17 Collier Bankr.cas.2d 193, Bankr. L. Rep. P 71,730in the Matter of Energy Cooperative, Inc., a Delawarecorporation, Bankrupt- Appellant, 814 F.2d 1226 (7th Cir. 1987)

Energy Cooperative, Inc. ("ECI") appeals the dismissal of its suit against Phillips Petroleum Company ("Phillips") to recover more than $7.3 million which ECI claims is a voidable preference under section 547(b) of the Bankruptcy Code. 11 U.S.C. § 547(b) (1982). We conclude that this cause of action is barred by res judicata and accordingly affirm the decision of the district court.

ECI operated a petroleum refinery in East Chicago, Indiana. In the course of its business, ECI traded petroleum products pursuant to "exchange agreements" with other oil companies, including the defendant-appellee, Phillips. Under these exchange agreements, ECI

agreed to deliver various types of crude oil, refined oil and/or other oil and petroleum products to various suppliers, refineries and/or distributors at various locations throughout [t]he United States ... in exchange for the respective agreements of such suppliers, refineries and/or distributors to deliver such crude oil, refined oil and/or other oil and petroleum products to ECI.

In re Energy Cooperative, Inc., No. 81-B-005811 (Bankr.N.D. Ill. June 19, 1981) (the "Compromise Authorization Order").

ECI filed a voluntary petition in bankruptcy under chapter 11 of the Bankruptcy Code, 11 U.S.C. § 101 et seq. (1982),¹  on May 15, 1981. The company operated as debtor-in-possession under chapter 11 until May 31, 1984 when the case was converted to a proceeding under chapter 7.

On June 19, 1981, the bankruptcy court entered an order authorizing ECI to compromise, settle and collect balances that were owed to it under its pre-bankruptcy exchange agreements. Compromise Authorization Order. The court found that, due to falling oil prices, swift settlement of the exchange agreements was in the best interests of ECI and its creditors. Id. at 7. The order provided, in relevant part, as follows:

IT IS HEREBY ORDERED, ADJUDGED, AND DECREED:

1. That the Debtor be, and it hereby is, authorized, without any appraisal or further notice to, hearing, or approval by, this Bankruptcy Court, or any creditors, entities, or parties in interest:

(i) to effect and authorize the taking by the Exchange Partners of various set-offs arising from any business dealings of ECI with the Exchange Partners, to which the Exchange Partners may be entitled;

(ii) to negotiate and agree with each of the Exchange Partners upon a final settlement and liquidation of the obligations remaining under each respective Exchange Agreement; and

(iii) where appropriate, to adjust and compromise any disputed amounts or obligations owing under the Exchange Agreements; provided, that the Debtor shall make no adjustment, compromise or settlement of any amounts or obligations owing under the Exchange Agreements, which adjustment, compromise or settlement, if it had been made prior to the commencement of this reorganization case, could be avoided by the Debtor or a trustee, pursuant to applicable provisions of the Bankruptcy Code [.]

Id. at 9-10. Subparagraph (iii) was modified on July 23, 1981 by order of the bankruptcy court to clarify its scope and extent. In re Energy Cooperative, Inc., No. 81-B-005811 (Bankr.N.D. Ill. July 23, 1981). The amendment of this provision became effective, nunc pro tunc, as of June 19, 1981, and provided:

(iii) where appropriate, to adjust and compromise any disputed amounts or obligations owing under the Exchange Agreements, provided, however, that the Debtor has no authority to settle, adjust or compromise any claim, cause or right, which claim, cause or right could form the basis of any cause of action which may be brought pursuant to any avoiding or recovery provisions of the Bankruptcy Code.

Id. at 3.

Acting pursuant to the Compromise Authorization Order, ECI attempted to collect an exchange account balance due from Phillips.²  The parties did not dispute the amount owed, only the form of payment. Phillips declined to pay ECI in cash, claiming that under the terms of their exchange agreement, ECI was only entitled to delivery of product. ECI then filed a complaint in bankruptcy court alleging that Phillips owed ECI $1,564,666.97 for petroleum that ECI had over-delivered to Phillips under the exchange agreement. Complaint to Recover Exchange Balance p 6. ECI subsequently agreed to accept delivery of product in settlement of this action, and the suit was dismissed on ECI's motion on September 22, 1982. In re Energy Cooperative, Inc., No. 81-B-05811 (Bankr.N.D. Ill. Sept. 22, 1982). The order dismissing the suit stated that the proceeding was dismissed "with prejudice" and did not provide that ECI reserved the right to litigate any other issues arising from its exchange agreement in subsequent suits involving Phillips.

