Opinion
No. 01-80946, Adv. No. 02-8212
May 6, 2003
OPINION
The Debtor, Todd A. Wilson ("DEBTOR"), filed a Chapter 7 petition on March 9, 2001. Prior to filing bankruptcy, the DEBTOR had, on the advice of his attorney, transferred his interest in his residence to his wife. Although he was represented in the bankruptcy by a member of the same law firm, the transfer was not disclosed. Based upon that nondisclosure, the DEBTOR'S discharge was denied. Gary T. Rafool, the Chapter 7 Trustee ("TRUSTEE"), brought this complaint against the Defendants, Fellheimer Law Firm, Ltd., P.C., Ronald K. Fellheimer, Robert M. Travers, Mark A. Fellheimer, and Robert P. Follmer (collectively referred to as the "DEFENDANTS"), for legal malpractice, both during the course of representing the DEBTOR in the bankruptcy proceedings and prior to the filing of the bankruptcy petition, seeking damages in an amount sufficient to pay all claims against the estate, in addition to attorney fees and TRUSTEE'S fees.
The DEFENDANTS filed a motion to dismiss and a supplement to motion to dismiss asserting, as alternative grounds for dismissal: (1) pursuant to Federal Rule of Civil Procedure 12(b)(6), failure to state a cause of action, and (2) the doctrine of forum non conveniens. Alternatively, the DEFENDANTS sought to "remand" the proceeding to state court. The DEFENDANTS demanded a trial by jury. The DEFENDANTS filed a memorandum in support of their motion, contending that the TRUSTEE lacked standing to bring the complaint. A hearing on the motion to dismiss was conducted on December 2, 2002. Because the motion to dismiss raised both jurisdictional and substantive concerns, the Court directed the parties to address the jurisdiction issues first, focusing upon the general jurisdictional statute, 28 U.S.C. § 157, and requested that the parties submit briefs on the following three issues (1) whether the TRUSTEE'S claim was a core proceeding, a non-core related proceeding or a non-core, non-related proceeding,(2) whether the claim for legal malpractice was property of the bankruptcy estate, and (3) whether the Court should exercise discretionary abstention under 28 U.S.C. § 1334(c)(1). The Court set a status hearing for February 10, 2003.
The suit was commenced as an original action in this Court. There is no parallel suit pending in state court. Though not identified as such, the relief which the DEFENDANTS seek is abstention.
Pursuant to Section 1334(b), in addition to having original and exclusive jurisdiction over bankruptcy cases, the federal district courts have original, but not exclusive, jurisdiction over three types of matters: (1) proceedings "arising under" title 11; (2) proceedings "arising in" a case under title 11, and (3) proceedings "related to" a case under title 11. 28 U.S.C. § 1334. "Arising under" is interpreted to mean a proceeding which invokes a cause of action created by a specific provision of the Bankruptcy Code. 1 Collier on Bankruptcy, ¶ 3.01[4][c][i]. "Arising in" encompasses administrative matters unique to the management of a bankruptcy case, which are not based on any right created by the Bankruptcy Code, but would not otherwise exist outside of the bankruptcy. Id. at ¶ 3.01[4][c][iv]. In determining the scope of jurisdiction, it is only necessary to determine whether a matter is at least "related to" the bankruptcy. In re U.S. Brass Corp. 301 F.3d 296, 304 (5th Cir. 2002).
Section 157, which establishes the jurisdictional limits of the bankruptcy court, authorizes the district court to refer bankruptcy cases and the three types of matters to the bankruptcy court, dividing all proceedings into two categories: core and non-core. 28 U.S.C. § 157. "Core" matters equate with proceedings both "arising in" and "arising under" the Bankruptcy Code. "Non-core" proceedings are synonymous with proceedings "related to" the bankruptcy case. With respect to non-core claims, unless the parties otherwise agree, the bankruptcy court can only recommend findings of fact and conclusions of law to the district court. 28 U.S.C. § 157(c). Thus, the core/non-core determination is not jurisdictional, but relates only to the power of the bankruptcy court to resolve the issues.
