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No Easy Way Out: Legal Malpractice Defendants Desiring an Alternative Forum May Be Forced to Litigate in Bankruptcy Court until the Case is “Trial Ready”

Some legal malpractice defendants are content to litigate claims asserted by debtors in the bankruptcy court.  But many others, fearing that the debtor’s creditors may view them as a deep-pocketed resource to augment their own recoveries, would prefer to defend malpractice claims in what they view as a more neutral forum.  A recent decision by the United States District Court for the Southern District of Florida underscores how difficult it can be for lawyers and law firms in this latter group to move a legal malpractice case out of bankruptcy court, even when it is clear that the bankruptcy court cannot finally adjudicate the dispute. 

In Menotte v. Englett and Associates, PLLC, the Court refused to withdraw the reference – even though the claims against the defendant were not core and the defendant was entitled to a jury trial – because “other factors” justified delaying withdrawal of the reference “until the case is ready for trial.”[1]  This decision follows a robust line of cases, one that is hardly limited to malpractice actions, and presents a quandary for those malpractice defendants for whom the bankruptcy court is not the preferred forum.  If the District Court refuses to withdraw the reference until the case is trial ready, these defendants may have no choice but to remain in bankruptcy court for months if not years of discovery and other pre-trial proceedings. 

Background

Federal district courts have original jurisdiction over all proceedings arising in, arising under or related to a case under the Bankruptcy Code, but may refer them to the bankruptcy court.[2]  Each judicial district in the nation has done just that:  all bankruptcy matters filed in any federal district are automatically referred to the bankruptcy court in that district.  But, where an Article III court is required, “[t]he district court may withdraw, in whole or in part, any case or proceeding referred [to the bankruptcy court], on its own motion or on timely motion of any party, for cause shown.”[3] 

The statute does not define the term “cause,” but most courts look to the same factors to determine whether to withdraw the reference:  whether the proceeding is core or non-core[4]; whether there is a right to a jury trial[5]; and whether any “other factors” weigh in favor of withdrawal.[6] 

The first two prongs of this analysis are rarely problematic for malpractice defendants.  Claims by a debtor for legal malpractice are paradigmatically non-core:  they involve rights created by state law that are independent of and antecedent to the bankruptcy petition and do not depend on the bankruptcy laws for their existence.[7]  Likewise, malpractice claims are legal claims that entitle the defendant to a trial by jury.[8] 

In fact, some courts have concluded that withdrawal of the reference may be appropriate simply upon a showing that the matter is not core and the moving party has a right to a jury trial.[9]  However, one final prong of the analysis – whether “other factors,” support withdrawal – is often used to delay withdrawal of the reference even where it cannot be denied altogether. 

“Other Factors” Can Delay Withdrawal of the Reference for Years

The “other factors” that courts consider – including judicial efficiency, uniformity of bankruptcy administration, delay and cost to the parties, and prevention of forum shopping – are frequently cited to deny or delay withdrawal of the reference of non-core claims for which the defendant has a right to a jury trial.[10]  From the perspective of a malpractice defendant seeking a different venue than the bankruptcy court, these concepts are so malleable that their application can lead to unpredictable and inconsistent results.[11]  Courts that favor immediate withdrawal tend to reason that it promotes judicial economy and avoids duplication given that dispositive motions will be subject to de novo review by the district court and the proceeding will eventually be transferred to the district court for a jury trial.  Courts that decline to withdraw immediately also claim the mantle of efficiency, reasoning that the bankruptcy court is better-positioned to supervise discovery and other pretrial matters.[12] 

In Menotte, for example, citing the Bankruptcy Court’s familiarity with the adversary proceeding, the Court held that “withdrawal of the reference is presently premature, and will be appropriate only if and when this adversary proceeding becomes ready for a jury trial.”[13]  The “trial-ready” requirement is not found anywhere in the statute, but it is routinely cited by district courts – the same district courts that would otherwise inherit the matter in question – to defer withdrawal of the reference, sometimes for years of discovery and other pre-trial matters.[14] 

Defendants of pre-petition malpractice claims brought by a debtor – indeed any party seeking a a forum other than the bankruptcy court – may find that even the right to a jury trial on a non-core claim that the bankruptcy court cannot finally adjudicate is not sufficient to merit immediate withdrawal of the reference.  Instead, the district court has the discretion to maintain the reference of these claims to the bankruptcy court until they are ready for trial, even if that is years away.   

 

[1] Menotte v. Englett and Associates, PLLC, et al.  (In re: Olander), Case No. 17-80077 (S.D. Fla. July 31, 2017) [D.I. 5] (“Menotte”)

[2] 28 U.S.C. § 157(a). 

[3] 28 U.S.C. § 157(d) (emphasis added).  (This is generally known as “permissive” withdrawal. The statute also provides for mandatory withdrawal of the reference upon a determination that resolution of the proceeding requires consideration of both the Bankruptcy Code and other federal laws regulating organizations or activities affecting interstate commerce.  This analysis in this article focuses on permissive withdrawal). 