On October 14, 1982, ECI filed a complaint against Phillips which forms the basis of the suit before us.³  ECI seeks recovery of $7,320,762.00 that it transferred to the defendant on account of debts owed by ECI under their exchange agreement. Complaint to Recover Preferential Transfer p 6. The theory of ECI's present suit is that the money transferred by ECI was a preference under section 547(b) of the Bankruptcy Code, 11 U.S.C. 547(b) (1982), and the transfer was, therefore, voidable by ECI. Id. p 9. Phillips subsequently moved to dismiss the proceeding as res judicata, contending that the dismissal of the earlier suit to collect the exchange account balance barred any further litigation arising out of Phillips' exchange agreement with ECI.

On November 7, 1985, the district court, which had assumed jurisdiction by withdrawing the reference of this case to the bankruptcy court, granted Phillips' motion on the basis of both res judicata and equitable estoppel. In re Energy Cooperative, Inc., Nos. 81-B-5811, 82-A-3736, 85-C-3556 (N.D. Ill. Nov. 7, 1985) ("Transcript of Proceedings"). With respect to equitable estoppel, the court found that ECI never claimed during the pendency of the account balance suit that it was entitled to recover the $7.3 million that it had previously transferred to Phillips. Accordingly, if Phillips had been made aware that ECI intended to assert this preference claim, it would have recognized its status as a creditor of ECI and would never have transferred $1.5 million of petroleum products to the bankrupt in the account balance settlement. The court found that the present suit was also barred by res judicata because the alleged preference arose out of the same exchange agreement that was the subject of the earlier suit. On January 29, 1986, the district court denied the trustee's motion to vacate its earlier ruling granting Phillips' motion to dismiss. In re Energy Cooperative, Inc., Nos. 85-C-3556, 81-B-5811, 82-A-3736, mem. op. (N.D. Ill. Jan. 29, 1986) ("mem. op."). This appeal followed.

Because the prior litigation was brought in federal court, the federal rule of res judicata determines whether the account balance suit bars ECI from maintaining this action. See Restatement (Second) of Judgments Sec. 87 (1982); 18 C. Wright, A. Miller, E. Cooper, Federal Practice and Procedure Sec. 4466 (1981); Degnan, Federalized Res Judicata, 85 Yale L.J. 741, 769 (1976).

For res judicata to apply, three requirements must be met: (1) an identity of the parties or their privies; (2) an identity of the causes of actions; and (3) a final judgment on the merits. Federated Dep't Stores, Inc. v. Moitie, 452 U.S. 394, 398, 101 S. Ct. 2424, 2427, 69 L. Ed. 2d 103 (1981); see also Car Carriers, Inc. v. Ford Motor Co., 789 F.2d 589, 595 n. 9 (7th Cir. 1986); 1B J. Moore, J. Lucas, T. Currier, Moore's Federal Practice paragraphs 0.410, 0.411 (2d ed. 1984). The only disputed requirement in this case is whether there is a sufficient identity of the causes of action.

The district court, in dismissing ECI's suit, applied the "operative facts" or "same transaction" test to define "cause of action," Transcript of Proceedings at 5-6, which is the dominant definition applied in this circuit. Under this test, a "cause of action" consists of " 'a core of operative facts' which give rise to a remedy." Car Carriers, 789 F.2d at 593 (quoting Alexander v. Chicago Park Dist., 773 F.2d 850, 854 (7th Cir. 1985), cert. denied, --- U.S. ----, 106 S. Ct. 1492, 89 L. Ed. 2d 894 (1986)); see also Mandarino v. Pollard, 718 F.2d 845, 849 (7th Cir. 1983), cert. denied, 469 U.S. 830, 105 S. Ct. 116, 83 L. Ed. 2d 59 (1984); Harper Plastics, Inc. v. Amoco Chemicals Corp., 657 F.2d 939, 944 (7th Cir. 1981).

