Schultze v. Chandler
Schultze v. Chandler, ___F.3d ___, 2014 WL 3537030 (9th Cir. July 18, 2014, amended August 1, 2014): In a published decision, the Ninth Circuit Court of Appeals held that a post-petition malpractice claim originally filed in state court against an attorney for an unsecured creditors’ committee is a core proceeding. Agreeing with other circuits, the Ninth Circuit found that the malpractice lawsuit, which was removed to a bankruptcy court from state court, fell within the definition of a core proceeding because: (1) the attorney’s employment and compensation was approved by the bankruptcy court; (2) his duties as committee counsel pertained solely to the administration of the bankruptcy estate; and (3) the claim asserted against him was based purely on acts that occurred in the administration of the estate.
FACTS
Plaintiffs were individual investors in Colusa Mushroom, Inc. ("Debtor"), a mushroom enterprise that filed a voluntary chapter 11 petition in the United States Bankruptcy Court for the Northern District of California. The Bankruptcy Court appointed an unsecured creditors’ committee ("Committee"), consisting of Plaintiffs, other individuals, and a business entity. The Committee obtained an order from the Bankruptcy Court authorizing it to employ David Chandler ("Committee Counsel") as its attorney.
The Debtor’s confirmed plan of reorganization provided for the sale of its business and assets to a third party, Premier Mushroom, LP ("Buyer"). All unsecured creditors, including Plaintiffs, were to share pro-rata in the sale proceeds. Pursuant to the terms of the sale, Buyer paid a down payment and executed a promissory note for the payment of the remainder of the sale price ("Note"). Buyer was to make three annual payments and a final balloon payment.
Security for the Note was to be provided in the form of a deed of trust on real property and a secured interest on personal property, junior to three other liens. The Debtor and Buyer, not Committee Counsel, conducted the closing of the sale. Following the closing of the sale, the Bankruptcy Court entered a final decree and administratively closed the bankruptcy case.
Buyer defaulted on the balloon payment. Plaintiffs then learned that Debtor’s counsel failed to file the financing statements necessary to perfect the estate’s junior security interest in the personal property. Because the security interest was not perfected, Buyer was able to further encumber the purchased assets and the net recovery from post-default assets was significantly less than it would have been had the security interest been properly perfected.
Plaintiffs commenced a malpractice action in state court against Committee Counsel, contending that he was negligent in failing to ensure that Debtor’s attorney properly perfected the security interest. Although the Committee had been dissolved, Committee Counsel removed the malpractice lawsuit to the Bankruptcy Court. Plaintiffs attempt to remand the case was denied. The Bankruptcy Court then granted Committee Counsel’s motion to dismiss on the grounds that he owed no duty to Plaintiffs individually because he represented the Committee as a whole, and not its individual members. Plaintiffs appealed the Bankruptcy Court’s dismissal to the district court, which affirmed. Plaintiffs then appealed to the Ninth Circuit.
REASONING
As set forth below, the Ninth Circuit found that the district court properly concluded that the Bankruptcy Court possessed jurisdiction over the malpractice action because it was a core proceeding.
A bankruptcy court has jurisdiction over "all civil proceedings arising under title 11, or arising in or related to cases under title 11." 28 U.S.C. § 1334(b). Claims that arise under or in title 11 are deemed to be core proceedings, while claims that are related to title 11 are noncore proceedings. Maitland v. Mitchell (In re Harris Pine Mills), 44 F.3d 1431, 1435 (9th Cir. 1995).
The Ninth Circuit explained that core proceedings arising in title 11 can be matters "that are not based on any right expressly created by title 11, but nevertheless, would have no existence outside of the bankruptcy." In contrast, where the post-petition proceeding involves rights unconnected to the bankruptcy, the Ninth Circuit stated that the proceeding is noncore.
Noting that all circuit courts are in agreement, the Ninth Circuit stated that "where a post-petition claim was brought against a court-appointed professional, we have held the suit to be a core proceeding." The rationale is that a court must be able to police the fiduciaries in restructuring the debtor-creditor relationship, whether it be a trustee, debtor-in-possession, or other court-appointed professional. In this case, Committee Counsel’s employment and compensation were approved by the Bankruptcy Court, his duties pertained solely to the administration of the bankruptcy estate, and the claim asserted against him pertained to acts that occurred in the administration of the estate. Accordingly, the lawsuit fell within the definition of a core proceeding.
In reaching this conclusion, the Ninth Circuit rejected a number of arguments advanced by Plaintiffs. First, citing 28 U.S.C. § 157(b)(3), the Ninth Circuit explained that it did not matter that Plaintiffs’ claim was predicated on state law. Second, the Court also rejected the notion that Plaintiffs’ claim did not invoke any right created by federal bankruptcy law because "arising in" jurisdictional analysis looks at whether the matter has no existence outside of the bankruptcy. In this case, the basis for the claim occurred within the administration of the estate, and any alleged duties arose from obligations created under bankruptcy law.
The Ninth Circuit also affirmed the district court’s grant of the motion to dismiss because Committee Counsel did not owe an individual duty of care to Plaintiffs. Rather, he represented the Committee only, and that is to whom his fiduciary duties ran. Moreover, in his capacity as Committee Counsel, he was not charged with the duty of recording the financing statement. That duty fell to Debtor’s attorney.
COMMENTARY
The Supreme Court’s recent decisions in Executive Benefits Insurance Agency v. Arikson (In re Bellingham Ins. Agency, Inc.), 134 S. Ct. 2165 (2014) and Stern v. Marshall, 131 S. Ct. 2594 (2011), illustrate that the distinction between core and noncore proceedings can provide for vexing ramifications affecting jurisdiction and the ability of a bankruptcy court to enter a final judgment. This decision provides some practical clarity by holding that a post-petition state law claim against professionals is a core proceeding. Further rulings such as this will help harmonize these recent Supreme Court rulings and the sometimes blurred-lines between core and noncore proceedings that can create jurisdictional instability.
This analysis is from CA State Bar Business Law Section’s Insolvency Law Committee e-newsletter of 8/18/14