LEGAL MALPRACTICE CLAIMS AND BANKRUPTCY ...Legal Malpractice Claims and Bankruptcy Chapter 5 iv Holder v. Garner, Lovell & Stein PC , 1999 W.L. 642216 (not published) (Tx. App. - Amarillo

LEGAL MALPRACTICE CLAIMS AND BANKRUPTCY:CONTINUE TO WATCH YOUR STEP!

©2000 Janis Reinken andTexas Lawyers' Insurance Exchange (Austin)

in collaboration with contributing authors

Hon. Ronald B. King, Judge,United States Bankruptcy Court (San Antonio)

and

Joseph D. Martinec,Langley & Banack (Austin)

State Bar of TexasAdvanced Consumer Bankruptcy Course

October 12, 2000Dallas, Texas

Chapter 5

Legal Malpractice Claims and Bankruptcy Chapter 5

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Table of Contents

BIBLIOGRAPHY ..................................................................................................................................iii

I. EXPOSURE TO MALPRACTICE CLAIMS ....................................................................................1A. Is Your Number Coming Up?......................................................................................................1

II. DUTIES TO CLIENTS AND NON-CLIENTS..................................................................................2A. Claims on Behalf of the Debtor or Estate: Who has Standing to Assert a Legal Malpractice Causeof Action? .........................................................................................................................................2

1. Pursuit of legal malpractice claims by the Trustee or Debtor: do the claims belong to theestate? .........................................................................................................................................22. Pursuit of legal malpractice claims directly by the Debtor: fewer reported opinions mayindicate pursuit of claims by Trustees is more common. ..............................................................4

B. Attorney Duties to Non-Clients: Alas, Privity, We Knew Thee Well...........................................61. Confusion as to legal representation: will the "real" client please stand up? Document thescope of engagement (or lack of one)...........................................................................................62. Attempts by Non-Clients to create a "constructive" attorney-client relationship: efforts toexpand an attorney's duties beyond the privity circle....................................................................83. Joint defense arrangement may extend duty of confidentiality to non-client, even if notdisqualified from representation. ............................................................................................... 11

C. Consumers to a Transaction: Responsibilities To Clients and Non-Clients under the TexasDeceptive Trade Practices Act ......................................................................................................... 12

1. Post-1995 DTPA issues involving legal services. ................................................................ 122. Professional services exemption under the DTPA (1995). ................................................... 12

III. LIMITATIONS PERIOD ON ASSERTING LEGAL MALPRACTICE CLAIMS FOR DEBTORS 15A. Limitations on Legal Malpractice Actions as Applied in Bankruptcy ......................................... 15

1. Statutory tolling under 11 U.S.C. Section 108(a). ................................................................ 152. Limitations ran two years after attorney's final post-petition fee bill, where no tollingallegations pleaded. ................................................................................................................... 16

B. Accounting Malpractice Claims - Limitations Statute Begins to Run on IRS Notice of DeficiencyDate (attorneys providing tax advice, be alert!) ............................................................................... 16

IV. IGNORANCE IS NOT BLISS: CLIENT COMMUNICATIONS AND AMBIGUITY..................... 17A. Documenting Advice to Clients: Get the Complete Picture, Define the Scope of Engagement inWriting, and Avoid Giving Business Advice.................................................................................... 17B. Uncovered Claims: Crime or Fraud, RICO, Fraud on a Tribunal............................................... 17

1. Crime or Fraud Exception to Attorney-client Privilege: Depositions in Malpractice CaseAdmissible as Proof of Crime in Chapter 11 Fraud. ................................................................... 172. RICO & Conspiracy Claims: Seventh Circuit Steps Out (Disgruntled investors sue law firmfor bankrupt corporation, win remand to assert RICO and conspiracy claims against firm.)........ 183. Fraud on a Tribunal: Remand for Court to Conduct Factfinding on “Colorable Claim.”(Alleged conflicts in representing Debtor, trustee, and others. Debtor had a "colorable claim" of aconcealed conflict interest interfering with the court's impartial adjudication.) ........................... 19

V. JUST SHOW ME THE MONEY: FEE CLAIMS, MALPRACTICE COUNTERCLAIMS, ANDCOURT SCRUTINY OF FEES AND CONDUCT MEAN RISKY BUSINESS..................................... 20

A. Bringing Home the Bacon: of Objections and Malpractice Claims. ............................................ 201. Objections to proof of claim for attorney fees and malpractice counterclaims: an objectionjoined with a claim for relief under Rule 3007 may require separate filing and service of anadversary proceeding (or may not, depending on the forum). ..................................................... 20


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2. Legal malpractice claims in adversary proceedings: joint and several liability possible, whereattorneys found liable for gross negligence and breach of fiduciary duty connected withundisclosed conflicts of interest from prior representation.......................................................... 213. Post-confirmation adversary claim for legal malpractice based on pre-petition advice andother non-bankruptcy malpractice claims: jurisdiction of all claims exercised in BankruptcyCourt, and attorney's fee claim subjected attorney to jurisdiction and waived jury trial............... 224. Post-discharge assertion of legal malpractice claims attempted by creditor on behalf ofdebtor's estate was unsuccessful, where debtor had alleged no claims. ....................................... 225. Conflicts not waivable by consent: no claim pursuit in 7 against creditors previouslyrepresented in 11. ..................................................................................................................... 23

B. Saving Your Bacon: Fee Reductions, Preferences, Sanctions, Disgorgement, and DisciplinaryReferrals (Be Careful about Conflict Waivers)................................................................................. 23

1. Attorney fees and performance subject to scrutiny by Bankruptcy Court without filing of anobjection and a legal malpractice claim...................................................................................... 232. Pre-petition payment of attorney fees as voidable preference. .............................................. 243. Sanctions in bankruptcy court against Debtor and counsel ................................................... 254. Disgorgement of fees and a disciplinary referral by the Bankruptcy Court held not an abuse ofdiscretion: an attorney has fiduciary duties to the estate and cannot ignore the Debtor's disregardof Bankruptcy Court orders. ...................................................................................................... 275. Trustee may pursue breach of fiduciary action and fee forfeiture against attorneys, damagesor not (more perils of dual representation). ................................................................................ 27

VI. PARTICULAR PRACTICE & PROCEDURE ISSUES:.................................................................. 28A. Deadlines, Res Judicata, Tax Year Elections, Trustee Liability .................................................. 28

1. Beware of traps in calculating deadlines. ............................................................................. 282. Compulsory Counterclaims; Res Judicata Issues. ................................................................ 283. Potential Counterclaims Against Creditors .......................................................................... 284. Short Year Tax Elections: Yes or No? ................................................................................ 295. Trustee Personal Liability: None for Mere Negligence (at least in the Fifth Circuit.)........... 29

VII. CONCLUSION: CONTINUE TO WATCH YOUR STEP! ...................................................... 29


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BIBLIOGRAPHY

3Z Corporation v. Stewart Title Guaranty Co. 851 S.W.2d 933 (Tex. App. - Beaumont 1993, writ denied).

Akin v. McDaniel, 1991 WL 258732 C (not published) (Tex. App. - Dallas 1991, no writ).

Allen v. Moore (In re Allen), 179 B.R. 818 (U. S. Bk. Ct. E. D. Tex. [Beaumont] 1995).

American Bar Association, Legal Malpractice Claims in the 1990's. American Bar Association, StandingCommittee on Lawyers' Professional Liability, Chicago, Illinois -- October 1996 (PC #4140028).

Andrews v. Diamond Rash Leslie & Smith, 959 S.W.2d 646 (Tex. App. - El Paso 1997, writ denied).

F. E. Appling Interests v. McCamish Martin Brown & Loeffler, 991 S.W.2d 787 (Tex. 1999).

Arthur Andersen v. Perry Equipment Corp., 945 S.W.2d 812 (Tex. 1997).

Banc One Capital Partners Corporation v. Kneipper, 67 F.3d 1187, 1119 (5th Cir. (Tex.) 1995).

Barcelo v. Elliott, 923 S.W.2d 575 (Tex. 1996).

Besing v. Seeligson. Douglass. Falconer & Vanden Eykel, 822 S.W.2d 107 (Tex. App. - Dallas 1991, writdenied).

Brouwer v. Raffensperger, Hughes & Co., No. 199 F.3d 961 (7th Cir. 2000), cert. den. 120 S. Ct. 2688 (U.S. 2000).

Burrow v. Arce, 977 S.W.2d 299 (Tex. 1998).

Citizens Bank & Trust Co. v. Case (In re Case), 937 F.2d 1014 (5th Cir. (Miss.) 1991).

CJC Holdings. Inc.. v. Wright & Lato. Inc., 989 F.2d 791, 793 (5th Cir. (Tex.) 1993).

Cosgrove v. Grimes, 774 S.W.2d 662 (Tex. 1989).

Dauter-Clouse v. Robinson, 936 S.W.2d 329 (Tex. App.--Houston [14th] 1997, no writ).

Douglas v. Delp, 987 S. W.2d 879 (Tex. 1999).

Eubanks v. FDIC, 977 F.2d 166 (5th Cir. 1992).

Federal Land Bank Association of Tyler v. Sloane, 825 S.W.2d 439 (Tex. 1991).

First National Bank of Durant v. Trans Terra Corporation International v. Douglass, 142 F.3d 802 (5th Cir.(Tex.) 1998).

Gamboa v. Shaw, 956 S.W.2d 662 (Tex. App. - San Antonio, 1997, no writ).

General Motors Acceptance Corp./Crenshaw Dupree & Milam LLP v. Crenshaw Dupree & Milam LLP,986 S.W.2d 632 (Tex. App. - El Paso 1998, review denied 1999).

Gulf Coast Investment Corporation v. Brown, 821 S.W.2d 159 (Tex. 1992).

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Holder v. Garner, Lovell & Stein PC, 1999 W.L. 642216 (not published) (Tx. App. - Amarillo 1999,review denied 2000).

Hughes v. Mahaney & Higgins, 821 S.W.2d 154 (Tex. 1991).

In re Baudoin, 981 F.2d 736 (5th Cir. 1993).

In re Dunlap, 217 F.3d 311 (5th Cir. 2000).

In re Educators Group Health Trust, 25 F.3d 1281 (5th Cir. 1994).

In re Garver, 116 F.3d 176 (6th Cir. 1997).

In re Gregory, 214 B. R. 570 (D.S.D. Tex. [Houston] 1997).

In re Howell, 148 B.R. 269 (U. S. Bk. Ct. S. D. Tex. 1992).

In re Hunt International Resources Corporation, 1992 W.L. 235580 (motion to disqualify); 1992 W.L.235579 (motion to reconsider) (U. S. Bk. Ct. N.D. Tex. 1992).

In re Intelogic [Interlogic] Trace. 200 F.3d 382 (5th Cir. Jan. 25, 2000).

In re J. B. Marion Inc., 199 B.R. 635 (U. S. Bk. Ct. S. D. Tex. [Houston] 1996).

In re Kendavis, 91 B.R. 742 (U. S. Bk. Ct. N.D. Tex. 1988).

In re Mathiason, 16 F.3d 234, 238 (8th Cir. (Minn.) 1994).

In re Moore, 132 B.R. 533 (W. D. Pa. 1991).

In re Norriss Brothers Lumber Company. Inc., 133 B.R. 599 (U. S. Bk. Ct. N. D. Tex. [Wichita Falls]1991).

In re Quality Beverage Company, Inc., 216 B.R. 592 (U. S. Bk. Ct. S.D. Tex. 1995).

In re Robinson, 217 B.R. 527, 530 (U. S. Bk. Ct. B. D. Tex. [Sherman] 1998).

In re Saunders, 124 B.R. 234 (U. S. Bk. Ct. W. D. Tex. [San Antonio] 1991).

In re Saunders, 155 B.R. 405 (U. S. Bk. Ct. W. D. Tex. 1993).

In re Smyth, 207 F.3d 758 (5th Cir. 2000).

In re Solomon ___ F Supp. __, 11 Tex. U.S. Bk. Ct. Rep. 162, 1997 WL 102485 (D. N. D. Tex. March 5,1997).

International Trust Corp. v. Pirtle, 1997 W.L. 20870 (not published) (Tex. App. - Amarillo 1997, no writ).

Jampole v. Matthews, 857 S.W.2d 57 (Tex. App.--Houston [1st] 1993, writ denied).

Judwin Properties Inc. v. Griggs & Harrison, 911 S.W.2d 498 (Tex. App. - Houston [1st] 1995 no writ).

Latham v. Castillo, 972 S. W.2d 66 (Tex.1998).























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Lawler v. Guild Hagen & Clark. Ltd (In re Lawler). 106 B.R. 943 (D. N. D. Tex. [Dallas] 1989).

McLaughlin v. Martin, 940 S.W.2d 261 (Tex. App. - Houston [14th] 1997, no writ).

Miller v. Stonehenge / FASA-Texas JDC: L.P., 993 F.Supp. 461 (D. N. D. Tex. [Dallas] 1998).

Murphy v. Campbell, 964 S.W.2d 265 (Tex. 1997).

Parker v. Carnahan, 772 S.W.2d 151, 156 (Tex. App. - Texarkana 1989, writ denied).

Pearson v. First NH Mortgage Corp., ___ F.3d ___, No. 98-2207 (1st Cir. 1999).

Poth v. Small Craig & Werkenthin, 967 S.W.2d 511, (Tex. App. - Austin 1998, writ denied).

Randolph v. Resolution Trust Corporation, 995 F.2d 611 (5th Cir. (Tex.) 1993).

Simmons v. Johnson Curney & Fields P.C. (In re Simmons) 205 B.R. 834 (U. S. Bk. Ct. W. D. Tex. [SanAntonio] 1997).

Soliz v. Southern Farm Bureau Casualty Company Inc. (In re Soliz), 77 B.R. 93 (U. S. Bk. Ct. N. D. Tex.(Lubbock) 1987).

Southmark Corporation v. Schulte, Roth & Zabel (In re Southmark Corporation), 242 B.R. 330 (D.N.D.Tex. [Dallas] 1999); same case, 217 B.R. 499 (U. S. Bk. Ct. N. D. Tex. [Dallas] August 13, 1997; 88 F.3d311(5th Cir. 1997); 217 B.R. 181 (U. S. Bk. Ct. N. D. Tex. [Dallas] March 24, 1997).

Swift v. Seidler (In re Swift, 198 B.R. 927 (U. S. Bk. Ct. W. D. Tex. [San Antonio] 1996).

Taco Bell v. Cracken, 939 F. Supp. 528 (D. N. D. Tex. 1996).

The Cadle Co. v. Sweet & Brousseau, P. C., ___ F. Supp. ___ 1998 WL 101749, No. 3:97-CV-0298-G(D. N. D. Tex. March 3, 1998); 1998 WL 158660 (March 26, 1998, opinion on m/reconsider).

UNC Inc.v. Hall,___F.Supp.___1998 WL 118151, No. 3:96-CV-2456-P (D. N. D. Tex. 1998).

United States v. Ballard, 779 F.2d 287 (5th Cir. (Miss.) 1986).

Van Dyke v. Boswell O'Toole Davis & Pickering, 697 S.W.2d 381 (Tex. 1985).

Vaughn v. Akin Gump Hauer & Feld, L.L.P., ___F.Supp. ___, 1997 WL 560617 (U. S. Dist. Ct. N. D.Tex., 1997) (originally In re Legal Econometrics, Inc., 191 B.R. 331 (U. S. Bk. Ct. N. D. Tex. 1995).

Vining v. Ward (In re Ward), 894 F.2d 771 (5th Cir. (La.) 1990).

Vinson & Elkins v. Moran, 946 S.W.2d 381 (Tex. App. - Houston [14th] 1997), writ dism'd by agr.).

Wheeler v. Magdovitz, 137 F.3d 299 (5th Cir. 1998).

Williams v. Khalaf, 802 S.W.2d 651 (Tex. 1990).

Willis v. Maverick, 760 S.W.2d 642 (Tex. 1988).



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LEGAL MALPRACTICE CLAIMS AND BANKRUPTCY:CONTINUE TO WATCH YOUR STEP!©2000 Janis Reinken and Texas Lawyers' Insurance Exchangein collaboration with contributing authors, Hon. Ronald B. King and Joseph D. Martinec

I. EXPOSURE TO MALPRACTICECLAIMS

Bankruptcy lawyers, and those who handlerelated areas such as real estate, banking, businessentities, and commercial transactions, can face ahost of potential legal malpractice problems fromseveral fronts. There has always been the potentialfor malpractice claims from clients, but the risk ofclaims from non-clients has risen over the lastcouple of years. Asserting fee claims can createproblems with counterclaims, and certain matterseven draw judicial sanctions. Although the threatof fee forfeiture is nothing new to bankruptcyattorneys, recent developments concerning breachof fiduciary duty claims could elevate concernsabout approval of fee applications.

