By Taylor Ey

Today, the Fourth Circuit issued its public opinion in Covert v. LVNV Funding, LLC, affirming the decision of the District Court of Maryland, Greenbelt.

Procedural History

In 2008, Plaintiffs Covert, Haworth, Haworth, Ayele, and Brown separately filed petitions for Chapter 13 bankruptcy in Bankruptcy Court for the District of Maryland.  Defendants, LVNV Funding, LLC (“LVNC”) had acquired defaulted debt against each plaintiff.  LVLN filed proofs of claim against each plaintiff.  “A proof of claim is a form filed by a creditor in a bankruptcy proceeding that states the amount the debtor owes to the creditor and the reason for the debt.”  The bankruptcy court confirmed a plan that these claims were to be paid in pro rata amounts.

In March 2013, plaintiffs filed a class-action lawsuit, alleging that defendants had violated the federal Fair Debt Collection Practices Act (“FDCPA”) and Maryland law by filing proofs of claim without a Maryland debt collection license.  The district court granted defendants’ motion to dismiss for failure to state a claim under Fed. R. Civ. Pro. 12(b)(6).

The District Court Properly Dismissed Plaintiffs’ Complaint for Failure to State a Claim

Plaintiffs alleged that the defendants were not legally entitled to collect the debt because they did not have a license at the time they filed in bankruptcy court.  Plaintiffs requested injunctive relief and an instruction requiring defendants to return to the plaintiffs all the money paid pursuant to the proofs of claim.  Defendants asserted that plaintiffs failed to state a claim for which relief could be granted, and thus the claims should be dismissed.  The Fourth Circuit held that the district court properly dismissed the claims, but should have done so on res judicata grounds.

The Doctrine of Res Judicata in the Bankruptcy Context

In bankruptcy cases, prior bankruptcy judgment has res judicata effect when three conditions are met: “(1) the prior judgment was final and on the merits, and rendered by a court of competent jurisdiction in accordance with the requirements of due process; (2) the parties are identical, or in privity, in the two actions; and, (3) the claims in the second matter are based upon the same cause of action involved in the earlier proceeding.”  In re Varat Enters., Inc., 81 F.3d 1310, 1315 (4th Cir. 1996).

The Bankruptcy Court Decision Had Res Judicata Effect

The confirmation of a bankruptcy plan was a final judgment on the merits, and thus the bankruptcy judgment met the first element of the test.

Because both plaintiffs and defendants were parties to the proceedings in the bankruptcy court, the second element was met.

The claims before the district court arose “out of the same transaction or series of transactions, or the same core of operative facts” as those in the bankruptcy court action.  Varat, 81 F.3d at 1316. The plaintiffs would need to rely on the same facts as in the bankruptcy case to succeed in the present action.  Therefore, the bankruptcy judgment met the third element of the test.  Because all three elements are met, the plaintiffs’ claims were barred by res judicata.

The District Court’s Reading of the Cen-Pen Exception Was Too Broad

The district court held that plaintiffs’ claims were not barred by res judicata because it applied the Cen-Pen exception.  In Cen-Pen, the Fourth Circuit held that “[i]f an issue must be raised through an adversary proceeding it is not part of the confirmation process and, unless it is actually litigated, confirmation will not have a preclusive effect.”  Cen-Pen Corp. v. Hanson, 58 F.3d 89, 93 (4th Cir. 1995).

According to the Fourth Circuit, the district court misread Cen-Pen as creating a rule that “plan confirmation does not have preclusive effect to any issue that must have been decided through an adversary process.”

In this case, the Fourth Circuit clarified the rule.  First, the exception is limited to the facts; it applies to cases of secured claims after a bankruptcy proceeding.  In contrast, the present case involved a process used to collect an unsecured claim.  Moreover, because the parties in Cen-Pen were not directly involved in the bankruptcy proceeding that court sought to protect those parties’ rights in the subsequent proceeding.  Instead, the parties in this case were on notice as parties to the previous bankruptcy proceeding and did not need protection.

The District Court’s Decision Is Affirmed

Because plaintiffs did not assert any evidence suggesting that they could not have raised their present claims in the previous action, plaintiffs’ claims were barred.  The Fourth Circuit warned that holding otherwise would run counter to bankruptcy law policy.