Circuit Split as to Whether Res Judicata Can Be Afforded in District Court to Bankruptcy Court Judgment on Non-Core Claim — Collateral Estoppel OK — Impact of Stern Unresolved — No Collateral Attack Based on Standing

From Matrix IV, Inc. v. Am. Nat’l Bank & Trust Co. of Chi., 2011 U.S. App. LEXIS 15537 (7th Cir. July 28, 2011):

A. Origin of the Dispute

***Stylemaster was and Matrix continues to be in the molded-plastics industry. Starting in 1994, Stylemaster bought plastic injection molds from an outside vendor and had them shipped directly to Matrix. Matrix fashioned the molds into plastic storage containers for Stylemaster (think the long plastic storage bins that slide under beds), which in turn distributed the containers to big-box retailers like Kmart and Target. Over time, Stylemaster had difficulty paying Matrix's invoices and the relationship soured. As of November 1997, Matrix claimed that Stylemaster owed it approximately $2.4 million. The two companies negotiated a solution whereby Matrix claimed a first-priority lien over the molds in its possession and promised to supply Stylemaster with storage containers in the upcoming years in exchange for Stylemaster's promise to pay Matrix's outstanding invoices. Stylemaster paid Matrix's pre-November 1997 invoices in 1999, and by 2002 had paid all invoices dated prior to July 2001. Whether this extinguished Matrix's lien would become a subject of debate in the bankruptcy.

Also in 1997 Stylemaster entered into a loan agreement with its primary lender ANB. To secure a credit line with the bank — something that it had trouble doing given its shaky finances — Stylemaster pledged all of its assets and property as security. ANB filed a Uniform Commercial Code financing statement with the Illinois Secretary of State ***.

In 1998 Stylemaster's principals formed Gateway Park LLC ("Gateway"), which negotiated with the City of Chicago to build an industrial park on the city's southwest side. Stylemaster told Matrix that after it moved into this new industrial space, it would need an even greater supply of plastics. Matrix dubs this the "Greater Gateway Scheme" and claims that Stylemaster sought to build up its inventory in order to increase its line of credit with ANB and then use the larger credit line to move its plastics manufacturing in-house. To carry out this scheme, Matrix says, Stylemaster delayed payment to suppliers and sought to destroy the suppliers' possessory liens over the plastic molds. The plan was for Stylemaster to file for bankruptcy, and thereafter its principals would form a successor company that would buy Stylemaster's assets at a firesale price. According to Matrix, ANB participated in this scheme by loaning Stylemaster money in exchange for a lien over the plastic molds in Matrix's possession.

*** In 2002 Matrix sued Stylemaster in Illinois state court for breach of contract based on *** payment delinquencies.

B. Bankruptcy Proceedings

Less than a month after this state-court contract action was filed, Stylemaster filed for bankruptcy under Chapter 11. Matrix submitted a claim contending that Stylemaster owed it approximately $7.2 million, and ANB claimed it was owed approximately $9.6 million. Shortly after the bankruptcy filing, the owners of Stylemaster formed a new company J.R. Plastics, which after full disclosure as an insider buyer, purchased Stylemaster's assets at a judicially approved bankruptcy sale under § 363 of the Bankruptcy Code. As part of the bankruptcy settlement, ANB agreed to assign its secured interest and lien over the molds in Matrix's possession to J.R. Plastics.

Before approving the sale, the bankruptcy court held a three-day evidentiary hearing to determine whether the sale should proceed. See 11 U.S.C. § 363(b) (generally requiring notice and a hearing prior to a sale in bankruptcy of assets or property of the estate). Matrix filed an objection to the sale on the ground that it had a lien on plastic molds in its possession that Stylemaster was claiming as assets and that its lien should have priority over ANB's lien. Matrix also filed a motion to dismiss the bankruptcy petition or convert the Chapter 11 case to a Chapter 7 case. The basis for the motion was that Stylemaster had engaged in "significant acts of fraud, dishonesty, incompetence and/or gross mismanagement" and "intentionally and fraudulently induced Matrix IV to produce and ship it goods with no intention of paying for those goods." The motion also alleged that Stylemaster had misrepresented that the large, expedited orders were from Kmart when they actually went directly into Stylemaster's inventory.

