Opinion
Civil Action No. 1:21-cv-1055
2021-12-21
Martin C. CONWAY and Pesner Kawamato Conway, P.C., Plaintiffs, v. SMITH DEVELOPMENT, INC., Defendant. In re: Smith Development, Inc.
Danny Mark Howell, Robert Jackson Martin, IV, Law Offices of Danny M. Howell PLLC, McLean, VA, for Plaintiffs. John S. Lopatto, III, Law Offices of John Lopatto, Washington, DC, for Defendant.
Danny Mark Howell, Robert Jackson Martin, IV, Law Offices of Danny M. Howell PLLC, McLean, VA, for Plaintiffs.
John S. Lopatto, III, Law Offices of John Lopatto, Washington, DC, for Defendant.
ORDER
Liam O'Grady, United States District Judge
Introduction
This matter comes before the Court on the Report and Recommendation of the Honorable United States Bankruptcy Judge Klinette H. Kindred. Dkt. 2 at 1. The Report and Recommendation has been properly objected to by the Defendant, the Plaintiff has filed a memorandum in support, and oral arguments were held before the bankruptcy court. See Id. at 61; Dkt. 2-1 at 1; Dkt. 2-1 at 153. The matter concerns the bankruptcy court's stay of an underlying state court action in Alexandria circuit court between the same Parties in this civil action. Dkt. 2 at 61. After receiving the Report and Recommendation of the bankruptcy judge, this Court does not find the need to gather more evidence or hold additional hearings. For the reasons stated below, this Court does not adopt the Report and Recommendation of the Eastern District of Virginia Bankruptcy Court.
Background
The bankruptcy court has presented the following undisputed facts of the long and circuitous procedural route that this case has traveled preceding this decision. The Defendant, Smith Development, Inc. ("Defendant"), is a company that builds residential housing. Dkt. 2 at 2. In 2008, the housing crisis lead to serious financial problems for the Defendant's business that eventually caused the company to file a voluntary petition for Chapter 11 bankruptcy. Id. On March 20, 2009, the bankruptcy court approved the appointment of the Plaintiffs, an attorney Martin C. Conway and the law firm Pesner Kawamato Conway, P.C. ("Plaintiffs"), to represent the Defendant during the Chapter 11 bankruptcy. Id. The Parties entered into a representation agreement that defined the scope of legal services that the Plaintiffs would perform on behalf of the Defendants. Dkt. 2-1 at 79.
During the bankruptcy proceeding, Smith Development Inc. (as the debtor) filed three adversarial actions seeking damages for the default of three investors who had allegedly contracted to buy homes from the Defendant. Dkt. 2 at 2-3. Subsequently, the bankruptcy was converted to a Chapter 7 liquidation bankruptcy and a trustee was appointed to manage the estate. Id. at 3. The trustee then obtained the representation of the Plaintiffs to act as special counsel with the authorization of the bankruptcy court. Id. The adversarial proceedings were settled, the Plaintiffs fees were approved, and the bankruptcy case was closed on September 6, 2012. Id. at 4.
The Defendant then filed two legal malpractice lawsuits against the Plaintiffs asserting negligence in their representation of the Defendant and negligence in the settlement of the adversarial proceedings during the Chapter 7 phase of the bankruptcy. Id. at 4. The first malpractice lawsuit was filed in 2017 and was eventually non-suited by the Defendant. Id. at 5. The second lawsuit was filed in April 11, 2019 in Alexandria circuit court. Id. On July 25, 2019, the Defendant filed a motion with the bankruptcy court to reopen the bankruptcy case and to obtain permission under the Barton doctrine to file a legal malpractice action against the Plaintiffs in the current case. Id. The motion to the bankruptcy court was denied and the denial was not appealed. Id. at 5-6. On January 27, 2021, the Plaintiffs filed a motion to reopen the bankruptcy case to obtain damages and injunctive relief. Id. at 6. The bankruptcy court held hearings and then issued its Report and Recommendation to this Court. Id. The bankruptcy court has recommended for the Court to adopt that:
1. the Defendant has violated the Barton doctrine;
2. the Defendant and the Defendant's counsel willfully violated the automatic stay;
3. the court proceedings between the parties in the Alexandria circuit court should be enjoined and;
4. the Plaintiffs are to be awarded $207,211.72 for the legal fees and costs incurred while defending the Malpractice action.
