Southmark Corp. v. Coopers & Lybrand

UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

_______________________

No. 96-10320
_______________________

In The Matter of: SOUTHMARK CORPORATION,

Debtor.

SOUTHMARK CORPORATION,

Appellant,

versus

COOPERS & LYBRAND; THOMPSON & KNIGHT,

Appellees.

__________________________________________________________________

Appeal from the United States District Court
for the Northern District of Texas
___________________________________________________________________
January 11, 1999

Before JOLLY, JONES, and PARKER, Circuit Judges.

EDITH H. JONES, Circuit Judge:

This appeal arises from a malpractice suit filed by

Southmark Corporation (“Southmark”) against Coopers & Lybrand

L.L.P. (“Coopers”), the accountant to the court-appointed Examiner

in Southmark’s reorganization case under Chapter 11 of the

Bankruptcy Code. Southmark filed suit in a Texas state court in

April, 1995. Coopers removed the case to the bankruptcy court that
had presided over Southmark’s reorganization. In an unusual twist,

Southmark did not perceive the bankruptcy court as a beneficial

forum, so it moved for the court’s mandatory abstention, or

alternatively, for discretionary abstention or remand. 11 U.S.C.

§§ 1334(c) (1984). Coopers sought summary judgment, a motion the

bankruptcy court granted while denying Southmark’s challenges to

the forum. On appeal, the district court affirmed. We hold that

the state-law malpractice claim is a “core proceeding” in

bankruptcy and that the bankruptcy court’s earlier ruling requiring

Coopers to disgorge part of its fees for breach of bankruptcy

disclosure rules gives rise to issue preclusion but not necessarily

to claim preclusion.

I. BACKGROUND

Southmark Corporation was a real estate investment trust

that sponsored private and publicly syndicated real estate

partnerships during the early 1980's. From 1982 until 1989

(shortly before Southmark declared bankruptcy), Drexel Burnham

Lambert, Inc. (“Drexel”) served as Southmark’s primary investment

banker, underwriter, securities broker and investment and financial

advisor. Drexel was the underwriter for various Southmark

offerings of junk bonds and preferred stock, totaling more than $1

billion.

During this period, Drexel was ostensibly underwriting

high-yield bond issues for companies with the understanding that

2
the companies would use the proceeds to purchase high-yield bonds

from other Drexel clients. Southmark became involved in the Drexel

scheme. In October, 1986, Southmark issued $400 million in junk

bonds and $100 million in preferred stock and subsequently invested

the bond proceeds and part of the preferred stock revenues in other

junk bond securities.

As with many speculative ventures in the 1980's, the

expanding balloon eventually burst. In April 1989, Southmark

announced a $1 billion write-down of its asset values, wiping out

shareholders’ equity. A few months later, Southmark filed for

Chapter 11 bankruptcy protection. Eventually, the holders of

Southmark’s public debt received approximately 5 cents on the

dollar in cash and securities in the reorganized Southmark that

were projected at the time to be worth as much as 13 cents on the

dollar.

Shortly after filing bankruptcy, Southmark requested the

appointment of an Examiner to provide an unbiased, independent

assessment of the propriety and practicality of pursuing litigation

against third-parties. The court-appointed Examiner applied to the

bankruptcy court to retain Coopers as the Examiner’s accountant.

Coopers was expressly directed by the court to investigate, among

other things, Drexel’s dealings with Southmark. Coopers disclosed

at the time of its retention that it did some accounting work for

Drexel, but the firm failed to disclose either the kind and degree

3
of work it did for Drexel, or that Coopers did substantial auditing

work for Drexel.

Drexel’s parent company, reeling from reverses in the

junk-bond market, filed bankruptcy in February 1990. Southmark

alleges that Coopers did not satisfactorily investigate Drexel’s

exposure to claims based upon Southmark’s ill-fated junk bond

investments. A Coopers employee charged that he was removed from

this aspect of the Southmark account when he recommended

investigating claims against Drexel to his superiors and was

ordered to desist because (unbeknownst to Southmark) Drexel was one

of Coopers’ largest accounting clients. In the end, Coopers

submitted a report to Southmark that downplayed the viability of

these particular claims against Drexel. Southmark elected not to

pursue these claims by filing a timely proof of claim in the Drexel

bankruptcy case.