This paper is intended to provide an overviewprimarily of cases from Texas state and federalcourts, and from the United States Court ofAppeals for the Fifth Circuit, with a few notabledevelopments in other jurisdictions. References tospecific law firms or attorneys by name have beenmade where relevant to the style andunderstanding of the cases cited, and is notintended to reflect adversely or level criticism (nooffense is intended, and hopefully none will betaken). Nothing contained in this paper is intendedto establish or revise the standard of careapplicable to Texas attorneys; rather, the hope isthat by implementing the suggestions made here,attorneys may help establish a strong summaryjudgment defense in response to a malpracticeclaim, or improve the chances of a successfuldefense to a grievance complaint.

In the words often used by Chief JudgeBuchmeyer of the Northern District of Texas, "Becareful out there."

A. Is Your Number Coming Up?The American Bar Association is compiling

its five-year survey of legal malpractice claims,which was not in publication at the time this paperwas prepared. The October 1996 study, "LegalMalpractice Claims in the 1990's," analyzedstatistics on legal malpractice cases based upon1990-95 data. Survey participants included sevenlarge commercial carriers, and sixteen lawyer-owned bar-related insurance companies (none

from Texas, however). Each reported relevantstatistics about the aggregate claims against theirinsureds. Copies of the report by the ABAStanding Committee on Lawyers' ProfessionalLiability may be obtained from ABA OrderFulfillment, 1/800-285-2221, PC #4140028.

Of all the claims surveyed, 7.91% or 1,516 ofall 19,158 claims studied were attributable tocollection and bankruptcy representation. Thisreveals a 2.58% decline in claims from 10.49%, ascompared with 3,066 of 29,227 reported in the1986 study.

Based on the classification of all substantiveand non-substantive errors, 47% of all claimsallegedly arose from substantive mistakes, 27%from administrative errors, 17% from clientrelation problems, and 9% from intentionalwrongs. ABA 1996 Study, p. 13. In the collection/ bankruptcy area alone, substantive errors stood at41%, administrative errors at 23%, client relationserrors 18%, leaving 12% for intentional wrongsand 6% for other errors. ABA 1996 Study, p.35. Interms of litigation and non-litigation errors in thecollection / bankruptcy category, 55% of the errorsrelated to litigation, 23% to the preparation ofdocuments, 20% to faulty advice, 3% to non-litigation investigation, and 6% to other errors.

Overall1 compared to the 1980-85 ABA Study,fewer claims were reported arising from lawyers'own business transactions with client. More claimsalleged conflicts of interest, however, due in partto complex client relationships reaching over anextended time period, lack of clarity as to the"real" client, and ambiguities in the scope of theengagement. ABA 1996 Study, p.21. In general,the study cites a decline in claims involvinginvestments, failed foreclosures, title search, andescrow activities. Id.

After a recession in a state or region, thefrequency and severity of claims against lawyerscan be expected to increase. This is partly due tomore transactions coming apart, more defaults andbankruptcies leaving creditors without recourse,more controversy over marital and corporateassets, and such. In short, declining economicconditions tend to generate more legal malpracticeclaims than when economic indicators are stableor improving. ABA 1996 Study, p.20.


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Other practice areas often connected withcollection/bankruptcy law matters include trust,estate and probate; real estate; corporate andbusiness organization; and business transactionsand commercial law. These five categoriesaccounted for 7.91%, 7.59%, 14.35%, 8.87% and10.66 % of all the claims respectively.Collectively, these five areas represented 49.38%or nearly half of all malpractice claims reviewed.ABA 1996 Study, p.7.

To minimize the exposure to legalmalpractice claims and grievance complaintswhen the next economic downturn occurs, now isthe time to exercise good practice habits andavoid errors before they occur.

II. DUTIES TO CLIENTS AND NON-CLIENTSA. Claims on Behalf of the Debtor or Estate:Who has Standing to Assert a LegalMalpractice Cause of Action?1. Pursuit of legal malpractice claims by theTrustee or Debtor: do the claims belong to theestate?

A malpractice claim may be brought againstan attorney for alleged mistakes in representing adebtor, Swift v. Seidler (In re Swift), 198 BR. 927(U. S. Bk. Ct. W. D. – c/a belongs to Debtor. (5th

Cir.) Tex. [San Antonio] 1996); Allen v. Moore(In re Allen), 179 B.R. 818 (U.S. Bk. Ct. E. D.Tex. [Beaumont] 1995). If a legal malpracticecause of action under state law accrued prior to thebankruptcy, then only the trustee or debtor-in-possession may dispose of this contingent asset ofthe estate. Swift v. Seidler (1n re Swift), supra. Inessence, that would tend to discourage (but noteliminate) legal malpractice actions broughtdirectly by a debtor.

A legal malpractice claim becomes theproperty of the bankruptcy estate if the cause ofaction accrued prior to filing the bankruptcy,whether the malpractice suit is filed before,during, or after the bankruptcy. Swift v. Seidler(In re Swift), supra (pre-petition claims); Douglasv. Delp, 987 S. W.2d 879, 42 Tx. S. Ct. J. 431 (Tex.1999); Allen v. Moore (1n re Allen), supra (suitfiled during bankruptcy); Wheeler v. Magdovitz(In re Wheeler), 137 F.3d 299 (5th Cir. 1998)(post-bankruptcy claim brought).

The trustee has standing to commence thelegal malpractice action or dispose of it, but cannot assign the legal malpractice claims to anyother parties. In re J. B. Marion, Inc., 199 B.R.

635 (U.S. Bk. Ct. S.D. Tex. [Houston] 1996); Delpv. Douglas, supra.

The trustee may, however, abandon the causeof action allowing the debtor to resume control ofthe malpractice matter. Allen v. Moore (In reAllen), supra, 179 B.R. 818.

In the event of a pre-petition coverage disputeas to the insurance proceeds payable on aprofessional liability claim, it is likely that anysettlement proceeds payable would belong to theestate (rather than to the debtor or claimantsagainst the debtor). This is because the Trusteewould succeed to all the bankrupt's causes ofaction arising from the contract right dispute withthe insurer, as distinguished from anacknowledged liability policy benefit. Cf., Solizv. Southern Farm Bureau Casualty Company. Inc.(In re Soliz), 77 B.R. 93 (U.S. Bk. Ct. N. D. Tex.(Lubbock) 1987) (Trustee wins auto liabilityinsurance coverage dispute involving fightbetween the injured parties and the Trustee overthe settlement funds).

a Pre-petition accrual of legal malpracticeclaims: property of the estate.

(1) Legal malpractice cause of action was estateasset because filing of bankruptcy petition, notfraud conviction, served as accrual date.

Wheeler v. Magdovitz (In re Wheeler), 137F.3d 299 (5th Cir. 1998).

A false Chapter 7 petition was filed assertingthe Debtor had "no assets," and resulted in thepost-discharge indictment and conviction of theDebtor, Wheeler, for falsifying and concealingassets which should have been disclosed as part ofthe bankruptcy estate. The Bankruptcycommenced May 1, 1989 and Wheeler wasdischarged August 30, 1989, and the indictmentoccurred approximately five years later, June 10,1994.

Wheeler argued that the malpractice claimagainst the bankruptcy attorney accrued after thedischarge when Wheeler was convicted, and notpre-petition. The Court found that the state lawmalpractice claim against attorney Magdovitzarose pre-petition at the time of preparing andfiling the petition. Therefore, the Chapter 7 estateowned the legal malpractice cause of action, andthe Debtor should have discovered anydiscrepancies in the actual assets and those listedin the petition, at the time he signed the petition,which clearly misrepresented his assets andliabilities. 137 F.3d at 301.












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(2) Post-petition assertion of legal malpracticeclaims, pre-petition accrual means they are assetsof Chapter 7 estate.

Allen v. Moore (In re Allen), 179 B.R. 818(U.S. Bk. Ct. E. D. Tex. [Beaumont] 1995). Inthis case, the legal malpractice ease was filed post-petition. Here, the Allens filed for Chapter 11 afterthe defendant law firm was unsuccessful inassisting them in renegotiating a secured bankloan. The case was converted to Chapter 7 and theDebtors filed suit in state court against thelawyers, alleging that they negligently advised Mr.Allen to quit his job before filing bankruptcy,causing him to be unable to fund the Chapter 11reorganization.

The malpractice claim was filed in State courtalleging negligent pre-petition advice, and theattorney defendants removed to Bankruptcy Court,claiming that the state court claims werebankruptcy estate property. The Chapter 7 trusteeintervened, arguing that the claims belonged to thedebtor's estate.

The Bankruptcy Court held that the state courtsuit accrued pre-petition because all the operativefacts occurred pre-petition, therefore the suit wasChapter 7 estate property. 179 B.R. at 821.Unless the Trustee abandoned the claims, only theTrustee would have standing to administer thestate court lawsuit. Id. Therefore, the BankruptcyCourt denied the motion to remand the malpracticesuit to the state district court.

(3) Claims owned by creditors: direct harm toindividual creditor treated differently than claimsof damages caused to creditors generally, whichDebtor / estate own.

In re Educators Group Health Trust, 25 F.3d1281 (5th Cir. 1994). The Chapter 7 trusteebrought suit in the bankruptcy court to determineownership of claims which had been brought byindividual school districts against the officers ofthe third party administrator of the debtor.

The 5th Circuit, following solid authorityfound that the debtor owns those causes of actionwhich resulted in damage to the debtor andcreditors generally, e.g. fraudulent conveyances,mismanagement, corporate looting. However, theCourt determined that where there was direct harmto an individual creditor resulting from actionsdirected against that creditor, e.g. arising under theDTPA, Texas Insurance Code, or fraud, the causeof action could be brought by that individualcreditor.

Such reasoning raises the discomfitingprospect that in a malpractice case or a casearising out of negligent misrepresentation, certaincauses of action could belong both to the estateand individual creditors.

(4) Pre-petition legal malpractice suit: Trustee canpursue or settle, and may sell or assign the causeof action in settlement; claims under spouse jointmanagement disposed by Bankruptcy Court.

Douglas v. Delp, 978 S.W. 2d 879 (Tex.1999).

This illustrates how a debtor's spouse mightpursue pre-petition claims against counsel, in spiteof disposition by a bankruptcy court of theindividual debtor's legal malpractice claims. InDelp, the pre-petition legal malpractice claim wassettled in bankruptcy Chapter 11 via the purchaseby the carrier's agent at a trustee sale. Claims ofpre-petition malpractice, DTPA violations, andmental anguish were listed as assets of the estate.The non-debtor spouse's sole-managementcommunity property is not included in the debtor-spouse's bankruptcy estate under 11 U.S.C. Sec.541(a). 948 S.W.2d at 494.

The wife's claims were treated by the SupremeCourt as jointly-managed community, thereforethe disposition of claims by both spouses wasproper as part of the bankruptcy estate, over whichthe Texas Supreme Court had no jurisdiction andwhich she had no standing to pursue. The wife hadresigned her directorship in the company as part ofthe underlying divorce settlement.

In this Chapter 11 case, Delp sued the lawfirm before filing bankruptcy, claiming damagesfrom negligent legal advice on a comprehensivesettlement agreement resolving a dispute withHarvison, another partner-board member of an oilcompany, Nu-Way. According to the Court ofAppeals opinion, the settlement enabled Harvisonto purchase a $1.2 million judgment lien Nu-Wayowed to Sunbelt Savings for $150,000, thenforeclose on the company assets, which Delpclaimed caused his bankruptcy. 948 S.W.2d at487-88 (Tex. App. - Fort Worth 1997). As part ofa liquidating trust of nonexempt assets, the trusteeattempted to sell/assign the husband's interest inthe legal malpractice claims to the attorney'sinsurer (through its agent), then dismiss all claimsin their entirety, but only the husband, Delp, hadfiled for personal bankruptcy, and the Court ofAppeals reversed and remanded for the wife topursue her legal malpractice claims.







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The Supreme Court reversed and rendered,ordering a take nothing on the wife's DTPA andmental anguish claims in State court anddismissing the other malpractice claims for lack ofjurisdiction. Therefore, the trustee's settlementwith the insurer could go forward. The Courtspecifically disavowed availability of mentalanguish damages due to the economic loss,therefore the wife had no standing in State courton that claim, regardless of whether it would havebeen her separate property or under her solemanagement.

It thus appears that pre-petition DTPA ormalpractice claims (and perhaps others) by adebtor's spouse for damages other than meremental anguish (non-economic) would need toqualify as sole management community underTEX. FAM. CODE, Sec. 5.22(a) or as separateproperty in order for the non-bankrupt spouse tohave standing to pursue them in State court.

(5) Distribution of insurance proceeds followingcoverage dispute arising prior to bankruptcy:settlement funds became part of estate.

Soliz v. Southern Farm Bureau CasualtyCompany. Inc. ([n re Soliz), 77 B.R. 93 (U. S. Bk.Ct. N. D. Tex. (Lubbock) 1987).

Insurance settlement proceeds that may bederived from a pre -petition coverage suit becomea bankruptcy estate asset upon filing of thepetition, because they arise from a cause of actionbelonging to the debtor which passes to thetrustee. Ralph Soliz, the Debtor, filed a pre-petition coverage suit in Texas in 1977 against anauto insurer and its agent, and the injured tortclaimants intervened to protect their prior NewMexico judgments. The Debtor filed bankruptcysome two years later, and the question arose as todistribution of the insurance proceeds uponsettlement with Southern Farm Bureau.

The Bankruptcy Court, per Judge Akard,determined that the Trustee succeeded to all thebankrupt's causes of action arising from thecontract right dispute with the insurer, asdistinguished from an acknowledged liabilitypolicy benefit. The tort claimants here were notentitled to a constructive trust as to the settlementproceeds because the cause of action was analleged contract right with the insurancecompany, which belonged exclusively to thebankrupt before the petition. Therefore, the tortclaimants would not be entitled to the coverageclaim as third-party beneficiaries. 77 B.R. at 97.

2. Pursuit of legal malpractice claims directly bythe Debtor: fewer reported opinions may indicatepursuit of claims by Trustees is more common.a Post-petition legal malpractice claim accruedafter Chapter 7 filed, upon filing of an objection toIRS exemption claim: under "legal injury" rule,Debtor may pursue malpractice claim, not Trustee.

Swift v. Seidler (In re Swift), 198 B.R. 927(U. S. Bk. Ct. W. D. Tex. [San Antonio] 1996);same case 129 F.3d 792 (5th Cir. (Tex.) 1997).In an odd twist, the Bankruptcy Court found thatSwift's post-petition legal malpractice claim) forerroneous pre-petition legal advice resulting indenial of IRS exemption of certain assets, had notaccrued prior to the bankruptcy and therefore wasnot "property of the estate." This cause of actiondid not accrue until the debtor's claimedexemption of an IRA drew an objection in thebankruptcy. 198 B.R. at 931. The Courtcharacterized this as an application of the "legalinjury" rule rather than the Texas "discovery rule."198 B.R. at 932, fn.1.

"Bad legal advice" was allegedly given priorto filing of a bankruptcy petition, the legal injuryof which was unknown until Swift's IRA wasdeclared a non-exempt asset. Swift was merelyconsidering bankruptcy when he requested pre-bankruptcy planning advice from attorney Seidlerabout debts and assets. Seidler later filed thebankruptcy for the Debtor. The IRS ruling on thenon-exempt asset was eventually approved by theBankruptcy Court, the U.S. District Court, and theFifth Circuit.

The Bankruptcy Court recognized generallythat pre-petition causes of action for legalmalpractice become property of the bankruptcyestate once the debtor files bankruptcy, if thedebtor could have brought the cause of actionunder applicable state law. If a legal malpracticecause of action under state law has accrued or wasfiled prior to the bankruptcy, then only the trusteeor debtor-in-possession may dispose of thiscontingent asset of the estate. 198 B.IL at 929-30.However, the Bankruptcy Court decided, in thisinstance, the Debtor was the proper party topursue the claim, not the Chapter 7 trustee. Thelegal malpractice claim was originally anadversary proceeding brought by the Debtor andthe Trustee, but the Debtor was allowed adismissal without prejudice, and the defendantattorney did not challenge the Trustee's standing topursue the claim. The Bankruptcy Court approvedthe compromise settlement agreement between theTrustee and the defendant attorney in 1993. In this







5

1996 opinion, however, the same Court ruled thatthe comprehensive settlement agreement with theTrustee was merely voidable at the instance of theadversely affected party (the defendant attorney),and since the attorney still faced the prospect ofliability to the debtor, he could move to rescind theCSA.

b Debtor obtains confirmed plan retaining allinterests in any subsequent malpractice litigation.

Simmons v. Johnson Curney & Fields P.C. (Inre Simmons), 205 B.R. 834 (U. S. Bk. Ct. W. D.Tex. [San Antonio] 1997). Jurisdiction, notstanding or accrual of the cause of action, was theissue presented here. However, under theconfirmed plan, the Debtor retained all interests inany subsequent malpractice litigation involvingstate and federal law claims and DTPA claims.The Bankruptcy Court recommended that the legalmalpractice claims be tried in one proceeding inBankruptcy Court rather than in U. S. DistrictCourt, although the District Court would haveoriginal and supplemental jurisdiction under 28U.S.C. 1334. See a further discussion of this casein Part V.A.3.

c Pre-petition legal malpractice c/a assertedpost-petition: Debtor could pursue where half ofrecovery would benefit creditors.

