Dear constituency list members of the Insolvency Law Committee, the following is a case update written by Retired Judge Meredith Jury, analyzing a recent decision of interest:
In Akhlaghpour v Orantes, 86 Cal. App. 5th 232 (2022), the California Court of Appeal reversed a trial court decision which granted a demurrer without leave to amend and dismissed a lawsuit filed by a former chapter 11 debtor against her chapter 11 attorney for malpractice. The debtor/plaintiff had sued her counsel without leave from the bankruptcy court, causing the trial court to conclude it lacked jurisdiction under the Barton doctrine. The Court of Appeal held that only those claims arising from the time period when former counsel was acting as attorney for the debtor in possession were subject to Barton and the complaint covered acts both before and after that time.
The Court of Appeal concluded that plaintiff was entitled to leave to amend, both to seek bankruptcy court approval for the Barton-related claims and to assert the claims not subject to Barton. Of further interest in the decision is the claim preclusive effect of the bankruptcy court’s approval of counsel’s chapter 11 fees and whether the claims were property of the debtor or the bankruptcy estate.
To view the opinion, click here.
Plaintiff/debtor Mehri Akhlaghpour (Akhlaghpour) is a tax preparer with two financial services corporations. In 2017, she faced significant claims filed against her by her former clients, totaling several million dollars. She owned five rental properties and other assets. Seeking to resolve her debt issues, she employed Giovanni Orantes (Orantes) as bankruptcy counsel and he filed a chapter 11 petition for her on October 11, 2017. In early January 2018, the bankruptcy court approved Orantes’ employment as attorney for Akhlaghpour as debtor in possession, effective on the filing date.
Unbeknownst to Orantes (per him), on the day before the chapter 11 was filed, Akhlaghpour had encumbered her rental properties with deeds of trust exceeding one million dollars in value to a lender known as Emymac. These late-recorded encumbrances caused the United States Trustee (UST) to file a motion for appointment of a chapter 11 trustee, which was granted on January 25, 2018, with appointment effective on February 2, 2018. The bankruptcy court denied Akhlaghpour’s subsequent attempt to dismiss the chapter 11. In April and May 2018, the chapter 11 trustee sold the rental properties. By September 2018 Akhlaghpour had procured court-approved settlements with all her creditors. She and the trustee filed a joint motion to dismiss the case, which the bankruptcy court granted on December 4, 2018. Three days later the bankruptcy court approved Orantes’s unopposed fee application for services from October 11, 2017 to February 6, 2018.
On December 27, 2019, Akhlaghpour sued Orantes for legal malpractice, breach of contract, breach of fiduciary duty and related state court claims in state court. The alleged facts concerned Orantes’s conduct both before and after the chapter 11 trustee was appointed. Orantes demurred on the ground that Akhlaghpour had failed to comply with the Barton doctrine which, per Orantes, requires leave of the bankruptcy court before a party may initiate a state court lawsuit against a professional whose employment was approved by the bankruptcy court. The state court granted the demurrer without leave to amend, concluding that it lacked jurisdiction over the claims because Akhlaghpour failed to comply with Barton. Akhlaghpour appealed to the California Court of Appeal, which reversed and remanded.
The Court first addressed the applicability of the Barton doctrine in general to state court litigation. The genesis of the doctrine is a Supreme Court decision, Barton v Barbour, 104 U.S. 126 (1881), which held that before filing a lawsuit against a receiver for a railroad appointed by a Virginia court, the plaintiff must seek leave of the appointing court to file the suit. Barton’s progeny has extended that filing restriction to trustees in bankruptcy cases (see, for example, Beck v Fort James Corporation (In re Crown Vantage), 421 F. 3d 963, 970 (9th Cir. 2005) (collecting cases)) and later to counsel appointed by bankruptcy courts to represent debtors in possession and creditors’ committees. The Court recognized the requirement that “all legal proceedings that affect the administration of the bankruptcy estate be brought either in bankruptcy court or with leave of the bankruptcy court.” In re Harris, 590 F. 3d 730, 742 (9th Cir. 2009). The Court concluded that the prefiling requirements of Barton applied but limited the timeframe.