Instead, Southmark focused its limited resources on

seeking recovery against Michael Milken, the mastermind behind

Drexel’s junk bond operation, who, unlike Drexel, had not filed

bankruptcy. Southmark developed claims against Milken that it

asserts are identical to the claims it could have raised against

Drexel if Coopers had completed its investigation. Southmark

eventually reached a settlement agreement that could yield more

than $20 million from the Milken settlement fund.

4
 II. PROCEDURAL HISTORY

In April 1993, Galbally, then a Coopers employee, met

with Southmark’s general counsel and alleged that Coopers had

thwarted his efforts to investigate the Drexel claims. Southmark

thereupon filed a disgorgement motion in the bankruptcy court

pursuant to FED. R. CIV. P. 60(b) and Bankruptcy Rule 9024, seeking

reconsideration of the court’s previous award of fees to Coopers

for its work as the Southmark Examiner’s accountant. After

extensive discovery, briefing, and a hearing, the bankruptcy court

awarded Southmark $585,042.48 in recovery from Coopers in a

modified final order entered April 4, 1995.

Three days later, Southmark commenced the instant case in

a Texas state court, alleging that Coopers held back from a full

investigation of certain potential claims by Southmark against

Drexel; failed to disclose this omission; and misrepresented its

investigative efforts because Drexel was a large audit client of

Coopers. Additionally, Southmark alleged that Coopers’ failure to

investigate deterred Southmark from pursuing potential claims

against Drexel or filing a proof of claim in the Drexel bankruptcy.

Southmark’s state law causes of action for breach of contract,

fraud, breach of fiduciary duty and negligent misrepresentation

alleged that Coopers’ conduct caused it to suffer damages,

including the total fees it paid Coopers during its bankruptcy case

5
and the amounts it would have recovered on timely claims against

Drexel.

Coopers answered the state court petition and then

removed the case to the federal district court, which referred the

action to the same bankruptcy court that had conducted Southmark’s

bankruptcy and the disgorgement proceeding.1 Southmark filed a

motion for mandatory abstention, or, in the alternative

discretionary abstention or remand based in part on the argument

that the state law action was a non-core proceeding and therefore,

abstention was required under 28 U.S.C. § 1334(c)(2). Coopers

moved for summary judgment. The bankruptcy court granted Coopers’

motion and dismissed the action as barred by both collateral

estoppel and res judicata; the court denied Southmark’s abstention

motion as moot without expressly addressing its merits.

On appeal by Southmark, the district court affirmed.

Announcing its reasoning in open court, the district court found

that Southmark’s action presented a core proceeding and that the

bankruptcy court had implicitly so found in its earlier order, and

he affirmed the bankruptcy court’s findings regarding preclusion.

Southmark has appealed.

III. ANALYSIS

1
Along the way, Coopers joined Southmark’s former general
counsel as a third-party defendant.

6
 No factual findings of the bankruptcy court are contested

on appeal. The conclusions of law of both the bankruptcy and

district court are subject to de novo review. Criswell v. Hensley,

102 F.3d 1411, 1414 (5th Cir. 1997).

A. Southmark’s Motion to Abstain

Lurking like a troll beneath a bridge, procedural

complexities bedevil a straight path to analysis of this case.

That the bankruptcy court has some kind of jurisdiction over this

malpractice action against court-appointed professionals is not in

doubt. But what the court can do with its jurisdiction depends

first on whether the malpractice case is a “core” bankruptcy matter

or one that is “related to” Southmark’s reorganization case. If

the suit against Coopers is merely “related to” bankruptcy, the

bankruptcy court was required to abstain from hearing it. 28

U.S.C. § 1334(c)(2).2 If, however, the controversy lies “at the

core of the federal bankruptcy power,” Northern Pipeline Constr.

Co. v. Marathon Pipe Line Co., 458 U.S. 50, 71, 102 S. Ct. 2858,

2870-71 (1982), the bankruptcy law permits but does not require

2
The parties do not dispute that additional statutory criteria
for mandatory abstention are met here. Those criteria include a
state-law cause of action, no other basis for federal court
jurisdiction, and the pendency of state court litigation that can
timely adjudicate the claim. See 28 U.S.C. § 1334 (c)(2).

7
abstention. 28 U.S.C. § 1334(c)(1).3 The root issue is as simple

-- and complex -- as that.