Andrews v. Diamond Rash Leslie & Smith,959 S.W.2d 646 (Tex. App.--El Paso 1997, writdenied).

This case appears to be an exception to therule that a pre-petition cause of action belongs tothe estate rather than the debtor. However, notethat the plan required that half of any proceedsrecovered would benefit the creditors. Here,summary judgment for the attorney defendantswas reversed and remanded allowing the Debtorto pursue pre-petition malpractice claims notbrought until six days short of two years afterfiling Chapter 11, unburdened by judicial estoppeldefenses. Pre-petition errors were alleged in thedefendant attorney's preparation of a 1988 realproperty lease. Approval of the Bankruptcy Courtwas obtained to engage counsel to sue the firm,within two years following the filing of the 1992bankruptcy petition. See Part III .A. I a. for adiscussion of the limitations aspects of this case.

d Debtor attempted legal malpracticecounterclaims, separate adversary proceeding, andstate court suit: pursuit halted by summaryjudgment and res judicata.

Akin v. McDaniel, not published,1991WL258732 C (Tex. App.--Dallas 1991, nowrit).

This case involved an adversary proceeding aswell as a state court suit attempting usury claimsagainst the attorney who represented the Debtorprior to bankruptcy. An adversary proceeding wasbrought against the attorney six years after the1981 petition, but was dismissed for lack ofjurisdiction. The state court action was broughteight years after filing bankruptcy, and theattorney-defendant obtained summary judgmenton limitations. The Debtor's summary judgmentmotion on usury was denied due to res judicata ofthe 1989 bankruptcy court ruling. The BankruptcyCourt ruled in favor of the attorney on his feeclaim and against the Debtor on the usury claim,which was appealed to the Northern District ofTexas.

e Client as Creditor of bankrupt attorney: norecovery if loss stems from poor investment.

In re Garver, 116 F.3d 176 (6th Cir.1997).Attorneys who invest in their clients businessesrun the risk of being sued if the venture fails; theGarver case is one instance when an attorney wasable to discharge a malpractice verdict in Chapter7. The attorney held controlling interest in one ofhis clients (a holding company), and was suedsuccessfully by another client who had invested inanother business acquired by the holdingcompany. The investor-client, REA, exchanged$600,000 for half interest in a company (A. A.Gage, later bankrupted) for an unsecuredpromissory note, which the attorney signed onbehalf of the holding company when it acquired allof the Gage stock. The attorney sought todischarge his liability (a $600,000 jury verdict) forbreach of contract and fiduciary duty.

The Sixth Circuit reversed the BankruptcyCourt and the District Court, which had found thedebt nondischargeable because it resulted in adefalcation by the attorney, a tax specialist, whoheld controlling interest in the holding company(Fostoria Braude Corp.). The Sixth Circuitdischarged the debt, since the client did notcontend the attorney misappropriated the money oraccounted for it improperly, and under the facts,





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the venture had simply turned out to be a poorinvestment.

B. Attorney Duties to Non-Clients: Alas,Privity, We Knew Thee Well1. Confusion as to legal representation: will the"real" client please stand up? Document thescope of engagement (or lack of one).

Like other lawyers, bankruptcy practitionersare vulnerable to actions by non-clients as well asclients, and even by third parties to thetransaction. It is fairly common for parties tomisunderstand the lack of a direct attorney-clientrelationship in some contexts. For example,confusion about representation may occur inmatters that may be linked with a bankruptcy, suchas real estate closings, probate estates, uncontesteddivorces, or with officers or shareholders of asmall corporation, or partners in a transaction.See, e.g., Poth v. Small, Craig & Werkenthin, 967S.W.2d 511, (Tex. App. - Austin 1998, writdenied) (corporation combined with a real estatepartnership); Vinson & Elkins v. Moran, 946S.W.2d 381 (Tex. App.--Houston [14th] 1997),writ dism'd by agr. (some evidence of directrelationship between attorney and beneficiaries ofestate); Parker v. Carnahan, 772 S.W.2d 151, 156(Texarkana -1989, writ denied) (divorce case);Gamboa v. Shaw, 956 S.W.2d 662 (Tex. App. -San Antonio, 1997, no writ) (purportedshareholder claimed third party beneficiary status).

Attorneys themselves sometimes lose focus asto whom they represent. In transactional matters,it is all too easy to begin thinking in terms ofdoing what ever it takes to make "The Deal"happen. Comfort letters and opinion letters areoften requested in order to facilitate "The Deal."Remember that attorneys represent clients, not"deals."

Texas courts apply the principle that if anattorney does not in fact represent a party, theattorney has a duty to notify one who manifests areasonable belief that the attorney represents thatperson or entity, that the attorney is notrepresenting that party. See, e.g., Parker v.Carnahan, supra, Banc One Capital PartnersCorporation v. Kneipper, 67 F.3d 1187, 1199 (5th

Cir. (Tex.) 1995).It is the attorney's duty to resolve the

ambiguity as to the existence of an attorney-clientrelationship, at the earliest feasible opportunity.It is also in the attorney's best interest to do so, toavoid legal malpractice claims. Once the claim

has been brought, the alleged client's memory may"recover" additional details allegedly confirmingthe understanding of representation, often to theattorney's astonished disagreement. Therefore,documenting the lack of representation is animportant step toward preventing legalmalpractice claims by non-clients.

a Acknowledged dual representation of lenderand borrower in buyout: written waiver of conflictinvalid without disclosure of independent counseland counsel’s independence of judgment.

Sometimes, even a written waiver of conflictconsenting to dual representation is insufficient toward off a malpractice action. In General MotorsAcceptance Corp./Crenshaw Dupree & MilamLLP v. Crenshaw Dupree & Milam LLP, 986S.W.2d 632 (Tex. App .- El Paso 1998), theattorneys were sued by GMAC after theborrower's claims against GMAC and the law firmwere settled. The borrower had signed a waiver ofconflict, but because of the conflict of interest,sued GMAC and the law firm handling thefinanced acquisition of a Hyundai dealership.GMAC sued the law firm for having failed toobtain a valid written waiver from borrower.

The Court reversed and remanded the lawfirm's summary judgment, agreeing that theborrower's waiver was ineffective because the lawfirm attempted to represent both lender andborrower in the financed acquisition, and the riskswere not properly explained. Specific issuesconcerned failure to disclose the need forindependent counsel and the independence ofjudgment issues regarding the law firm's dualrepresentation. 986 S.W.2d at 635. As attorneyand agent for GMAC, a fiduciary duty existed toobtain a valid written waiver. Id. At 636.

b Third party type claims against attorneys:privity stands with the Trustee not the Debtor.

In re Solomon, ___ F. Supp. ___, 11 Tex. U.S.Bk. Ct. Rep. 162, 1997WL102485 (D. N. D. Tex.March 5, 1997).

This appeal resulted from a summaryjudgment by the Bankruptcy Court, declaring thatthe plaintiffs (the individual debtor and his wife)had no cause of action against the trustee’sattorneys and no standing to sue the trustee (anattorney). The debtor and his wife allegeddamages of $2 million for negligent administrationof the estate specifically regarding certain landsales, as well as collusion and breach of trust.












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The Northern District affirmed the summaryjudgment as to the trustee's attorneys on privitygrounds, citing Taco Bell v. Cracken, 939 F. Supp.528 (D. N. D. Tex., 1996) for the general rule thatattorneys are not liable to non-clients for damagesresulting from legal services performed. TheCourt reasoned that the trustee's attorneys wereapproved by the court to represent the bankruptcyestate and the trustee, therefore they had no legalduty to the Debtor (or his wife) individually.

As to the trustee, the Court affirmed thesummary judgment due to lack of individualstanding by the debtor and his wife to bring claimsagainst the trustee for direct injuries to the estate.However, since the alleged damages exceeded thevalue of the bankruptcy estate, the Courtdetermined that the Debtor and his wife were notmerely asserting claims on behalf of creditors, butthat if the damages were proved there would be asurplus to which they might be entitled asindividuals. Reversing that portion of thesummary judgment as to the "surplus" damageclaims against the trustee, the individual debtorand his wife did have standing, based on theCourt's "pleadings only" review. The Court didnot adopt the trustee's argument that his actions astrustee were protected by absolute immunity sincethe Bankruptcy Court had approved them.

c Individual corporation officers have no privitywith the attorney representing the corporation.

Poth v. Small, Craig & Werkenthin, 967S.W.2d 511, (Tex. App. - Austin 1998, writdenied).

Summary judgment for the defendantattorneys was affirmed. The corporation's legalmalpractice claims were barred due to limitations,and personal claims against the attorneys by thePlaintiff president were barred due to lack ofprivity. Held: the discovery rule did not toll thestatute of limitations for the Plaintiff / president,because knowledge of the real estate partners wasimputed to the corporation, since they wereoperating the company under the voting trust,acting under a broad power of attorney, and wereauthorized to exercise other controls, and thealleged legal errors/omissions were not "inherentlyundiscoverable."

Poth, the president/ sole shareholder of acorporation, and two other persons had a realestate partnership that worked closely with thecorporation, a construction business. In a cash-flow crunch, control of the corporation wastransferred by the president / sole shareholder to

the two real estate partners in exchange forfunding of certain expenses; among them someanticipated litigation. Attorneys for the real estatepartners prepared the documents.

The president also entered a voting trustagreement whereby the real estate partners becametrustees of the president's stock voting rights in thecompany. The president also granted the partnersa general power of attorney, which designated alaw firm to represent the corporation's interests.However, the real estate partners hired thedefendant law firm which billed $400,000 to thecorporation for work on a case, creating ashortfall.

d Beneficiaries of a probate estate have noprivity with the attorney for the executor, butevidence may establish a direct attorney-clientrelationship.

Vinson & Elkins v. Moran, 946 S.W.2d 381(Tex. App.--Houston [14th 1997, writ dism'd byagr.).

Although not a bankruptcy case, this legalmalpractice case received substantial publicitybecause the jury verdict exceeded $35 million tothe heirs of a large estate, based in part on someevidence of a direct attorney-client relationship.The heirs of W. T. Moran stood to inherit an estatevalued between $85-100 million, and First CityNational Bank (FCNB) was one of three co-executors originally appointed to handle theadministration. FCNB hired Vinson & Elkins tofile a will construction suit in 1984, which waseventually settled and V&E took over theadministration from another law firm. The juryfound V&E liable for negligence, breach offiduciary duty, conspiracy, and DTPA violations,largely based upon failure to reveal multipleconflicts of interest and also "bad advice"regarding deferral of the federal estate tax.

The Fourteenth Court of Appeals reversed inpart, finding that the heirs had no standing to sueunder a malpractice assignment from thesuccessor executor, however there was someevidence to support direct liability to the'beneficiaries on the jury's finding that anattorney-client relationship had been createdbetween V&E and the beneficiaries.







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2. Attempts by Non-Clients to create a"constructive" attorney-client relationship: effortsto expand an attorney's duties beyond the privitycircle.a Disappointed shareholders of bankruptcorporation: no third party beneficiary protectionfor putative shareholder.

Gamboa v. Shaw, 956 S.W.2d 662 (Tex. App.--San Antonio, 1997, no writ).

Summary Judgment for the attorney defendantwas affirmed on appeal, in an action where theunderlying litigation by the purported shareholderalleged breach of fiduciary duty, conflict ofinterest, and civil conspiracy against the attorneywho represented the corporation and majority.Here, the Court ruled that an attorney's liabilityfor failing to fulfill duties to corporate client (suchas preventing wrongs against the corporation) donot extend to shareholders and creditors ofcorporation because of privity rules. Gamboa hadinvested in a company which filed bankruptcy andhe alleged that attorney Shaw failed to fulfill hisduties to the corporation, damaging third partybeneficiaries of the corporation such as creditorsand alleged shareholders.

Citing Barcelo v. Elliott, 923 S.W.2d 575(Tex. 1996), the Court of Appeals applied theprivity rule barring the claims for breach offiduciary duty and conflict of interest, noting thatan attorney owes no duty to non-client thirdparties, even if the third party is damaged by theattorney's negligent representation of the client.956 S.W.2d at 664. In theory, the conspiracyrelated back to the two shareholders havingallegedly misappropriated company assets, whichgave rise to the initial litigation. The Courtaffirmed the summary judgment for the attorney asto the conspiracy theory, because the cause ofaction for wrongs against a corporation belongsto the corporation and not to the shareholders,even if Gamboa could have raised a fact issue as tohis shareholder claim. Id. at 666.

b More problems w/Non-Clients: negligentmisrepresentation theories and reliance by otherparties to a transaction or lawsuit.(1) (1). Title opinion: negligent misrepresentationcause of actionrecognized under Section 552,Restatement of Torts (Second), in absence ofprivity.

First National Bank of Durant v. Trans TerraCorporation International v. Douglass, 142 F.3d802 (5th Cir. (Tex.) 1998).

An attorney provided a title opinion for itsclients, Trans Terra and Mr. Epps, then provided asupplemental title opinion on November 22, 1993,addressed to the Bank as requested by the clients,for the purpose of closing a $1.5 million loantransaction. The opinion recited that the deedrecords had been examined from inception up tothe date of the November 22 opinion, when in factthe attorney had not physically examined thecourthouse records to supplement the title opinionshe provided previously to his clients. The attorneyrelied on information from the client, Mr. Epps,and the landman but he had received no newinformation from the landman prior to theNovember 22 supplemental title opinion.Unfortunately, the opinions reflected the client'snet revenue interest as .33 on the subject wells, butthe correct NRI were .039375 and .028150.

The jury awarded damages to the bank equalto the loan deficiency, finding that the attorneyhad been negligent and that there was an attorney-client relationship created. The Court grantedjudgment notwithstanding the verdict, finding thatthe bank was not the attorney's client. At thispoint, the attorney obtained a summary judgment,then dismissed his bankruptcy case.

The Fifth Circuit reversed and remanded,holding that there was no attorney-clientrelationship between the title opinion attorney andthe bank, and therefore no viable claim fornegligence or legal malpractice. Merelyaddressing the opinion letter to the bank at therequest of his client was not sufficient to create anattorney-client relationship. 142 F.3d at 808.Also, the Court was not concerned about a conflictof interest, since presumably both the client andthe Bank would desire accuracy in the title opinionletter. Id., at 810. However, the Fifth Circuitfound that under Texas law, the bank did have acause of action for negligent misrepresentation asalleged, and affirmed the jury's liability verdictagainst the attorney on this issue. The bank hadexpressly waited to fund the loan pending receiptof the attorney's updated title opinion. 142 F.3d at810.

Citing Federal Land Bank Association ofTyler v. Sloane, 825 S.W.2d 439 (Tex. 1991), theFifth Circuit opted to follow the standard ofSection 552, Restatement of Torts (Second)(1977), as follows:

“(1)One who, in the course of his business,profession or employment, or in any othertransaction in which he has a pecuniary








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interest, supplies false information for theguidance of others in their businesstransactions, is subject to liability forpecuniary loss caused to them by theirjustifiable reliance upon the information, if hefails to exercise reasonable care orcompetence in obtaining or communicatingthe information."

Justice Jones dissented, emphasizing that Texascase law is unclear regarding the liability oflawyers for negligent misrepresentation absent aprivity relationship, and noting direct conflict intwo lines of Courts of Appeals cases as to theirstatement of the law in Texas. She commentedthat the Appling case cited by the majority [F. E.Appling Interests v. McCamish Martin Brown &Loeffler, 991 S.W.2d 787 (Texas 1999)],discussed hereinbelow, departs from prior caselaw in Texas, and therefore she would not havecited it as representing the Texas law to be appliedin federal court. However, the Texas SupremeCourt has negated that concern with its affirmanceof the Texarkana Court of Appeals decision.

(2) Private placement memorandum opinionletter: lack of privity with investors barsnegligence and malpractice claims against attorneyfor representations but fraud and conspiracyclaims survive (no theory of negligentmisrepresentation discussed).

Banc One Capital Partners Corporation v.Kneipper, 67 F.3d 1187, 1119 (5th Cir. (Tex.)1995).

Banc One invested $1 million in a $7.5 millionprivate placement offering in Film Dallas, Inc., amovie production company which filed forbankruptcy after raising most of the capital. BancOne and the other investors sued the sellers andJones, Day, Reavis & Pogue, which prepared theprivate offering memorandum. Kneipper, apartner of the law firm, had formed Film Dallas asa joint venture party, and he was also an officerand Chairman of the Board of Film Dallas whenthe private offering was made.

The securities were offered as all-or-nothing,such that if they did not obtain the $7.5 millioncapital by the deadline, the investors' funds wouldbe returned. In connection with the closing, thelaw firm provided an opinion letter to the investorsthat all of Film Dallas' material contracts andagreements had been disclosed. The firm's lettercontained a disclaimer that it was furnished "ascounsel for the company, to you, solely for your

benefit, and we are not hereby assuming anyprofessional responsibility to any other personwhatsoever."

However, it was not disclosed until after theclosing that one of the investor's contributions wassubject to a $500,000 reduction for rent escrow.Also, the original joint venture partner requiredKneipper and another party to sign a stockrepurchase agreement, which agreement was notdocumented until after the closing. However,representations were made to the investors that thejoint venture partner had agreed to invest anadditional $500,000.

