuit. Preclusion rules deter repetitive and piecemeal litigation by preventing the relitigation of issues that have been finally decided and the assertion of claims covering transactions that have already been disputed in court. The criteria for issue and claim preclusion are different, however, and one rule may apply when the other does not. While we doubt that a basis for claim preclusion existed here, issue preclusion prevents Southmark from relitigating the cause of its failure to file a timely proof of claim in the Drexel bankruptcy.
34 Issue preclusion, formerly known as collateral estoppel, applies when the following elements are met: 35 (1) the issue at stake must be identical to the one involved in the prior action; (2) the issue must have been actually litigated in the prior action; and (3) the determination of the issue in the prior action must have been a part of the judgment in that earlier action. 36 RecoverEdge L.P. v. Pentecost, 44 F.3d 1284, 1290 (5th Cir.1995). Relitigation of an issue is not precluded unless the facts and the legal standard used to assess them are the same in both proceedings. Id. at 1291 (citations omitted). 9 The bankruptcy court and the district court found that Southmark was bound by issue preclusion from asserting that Coopers' malpractice caused Southmark to suffer damages, as that issue had already been litigated and decided in the bankruptcy court disgorgement proceeding. 37 Southmark first argues that the relevant issues are not identical. The disgorgement proceeding only resolved whether Coopers' failure to disclose a conflict of interest caused Southmark to fail to file a claim against Drexel (the bankruptcy court concluded it did not). In the instant case, Southmark alleges that Coopers's failure to adequately investigate the viability of a claim against Drexel caused Southmark to fail to file a timely claim. 38 Coopers responds that the causation of damages issue is the same in the disgorgement proceeding and the instant case. We agree. It was undisputed that Coopers did not disclose to the bankruptcy court its significant auditing relationship with Drexel. In order to gauge the penalty for nondisclosure, the bankruptcy court had to assess whether Coopers' ethical conflict, reflected in nondisclosure of the relationship and inadequate investigation of Drexel claims, led Coopers to downplay potential Southmark claims against Drexel and to discourage Southmark from pursuing its rights against Drexel. Southmark asserts that the issues are different because Coopers could have failed to disclose its conflict of interest to the Bankruptcy Court and still could have done its job properly. This distinction is theoretically possible but inconsistent with the way in which the disgorgement proceeding was litigated. Southmark wanted the bankruptcy court to find that Coopers' overall lapses caused Southmark to fail to file a timely proof of claim, a scenario that would enhance its argument for full disgorgement of Coopers' multimillion dollar court-approved fees. 10 In contrast, to minimize the impact of its actions, Coopers contended that it did not influence Southmark's decision not to file a proof of claim against Drexel. 39 Regarding causation, the bankruptcy court stated that Coopers did not cause Southmark to fail to file timely proof of claim in the Drexel bankruptcy case. As the court reasoned, the Examiner notified Southmark of the Drexel proof of claim bar date and that the Examiner would not develop the securities claims; the basis for the Drexel claim was being alluded to by the media; and Southmark had made an intentional decision to pursue other avenues with its limited resources. Near the end of the disgorgement order, the court rephrased its causation finding, noting that the non-disclosure did not cause Southmark to fail to timely file a proof of claim in the Drexel case. (emphasis added). The court was not limiting the generality of its earlier finding, however, for this additional finding bears on the narrow compass of a violation that the court finally found after rejecting Southmark's attack on Coopers' total fee. 40 The court's findings of no causation, as well as its recitation of the law applicable to disgorgement, lead us to reject Southmark's additional contention that a causation finding was not necessary. Southmark is wrong because the amount of disgorgement depended in large part on the harm done to Southmark by Coopers' ethical lapse. See In re Kendavis Indus. Int'l., Inc., 91 B.R. 742, 762 (Bankr.N.D.Tex.1988). The bankruptcy court wrote that he had to consider that [causation] issue in performing the fact-specific inquiry required by case law to determine whether a professional must disgorge fees. The bankruptcy court also wrote in ruling on issue preclusion that he would have had to reappraise the disgorgement amount if he had been convinced that Coopers' omissions caused Southmark to forfeit a significant recovery opportunity in the Drexel bankruptcy. As he observed, Southmark sought a multimillion dollar recovery from Coopers. A ruling on causation was necessary to the court's decision on the amount of disgorgement. 11 41 Southmark finally urges that causation was not actually litigated in the disgorgement proceeding. After a careful review of the record and the bankruptcy court's rulings, we cannot accept this contention. Southmark sought full return of Coopers' accounting fees in the disgorgement proceeding, while Coopers parried by arguing that it should not have to return fees for valuable services rendered in aspects of the bankruptcy other than the Drexel claims and by denying that its breaches caused Southmark's non-filing of a Drexel claim. The court balanced the facts and equities, finally arriving at a disgorgement penalty that quadrupled the amount of fees Coopers charged on Drexel matters but rejected both the complete restitution of fees sought by Southmark and restitution based on any causal connection between Coopers' actions and Southmark's failure to file a claim against Drexel. 42 The three criteria for issue preclusion accordingly have been satisfied on the causation of Southmark's damages with respect to the Drexel bankruptcy.