Three procedural obstacles must be cleared before the

merits discussion can proceed. First, although this court may

review the bankruptcy court’s decision not to abstain, our

jurisdiction is an historical anomaly. For bankruptcy cases

commenced after the 1994 amendments to the bankruptcy law,

decisions either to abstain or not to abstain are not, with very

limited exceptions, reviewable on appeal.4 Southmark’s case

predates this amendment and was filed when decisions not to abstain

were reviewable on appeal.5 The standard on appeal is abuse of

discretion. In re Howe, 913 F.2d 1138, 1143 n.6 (5th Cir. 1990).

3
A court may discretionarily “abstain from hearing state law
claims whenever appropriate ‘in the interest of justice, or . . .
comity with state courts or respect for State law.’” Gober v.
Terra + Corp., 100 F.3d 1195, 1206 (5th Cir. 1996) (quoting 28
U.S.C. § 1334(c)(1)).
4
28 U.S.C. § 1334(d) (1994). “Any decision to abstain or not
to abstain made under this subsection (other than a decision not to
abstain in a proceeding described in subsection (c)(2)) is not
reviewable by appeal or otherwise by the court of appeals...or by
the Supreme Court....”).
5
28 U.S.C. § 1334(c)(2), enacted in the Bankruptcy Amendments
Act of 1984, Pub. L. 98-353, July 10, 1984, 98 Stat. 333. (“Any
decision to abstain made under this subsection is not reviewable by
appeal or otherwise.”). See 1 Collier on Bankruptcy (15th Ed.) §
3.01, at 3-74. By negative implication, as Collier’s notes,
decisions not to abstain are reviewable on appeal. Id.

8
 Second, we note, only to reject out of hand, Coopers’

assertion that statutory abstention does not apply to cases removed

to federal court on the basis of bankruptcy jurisdiction. 28

U.S.C. § 1452. There is no textual support in the statute for this

position, only a handful of bankruptcy court opinions support it,

and the vast majority of courts hold otherwise.6 We endorse the

majority rule.

Third, the bankruptcy court should have decided the

jurisdiction/abstention issues before reaching the preclusion

issues. Marathon Oil Co. v. Ruhrgas, 145 F.3d 211 (5th Cir. 1998)

(en banc), cert. granted, 67 U.S.L.W. 3273 (U.S. Dec. 7, 1998) (No.

98-470). Its diffidence may understandably have been related to

its uncertainty whether Southmark’s claims invoke core or non-core

jurisdiction. But no pussy-footing around is allowed on

jurisdictional issues.

All of that said, the question is how Southmark’s claims

fit into bankruptcy jurisdiction. The progenitor of the current

6
See In Re United States Brass Corp., 173 B.R. 1000, 1004
(Bankr. E.D. Tex. 1994) (“it is the majority opinion that
abstention does apply to [removed] cases. . .”); see also Robinson
v. Michigan Consol. Gas Co., Inc., 918 F.2d 579, 584 n.3 (6th Cir.
1990); Williams v. Shell Oil Co., 169 B.R. 684, 690 (S.D. Cal.
1994). But see In re Branded Products, 154 B.R. 936 (Bankr. W.D.
Tex. 1993) (mandatory abstention is inapplicable to cases removed
from state courts pursuant to 28 U.S.C. § 1452).

9
bankruptcy system is another Marathon case,7 in which the Supreme

Court struck down as constitutionally too far-reaching Congress’s

assignment of jurisdiction to non-Article III bankruptcy judges

under the 1978 Bankruptcy Code. In Marathon, the debtor filed suit

on a pre-bankruptcy state-law breach of contract claim. Justice

Brennan, writing for the plurality, distinguished between “the

restructuring of debtor-credit relations, which is at the core of

the federal bankruptcy power” and the “adjudication of state-

created private rights, such as the right to recover contract

damages that is at issue in this case.” 458 U.S. at 71, 102 S. Ct.

at 2871. The narrowest construction of Marathon, that placed upon

it by Chief Justice Burger’s dissenting opinion, is this:

a “traditional” state common law action, not
made subject to a federal rule of decision,
and related only peripherally to an
adjudication of bankruptcy under federal law,
must, absent the consent of the litigants, be
heard by an “Art. III court” if it is to be
heard by any court or agency of the United
States.

Id. at 92, 102 S. Ct. 2882 (Burger, C.J., dissenting).