[4] Claims in bankruptcy are divided into two categories:  “core” and “non-core.”  28 U.S.C. § 157(b).  A bankruptcy court may “hear and determine” and “may enter appropriate orders and judgments” with respect to core proceedings.  Id.  But, absent consent of the parties, a bankruptcy court may not enter final orders with respect to non-core proceedings and instead must “submit proposed findings of fact and conclusions of law to the district court” for de novo review.  28 U.S.C. § 157 (c)(1).  So, a finding that a matter is non-core favors withdrawal of the reference because the district court’s involvement is preordained. 

[5] A Bankruptcy Court is not permitted to conduct a jury trial without the consent of the parties.  28 U.S.C. § 157(e).  For this reason, the right to a jury trial favors withdrawal of the reference. 

[6] See, e.g., In re Orion, 4 F.3d 1095, 1101 (2d Cir. 1993) (“[O]nce a district court makes the core/non-core determination, it should weigh questions of efficient use of judicial resources, delay and costs to the parties, uniformity of bankruptcy administration, the prevention of forum shopping, and other related factors.).   

[7] Courts are almost uniform in holding that such claims are not core.  In re Queyrouze, 2015 U.S. Dist. LEXIS 122802 (E.D. La. Sept. 15, 2015) (allegations of negligence and legal malpractice are non-core); Distefano v. Law Offices of Barbara H. Katsos, P.C., 2011 U.S. Dist. LEXIS 63155 (E.D.N.Y. 2011) (“well-settled” that pre-petition legal malpractice claims are non-core); Joseph DelGreco & Co. v. DLA Piper LLP (US), 2011 U.S. Dist. LEXIS 10972 (S.D.N.Y. Jan. 26, 2011)( “It is clear that a claim alleging pre-petition malpractice is a non-core claim”).

To be clear, this does not extend to claims for legal malpractice in connection with the bankruptcy case itself.  Allegations that a lawyer or law firm committed malpractice while representing a debtor, and after its retention has been authorized by the Bankruptcy Court under the applicable provisions of the Bankruptcy Code, are analyzed differently.  There is a strong argument that such claims are core. See, e.g., In re KSL Media, Inc., 2016 U.S. Dist. LEXIS 1917 (C.D. Cal. 2016) (“claims based solely on acts committed by bankruptcy fiduciaries that occurred either in the administration of the estate or in preparation for that administration” are core).

[8] See, e.g., DelGreco at *12 (“[A] claim for malpractice is legal . . . and the Seventh Amendment therefore preserves the right to jury trial in such cases”).

[9] See  DelGreco, 2011 U.S. Dist. LEXIS 10972, at *11–12 (“a finding that a claim is non-core and that a jury demand has been filed may create cause for withdrawing the reference”); Orion, 4 F.3d at 1101 (“If a case is non-core and a jury demand has been filed, a district court might find that the inability of the bankruptcy court to hold the trial constitutes cause to withdraw the reference.”).

[10] JLL Consultants, Inc. v. Goldman Kurland & Mohidin, LLP, 565 B.R. 556, 566 (D. Del. 2016)(“Permitting the Bankruptcy Court to oversee pretrial matters in this proceeding, and withdrawing it only when it is ripe for a jury trial, promotes judicial economy and a timely resolution of this case.”); Youngman v. Hoffman, 2009 U.S. Dist. LEXIS 94593 (D.N.J. 2009)(“[T]his Court finds that the better course, for uniformity and efficiency in bankruptcy administration and to expedite the bankruptcy process, is to not interfere with the Bankruptcy Court's ongoing management of the case, leaving it with the Bankruptcy Court until all pre-trial matters are resolved-- i.e. until such time as a jury trial becomes necessary.”).

[11] Compare Wellman Thermal Sys. Corp. v. Columbia Cas. Co., 2005 U.S. Dist. LEXIS 45725, 11-12 (S.D. Ind. 2005) (“Certain efficiencies would be lost were the bankruptcy court to proceed with pretrial matters; the district court would not gain a valuable familiarity with the case that could assist it leading  up to and through trial”) with Heller Ehrman LLP v. Arnold & Porter, LLP, 464 B.R. 348, 357 (N.D. Cal. 2011)(“[T]he bankruptcy judge is particularly familiar with the facts and legal issues that underlie the claims . . [and thus] is better equipped to handle any pre-trial proceedings.”).

[12] See DeGiacomo v. Holland & Knight, LLP, 2014 U.S. Dist. LEXIS 61998 (D. Mass. 2014) (collecting cases). 

[13] Menotte at 3. 

[14] See Buchwald v. Renco Group, 2004 U.S. Dist. LEXIS 9389 (S.D.N.Y. May 20, 2004) (collecting cases and noting that, “often, courts in this District have found it appropriate to defer withdrawing the reference until the case is trial ready.”)