Bankruptcy judges: Don’t issue a report and recommendation from an abundance of caution if someone contends there is no power to enter a final order. That’s the lesson to be learned from a Fourth Circuit decision on April 4.
Why? Because a report and recommendation alters the standard of appellate review.
The Malpractice Suit
A law firm was general bankruptcy counsel for a corporate chapter 11 debtor that was a residential home developer. In the chapter 11 case, the firm initiated adversary proceedings against three home buyers who had allegedly defaulted on their purchase contracts.
While the adversary proceedings were pending, the case converted to chapter 7. The chapter 7 trustee retained the firm as special counsel to continue the suits. With bankruptcy court approval, the firm settled the three suits in 2011.
The bankruptcy court approved the trustee’s final report and closed the case in 2012.
In 2017, about five years later, the debtor sued the firm in state court, alleging that the firm committed malpractice by simultaneously representing the debtor and the chapter 7 trustee. The debtor contended that the conflict led the firm to settle the suits for less than fair value.
The firm moved to reopen the case in 2021 and importuned the bankruptcy court to enjoin the state court suit under the so-called Barton doctrine.
The doctrine arose from Barton v. Barbour, 104 U.S. 126 (1881), where the Supreme Court held that receivers cannot be sued without permission from the appointing court. After adoption of the Bankruptcy Act of 1898, the doctrine was extended to cover bankruptcy trustees and was subsequently broadened by many circuits to protect court-appointed officials and fiduciaries, such as trustees’ and debtors’ counsel, real estate brokers, accountants, and counsel for creditors’ committees.
The bankruptcy court agreed that the suit violated Barton, that the debtor willfully violated the automatic stay and that sanctions were warranted.
The bankruptcy court concluded that she was presiding over a “core” proceeding since the dispute involved a malpractice claim against an estate professional. Because “the Debtor has repeatedly challenged this Court’s authority to hear and decide issues related to this matter,” the bankruptcy judge decided to “issue a report and recommendation to the District Court to alleviate any Article III concerns the Debtor may have.”
The District Court Abstains
The district court rejected the report and recommendation, deciding instead to abstain under 28 U.S.C. § 1334(c)(1), thus sending the malpractice suit back to the state court less familiar with the bankruptcy case and pivotal bankruptcy law.
According to the Fourth Circuit’s opinion by Circuit Judge Allison Jones Rushing, the district judge reasoned that disputed factual issues would bear on applicability of the Barton doctrine and whether the malpractice claim was estate property.
The law firm appealed.
No Appellate Review
Circuit Judge Rushing exercised her “independent obligation” to ensure the appellate court’s jurisdiction. To that end, she cited 28 U.S.C. § 1334(d). Except in chapter 15 cases, the subsection says, “Any decision to abstain or not to abstain made under subsection (c) . . . is not reviewable by appeal or otherwise by the court of appeals.”
“Whatever the merits of the district court’s reasoning,” Judge Rushing said that the district court’s “abstention decision falls squarely within Section 1334(c)(1) and is thus ‘not reviewable by appeal.’ 28 U.S.C. § 1334(d).”
Judge Rushing dismissed the appeal for lack of appellate jurisdiction.
What If?
With respect, the district court’s decision to have the state court make the Barton determination turned the doctrine inside out. The doctrine was designed so that the appointing court, the tribunal most familiar with the case, will decide on allowing suit against an estate professional.
Correctly or not, the Barton doctrine is a matter of the federal court’s jurisdiction. Federal courts do not call up state courts to determine the federal court’s jurisdiction.
Because the bankruptcy court had issued a report, not a final decision, the district court conducted de novo review, and abstention made a possibly erroneous decision unreviewable on further appeal. Had the district been compelled to accept findings of fact unless clearly erroneous, the district court would have been hard-pressed to overturn the imposition of Barton protection.
In this writer’s view, nothing is to be gained by issuing a report and recommendation when the bankruptcy judge believes there is constitutional authority to issue a final order but someone strenuously objects. If the bankruptcy court issues ordinary findings and conclusions, and if the district court decides there was no power to enter a final order, the district court can take the bankruptcy court’s ruling as a report and recommendation.
By labeling the decision as a report and recommendation, the bankruptcy court subjects the decision to de novo review. Furthermore, issuing a report requires district court review. An ordinary opinion may or may not be appealed.
In the case that went to the Fourth Circuit, the law firm had several theories familiar to bankruptcy courts that might have short-circuited the malpractice suit. To begin with, the alleged malpractice occurred in the course of representing the chapter 7 trustee and thus would appear to be an estate asset that could be pursued only by the trustee. The debtor, even if it still exists in a corporate sense, should have no standing, and creditors’ claims were not discharged in chapter 7. As a result, the debtor stood to gain nothing.
The law firm also had res judicata defenses.
The bankruptcy court presumably granted final allowances of compensation to the law firm. Courts have held that final allowances result in res judicata defenses barring claims for a professional’s conduct during the case, on the theory that claims should have been brought in response to the application for an allowance. Res judicata would seem to apply to the debtor because it was a party in the case when the allowances were made.
The law firm had similar defenses arising from the bankruptcy court’s approval of the trustee’s retention of the firm and the bankruptcy court’s approval of the settlements with the defaulting homeowners.
Let’s hope the state court grasps the significance of the actions taken in bankruptcy court. When it’s all over, perhaps the firm can return to bankruptcy court once again seeking sanctions to reimburse the firm for its attorneys’ fees, relief that the bankruptcy court had intended to grant in the first instance.
Bankruptcy judges: Don’t issue a report and recommendation from an abundance of caution if someone contends there is no power to enter a final order. That’s the lesson to be learned from a Fourth Circuit decision on April 4.
Why? Because, a report and recommendation alters the standard of appellate review.
A law firm was general bankruptcy counsel for a corporate chapter 11 debtor that was a residential home developer. In the chapter 11 case, the firm initiated adversary proceedings against three home buyers who had allegedly defaulted on their purchase contracts.
While the adversary proceedings were pending, the case converted to chapter 7. The chapter 7 trustee retained the firm as special counsel to continue the suits. With bankruptcy court approval, the firm settled the three suits in 2011.
The bankruptcy court approved the trustee’s final report and closed the case in 2012.
In 2017, about five years later, the debtor sued the firm in state court, alleging that the firm committed malpractice by simultaneously representing the debtor and the chapter 7 trustee. The debtor contended that the conflict led the firm to settle the suits for less than fair value.
The firm moved to reopen the case in 2021 and importuned the bankruptcy court to enjoin the state court suit under the so-called Barton doctrine.