Standard of Review
The Court makes its findings in accordance with Federal Bankruptcy Rule 9033. McCarthy v. Giron , 2014 WL 2696660 at *5, 2014 U.S. Dist. LEXIS 79007 at *11 (E.D. Va. June 6, 2014). The Court makes a de novo review of the "findings of fact or conclusions of law to which specific written objection has been made in accordance with this rule." Fed. Bankruptcy R. 9033(d).
The Court finds that the objections the Defendant has made to the bankruptcy court's particular conclusions of law meet the specificity requirements of Rule 9033(d).
Discussion
Jurisdiction is proper in the instant matter because the case arose in a civil action brought under Title 11 28 USC § 1334 (2021). The bankruptcy court has urged this Court to adopt the recommendation against the Defendant for two reasons: (1) the Defendant did not receive permission from the bankruptcy court before initiating its action in state court in accordance with the Barton doctrine and (2) any claims against the Defendants would be property of the estate and a violation of 11 U.S.C. § 362(a)(3) ("any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate" is a violation of an automatic stay). The Court does not find these arguments to be correct interpretations of the law. For the reasons outline below, the Court finds: (1) the Barton doctrine was not violated, (2) the malpractice claim is not property of the estate, (3) invocation of the Rooker-Feldman doctrine is not necessary, (4) and the doctrines of abstention determine that the Report and Recommendation should not be adopted and the proceedings should continue in state court.
The Barton doctrine does not apply to the actions the Plaintiffs took as the Defendant's attorney.
The bankruptcy court has held that the filing of the malpractice action in Alexandria circuit court was a clear violation of the Barton doctrine. Dkt. 2 at 7. The Barton doctrine is a court created requirement that leave of the court must be obtained before a party can sue a trustee for the trustee's actions in administering an estate. Barton v. Barbour , 104 U.S. 126 at 136-137, 26 L.Ed. 672 (1881). The Barton doctrine applies to attorneys hired by the trustee of an estate. McDaniel v. Blust , 668 F.3d 153, 156 (4th Cir. 2012) (citing Lowenbraun v. Canary (In re Lowenbraun) , 453 F.3d 314, 321 (6th Cir. 2006) ). A legal action against an estate's trustee requires the permission of the appointing court to proceed depending upon "the nature of the function that the trustee or his counsel was performing during commission of the actions for which the liability is sought." Id. at 157. The Fourth Circuit has also stated that permission under the Barton doctrine should be granted unless "it is clear that the claim is without foundation." Id. at 156 n. 1 (quoting Anderson v. United States , 520 F.2d 1027, 1029 (5th Cir. 1975) ).
The bankruptcy court has denied the Defendant permission to pursue a civil action against the Plaintiffs because:
The Malpractice Actions seek to recover damages from Conway and his firm in relation to their representation of the Trustee in connection with the Settled Adversary Proceedings. Conway and his firm's actions were clearly taken in furtherance of the trustee's duties to recover assets for the estate (e.g., through settling adversary proceedings).
Dkt. 2 at 8. In reaching this conclusion, the bankruptcy court has explicitly decided the state law claims raised by the Defendant, Smith Development Inc. The Court cannot agree with the bankruptcy court's assessment that raising a malpractice claim against that party's own attorney is necessarily an "ultra vires argument." Dkt. 2 at 7. This is because binding Supreme Court decisions dictate that a bankruptcy court lacks the inherent power to adjudicate a state law claim. Stern v. Marshall , 564 U.S. 462, 484, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011) (When a traditional common-law suit is brought within federal jurisdiction, "...the responsibility for deciding that suit rests with Article III judges in Article III courts.") (citations omitted); Exec. Bens. Ins. Agency v. Arkison , 573 U.S. 25, 36, 134 S.Ct. 2165, 189 L.Ed.2d 83 (2014) (A bankruptcy court that hears a non-core claim that is otherwise related to a case under Title 11 will submit proposed findings of fact and conclusions of law upon which the district court will review de novo ). A bankruptcy court may still adjudicate a common law claim, but only with consent of the parties. Wellness Int'l Network, Ltd. v. Sharif , 575 U.S. 665, 674, 135 S.Ct. 1932, 191 L.Ed.2d 911 (2015) ("Our precedents make clear that litigants may validly consent to adjudication by bankruptcy courts.")
