Opposition Brief — Chitwood v. McLemore, 111 S. Ct. 348 (1990) (No. 90-428)

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No. 90-428 a

JOSEPH F. SPANI °

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In The

Supreme Court of the United States

October Term, 1990

RICHARD E. CHITWOOD and

EMMA A. CHITWOOD,

Petitioners,

JOHN C. McLEMORE, TRUSTEE IN BANKRUPTCY

FOR CIRCLE W. DAIRY FARMS, et al.,

Respondent.

.

BRIEF IN OPPOSITION TO PETITION FOR

WRIT OF CERTIORARI

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Davip RANDOLP!I SMITH

KINNARD & SMITH

St. Cloud Corner, Sixth Floor

500 Church Street

Nashville, TN 37219

(615) 259-4686

Counsel of Record

COCRLE LAW BRIEF PRINTING CO., (800) 225-6964

O® CALL COLLECT (402) 342-2831

PARTIES TO THE PROCEEDING BELOW

The petitioners in this action are Richard E. Chit-

wood and Emma A. Chitwood. The respondent in this

action is John C. McLemore, Trustee in Bankruptcy for

Circle W. Farms, Inc., Willard R. Weaver and Ivanell

Weaver.

ii

TABLE OF CONTENTS

Page

PARTIES TO THE PROCEEDING BELOW .......... i

TABLE OF ALSTRIUMRELED 6000s ccdsndcaasatacdkasn iii-iv

STATEMENT OF THE CASB.......ccccccccsccccees 1

SUMMARY OF ARGUMENT..............--0-+4+5: 4

REASONS FOR DENYING THE PETITION......... 5

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TABLE OF AUTHORITIES

CASES

Benjamin v. Diamond (In re Mobile Steel Co.), 563

By

Chicot County Drainage District v. Baxter State Bank,

308 U.S. 371, 60 S. Ct. 317, 84 L.Ed. 329 (1940)

Circle v. Jim Walter Homes, Inc., 654 F.2d 688 (10th

RE Nin bbc dec 4% 0 oss

County Fuel Co., Inc. v. Equitable Bank Corp., 832

RUPP isos cess ascaneccsecs

Henry v. Farmer City State Bank, 808 F.2d 1228 (7th

ee ued ssenean

Martino v. McDonald’s System, Inc., 598 F.2d 1079

(10th Cir. 1979), cert. denied, 444 U.S. 966 (1979)

Pepper v. Litton, 308 U.S. 275, 60 S.Ct. 238, 84 L.Ed.

ink ae thon oa ew ae as 40 wh ooo 40

Robinson v. First National City Bank, 482 F.Supp. 92

ere eer ree err

Rudell v. Comprehensive Accounting Corp., 802 F.2d

I a6 6 60a sks bo see ecladas

Southmark Properties v. Charles House Corp., 742

i |

Trone v. Smith (In re Westgate-California Corp.), 642

ee

Yentile v. Howland, 26 Mass. App. Ct. 214, 525

N.E.2d 689 (Mass. App. Ct. 1988).............

eee eee eee eee eee

iv

TABLE OF AUTHORITIES - Continued

Page

RULES

iS 9 aS eT eT PEP OLS Tre TORT er eT Tor 6

PO CEE Ms sco cic csee cei ensnsebeesennst 6, 11

ee EM Beer eee eee er ee 4, 7, 8, 9, 14

RESTATEMENT (SECOND) JUDGMENTS

pees OB ee Sr 11

RESTATEMENT (SECOND) JUDGMENTS § 22,

Illustration 10 at page 190 (1982)................. 11

MiscELLANEOUS

3 Collier on Bankruptcy § 510.05 (1989)................ 6

Moore, 3 Moore's Federal Practice § 13.12 (2d ed.

PALA Ray FN Rep ae nw > arlene 7

Wright, Miller and Cooper, 18 Federal Practice and

PS OD CED a 6 6 8i6c ered chkewen se wcnecsecwa 8

STATEMENT OF THE CASE

On September 26, 1982, the debtors Willard R.

Weaver, Ivanell Weaver, and Circle W. Dairy Farms filed

for bankruptcy in the United States Bankruptcy Court for

the Middle District of Tennessee. On October 21, 1982,

John C. McLemore was appointed as bankruptcy trustee.