ECI contends that we should apply an ostensibly narrower definition of "cause of action" than that applied by the district court. According to ECI, to determine whether two suits arose out of a common core of operative facts, the appropriate question is whether the same evidence could support both claims. Appellant's Brief at 23-25. ECI also argues that we should apply a second test, apart from the operative facts test, under which the similarity of the claims is assessed with emphasis on the source of the rights and injuries at issue. Id. at 30. To support its position, ECI relies primarily on cases applying Illinois res judicata law, which employ these narrower formulations of the standard for claim preclusion. See, e.g., Redfern v. Sullivan, 111 Ill.App.3d 372, 376, 67 Ill.Dec. 166, 444 N.E.2d 205, 208 (4th Dist.1982); City of Elmhurst v. Kegerreis, 392 Ill. 195, 205-06, 64 N.E.2d 450, 454 (1945).⁴ 

As noted, however, because the prior suit in this case was adjudicated in federal court, the federal res judicata law governs, and the federal rule seems less demanding than that applied by the Illinois cases cited by ECI. This court recently endorsed the approach of section 24 of the Restatement (Second) of Judgments (1982): "Once a transaction has caused injury, all claims arising from that transaction must be brought in one suit or lost." Car Carriers, 789 F.2d at 593.⁵  This is, therefore, the approach we apply here.⁶  Applying the federal definition of "cause of action," the district court concluded that the account collection litigation and the present suit arose out of the same core of operative facts because "the rights and obligations of the parties under the exchange agreements were a necessary factual underpinning for the preference case and were fully settled in the first lawsuit." Mem. op. at 3-4. We agree that the present suit is barred because it involves the same "cause of action" as the account balance suit. Both claims arose out of the same transaction, the exchange of petroleum products between ECI and Phillips pursuant to their exchange agreement. The first suit alleged that ECI over-delivered petroleum products to Phillips under the agreement, and the present suit contends that ECI can set aside as a voidable preference payments by ECI for product delivered by Phillips under the agreement.⁷  Both the account balance claim and the preference claim involve the reconciliation of the balance of the exchange agreement. The contract claim is for the total balance; the preference claim asks the court to look at transactions for the last 90 days only and net these out. Because each claim seeks to reconcile the parties' obligations under their contract and because the time periods covered by the two claims overlap, we conclude that the two arise out of the same transaction.

The link between the two claims is also supported by the relationship between the claims and Phillips' right of setoff. Phillips contends that if we were to allow ECI to split its claims, Phillips would be unable to raise as a defense its right to offset the amount it owed ECI for over-delivery of product against the approximately $7.3 million ECI would owe Phillips if that amount were set aside as a voidable preference. The district court relied on the potential prejudice to Phillips' setoff right, noting that " [h]ad Phillips known that ECI intended to assert its right to avoid the preferential transfers, Phillips would have recognized its status as a creditor, rather than a debtor, of ECI. Instead, Phillips transferred $1.5 million worth of petroleum products to ECI." Transcript of Proceedings at 5.

ECI contends that Phillips did not have the right to offset the amount it owed ECI under the exchange agreement against the $7.3 million ECI would owe Phillips if that amount were set aside as a voidable preference. ECI argues that Phillips' right to setoff arises under section 553(a) of the Bankruptcy Code. Section 553(a) provides, in relevant part:

Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case....

11 U.S.C. 553(a) (1982). While Phillips' debt to ECI clearly arose pre-petition, ECI argues that its debt to Phillips arose post-petition: "Obviously, a claim arising from the post-petition avoidance of a preference cannot have arisen pre-petition." Appellant's Reply Brief at 20.

Phillips relies on In re Nepsco, Inc., 55 B.R. 574 (Bankr.D. Me. 1985), to establish that it would have been able to assert a right of setoff had ECI raised the preferential transfer claim in the earlier suit. In Nepsco, the trustee sued Contractors Group, Inc. ("CGI") seeking to recover preferential transfers in the amount of $6,221.56 allegedly made by the debtor to CGI. CGI owed the debtor $7,250.00 arising from pre-petition debts. CGI contended that the trustee met his burden of proof on all the elements necessary to recover a preferential transfer, except for the requirements of 11 U.S.C. § 547(b) (5). Section 547(b) (5) provides that the trustee may avoid a transfer of the debtor's interest in property

(5) that enables such creditor to receive more than such creditor would receive if--

(a) the case were a case under chapter 7 of this title;

(b) the transfer had not been made; and

(c) such creditor received payment of such debt to the extent provided by the provisions of this title.