It is clear in the instant case that the Defendant did not, and has not previously, consented to the authority of the bankruptcy court to adjudicate any state law malpractice claims. Dkt. 2 at 6 ("However, because the Debtor [Defendant Smith Development Inc.] has repeatedly challenged this Court's authority to hear and decide issues related to this matter, the Court will issue a report and recommendation to the District Court to alleviate any Article III concerns the Debtor may have.") On the limited record presented to the Court, it appears that the bankruptcy court has made the finding that a potential malpractice claim would be frivolous based on the prior approval of the Plaintiffs' fees and the approval of appointment as special counsel. Dkt. 2 at 7 (the bankruptcy court found that the challenge to the approval of Plaintiffs as special counsel was functionally like the arguments Defendant seeks to raise in their state court claims). The bankruptcy court's reasoning appears to align with prior Fourth Circuit precedent that held that the approval of fees was a final decision on malpractice claims against bankruptcy trustees. Grausz v. Englander , 321 F.3d 467, 473-474 (4th Cir. 2003) (claim preclusion prevented the assertion of a malpractice claim when the debtor knew of a fee approval and had a proper forum to litigate the malpractice claim). The Defendant raised the arguments concerning fee applications to the Alexandria circuit court as well as arguments that the issues have been decided by the doctrine of res judicata. The state court judge did not find these arguments prevented the circuit court from hearing the case. Dkt. 2 at 128.
This decision was made prior to the Supreme Court's decision in Stern . 564 U.S. 462, 131 S.Ct. 2594.
The Court does not find that there has been a sufficient conclusion of law to rule that the Barton doctrine would categorically deny the Alexandria circuit court jurisdiction to hear the civil action currently before it. At the very least, deciding whether the action would be barred by the Barton doctrine requires the resolution of state law claims that can only be performed by an Article III or state court, which is an opportunity that has not been afforded to the Defendant.
The ownership of a malpractice claim depends on factors not identified or discussed in the Report and Recommendation.
The bankruptcy judge has found that the cause of action, the purported legal malpractice claims, would be property of the estate and that they had not been abandoned by the trustee. Dkt. 2 at 8. This assumption is not supported by an analysis of the alleged malpractice claims or analysis of legal malpractice under Virginia law.
Generally, the property of the estate is defined by 11 USC § 541. The scope of this statute is "broad and includes intangible property such as a cause of action." In re Wilson , 94 B.R. 886, 888 (Bankr. E.D. Va. 1989). § 541 (a)(1) also defines the estate to be "all legal or equitable interests of the debtor in property as of the commencement of the case." Accordingly, courts in this district have held that a cause of action that arises after the conversion to, or petition for, a Chapter 7 bankruptcy will become property of the debtor rather than property of the estate. Labgold v. Regenhardt , 573 B.R. 645, 649 (E.D. Va. 2017) ("In this regard, the Court follows the weight of authority in holding that if a malpractice claim accrued post-petition, it is property of the debtor rather than the estate and therefore not a part of the estate.") (errors corrected). This appears to be in line with the reasoning of other courts regarding causes of action that arise post-petition. See Witko v. Menotte (In re Witko) , 374 F.3d 1040, 1042 (11th Cir. 2004) ("Pre-petition causes of action are part of the bankruptcy estate and post-petition causes of action are not."); Spartan Tube & Steel v. Himmelspach (In re RCS Engineered Prods. Co.) , 102 F.3d 223, 225 (6th Cir. 1996) (Holding that if a particular cause of action is available to the debtor determines if that claim is property of the bankruptcy estate); In re Holstein , 321 B.R. 229, 235 (Bankr. N.D. Ill. 2005) ("A cause of action that accrues only after the case is commenced, on the other hand, is the debtor's to pursue for his own benefit.") (citation omitted).
