Business Reorganization Committee

ABI Committee News

Plan Proponent Beware! The Doctrine of res judicata and Post-confirmation Avoidance Actions

by Michael D. Sousa1

As many will recall from first-year civil procedure, the doctrine of res judicata precludes a party from litigating claims that were or could have been asserted in a prior proceeding.2 In order for the doctrine of res judicata to apply, most courts require the presence of at least three factors:

  1. A final judgment on the merits, rendered by a court of competent jurisdiction, in a prior action involving;
  2. The same parties or their privies; and
  3. A subsequent suit based on the same cause of action.3

However, most courts also recognize an exception to the res judicata doctrine. A particular litigant’s claims will not be precluded under the doctrine of res judicata if the court in an earlier action expressly reserves the litigant’s right to bring those claims in a subsequent action.4

The common law doctrine of res judicata is replicated in the bankruptcy context by operation of §§1141(a) and 1123(b)(3)(B) of the Bankruptcy Code.5 Section 1141(a) of the Code provides as follows:

Except as provided in subsections (d)(2) and (d)(3) of this section, the provisions of a confirmed plan bind the debtor, any entity issuing securities under the plan, any entity acquiring property under the plan, and any creditor, equity security holder, or general partner in the debtor, whether or not the claim or interest of such creditor, equity security holder, or general partner is impaired under the plan and whether or not such creditor, equity security holder, or general partner has accepted the plan.6

Pursuant to §1141(a), the effect of plan confirmation is to bind all parties to the terms of a plan of reorganization.7 That is, the confirmation of a plan of reorganization “has the effect of a judgment by the district court and res judicata principles bar relitigation of any issues raised or that could have been raised in the confirmation proceedings.”8 Much like the common law exception to the doctrine of res judicata, §1123(b)(3)(B) of the Bankruptcy Code enables a debtor to expressly reserve causes of action in a plan of reorganization, and in particular, avoidance claims. Section 1123(b)(3)(B) states in relevant part that a plan of reorganization may provide for “the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interests….”9 The failure of a plan of reorganization to provide for the retention and enforcement of avoidance claims by a debtor under §1123(b)(3)(B) would likely result in the future loss of such claims.10 However, due to the absence of guidance in either the Bankruptcy Code or the legislative history to §1123, courts are currently divided on how specific the language of the retention of an avoidance action in a plan of reorganization must be to adequately preserve the claim for post-confirmation adjudication.

The split of authority on this issue generally falls into two camps. On one hand, several courts follow an approach adopted by the Bankruptcy Court for the Western District of Texas in Mickey’s Enterprises, Inc. v. Saturday Sales, Inc. (In re Mickey’s Enterprises, Inc.), 165 B.R. 188, 194 (Bankr. W.D. Tex. 1994), which concluded that the doctrine of res judicata bars a subsequent action unless the debtor’s disclosure statement or plan of reorganization, or both, specifically reserves the right to litigate that specific claim. The disclosure statement in In re Mickey’s Enterprises, Inc. contained the following provision in relevant part: “all causes of action…are preserved and retained for enforcement by the Reorganized Debtor whether or not commenced prior to the Effective Date. The Causes of Action retained, include, without limitation:…(ii) all preference claims pursuant to §547 of the Bankruptcy Code….”11 In an effort to prevent unwitting creditors from later being “sandbagged” with a lawsuit from the reorganized entity, the In re Mickey’s Enterprises, Inc. court held that “any bankruptcy litigation that the plan proponent is planning on bringing against a known creditor with known claims who has a right to be involved in the confirmation process and who can still timely file claims should be fully disclosed.”12 Because the disclosure statement contained only a general retention clause, and no specific reference was made to any possible avoidance action against the particular post-confirmation defendant, the court barred the claim under the doctrine of res judicata.13

On the other hand, several courts follow the approach adopted by the U.S. Bankruptcy Court for the District of Delaware in Peltz v. Worldnet Corp. (In re USN Communications, Inc.), 280 B.R. 573, 594 (Bankr. D. Del. 2002), which held that the doctrine of res judicata does not bar a post-confirmation preference action where the disclosure statement and plan of reorganization contain a general reservation of the right to pursue preference actions post-confirmation. The court in In re USN Communications, Inc. set forth several persuasive arguments in favor of the adequacy of a general reservation of avoidance actions post-confirmation.