Without ruling on the motion to dismiss, the bankruptcy court ordered the auction sale to proceed and set a date for filing written objections to the sale. Matrix filed another objection, arguing that Stylemaster, by not properly disclosing its assets, had discouraged potential bidders and given an unfair advantage to J.R. Plastics, an insider, in the bidding process. The bankruptcy court issued an order approving the sale, permitting the debtor to assign a lien to J.R. Plastics, and finding that J.R. Plastics was a good-faith purchaser. This order also specified that ANB held a first perfected priority lien on all of Stylemaster's assets except the lien contested by Matrix.

Matrix did not appeal this order but instead filed a motion to reconsider. ***The bankruptcy court held a hearing on the motion for reconsideration, which the court construed as a request for relief from judgment under Rule 60(b) of the Federal Rules of Civil Procedure and its bankruptcy equivalent, Rule 9024 of the Federal Rules of Bankruptcy Procedure. Matrix reiterated its fraud argument and noted that the bankruptcy court had not made a specific finding of fact that J.R. Plastics was a good-faith purchaser. The bankruptcy judge explained that he had previously given the parties an opportunity to offer evidence of fraud at the original hearing and asked if Matrix was seeking to offer new or additional evidence. Matrix said it had no further evidence to offer. The bankruptcy judge then recounted Matrix's allegations in some detail and found that there was no evidence to support the claim of fraud or collusion in the sale process. The court also entered a specific finding that J.R. Plastics was a good-faith purchaser. The court concluded that Matrix's claim of fraud and collusion was "unwarranted and frivolous" and did not have "one breath of merit." Matrix did not appeal this ruling to the district court.

Although the asset sale was approved, the lien-priority dispute between Matrix and ANB remained. ANB commenced an adversary proceeding seeking a declaration that its lien had priority over Matrix's lien and corresponding injunctive relief. ANB eventually moved for summary judgment, to which Matrix responded by repeating its allegations of fraud, arguing that ANB's lien should be equitably subordinated to its own. *** The judge *** ordered Matrix to assert its equitable-subordination claim as an affirmative defense.

Matrix complied with this order by submitting a more definite statement of facts purporting to establish its now-familiar claim of fraud: Stylemaster was not paying Matrix for its orders; Stylemaster assured Matrix of the superiority of its lien; ANB had knowledge of Matrix's lien or at least should have conducted a reasonable investigation to discover the lien; and ANB and Stylemaster conspired to amend their loan agreement to include a lien on molds in Matrix's possession but never apprised Matrix of this change. After a full trial, the bankruptcy judge held in an oral ruling that ANB's lien had priority over Matrix's lien. *** The judge found that Stylemaster's payments through 2001 had extinguished Matrix's lien and that any post-2001 lien was subordinate to ANB's UCC lien. *** On appeal the district court affirmed, but remanded with instructions to the bankruptcy court to issue a formal order on Matrix's equitable-subordination claim; although it was implicit in its oral ruling, the bankruptcy judge had never formally rejected Matrix's equitable-subordination affirmative defense.

On remand the bankruptcy court formally ruled on the equitable-subordination defense, holding that Matrix had insufficient evidence to support a finding of fraud. *** Matrix appealed this ruling, and the district court affirmed. *** The district court held that Matrix's equitable-subordination defense was inadequate and could not withstand a Rule 12(b)(6) challenge. Id. at *4. The court said the fraud claim was "patently defective" and that ANB's conduct was not unfair or inequitable. ***

Matrix ultimately filed consolidated appeals in this court asking that all prior judgments be vacated. We summarily affirmed. The bankruptcy plan was eventually confirmed, and a final decree was entered.

C. The Present Suit

While the bankruptcy proceedings were still ongoing, Matrix filed this suit against ANB and Gateway alleging claims for violation of RICO and common-law fraud. The complaint was initially dismissed on the ground that Matrix had not pleaded any misrepresentations by ANB or Gateway and had failed to allege activities that constituted a RICO enterprise. Matrix was given leave to amend and did so. The allegations in the amended complaint were again familiar: ANB and Gateway schemed to defraud Matrix by building up Stylemaster's inventory, refusing to pay Matrix's invoices, and ultimately allowing J.R. Plastics to buy Stylemaster's inventory at a firesale price; ANB and Stylemaster (and by extension, Gateway) concealed the fact that ANB had acquired a superior lien over Matrix's molds; Stylemaster falsely represented that Matrix's lien would be superior to any subsequent liens; ANB knew that Stylemaster was insolvent but still gave Stylemaster a line of credit; and ANB had knowledge of Matrix's lien and failed to conduct a reasonable investigation of outstanding liens. For predicate racketeering acts, the amended complaint pointed to letters ANB sent to Style-master in servicing the loans and also identified certain acts committed in the course of the bankruptcy litigation that it alleged were a fraud on the court.