The jury found for the investors on theirconspiracy allegations, but against them onsecurities fraud. The District Court had grantedsummary judgment to the defendants on theprofessional negligence and legal malpracticeclaims, entering a take nothing judgment as to allfour issues decided by the jury. Evidently, noallegation of negligent misrepresentation wasraised in the pleadings, as the opinion of the FifthCircuit does not address this issue.

The Fifth Circuit held as a matter of law thatthe parties had manifested no intent to create anattorney-client relationship, and the disclaimerwas sufficient to alert. the investors that Jones,Day did not represent them. Therefore, thesummary judgment was affirmed as to professionalnegligence and legal malpractice. 67 F.3d at 1199.By failing to assert a res judicata defense timely,the defendants waived that defense, which mighthave estopped the investors' claims because of arelease contained in Film Dallas' confirmed planof reorganization. The ease was remanded for anew trial on the securities fraud and conspiracyclaims.

(3) Litigation settlement documents: duty owed toopposing litigant, negligent misrepresentationcause of action recognized under Section 552,Restatement of Torts (Second), for representationsmade by attorney and client, absent privity.

F. E. Appling Interests v. McCamish MartinBrown & Loeffler, 991 S.W.2d 787 (Texas 1999).The opinion of the Texarkana Court of Appealswas criticized in the dissenting opinion of FirstNational Bank of Durant v. Trans TerraCorporation International v. Douglass, supra,however the Texas Supreme Court affirmed theCourt of Appeals and reversed the attorneys'summary judgment.





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McCamish represented Victoria Savings in thesettlement of litigation between it and ApplingInterests (Appling), which had its own counsel.McCamish and Victoria Savings warranted in thesettlement documents that the settlement would beenforceable against the FSLIC. However, VictoriaSavings already had been placed undersupervisory control by State regulators, meaningthe Board had no authority to commit to thesettlement without obtaining regulatory approval,which was not done. The FSLIC was able tooverturn the settlement, and the trial court grantedsummary judgment to McCamish (no duty) andthe Court of Appeals reversed & remanded.

Citing no Texas case law, the Texarkana Courtreversed the summary judgment for the attorneydefendants, applying a negligent misrepresentationtheory under Section 552 of Restatement (Second)of Torts. The Texarkana Court stated that thespecific representation made to Appling was oneon which it was known Appling would rely,therefore an independent duty arose betweenattorney McCamish and non-client Appling, eventhough Appling was represented by its owncounsel in the litigation settlement. The SupremeCourt affirmed, giving the Appling parties anopportunity to prove their negligentmisrepresentation claims.

c Still more problems with Non-Clients: RICOand conspiracy claims; legal malpractice orintentional tort claims related to wrongfulforeclosure and execution claims; legalmalpractice assignments fail(1) Disgruntled investors sue law firm forbankrupt corporation, win remand to assert RICOand conspiracy claims against firm.

Brouwer v. Raffensperger, Hughes & Co., 199F.3d 961(7th Cir. 2000), cert. den. 120 S. Ct.2688 (U. S. 2000). Here, non-client investors suedthe law firm after the insiders settled allegations ofsiphoning off corporate assets and creating awholly owned subsidiary. Civil RICO andconspiracy claims are usually not covered by mostprofessional liability policies. The Seventh Circuitheld that proof of the RICO violations could bebased on knowingly facilitating the unlawfulactivities of operators or managers, and personalparticipation would not be required. Seeadditional discussion below, under IV.B.2.Uncovered Claims.

(2) No attorney liability found for wrongfulforeclosure, j.n.o.v after jury trial on remand.

Gulf Coast Investment Corporation v. Brown,821 S.W.2d 159 (Tex. 1992).

The underlying wrongful non-judicialforeclosure case gave rise to a legal malpracticeclaim which was tolled until final resolution of thewrongful foreclosure action. The attorneyrepresenting the creditor failed to give propernotice of intent to accelerate the note, nullifyingthe foreclosure. Form letters were sent to therespective debtors giving notice of default, butomitting notice bf intent to accelerate. TheDebtors, the Smiths and the Katonas3 sued thelawyers and the creditor for wrongful foreclosurefor failure to notify of the intended acceleration.The summary judgment on limitations for theattorneys was reversed and remanded.

On trial after remand, the judgment wasgranted notwithstanding the verdict, and affirmedby the Fourteenth Court of Appeals, finding thatthe evidence supported the jury verdict against thecreditor but exonerated the attorney defendantsfrom any negligence or breach of fiduciary duty.Opinion after remand not published,1994WL151355 (Tex. App.--Houston [14th] 1994,no writ).

(3) Creditor/client cannot assign legal malpracticeclaims to wrongful foreclosure claimant.

McLaughlin v. Martin, 940 S.W.2d 261 (Tex.App.--Houston [14th] 1997, no writ).

This opinion reiterates the principle that legalmalpractice claims are invalid in Texas and notassignable, regardless of whether the malpracticeclaims were based on litigation or non-litigationsituations. This non-bankruptcy case involved awrongful foreclosure suit against the attorney andclient (creditor), and the client settled, giving anassignment to the plaintiff/borrower of legalmalpractice claims against the attorney. Theplaintiff/borrower had sued American GeneralRealty Investment Corporation (AGRIC) whichheld the notes and deed of trust, and also itsattorneys (who were non-suited at time of trial).Following the granting of a partial summaryjudgment to AGRIC, a mediated settlement wasreached with AGRIC in which it assigned its legalmalpractice claims to the plaintiff.








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(4) Non-Client creditors: attempted assignmentsof legal malpractice claims by Trusteeunsuccessful

In re J. B. Marion Inc., 199 B.R. 635 (U. S. Bk.Ct. S. D. Tex. [Houston] 1996).

In this Involuntary Chapter 7 case, a creditorgroup sought to prosecute contingent claims of thedebtor, via an assignment of those assets(including legal malpractice claims) by thebankruptcy trustee by motion under 11 U.S.C. Sec.363. The creditors objected to the attorney's claimfor $65,867.24 in fees and expenses, and allegedlegal malpractice claims (e.g., waste of assets,diminution of estate value) against the debtor'sformer counsel.

The Bankruptcy Court held that all claims bythe debtor's estate except the legal malpracticeclaims, could be assigned by the trustee to thecreditor group. For public policy reasons,however, the Court concluded that the legalmalpractice claims against former counsel for thedebtor are non-assignable by the trustee, andremain assets of the bankruptcy estate under 11U.S.C. Sec. 363. 199 B. R. at 638. Only thetrustee could pursue the pre-petition and post-petition legal malpractice claims on behalf of thedebtor's estate under 11 U.S.C. Sec. 541(a) (7), (c)(1) (1978), which allows the property of the debtorto be transferred to the estate without regard tostate law conditions or restrictions. Id.

(5) No summary judgment for attorney assistingU. S. Marshal in writ of execution, tort claims ofdebtor's wife withstand 12(b)(6), attorney was notperforming professional legal services.

Miller v. Stonehenge/FASA-Texas JDC L.P.,993 F.Supp. 461 (D. N. D. Tex. [Dallas] 1998).

In this case, the wife of a judgment debtorsued the attorney and judgment creditor for abuseof process, invasion of privacy, intentionalinfliction of emotional distress, conspiracy, andcivil rights violations. The wife was not a party tothe underlying civil action and not liable under the$23.6 million judgment. Collier, the attorney forthe judgment creditor, had obtained a writ and anorder in aid of execution. The opinion recites thatCollier demanded access and under threat of force,inspected, inventoried, and videotaped the wife's"personal and intimate" property and effects, anddemanded that she not leave the premises. Theattorney had accompanied two U. S. Marshals,three jewelry appraisers, a videographer, and alocksmith to execute the writ at the Dallas home ofjudgment debtor Vance C. Miller, who was not

there although the wife was. Soon, her two sonsand the husband's attorney arrived, and theycautioned Collier that only the husband's non-exempt property was subject to the writ, and thesons insisted that there was no such property onthe premises.

The attorney's 12(b)(6) motion was denied, perChief Judge Buchineyer. The Court reasoned thatthe U S. Marshal, not the creditor's attorney, isresponsible for serving a writ of execution and theattorney is not an "anticipated or essentialparticipant in this process." 993 F.Supp. at 465.Regardless of the order in aid of execution, theCourt held that the skills of an attorney had norole in the events and the order did not authorizeCollier to "accost" the wife on her way to the caror to prevent her from leaving the premises. Theattorney was not performing any professionalduties by assisting in the execution of the writ,therefore the wife's claims against the creditor'sattorney withstood the motion to dismiss.

[status note: per the Court Clerk, the case wastried to a take nothing judgment on July 24, 1998,and the defendant discharged]

3. Joint defense arrangement may extend duty ofconfidentiality to non-client, even if notdisqualified from representation.

International Trust Corp. v. Pirtle, 1997 W.L.20870 (not published) (Tex. App.- Amarillo1997). A bankrupt joint venturer tried todisqualify an attorney hired to represent anotherjoint venturer in litigation defense, and prevent theattorney from testifying as to confidentialinformation in a subsequent arbitration. There hadbeen a provision in the joint venture agreementwhich gave the venturer a right to approve counselhired to represent the venture.

The alleged conflict arose from the attorney'sattempt to represent the joint venture and itsconstituent in litigation which resulted inarbitration concerning the underlying joint ventureagreement. The attorney contended that he was notprohibited from disclosing what he learned indiscussions with the venturer because there was noattorney client relationship.

The Court agreed that no such relationshipexisted and denied the mandamus to compel thetrial court's disqualification of counsel; however,applying Disciplinary Rules 1.06, 1.09, and 1.12,held the attorney would be prohibited fromdisclosing confidential information learned in a“joint defense” between the venturer and the jointventure. The Court concluded that although there





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was no written joint defense agreement, there wasa joint defense, and that the hiring of the attorneyover the other venturer’s objection may have beena breach of the agreement. However, it was notgrounds for disqualification (and the venturer mayhave waived the breach by authorizing limitedrepresentation by the attorney).

The moral of the story: when engaged incooperative efforts between and among creditors'committees, debtors, litigants, and similaralliances, consider the potential for duties ofconfidentiality that might apply by extension.

C. Consumers to a Transaction:Responsibilities To Clients and Non-Clientsunder the Texas Deceptive Trade Practices Act1. Post-1995 DTPA issues involving legalservices.

The DTPA was amended in 1995, limiting itsimpact on professional malpractice claims againstattorneys and law firms. Published appellateopinions decided under the 1995 amendments arefew in number. However, whether one is a"consumer" to the transaction and protected by thestatute is a question of law (and potential summaryjudgment material), although the factual evidencemay prove or disprove one or more of consumerstatus. See, e.g., 3Z Corporation v. Stewart TitleGuaranty Co., 851 S.W.2d 933 (Tex. App.-Beaumont 1993, writ denied).

A developing area concerns professionalopinions rendered in business transactions for thebenefit of parties other than the client. Notice thecommon elements of certain facts in First NationalBank of Durant v. Trans Terra CorporationInternational v. Douglass, 142 F.3d 802 (5th Cir.(Tex.), 1998), Banc One Capital PartnersCorporation v. Kneipper, 67 F.3d 1187 (5th Cir.(Tex.) 1995), and Arthur Andersen v. PerryEquipment Corp. 945 S.W.2d 812 (Tex. 1997). Inthese cases, respectively, representations weremade at a client's request to a bank (oil and gastitle opinion), private investors placement offeringmemorandum), and to the purchaser of a business(audited financial statements). Causes of actionfor legal and accounting malpractice wererecognized in the TransTerra case (negligentmisrepresentation) and in Perry Equipment(DTPA), in spite of the absence of privity.

Section 17.49 (c) of the Texas Business &Commerce Code now provides the followingexemption:

"Nothing in this subchapter shall apply to aclaim for damages based on the rendering ofprofessional service, the essence of which isthe providing of advice, judgment, opinion, orsimilar professional skill. This exemption doesnot apply to:(1) an express misrepresentation of a materialfact that cannot be characterized as advice,judgment, or opinion;(2) a failure to disclose information inviolation of section 1 7.46~)(23);(3) an unconscionable action or course ofaction that cannot be characterized as advice,judgment, or opinion;(4) breach of an express warranty that cannotbe characterized as advice, judgment, oropinion."

Attorneys should not overlook the significance ofthe 1995 monetary exemptions of Section 17.49 (1)and (g), when representing clients in bankruptcymatters involving complaints concerning realestate transactions, especially agricultural realestate matters. This could prove important inclaims for or against your client1 or against you, ifyou performed legal services in a non-exempt realestate transaction. See, e.g., Arthur Andersen v.Perry Equipment Corp., 945 S.W.2d 812 (Tex.1997).

The 1995 DTPA exemption for writtencontracts applies to a transaction or project or setof related transactions of consideration exceeding$100,000 and not involving the consumer'sresidence ["homestead" is not mentioned in thisprovision]. Also, deals are exempt from theDTPA which involve consideration of over$500,000 (no written contract requirement) and donot involve a consumer's residence [again,"homestead" is not mentioned]. In other words,for non-residential real estate transactions of morethan $100,000, attorneys need to be aware thatafter the 1995 DTPA amendments, the generalexposure to these particular DTPA claims is nowmore limited than it is for transactions of 1ess than$100,000 or for transactions involving consumerresidences.

2. Professional services exemption under theDTPA (1995).(1) DTPA claims by clients: Northern Districtobserves liability exemption for law firm after1995 amendments.







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The Cadle Co. v. Sweet & Brousseau, P.C.___ F. Supp. ___, 1998WL101749, No. 3:97-CV-0298-G (D. N. D. Tex. March 3, 1998);1998WL158660 (March 26, 1998, opinion onm/reconsider).

The client company complained about the lawfirm's failure to respond to admission requests in asuit on a note. After a judgment against the client,it sued alleging legal malpractice and DTPA. Thelaw firm's motion for partial summary judgmentwas granted, based on the argument that TEX.BUS. & COMM. CODE Sec. 17.49(c) exemptsthe firm from DTPA liability. Judge Fishobserved that 17.49(c) provides that thissubchapter does not apply to damage claims basedon rendering of professional services. Initially, thepartial summary judgment was granted due to theclient's failure to respond to the firm's motion.The Court denied the motion to reconsider, afterclarifying that Cadle Company respondedbelatedly without leave.

b DTPA claims by non-clients: reliance onrepresentations and third-party beneficiarytheories.(1) Notice to a non-client they are not your client.Parker v. Carnahan, 772 S.W.2d 151, 156 (Tex.App.--Texarkana 1989, writ denied).

Although this was not a bankruptcy matter,this case is often cited as the leading authority forthe rule that an attorney has a duty to give noticeof non-representation to one who manifests areasonable belief that the attorney representsthem, if in fact the attorney does not represent thatparty. Here, the wife was held to be a DTPAconsumer as to the husband's acquisition of legaland accounting services.

(2) DTPA mental anguish requires proof ofproducingcause, but not "suit within a suit" as innegligence (pre-amendment claims).

Latham v. Castillo, 972 S. W.2d 66(Tex.1998).

This legal malpractice case arose out of amedical malpractice cause of action accruing priorto the 1995 DTPA amendments. The trial courtdirected a verdict against plaintiffs on all claims.Summary judgment for Latham, the lawyer, wasreversed and remanded as to the pre-1995 DTPAclaims, based on some evidence of producingcause of mental anguish damages, even though noevidence of economic damages was shown.Summary Judgment was upheld for the lawyer on

the claims of fraudulent misrepresentation andbreach of contract, plaintiffs taking nothing due tolack of pleading or proof of fraud damages ormedical malpractice damages or out of pocketlegal expenses.

The Supreme Court said that DTPA claimsrequire proof of producing cause of actualdamages, but proof is not required that theunderlying case would have been successful inorder to recover against the attorney, as it wouldbe in an ordinary malpractice claim. Mentalanguish damages were the only damages alleged,and were held not recoverable under breach ofcontract theory. The Supreme Court notes that thetrial court should instruct the jury at trial onremand, that jurors must distinguish betweenmental anguish caused by the underlying matter(death of the two minor daughters), and the mentalanguish caused by the attorney's actions.

Attorney Latham had successfully obtained alegal malpractice settlement of $400,000 based onthe first lawyer's unauthorized $70,000 settlementof a $6,000,000 default judgment, as to first of twodaughters. Latham was hired on the legalmalpractice case about two months before the two-year statute ran on the underlying claim regardingthe second daughter (2/14/90). Some evidence ofan affirmative misrepresentation by the attorneywas cited, that it was unconscionable to representthat he was actively prosecuting the medicalmalpractice claim for the death of the seconddaughter, when he was not doing so. A DTPAclaimant must prove producing cause of actualdamages, but need not prove the suit within a suit"element of Cosgrove v. Grimes, 774 S.W.2d 662(Tex. 1989), as in a legal malpractice claim.

(3) Audited financial statements as basis forDTPA claims against accounting firm (attorneys,be alert).

