The following is a case update written by the Hon. Meredith Jury (ret.), analyzing a recent decision of interest:
Over an adamant and analytical dissent, the United States Court of Appeals for the Ninth Circuit in an unpublished decision affirmed both the bankruptcy court and the Bankruptcy Appellate Panel (BAP) in ruling that a claim for legal malpractice was property of the debtor rather than property of the bankruptcy estate. The malpractice claim arose when debtors’ attorney caused them to file their chapter 7 petition six days too early to discharge a quarter million dollars of taxes owed to the Internal Revenue Service. The dissent asserted that the malpractice claim accrued instantaneously upon the filing of the petition because inevitable damage occurred then, making the claim estate property, whereas the majority ruled that the damages accrued post petition and therefore the claim belonged to the debtor. Krohn v Glaser (In re Glaser), 2020 WL 3536532 (9th Cir. 2020). To view the memorandum, click here:
Debtors Jan Glaser and Tatyana Khomyakova filed a chapter 7 case in 2016, seeking among other things to discharge substantial IRS tax debt for the 2011 and 2012 tax years. As it turned out, because they had received a six month extension from the IRS in connection with the 2012 tax debt, the petition was filed six days too early to discharge that debt. Faced with that result, the debtors sued their bankruptcy attorney in Nevada state court for legal malpractice, alleging that if she had made the proper investigation and inquiries about the tax debt, she would not have filed the case prematurely and they would have been able to discharge the debt.
When the chapter 7 trustee Shelley Krohn learned of the state court action, she advised the debtors’ state court counsel that the claim was property of the bankruptcy estate because it was sufficiently rooted in the debtors’ pre-bankruptcy past on account of their counsel’s representation of them and her preparation of the bankruptcy case initiation documents before the case was filed. After the state court counsel opposed, asserting the claim arose post petition, the Trustee filed a motion in the bankruptcy court for determination that the claim was an estate asset and also removed the malpractice case to federal court. Debtors filed a motion to remand and the bankruptcy court consolidated the motions for hearing.
The bankruptcy court ruled that the malpractice claim was not property of the estate because actual damages were an essential part of such claim under Nevada law and the damages here did not occur until the case was not dismissed before discharge. The BAP affirmed in an unpublished decision, agreeing that the debtors only suffered damages post petition and there was no claim without actual damages. The trustee appealed to the Ninth Circuit, which also affirmed.
Like most unpublished dispositions from the Ninth Circuit, the court’s reasoning is succinct. It noted that under Nevada law, a claim for legal malpractice does not accrue until “damage has been sustained”, citing the Nevada Supreme Court sitting en banc. It then followed the reasoning of the bankruptcy court and the Ninth Circuit Bankruptcy Appellate Panel that the damage here did not happen until counsel failed to dismiss the case prior to discharge and the IRS then demanded payment. The court swept aside the concept from Segal v Rochelle, 382 U.S. 375 (1966) – that if an interest is sufficiently rooted in the prebankruptcy past, it is property of the estate – by stating there was no interest in a cause of action for legal malpractice until damages were incurred. Since, in their view, that occurred postpetition, the claim belonged to the debtors.
The dissent concurred that actual damages were necessary to the accrual of the malpractice claim, but disagreed about when inevitable damages occurred here. It asserted that the too-early filing of the petition immediately placed debtors in a prejudicial position that counts as damage under Nevada law. Unless some action to undo the early filing occurred, the IRS debt was not going to be discharged. Therefore, it reasoned that once the petition was filed, the debtors were placed in a prejudicial position that would require attorney intervention. That outcome was damage and therefore the claim for legal malpractice existed “as of the commencement” of the case and it belonged to the estate. (Citing Johnson v Alvarez (In re Alvarez), 224 F. 3d 1273, 1278 (11th Cir. 2000)).
States follow one of three general rules in determining when a claim for legal malpractice accrues: (1) the “occurrence rule” which holds that such an action accrues “simultaneously with the performance of the negligent act.” Sec. Bank & Tr. Co v. Larkin, Hoffman, Daly & Lindgren, Ltd., 916 N.W.2d 491. 496 (Minn. 2018); (2) the “discovery rule”, under which the cause of action accrues when the client knows or should know the facts giving rise to the claim, Antone v. Mirviss, 720 N.W. 2d 331, 335 (Minn. 2006); and (3) the middle ground “some damage rule” which is the rule followed in Nevada, California, and many other states. In other words, generally speaking, in a state with the “some damages” rule, there is a claim for legal malpractice when (a) there is an attorney client relationship with a duty of care; (b) the attorney commits negligent acts or otherwise breaches that duty; (c) there is a proximate causal connection between the negligent conduct and the resulting injury; and (d) there is “some” actual loss or damages as a result.