11 U.S.C. § 547(b) (5) (1982). CGI's position was that if it did not receive the alleged preferential transfers, it would have had the right under section 553(a) to offset the amount it owed the debtor against the amount the debtor allegedly owed CGI. The trustee in Nepsco raised the same argument advanced by ECI in this case: "The trustee claims that as a result of the preferential transfers, CGI had no claim against the debtor's estate at the time of the filing of the Chapter 7 petition and therefore had no claim which would be the subject of a setoff under 11 U.S.C. § 553." 55 B.R. at 575-76. The court rejected the trustee's argument, reasoning that the sole issue before it was "whether CGI, in receiving the pre-filing payments from the debtor, received more than it would have received had the payments not been made." Id. Section 553 was relevant only to the extent that it bore on the question of what CGI would have been entitled to had the alleged preferential transfers not been made. If the debtor had not paid its pre-petition debt of $6,221.56 to CGI, CGI would have been entitled to a right of setoff under section 553(a).

The reasoning in Nepsco supports the conclusion that in the case before us the two suits involve the same cause of action. Had ECI raised the preference issue in its account balance suit, Phillips could have asserted its right to offset the $1.5 million balance it owed ECI under their exchange agreement against the $7.3 million ECI would owe Phillips if that amount were set aside as a voidable preference. The net result would be that Phillips would have to transfer a total of $7.3 million as a preference, and ECI would owe Phillips $5.8 million (the $7.3 million it would owe Phillips at the time Phillips repays that amount less the $1.5 million Phillips owed it). Phillips claims that it lost its setoff right once it transferred the $1.5 million to ECI in settlement of the first suit. Thus, if we allow ECI to split its claims, Phillips must transfer a total of $8.8 million to ECI (the sum of $7.3 million and $1.5 million), and ECI would owe Phillips the total amount returned as a voidable preference, $7.3 million. If Phillips has indeed lost its right of setoff, Phillips would obviously be placed in a worse position by ECI's splitting of its claims.⁸ 

ECI contends that even if the two suits involve the same cause of action, this case must be distinguished from the normal operation of the doctrine of res judicata because the bankruptcy court reserved ECI's right to bring voidable preference claims. If a court reserves for later resolution an issue that might otherwise have been adjudicated in the initial proceeding, res judicata will not operate to bar the subsequent suit. See Restatement (Second) of Judgments Sec. 26(1) (b), comment b (1982). According to ECI, the Compromise Authorization Order issued by the bankruptcy court effectively reserved its right to bring this later suit. The bankruptcy court, through its order, authorized ECI to settle the account balance claims because of the need for prompt action resulting from the declining oil price, but the court set aside any other claim "which may be brought pursuant to any avoiding or recovery provisions of the Bankruptcy Code," including preference claims, for later disposition. Compromise Authorization Order Sec. 1(iii). ECI argues that neither the bankruptcy court nor the parties believed at the time the account balance suit was settled that any further litigation between the parties arising from the exchange agreement would be precluded. ECI contends that it did not believe that it had the authority to compromise voidable preference claims under the order and that Phillips was aware of the order and its limitations on ECI's settlement powers. ECI also argues that the bankruptcy court, by approving settlement of the account balance suit, did not intend to prevent ECI from bringing this later suit; had the court believed that the earlier suit would settle all claims between ECI and Phillips arising out of the exchange agreement, including more than $7.3 million worth of preference claims, the court would have informed ECI's other creditors and would have held a hearing to determine that settlement of the claims was in the best interests of the bankrupt and its creditors.

Phillips contends that although it had notice of the Compromise Authorization Order at the time it settled the account balance suit with ECI, it did not interpret this order as preventing ECI from settling its preference claims against Phillips. Under Phillips' interpretation of the order, ECI was only prohibited from compromising preference claims with exchange partners who disagreed with ECI as to the amounts due under the exchange agreements. The restriction on ECI's ability to compromise claims other than account balances is contained in section 1(iii) of the order that authorizes ECI "to adjust and compromise any disputed amounts or obligations owing under the Exchange Agreements." Compromise Authorization Order Sec. 1(iii). Section 1(ii), which does not contain a similar restriction, authorizes ECI "to negotiate and agree with each of the Exchange Partners upon a final settlement and liquidation of the obligations remaining under each respective Exchange Agreement." Id. Sec. 1(ii). Phillips contends that because section 1(ii) did not contain a restriction comparable to that found in section 1(iii), ECI was not prohibited from settling preference claims in conjunction with account balances settled under section 1(ii). Phillips further argues that because it and ECI did not dispute the amount at issue under their exchange agreement, they settled their exchange balance pursuant to section 1(ii) of the order, and ECI thus also compromised its preference claims against Phillips when it agreed to settlement of the first suit. Phillips believes that the dichotomy in ECI's authority set up in section 1(ii) and section 1(iii) is explained by the fact that if "ECI and its exchange partner agreed as to the amount due [this] would be some insurance that the estate was receiving all it was entitled to." Appellee's Brief at 24.