Gateway moved to dismiss the amended complaint, relying on res judicata and collateral estoppel (among other arguments). By this time the case had been transferred to a different district judge who denied the motion. Gateway filed a motion to reconsider.... The district court granted the motion to reconsider and ultimately entered judgment on the pleadings dismissing the suit on both res judicata and collateral-estoppel grounds. The court explained that Matrix's RICO and common-law fraud claims were compulsory counterclaims that could have and should have been brought in the bankruptcy proceedings.

Gateway then moved for Rule 11 sanctions. *** The district court denied the motion for sanctions. ***

II. Discussion

***The doctrine of "[r]es judicata bars not only those issues actually decided in the prior suit, but all other issues which could have been brought." *** Res judicata has three elements: "(1) an identity of the parties or their privies; (2) [an] identity of the cause of action; and (3) a final judgment on the merits." *** Here, Matrix only challenges the second and third elements***

The second element — whether an "identity of the cause of action" exists — depends on whether the claims arise out of the same set of operative facts or the same transaction. *** This "transactional" inquiry focuses on whether the claims comprise the same "core of operative facts [that] give rise to a remedy." *** Even if the two claims are based on different legal theories, the "two claims are one for purposes of res judicata if they are based on the same, or nearly the same, factual allegations." ***

The doctrine of collateral estoppel — issue preclusion — is narrower. For collateral estoppel to apply, "(1) the issue sought to be precluded must be the same as that involved in the prior litigation, (2) the issue must have been actually litigated, (3) the determination of the issue must have been essential to the final judgment, and (4) the party against whom estoppel is invoked must be fully represented in the prior action." ***

We start by noting our general agreement with the district court that the claims Matrix advances in this case are based on the same core of operative facts as the claims it litigated and lost in the bankruptcy proceedings. It makes no difference that the earlier claims took a different form — that is, an equitable-subordination defense in the lien-priority adversary proceeding and an objection to the bankruptcy asset sale on the ground that J.R. Plastics was not a good-faith purchaser. It's quite clear that the allegations of fraud Matrix asserted in the Stylemaster bankruptcy are the same basic allegations it makes here: (1) Stylemaster built up its inventory with goods from Matrix that it had no intention of paying for; (2) its principals formed a new corporate entity, J.R. Plastics, to buy Stylemaster's assets at a reduced price in a bankruptcy sale; (3) Stylemaster arranged a line of credit with ANB secured by Stylemaster's unpaid-for inventory; and (4) Stylemaster and ANB conspired to establish the priority of ANB's lien over Matrix's. Under well-established claim-preclusion doctrine, this common nucleus of operative facts means the claims are the same even though they involve different legal theories. ***

Matrix insists that the claims cannot be the same because the alleged RICO conspiracy includes events subsequent to Stylemaster's bankruptcy filing. More specifically, Matrix asserts that ANB committed a fraud on the bankruptcy court by pursuing a claim for which it did not have standing. A question relating to ANB's standing in the bankruptcy proceeding cannot form the basis of an otherwise impermissible collateral attack on the judgments rendered by the bankruptcy court. See Ins. Corp. of Ireland, Ltd. v. Compagnie des Bauxites de Guinee, 456 U.S. 694, 702 n.9 (1982) ("A party that has had an opportunity to litigate the question of subject-matter jurisdiction may not . . . reopen that question in a collateral attack upon an adverse judgment."). Moreover, only a few of the allegations in the amended complaint pertain to events that occurred during the bankruptcy proceeding; they do not suffice to destroy the essential factual commonality of these claims. Nearly all the facts comprising the alleged fraudulent scheme predate Stylemaster's bankruptcy filing; without the alleged prebankruptcy scheme, Matrix has no RICO or common-law fraud claim. ***

Matrix's equitable-subordination defense in the lien priority proceeding rested on the same fraud allegations Matrix raised and lost in its objection to the § 363 sale; in turn, these same allegations form the basis of the RICO and fraud claims asserted here.