I see a split in bankruptcy cases and inconsistent decisions when the “some damages” malpractice claim arises as a result of the filing of a bankruptcy petition. Here, the petition was filed too early to discharge tax debt. Other similar examples are where the initially-filed documents are so misleading they result in denial of discharge; the filing is premature to allow a debtor to take advantage of a lucrative homestead exemption when the debtor has either moved or exchanged properties in a timeframe that affects the available exemption; an asset was omitted from the schedules which resulted in the debtor losing the right to exempt it; or legal title to assets on the petition date did not properly reflect the true equitable interest in those assets among spouses or family members, resulting in either costly litigation about who owns what or outright loss of an asset to the trustee that actually belonged to a parent or some other family member or close friend. In any of these circumstances, the actions of bankruptcy counsel might be negligent and the proximate cause of some injury to the debtors. The question then becomes, who holds that claim: the estate or the debtor. The simple rule, of course, is if it existed prepetition or was sufficiently rooted in the prebankruptcy past, then it belongs to the estate, but if it arose postpetition, it belongs to the debtors.
As this case illustrates, in application it is not so simple. I have found cases all over the map dealing with a legal malpractice claim which exists because the petition was filed on a certain date. In Glaser, with disagreement about what is “some damage”, three courts are saying the claim belongs to the debtors but the dissent, with more analysis than the Circuit majority, says it belongs to the estate. Ruling similarly are Avery v. Mikkelsen (In re Mikkelsen), 2018 WL 4182448 (Bankr. D. ID. 2018) (the homestead declaration prepared by the bankruptcy attorney and filed prior to the petition date which was found ineffective resulted in a claim held by the debtors because only after the trustee challenged its effectiveness did the “some damage” occur; Church Joint Venture, L.P v. Blasingame (In re Blasingame), 597 B.R. 614 (6th Cir. BAP 2019) (discharge was denied based on the original schedules and other misinformation, resulting in a claim held by the debtor because the denial was postpetition; and 22845 Sparrowdell, LLC dba PBOG v. Lipel (In re Lipel), 2020 WL 3270736 (Bankr. C.D. Cal. 2020) (another early filing which failed to discharge IRS debt and where the court awarded the claim to the debtors).
However, some cases side with the asset belonging to the estate: Bruess v Dietz (In re Bruess), 2020 WL 3642324 (D. Minn. 2020) (petition was filed prematurely to accord debtor the full value of a Minnesota homestead exemption where there was a section 522(p) issue because debtor had acquired her interest within 1215 days of the filing date; district court on appeal affirmed bankruptcy court’s finding the estate owned the claim); Helbling v Josselson (In re Almasri), 378 B.R. 550 (Bankr. N.D. OH 2007) (malpractice claim was deemed property of the estate when debtor told his bankruptcy counsel of a bank account and business, but attorney left them out of the schedules, resulting in denial of debtor’s discharge, because claim was rooted in the prebankruptcy past); and Winick & Rich, P.C. v. Strada Design Assocs. (In re Strada Design Assocs.), 326 B.R. 229 (Bankr. S.D. NY 2005) (malpractice claim was property of the estate when debtor’s counsel failed to advise it that it could file a chapter 11, not only a chapter 7).
In sum, these decisions about who holds a legal malpractice claim against debtors’ bankruptcy counsel are inconsistent with each other, particularly when the error committed was in the filed petition. Some courts found no damage until the action resulting in the negative event is commenced and, therefore, a postpetition claim belonging to the debtor, whereas others found the damage is inevitable upon filing, therefore a prepetition claim belonging to the estate. The result in any given case could turn on how counsel “spins” the issue for the reviewing court and the court’s response to that “spin,” as shown by the dissent in Glaser.
These materials were authored by the Hon. Meredith Jury (ret.). Editorial contributions were made M. Douglas Flahaut, Partner at Arent Fox LLP.