Schultze et al v. Chandler et al

Filing 10

ORDER AFFIRMING RULINGS OF BANKRUPTCY COURT. Signed by Judge Alsup on December 27, 2011. (whalc1S, COURT STAFF) (Filed on 12/27/2011)

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IN THE UNITED STATES DISTRICT COURT

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FOR THE NORTHERN DISTRICT OF CALIFORNIA
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For the Northern District of California

United States District Court

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RICHARD K. SCHULTZE, LORENZO V.
ZUNINO, ROBERT BECCHETTI, and
RICHARD QUESTONI,

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Appellants,

No. C 11-4940 WHA

ORDER AFFIRMING RULINGS
OF BANKRUPTCY COURT

v.
DAVID N. CHANDLER, SR, and DAVID
N. CHANDLER, P.C.,
Appellees.
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INTRODUCTION

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In this legal malpractice action arising out a Title 11 proceeding, appellants appeal the

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bankruptcy court’s finding of jurisdiction and order dismissing the action. For the reasons below,

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the decisions are AFFIRMED.

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STATEMENT
Appellants were investors in Colusa Mushroom, Inc., a California company that grew

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mushrooms for commercial sale. In August 2005, Colusa filed for Chapter 11 bankruptcy.

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Appellants alleged that to protect their investments in Colusa, they contacted defendant David

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Chandler, a bankruptcy attorney (Compl. ¶ 5). In September 2005, an Official Creditors

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Committee of unsecured creditors, composed of appellants and two other individuals and one

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business entity, was created pursuant to Bankruptcy Code Section 1102 (Compl. ¶ 6). As

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chairman of the Committee, appellant Richard Schultze executed an application for permission to

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employ Chandler as counsel for the Committee. Chandler’s employment was approved by the

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bankruptcy court pursuant to Bankruptcy Code Section 1103(a).

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With the bankruptcy court’s approval, a plan of reorganization was formed that required

appellants, were to receive pro rata shares of the proceeds. The sales price was paid in cash and a

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promissory note, which was required to be secured against Colusa’s assets. Premier and Colusa

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agreed to use their respective counsel for purposes of closing escrow on the sale. This did not

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include defendant Chandler. Counsel for Colusa failed to file the financing statement to secure

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the promissory note, as required by the approved plan of reorganization (Compl. ¶ 13). Premier

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For the Northern District of California

Colusa to sell its business and assets to a third party, Premier. All unsecured creditors, including

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United States District Court

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paid the initial installments as provided by the terms of the note but defaulted four years later

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in 2010. Because the note was not secured, Premier was able to take out additional loans on and

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over-encumbered the assets of Colusa. Thus, appellants’ interest in the promissory note was

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worth significantly less than that intended under the reorganization plan (Compl. ¶ 15).

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After the Colusa bankruptcy was reopened and converted to Chapter 7 (Br. 3), appellants

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commenced action against Chandler and his law firm in state court for malpractice. Appellants

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alleged that Chandler was negligent because he failed to ensure that the security was properly

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perfected (Compl. ¶ 13).

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Chandler removed the malpractice action to federal bankruptcy court on April 8, 2011.

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Appellants moved to remand back to state court. Bankruptcy Judge Alan Jaroslovsky found that

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there was federal jurisdiction for the malpractice action and denied appellants’ motion to remand

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(Bankruptcy Record Doc. 8). Subsequently, Judge Jaroslovsky dismissed the action because he

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found that Chandler did not owe a duty to appellants (Bankruptcy Record Doc. 23). Appellants

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challenge both rulings in this appeal.

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ANALYSIS
The district court reviews the bankruptcy court’s findings of fact under the clearly

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erroneous standard and its conclusions of law de novo. Mixed questions of law and fact are

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reviewed de novo. In re JTS Corp., 617 F.3d 1102, 1109 (9th Cir. 2010).
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JURISDICTION.

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Judge Jaroslovsky held that because appellants’ malpractice claim was inseparable from

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the bankruptcy context, there was federal jurisdiction over the matter and it should be treated as a

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core proceeding (Bankruptcy Record Doc. 8).

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A bankruptcy court has jurisdiction over “all civil proceedings arising under title 11, or

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arising in or related to cases under title 11.” 28 USC 1334(b). Claims that arise under or in

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title 11 are deemed to be “core” proceedings, while claims that are related to title 11 are

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“noncore” proceedings. Core proceedings are matters that arise only in bankruptcy cases and

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would have no existence outside of the bankruptcy. In re Harris Pine Mills, 44 F.3d 1431, 1435

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For the Northern District of California

United States District Court

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(9th Cir. 1995).
Appellants argue that their malpractice claim was not a core proceeding because

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malpractice was a creature of state law. They also argue that their claim is not related to the

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bankruptcy proceeding because it did not affect the debtor, other creditors, or the administration

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of the debtor’s estate (Br. 8–9). This order disagrees.

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Although appellant alleged a state law malpractice claim, the allegations supporting the

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claim were entirely unique to bankruptcy law and proceedings. Appellants were allegedly

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harmed because they were members of a Committee created pursuant to Bankruptcy Code Section

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1102. The action was against Chandler, an attorney who was approved by the bankruptcy court to

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act as counsel for the Committee pursuant to Bankruptcy Code Section 1103(a). Chandler’s role

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as attorney for the Committee was unique to bankruptcy law. See 11 USC 328–331 (Bankruptcy

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Code provisions describing the basis for compensation of appointed counsel). The sale of

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Colusa’s assets to Premier was made pursuant to a plan approved by the bankruptcy court.

