Failure to Raise a Stern Objection Violates a Lawyer’s Standard of Care

In Wellness International, the Supreme Court held that an objection to the power of the bankruptcy court to enter a final order can be waived. Wellness International Network Ltd. v. Sharif, 135 S. Ct. 1932 (2015).

Have you wondered whether the lawyer in Wellness International committed legal malpractice by failing to raise the Stern objection before it was deemed waived?

Here’s the answer: Failing to raise the Stern objection violated the standard of care imposed on the lawyer and was therefore malpractice, technically speaking. However, the lawyer escaped liability because District Judge Thomas M. Durkin of Chicago found no proximate cause between the failure to raise the Stern objection and the client’s damages. Why? Because courts would have ruled the same way even if the lawyer had preserved the Stern defense.

The takeaway: For insulation from malpractice, a lawyer must document the client’s fully informed, knowing waiver.

Stern and Wellness International

Stern was the supposedly narrow opinion where the Supreme Court held that the bankruptcy court lacked constitutional authority to issue a final judgment on a state law counterclaim asserted against a creditor. Stern v. Marshall, 131 S. Ct. 2594 (2011).

Until Wellness International came along, the courts were split on whether a party could waive a Stern objection by failing to raise the objection to the bankruptcy court’s power. Of course, Wellness International held that the objection can be waived.

The Path to the Supreme Court

The client had sued Wellness International in federal district court. The client’s misconduct in discovery prompted the district court to enter summary judgment in favor of Wellness International and against the client for some $650,000. The judgment caused the client to file bankruptcy, where he was represented by a lawyer who ended up handling an aspect of the bankruptcy case that went up all the way to the Supreme Court.

Again because of discovery abuses attributable to the client’s conduct, the bankruptcy court entered judgment against the bankrupt client, ruling that a trust was actually the debtor’s property. The lawyer appealed to the district court but did not raise a Stern objection until a supplemental brief after the appeal otherwise had been fully briefed.

Affirming the bankruptcy court, the district court found that the Stern objection had been waived.

On appeal to the Seventh Circuit, the lawyer did not raise the Stern objection until a reply brief. The Seventh Circuit nonetheless ruled that a Stern objection could not be waived. However, the Supreme Court reversed in Wellness International by holding that Stern issues could be waived.

On remand from the Supreme Court, the Seventh Circuit held that Stern objections were waived because they had not been raised until the reply brief.

Back in district court, the lawyer sued the client for fees. The client counterclaimed, contending the lawyer committed malpractice by not raising Stern objections earlier in the district and circuit court appeals.

Judge Durkin had already decided that the client was liable for $150,000 in attorneys’ fees. In his September 30 opinion, he ruled on the client’s malpractice counterclaims.

To prevail on the malpractice counterclaims, Judge Durkin explained that the client had the burden of showing, by a preponderance of the evidence, that the lawyer violated the “applicable standard of care” and that the violation “proximately caused” the client’s injury. In other words, he said, the client must “hypothetically show” that judgment would not have been entered against him had the lawyer complied with the standard of care.

On the standard of care, Judge Durkin concluded that the lawyer “was certainly aware of Stern’s potential impact by the time he sought leave to file a supplemental brief” in the district court appeal from the $650,000 judgment. He went on to say that the lawyer “compounded his mistake in district court briefing by repeating it on appeal” to the Seventh Circuit.

Judge Durkin therefore held that the lawyer “violated the standard of care.” But that was not the end of the story. The client still had to show proximate cause.

That’s where the client came up short on his malpractice counterclaim. Judge Durkin framed the question as “whether the appellate court would have decided the appeal differently had the [Stern] issue been properly raised.”

Even if Stern had been raised, Judge Durkin concluded that “no reasonable court” would have ruled in favor of the client in view of his numerous discovery abuses.

As a result, Judge Durkin ruled against the client on his malpractice counterclaim and entered judgment in favor of the lawyer on his claim for legal fees.

What Does the Opinion Mean?

Judge Durkin saw the failure to raise a timely Stern objection as a violation of the standard of care. A lawyer should therefore explain the issue to a client and document the client’s agreement to waive the objection.

So, assume a lawyer waives the objection without the client’s consent and the bankruptcy court enters a final judgment against the client. What then? Is it malpractice automatically?

No. It’s not automatically malpractice. But why not?

If there was a valid Stern objection, the waiver only matters in terms of the standard on appeal. If there had been a Stern objection, the bankruptcy judge’s findings of fact would have been subject to the lower standard of de novo review, not the higher clear-error test.

There will no liability for a Stern waiver unless it was a close case where the reviewing court would have disagreed with the bankruptcy court’s fact-findings.

What does the case tell us? Always have the client make a fully informed, knowing waiver of Stern objections. Otherwise, the lawyer will be in the uncomfortable position of arguing in a malpractice suit that the client was destined to lose, but that defense will raise questions about whether the lawyer charged too much and should have convinced the client to settle.