In addition to actions for negligentmisrepresentation, conspiracy, and RICOviolations, non-clients may also assert DTPAclaims against professionals performing servicesfor clients. Arthur Andersen v. Perry EquipmentCorp., 945 S.W.2d 812 (Tex. 1997). Although thisopinion pre-dates the Appling decision and the1995 amendments to the DTPA, it illustrates theimportance placed by juries and courts on thereliance of a third party based on professionalopinions provided for the benefit of a client intransactional matters, especially when recoveryfrom a bankrupt party directs blame toward theprofessionals. In Perry Equipment, the purchaser






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of a business brought a third-party DTPA actionagainst an accounting firm, when the business itbought filed for bankruptcy fourteen months afterthe sale. The jury found fraud, negligence (51%),breach of warranty, and violation of the DTPA,but not negligent misrepresentation or grossnegligence.

The Supreme Court held that the third party(purchaser) had consumer standing under theDTPA because the purchase of the company wasconditioned upon an independent audit, andacquisition was based upon that audit. 945 S.W.2dat 815, fn. 1. The Court pointed out that the auditreport of a favorable financial condition wascentral to the decision to buy, not merelyincidental.

The original $9 million judgment was reversedand remanded for review of the measure ofdamages and attorney fees. Also, the Court notedthat attorneys’ fees under the DTPA cannot besupported solely by a contingent-fee agreement.Justice Cornyn wrote for the majority, "to recoverattorney's fees under the DTPA, the plaintiff mustprove that the amount of fees was both reasonablyincurred and necessary to the prosecution of thecase at bar, and must ask the jury to award the feesin a dollar amount, not as a percentage of thejudgment." The second and revised opinion of theSupreme Court changed some of the language ofthe first opinion, but reached the same ultimateconclusion.

(4) Beneficiaries of a probate estate are notconsumers and have no DTPA standing.

Vinson & Elkins v. Moran, 946 S.W.2d 381(Tex. App.-Houston [14th] 1997), writ dism'd byagr.).

This legal malpractice case was brought byand on behalf of the heirs of W. T. Moran. Theystood to inherit an estate valued between $85-100million, and First City National Bank (FCNB) wasone of three co-executors originally appointed tohandle the administration. FCNB hired Vinson &Elkins (V&E) to file a will construction suit in1984, which was eventually settled and V&E tookover the administration from another law firm.

The jury found V&E liable for negligence,breach of fiduciary duty, conspiracy, and DTPAviolations, largely based upon failure to revealmultiple conflicts of interest and also "bad advice"regarding deferral of the federal estate tax.

The Fourteenth Court of Appeals reversed inpart, holding that the beneficiaries had no viableDTPA claims because they were not "consumers,"

and therefore had no standing under the Act to suethe estate's attorneys. Also, the Court found thatthe heirs had no standing to sue under amalpractice assignment from the successorexecutor (a bank). However, there was someevidence to support the jury's finding of directliability to the beneficiaries that an attorney-clientrelationship had been created between V&E andthe beneficiaries, due to the course of conduct ofthe law firm (meeting with beneficiaries,answering questions, providing copies ofcorrespondence, etc.). The Court confirmed thatlegal malpractice claims are not assignable inTexas, and that only the representatives of theestate or their successor representatives wouldhave standing 10 assert legal malpractice claimson behalf of the estate, and could not make a validassignment of legal malpractice claims (whetherbased on ordinary negligence or intentional torts)to the beneficiaries.

(5) Title companies subject to DTPA claims foraffirmative misrepresentation as to lack of defects:consumer status is a question of law.

3Z Corporation v. Stewart Title Guaranty Co.851 S.W.2d 933 (Tex. App.--Beaumont 1993, writdenied).

In this non-bankruptcy case, SummaryJudgment for the title company was reversed andremanded for trial on a landowner's standing asDTPA consumer, because of a material factquestion as to whether the title company wasselling a title policy being purchased by thegrantee, or whether the title company wasproviding a free title examination. Stewart TitleCompany of Montgomery County, Inc., arguedunsuccessfully that the grantee, 3Z, was not aconsumer because it failed to purchase the titlepolicy within the life of the policy commitment.

The question of DTPA consumer status is aquestion of law and the title company failed toestablish as a matter of law that the buyer was nota consumer. The Beaumont Court notes there is adistinction under the DTPA between failure todisclose information and an affirmativemisrepresentation. However, a title company canbe liable under the DTPA for affirmativelymisrepresenting the lack of title defects, eventhough it owes no duty to discover and discloseany defects. 851 S.W.2d at 937.







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III. LIMITATIONS PERIOD ON ASSERTINGLEGAL MALPRACTICE CLAIMS FORDEBTORS

As a general proposition in Texas, the two-year statute governs legal malpractice and DTPAclaims against attorneys. Willis v. Maverick, 760S.W.2d 642 (Tex. 1988), TEX. BUS. & COMM.CODE, Sec. 17.565; Randolph v. Resolution TrustCorporation, 995 F.2d 611 (5th Cir. (Tex.) 1993).In cases where the alleged legal error or omissioncould not have been discovered within the two-year period, then the "discovery rule" alsolengthens the filing period. Willis v. Maverick,supra. However, the statute may be tolled inmatters of underlying litigation, until theconclusion of all proceedings of the litigation.Hughes v. Mahaney & Higgins, 821 S.W.2d 154(Tex. 1991). The Hughes rule was followed in awrongful foreclosure context, where the statute oflimitations was tolled on the legal malpracticeclaim against an attorney conducting a non-judicial foreclosure, until final resolution of thewrongful foreclosure action. Gulf CoastInvestment Corporation v. Brown, 821 S.W.2d159 (Tex. 1992). In UNC. Inc. v. Hall, __ F.Supp.___ 1998 WL 118151, No. 3:96-CV-2456-P (D.N.D. Tex. 1998); however, the underlyinglitigation established no error-in-fact in thedrafting of certain promissory notes, therefore thelegal malpractice action was barred by collateralestoppel.

An exception to the Hughes tolling rule can befound in tax deficiency cases, in which the noticeof the deficiency triggers the running of thestatute, and not the concluding date of allproceedings determining the ultimate outcome ofthe tax dispute. Murphy v. Campbell, 964 S.W.2d265 (Tex. 1997).

The bankruptcy tolling provision, 11 U.S.C.Sec. 108 (a) (1993), allows the trustee or thedebtor to pursue a legal malpractice claim as lateas two years after the order for relief Andrews v.Diamond Rash Leslie & Smith, 959 S.W.2d 646(Tex. App.--El Paso 1997, writ denied).

Fraud allegations in malpractice cases,however, fall under the four-year statute, subjectto the same tolling considerations. Williams v.Khalaf, 802 S.W.2d 651 (Tex.1990). A four-yearperiod also applies to contract actions (as in feedisputes). TEX. CIV. PRAC. & REM. CODE Sec.16.004; Jampole v. Matthews, 857 S.W.2d 57(Tex. App.--Houston [1st] 1993, writ denied).

A. Limitations on Legal Malpractice Actionsas Applied in Bankruptcy1. Statutory tolling under 11 U.S.C. Section108(a).a Limitations extended by "discovery rule" dateprior to bankruptcy and additional statutory tollingunder 11 U.S.C. Sec. 108 (a).

Andrews v. Diamond Rash Leslie & Smith,959 S.W.2d 646 (Tex. App.--El Paso 1997, writdenied).

Summary judgment for the attorneydefendants was reversed and remanded, allowingthe Debtor to pursue pre-petition malpracticeclaims not brought until nearly six years after theerror, but just six days short of two years afterfiling Chapter 11, unburdened by judicial estoppeldefenses. However, note that the plan required thathalf of any proceeds recovered would benefit thecreditors.

Pre-petition errors were alleged in thedefendant attorney's preparation of a 1988 realproperty lease, which allegedly damaged Andrewswhen rail service to the property was cut off andnot restored and no rental reduction was obtained,and eviction occurred (sometime between October1990 and July 1992) for failure to make leasepayments. Chapter 11 was filed by Andrews July7, 1992, listing a legal malpractice claim against adifferent firm that unsuccessfully defended theeviction, but not listing any claims specificallynaming defendants Rash and his law firm. Also,no specific mention of that claim was made in thefirst amended plan, although it did mention a legalmalpractice action then pending against attorneysenlisted prior to bankruptcy to protect hisleasehold rights, and complaining generally ofother attorneys who failed to represent hisleasehold interests adequately.

Andrews obtained bankruptcy court approvalin 1994 to engage counsel to sue Rash and hisfirm, and the suit was filed July 1, 1994. TheCourt held that the alleged malpractice wasdiscovered no later than October 12, 1990,ordinarily giving him until October 12, 1992 tofile within the two-year statute. However, by filingbankruptcy on July 7, 1992, he received theadditional benefit of the tolling provision of 11US. C. Sec. 108 (a) (1993), allowing the trustee orthe debtor to pursue the claim as late as two yearsafter the order for relief. Therefore, he had untilJuly 6, 1994 to sue the attorneys because of thebankruptcy tolling provision.














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b However, no tolling allowed under 11 U.S.C.Sec. 108(a) for a legal malpractice claim filedpost-confirmation.

Besing v. Seeligson. Douglass. Falconer &Vanden Eykel. et al, 822 S.W.2d 107 (Tex. App.--Dallas 1991, writ denied).

Besing and his professional corporation lost anunderlying litigation matter, after which Besingand his professional corporation filed Chapter 11in March 1988. The plan was confirmed in June1989 but the legal malpractice claim was not fileduntil September 1989.

Applying the two-year statute of limitationsfrom the date of last representation in August1987, the Court affirmed summary judgment forthe three defendant law firms and individualattorneys. Under Section 108(a) of the BankruptcyCode, the state limitations period would not havebeen extended unless the malpractice claims hadbeen received prior to confirmation of the plan, inwhich case the cause of action could have beenpursued either by the debtor-in-possession (or atrustee, had there been one). But, asserting a legalmalpractice claim after confirmation of thedebtor's plan does not entitle the debtor to anextension or tolling of the limitations period underSection 108(a). 822 S.W.2d at 109. [Caveat: theinterpretation of Section 108(a) probably remainssound, but this opinion predates Hughes v.Mahaney & Higgins, 821 S.W.2d 154 (Tex. 1991),which might have extended the limitations periodif the tolling principle had been applied (i.e., thatthe statute begins running only once theunderlying litigation has become final).]

2. Limitations ran two years after attorney's finalpost-petition fee bill, where no tolling allegationspleaded.

Akin v. McDaniel, not published,1991WL258732 C (Tex. App.--Dallas 1991, nowrit).

Attorney's fee claims in a bankruptcyadversary proceeding met with usury claims in1988, some seven years after the attorney filed thedebtor's petition in March 1981. The attorneybegan representation in November 1979, and onemonth after the attorney submitted his February1981 fee bill, the client filed bankruptcy, listing theattorney's claim, including a 10% markup over theoriginal invoice amount. No grounds werepleaded supporting tolling of the two-year period,which the Court ruled ran two years after the final

bill for legal services was submitted in January1984.

The Debtor had filed a separate adversaryproceeding in 1987 on legal malpractice andbreach of warranty claims, but it was dismissed forlack of jurisdiction in 1989. In June 1989, thebankruptcy court ruled in favor of the attorney onhis fees and against the Debtor on the usury claim,which ruling was appealed to the Northern Districtof Texas.

This state court malpractice suit was broughtin February 1989, after the dismissal of theadversary proceeding, including allegations ofusury and breach of warranty. Summary judgmenton limitations was granted to the attorney-defendant, and the Debtor's summary judgmentmotion on usury was denied.

B. Accounting Malpractice Claims -Limitations Statute Begins to Run on IRSNotice of Deficiency Date (attorneys providingtax advice, be alert!)

Murphy v. Campbell, 964 S.W.2d 265 (Tex.1997), m/ rehearing overruled 5/8/98); same caseBankruptcy Estate of Rochester v. Campbell, 910S.W.2d 647 (Tex. App.--Austin,1995).

This accounting malpractice suit was filed onthe fourth year anniversary of the IRS deficiencynotice to the Debtor. The Texas Supreme Courtheld that the cause of action against theaccountants accrued when the IRS issued thedeficiency notice to the taxpayer, not when TaxCourt ruling was adopted through settlement.Lawyers and accountants giving tax advice are tobe treated the same regarding the discovery rule.The Court declined to toll the statute as in Hughesv. Mahaney & Higgins, 821 S.W.2d 154 (Tex.1991), which involved a suit for attorneymalpractice in the prosecution or defense of aclaim resulting in litigation, and was restricted toits circumstances. Because the statute was nottolled in Murphy as it was in Hughes, defendantsTouche Ross and could not be sued for claimsgoverned by the two-year statute. The four-yearstatute did not apply because the summaryjudgment evidence was sufficient to support afinding of no fraud.

The Court noted that Murphy could haveavoided this outcome by filing the malpracticecase and requesting abatement pending theoutcome of the tax suit.









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IV. IGNORANCE IS NOT BLISS: CLIENTCOMMUNICATIONS AND AMBIGUITYA. Documenting Advice to Clients: Get theComplete Picture, Define the Scope ofEngagement in Writing, and Avoid GivingBusiness Advice.

Obviously, the business judgment skills ofbankruptcy clients vary widely from person toperson: some have small business and some havemulti-million dollar enterprises. Some havebusiness degrees and some don't. Most lawyerswould probably agree, however, that some clientsprove to be "problem" clients from the onset, asevidenced from poor record keeping, poorbusiness decisions, and such. Perhaps somelawyers have had difficulties with bankruptcyclients who are not always truth-tellers.

Examples of undocumented legal advice whichcan form the basis of a malpractice claim include:failure to advise of criminal implications; failureto identify contingent claims as assets; transfersthat become voidable due to timing decisions;recommendations whether or when to filebankruptcy as affected by the 240-day ruleregarding dischargeability of federal taxes; failureto obtain all relevant documents or information;and failure to coordinate with accountants andothers to obtain important information. Not allsuch claims may have merit, but may be assertedagainst the attorney later, and will be judged inhindsight.

Experience repeats itself over time, revealingthat in legal malpractice claims, many such clientsshow little reservation in blaming the lawyer eventhough the client may have overlooked or evenwithheld information needed by the lawyer, oreven directly disregarded the lawyer's legaladvice.

For example, remember Allen v. Moore (In reAllen), 179 B.R. 818 (U. S. Bk. Ct. E. D. Tex.[Beaumont] 1995), discussed in II. A. 2. a. (2).The Allens filed for Chapter 11 after the defendantlaw firm was unsuccessful in assisting them inrenegotiating a secured bank loan. They filed suitin state court against the lawyers, alleging thatthey negligently advised Mr. Allen to quit his jobbefore filing bankruptcy, making him unable tofund the Chapter 11 reorganization, converting itto a Chapter 7. And, consider United States v.Ballard, 779 F.2d 287 (5th Cir. (Miss.) 1986), acase in which the client sued the attorney formalpractice after discharge in the bankruptcy. Thecivil depositions given by Ballard and the attorneywere admitted into evidence, supporting a

conviction for Ballard's bankruptcy fraud indisregard of the attorney's pre-petition adviceconcerning transfers of real estate.

It also helps to look at the big picture. Forexample, if a client inquires about asset transferswithout any mention of bankruptcy, it would makesense to inquire if bankruptcy is contemplated, asthe preference periods may invalidate transfersthat would otherwise seem fairly conventional.Note that under most malpractice policies, givingbusiness advice may be excluded from thedefinition of professional legal services andtherefore outside the scope of coverage.

Problem client or not, the careful bankruptcylawyer is well-advised to make a habit ofdocumenting legal advice given to clients, startingwith "pre-petition planning," and also whencommencing the bankruptcy, and on through theadministration. See the discussion of Simmons v.Johnson Curney & Fields P.C. (In re Simmons)205 B.R. 834 (U. S. Bk. Ct. W. D. Tex. [SanAntonio] 1997) at Part V. A. 3., where the debtor'sadversary claims alleged poor legal advice, whichclaims could not have existed "but for thebankruptcy" and originated out of pre- and post-petition advice of counsel concerning preparationfor the bankruptcy and the bankruptcy itself.

Define in writing the scope of yourresponsibilities and those of accountants andothers participating in the process. Watch out forthe debtor who says, "Oh, you won't need to worryabout 'xyz,' my accountant is taking care of that."If accountants, bookkeepers, or other persons haveinformation (such as the date of an IRS deficiencynotice), it is risky to rely on the Debtor to providethat information. See, Murphy v. Campbell, 964S.W.2d 265 (Tex. 1997) (1RS deficiency noticecauses statute to begin to run on tax advicemalpractice claims). Make timely arrangements tomeet with persons who possess or generaterelevant data needed, whether or not the Debtorsuggests it. It is safer to be assertive and go afterthe information, than try to prove that your client'scontributory negligence or the accountant'scomparative negligence was greater than yours.

B. Uncovered Claims: Crime or Fraud,RICO, Fraud on a Tribunal1. Crime or Fraud Exception to Attorney-clientPrivilege: Depositions in Malpractice CaseAdmissible as Proof of Crime in Chapter 11Fraud.

