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.
22
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
24
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.
27