E-Alert Case Updates

Fourth Circuit Bars Unsecured Creditors Claim for Res Judicata in Chapter 13 Bankruptcy Controversy

LVNV Funding, LLC v. Harling
CA No. 16-1346 (4th Cir. Mar. 30, 2017). United States Court of Appeals for the Fourth Circuit
by Matthew S. Sarna, Law Clerk
Semmes, Bowen & Semmes (www.semmes.com)

Available at: http://www.ca4.uscourts.gov/Opinions/Published/161346.P.pdf

In LVNV Funding, LLC v. Harling, CA No. 16-1346 (4th Cir. Mar. 30, 2017), the Fourth Circuit affirmed the decision of the United States Bankruptcy Court for the District of South Carolina and found that the Chapter 13 debtor’s objection to LVNV’s claims was not barred by the doctrine of res judicata.

On July 11, 2014, Jeffrey Rhodes (“Debtor”) filed a voluntary petition for relief under Chapter 13. The plan was confirmed on October 17, 2014. Derrick and Teresa Harling subsequently filed a similar Chapter 13 petition; their case was consolidated on appeal. Debtor utilized form Chapter 13 plans, which are common in the bankruptcy courts for the District of South Carolina. In the form plan, notably, in contrast to the specific provisions for secured creditors, the plan provided for treatment of the unsecured creditors as a single class. Additionally, the plan contained a provision reserving the Debtor’s rights to object to creditor claims after the plan’s confirmation.

Shortly after the plan’s confirmation, Debtor filed an objection to LVNV, an unsecured creditor’s claim, under 11 U.S.C. § 502, asserting that LVNV’s claim was barred by the statute of limitations. In response, LVNV interposed the defense that Debtor’s objection was invalid under the doctrine of res judicata. LVNV claimed that Debtor’s confirmation order was a “final judgment” on the validity of LVNV’s claims, precluding Debtor’s later objections. The bankruptcy court disagreed and sustained the objections. As a result, LVNV’s claim was barred by the applicable statute of limitations, removing it from entitlement to distribution.

On appeal, the Fourth Circuit analyzed whether the bankruptcy court erred in approving Debtor’s objection to the unsecured claim. In its holding, the Court found that the requirements for the application of res judicata were not present and LVNV’s position further contradicted the plain language of the Bankruptcy Code.

The Court began its analysis by looking to the conditions necessary for the application of res judicata. Res judicata applies when: 1) there is a prior judgment, which is final, on the merits…; 2) the parties to the second matter are identical to, or in privity with, the parties in the first action; and 3) “the claims in the second matter are based upon the same cause of action involved in the earlier proceeding.” Covert v. LVNV Funding, LLC, 779 F.3d 242, 246 (4th Cir. 2015). The Court zeroed in on this last element as the true contention in this case.

Looking to the Bankruptcy Code for guidance, the Court explained that, under § 1322(b)(1), a Chapter 13 debtor can treat unsecured creditors as a single class. As such, the bankruptcy court will only examine the “pool” of funds available to the class as a whole during confirmation, as opposed to any individual unsecured creditors’ claims. Accordingly, no provision of the Bankruptcy Code provides for a determination of the merits of an individual unsecured claim within the pool of unsecured claims as part the confirmation procedure. In direct contrast to this concept, the Court explained, a Chapter 13 plan must address the rights of each individual secured creditor. See 11 U.S.C.§ 1325(a)(5).

In this case, the Court determined, when the bankruptcy court entered the confirmation orders, the “cause of action” was whether Debtor’s plan met the requirement for confirmation; which it did. In the later proceeding, however, the “cause of action” changed completely and became the validity of Debtor’s objection to LVNV’s claim. Because the bankruptcy court adjudicated the confirmation order as to unsecured creditors as a single class, the cause of action naturally shifted when LVNV, as an individual unsecured creditor, sought to challenge Debtor’s objection.

To reinforce this decision, the Court looked to the plain language of the Bankruptcy Code, which governs the allowance of claims and “contested matters.” The Court explained that, only when an objection is filed, does the bankruptcy court determine the amount and allowance of that specific claim. See 11 U.S.C. § 502(b). Further, “The filing of an objection to claims begins a “contested matter,” governed by Federal Rules of Bankruptcy Procedure 3007 and 9014. See, e.g., Gentry v. Siegel, 668 F.3d 83, 92 (4th Cir. 2012). Synthesizing this information, the Court concluded that Congress made clear that Chapter 13 plan confirmation and claim allowance on contested unsecured claims are “separate and distinct” actions within a debtor’s bankruptcy process. Accordingly, because the “cause of action” in each proceeding was substantially different, LVNV could not rely on res judicata to invalidate Debtor’s objection.

In sum, the Fourth Circuit ruled that res judicata was inapplicable to the bankruptcy court’s later determination of LVNV’s contested unsecured claims. Therefore, the Fourth Circuit affirmed the decision of the bankruptcy court.