D-1 Enterprises, Inc. v. Commercial State Bank

• Decision Date: 09 January 1989
• Docket Number: No. 87-2699,D-1,87-2699
• Citation: 864 F.2d 36
• Parties: Bankr. L. Rep. P 72,661 ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. COMMERCIAL STATE BANK, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 36

864 F.2d 36

Bankr. L. Rep. P 72,661

D-1 ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. COMMERCIAL STATE BANK, Defendant-Appellee.

No. 87-2699.

United States Court of Appeals Fifth Circuit.

Jan. 9, 1989.

John J. Durkay, James L. Weber, Mehaffy, Weber, Keith & Gonsoulin, Beaumont, Tex., for plaintiffs-appellants.

Howard L. Close, Gary Neale, Reger, Scott Dollinger, Orgain, Bell & Tucker, Beaumont, Tex., for defendant-appellee.

Appeal from the United States District Court for the Eastern District of Texas.

ON PETITION FOR REHEARING

(Opinion Aug. 18, 1988, 5th Cir., 852 F.2d 823)

Before BROWN, GEE and GARWOOD, Circuit Judges.

GEE, Circuit Judge:

In response to the petition for rehearing, we withdraw our opinion of August 18, 1988, and substitute the following. The issue in this debtor's bankruptcy appeal is whether an agreed order lifting a stay and abandoning certain assets of the debtor to a creditor, entered in a "contested proceeding," is res judicata of various tort claims against that creditor for bad faith acceleration of a note, wrongful foreclosure and the like and, if not, whether these were compulsory counterclaims to the creditor's motion to lift the stay. Concluding that neither is the case, we reverse.

Facts and Prior Proceedings

Plaintiffs-appellants, related corporations in the security equipment business, owed Commercial State Bank almost one million dollars when Commercial decided to call the loans and foreclose on the collateral. D-1 filed Chapter 11 proceedings to stave off Commercial. After about six months--several minor bankruptcy orders and one aborted attempt to sell all the assets of D-1 to a third party having ensued--the bankruptcy court accepted an agreed order lifting the stay and "abandoning" most of D-1's assets to Commercial. A few months later, D-1 received permission from the bankruptcy court to hire outside counsel to pursue potential lender-liability claims against Commercial. Later still, D-1 filed this adversary proceeding within the continuing bankruptcy case. Because of an overcrowded bankruptcy docket, the parties petitioned the district court to withdraw the reference and to try the case itself. The district court did so, then ruled in response to Commercial's motion to dismiss that the D-1 claims were barred by "res judicata " because they should have been raised earlier in the course of the bankruptcy. D-1 appeals.

Are the Debtor's Claims Barred?

Southmark Properties:

The creditor relies principally upon our decision in Southmark Properties v. Charles House Corp., 742 F.2d 862 (5th Cir.1984) (Garwood, J.). In that case, a Chapter X debtor had agreed to a sale of mortgaged property at a reorganization trustee's sale and to allow its main creditor to bid the amount of its debt. The creditor's state court foreclosure suit had previously been enjoined in the Chapter X proceedings. The creditor agreed to dismiss various pending state court actions against the debtor and to abandon its challenge to the Chapter X proceedings. The sale was a public cash auction open to any interested buyer and the district court's order of sale provided that the property "shall be sold free and clear of all ... claims" and that the creditor be allowed to bid the amount of its debt. At the sale, the creditor did so, and thus acquired the property. Shortly thereafter the district court entered an order confirming the sale. Because the property was the debtor's only asset, the reorganization petition was later dismissed on motion of the trustee. "No appeals were taken from the order directing the sale, or that confirming it, or the 1978 order dismissing the reorganization." Southmark Properties, 742 F.2d at 867.

More than three years later, the former debtor and its principals brought suit in state court against the former creditor alleging that the former creditor had violated various provisions of the loan agreement, had engaged in fraudulent and extortionate behavior, and had breached its duty under Louisiana law to perform the contract "in good faith." The former creditor filed a suit in federal court seeking declaratory and injunctive relief from the state court action. The district court granted the injunction and the former debtor appealed.

On appeal, our panel first held that the federal court had ancillary jurisdiction over the case to "protect or effectuate" the earlier judgment of the bankruptcy court. See 28 U.S.C. Sec. 2283 (Anti-Injunction Act). The Court went on to consider the merits of the res judicata claim, holding that the suit was barred because the former debtor had had a full and fair opportunity to litigate the lender-liability claims in the bankruptcy proceeding. The district court's injunction was affirmed.

Essential to the application of the doctrine of res judicata is the principle that the previously unlitigated claim to be precluded could and should have been brought in the earlier litigation. Southmark Properties, 742 F.2d at 871. The law as it existed under former Chapter X would have allowed the debtor's claim against the creditor, even on a largely unrelated matter, to have been asserted as an affirmative defense to the creditor's efforts to foreclose. The Bankruptcy Reform Act of 1978 (the "Bankruptcy Code"), however, provides an expedited procedure for obtaining relief from the automatic stay of Sec. 362(a) of the Bankruptcy Code. Section 362(e) of the Bankruptcy Code requires a preliminary hearing within 30 days after a request for relief from the stay is filed and the commencement of a final hearing not later than 30 days after the conclusion of such preliminary hearing. Further, Bankruptcy Rule 4001 provides for a termination of the stay 30 days after the final hearing is commenced unless the court earlier orders the stay continued pending a conclusion of the final hearing. Bankr.R. 4001(a)(2).

The legislative history of Sec. 362(e) makes clear that counterclaims against a creditor seeking to lift the stay on largely unrelated matters are not to be handled in the summary fashion required by the expedited nature of the proceeding. House Report No. 95-595, 95th Cong., 1st Sess. 344 (1977), U.S.Code Cong. & Admin.News 1978, p. 5787; accord, Little Creek Dev. Co. v. Commonwealth Mortgage Corp. (In re Little Creek Dev. Co.), 779 F.2d 1068, 1074 (5th Cir.1986). Instead, they will be the subject of more complete proceedings to recover property of the estate or to object to the allowance of a claim. Consistent with the legislative history, the courts have held that "indirect defenses," such as breach of contract, fraud and the like, would be severed from the expedited stay litigation if raised in an effort to defeat the creditor's motion. Little Creek, 779 F.2d at 1074. See M. Bienenstock, Bankruptcy Reorganization 140-49 (1987), and cases cited therein. The lender liability claims asserted in the adversary proceeding at issue in this case were not, under the foregoing analysis, "direct defenses" that the debtor could or should have litigated in response to the creditor's motion for relief from the stay. Little Creek, 779 F.2d at 1074. Hence, they are not among the claims that would be precluded by the application of res judicata....