The Court found that the February 2, 2018 appointment of the chapter 11 trustee curtailed the scope of Orantes’s employment as attorney for Akhlaghpour as debtor in possession Therefore his “official capacity” acts began with some pre-petition and pre-approval conduct which “crossed the divide of the Petition Date,” but concluded no later than February 2, 2018. From that date forward, his representation of Akhlaghpour was as “debtor out of possession,” for which a malpractice suit would not be subject to the Barton doctrine. Because the operative state court complaint alleged wrongful conduct by Orantes which occurred both before and after his “official capacity” acts, the Court reasoned that even without permission, some aspects of the malpractice case could proceed, making dismissal for lack of jurisdiction without leave to amend error. In addition, nothing prevented Akhlaghpour from reopening the bankruptcy case to seek approval to sue for the official capacity behavior.
Next, the Court addressed the potential claim preclusive (res judicata) effect of the bankruptcy court order which approved Orantes’s unopposed fee application. Applying the federal preclusion standard, a series of federal cases have ruled that claim preclusion bars a chapter 11 debtor’s malpractice claim against its bankruptcy counsel when the bankruptcy court approves a final fee application. After all, the court’s fee award implies a finding that the services were beneficial to the estate, necessary for case administration, and performed properly—all contrary to assertions of malpractice. That Akhlaghpour alleged she was unaware of the malpractice at the time of the fee application was of no consequence because claim preclusion bars any claim which could have been raised at the time the matter was litigated.
That did not end the inquiry regarding the effect of the fee order, however. Since some of the alleged wrongful acts fell outside the timeframe of the fee application, the preclusive effect did not apply to those allegations. Therefore, leave to amend to clarify the applicable timeframe of the asserted malpractice was the appropriate remedy.
Finally, addressing Orantes’s argument that Akhlaghpour lacked standing to pursue the malpractice claims because they belonged to the bankruptcy estate, the Court considered whether the asserted claims were held by the estate or the debtor. It found that the answer to that question is not well-defined under Ninth Circuit standards and other federal cases. The general rule is that “[p]re-petition causes of action are part of the bankruptcy estate and post-petition causes of action are not.” In re Witko, 374 F. 3d 1040, 1042 (11th Cir. 2004). However, the Court recognized that the line between pre- and post-petition claims is wavy, with some cases concluding that even if claims arose post-petition, if they were “sufficiently rooted” in the debtor’s pre-bankruptcy past, they can be considered estate property. The Court noted a recent unpublished disposition by the Ninth Circuit, In re Glaser, 816 Fed. Appx. 103 (9th Cir. 2020) (including a lengthy and analytical dissent), which addressed the “sufficiently rooted” standard but added little clarity on the issue. However, the Court concluded that without an operative amended complaint to consider, it could not decide as a matter of law who owned the claims asserted by Akhlaghpour. This determination supported its earlier ruling that leave to amend was the appropriate remedy, compelling reversal.
This review is longer than I usually write, but this well-written and delightfully readable Court of Appeal decision is packed with issues which affect the insolvency community. Its analysis and conclusions are all consistent with my view of the applicability of the Barton doctrine, the claim preclusive effect of a bankruptcy court order approving fees for court-approved counsel, and the remaining unresolved issues surrounding which malpractice claims belong to the estate versus the debtor under California and federal law. The takeaways are clear: (1) do not sue any professional whose employment is approved by a bankruptcy court in any other court (including a district court) without the bankruptcy court’s permission if the alleged wrongful acts fell within the scope of the court-approved employment; (2) if a debtor believes its attorney has not performed up to the standard of care in a bankruptcy proceeding, object timely to any fee applications, particularly the final; and (3) which bankruptcy-related claims belong to the debtor versus the estate is a fact-driven decision likely to generate controversy without further clarification from the Ninth Circuit.
This case update was written by Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the Insolvency Law Committee with editorial contributions by Maggie E. Schroedter of Robberson Schroedter LLP.
Thank you for your continued support of the Committee.