Finally, there can be little doubt that the bankruptcy court rendered final judgments on the merits. The bankruptcy orders confirming the asset sale under § 363 and dismissing the equitable-subordination defense in the lien-priority adversary proceeding — orders affirmed by the district court and this court — were final orders. Matrix maintains that these orders did not dispose of its fraud claim on the merits. We disagree. As we have explained, the heart of Matrix's request that the bankruptcy court reconsider its approval of the asset sale was a contention that Stylemaster and J.R. Plastics participated in an inventory-buildup fraud, the purpose of which was to permit J.R. Plastics to purchase Style-master's assets for a fraction of their value. The bankruptcy court held a hearing on the motion, rejected Matrix's allegations of fraud, held that J.R. Plastics was a good-faith purchaser, and permitted the sale to proceed. That was a merits determination.

And Matrix had another full airing of its fraud claim when it raised — and lost — its equitable-subordination defense in the lien-priority adversary proceeding. ***

[Circuit Split.] Normally we could conclude our opinion and affirm the district court without further ado; the elements of claim preclusion are established, and there is circuit precedent for applying it here. But a pronounced conflict in our caselaw on this issue gives us reason to pause. In Barnett v. Stern, 909 F.2d 973 (7th Cir. 1990), a bankruptcy trustee brought a RICO claim in district court based on a fraudulent transaction that had been the subject of an adversary action in the bankruptcy proceedings. In an attempt to outmaneuver his creditors, the debtor had formed a sham third-party trust, naming his son as trustee. Id. at 975. The bankruptcy trustee filed an adversary action to recover the assets held in the trust; he claimed the trust was the alter ego of the debtor and its assets belonged to the bankruptcy estate. The bankruptcy court agreed and ordered the bankruptcy trustee to take control of the assets in the third-party trust. Id. The bankruptcy trustee later filed a RICO suit in district court against the debtor's son for his part in the fraudulent scheme. Id. at 975-76. The district court held that the suit was barred by res judicata, but we reversed. Id. at 978-82.

Barnett's holding was grounded on an analysis of the interplay between claim-preclusion principles and the bankruptcy court's authority to render final judgments. To explain Barnett thus requires a short detour into the bankruptcy court's jurisdiction. The Bankruptcy Code provides 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, 131 S. Ct. at 2604 (quoting 28 U.S.C. § 157(b)(1)). Section 157(b)(2) provides a nonexhaustive list of "core" proceedings; as relevant here, these include "determinations of the validity, extent, or priority of liens" and "orders approving the sale of property." See 28 U.S.C. § 157(b)(2)(K), (N). Bankruptcy courts may also hear actions that are "related to" core proceedings but cannot resolve these "noncore" proceedings unless all parties consent. Id. § 157(c)(1), (2). Absent the parties' consent, in noncore proceedings the bankruptcy court is limited to making proposed findings of fact and conclusions of law to the district court, and the district court may enter a final judgment after considering those findings and conclusions de novo. Id. § 157(c)(1).

Barnett relied heavily on Howell Hydrocarbons, Inc. v. Adams, 897 F.2d 183 (5th Cir. 1990), in which the Fifth Circuit reasoned that because a bankruptcy court could not by itself adjudicate a noncore claim to finality under § 157(c)(1), a party to a noncore proceeding would not have a "full and fair" opportunity to litigate the claim for purposes of res judicata. 909 F.2d at 978-80. Barnett adopted the Fifth Circuit's reasoning and held that a bankruptcy court's resolution of a core claim will not have res judicata effect on a noncore claim that could have been brought, but wasn't, under the court's "related" jurisdiction. Id. at 981-82. Barnett further held that the trustee's RICO claim was a noncore proceeding, and the bankruptcy court's adjudication of the adversary proceeding to recover the assets in the sham trust — a core proceeding — did not have res judicata effect on the later noncore RICO claim. Id. at 980-82. This was so even though the claims arose out of the same transaction and operative facts. Id.