Phillips' interpretation of the Compromise Authorization Order is not persuasive. Whether ECI may give up more than $7.3 million worth of preferences cannot reasonably be predicated on whether ECI and its exchange partner agree on the amount owed under their exchange agreement. If ECI and Phillips agree on the exchange balance amount, there is some assurance that the bankrupt is getting everything to which it is entitled with respect to the exchange balance claim. Agreement does not ensure, however, that the bankrupt is getting everything to which it is entitled with respect to other claims, including preferences. Further, even if we were to accept Phillips' interpretation of the order, we would still find that ECI was not authorized to compromise its preference claims against Phillips. Section 1(iii) of the order authorized ECI "to adjust and compromise any disputed amounts or obligations owing under the Exchange Agreements." Compromise Authorization Order Sec. 1(iii) (emphasis added). While the parties did not dispute the amount owing under their agreement, they did dispute the obligation. Their quarrel with the obligation involved whether payment should be made in the form of cash or petroleum products. Thus, ECI was not authorized by the Compromise Authorization Order to settle any preference claims it might have against Phillips.

The most plausible interpretation of the Compromise Authorization Order is that the bankruptcy court intended to prohibit ECI from compromising any claim arising under the Bankruptcy Code, whether or not the parties disputed their obligations under the exchange agreements. Nonetheless, it is inescapable that, although the Compromise Authorization Order prohibited ECI from settling its preference claims, this order was modified as to Phillips when the court approved the settlement of the account balance suit "with prejudice." In settling the account balance suit, the burden was on ECI to preserve any further claims it might assert against Phillips arising out of their exchange agreement. If the order dismissing the first suit had not indicated that it was dismissed with prejudice, the reservation in the Compromise Authorization Order might have been sufficient to reserve ECI's right to bring subsequent suits. The order dismissing the account collection case, however, was not silent on the question of ECI's right to pursue future claims against Phillips. The suit was dismissed "with prejudice," indicating that the order barred any subsequent suits on the same cause of action. See, e.g., Phillips v. Shannon, 445 F.2d 460, 462 (7th Cir. 1971) (" ' [A] dismissal with prejudice is a final judgment on the merits which will bar a second suit between the same parties for the same cause of action.' ") (quoting Cleveland v. Higgins, 148 F.2d 722, 724 (2d Cir.), cert. denied, 326 U.S. 722, 66 S. Ct. 27, 90 L. Ed. 428 (1945)); Pfeiffer Co. v. United States, 385 F. Supp. 367, 371 (E.D. Mo. 1974), aff'd, 518 F.2d 124 (8th Cir. 1975).⁹  Thus, while the Compromise Authorization Order reserved ECI's right to assert preference claims, the order was modified as to Phillips by the court's dismissal of the account balance litigation with prejudice.¹⁰ 

An alternative, and at least equally valid, interpretation of the Compromise Authorization Order (although one not raised by either party) is that the order did not authorize ECI to split its claims. The order, by its terms, gave ECI the power to settle its account balance claims "without any appraisal or further notice to, hearing, or approval by, this Bankruptcy Court, or any creditors, entities, or parties in interest." Compromise Authorization Order Sec. 1. Pursuant to this order, ECI initially attempted to settle its account balance claim with Phillips without the participation of the bankruptcy court; ECI filed suit only after private settlement negotiations failed. If the two parties had been able to settle the contract claim without the participation of the court, ECI, under the terms of the Compromise Authorization Order, would not have been able to compromise any other claim it might have against Phillips arising out of their exchange agreement. Once ECI determined that it must file suit to recover the account balance due it, the Compromise Authorization Order and its attempted reservation of claims did not apply because that order focuses on ECI's attempt to settle only and not on lawsuits that ECI might file to bring about a resolution of the disputes. Viewed in this light, the Compromise Authorization Order has nothing directly to do with the complaint that ECI filed or with the disposition of the action based on it. Thus, ECI is barred by res judicata from bringing its preference claim because it did not raise this claim in its complaint in the contract suit.

Because we conclude that this suit is barred by res judicata, we need not consider whether ECI is equitably estopped from bringing this suit. The judgment of the district court is

AFFIRMED.