North Carolina practitioners seeking guidance on claim preclusion and issue preclusion now need to look no further than the Court of Appeals’ decision Tuesday in Barrow, et al. v. D.A.N. Joint Venture Prop. of NC, LLC, et al. In an opinion befitting a model answer to a treacherous law school Civil Procedure exam question, the Court addressed the issue of whether parties’ failure to raise a statute of limitations argument in an adversary proceeding in a federal bankruptcy case precluded those same parties from making a statute of limitations argument in a subsequent action filed in state superior court. The Court ultimately held that the doctrine of claim preclusion prevented the parties in the superior court case from attacking the validity of a guaranty agreement on the basis of statute of limitations. To get to that decision the Court outlined and explained the black letter law of preclusion, making the opinion one that will likely be cited frequently in future cases that involve the often confusing and complex issues of claim preclusion and issue preclusion. Along the way, Chief Judge Martin’s decision also touched on choice of law issues, core proceedings vs non-core proceedings in bankruptcy, privity, and a host other legal doctrines, making this one of the more educational Court of Appeals opinions that I’ve read in quite some time.

The backdrop for the issues in Barrow involved a group of individuals who pursuant to a guaranty agreement personally guaranteed notes issued by Wachovia Bank to L.L. Murphrey Company. (Warning: If you don’t practice bankruptcy law, you, like me, may not understand a word of the rest of this paragraph.) L.L. Murphrey filed a federal bankruptcy petition in the Eastern District of North Carolina. At the time of that petition, L.L. Murphrey was in default on several of the Wachovia notes that were guaranteed by the guarantors. As part of the Bankruptcy Court’s Plan of Reorganization, the Wachovia notes were ultimately sold to D.A.N. Joint Venture. The Plan of Reorganization provided that the guaranties of the notes would remain in effect, but were modified to reflect the amount of the “Recapitalized Debt.” A dispute subsequently arose as to the amount of the recapitalized debt, and L.L. Murphrey and three of the guarantors filed an adversary proceeding in the bankruptcy court against D.A.N. Joint Venture. In the adversary proceeding, the parties “sought a declaration that the guarantors were contingently liable for only the amount of the recapitalized debt. They also requested an injunction requiring D.A.N. Joint Venture to stop demanding payment from L.L. Murphrey and the guarantors in excess of the amount of the recapitalized debt.” The bankruptcy court ultimately issued an order denying the claim for injunctive relief and declaring that the liability of the guarantors could not exceed the amount of the recapitalized debt.

Subsequently, the three guarantors who had been plaintiffs in the adversary proceeding in the bankruptcy court brought an action in North Carolina Superior Court against D.A.N. Joint Venture (and joining the two other guarantors as defendants), seeking a declaration that the expiration of the statute of limitations prevents D.A.N. Joint Venture from enforcing its rights against the guarantors under the guaranty agreement. The trial court granted summary judgment in favor of the guarantors and apparently (the case is not entirely clear on this point) relieved them from any obligation to D.A.N. Joint Venture pursuant to the guaranty agreement. D.A.N. Joint Venture appealed.

The basis for D.A.N. Joint Venture’s appeal was that the order from the federal bankruptcy court in the adversary proceeding, which order addressed the guarantors’ liability to D.A.N. Joint Venture, precluded the state trial court from relieving the guarantors from liability on statute of limitations grounds. Referring to the question presented on appeal as an “interjurisdictional preclusion issue,” the Court of Appeals first addressed the appropriate law to be applied and determined that federal common law governed the preclusion issue. The Court then embarked on a comprehensive discussion of claim preclusion and issue preclusion, ultimately deciding that claim preclusion, and not issue preclusion, applied to the case at hand. However, before the Court could apply the law of claim preclusion to the situation presented, it first had to determine whether claim preclusion applies to a declaratory judgment. (Hopefully by now you understand why this conjured up images of law school). While ordinarily a declaratory judgment would only implicate issue preclusion, because the guarantors also sought affirmative injunctive relief in the bankruptcy adversary proceeding, the Court held that claim preclusion would apply to the bankruptcy court order.

After addressing those complicated preliminary issues, the Court got to the comparatively simple task of analyzing whether claim preclusion applied to prevent the guarantors from asserting the statute of limitations in the state court case as a bar to any liability they had under the guaranty agreement. The Court laid out the test for claim preclusion as follows:

Claim preclusion applies to an adjudication when (1) a
court of competent jurisdiction enters a final judgment on the
merits; (2) there is a second suit involving the claimants or
parties in privity with the claimants; and (3) the claims in the
second suit are based on the same cause of action as the first
suit or could have been asserted in the first suit.

With respect to the first prong of the test, the Court further broke that down into three subparts:

Subpart one requires a court of competent jurisdiction.
Subpart two requires a final judgment. Subpart three mandates
that the final judgment be on the merits.

The remainder of the Court’s opinion is its analysis of the case pursuant to the above framework. After detailed consideration of each factor, not one of which was very straightforward (for example, with respect to the second prong of the test the Court had to delve into privity issues), the Court ultimately held that all the necessary components for claim preclusion existed and that because the guarantors could have argued against their liability under the guaranty agreement on statute of limitations grounds in the adversary proceeding, but did not, they were precluded from advancing that argument in the subsequent state court suit. The Court therefore reversed the trial court’s grant of summary judgment in favor of the and summarized its holding as succinctly as could be expected, stating

claim preclusion applies to the 10 May 2012
bankruptcy court order because the claimants in the adversary
proceeding asked for an injunction in addition to declaratory
relief. Next, the bankruptcy court was a court of competent
jurisdiction that issued a final judgment on the merits because
there was a hearing concerning the substance of the legal issues
in dispute between the parties on a core proceeding as well as
an order disposing of all claims between claimants. Also, the
adversary proceeding and the superior court proceeding involved
the guarantors asserting rights against D.A.N. Joint Venture,
thus both cases involved the same claimants. Finally, both
cases arose from the same cause of action because both cases
focused on how the Plan of Reorganization impacts the
relationship of guarantors and D.A.N. Joint Venture and nothing
prevented guarantors from asserting their statute of limitations
claim in the adversary proceeding. Therefore, Larry Barrow’s,
Lois Barrow’s, and Doris Murphrey’s failure to raise the statute
of limitations issue during the adversary proceeding precludes
us from now considering whether the statute of limitations
prevents defendant from recovering from the guarantors.

So, the next time you find yourself confronted with a case involving a possible issue of claim preclusion, or if you are a law school professor looking for a ready-made Civ Pro exam question, the first place you ought to go is to Barrow v. D.A.N. Joint Venture. As for me, I’m going to slowly back away from the keyboard and hope my head stops spinning sometime soon…

-Patrick Kane