Because the number of unsatisfied clients who find themselves in bankruptcy are filing malpractice lawsuits against their pre-bankruptcy counsel is on the rise so, too, is the number of attorneys who find themselves on the defending end of such claims. Debtors and Trustees pursuing such claims, as well as attorneys defending against a bankruptcy debtor’s malpractice lawsuit, should consider the pros and cons of adjudicating these claims through an adversary proceeding in the bankruptcy court or via a state court action outside the bankruptcy realm. Malpractice strategies in this context should include an evaluation of the bankruptcy court’s subject matter jurisdiction over the malpractice claims, and the impact of the abstention statutes. This blog will be presented in a 3-part series to examine a bankruptcy court’s subject matter jurisdiction in legal malpractice actions, and the potential effect of the abstention statutes.
Bankruptcy Court subject matter jurisdiction
District Courts, including Bankruptcy Courts, have original and exclusive jurisdiction over all cases arising under Title 11. 28 U.S.C. 1334(a). District Courts also have original, but not exclusive jurisdiction over cases arising under Title 11, or arising in or related to cases under Title 11. 28 U.S.C. 1334(b). An objection to subject matter jurisdiction may properly be raised at any time either by a party or by the court sue sponte. Carlisle v. United States, 517 U.S. 416, 434, 116 S. Ct. 1460, 134 L. Ed. 2d 613 (1996). A court’s consideration of a challenge to subject matter jurisdiction is not made on the merits and is without a preclusive effect. Verret v. Elliot Equip. Corp., 734 F.2d 235, 238 (5th Cir. 1984). When subject matter jurisdiction is challenged the court may consider evidence and look beyond the pleadings. Montez v. Dept. of Navy, 392 F.3d 147, 149 (5th Cir. 2004). If a court determines that it lacks subject matter jurisdiction the court must dismiss the action. Rule 7012(h)(3). On the other hand, even where the bankruptcy court has jurisdiction over a proceeding, in some circumstance it may opt to not exercise that jurisdiction.
Where a debtor’s malpractice claims stem from pre-petition legal representation not dealing with the bankruptcy case, such claims will typically be based on state law and have no independent ground of Federal Jurisdiction. In other words, but for the bankruptcy proceeding, a plaintiff’s pre-petition malpractice claim could only be brought in state court. As such, these claims neither arise under Title 11 nor arise in a bankruptcy case.
Proceedings are related to bankruptcy cases if their outcome could conceivably have any effect on the estate being administered in bankruptcy. See Fire Eagle, LLC v. Bischoff (In re Spillman Dev. Group, Ltd.), 710 F.3d 299, 304 (5th Cir. 2013)(citing Bass v. Denney ( In re Bass), 171 F.3d 1016, 1022 (5th Cir. 1996)). The Spillman court defined “conceivable effect” as any effect that “could alter the debtor’s rights, liabilities, options, or freedom of action (either positively or negatively) and which in any way impacts upon the handling and administration of the bankrupt estate.” Id. An award in favor of a Debtor/Plaintiff could conceivably impact the administration of the bankruptcy estates by increasing the amount of money available for distribution to the unsecured creditors of the bankruptcy estate. Consequently, bankruptcy courts typically retain related to jurisdiction over such malpractice claims, as the adjudication of same could conceivably affect the administration of the bankruptcy estate with additional funds. The remedies/strategies for related to jurisdiction include mandatory abstention under 28 U.S.C. §1334(c)(2) and permissive abstention under 28 U.S.C. §1334(c)(1). These abstention statues will be examined in parts 2 and 3 of this blog series.