In United States v. Ballard, 779 F.2d 287 (5th

Cir. (Miss.) 1986), the debtor, Ballard, was an auto








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parts dealer who brought a malpractice actionagainst an attorney for failing to file a bankruptcypetition after being paid $1,000 to do so. Withinone year prior to the bankruptcy (filed by adifferent attorney), Ballard had deeded someacreage to attorney Smith, who then deeded it toBallard's father-in-law in return for a $14,000check. Smith kept $4,000 of the amount for legalfees due, and put $10,000 in Mrs. Ballard's safetydeposit box, to which Ballard had access. Ballardfiled Chapter 11 in 1980 and was discharged in1981.

Ballard gave his deposition in the malpracticesuit he filed in 1982, and he was indicted in 1984for making false statements in his bankruptcypetition, i.e. that he had not transferred any realtywithin one year before the bankruptcy and that hehad no safe deposit box. Ballard was convictedunder 18 U.S.C. Sec. 152 for "knowingly andfraudulently mak[ing] a false oath or account in orin relation to any case under Title 11." Heappealed, claiming various errors includingadmitting into evidence his own civil depositiontestimony and that of the Smith, the pre-petitionattorney. Smith had testified that he advisedBallard he would either need to disclose thetransfer of the realty or else wait longer than a yearto file the petition. The District Court reasonedthat by bringing the civil malpractice action, theattorney-client privilege in the civil matter alsowaived the privilege for purposes of the criminaltrial against the client.

The Fifth Circuit disagreed as to this premise,however affirmed the conviction, determining thatBallard's civil testimony was voluntary andtherefore admissible, and the attorney's testimonywas admissible because of the crime or fraudexception to the attorney-client privilege. 779 F.2dat 292-93. Further, Ballard's ignorance as to thecriminal implications of his deposition testimonydid not require suppression of Ballard's voluntaryadmissions against interest. 779 F.2d at 291. TheCourt declined to address the issue of whether theattorney would have been required ethically toreveal confidences as to the property transactionunder the Model Rules. For purposes of theprivilege, "Once the party seeking disclosuremakes a prima facia case that the attorney-clientrelationship was used to promote an intendedcriminal activity, the confidences within therelationship are no longer shielded.” 779 F.2d at292.

Here, the opinion of Justice Rubincharacterized the conveyance and transfer of funds

as part of a fraudulent scheme to conceal thedebtor's property either from creditors or from thetax collector or both, and attributed Smith's adviceconcerning the illegality of the plan and his refusalto proceed, as the cause of Ballard's decision tohire other counsel. 779 F.2d at 293.

2. RICO & Conspiracy Claims: Seventh CircuitSteps Out (Disgruntled investors sue law firm forbankrupt corporation, win remand to assert RICOand conspiracy claims against firm.)

Brouwer v. Raffensperger, Hughes & Co., 199F.3d 961(7th Cir. 2000), cert. den. 120 S. Ct.2688 (U. S. 2000). This case illustrates the type ofnon-negligence allegations that non-clients mightbring against counsel and a debtor, which areusually not covered by most professional liabilitypolicies. The Seventh Circuit held that proof ofthe RICO violations could be based on knowinglyfacilitating the unlawful activities of operators ormanagers, and personal participation would not berequired.

Here, some investors sued an underwritingfirm and law firm who performed work for abankrupt Indiana corporation (Firstmark), forRICO violations and conspiracy. Theunderwriting firm (Raffensperger) was dismissedand summary judgment granted to the law firm(Barnes & Thornburg), for a $57 million loss bythe plaintiff-class. The insiders had settled, whoallegedly were contemporaneously siphoning offassets of the corporation, which had beentransformed into a wholly owned subsidiary.

On remand, the plaintiffs would have a chanceto prove allegations that the law firm wasallegedly hired to perform the due diligence as abasis for providing the minimum yields for whichcorporate notes were to be sold; that it concealedthe conspiracy and the substantive violations in theNASD registration statements; halted the issuanceof certain notes to keep the problems frombecoming public; then facilitated the sale of thesubsidiary to another client of the law firm. Thealleged RICO violation concerned the sale of notesby the parent company to pay interest andprincipal on previously sold notes and to financethe sale of more notes. The alleged conspiratorssupposedly deceived investors into purchasingnew notes, rolling the current notes over, orotherwise refraining from redeeming notes.

Under Sec. 1962 (c), it is unlawful for "anyperson employed by or associated with anyenterprise engaged in, or the activities of whichaffect, interstate or foreign commerce, to conduct






19

or participate, directly or indirectly, in the conductof such enterprise's affairs through a pattern ofracketeering activity or collection of unlawfuldebt."

The Seventh Circuit reversed and remanded todetermine liability based on the Court'sinterpretation that Subsection (d) of 18 U.S.C. Sec.1962 does not require agreement by an "outsider"to participate personally in the operation ofmanagement of an enterprise to prove a RICOconspiracy to commit a subsection (c) violation.Regarding the kind of personal participation thecourt held as necessary to establish an outsider'sviolation of subsection (d):

"One's agreement must be to knowinglyfacilitate the activities of the operators ormanagers to whom subsection (c) applies. Onemust knowingly agree to perform services of akind which facilitate the activities of those whoare operating the enterprise in an illegalmanner. It is an agreement, not to operate ormanage the enterprise, but personally tofacilitate the activities of those who do."

3. Fraud on a Tribunal: Remand for Court toConduct Factfinding on “Colorable Claim.”(Alleged conflicts in representing Debtor, trustee,and others. Debtor had a "colorable claim" of aconcealed conflict interest interfering with thecourt's impartial adjudication.)

Pearson v. First NH Mortgage Corp., ___ F.3d___, (1st Cir. [D. C. D. New Hampshire] 1999)resulted from a fee dispute with the Debtor due tothe unraveling of multiple conflicts (prior andexisting). At one point or another before andduring the bankruptcy, either the lawyer or thefirm had represented the Chapter 7 Debtor, theother joint owners of the condo company, theBank, and the trustee. Attempts to have estateclaims against the attorneys abandoned by thetrustee met with this two-year swordfight, and atrip back to the bankruptcy court. The facts maybe convoluted, but they show how tangled the webcan get when a bankruptcy attorney tries to weartoo many hats.

Pearson, the Debtor and half owner of BWI (acondominium company) sought relief from acomprehensive settlement agreement of all chapter7 estate claims against the construction lender(First New Hampshire Bank or "First Bank"), itsaffiliates, agents, and attorneys, which had beenaffirmed by the district court. The CSA was

prepared by the Debtor's attorney, who latergained approval to represent the trustee on certainclaims by the estate. Debtor Pearson contendedthe CSA was not binding, due to a fraud allegedlyperpetrated upon the bankruptcy court by hisformer Chapter 7 counsel (Gannon), the Chapter 7trustee, and by First Bank. A partner of the firmalso served as a director of the bank. The law firmhad formed the original condo-marketing companyfor which Pearson and the Tamposi family hadobtained the construction financing from FirstBank and the mortgage lender.

The First Circuit vacated and remanded to thebankruptcy court, finding an abuse of discretion bythe bankruptcy court in its denial of the Rule 9024Motion to set aside the CSA, and its refusal toallow discovery or conduct an evidentiary hearingwithout the Debtor producing a "smoking gun."

Pearson, half owner of the condo-marketingcompany, alleged undisclosed and unwaivableconflicts of interest, based on the attorney'sverified statements made in his application toserve as special counsel to the trustee. The othercompany owners, the Tamposi family, had suedPearson on a personal loan guaranty of $500,000,which First Bank had assigned to them. The lawfirm had represented the Tamposis in establishinga separate company to acquire the condos at thebank's foreclosure sale. Pearson (pro se) suedthem and the bank to set aside the guaranty and theforeclosure sale.

Before Pearson filed Chapter 7, the Tamposisobjected to the law firm defending Pearson in theguaranty action and the firm withdrew.Nevertheless, when Pearson filed for Chapter 7,the firm applied for appointment as counsel andlisted both the bank and the Tamposis as creditors,but made no mention of any conflict-of-interestclaim the Debtor might have held against the lawfirm. The attorney's verified statement filed underRule 2014 asserted there were no conflicts ofinterest that would prevent his representation ofPearson in the Chapter 7.

Later, the Chapter 7 trustee successfullyapplied to have the attorney appointed as specialcounsel to litigate the Chapter 7 claims other thanthose against First Bank (including those againstthe Tamposis). The attorney verified that noconflict of interest existed since he was not beingretained to represent the Trustee regarding theclaims against the condo-marketing company (thefirm's former client) or the bank. The Courtapproved the application and the attorney settled


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all the Chapter 7 estate claims against theTamposis.

Then the Trustee applied to appoint theattorney as special counsel to represent the estatein claims against First Bank, at which point theattorney represented in another verified statementthat the Tamposi settlement eliminated the conflictbetween them and Pearson, and no related mattersexisted regarding his firm's earlier representationof the bank in other matters. The Bank objectedbut the special counsel application became mootwhen the Bank and the trustee agreed tocompromise all Chapter 7 claims against FirstBank for $40,000 and a release of the bank and itsaffiliates, officers, directors, and agents (includingattorneys). The attorney ceased representingPearson after a fee dispute arose. The trustee latermoved to abandon certain assets including anyconflict claims or breach of loyalty claims againstthe particular firm and the named bankruptcyattorney.

The First Circuit considered the 2014statements an affirmative misrepresentation to thetribunal as "demonstrably false," violatingcounsel's duty of candor to the tribunal. Held, thebankruptcy court abused its discretion by denyingthe Rule 9024 Motion to set aside the CSA, and bydenying an evidentiary hearing on the motion toabandon the estate claims against the lawyers,given the evidence of serious conflicts of interest.The Court was also troubled that the firm hadrepresented multiple clients with "materiallyadverse" interests in "substantially relatedmatters," in which the lawyers could have beenmaterial fact witnesses. Because the Debtor had a"colorable claim" of a concealed conflict interestinterfering with the court's impartial adjudication,the Court vacated and remanded to the bankruptcycourt for further factfinding and to determinewhether a fraud had been perpetrated upon thecourt and tailor an appropriate remedy.

V. JUST SHOW ME THE MONEY: FEECLAIMS, MALPRACTICECOUNTERCLAIMS, AND COURTSCRUTINY OF FEES AND CONDUCTMEAN RISKY BUSINESS

Asserting fee claims can be the source ofvarious woes for attorneys, so continue to watchyour step! Under Texas law, a legal malpracticeclaim is a mandatory counterclaim to a claim forfees. See, e.g., Van Dyke v. Boswell O'TooleDavis & Pickering, 697 S.W.2d 381 (Tex. 1985)(divorce case, counterclaim to fee intervention);

Judwin Properties Inc. v. Griggs & Harrison, 911S.W.2d 498 (Tex. App.--Houston [1st] 1995 nowrit) (counterclaim to fee suit).

Whether or not the Debtor or Trusteedetermine to assert any legal malpractice claims orcounterclaims, bankruptcy attorneys no doubt arepainfully aware that the Bankruptcy Court has thepower to scrutinize the value and reasonablenss ofprofessional fees and determine the cost-benefitanalysis of the legal services performed. TheCourt may void the payment you received as apreference, reduce your fees, or even orderdisgorgement of fees or sanctions. And, feeclaims notwithstanding, the Bankruptcy Court mayeven refer an attorney to the disciplinaryauthorities under appropriate circumstances.

A. Bringing Home the Bacon: of Objectionsand Malpractice Claims.1. Objections to proof of claim for attorney feesand malpractice counterclaims: an objection joinedwith a claim for relief under Rule 3007 mayrequire separate filing and service of an adversaryproceeding (or may not, depending on the forum).Lawler v. Guild Hagen & Clark. Ltd (In reLawler). 106 B.R. 943 (D. N. D. Tex. [Dallas]1989).

The bankruptcy court dismissal of Lawler'slegal malpractice counterclaims was affirmed onappeal to the U.S. District Court. Lawler'sinvoluntary bankruptcy was filed in January 1976,in Nevada concerning the purchase andforeclosure of a Nevada ranch, as to which aNevada law firm performed pre-petition legalwork. The case was later converted to a Chapter11 proceeding under the pre-Code Bankruptcy ActRules, and was transferred to the Northern DistrictDivision of Dallas. The law firm filed its originalproof of claim for $15,565.40 in unpaid legal feesand expenses in February of 1976, and submittedan identical proof of claim in 1978 after thetransfer to Dallas.

The Debtor objected in 1982 as to offsets andlack of supporting documentation, but did not raiseany issues of malpractice. In February, 1984, priorto confirmation of the "New Plan,'3 the firmamended its proof of claim to add itemizedstatements and request 7% interest after the finaldate of services rendered in 1975. Lawler hadhired the law firm in 1974 after defaulting on a$250,000 note payment to the third lienholder, andthe firm sued the lienholder to force conveyance ofthe ranch when Lawler paid the second lienobligation. However, the attorney never formally






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withdrew from representing Lawler before thecourt dismissed the case against the lienholder in1975.

On the April 1984 initial hearing of the proofof claim, the Debtor filed an amended objectionalleging malpractice and seeking counterclaimand setoff damages of $510,000 (his equity).Lawler complained that the attorney released hisclaim in a $1.2 million ranch without hisknowledge or consent.

There was no ruling on the fee claim orobjection prior to the reassignment of the case tothe Bankruptcy Court, Lubbock Division of theNorthern District of Texas, before Judge John C.Akard. During recess of the trial on the amendedclaim and objections in October 1986, the law firmwas granted leave to withdraw its proof of claim,conditioned upon dismissal of Lawler's objectionsas to counterclaims or offsets.

The District Court affirmed Judge Akard'sruling of July, 1987, allowing withdrawal of thelaw firm's proof of claim with prejudice, anddismissing Lawler's objection and counterclaimdue to lack of proper notice, filing, and service asa separate adversary proceeding, and for failure tomeet the Nevada two year statute of limitationsthen in effect. The District Court reasoned that anobjection to a proof of claim merely commences acontested matter under Code Rule 9014 or ActRule 914, but under Rules 3007 and 306(c), anadversary proceeding must be commenced when alegal malpractice claim for affirmative relief isfiled. Lawler, 106 B.R. 943 at 956.

However, at least two other courts havereached a different conclusion. In re Mathiason, 16F.3d 234, 238 (8th Cir. (Minn.) 1994), held that anobjection joined with a Rule 7001 request forrelief automatically becomes an adversaryproceeding under Rule 3007 without commencinga separate proceeding. In re Robinson, 217 B.R.527, 530 (U. S. Bk. Ct. B. D. Tex. [Sherman]1998) distinguished Lawler, holding that Rule3007 did not require filing and service in aseparate adversary proceeding of an objection tothe validity and extent of an auto lien and requestfor relief under Rule 7001.

The District Court in Lawler found the resultwould be the same under the Bankruptcy CodeRules 7003 and 7004 or the Bankruptcy Act Rules703 and 704, and the Bankruptcy Court did notabuse its discretion. 106 B.R at 950. However,the malpractice allegations still could be employeddefensively as part of the contested proof of claimproceedings. Id., at 962.

2. Legal malpractice claims in adversaryproceedings: joint and several liability possible,where attorneys found liable for gross negligenceand breach of fiduciary duty connected withundisclosed conflicts of interest from priorrepresentation.

Vaughn v. Akin Gump Hauer & Feld, L.L.P.,___F.Supp. ___, 1997 WL 560617 (U. S. Dist. Ct.N. D. Tex., 1997) (originally In re LegalEconometrics, Inc., 191 B.R. 331 (U. S. Bk. Ct. N.D. Tex. 1995).

This appeal from a 1995 seven-day non-jurytrial in bankruptcy court resulted in an $8 millionlegal malpractice judgment of $4 million actualdamages and $4 million punitive damages forbreach of fiduciary duties and gross negligence.The adversary proceeding alleged negligence,gross negligence, intentional breach of fiduciaryduty, and civil conspiracy. Conflicts of interestwere highlighted as to the attorneys 'failure todisclose a previously existing relationship withKelso, the Debtor's agent and voting trustee.Expert testimony was introduced about theirnegligence and breach of fiduciary duties in failingto make these disclosures, and the BankruptcyCourt referred to the Texas Disciplinary Rules ofProfessional Conduct, not as a legal standardgoverning the creation of an attorney-clientrelationship, but as "guidance on the activities anattorney performs for a client."

The District Court, per Chief JudgeBuchmeyer, affirmed the liability findings(including joint and several liability), and vacatedand remanded for recalculation of actual as well aspunitive damages.

Questionable features of the legalrepresentation were highlighted as follows. Thelegal services involved a complex restructuring ofassets of Grady Vaughn's company, Chama, forwhom defendant Kelso acted as agent for Vaughnand introduced Vaughn to the Akin, Gumpattorneys in 1989. Kelso had a pre-existingattorney-client and personal relationship with theattorneys, which neither he nor the attorneysdisclosed to Vaughn. The State of New Mexicowas pursuing Vaughn and Chama for mattersincluding illegal transportation of stolen game.The restructuring of Chama devised by theattorneys involved creation of other companieswhich would receive long-term (50-year) leasesfrom Chama and Kelso was originally made thevoting trustee. Thus, in the event of foreclosure onVaughn's 2/3 stock ownership by the bank or its








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successor, the leases would tie up the land andcause problems for the new stockholder.