At the status hearing, the Court focused upon the DEFENDANTS' demand for a jury trial. Pursuant to 28 U.S.C. § 157(e), three conditions must be met in order for this Court to be authorized to conduct a jury trial: (1) a party must have a right to a jury trial, (2) the bankruptcy court must be authorized by the district court to conduct jury trials, and (3) all of the parties to the litigation must expressly consent. The TRUSTEE does not contest the DEFENDANTS' right to a jury trial and this Court may conduct the trial. Pointing out that the Court would be unable to conduct a jury trial without the unanimous consent of all of the parties, including each one of the DEFENDANTS, the Court gave the parties an opportunity to file a written consent. The Court, predicting that the DEFENDANTS would not likely consent to a jury trial, expressed its concerns whether it would be proper to rule on the remaining issues, if the case would be heard by another court. The TRUSTEE filed his consent on February 25, 2003. The DEFENDANTS have not consented.
See CDIL-LR 4.2.
1. The TRUSTEE'S claim is a core proceeding over which the Court has "arising in" jurisdiction.
The DEFENDANTS filed their memorandum first and, without analysis, agreed with the TRUSTEE'S characterization of his complaint as a non-core related matter over which this Court has "related to" jurisdiction. Given the DEFENDANTS' concession, the TRUSTEE likewise declined to address the issue. Notwithstanding the parties' apparent agreement, this Court questions the parties' characterization of the TRUSTEE'S action.
Although the often repeated definition of what constitutes a proceeding "arising in" a bankruptcy case refers to administrative matters that would not exist outside of the bankruptcy, some courts have adopted a broader construction that includes claims based on non-bankruptcy law if they would not have arisen "but for" the bankruptcy. In re A.H. Robins Co., Inc., 86 F.3d 364, 372 (4th Cir. 1996). Reasoning that the claim would not have existed but for the bankruptcy case, a number of courts hold that a claim of legal malpractice which originated out of pre- and post-petition advice of counsel concerning the bankruptcy itself, is a matter that falls within "arising in" jurisdiction. Grausz v. Englander, 321 F.3d 467 (4th Cir. 2003); Matter of Murphy, 213 B.R. 813 (Bankr.S.D.Miss. 1997); In re Simmons, 205 B.R. 834 (Bankr.W.D.Tex. 1997); In re Diversified Contract Services, Inc., 167 B.R. 591 (Bankr.N.D.Cal. 1994). 28 U.S.C. § 157(b)(1) equates "core proceeding" with proceedings "arising under title 11" and proceedings "arising in a case under title 11." A proceeding "arising in" a bankruptcy case is a core proceeding. Matter of Wood, 825 F.2d 90 (5th Cir. 1987). The fact that resolution of a matter may be affected by state law does not, by itself, render the proceeding non-core. 28 U.S.C. § 157(b)(3).
The Seventh Circuit has not addressed this issue. Because the TRUSTEE'S claim directly affects the amount of property for distribution to creditors, it is at least within this Court's "related to" jurisdiction under existing Seventh Circuit precedent. See, Matter of FedPak Systems, Inc., 80 F.3d 207 (7th Cir. 1996).
The cause of action for legal malpractice asserted by the TRUSTEE is based on the pre- and post-bankruptcy advice that the DEFENDANTS gave the DEBTOR. As such, it falls squarely within the purview of those cases that hold that such matters are within the court's "arising in" jurisdiction. This Court agrees with the rationale of those cases. Accordingly, the TRUSTEE'S claim is one over which this Court has "arising in" jurisdiction and which is, therefore, a core proceeding in which the bankruptcy court has authority to enter final judgment.
2. The TRUSTEE'S claim is property of the bankruptcy estate not claimed as exempt.
As requested by the Court, both parties addressed the issue of whether the legal malpractice claim was property of the estate. The DEFENDANTS' argument that the DEBTOR'S legal malpractice claim, non-assignable under Illinois law, is exempt and therefore does not "belong" to the bankruptcy estate is misconceived. The DEFENDANTS rely upon the observations by the Illinois Appellate Court for the Second District in Hoth v. Stogsdill, 210 Ill. App.3d 659, 569 N.E.2d 34, 155 Ill. Dec. 34 (2 Dist. 1991). Recognizing that a legal malpractice claim would be included as property of the bankruptcy estate under Section 541(a)(1) of the Bankruptcy Code, which provides that the filing of a bankruptcy petition creates an estate comprised of all legal and equitable interests of the debtor in property, the court addressed the exemptibility of a claim for legal malpractice under Illinois law.
A legal malpractice action, however, is not included in the list of personal property exemptions permitted by Illinois statute. (Citation omitted).