43 Although issue preclusion prevents Southmark's attempt to relitigate a critical issue against Coopers, we must briefly distinguish that result from the lower courts' rather perfunctory reliance on claim preclusion. Claim preclusion, 12 or res judicata, bars the litigation of claims that either have been litigated or should have been raised in an earlier suit. Super Van Inc. v. San Antonio, 92 F.3d 366, 370 (5th Cir.1996). The test for claim preclusion has four elements: 44 (1) The parties are identical or in privity; (2) the judgment in the prior action was rendered by a court of competent jurisdiction; (3) the prior action was concluded to a final judgment on the merits; and (4) the same claim or cause of action was involved in both actions. 45 Swate v. Hartwell, 99 F.3d 1282, 1286 (5th Cir.1996). 46 To determine whether two suits involve the same claim under the fourth element, this court has adopted the transactional test of the Restatement (Second) of Judgments, § 24. Southmark Properties v. Charles House Corp., 742 F.2d 862, 870-71 (5th Cir.1984). Thus, the critical issue is whether the two actions under consideration are based on the same nucleus of operative facts.  In re Baudoin, 981 F.2d 736, 743 (5th Cir.1993) (quoting In re Howe, 913 F.2d 1138, 1144 (5th Cir.1990)). In the instant case, the bankruptcy court found that the disgorgement proceeding and this action involved the same nucleus of operative facts; indeed, this action was litigation resulting from a single transaction with different forms of relief being requested. The court also observed that Southmark could have raised its present claims when it originally sought disgorgement of Coopers' fees: to the extent any of Southmark's claims were non-core, the district court could have adopted the bankruptcy court's findings of law and fact or withdrawn the order of reference. 47 Southmark asserts that the bankruptcy court erred in finding claim preclusion because disciplinary measures pursuant to procedural rules do not have preclusive effect on subsequent substantive claims. Southmark cites Cohen v. Lupo, 927 F.2d 363, 365 (8th Cir.1991), which held that the tort of malicious prosecution and a Rule 11 disciplinary proceeding differ in their nature, the elements of the claims, and the potential remedies. 13 By analogy, Southmark contends that a disgorgement proceeding pursuant to 11 U.S.C. § 328(c) should similarly not bar subsequent substantive claims, as it is essentially a remedial penalty provision. See, e.g., Rome v. Braunstein, 19 F.3d 54, 58 (1st Cir.1994) (citing legislative history for the proposition that § 328(c) authorizes a 'penalty' for failing to avoid a disqualifying conflict of interest). 48 Southmark has expressed an important insight, but we believe the roots of the claim preclusion problem lie deeper than the distinction between an ancillary penalty proceeding (e.g. Rule 11 or disgorgement) and a substantive cause of action. While this court has held that claim preclusion applies only to core proceedings in bankruptcy, 14 we have not determined that it applies to all core proceedings. Thus, we have held that claim preclusion does not apply where, because of bankruptcy's truncated procedures on motions to lift stay, lender liability claims could not have been brought and litigated in the earlier proceeding. D-1 Enterps., Inc. v. Commercial State Bank, 864 F.2d 36, 38-39 (5th Cir.1989). 15 Whether the non-trial-type procedures utilized in the bankruptcy court to decide the disgorgement proceeding, or the unavailability of a jury trial, 16 or both circumstances may have meant that Southmark's state-law claims against Coopers could not have been litigated, or litigated effectively, before the bankruptcy court in the earlier proceeding, is an interesting question. Cf. In re Howe, 913 F.2d at 1146. We will not speculate on complications arising from the additional possibility, mentioned by the bankruptcy court, that if Southmark had filed its malpractice action together with the motion to disgorge fees, the bankruptcy court could have heard both matters pursuant to a referral from the district court. Enough has been said to dispel the notion that claim preclusion is obviously applicable here.