Prior to September, 1982, Richard E. Chitwood and

Emma A. Chitwood leased dairy cows to the Weavers.

After the Weavers filed for bankruptcy, the Chitwoods

directed that any cattle which they might own should be

removed from the bankrupt’s estate. When McLemore

was appointed trustee, he went to the Weaver farm

expecting to find over 1,000 head of cattle. Instead, he

found approximately 40 head of cattle. McLemore began

a search for the missing cattle, eventually locating 400 of

them, and returned the cattle to the Weaver farm.

McLemore attempted to run the farm, but it soon

became necessary to liquidate all the assets. On February

4, 1983, McLemore duly notified creditors, including the

Chitwoods, that he would sell all cattle located on the

debtor’s farm, free and clear of all rights and claims by

lien, ownership, or otherwise, and apply to the reorgani-

zation court for an order authorizing the sale. The Chit-

woods, through counsel, filed and served written

objections to the sale, but the objections were thereafter

withdrawn.

On February 15, 1983, a hearing was held before the

Honorable George C. Payne, II, who approved the

trustee’s application and sale. The sale was later con-

firmed by an order signed by the Honorable Thomas A.

Wiseman, Jr., which provided, in pertinent part, that:

(1) the sale price obtained by the trustee was

reasunable;

(2) all objections to the sale, with one excep-

tion not material to the issues presently

before this Court had been withdrawn;

(3) the rights of all parties concerning any

interest in the cattle attached to the pro-

ceeds, any claimants to promptly file plead-

ings to adjudicate the same; and

(4) the trustee could use the proceeds to satisfy

prior borrowings from the Third National

Bank.

The Chitwoods then commenced an independent

diversity action against the trustee, alleging that the

trustee’s sale constituted a conversion of the cattle (origi-

nal Count I), that the trustee had negligently cared for the

cattle prior to sale (original Count II), that the caitle sold _

by the trustee were subject to Plaintiffs’ interests as les-

sors (original Count III), and that a constructive trust for

their benefit was imposed upon the proceeds of sale

(original Count IV). The Chitwoods later amended their

complaint to assert claims for money had and received in

the court-approved sale (substituted Count I), unjust

enrichment of the trustee’s pre-sale possession of the

subject cattle (su*stituted Count III), trespass from the

trustee’s action in obtaining possession of the cattle (sub-

stituted Count IV), and conversion arising out of the

trustee’s possession, pledge and disposition of the subject

cattle (new Count V). The underlying issue on all counts

of the Complaint was the ownership of cattle found on

the Weaver farm. Before any recovery could be allowed in

the diversity action, the Plaintiffs necessarily had to

prove that they owned the cattle. If the Plaintiffs were not

owners of the cattle, then no recovery could be had. The

trial began on the district court action before the District

Judge Thomas A. Wiseman, Jr. on August 3, 1987. On the

third day of trial, Judge Wiseman declared a mistrial and

recused himself when it was discovered that he, himself,

had signed the order approving the sale of the cattle in

May of 1983. The case was placed upon the docket of

District Judge John T. Nixen for retrial.

In the related bankruptcy proceeding, in response to

the Chitwoods’ objections to stipulations and an order of

disbursement previously entered by the Court, the

trustee asserted an equitable subordination defense to the

Chitwoods’ objections and also filed an independent

complaint seeking equitable subordination of all claims

and interests of the Chitwoods. The bankruptcy court

heard evidence in this equitable subordination proceed-

ing, and on November 25, 1987, the court entered an

order which specifically found that “the cows on the

Weaver farm were there, as a result of leases with various

persons or were owned by Weaver and subject to duly

perfected security interests of creditors. Those cattle were

indiscriminately branded without any attempt being

made to determine the true interest holder.” The court

further found that Richard Chitwood was guilty of mis-

conduct which resulted in injury to the creditors “of the

estate, both in actual expenses incurred by the estate and

loss to other claimants and interest-holders whose cattle

cannot be accurately identified.” In reaching factual find-

ings that the cattle on the Weaver farm, which were the

subject of the sale, were owned by “various persons or by

Weaver” and could not be accurately identified, the court

obviously determined the issue of ownership and adjudi-

cated the rights of the creditors, including the Chitwoods.