It is not entirely clear whether the exemptions referred to in section 522 are only statutory in nature. If common law exemptions apply, then [the debtor's] legal malpractice claim would constitute exempt property, as, in Illinois, a common law action for legal malpractice is personal to the client and not assignable. (Clement v. Prestwich (1983), 114 Ill. App.3d 479, 480, 70 Ill. Dec. 161, 448 N.E.2d 1039.) Such an action arises from the personal relationship which exists between attorney and client and is a claim that the client's attorney has breached his personal duty and trust to that client by failing to exercise the requisite degree of care and skill or by failing to give the utmost loyalty and fidelity to the client's interest (Christison v. Jones, 83 Ill. App.3d at 338, 39 Ill. Dec. 560, 405 N.E.2d 8), and that the client has been injured as a result of the breach. (Clement, 114 Ill. App.3d at 480, 70 Ill. Dec. 161, 448 N.E.2d 1039.) "[S]ound public policy prohibits the assignment of [legal malpractice] claims since an assignee would be a stranger to the attorney-client relationship, who was owed no duty by the attorney and who suffered no injury from the attorney's actions." ( 114 Ill. App.3d at 480-81, 70 Ill. Dec. 161, 448 N.E.2d 1039.) Based on this finding and if common law exemptions are permitted to exclude certain property from the bankruptcy estate, a bankruptcy trustee could not possess an action for legal malpractice even though it was an asset of the bankruptcy estate. (Footnote added).
Hoth's conclusion that an action for legal malpractice is property of the bankruptcy estate is in line with the majority of cases deciding the issue, that claims for legal malpractice are property of the bankruptcy estate. In re Alvarez, 224 F.3d 1273 (11th Cir. 2000); In re Tomaiolo, 2002 WL 226133 (D.Mass. 2002); In re Haynes, 1999 WL 33592904 (Bankr.C.D.Ill. 1999); In re Hice, 223 B.R. 155 (Bankr.N.D.Ill. 1998).
The conundrum posed by the court in Hoth need not be resolved in this case, at least at this juncture. A significant change made by the Bankruptcy Reform Act of 1978 was to bring all property of the debtor, including exempt property, into the bankruptcy estate, then permitting the debtor to exempt certain property. See, Matter of Yonikus, 996 F.2d 866 (7th Cir. 1993). It is well-settled that a claim of exemption is personal to the debtor and can only be asserted by him. In re Yates, 287 F.3d 521 (6th Cir. 2002). There can be no exemption unless the property is properly scheduled as exempt pursuant to Bankruptcy Rule 4003(a). U.S. v. Shadduck, 112 F.3d 523 (1st Cir. 1997). The DEBTOR has not asserted an exemption in the claim for legal malpractice against the DEFENDANTS. The DEBTOR received notice of the TRUSTEE'S application to employ an attorney to pursue the malpractice claim against the DEFENDANTS. Though the DEBTOR'S attorney, one of the DEFENDANTS, was permitted to withdraw, the DEBTOR is not unaware of the TRUSTEE'S claim. Because he stands to benefit from this proceeding, he may well be content to let the TRUSTEE take the lead, or he may simply believe that there is no exemption available under Illinois law.
The state law personal property exemptions available to Illinois residents are primarily set forth in Section 12-1001 of the Illinois Code of Civil Procedure. It is generally recognized that debtors are not limited to that specific provision but that Illinois has other similar remedial provisions which constitute specific exemptions under different legislative enactments. In re McClure, 175 B.R. 21 (Bankr.N.D.Ill. 1994). The essence of an exemption is a "present right . . . which withdraws the property from levy and sale under judicial process." White v. Stump, 266 U.S. 310, 313, 45 S.Ct. 103, 104, 69 L.Ed. 301 (1924). In this Court's view, however, it takes more than a prohibition against assignment to constitute such an exemption, given Section 541(c)(1) of the Bankruptcy Code, which provides for inclusion of a debtor's interest in property of the estate "notwithstanding any provision in an agreement, transfer instrument, or applicable non-bankruptcy law — (A) that restricts or conditions transfer of such interest by the debtor. This Court is not aware of any Illinois statutory provision that permits a debtor asserting a claim for damages based upon legal malpractice to exclude the claim, and its proceeds, from the reach of his creditors.