Congress, re-enacting bankruptcy courts’ jurisdiction in

the wake of Marathon, drew on the “core” terminology to describe

matters or proceedings that are an integral part of the bankruptcy

case. For present purposes, such core jurisdiction statutorily

7
Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458
U.S. 50, 102 S. Ct. 2858 (1982).

10
includes “matters concerning the administration of the estate,” 28

U.S.C. § 157(b)(2)(A) and “other proceedings affecting the

liquidation of the assets of the estate or the adjustment of the

debtor-creditor ... relationship ....” Id. at § 157(b)(2)(O). The

statute also permits bankruptcy courts to hear and determine other

matters that are “related to” bankruptcy but are not “core”

matters, subject to the ultimate authority of the district court.8

In this circuit, Judge Wisdom authored a significant

opinion interpreting both Marathon and the post-Marathon

jurisdictional amendments. See In re Wood, 825 F.2d 90 (5th Cir.

1987). Wood involved a lawsuit filed by a third-party against the

debtor over shares of stock acquired by the debtor post-petition.

Judge Wisdom distilled the formula for bankruptcy court

jurisdiction thus:

We hold, therefore, that a proceeding is
core under section 157 if it invokes a
substantive right provided by title 11 or if
it is a proceeding that, by its nature, could
arise only in the context of a bankruptcy
case. The proceeding before us does not meet
this test and, accordingly, is a non-core
proceeding. The plaintiff’s suit is not based
on any right created by the federal bankruptcy

8
“Related-to” matters are those which, being peripheral to the
concerns of the bankruptcy case and based on extrinsic sources of
law, require mandatory abstention. See discussion supra note 2.
The bankruptcy court may make a recommendation to the district
court on the disposition of related-to matters, but it may not
enter judgment concerning them unless the parties expressly so
consent. 28 U.S.C. § 157(c).

11
 law. It is based on state created rights.
Moreover, this suit is not a proceeding that
could arise only in the context of a
bankruptcy. It is simply a state contract
action that, had there been no bankruptcy,
could have proceeded in state court.

Id. at 97 (footnote omitted).

Southmark contends that its claims against Coopers do not

satisfy the Wood test for core bankruptcy jurisdiction. First,

Southmark’s claims arise under state, not federal law and involve

the company’s “private rights” against Coopers rather than a

“restructuring of debtor-creditor relations.” Second, Southmark

contends, the action against Coopers is not “a proceeding that, by

its nature, could arise only in the context of the bankruptcy

case.” Id.

Although Southmark is correct in focusing attention on

Marathon, the post-Marathon jurisdictional provisions, and on Wood,

its interpretation of core bankruptcy matters is too narrow. To

begin with, the state law origin of Southmark’s claims is not

dispositive. The jurisdictional statute expressly provides that

the applicability of state law to a proceeding is insufficient in

itself to render it a non-core proceeding. 28 U.S.C. § 157(b)(3).

This provision, as Wood explains, recognizes Justice White’s

sensible observation in Marathon that many truly bankruptcy issues,

like the determination of the basis for creditors’ claims, turn on

state law. Wood, 825 F.2d at 96. That Southmark’s claims against

12
the court-appointed accountant for its examiner arose under state

law does not prevent them from involving core jurisdiction.

Southmark also disputes that its claims could arise “only

in the context of a bankruptcy case,” inasmuch as Southmark could

have sued any accounting firm that worked for it on similar grounds

of disloyalty, non-disclosure and malpractice. It is somewhat

disingenuous for Southmark to attempt to pry these claims out of

their bankruptcy setting. Southmark’s petition alleges inter alia

claims for breaches of fiduciary duty and of the contract whose

terms were approved by the bankruptcy court. Southmark prays for

actual damages including return of the entire $4 million fee it

paid Coopers from money belonging to the debtor’s estate. The fee

award was both approved by the bankruptcy court and subjected to

the bankruptcy court’s later disgorgement order.