One of the attorneys was named successortrustee to Kelso in 1990. Grady Vaughn was suedin 1991 by his brother, Gary, claiming many of thetransactions were improper and he won aninjunction in 1992 depriving Grady Vaughn ofm6st of his remaining income from the entities.Under the restructuring, Kelso obtained totalcontrol of the property and the attorneys weresupposed to have prepared a resignation letter tobe signed by Kelso allowing Vaughn to removehim as voting trustee, but the letter was neverprepared. The Bankruptcy Court found that butfor the restructuring and tying up of the Vaughn'sassets and income under Kelso's control, thebrother's injunction suit against Grady Vaughnwould not have occurred, depriving him of accessto the assets and income.

3. Post-confirmation adversary claim for legalmalpractice based on pre-petition advice and othernon-bankruptcy malpractice claims: jurisdiction ofall claims exercised in Bankruptcy Court, andattorney's fee claim subjected attorney tojurisdiction and waived jury trial.

Simmons v. Johnson Curney & Fields P.C. (Inre Simmons) 205 B.R. 834 (U. S. Bk. Ct. W. D.Tex. [San Antonio] 1997).

The debtor/plaintiff claimed that he wassanctioned and penalized because he followed theimproper advice of the attorneys. 205 B.R. 834 at845. The claims (legal malpractice, breach ofcontract, breach of fiduciary duty, and DTPA)originated out of pre- and post-petition advice ofcounsel concerning preparation for thebankruptcy and the bankruptcy itself, thereforethey fell within the "arising under" jurisdiction ofthe District Court under 28 U.S.C. Sec. 1334.

As to the attorney-defendants' demand for ajury, the Bankruptcy Court decided that this righthad been waived by submitting a claim forprofessional services against the plaintiff’sbankruptcy estate, and participating in theallowance and disallowance of claims as apriority creditor. 205 B.R. at 849-850. A feeapplication arises out of the same nexus ofoperative facts as a malpractice claim, thereforethe defendant attorneys consented to thejurisdiction of the court on all issues relating tothe fee submission, including the malpracticeclaims, resulting in a waiver of a jury trial. Id.This opinion does not reach the merits of the legalmalpractice claims or attorney fees claims,

however the Bankruptcy Court concluded it shouldexercise jurisdiction over all the malpracticeclaims in one proceeding, instead of abstaining infavor of the District Court. Under the confirmedplan, the Debtor retained all interests in anysubsequent malpractice litigation. The BankruptcyCourt recommended that the District Court declineits jurisdiction (bankruptcy jurisdiction andsupplemental jurisdiction) of all non-bankruptcyand bankruptcy4inked malpractice claims, stateand federal, conferred under 28 U.S.C. Sec. 1334.The Bankruptcy Court also decided that underprevious U. S. Supreme Court decisionsinterpreting 28 U.S.C. Sec. 1367(a), the legalmalpractice claims unrelated to the bankruptcycould be consolidated as they would normally beexpected to be tried in one proceeding. 205 B.R.834 at 845.

The opinion discusses at length the variousgrounds of potential jurisdiction, supplementaljurisdiction of the District Court, and BankruptcyCourt discretionary abstention from jurisdiction.The Bankruptcy Court decided that even thoughthe state law claims dominated over the federalones, they met the "arising under" jurisdictionalrequirement of 28 U.S.C. 1334(c)(2), because theadversary claims brought post-confirmation understate law could not have existed "but for thebankruptcy."

4. Post-discharge assertion of legal malpracticeclaims attempted by creditor on behalf of debtor'sestate was unsuccessful, where debtor had allegedno claims.

Dauter-Clouse v. Robinson, 936 S.W.2d 329(Tex. App.--Houston [14th] 1997, no writ).

This unusual case involved the bankruptcy ofan attorney following a $6.1 million malpracticejudgment against him, and subsequent claims by acreditor against the debtor / attorney's defensecounsel. Summary Judgment for the debtor's legalmalpractice defense counsel was affirmed by theFourteenth Court. The judgment creditor, aprevious divorce client, filed her counterclaimsagainst the attorney originally in response to hisfee claims, her malpractice judgment wasdischarged in the chapter 7 proceeding. She thenfiled suit against the debtor / attorney's defensecounsel.

The debtor / attorney had raised nomalpractice claims against his defense counselduring the bankruptcy, and in his affidavit indefense of his lawyers Hirsch, Glover, Robinson& Scheiness, he swore that he was satisfied with








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their defense of the legal malpractice action. TheCourt of Appeals therefore found the debtor /attorney had no cognizable property interest in amalpractice claim against his defense counsel.Thus, since there was no claim by the debtor Iattorney, it never became a part of the bankruptcyestate and was not subject to administration forthe benefit of creditors, and could not be pursuedby Dauter-Clouse.

5. Conflicts not waivable by consent: no claimpursuit in 7 against creditors previouslyrepresented in 11.

In re Quality Beverage Company, Inc., 216B.R. 592 (U. S. Bk. Ct. S.D. Tex. 1995). Theaccountants who had represented the creditorscommittee in the Chapter 11, sought employmentby the Chapter 7 trustee to investigate preferenceclaims, including claims against former membersof the creditors committee. The court denied theapplication, finding an actual non-waivableconflict.

B. Saving Your Bacon: Fee Reductions,Preferences, Sanctions, Disgorgement, andDisciplinary Referrals (Be Careful aboutConflict Waivers)1. Attorney fees and performance subject toscrutiny by Bankruptcy Court without filing of anobjection and a legal malpractice claim.a The fee award for an attorney's collectionefforts may be reconsidered, but an attorney nototherwise appearing before the Bankruptcy Courthas no duty to inform the Court of an unscheduledasset.

Vining v. Ward (In re Ward), 894 F.2d 771(5th Cir. (La.) 1990).

The Bankruptcy Court entered a $16,000judgment against the Debtors' law firm and theDebtors, for negligent misrepresentation to theBankruptcy Court. The District Court affirmed.The Fifth Circuit determined that although it wasnecessary to reevaluate the award of attorney'sfees to the law firm in the underlying matter, thereexisted no tort of negligent misrepresentationagainst a bankruptcy court. The attorney hadbeen granted fees of $8,000 for obtainingcollection of a pre-petition judgment for thedebtor, but had not otherwise appeared before theBankruptcy Court.

The Fifth Circuit reversed and remanded,holding the Debtor's collection attorney had noduty to inform the court of an unscheduled asset (apre-petition judgment for. the debtor), however the

award of fees should be reconsidered in light ofwhether the judgment was collectible. If not, thevalue of the legal services to the bankruptcy estatemight prove less than it appeared when the feeswere granted.

b Conflicts of interest: fee application may beapproved, hold your breath.

In re: Howell, 148 B.R. 269 (U. S. Bk. Ct. -S.D. Tex. 1992) distinguishes “mom and pop”Chapter 11 proceedings from those involvingmultiple shareholders. Counsel’s fee applicationwas approved in spite of the conflict inherent inthis dual representation situation (individual andcorporate representation). Judge Karen Brownheld that the bankruptcy court retains the right toexercise discretion over potential conflicts versusactual conflicts, rejecting Judge Abramson’sposition in In re: Kendavis, 91 B.R. 742 (U. S. Bk.Ct. N.D. Tex. 1988) that “the concept of potentialconflicts is a contradiction in terms.”

Acknowledging the “egregious nature of theattorneys’ behavior” in Kendavis, Judge Brownnonetheless adhered to the prior rulings of the 1st,3rd and 5th Circuits that granted the bankruptcycourt the discretion to decide when a potentialconflict arising out of representing Mom and Popand their wholly-owned corporation renderscounsel not “disinterested”.This approach seems sensible but remains riskyfor counsel, who must in effect bet on a clean billof health while the conflicts issue hangs overhead,subject to being judged after the fact regarding theapplication for approval of fees and expenses.

c Court-imposed reduction of fees based uponresults accomplished and benefit to the estate.In re Saunders, 124 B.R. 234 (U. S. Bk. Ct. W. D.Tex. [San Antonio] 1991).

The review of legal fees and expenses uponapplication to the Bankruptcy Court is a familiarconcept to experienced bankruptcy counsel.However, this case illustrates how the fees may besubject to reduction even without the assertion of alegal malpractice claim by the Debtor, based uponthe results accomplished and the whether anybenefit to the estate resulted from the services inquestion. In this instance, a San Antonio firmsuffered a 20% reduction in its application of$169,145.50, for having billed too manyunsubstantiated and duplicative hours, havingbilled for multi-attorney appearances and in-houseconferences.








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In re Kendavis Industries International, Inc.,91 B.R. 742 (U. S. Bk. Ct. N.D. Tex.1988).

“One of a bankruptcy court’s least favoriteduties is the enforcement of the Codeprovisions dealing with compensation ofprofessionals.”

With this prefatory comment, Judge Abramsonbegan his opinion on a motion for disgorgement offees paid to debtor’s counsel. The cases had beenfiled in 1985 and by 1988 there had been nosuccessful plans of reorganization proposed bydebtor and the creditors committee and variousmajor creditors had joined in the effort to seekdisgorgement. The Court found, after concludingthat it was not bound by interim orders awardingfees, that debtor’s counsel had clearly becomealigned with the interests of the Davis familyrather than the creditors, and that every plan filed,every tactic adopted was intended to advance theinterests of the Davis family. Debtor’s counselwas therefore not disinterested and had an actualconflict of interest.

The court also found that debtor’s counsel hadfailed to disclose a $500,000.00 retainer fromsubsidiaries of the debtor, and that the same firmwas billing for representation of the subsidiariesand being paid from the debtor-in-possessionaccount without court order. Ultimately, the courtdisallowed 50% of the fees requested and requireddisgorgement of fees paid but not disclosed. Froma practice standpoint, an unfortunate aspect of theopinion is that the court concluded (perhapsillogically, but perhaps compelled by theegregious facts of the case) that a ‘“potential”conflict is a contradiction in terms.’ Numerouscourts have thereafter used this catch-phrase toavoid the detailed analysis contained in thisopinion, although its central lesson must beextracted from that analysis. As a practical matterwhen representing a debtor, fees not disclosed andapproved may be forfeited or disgorged unlesscounsel is able to demonstrate some obviousbenefit to creditors from the tactics adopted andthe plan filed.

d Alleged fraud upon a tribunal: conflicts inrepresenting Debtor, trustee, and others. Debtorhad a "colorable claim" of a concealed conflict ofinterest interfering with the court's impartialadjudication.

Pearson v. First NH Mortgage Corp., ___ F.3d___, (1st Cir. [D. C. D. New Hampshire] 1999)

illustrates how a fee dispute with a Debtor can setin motion the unraveling of multiple conflicts(prior and existing). At one point or anotherbefore and during the bankruptcy, either thelawyer or the firm had represented the Chapter 7Debtor, the other joint owners of the condocompany, the Bank, and the trustee. The FirstCircuit vacated and remanded to the bankruptcycourt, finding an abuse of discretion by thebankruptcy court in its denial of the Rule 9024Motion to set aside the CSA, and its refusal toallow discovery or conduct an evidentiary hearingof a “colorable claim” without requiring theDebtor to produce a "smoking gun." See furtherdiscussion under IV. B. 2. Uncovered Claims.

2. Pre-petition payment of attorney fees asvoidable preference.a Voidable preference granted, where law firmreceived funds knowing that funds were subject toavoidance when paid from escrowed settlementfunds.

Southmark Corporation v. Schulte, Roth &Zabel (In re Southmark Corporation), 242 B.R.330 (D.N.D. Tex. [Dallas] 1999); same case, 217B.R. 499 (U. S. Bk. Ct. N. D. Tex. [Dallas] August13, 1997; 88 F.3d 311(5th Cir. 1997); 217 B.R.181 (U. S. Bk. Ct. N. D. Tex. [Dallas] March 24,1997).

Southmark paid $3.3 million to the ParksGroup in settlement of a proxy contest and relatedlitigation, which payment was held by the FifthCircuit to have been a transfer for, or on accountof, an antecedent debt. As matters stood as of the1999 District Court opinion, the Debtor wasawarded judgment against the law firm forpreferential transfer of fees of $1,000,000, plusprejudgment and postjudgment interest.

On remand following appeal of the FifthCircuit ruling and denial of writ of certiorari,competing summary judgment motions had beenfiled by Southmark and by Schulte, Roth,attorneys for the Parks Group, as to the $1,000,000the law firm's fees. Initially, the Bankruptcy Courthad determined on trial of the matter to dismissSouthmark's adversary proceeding seeking to setaside the allegedly preferential payment to the lawfirm. However, on the first appeal the Courtreversed and remanded. 88 F.3d 311. On remand,the Bankruptcy Court (per Judge Felsenthal)granted summary judgment for Debtor on thepreferential transfer but issued a post-trial orderthat the law firm was neither an “initial” nor a“subsequent” transferee, and therefore not liable











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for the $1 million received for its legal fees fromthe proxy contestant. 217. B.R. 181. Then, onappeal to the Northern District of Texas (per JudgeLindsay), the Court held that the law firm knewthat the escrowed funds were subject topreferential treatment, and granted judgment infavor of the Debtor against the law firm for $1million, prejudgment and postjudgment interest,and taxed costs of appeal to the law firm. 242B.R. 330, 343 (D.N.D. Tex. 1999).

Southmark had contended that it was entitledto judgment against the law firm for its $1,000,000of the $3.3 million settlement paid to the ParksGroup by Southmark following settlement of theproxy fight, as an avoidable preference. In theearlier opinion, the Court denied these aspects ofthe parties' motions in order to try the fact issueson the voidability of the transfer as beingpreferential. At trial, the Court originally foundthat the proxy contest settlement was resolved inthe ordinary course of business but the proxycontest itself was an extraordinary event notoccurring in the usual course of business, and not acontemporaneous exchange.

The law firm had received the $3.3 millionsettlement funds as escrow agent for the ParksGroup, and remitted the amount for Parks benefitto R & P Ventures, which then transferred$1,000,000 to Byron Investments and it paid thelaw firm for legal services to the Parks Group.Schulte, Roth (New York) contended that itreceived the funds in good faith, for value andwithout knowledge of the voidability of thetransfer. However, the lower Court’s opinionnoted that Schulte, Roth knew enough facts to leada reasonable person to believe that the $3,300,000transfer to the Parks Group was voidable, partlybecause the latest fee total was communicatedorally to Parks on the settlement date, rather thanby a written fee bill. The District Court observedthe expeditious nature of facts under which thefunds were transferred and delivered via overnightmail to the law firm.

b Pre-petition payment of legal fees supportedinvoluntary bankruptcy petition and raisedquestion of antecedent debt / voidable preference.In re: Norriss Brothers Lumber Company. Inc.,133 B.R. 599 (U. S. Bk. Ct. N. D. Tex. [WichitaFalls] 1991).

This case exemplifies that obtaining paymentfor legal fees earned prior to an involuntarybankruptcy does not necessarily mean you get tokeep them. The Debtor, Norriss Brothers (NBLC),

was sued in state court by Bank One (MBank)March 6, 1991, the same date when NBLCsurrendered some of its property to First NationalBank of Burkburnett under a Deed in Lieu ofForeclosure and a Bill of Sale. Bank One's noteswere evidently under-collateralized. Two daysbefore suit was filed by Bank One in state court,NBLC held an auction of equipment and fixtures,and the proceeds of sale were used to pay legalfees owed by NBLC. About two months later, BankOne and two other creditors filed an involuntaryChapter 7 petition against NBLC on May 10,1991. Other creditors then intervened.

In late 1990, NBLC had entered into aworkout agreement with Bank One in which itgained 90 days to find a new lender, which did nothappen. In January and February of 1991,theDebtor was busy transferring assets to the motherof one of the shareholders, and to a newcorporation, Norriss Container, Inc., in which shewas the sole shareholder. NBLC ceased itsoperations in late February 1991, and beganbusiness operations as Norriss Container.

The Bankruptcy Court determined thatalthough Bank One filed its involuntary petition inbad faith because a bona fide dispute alreadyexisted, the circumstances of the arguablyfraudulent conveyances and arguably preferentialtransfers of funds to the NBLC attorneys andothers constituted special circumstances sufficientto sustain the involuntary petition in spite of thethree-creditor requirement. 133 B.R. 599 at 609.

3. Sanctions in bankruptcy court against Debtorand counsela Court's inherent powers and Bankruptcy Rule9011 allow sanctions (attorney fees) for frivolouscounterclaim / defense.

Citizens Bank & Trust Co. v. Case (In re Case),937 F.2d 1014 (5th Cir. (Miss.) 1991).