It's hard to distinguish Barnett from this case. Like the alter-ego adversary proceeding in Barnett, the asset-sale confirmation and lien-priority adversary proceedings were core bankruptcy proceedings. Barnett holds that a later-filed RICO claim is noncore and therefore not barred by res judicata. Curiously, Barnett did not mention Met-L-Wood or Crop-Maker, even though its holding would have dictated a different result in Met-L-Wood and possibly Crop-Maker as well if it was determined that the fraud claim in that case would have been a noncore proceeding in the bankruptcy. Moreover, since Barnett our circuit has continued to apply res judicata in the bankruptcy context without reference to the core/noncore distinction. See, e.g., ITOFCA, Inc. v. MegaTrans Logistics, Inc., 322 F.3d 928, 930-31 (7th Cir. 2003) (barring subsequent copyright-infringement claim for debtor's failure to raise claim in bankruptcy proceeding); Adair v. Sherman, 230 F.3d 890, 894 (7th Cir. 2000) (remarking without mention of Barnett or noncore claims that as a "general rule" bankruptcy orders are res judicata in subsequent proceedings); La Preferida, Inc. v. Cerveceria Modelo, S.A. de C.V., 914 F.2d 900, 908-09 (7th Cir. 1990) (finding tort and contract claims to be barred by prior bankruptcy judgment sale, without reference to Barnett's core/noncore distinction). Only one of our cases discusses Barnett at all, and it held that the Barnett core/noncore argument had been waived and also distinguished the decision on its facts. See In re Kroner, 953 F.2d 317, 320 (7th Cir. 1992). Despite Met-L-Wood and Crop-Maker, our opinion in Kroner said Barnett neither "created new law" nor "purported to overturn prior precedent." Id. at 319.

Finally, we note as well that every other circuit to have addressed this issue since Barnett has rejected the core/noncore distinction for purposes of deciding the claim-preclusive effect of judgments entered in bankruptcy proceedings. See Plotner v. AT & T Corp., 224 F.3d 1161, 1173-74 (10th Cir. 2000); CoreStates Bank, N.A. v. Huls Am., Inc., 176 F.3d 187 (3d Cir. 1999); In re Int'l Nutronics, Inc., 28 F.3d 965, 969-70 (9th Cir. 1994); Sanders Confectionery Prods., Inc. v. Heller Fin., Inc., 973 F.2d 474 (6th Cir. 1992); Sure-Snap Corp. v. State St. Bank & Trust Co., 948 F.2d 869 (2d Cir. 1991). Even the Fifth Circuit, whose decision in Howell Hydrocarbons formed the basis of the reasoning in Barnett, has cast doubt on the continuing vitality of the distinction. See Matter of Baudoin, 981 F.2d 736, 741 n.10 (5th Cir. 1993) (remarking in dictum that it was not certain that "bankruptcy jurisdiction must always be core in order to be 'competent' for res judicata purposes").

The existence of both an intra- and inter-circuit conflict provides reason to revisit Barnett's conclusion that the distinction between core and noncore proceedings makes a dispositive difference in claim-preclusion analysis. The jurisdictional point under § 157(b) and (c) is clear, but the allocation of jurisdiction between the bankruptcy and district courts does not speak to a party's ability to receive a final judgment in a bankruptcy proceeding; rather, it stipulates which court has the authority to render the judgment. The Supreme Court's recent decision in Stern explains the statutory and constitutional dimensions of the jurisdiction-allocation question. 131 S. Ct. at 2608-11.

The question before the Court in Stern was whether Article III permits the bankruptcy courts to hear and finally decide a particular type of core proceeding. Under § 157(b)(2)(C), "counterclaims by the estate against persons filing claims against the estate" are specifically denominated as core proceedings. The counterclaim at issue in Stern was a state common-law tort claim by the estate for intentional interference with a testamentary gift. Id. at 2601-02. The Court held that although Congress had, in § 157(b)(2)(c), designated this kind of claim as "core," Article III did not permit the bankruptcy court to hear and finally decide it. Id. at 2608. That is, Congress could not delegate to a non-Article III court the judicial power "to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim."

As we have noted, Barnett keyed the claim-preclusive effect of bankruptcy-court orders to the core/noncore distinction, but the parties have not submitted Rule 28(j) letters on the effect of Stern on our reasoning in Barnett. As a general rule, resolving a conflict in circuit caselaw ought to be attempted only on full briefing and in a case in which the outcome depends on it. Because a narrower ground exists on which to resolve this case, we leave the resolution of the conflict for another day. By its terms, Barnett does not apply to collateral estoppel, 909 F.2d at 978 n.5, and here, the elements of collateral estoppel have plainly been satisfied. For the reasons we have already explained, the fraud allegations at issue in this case are the same as those that were actually litigated in the § 363 hearing and in the lien-priority adversary proceeding. The bankruptcy court was required to and did address them before entering its orders in those proceedings. Finally, Matrix was fully represented in the bankruptcy proceedings. Accordingly, Matrix is collaterally estopped from relitigating the very same issues here.

Share this article:

Share on facebook
Facebook
Share on twitter
Twitter
Share on linkedin
LinkedIn
Share on email
Email

Recent Posts

Archives