The United States Bankruptcy Court, therefore, reached

specific findings that the ownership of the cattle could

not be determined.

In April 1988, McLemore moved for summary judg-

ment in the district court case on the grounds that the

judgment and findings of the bankruptcy court in the

equitable subordination adversary proceeding barred liti-

gation of the Chitwoods’ complaint under the doctrine of

res judicata. The district court granted summary judgment

and the Sixth Circuit Court of Appeals affirmed the sum-

mary judgment in a per curiam opinion.

,%

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SUMMARY OF ARGUMENT

Issue preclusion (collateral estoppel) bars the Chit-

woods from asserting the claims made the basis of the

district court action because the bankruptcy court specifi-

cally found that ownership of the cattle could not be

determined. Claim preclusion bars the Chitwoods’ claims

because permitting the district court lawsuit to proceed

would undermine the bankruptcy court’s judgment and

nullify or impair settled rights. Fed.R.Civ.P 13(a)(1) does

not apply to the failure to assert defenses and does not

insulate a party who fails to assert a defense or counter-

claim in a subsequent proceeding from the application of

res judicata even though Rule 13(a)(1) may not require the

assertion of a counterclaim where litigation of the pend-

ing claims would impair the judgment in the subsequent

action or nullify settled rights.

a.

i

REASONS FOR DENYING THE PETITION

FOR WRIT OF CERTIORARI

I. The Trial Court Properly Granted Summary Judg-

nient Because The Chitwoods’ Claims Are Precluded

By The Doctrine Of Res Judicata.

The Chitwoods’ claims against McLemore are com-

pletely premised upon the supposed fact that McLemore

sold cattle that belonged to the Chitwoods.' The achilles

heel of petitioners’ argument, however, is that the United

States Bankruptcy Judge’s order following the equitable

subordination adversary proceeding specifically found

that the cattle in question were owned by “various per-

sons or were owned by Weaver [the debtor]” (Order at

page 3) and that “Those cattle were indiscriminately

branded without any attempt being made to determine

the true interest holder” such that the identity of the

cattle “cannot be accurately identified.” (Order at page 4).

Simply put, the bankruptcy court’s equitable subordina-

tion order and findings preclude the Chitwoods from

raising a claim in district court because allowing such a

subsequent action would plainly operate to undermine

the initial judgment and impair or nullify rights that were

established in the equitable subordination action.

1 Petitioners’ Brief repeatedly makes this assertion: “As

amended the complaint stated five grounds for relief arising

from respondent’s taking of petitioners’ cattle...” (Peti-

tioners’ Brief, page 6); ” ... the bankrupt estate had no right to

petitioner’s [sic] cattle” (Petitioners’ Brief, page 12); “How

many cattle did petitioners own?” (Petitioners’ brief, pages

14-15).

The equitable subordination proceeding was an

important and formal adversary proceeding under Bank-

ruptcy Rule 7001 and 11 U.S.C. § 510(c). The whole pur-

pose of the equitable subordination proceeding is to

determine whether a creditor has engaged in misconduct

which has resulted in injury to other creditors or has

conferred an unfair advantage on the creditor such that

subordination of the claim would not be inconsistent with

the bankruptcy act. 3 Collier on Bankruptcy § 510.05 (1989).

As Judge Payne’s Bankruptcy order of November 25, 1987

clearly indicates, Richard Chitwood was an active partici-

pant in a scheme to coerce investors to invest additional

funds in the Weaver operation, and to indiscriminately

brand cows such that they were incapable of being identi-

fied. The court specifically found that the indiscriminate

branding was done either with the approval or acquies-

cence of Chitwood, or at his direction. (¢ 6 Bankruptcy

Judge’s Order.) Under the circumstances, in order to

adjudicate the rights of the creditors, equitable subor-

dination of the Chitwood claims was deemed appropri-

ate. To permit the Chitwoods to now obtain funds

through a suit premised on ownership rights found not to

exist would clearly undermine the bankruptcy court's

judgment and impair the rights which were established in

the equitable subordination proceeding.

