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No Déjà Vu – Lender Liability Claims Barred by Res Judicata Effect of Bankruptcy Sale Order

    Client Alerts
  • March 15, 2016

Put down your remotes for just a minute and let’s talk about res judicata. You remember that lovely Latin legal concept don’t you? Or maybe you prefer the more modern English version of “claim preclusion”? Either way it means that once a party has gotten a final judgment on the merits regarding a particular matter, it is barred from suing on that same issue (or on related issues that could have been raised the first time). (Just think of it as the “You only get to bat once, so make it a good one” rule). 
Well, on Friday (March 11, 2016), the Fourth Circuit in Providence Hall Associates Limited Partnership v. Wells Fargo Bank, N.A. held that bankruptcy sale orders have res judicata effect. Which is good news for lenders, particularly Wells Fargo which saw the lender liability claims against it dismissed. (This is where your imagination needs to insert the judge clad in the umpire uniform yelling “You’re outta here!”)

The Facts

PHA entered into three financial transactions with Wells Fargo: (1) a $2.5 million loan; (2) a $500,000 line of credit and (3) an interest rate swap whereby PHA swapped the floating rate on the loan for a fixed rate. When PHA defaulted, Wells Fargo terminated the interest rate swap leaving PHA owing $317,850 in swap termination damages (in addition to the outstanding balances on the loan and line of credit).  
PHA filed a Chapter 11 bankruptcy, and also sued Wells Fargo for allegedly false representations that Wells Fargo would forbear from collecting the line of credit. The bankruptcy court appointed a Chapter 11 Trustee to run PHA’s operations and the trustee sought court approval to sell some properties to satisfy the debt to Wells Fargo. After those sales were approved by bankruptcy court order, the Trustee paid the Wells Fargo debt, dismissed the lawsuit against Wells Fargo without prejudice and PHA’s Chapter 11 case was dismissed. 
More than a year after the bankruptcy was dismissed, PHA sued Wells Fargo again. In the new lawsuit, PHA asserted the same claims as before, but also alleged that the interest rate swap was a “sham” because the LIBOR rate on which the swap was based was “illegally rigged and manipulated.” The district court dismissed the claims on res judicata grounds and the Fourth Circuit affirmed.

The Law

             Res judicata requires three elements:
                        (1) a final judgment on the merits in a prior suit;
                        (2) an identity of the cause of action in both the earlier and later suits; and
                        (3) the same parties in each suit.
PHA argued that bankruptcy sale orders were not orders “on the merits” because they did not dispose of the entire bankruptcy case (as a confirmed bankruptcy plan would), and the orders did not specifically address the validity of the Wells Fargo claims. However, the Fourth Circuit rejected this argument and held that since the Chapter 11 trustee sold the properties specifically to pay Wells Fargo’s claims, that amounted to an admission that the claims were valid.

It bears repeating that it would be counterproductive to liquidate the bankruptcy estate’s property to pay off debts owed to a creditor – bringing about the close of bankruptcy proceedings – only to later allow claims to be brought against that creditor regarding the now-satisfied debts. Such a result would be the model of inefficiency, at odds with the purpose of res judicata and Chapter 11 bankruptcy.

PHA also argued that the “sham” swap claim should not be barred because it was a newly asserted claim and therefore could not have been previously decided as a result of the sale orders.  However, the Fourth Circuit properly noted that res judicata also applies to claims which “could have been brought” arising from the same facts, and therefore that claim was also barred.

The Moral

Res judicata is a two-way street. So whichever side you are on, if you intend to sue, bring all of your claims at one time and avoid any intervening judicial proceedings which could be deemed to otherwise resolve the underlying claims for you. 
Questions regarding this case update or financial services litigation can be addressed to Will Esser at / 704-372-9000. This legal update does not constitute the provision of legal advice or the creation of an attorney/client relationship with any party.