After confirmation of the Chapter 11 plan ofattorney/debtor Case, a state court suit wasbrought in Mississippi by the bank over default ofa note Case signed to settle the claim in thebankruptcy. The debtor counterclaimed for breachof contract, saying that the bank had agreed hecould satisfy the note by providing legal services.The bankruptcy court found that the frivolousdefense was asserted for the improper purpose ofdelaying collection of the bank's note.The bankruptcy was reopened and the bankruptcycourt assessed sanctions of $32,022.95 jointly andseverally against the debtor (actually, hisdecedent's estate) and his counsel, Smith, the







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amount being the attorney fees incurred by thecreditor in state court and in the bankruptcy court.The bankruptcy court also determined that thesanctions were non-dischargeable as to the debtorand as to Smith. On appeal, the District Courtaffirmed the imposition of sanctions against Smithunder F.R.C.P. 11, and affirmed the bankruptcycourt's sanctions of $32,022.95 against Case andSmith both as to the state court and bankruptcycourt attorney's fees of the creditor.

The Fifth Circuit determined that because ofthe frivolous counterclaim and defense, thebankruptcy court properly assessed sanctionsagainst the Debtor and his counsel as to thecreditor's attorney fees incurred in the bankruptcycourt matter, but the collateral state court attorneyfees were not proper as sanctions in thebankruptcy court. 937 F.2d at 1025. Thebankruptcy court properly awarded the sanctions(as reformed) against the Debtor and his counselunder its inherent powers and Bankruptcy Rule9011. Further, the District Court had no power toimpose sanctions against the attorney under Rule11 for a frivolous appeal, because several appellateissues examined were not frivolous. Also, theDistrict Court had no power to declare thesanctions against the attorney nondischargeablebecause he was not a debtor seeking bankruptcyprotection.

b Rule 11 sanctions in the form of attorney’sfees held abuse of discretion, where legal theoryasserted was not frivolous.

CJC Holdings. Inc. v. Wright & Lato. Inc.,989 F.2d 791, 793 (5th Cir. (Tex.) 1993).

In this debtor/creditor case (no bankruptcy),Rule 11 sanctions were imposed against a creditorand its attorneys, but were reversed because theattorneys had advocated a plausible legal theory.Competing motions for sanctions were filed infederal district courts in Texas and New Jersey.The creditor, CJC, moved for sanctions in Texasbecause the debtor, Wright & Lato, launched acollateral attack on the underlying judgment inNew Jersey for lack of personal jurisdiction in theforum court, the Western District of Texas. JudgeNowlin of the Western District granted the debtor-defendants'. motion for attorney's fees as sanctionsfor the creditor having filed its sanction motion inthe forum court.

The Fifth Circuit reversed the sanctions,stating that the jurisdictional issue as between twofederal courts was not the determining factor, butthat the forum court had misapprehended the

argument urged by the creditor and because it wasplausible, therefore the Rule 11 sanctions were anabuse of discretion.

c Sanctions may apply (fee forfeiture), even ifcounsel not disqualified for violations of Rules2014, 2016; demonstrated benefit to estate mayoutweigh disfavor of having accepted unapprovedfees while representing Trustee, especially afteractual conflict develops.

In re Hunt International ResourcesCorporation, 1992 W.L. 235580 (motion todisqualify); 1992 W.L. 235579 (motion toreconsider) (U. S. Bk. Ct. N.D. Tex.1992). JudgeMcGuire’s opinion provides a conscientiousconflicts analysis of bankruptcy law and TexasDisciplinary Rules 1.06, 1.07, and 1.08 concerningmotions to disqualify, making this a must-readopinion even if the fact situation is too twisted tocarry much precedential effect. The Court pointedout that the Bankruptcy Code prohibits certainconflicts from being waived, requiring that theconflict of interest rules be applied more strictly inbankruptcy than in other areas of the lawregarding professionals retained by the estate.Further, even if the law allowed consent to theconflicts, the firms did not obtain consent from theTrustee, the Court, or the creditors.

The factual basis is exhaustively (andexhaustingly) set forth in this large complexinvoluntary Chapter 11, regarding the motion by adefendant in an adversary turnover proceeding todisqualify special counsel for a bankruptcy trustee.Through a combination of law firm mergers,dissolutions and general firm-hopping during theseven year history of this case, the judge was facedwith disengaging a cluster of lawyers whosedisclosures of the intricacies of their changingaffiliations were not adequate or timely enough,but whose “time spent and results accomplished”were favorable to the creditors of the estate.

Judge McGuire ultimately settled on aSolomonic remedy, finding that continuing withrepresentation of the Trustee after an actualconflict developed and accepting fee paymentsprior to court approval constituted violations ofRules 2014 and 2016. The motion to disqualifywas denied as inequitable to the Trustee and thecreditors, but the three law firms were sanctioned$200,000 against approximately $3,000,000 inrequested fees. The objecting party refused to let itrest, however, seeking reconsideration of theruling and proving additional non-disclosure byone of the firms in the process.



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The Court also docked “three-quarters of thefees and expenses” incurred in defending themotion for reconsideration plus an additional$5,000, but the motion to reconsider was denied.Other fees previously allowed and paid wereallowed to be kept, there being no prejudice orinjury found toward the estate from the prematuredrawdown.

Judge McGuire seems to have taken it all instride, noting that the law firm “has exhibited anaggressiveness and lack of ethical sensitivitywhich may, in part, be explained as a response to[movant’s] own aggressiveness in pursuing thesemotions.” 1992 W.L. 235779 (U. S. Bk. Ct. N.D.Tex.).

4. Disgorgement of fees and a disciplinaryreferral by the Bankruptcy Court held not an abuseof discretion: an attorney has fiduciary duties tothe estate and cannot ignore the Debtor's disregardof Bankruptcy Court orders.

In re Gregory, 214 B. R. 570 (D.S.D. Tex.[Houston] 1997), illustrates that the enforcementpower of the Bankruptcy Court over debtor'scounsel extends to the disciplinary arena. Here,the judge referred the debtor's attorney's conductfor disciplinary action, where the attorney'salleged neglect resulted in the Debtor's defalcationof funds derived from selling an estate asset.

The Debtor sold a homestead while still undera post-dismissal interim order retainingjurisdiction for supervision of asset sales, and theattorney failed to advise the Bankruptcy Court ofthe $43,000 loss to the estate when the Debtorimproperly expended the proceeds from the sale ofhis homestead. Not only did the bankruptcy judgeorder disgorgement of fees previously approved byan interim order, she referred the matter to theState Bar of Texas for disciplinary action.

The District Court found no abuse ofdiscretion, because an attorney for a Chapter 11Debtor-in-Possession has a duty as a fiduciary ofthe estate, and cannot ignore when the debtor isacting contrary to the best interests of the estateand disregarding orders of the bankruptcy court.214 B.R. at 575-76. Therefore, the bankruptcyjudge was acting within her discretion as a judicialofficer and a citizen in referring the loss ofbankruptcy estate funds to the appropriatedisciplinary body.

5. Trustee may pursue breach of fiduciary actionand fee forfeiture against attorneys, damages ornot (more perils of dual representation).

Holder v. Garner, Lovell & Stein PC, ___S.W.2d ___, 1999 W.L. 642216 (Tex. App. -Amarillo 1999), shows what can happen when alawyer attempts dual representation of party-plaintiffs with a waiver of conflict, they disagreeabout settlement options, and the disagreeing partysues then files bankruptcy.

Holder, the trustee, pursued pre-petitionmalpractice claims against the law firm which hadrepresented the Debtor (Jones) and a bank inlitigation against his employer. The Debtor hadsigned a conflict of interest disclosure / waiver,but when presented with a settlement proposal, herejected it although the Bank found it acceptable.Debtor discharged the law firm and pursued hisown action against the employer, which resulted ina $1.1 million recovery. Debtor sued the law firmbut then filed bankruptcy, thus the trustee tookover the claim. The law firm obtained summaryjudgment on claims of negligence, breach offiduciary duty, breach of contract, DTPA, fraudand unjust enrichment, all of which were reversedand remanded except the negligence claim.

Following Burrow v. Arce, 977 S.W.2d 299(Tex. 1999), the Amarillo Court held that a causeof action for breach of fiduciary duty giving rise toa disgorgement of fees by the law firm, is separateand distinct from a negligence action alleged asthe malpractice, and could be pursued by thetrustee whether or not the Debtor/estate sufferedactual damages. The trustee would be allowed topursue the fee forfeiture if able to prove thealleged breach of fiduciary duty, and otherdamages under the DTPA could be pursued if ableto prove liability and producing cause of statutorydamages.

Attorneys should bear in mind that their feesand their duties could be under scrutiny by abankruptcy trustee if the client files bankruptcy.Resolution of all causes of action assertable by aDebtor or a trustee should be considered whendrafting particular language of settlementagreements in malpractice actions (or otherwise).Conflict issues concerning diverging litigationinterests (including potential withdrawal) shouldbe considered carefully in joint litigationrepresentation agreements.





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VI. PARTICULAR PRACTICE &PROCEDURE ISSUES:A. Deadlines, Res Judicata, Tax YearElections, Trustee Liability1. Beware of traps in calculating deadlines.

A recent case on statutory and rule deadlinesis In re Dunlap, 217 F.3d 311 (5th Cir. 2000).Dunlap is a lawyer's nightmare on deadlinesmissed because of dismissal and reinstatement of abankruptcy case and conflicting deadlineinformation provided by the bankruptcy clerk tocreditors. The trustee and the debtor scheduledconflicting dates for the first meeting of creditorsand both dates were docketed by the Clerk. Noformal notices were sent and counsel for thecreditors obtained the new scheduling informationfrom the Clerk by phone, who quoted the trustee'sbar date (the later of the two). The BankruptcyCourt ruled that the bar date was 60 days after thedate the 341 meeting was actually held (the earlierdate), making one of the creditor's complaintsuntimely. The District Court counted the 60-dayperiod starting from the date the motion to dismisswas abandoned (a still earlier date), which cut offanother creditor's complaint.

Treated as a case of first impression, the FifthCircuit ruled that once the dismissal of the Chapter7 (on Debtor's motion) had been vacated, the 60-day time period for creditors to filenondischargeability complaints ran from the dateof the rescheduled creditors' meeting followingreinstatement of the case, meaning the deadlinefell on the bar date set by the trustee (the latter ofthe two) following the 341 date set by the trustee.What could bankruptcy counsel do to avoidmissing the creditors' bar date? The date given bythe Clerk was ultimately held to be the correctdate, however inconsistencies regarding Section341 hearing dates (held, set, or rescheduled)should be watched carefully, especially if it mightarguably accelerate the bar date. Or, file early ifyou can, not on the last day.

2. Compulsory Counterclaims; Res JudicataIssues.

In re Intelogic [Interlogic] Trace, 200 F.3d 382(5th Cir. 2000), is a Judge Leif Clark case inwhich failure by the trustee to object to anaccountant's fee application later barred amalpractice lawsuit against the accountants. ThisChapter 11 proceeding of IT became a Chapter 7,in which the accounting firm (Ernst & Young,LLP) filed for fees awarded for audit, negotiation,and consultation services, but not paid in the

Chapter 11. The trustee complained that theDebtor's cash position was jeopardized by theaccountants' failure to contact customers regardingprepayment of contracts, which caused thefinancial projections to be flawed in developing anoperating plan.

Relying in part on In Re Baudoin, 981 F.2d736 (5th Cir. 1993), the Fifth Circuit affirmed theDistrict Court and the Bankruptcy Court, and saidthese issues were barred by res judicata. 200 F.3dat 390. Since there was evidence that questionshad already been raised about the quality orreasonableness of the fees, they should have beenlitigated at the hearing on the fee application. Thematter could have been resolved as a contestedmatter, or if the Debtor or trustee objected andpresented a claim for relief, it could have beenresolved as an adversary matter.

Attorneys representing debtors (or trustees)should be aware that malpractice claims againstprofessional service providers could be barred byfailing to object to the application for professionalfees, if there is knowledge of potential claimsaffecting the nature and quality of servicesrendered. The Debtor (or trustee) is free to make adeliberate choice not to raise concerns about thequality of services at the fee hearing, withawareness of the consequences of such a decision.

3. Potential Counterclaims Against CreditorsIf there is an objection to be asserted,

potential counterclaims against creditors shouldbe listed as assets and addressed in response to aproof of claim. In re Baudoin, 981 F.2d 736 (5thCir. 1993), is a case in which the bank got the staylifted to foreclose on its collateral and filed adeficiency claim in a corporate case. The Debtorsfiled personal and corporate bankruptcy, and listedpotential claims against the bank among assets ofundetermined value in their Chapter 7, from whichthey were discharged without the bank filing aproof of claim. Evidently those claims were notlisted as corporate assets. The individual Debtorslater filed a $4 million lender liability case in statecourt against the bank. However, the bank's proofof claim filed in the corporate bankruptcy was stillpending when the lender liability action was filed.

The personal bankruptcies were reopened, andtreating the matter as a core proceeding, the FifthCircuit reversed the Bankruptcy Court and DistrictCourt, holding that res judicata did bar the lenderliability claim because it was a compulsorycounterclaim to the creditor's allowed claim in thecorporate case. 981 F.2d at 741. The corporation







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was wholly owned by the individuals. The Courtstated the corporation could and should have filedan objection to the claim asserting the lenderliability claim. A similar case, Eubanks v. FDIC,977 F.2d 166 (5th Cir. 1992), barred a lenderliability cause of action in a Chapter 11 confirmedplan case, because the cause of action was notretained in the plan or scheduled as an asset of theestate.

4. Short Year Tax Elections: Yes or No?Counsel should address the issue of a short

year tax election under 26 U.S.C. Section 1398 inadvance of the deadline, which falls on the 15th

day of the fourth month following commencementof the bankruptcy. A short year tax election mayin some cases operate to the detriment of the estateby increasing the priority tax claims against theestate. However, not necessarily. In re Saunders,155 B.R. 405 (U. S. Bk. Ct. W.D. Tex. 1993)(perJudge Clark) is a case when it was beneficialbecause although the Debtor made the short yearelection, no tax liabilities were generated. Thematter was raised when counsel for the Debtorapplied for payment of pre-petition servicesconcerning short year election counseling, whichwere granted administrative priority over theobjection of the Trustee. The attorneys made theelection for the Debtor to facilitate the use of netoperating loss carry forwards to eliminate anypriority tax claims for the short period. As aresult, the amount of money available fordistribution to creditors actually increased.

The 26 U.S.C. Section 1398 allows abankruptcy debtor a one-time election to dividethe filing year into two taxable periods or remainwith one tax year. The election must be made onthe 15th day of the fourth month following thecommencement date. Once made or missed, it isirrevocable. The election creates a separate taxentity for the short tax year and is an allowableclaim against the bankruptcy estate. See, In reMoore, 132 B.R. 533 (W.D. Pa. 1991). Theelection could be meaningless -- or have profoundfinancial effects.

5. Trustee Personal Liability: None for MereNegligence (at least in the Fifth Circuit.)

The standard of care applicable to trusteescould become an important issue whenrepresenting the trustee or a claimant against thetrustee. In re Smyth, 207 F.3d 758 (5th Cir. 2000)discusses the silence of the Bankruptcy Code onthe standard of care required of a trustee

performing statutory duties to collect the assets ofthe estate, close it expeditiously, and file taxreturns on behalf of the estate. Smyth, a realestate developer, was placed in involuntaryChapter 7, later converted to Chapter 11; thetrustee, a certified public accountant, employedhimself as accountant for the estate with theBankruptcy Court's approval. When the trusteeapplied to close the case and moved for finalpayment of his commission, a creditor objectedand sought the trustee's personal reimbursementto the estate for alleged damages attributed tovarious alleged errors in the estate's tax returns.

While the Ninth Circuit imposes liability on atrustee for mere negligence, the Sixth, Seventh,and Tenth Circuits have held that a willful anddeliberate violation of a trustee's fiduciary duties,before imposing personal liability. 207 F.3d at761. The Fifth Circuit refused to follow the NinthCircuit, holding here that a bankruptcy trusteeshould not be subjected to personal liability unlessfound to have acted with gross negligence,affirming the dismissal of the creditor's objectionfor lack of evidence to support even a claim ofmere negligence.

VII. CONCLUSION: CONTINUE TOWATCH YOUR STEP!

The trend in legal malpractice case law overthe past few years has been toward an everbroadening circle of duties owed by (or imposedupon) attorneys, not only to their clients but tonon-clients as well. The business climate in Texashas been generally favorable to investment deals,which has reduced the frequency of reported legalmalpractice claims. Grievance reports haveremained above 9,000 per year over the last fewyears. However, claims and grievances are notalways asserted promptly after an error oromission occurs: they may surface when leastexpected. More claims are likely to be brought bynon-clients than has previously been the case; thisincludes claims from successors to the originalclient (such as bankruptcy trustees).

Whenever the next economic slump arrives,the incidence of legal malpractice claims can beexpected to increase again. The watchword forattorneys is this: now is the time to exercise goodmalpractice and grievance prevention habits, inorder to minimize the exposure to legalmalpractice claims and disciplinary complaints inthe next economic downturn.





Documents

LEGAL MALPRACTICE CLAIMS AND BANKRUPTCY ...Legal Malpractice Claims and Bankruptcy Chapter 5 iv Holder v. Garner, Lovell & Stein PC , 1999 W.L. 642216 (not published) (Tx. App. - Amarillo