The Court is aware that the Fourth Circuit has reached a different conclusion in an unpublished opinion, Richman v. Garza (In re Richman) , 1997 WL 360644, at *1, 1997 U.S. App. LEXIS 16159 at *5-6 (4th Cir. 1997) (per curiam) (The Appeals Court held that if a legal malpractice claim had arose post-petition, it would still have been property of the Chapter 11 bankruptcy estate). However, Richman is distinguishable from the present case because it did not involve the property of a Chapter 7 estate and the result was reached after the district court applied Maryland law. The property of a Chapter 7 estate has several different features that distinguish it from other Chapters of the bankruptcy code. As the Supreme Court explained:
Chapter 7 allows a debtor to make a clean break from his financial past, but at a steep price: prompt liquidation of the debtor's assets. When a debtor files a chapter 7 petition, his assets, with specified exemptions, are immediately transferred to a bankruptcy estate. § 541(a)(1) ... Crucially, however, a Chapter 7 estate does not include the wages a debtor earns or the assets he acquires after the bankruptcy filing. § 541(a)(1). Thus, while a Chapter 7 debtor must forfeit virtually all his prepetition property, he is able to make a "fresh start" by shielding from creditors his postpetition earnings and acquisitions.
Harris v. Viegelahn , 575 U.S. 510, 513-514, 135 S.Ct. 1829, 191 L.Ed.2d 783 (2015) (emphasis in original). When a bankruptcy is converted to Chapter 7 in good faith "the converted Chapter 7 estate consists of the property of the [Chapter 13] estate as of the date of conversion ." Id. at 518, 135 S.Ct. 1829 (emphasis and alteration in original) (citing 11 U.S.C. § 348(f)(2) ). Therefore, when the Defendant, Smith Development Co., acquired the right to the cause of action will determine if the legal claim was property that belonged to the Chapter 7 trust or to the Defendant.
Whether or not a particular cause of action will be considered property of the bankruptcy estate will be decided by the applicable state law. Butner v. United States , 440 U.S. 48, 59, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). Therefore, determining when the Defendant's legal malpractice claims accrued, under Virginia law, determines if the claims arose pre-petition or post-petition, and accordingly who those claims would belong to. Labgold , 573 B.R. at 649 ("That question is determined by when that cause of action accrued under Virginia law.") In Virginia, a legal malpractice claim requires three elements: "1) the existence of an attorney-client relationship creating a duty; 2) a breach of that duty by the attorney; and 3) damages that were proximately caused by the attorney's breach of duty." Williams v. Joynes , 278 Va. 57, 62, 677 S.E.2d 261 (Va. 2009) (citations omitted). Under Virginia law, a legal malpractice claim is a breach of contract claim. Shipman v. Kruck , 267 Va. 495, 502, 593 S.E.2d 319 (Va. 2004). Under Virginia statute "the right of action shall be deemed to accrue... when the breach of contract occurs." Va. Code Ann. § 8.01-230 (2021). In the present case, if the alleged breach of contract occurred after the conversion to a Chapter 7 bankruptcy, then the cause of action would belong to the debtor (Defendant Smith Development Inc.).
Currently, the Court makes absolutely no findings or rulings on the merits of the alleged malpractice claims. The record before the Court reflects only a cursory inquiry into the Defendant's claims and the Court declines to adjudicate them based on the bankruptcy court's findings of fact.
The Rooker-Feldman doctrine will not be applied in the current case
The Defendant has argued that this Court should find that the Rooker-Feldman doctrine applies to the bankruptcy court's previous orders in the current adversarial action. Dkt. 2 at 69-70. The Supreme Court has explained that this doctrine is narrow in scope and is limited to "cases brought by state-court losers complaining of injuries caused by state-court judgments rendered before the district court proceedings commenced and inviting district court review and rejection of those judgments." Exxon Mobil Corp. v. Saudi Basic Indus. Corp. , 544 U.S. 280, 284, 125 S.Ct. 1517, 161 L.Ed.2d 454 (2005). The Parties disagree if the current case fits into the narrow scope of cases where the Rooker-Feldman doctrine applies. Clearly, the present case represents the inherent tensions between Federal and State courts with concurrent jurisdiction over a single cause of action. However, the Fourth Circuit has found that in cases where a conflict exists between the exercise of jurisdiction of the State and Federal courts, this conflict can be managed without applying the Rooker-Feldman doctrine. Thana v. Board of License Comm'rs for Charles Cnty. Md. , 827 F.3d 314, 320 (4th Cir. 2016) ("Rather, the Court has recognized that Congress' policy allows for concurrent litigation in federal and state courts, noting that any tensions between the two proceedings should be managed through the doctrines of preclusion, comity, and abstention.") (citing Exxon , 544 U.S. at 292-293, 125 S.Ct. 1517 ). For the reasons discussed below, the Court finds that it is unnecessary to decide if the Rooker-Feldman doctrine is applicable to the current case.