The seminal decision establishing claim preclusion

against a defendant where a subsequent action would

undermine the force of a prior judgment or impair settled

rights is Chicot County Drainage District v. Baxter State

Bank, 308 U.S. 371, 60 S. Ct. 317, 84 L.Ed. 329 (1940). In

Chicot, a drainage district instituted a proceeding to reor-

ganize debt pursuant to a federal law allowing municipal

debt adjustment. This lawsuit resulted in a plan of read-

justment and a formal decree. Later, a bank whose debt

had been “readjusted” filed a separate action to recover

bonds held by the drainage district. The essence of the

bank’s claim was that the federal law allowing the munic-

ipal debt adjustment was unconstitutional. The drainage

district pleaded res judicata and pointed to the prior

decree as a bar to the bank’s claim. This Court held that

res judicata precluded the bank’s claim because the bank

had notice of the proceeding of debt readjustment, had an

opportunity to present objections, and yet had raised no

questions concerning the validity of the act at the debt

readjustment proceeding.

The legal test for determining claim preclusion is not

whether the five counts of the Chitwoods’ complaint are

compulsory counterclaims under Fed.R.Civ.P. 13(a). Peti-

tioners’ brief fundamentally misconstrues the relation-

ship between the compulsory counterclaim rule,

F.R.Civ.P. 13(a), and res judicata as applied to a party ina

second action who failed to interpose a claim or defense

in the initial action where that party was a defendant.

Rule 13(a) speaks of the necessity or compulsion of

advancing claims for relief as counterclaims. The justi-

fication for compulsion is premised both upon principles

of waiver and estoppel. 3 Moore's Fed. Prac. § 13.12 [1] at

13-52 — 55 (2d ed. 1989). If the claim is already the subject

of another pending action, the “compulsion rule” set

forth in Rule 13(a) does not apply by virtue of the express

exception to the compulsory counterclaim rule set forth

in Rule 13(a)(1). The language of the Rule 13(a)(1), how-

ever, which provides that “the pleader need not state the

claim if at the time the action was commenced the claim

was the subject of another pending action,” simply does

not address whether: (1) defenses should or must be

averred, even if the defenses are the subject of a claim in

another pending action; and (2) whether pleading a coun-

terclaim may be required by some command of law other

than the compulsion principle set forth in Rule 13(a).

Respondent submits that res judicata (including claim and

issue preclusion) may well call for precluding the subse-

quent litigation of claims after a court judgment in the

“second” action even though Rule 13(a) did not require

the assertion of a counterclaim. The “need not” provision

of Rule 13(a)(1) cannot be construed to prevent preclu-

sion in all circumstances. As a leading treatise notes:

“Rule 13(a), for example, does not require asser-

tion of counterclaims that are already subjects of

a pending action, yet circumstances may arise in

which pursuit of the pending action should be

precluded after judgment in the later-instituted

action.” Wright, Miller & Cooper, 18 Fed. Prac. &

Proced. § 4414 at 110 (1981).

Numerous cases have applied issue and claim preclu-

sion to bar claims which were not compulsory counter-

claims under Fed.R.Civ.P. 13(a). In Circle v. Jim Walter

Homes, Inc., 654 F.2d 688 (10th Cir. 1981), home buyers

brought a suit for alleged violations of the Uniform Com-

mercial Credit Code. The court held that the suit was

barred by a prior foreclosure suit and observed: “The

same basic set of facts, of course, may constitute both a

defense to a claim by an opposing party and the basis of a

lawsuit against the party.” 654 F.2d at 690. The court

‘

ruled that principles of res judicata, specifically the com-

mon-law compulsory counter claim rule, precluded the

subsequent suit, even though the claims for Uniform

Commercial Credit Code violations in the second action

were not compulsory counterclaims in connection with

the prior foreclosure suit. The court determined that

allowing the subsequent action to proceed would operate

to undermine the initial judgment and nullify established

rights. Id.

Other courts have reached the same result (preclu-

sion) by applying res judicata, even though the formal

requirements of a compulsory counterclaim were absent.

See County Fuel Co., Inc. v. Equitable Bank Corp., 832 F.2d

290 (4th Cir. 1987) (debtor’s failure to assert a breach of

contract claim to a proof of claim filed by a creditor in

bankruptcy court barred a subsequent suit for breach of

contract against the debtor on principles of waiver even

though the breach of contract claim was not a compulsory

counterclaim in the bankruptcy action); Martino v.