In this case, the professional malpractice claims alleged

against Coopers are inseparable from the bankruptcy context. A

sine qua non in restructuring the debtor-creditor relationship is

the court’s ability to police the fiduciaries, whether trustees or

debtors-in-possession and other court-appointed professionals, who

are responsible for managing the debtor’s estate in the best

interest of creditors. The bankruptcy court must be able to assure

itself and the creditors who rely on the process that court-

approved managers of the debtor’s estate are performing their work,

13
conscientiously and cost-effectively. Bankruptcy Code provisions

describe the basis for compensation, appointment and removal of

court-appointed professionals, their conflict-of-interest

standards, and the duties they must perform. See generally 11

U.S.C. §§ 321, 322, 324, 326-331. Although standards for the

conduct of court-appointed professionals, the breach of which may

constitute bankruptcy malpractice, are not comprehensively

expressed in the statute, the Code need not duplicate relevant,

also-applicable state law. It is evident that a court-appointed

professional’s dereliction of duty could transgress both explicit

Code responsibilities and applicable professional malpractice

standards. For instance, in Billing v. Ravin, Greenberg & Zackin,

P.A., 22 F.3d 1242 (3d Cir. 1994), the professional malpractice

allegations included the attorneys’ failure to comply with court

orders and to submit a plan of reorganization to the bankruptcy

court. Award of the professionals’ fees and enforcement of the

appropriate standards of conduct are inseparably related functions

of bankruptcy courts.

Supervising the court-appointed professionals also bears

directly on the distribution of the debtor’s estate. If the estate

is not marshaled and liquidated or reorganized expeditiously, there

will be far less money available to pay creditors’ claims.

Excessive professional fees or fees charged for mediocre or, worse,

14
phantom work also cause the estate and the creditors to suffer.

Southland might retort that this concern for the general well-being

of the debtor’s estate is over-played -- technically, the

liquidation of any claim that the debtor holds against third

parties would enhance the debtor’s estate as much as collection on

a malpractice claim against court-appointed professionals.

Marathon held, in fact, that a debtor’s contract claim against a

third party (which had not filed a claim in bankruptcy) was not

within the bankruptcy court jurisdiction, even though successful

prosecution of the action would enrich the debtor’s estate. And in

Wood, a dispute over shares of stock acquired by the debtor post-

petition fell only within the related-to jurisdiction but not core

bankruptcy jurisdiction. These cases are, however, distinguishable

from a malpractice claim involving court-appointed professionals.

In the Marathon and Wood situations, the claims that were being

prosecuted could stand alone from the bankruptcy case. A

malpractice claim like the present one inevitably involves the

nature of the services performed for the debtor’s estate and the

fees awarded under superintendence of the bankruptcy court; it

cannot stand alone.

Even more significant, the claim against Coopers is not

just for malpractice, but for the value of the asset which Coopers

was to assist Southmark in recovering. If Coopers had done the job

15
for which it was retained, according to Southmark’s allegations,

Southmark would have filed a claim in the Drexel bankruptcy and

recovered a substantial sum for creditors. The claim against

Coopers may therefore be viewed as one to recover an asset of

Southmark’s estate that Coopers let slip away.

From yet another perspective, this is not just a

malpractice case like any other professional malpractice litigation

Southmark might pursue. Instead, Coopers has filed administrative

claims to obtain its fees in the bankruptcy court, and the debtor’s

action is similar to a counterclaim against Coopers. Unlike

essential parties in Marathon or Wood, Coopers is not a stranger to

the bankruptcy case, and this malpractice claim may invoke the

bankruptcy court’s core jurisdiction to adjudicate and determine

the extent of claims by and against Southmark’s estate. See 28

U.S.C. § 157(2)(B); see generally Billing, 22 F.3d 1242.

Although surprisingly few court of appeals cases have

explored the boundaries of bankruptcy courts’ core jurisdiction in

the wake of Marathon, at least three decisions are premised on the

understanding that professional malpractice claims against court-

appointed professionals are indeed core matters. See Billing, 22

F.3d 1242; Walsh v. Northwestern Nat’l Ins. Co., 51 F.3d 1473, 1476

(9th Cir. 1995); Sanders Confectionery Prods., Inc. v. Heller Fin.,

Inc., 973 F.2d 474, 483 n.4 (6th Cir. 1992). No appeals court

16
decision has held otherwise. In one case against a bankruptcy

trustee to recover property that did not belong to the debtors’

estate, the court rejected subject matter jurisdiction founded on

either core or related-to-bankruptcy jurisdiction. In re Guild and

Gallery Plus, Inc., 72 F.3d 1171, 1173 (3d Cir. 1996).

Southmark’s lawsuit draws into question Coopers’

performance of its duties under court order, and it seeks in part

to recover on the claim Southmark would have had against Drexel.