Abstention is appropriate for the Federal Courts in the current case
Congress has conferred original—but not exclusive—jurisdiction upon the Federal courts to decide issues "arising under title 11, or arising in or related to cases under title 11." 28 U.S.C. § 1334(b). This statute goes on to state "nothing in this section prevents a district court in the interest of justice, or in the interest of comity with State courts or respect for State law, from abstaining from hearing a particular proceeding arising under title 11 or arising in or related to a case under title 11." 28 U.S.C. § 1334(c)(1). A district court may choose to abstain under § 1334(c) and lift a stay placed upon a state court action. A.H. Robins Co. v. Piccinin , 788 F.2d 994, 1010 n. 14 (4th Cir. 1986) (citing Taggart, The New Bankruptcy Court System , 59 America Bank. L.J. 231,253 (1985)).
Courts have generally weighed similar factors when deciding if abstention is appropriate under 28 U.S.C. § 1334(c)(1), such as:
(1) the court's duty to resolve matters properly before it; (2) the predominance of state law issues and non-debtor parties; (3) the economical use of judicial resources; (4) the effect of remand on the administration of the bankruptcy estate; (5) the relatedness or remoteness of the action to the bankruptcy case; (6) whether the case involves questions of state law better addressed by the state court; (7) comity considerations; (8) any prejudice to the involuntarily removed parties; (9) forum non conveniens; (10) the possibility of inconsistent results; (11) any expertise of the court where the action originated; and (12) the existence of a right to a jury trial.
Blanton v. IMN Corp. , 260 B.R. 257, 265 (M.D.N.C. 2001) (collecting cases); see also Dutt v. Huggins , 2012 WL 5384943 at *1-2, 2012 U.S. Dist. LEXIS 157654 at *4 (D.S.C. September 14, 2012) ; Nolan v. Kruger , 2005 WL 8162296 at *2-3, 2005 U.S. Dist. LEXIS 60638 at *9 (N.D.W. Va. July 7, 2005).
As discussed above, the current matter before the Court clearly involves a claim based on state law. The state law claim may be proper against the Plaintiffs in their capacity as the attorney for the Defendant and the Plaintiffs would be a non-debtor party. Resolution of the circuit court case would not affect the bankruptcy estate. Although some of the factors could be argued to weigh in favor of non-abstention, the important factors (that are specifically named by Congress in the statute) of comity and respect for the state courts, clearly weigh in favor of abstention in the current case.
A Fourth Circuit decision that is particularly instructive in this case is Trustgard Ins. Co. v. Collins . 942 F.3d 195, 204 (4th Cir. 2019). In this case the Fourth Circuit found that the district court improperly granted declaratory judgment upon a factually insufficient record without considering if discretionary abstention was appropriate. Id. ("... the court reached the merits despite a thin and ambiguous record. In doing so, the court created both a substantial question about whether Article III jurisdiction existed and a serious potential to interfere with ongoing state proceedings.") In the present matter, the Federal Courts have already interfered with ongoing state proceedings without considering the important principles of comity and federalism that govern the integral interrelationships of concurrent state and federal jurisdictions. The factual underpinnings of the record before this Court have not been fully developed. The ongoing proceeding in Alexandria circuit court is an appropriate forum that can fully adjudicate the state law malpractice claim as a court of competent jurisdiction. For these reasons, this Court finds that abstention would be appropriate in the present matter.
Conclusion
The Court finds that the Defendant did not willfully violate the automatic stay. The Defendant had a good-faith belief—based on applicable law—that filing their action in circuit court did not violate the Barton doctrine. For the foregoing reasons, the Report and Recommendation of the bankruptcy court is not adopted. The bankruptcy court is hereby instructed to lift the May 4th Bridge Order on any of the parties in the Alexandria circuit court case. The bankruptcy court is instructed to close the current adversarial proceeding as to all the Parties and their attorneys. The bankruptcy court is further instructed to abstain from hearing this adversarial proceeding under 28 U.S.C. § 1334(c)(1).
It is so ORDERED.