McDonald's System, Inc., 598 F.2d 1079 (10th Cir. 1979),

cert. denied, 444 U.S. 966 (1979) (held that even though

Rule 13(a) did not apply since the first action was settled

prior to pleading, a franchisee was barred by failure to

assert an antitrust defense in the initial suit because

“successful prosecution would nullify rights established

by a consent judgment in the earlier action.” 598 F.2d at

1085); Rudell v. Comprehensive Accounting Corp., 802 F.2d

926 (7th Cir. 1986) (held that the failure to assert a

defense in a previous arbitration proceeding precluded

franchisees from bringing action alleging agreement was

procured by fraud. Once again, the formal requirements

of Rule 13(a) did not require pleading defenses in the

10

initial action); Henry v. Farmer City State Bank, 808 F.2d

1228 (7th Cir. 1986) (failure to assert a defense barred a

subsequent action. The court noted in a footnote (footnote

7) that defenses are different from a counterclaim and

may be asserted even without bringing a counterclaim for

affirmative relief); Yentile v. Howland, 26 Mass. App. Ct.

214, 525 N.E.2d 689 (Mass. App. Ct. 1988) (“The ‘salutary’

and well-established rules against claim-split-

ting . . . preclude the Yentiles from attempting in a

pending or subsequent action to undermine the Land

Court judgment establishing the validity of the option.

They may not raise a claim in the Superior Court which

was available as a defense in the Land Court action.

[citing numerous authorities.]” 525 N.E.2d at 690).

Petitioners seek to apply the language in Federal

Rule of Civil Procedure 13(a)(1) that compulsory counter-

claims “need not” be asserted if such claims are the

subject of a pending action as a blanket protection or

insurance against any adverse affect which may arise

from failing to interpose a claim or a defense in the

second action. The rule, however, provides no such safe

harbor. No statute or rule can speak or apply to every

situation which conceivably may arise. Although Rule

13(a)(1) does not require setting forth an affirmative

claim for relief as a compulsory counterclaim, the com-

pulsion and waiver principles set forth in Rule 13(a) are

not the limits of the res judicata universe and cannot be

said to control how a court, such as the district court in

this case, should handle a clear conflict between the

judgment and findings entered by the bankruptcy court

and the affirmative claims for relief brought by the Chit-

woods in their district court action. To protect the

11

decision of the bankruptcy court and the rights estab-

lished by the bankruptcy court’s judgment, it was well

within the equitable power of the district court to pre-

clude the Chitwoods from bringing their claims, even

though the district court lawsuit had been filed prior to

the equitable subordination bankruptcy proceeding. A

defendant may be precluded from bringing a claim where

successful presentation of the action would nullify a

judgment or would impair rights established in the initial

judgment. RESTATEMENT (SECOND) JUDGMENTS

§ 22(2)(b) (1982), Comment (f), (“Special circumstances

under which failure to interpose a counterclaim will oper-

ate as a bar.”) As the RESTATEMENT (SECOND) JUDG-

MENTS point out in Illustration 10 to § 22:

“A brings an action against B to acquire title to

certain real estate and obtains judgment by

default. B then brings an action against A to

acquire title to the same property, alleging that,

at the time of the first action, B had acquired

title to the property by adverse possession. The

action is precluded.” RESTATEMENT (SEC-

OND) JUDGMENTS § 22, Illustration 10 at page

190 (1982).

In short, res judicata fully applies in this case because

the Chitwoods were a party to a formal adversary pro-

ceeding — the equitable subordination claim — pursuant to

Bankruptcy Rule 7001 and 11 U.S.C. § 510(c). The entire

purpose of the equitable subordination proceeding was to

adjudicate the rights of creditors, including the Chit-

woods. The issue of cattle ownership was directly

addressed by the bankruptcy court’s findings that,

because of Chitwood’s misconduct and the circumstances

at the Weaver farm, the ownership of the cattle could not

12

be determined. In ruling in favor of the trustee at the

equitable subordination proceeding, the court specifically

found the necessary elements for equitable subordina-

tion:

(1) the Claimant engaged in some type of ineq-

uitable conduct;

(2) the misconduct resulted in injury to the

creditors of the bankrupt or conferred an

unfair advantage to the Claimant; and

(3) the equitable subordination of the Claimant

was not inconsistent with the provisions of

the bankruptcy code.” Bankruptcy Order at

p- 4. See Benjamin v. Diamond (In re Mobile

Steel Co.), 563 F2d 692, 700 (Sth Cir. 1977).