The DEFENDANTS have stopped short in their analysis of this issue. The DEFENDANTS are not acting as the DEBTOR'S keeper, but in their own interest. Moreover, the DEFENDANTS presume that jurisdiction is not proper if the DEBTOR could, and presumably would, claim the action as exempt. Whether the DEFENDANTS' position is correct, is not an issue this Court need decide because the cause of action is property of the estate and remains such in the absence of an allowable exemption. This Court notes, however, that the court in Grausz suggests the opposite is true. Dismissing the debtor's contention that federal bankruptcy jurisdiction was lacking because his malpractice claim was personal to him and not property of the estate, the court stated that "the claim arises in the bankruptcy case, regardless of whether it belongs to him or the estate." 321 F.3d at 472.
3. Discretionary abstention is not appropriate.
Although the classification of the DEBTOR'S claim for legal malpractice against the DEFENDANTS as core or non-core is not determinative for purposes of this Court's jurisdiction over this proceeding, the nature of the claim becomes an important factor in determining whether this Court should exercise its discretion and abstain from hearing this proceeding under 28 U.S.C. § 1334(c)(1).
Bankruptcy courts have the authority to decide and enter final orders regarding abstention issues. In re Pacific Gas Elec. Co., 279 B.R. 561 (Bankr.N.D.Cal 2002). In In re Dreis Krump Mfg. Co., 1995 WL 41416 (N.D.Ill. 1995), the district court concluded that the bankruptcy judge should rule on a motion for abstention, then pending in the bankruptcy court, relating to a personal injury action against the estate, despite the district court's stated intention to withdraw the reference at the time the case was ready to be tried.
The DEFENDANTS contend that this Court should abstain because the TRUSTEE'S claim is based solely on state law, abstention would have no appreciable effect on the administration of the case, and there is no independent basis for federal jurisdiction. The TRUSTEE identifies as the most important factor that the alleged malpractice occurred in proceedings before this Court. In addition, the TRUSTEE notes that no unsettled issues of state law are involved and that no action is currently pending in state court. A number of courts have declined to abstain from a legal malpractice action involving services rendered to a debtor in a bankruptcy case. In re SPI Communications Marketing, Inc., 112 B.R. 507 (Bankr.N.D.N.Y. 1990); In re Diversified Contract Services, Inc., 167 B.R. 591 (Bankr.N.D.Cal. 1994).
The Seventh Circuit has adopted the following factors identified by the Ninth Circuit as relevant in determining whether to abstain as a discretionary matter:
(1) the effect or lack thereof on the efficient administration of the estate if a Court recommends abstention, (2) the extent to which state law issues predominate over bankruptcy issues, (3) the difficulty or unsettled nature of the applicable law, (4) the presence of a related proceeding commenced in state court or other nonbankruptcy court, (5) the jurisdictional basis, if any, other than 28 U.S.C. § 1334, (6) the degree of relatedness or remoteness of the proceeding to the main bankruptcy case, (7) the substance rather than form of an asserted "core" proceeding, (8) the feasibility of severing state law claims from core bankruptcy matters to allow judgments to be entered in state court with enforcement left to the bankruptcy court, (9) the burden of [the bankruptcy court's] docket, (10) the likelihood that the commencement of the proceeding in bankruptcy court involves forum shopping by one of the parties, (11) the existence of a right to a jury trial, and (12) the presence in the proceeding of nondebtor parties.
Matter of Chicago, Milwaukee, St. Paul Pacific R. Co., 6 F.3d 1184 (7th Cir. 1993), quoting In re Eastport Associates, 935 F.2d 1071, 1075-76 (9th Cir. 1991). No single factor is determinative, and the factors should be applied flexibly, the importance and relevance of each factor depending upon the particular circumstances of each case. Federal courts should generally exercise their jurisdiction, if properly conferred, and abstention is the exception rather than the rule. 6 F.3d at 1189.
The first factor, the impact on efficient administration of the bankruptcy estate, is neutral. The lawsuit is the only asset of the estate, which must remain open until the asset is liquidated, whether in federal court or state court, unless the suit is abandoned by the trustee. Neither side argues that there would be any significant difference in the time it takes to get the case to trial in the federal system versus the state system.
The second factor, the extent to which state law issues predominate over bankruptcy issues, favors retention. Even though the legal malpractice cause of action is a creature of state law, the factual basis of the claim is inextricably intertwined with the substantive and procedural law of bankruptcy.
