12 N.Y.3d 38 (2009)
A bankruptcy court order allowing a creditor to seize a debtor’s bank account has res judicata effect in a subsequent state proceeding alleging that a portion of the funds in the account were state tax proceeds, when the party now challenging the seizure had notice of the bankruptcy action but failed to alert the bankruptcy court that the funds were tax receipts held in trust.
Summary
The Insurance Company of the State of Pennsylvania (ICSP), as subrogee of the State of New York, sued HSBC Bank USA, alleging misappropriation of state tax proceeds. Herkimer Wholesale Company, a tax stamp agent, went bankrupt. Herkimer owed New York State unpaid cigarette taxes. The State and ICSP, with knowledge of the bankruptcy proceedings, failed to inform the Bankruptcy Court that the funds in Herkimer’s account included tax proceeds held in trust for the State. The Bankruptcy Court allowed HSBC to foreclose on Herkimer’s collateral, including the bank account. ICSP, having paid the State’s claim, then sued HSBC, alleging misappropriation. The New York Court of Appeals held that res judicata barred ICSP’s claim because the issue of entitlement to the funds could have been raised in the bankruptcy proceeding.
Facts
Herkimer Wholesale Company, a cigarette distributor, purchased tax stamps from New York State, collecting the taxes when selling cigarettes. These tax proceeds were to be held in trust for the State. Herkimer obtained a bond from ICSP to secure unpaid stamps. Herkimer defaulted on a loan from HSBC, who held a security interest in Herkimer’s property. An involuntary bankruptcy proceeding was initiated against Herkimer, staying HSBC’s foreclosure efforts. Herkimer listed New York State as its largest unsecured creditor, but incorrectly classified the owed taxes as a debt, not trust funds. An agreement was reached allowing Herkimer to operate as a debtor-in-possession, with HSBC maintaining a security interest in the cash collateral account. Despite a warning from the Department of Taxation and Finance that the bank could not obtain a secured interest in cigarette tax stamps the Bankruptcy Court ultimately permitted HSBC to foreclose on all of Herkimer’s collateral.
Procedural History
Herkimer filed for bankruptcy. The State of New York filed a proof of claim in Bankruptcy Court. The Bankruptcy Court issued an order dissolving the stay, permitting HSBC to foreclose on Herkimer’s collateral. The State commenced an action against ICSP to enforce the guaranty. ICSP then initiated a third-party action against HSBC. Supreme Court granted summary judgment to the State and to HSBC. The Appellate Division affirmed. ICSP paid on the bond and initiated this lawsuit against HSBC. Supreme Court granted ICSP’s motion as to liability. The Appellate Division modified, but otherwise affirmed, rejecting HSBC’s res judicata defense. The Court of Appeals reversed.
Issue(s)
Whether a Bankruptcy Court order allowing a creditor to seize a debtor’s bank account is entitled to res judicata effect in a subsequent state proceeding alleging that a portion of the funds in the account were state tax proceeds that should not have been part of the bankruptcy estate, when the plaintiff and its subrogor had notice of the bankruptcy action and failed to alert the court that the funds at issue were tax receipts held in trust.
Holding
No, because the State and ICSP had a full and fair opportunity to litigate the matter in Bankruptcy Court but chose not to do so.
Court’s Reasoning
The Court of Appeals reasoned that res judicata bars ICSP’s claim. Res judicata applies to issues that could have been raised in the prior action. Here, the central issue was entitlement to the money in Herkimer’s collateral account. The Bankruptcy Court was the proper forum to adjudicate this question. Neither the State nor ICSP informed the Bankruptcy Court that Herkimer’s bank account included tax proceeds that were the sovereign property of the State. The court noted that the State simply had to declare that its money was being held in trust by Herkimer, or ICSP could have checked a box on its claim form indicating that the funds should be prioritized as tax proceeds owed to the state government. Because the Bankruptcy Court was not asked to segregate the tax funds in the account, the court was within its power to treat the monies as assets of Herkimer’s estate for distribution on HSBC’s secured claim. As the U.S. Supreme Court stated in Federated Department Stores, Inc. v. Moitie, 452 U.S. 394, 398 (1981) res judicata applies to “issues that . . . could have been raised” in the prior action and “any other admissible matter which might have been offered” for the purpose of “sustaining] or defeating] the claim or demand” at issue in the earlier proceeding Commissioner v Sunnen, 333 U.S. 591, 597 (1948). Therefore, ICSP’s causes of action are barred by res judicata.