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Appellants were claiming damages for money they would have received under the bankruptcy

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plan had the promissory note been properly secured.

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Appellants’ malpractice claim arose out of the underlying Colusa bankruptcy and was a
core proceeding.

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MALPRACTICE.

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Judge Jaroslovsky dismissed appellants’ malpractice claim after holding that Chandler did

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not owe a legal duty under California law to the appellants (Bankruptcy Record Doc. 23 at 2).

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Specifically, Judge Jaroslovksy held that there were no attorney-client relationships between

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Chandler and the appellants individually, and after weighing the appropriate considerations, held

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that Chandler had no legal duty to appellants as non-client beneficiaries under the circumstances.

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To state a claim for malpractice, a plaintiff must plead that the attorney had a duty to the

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plaintiff. Ordinarily, an attorney is liable only to his or her client. In exceptional situations, an

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attorney may have a duty to non-client beneficiaries if policy considerations weigh for the
“imposition of liability under the circumstances.” Chang v. Lederman, 172 Cal. App. 4th 67, 76

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For the Northern District of California

United States District Court

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(2009). Among the considerations to be weighed include “the extent to which the transaction was

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intended to affect the plaintiff, the foreseeability of harm to him, the degree of certainty that the

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plaintiff suffered injury, the closeness of the connection between the defendant’s conduct and the

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injury suffered, the moral blame attached to the defendant’s conduct, and the policy of preventing

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future harm.” Id. at 77.

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At issue is the scope of Chandler’s duty to appellants. Appellants argue that Chandler had

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a broad obligation to make sure the appellants’ interests were adequately protected because

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Chandler and appellants, on an individual basis outside the Committee, had attorney-client

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relationships. Appellants contend that the attorney-client relationships were implied-in-fact, and

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the relationships continued even after the Committee was formed and Chandler became the

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attorney of record for the Committee. This order disagrees.

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Appellants failed to plead sufficient factual allegations to plausibly claim that Chandler

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was acting as an attorney for the appellants individually outside his role as attorney for the

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Committee. Appellants did not pay or formally retain Chandler as an attorney prior to the

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Committee’s formation (Reply Br. 8). Instead, the pleadings only alleged that appellants

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contacted Chandler before the Committee was formed and he “agreed to represent them” (Compl.

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¶ 5). This conclusory allegation is insufficient to plausibly claim that Chandler had additional

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obligations to appellants outside his role as attorney for the Committee. Chandler was only paid
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for his role as counsel for the Committee. The only written agreement between Chandler and

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appellants was for Chandler to act as counsel for the Committee. The bankruptcy court only

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authorized Chandler to act as counsel for the Committee (Compl. ¶ 7). Moreover, there is a

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strong presumption that “a professional retained by a committee represents the committee and

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only the committee, and the professional’s fiduciary duty runs solely to committee.” 7 COLLIER

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ON BANKRUPTCY,

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appellants’ lawyer.

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1103.03[7]. Judge Jaroslovsky correctly found that Chandler was not

As members of the Committee, appellants were non-client beneficiaries of Chandler’s
duties to the Committee. Nevertheless, Chandler had no legal duty to appellants under these
circumstances because policy considerations weighed against the imposition of liability. It was

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For the Northern District of California

United States District Court

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unforeseeable that appellants would be harmed in the manner they alleged. Chandler’s conduct,

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or non-conduct, was far removed from the alleged injury. There was no moral blame attached to

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Chandler’s inaction. And public policy weighed against imposition of liability under the

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circumstances.

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It was Colusa’s counsel who failed to perfect the security interest in the promissory note.

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Judge Jaroslovsky found that it was not foreseeable that an experienced commercial lawyer, such

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as Colusa’s counsel, would fail to file a financing statement (Bankruptcy Record Doc. 23 at 3).

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Chandler did not cause this failure and had no right or power to file a financing statement himself.

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Judge Jaroslovsky also found that there was no moral blame on Chandler for not double-checking

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the actions of Colusa’s counsel (see ibid.). This order agrees.

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Public policy disfavored applying a legal duty in this situation. As Judge Jaroslovsky

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observed, “an active creditors’ committee represented by competent counsel is a blessing to a

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bankruptcy court, assisting the court in identifying issues and determining what actions are in the

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best interests of the bankruptcy estate.” This is because “such counsel usually serve without

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retainer, relying on confirmation of a plan or unencumbered estate assets for their fees; many are

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disappointed” (Bankruptcy Record Doc. 23 at 3). Imposing a legal duty in this situation would

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chill the willingness of counsel to represent committees and harm future bankruptcy proceedings.

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CONCLUSION
For the reasons stated, the bankruptcy court’s finding of jurisdiction and order dismissing
the action are AFFIRMED.

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IT IS SO ORDERED.

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Dated: December 27, 2011.

WILLIAM ALSUP
UNITED STATES DISTRICT JUDGE

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For the Northern District of California

United States District Court

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