The third consideration, the difficulty or unsettled nature of the applicable law, supports retention in that the legal malpractice claim does not involve any particularly difficult or unsettled issues of state law. The mere presence of a state law issue is not enough to warrant permissive abstention by a bankruptcy court. Matter of LS Industries, Inc., 989 F.2d 929, 935 (7th Cir. 1993).
As there is no related proceeding commenced in state court, the fourth factor favors retention. The fifth factor, whether any basis exists for federal jurisdiction other than the bankruptcy filing, supports abstention. No federal jurisdiction basis other than Section 1334 has been shown.
The sixth factor, the degree of relatedness of the lawsuit to the bankruptcy case, favors retention. The legal malpractice claim, "arising in" the bankruptcy, is highly related thereto.
The seventh inquiry, whether the substance of the lawsuit is genuinely a "core" proceeding, militates in favor of retention. Completion of the administration of this case depends entirely upon liquidating the legal malpractice claim, which arose in the bankruptcy proceeding.
The eighth factor, the feasibility of severing the claim from the bankruptcy, favors abstention. The legal malpractice cause of action is a stand-alone lawsuit that may be tried in state court as readily as in federal court.
The ninth factor favors retention. Addition of a single lawsuit will not materially affect the court's docket. The tenth factor, the likelihood that the parties are engaging in forum shopping, is neutral. Although the DEFENDANTS raise the spectre of illegitimate forum shopping by the TRUSTEE, the TRUSTEE clearly has the right to commence a core proceeding in bankruptcy court. No improper forum shopping occurred.
The eleventh factor, the existence of a right to jury trial, favors abstention. While the district court can conduct the jury trial, the DEFENDANTS' lack of consent to the conduct of the jury trial by the bankruptcy court raises the possibility that the case will progress through the pre-trial stage in bankruptcy court only to be transferred to the district court for trial. This dual tribunal problem would not exist if the lawsuit proceeds in state court. The twelfth factor, the presence of non-debtor parties, favors retention. There are no third-party defendants.
Alternatively, the DEFENDANTS could change their minds and decide to permit the jury trial to proceed in bankruptcy court. Or, the district court could withdraw the reference at this early stage to allow the entire proceeding to be conducted in its court.
Of the twelve factors, seven favor retention, three support abstention, and two are neutral. This Court places particular emphasis upon factors six and seven. As the malpractice claim is a core proceeding that arose out of and is highly related to the bankruptcy case, and the liquidation of which is necessary to the administration of the estate, it makes good sense to retain the matter in the bankruptcy court. Based upon the foregoing analysis, the Court declines to abstain from hearing this adversary proceeding.
4. Withdrawal of the reference must be raised in the District Court.
Although withdrawal of the reference is mandatory at some point prior to trial unless the DEFENDANTS consent to jury trial in bankruptcy court, the District Court may elect to postpone the withdrawal until the case is ready for trial, allowing this Court to handle all preliminary matters and pre-trial proceedings. See, In re Lars, Inc., 290 B.R. 467 (D.Puerto Rico 2003); In re Envisionet Computer Services, Inc., 276 B.R. 1 (D.Me. 2002). Alternatively, the District Court may withdraw the reference and reassign the pretrial matters to a magistrate judge. The DEFENDANTS, posturing for a favorable result, suggest that this Court first determine the abstention issue, and if the Court declines to abstain, they contend that the adversary complaint should be heard by the District Court, and request that this Court intercede on their behalf to have the reference withdrawn. Pursuant to Rule 5011(a) of the Rules of Bankruptcy Procedure, however, a motion for withdrawal must be heard by the District Court. The DEFENDANTS' conditional request for withdrawal of the reference in their brief is procedurally improper and should be disregarded.
Having ruled in the TRUSTEE'S favor on the procedural issues raised by the DEFENDANTS' motion to dismiss, it will be necessary for the Court to address the substantive issues which remain. Accordingly, the Court will direct the Clerk to set the motion to dismiss for further hearing. Should the DEFENDANTS file a motion to withdraw the reference, this proceeding may be stayed pending disposition of that motion. Fed.R.Bankr.Pro. 5011(c).
This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate Order will be entered.
ORDER
For the reasons stated in an Opinion entered this day, IT IS HEREBY ORDERED that:
1. This Court declines to abstain from hearing this proceeding under 28 U.S.C. § 1334(C)(1).
2. The Clerk of the Court is directed to set the motion to dismiss filed by the DEFENDANTS for further hearing.