December 2, 2016

In our previous entry, we examined the interaction between the bankruptcy estate and a cause of action, or claim, of the Debtor.  The issue can be complex.  In this entry, we look more closely at the issue of timing.  When the cause of action arises, or when it accrues, can define whether the property belongs to the bankruptcy estate.

Timing

In Johnson, Blakely, Pope, Bokor, Ruppel & Burns, P.A. v. Alvarez (In re Alvarez) 224 F.3d 1273, 1276 (11th Cir. 2000), the court looked at a malpractice claim arising from the actual bankruptcy filing in order to determine whether it was property of the bankruptcy estate.  Debtor filed a complaint against his former attorney alleging legal malpractice. The crux of the debtor’s malpractice claim was his allegation that his lawyer negligently disregarded his instructions to file a Chapter 11 on his behalf, and instead filed a Chapter 7. Debtor’s complaint alleged that as a result of his negligent actions the debtor sustained damages, including but not limited to, loss of control and ownership of several assets, including ownership interests in stocks, loss of opportunity, loss of assets, and other damages recoverable at law.

Typically, a cause of action for legal malpractice has three elements:

1.            The attorney’s employment;

2.            The attorney’s neglect of a reasonable duty;

3.            The attorney’s negligence was the proximate cause of loss to the client. 

The third element of a legal malpractice claim, that the attorney’s negligence was the proximate cause of loss to the client, is also referred to as the concept of redressable harm.  A cause of action accrues when the last element constituting the cause of action occurs.

The court concluded that, looking to state law, this interest in property, which arose simultaneously with the filing of the debtor’s bankruptcy petition, was an interest of debtor and property “as of” the commencement of the case, and thus, property of the estate. 

Debtor attempted to argue that the third element of his malpractice cause of action, that of redressable harm, did not occur until after the filing of his bankruptcy petition.  The court disagreed. 

At the moment the debtor’s bankruptcy petition was filed, his chapter 7 bankruptcy estate was created, his interest in property vested in the estate, and all of the legal ramifications creating an estate came into existence. The transfer of debtor’s interest in property to a chapter 7 bankruptcy estate, rather than a chapter 11 bankruptcy estate as the debtor intended, is sufficient injury the court held to indicate the debtor had a cognasizable interest in his legal malpractice claim at the precise moment his chapter 7 petition was filed.  The court specifically found that the debtor’s loss of ownership and control of his assets upon the bankruptcy filing constitutes a significant and tangible change which obviously caused harm to him. 

More About Timing – Sufficiently Rooted in the Pre-Petition Past

In Witko v. Menotte (In re Witko) 374 F.3d 1040 (11th Cir. 2004), the debtor filed a petition for bankruptcy in 1999, after a divorce proceeding was filed.  In 2000, in a separate proceeding regarding the marital dissolution, the state court trial judge denied his request for alimony. Thereafter, the debtor sued his divorce counsel for malpractice. The Trustee of the debtor’s bankruptcy case intervened seeking a determination that the malpractice claim was estate property.  The bankruptcy court held that the cause of action was property of the estate because the better rule is that where pre-petition acts form part of a chain of events that lead to a post-petition redressable harm, the cause of action is sufficiently rooted in the debtor’s pre-petition past. 

The case was appealed and the higher court, applying state law, concluded that the legal malpractice cause of action did not exist until the alimony action concluded with an adverse outcome that was proximately caused by his attorney’s negligence. 

The court held that until the underlying action is concluded with an outcome adverse to the client a malpractice claim is hypothetical, and damages are speculative.  The court went on to suggest that a negligence malpractice cause of action accrues when the client incurs damages at the conclusion of the related or underlying judicial proceedings. 

Therefore, the debtor did not suffer a harm in the alleged legal malpractice prior to or contemporaneous with his filing of a bankruptcy petition.  The judicial proceedings underlying his malpractice claim did not conclude until months later.  The debtor’s malpractice cause of action was unknown. No one could not anticipate that the debtor would lose his alimony claim due to the attorney’s malpractice.  The debtor’s legal malpractice cause of action did not exist at the time when he filed his bankruptcy, and the lower court was reversed.

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