When a malpractice action was filed against lawyers who were exculpated under a chapter 11 plan, Chief Bankruptcy Judge John E. Hoffman, Jr., of Columbus, Ohio, refused to enforce an arbitration agreement and dismissed the suit.
The corporate debtor was the country’s largest privately owned coal company. On confirmation, the chapter 11 plan called for the debtor to withdraw from a union pension plan, resulting in $6.5 billion in withdrawal liability.
Although the debt was discharged as to the debtor, the plan specifically said that claims for withdrawal liability would survive against the debtor’s owner and entities affiliated with him. Immediately after confirmation, the pension plan sued the owner and his entities for $6.5 billion.
Later, the owner died. His representatives and his entities filed a legal malpractice suit in state court against the law firm that had represented the owner in the chapter 11 case. The complaint alleged that the firm failed to negotiate for the plan to include a release from withdrawal liability. The complaint also alleged that the law firm had not told the owner that he was not being released.
The law firm removed the state court suit and filed a motion to dismiss, contending that the firm was protected by exculpations in the confirmed chapter 11 plan. The owner’s representatives responded by contending that the bankruptcy court did not have jurisdiction to retain the malpractice suit, given that the suit was purely between nondebtor third parties. The owner’s representatives also moved to enforce an arbitration agreement with the law firm, to permit an arbitration to proceed that they had also begun against the firm.
Jurisdiction
Judge Hoffman first addressed his jurisdiction to retain the malpractice suit. He first recited the familiar rule requiring a “close nexus” to the bankruptcy case before there can be “related to” jurisdiction. He was persuaded by Simmons v. Johnson, Curney & Fields, P.C. (In re Simmons), 205 B.R. 834, 838 (Bankr. W.D. Tex. 1997), to hold that a suit relates to the bankruptcy case if it calls a provision of the plan into question, even though the outcome of the suit “could have no conceivable effect on the estate and therefore would not be related to the bankruptcy case.”
Next, Judge Hoffman held that there can be “arising under” or “arising in” jurisdiction even if there is no “related to” jurisdiction. He went on to find “arising in” jurisdiction because the suit dealt with the negotiation and enforcement of the chapter 11 plan.
Arbitrate or Not?
Having found jurisdiction and deciding the malpractice suit was “core,” Judge Hoffman confronted the issue of enforcing the arbitration agreement found in the engagement agreement between the law firm and its then-client, the owner.
Even though the suit was “core,” Judge Hoffman said he was required by Shearson/Am. Exp., Inc. v. McMahon, 482 U.S. 220 (1987), to decide “whether arbitration would inherently conflict with the Bankruptcy Code’s underlying purposes.”
Judge Hoffman concluded that enforcing the exculpation provisions in the plan “was tantamount to enforcing an order of the court.” Furthermore, he said that “exculpation clauses are a fundamental protection that the Bankruptcy Code permits Chapter 11 plans to afford.” He therefore declined to enforce the arbitration agreement because “arbitration would conflict with the underlying purposes of the Bankruptcy Code.”
Abstention
Finding jurisdiction and declining to compel arbitration, Judge Hoffman dealt with the owner’s representatives’ motion for abstention.
With regard to mandatory abstention, Judge Hoffman said, “Mandatory abstention does not apply to core proceedings.”
Regarding permissive abstention, Judge Hoffman said there is a presumption in favor of exercising jurisdiction when confronted with an abstention motion. Noting the core nature of the suit, he denied the motion for abstention.
Dismissal on the Merits
Evidently, the plan and the disclosure statement were not attached to the complaint. “[W]hen deciding a motion to dismiss for failure to state a claim,” Judge Hoffman said that “a court may consider facts beyond those provided in a complaint . . . [u]nder the right circumstances.”
Judge Hoffman quoted provisions in the plan that explicitly exculpated the attorneys for the then-owner. Analyzing the malpractice complaint, he said that the allegations did not rise to the level of actual fraud, willful misconduct or gross negligence, claims not encompassed by the exculpations.
The malpractice plaintiffs raised several creative arguments. Among them, the plaintiffs argued that the attorneys should have negotiated for a third-party, nondebtor release in the plan. To that, Judge Hoffman cited the Sixth Circuit and said, “Nonconsensual third-party releases can only be approved when ‘unusual circumstances’ are present.”
It was “unlikely,” Judge Hoffman said, that the malpractice plaintiffs could show “the existence of all seven factors” required for a nondebtor release.
Judge Hoffman denied the motion to remand, denied the arbitration motion and granted the motion to dismiss, without leave to file an amended complaint.
When a malpractice action was filed against lawyers who were exculpated under a chapter 11 plan, Chief Bankruptcy Judge John E. Hoffman, Jr., of Columbus, Ohio, refused to enforce an arbitration agreement and dismissed the suit.
The corporate debtor was the country’s largest privately owned coal company. On confirmation, the chapter 11 plan called for the debtor to withdraw from a union pension plan, resulting in $6.5 billion in withdrawal liability.
Although the debt was discharged as to the debtor, the plan specifically said that claims for withdrawal liability would survive against the debtor’s owner and entities affiliated with him. Immediately after confirmation, the pension plan sued the owner and his entities for $6.5 billion.