First, while §1123(a) dictates what must be included in a plan of reorganization, §1123(b) simply identifies provisions that may be, but are not required to be, included in a plan of reorganization.14 In other words, a reservation of avoidance actions for post-confirmation litigation is not even required to be included in a confirmable plan of reorganization under the Bankruptcy Code. Since such a provision need not appear in a disclosure statement or plan of reorganization, it is simply inequitable to hold a debtor or other plan proponent to the high standard of specifying each and every known avoidance claim that may be asserted post-confirmation. Second, a general reservation of rights to pursue post-confirmation avoidance actions serves to expedite the reorganization process by permitting confirmation of a plan “‘before possible claims against others have been fully investigated and pursued. To say confirmation must await a final decision of all possible preference complaints would either inordinately delay confirmation, with all the attendant expense, or result in a windfall in favor of those who received preferential transfers.’”15 Third, with respect to preference actions, the court in In re USN Communications, Inc. noted that a general reservation is sufficient because the potential “targets” of a preference action “know, or should know, whether they received a payment from the debtor within the ninety days preceding the petition date.”16 Consequently, when a plan of reorganization or disclosure statement contains a general reservation of the debtor’s right to exercise its avoidance powers post-confirmation and pursue causes of action under §547 of the Code, “those creditors also know that there is a possibility that they may be the target of one of those actions.”17 Armed with this knowledge, a creditor cannot rightfully claim that a post-confirmation preference action is barred by the doctrine of res judicata.

Unfortunately, the complete treatment of this divided issue is obviously beyond the scope of this article. Nevertheless, a conservative-minded lawyer would be well-served by specifically identifying and reserving in the disclosure statement and plan of reorganization those avoidance actions that his or her client is aware of and intends to pursue post-confirmation. In the event disclosing all such actions is impractical prior to plan confirmation, such as in a large, complex chapter 11 reorganization, counsel should at the very least be guided by the suggestion of the bankruptcy court in In re USN Communications, Inc., namely, reserving in the disclosure statement and plan of reorganization the types or categories of claims to be preserved for intended post-confirmation litigation, such as §547 preference claims against a particular class of trade creditors. This approach might provide those creditors with sufficient notice that they may find themselves as defendants in a post-confirmation lawsuit, and may pass muster even in jurisdictions that require the specific reservation of known causes of action.

Footnotes

  1. Michael Sousa is currently serving a judicial clerkship with The Honorable Rosemary Gambardella, Chief Bankruptcy Judge for the District of New Jersey. Mr. Sousa is also pursuing his LL.M. in Bankruptcy degree from St. John’s University School of Law where he was named the American Bankruptcy Institute Scholar for 2004–2005. He also teaches Bankruptcy and Business Reorganizations at New York University. Return to article.
  2. Ampace Freightlines, Inc. v. TIC Fin. Sys. (In re Ampace Corp.), 279 B.R. 145, 155 (Bankr. D. Del. 2002). Return to article.
  3. Id. (citations omitted). Return to article.
  4. D&K Properties Crystal Lake v. Mut. Life Ins. Co. of N.Y., 112 F.3d 257, 260 (7th Cir. 1997). Return to article.
  5. All section references herein shall be to Title 11 of the United States Code unless otherwise noted. Return to article.
  6. 11 U.S.C. §1141(a) (West 2004). Return to article.
  7. In re Bleu Room Experience, Inc., 304 B.R. 309, 313 (Bankr. E.D. Mich. 2004) (citations omitted). Return to article.
  8. Id. (citations omitted). Return to article.
  9. 11 U.S.C. §1123(b)(3)(B) (West 2004). Return to article.
  10. In re Bleu Room Experience, Inc., 304 B.R. at 313. Return to article.
  11. 165 B.R. at 191 n.1. Return to article.
  12. Id. at 194. Return to article.
  13. Id. at 193–94. Return to article.
  14. 280 B.R. at 590. Return to article.
  15. Id. at 590–91 (citation omitted). Return to article.
  16. Id. at 593–94. Return to article.
  17. Id. Return to article.