Bankruptcy Courts are empowered to subordinate

claims of creditors where subordination will support a

joint and equitable distribution of the bankrupt estate.

Pepper v. Litton, 308 U.S. 275, 60 S.Ct. 238, 84 L.Ed. 281

(1939). The fundamental aim of equitable subordination is

“to undo or offset any inequality in the claim position of

a creditor that will produce injustice or unfairness to

other creditors in terms of the bankruptcy results.” Trone

v. Smith (In re Westgate-California Corp.), 642 F.2d 1174,

1177 (9th Cir. 1981). It is clear by the bankruptcy judge’s

findings of fact and conclusions of law that a good part of

the inequitable conduct exhibited by the Chitwoods was

the role Mr. Chitwood played in the indiscriminate

branding of the cattle. The indiscriminate branding was

done without a determination of the true interest holder,

thus making it impossible to determine the owner(s) of

the cattle. The cattle were branded with the Chitwood

13

brand (REC) without regard to whether the cattle truly

belonged to Chitwood. ({ 6 Bankruptcy Judge’s Order).

The proper time to determine the ownership of the

cattle was during the adversarial proceeding regarding

the trustee’s equitable subordination claim against the

Chitwoods. Mr. Chitwood, however, although repre-

sented by counsel, chose not to appear. Also, no appeal

was taken from the judge’s order. The reorganization

court’s order thus bars the Chitwoods from any remedy

based upon ownership of the cattle. Southmark Properties

v. Charles House Corp., 742 F.2d 862, 871 (5th Cir. 1984)

(prior judgment concludes all claims arising out of “com-

mon nucleus of operative facts”); Robinson v. First

National City Bank, 482 F.Supp 92 (S.D.N.Y. 1979), (court

held that since neither of the parties appealed the reor-

ganization court’s approval of compromise and settle-

ment of securities law and fraud claims, the bankruptcy

adjudication was considered the final judgment of the

merits of those claims, and thus, plaintiff’s settlement in

the reorganization proceedings barred relitigation of

those claims before the district court).

Issue preclusion, or the principle of collateral estop-

pel, clearly bars the Chitwoods from asserting the claims

made the basis of the district court action. As Judge

Nixon’s summary judgment memorandum makes clear,

the issue of cattle ownership was in dispute at the bank-

ruptcy proceeding and Judge Payne specifically found

that the cattle on the farm had been indiscriminately

branded without any attempt being made to determine

the true interest owner. The court further found that the

ce

14

cattle on the Weaver farm were owned by various per-

sons, including the Weavers, and that specific ownership

simply could not be determined.

The Chitwoods’ claims are predicated upon the same

facts which gave rise to the trustee’s equitable subordina-

tion claim. The central issue in both cases was ownership

and rights to particular cattle. That issue was decided by

the bankruptcy court adversely to the Chitwoods.

Relitigation would only undermine the bankruptcy court

judgment and disturb settled rights in contravention of

the law of collateral estoppel.

rN

4

CONCLUSION

The Chitwoods were unsuccessful in obtaining

money from the bankruptcy estate through the bank-

ruptcy court. In part, this was because of their own

misconduct in indiscriminate branding of cattle which

precluded proper identification of ownership interests.

The Chitwoods must not now be allowed to assert claims

predicated upon grounds which they have, or could have,

interposed in response to the complaint filed regarding

the subordination of their interest in the Weaver estate.

To do so would violate the doctrine of res judicata.

Although Fed.R.Civ.P. 13(a)(1) did not mandate that the

Chitwoods file counterclaims in the equitable subordina-

tion action, the bankruptcy court’s findings and judgment

now bar the Chitwoods’ claims.

15

Respondent respectfully requests that this Court

deny the petition for certiorari.

Respectfully submitted,

Davip RANDOLPH SMITH

KINNARD & SMITH

St. Cloud Corner,

Fifth Floor 500 Church Street

Nashville, TN 37219

(615) 259-4686

Attorney For Respondent