For these and other reasons just discussed, we conclude that

Southmark’s case against Coopers is a core proceeding in

bankruptcy. Because this is a core proceeding, the bankruptcy

court had discretion whether to abstain from hearing it. We hold

that the court did not abuse his discretion in declining to

abstain.

B. Preclusion Issues

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 that amount as a penalty, plus reimbursement of Southmark’s

costs and attorneys fees in prosecuting the motion. Coopers

17
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.

1. Issue Preclusion

Issue preclusion, formerly known as collateral estoppel,

applies when the following elements are met:

(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.

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

9
Southmark cites a fourth, “special circumstance” requirement
for application of issue preclusion. See Copeland v. Merrill Lynch

18
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.

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.

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

& Co. Inc, 47 F.3d 1415 (5th Cir. 1995). If such a requirement
applies in this case, a proposition we find highly questionable,
Southmark has in any event failed to support it factually. See
Recoveredge, 44 F.3d at 1290-91 n.12.

19
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.

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

10
For instance, Southmark’s pleadings in the disgorgement
proceeding specifically state that Southmark “surely would have”
filed a Drexel proof of claim had Coopers “further investigated and
disclosed” theories of liability against Drexel.

20
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.

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

21
causation was necessary to the court’s decision on the amount of

disgorgement.11

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.

The three criteria for issue preclusion accordingly have

been satisfied on the causation of Southmark’s damages with respect

to the Drexel bankruptcy.

11
Southmark disputes the bankruptcy court’s discretion to award
a sliding-scale disgorgement, and hence to consider causation of
damages. The company is apparently persisting in its earlier
contention in the disgorgement proceeding that a violation of §
328(c) requires restitution of all fees received by the
professional firm. But having lost and not appealed the bankruptcy
court’s failure to order complete disgorgement, Southmark cannot
now ignore the court’s fact-specific ruling.

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 2. Claim Preclusion

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:

(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.

Swate v. Hartwell, 99 F.3d 1282, 1286 (5th Cir. 1996).

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

12
Coopers did not raise res judicata as a defense once the case
was removed to bankruptcy court. Generally speaking, pursuant to
Fed. R. Civ. P. 8(c), res judicata is an affirmative defense and
should not be raised sua sponte. Carbonell v. Louisiana Dept. of
Health & Human Resources, 772 F.2d 185, 189 (5th Cir. 1985).
Without considering whether any exceptions to this rule apply in
this case, this court simply notes that Southmark failed to
complain of this omission on appeal, and thus, waived any
objections to the bankruptcy court’s sua sponte consideration of
res judicata.

23
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.

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

13
See also Lightning Lube, Inc. v. Whitco Corp., 4 F.3d 1153,
1196 (3d Cir. 1993) (“the denial of a Rule 11 motion does not
foreclose the assertion of a subsequent malicious prosecution

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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”).

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

suit....”); cf. Port Drum Co. v. Umphrey, 852 F.2d 148, 150 (5th
Cir. 1988) (“If Rule 11 did expand substantive rights, it would be
invalid under the Enabling Act” because it regulates procedure
rather than create a new substantive right or an independent cause
of action).
14
Howell Hydrocarbons, Inc. v. Adams, 897 F.2d 183, 189 (5th
Cir. 1990).

25
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.

CONCLUSION

Based on the foregoing discussion, we hold that the

bankruptcy court had core jurisdiction over this case; that it did

15
See also In re Howe, 913 F.2d at 1143-47 (holding that claims
raised in later litigation were barred because they could have been
fully litigated in Chapter 11 reorganization process).
16
We have also held that a debtor does not waive the right to
a jury trial by filing a voluntary bankruptcy case. In re Jensen,
946 F.2d 369 (5th Cir. 1991); but cf. Billing, 22 F.3d at 1242-54
(holding that debtors have no right to jury trial on malpractice
claims against their attorneys); Id. at 1254-1260 (Sloviter, C.J.,
dissenting). The authority of a bankruptcy court to hold a jury
trial, in cases like this, before the 1994 amendment to U.S.C. §
157(e), was in great doubt. See 1 Collier on Bankruptcy 15th
Edition Revised ¶3.08 (1998).

26
not abuse its discretion by refusing to remand; and that Southmark

was precluded from relitigating the finding that Coopers did not

cause it to fail to file a timely claim in the Drexel bankruptcy.

AFFIRMED.

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