Where the only injury resulting from bankruptcy counsel’s conduct was denial of discharge, the cause of action for legal malpractice accrued post-petition and belonged to the debtors rather than the chapter 7 bankruptcy estate. Church Joint Venture, L.P. v. Blasingame, No. 19-5505 (6th Cir. Jan. 26, 2021).
The debtors filed for chapter 7 bankruptcy but were denied discharge when the court learned of undisclosed assets in the form of personal property, shell companies, family trusts, etc. The debtors filed a malpractice lawsuit against their bankruptcy attorneys in state court. When the trustee declined to bring a suit against the debtors’ attorneys on behalf of the bankruptcy estate, the debtors’ primary creditor, CJV, obtained derivative standing to do so. CJV moved for summary judgment on the issue of whether the cause of action belonged to the estate. The court treated the debtors’ response as a cross-motion for summary judgment and granted judgment in favor of the debtors. The BAP for the Sixth Circuit affirmed. Church Joint Ventures, L.P. v. Blasingame (In re Blasingame), 597 B.R. 614 (B.A.P. 6th Cir. 2019).
On appeal, the Sixth Circuit began its analysis with the general rule that section 541 determines what interests become property of the bankruptcy estate, but state law determines the extent and nature of a debtor’s interest in property. In this case, Tennessee law establishes that a legal malpractice claim requires the plaintiff to show five elements: “(1) the attorney owed a duty to the plaintiff; (2) the attorney breached that duty; (3) the plaintiff suffered damages; (4) the breach was the but for cause of the plaintiff’s damages; and (5) the breach was the proximate cause of the plaintiff’s damages.”
The issue on appeal was when the damage element occurred and whether it was necessary that it occur pre-petition for the cause of action to become part of the estate. The bankruptcy court applied the “accrual theory” to find that the cause of action accrued when the debtors suffered the injury of being denied discharge. CJV argued that the violation accrued when the attorneys breached their duty to investigate and draft the Blasingames’s petition. The court found that under Tennessee law “[a] legal malpractice claim accrues as of the date on which the negligence became irremediable.” The court found that point necessarily occurred post-petition as, prior to filing their bankruptcy petition, the debtors could have chosen not to file at all.
Citing Segal v. Rochelle, 382 U.S. 375, 380 (1966), CJV argued that even if the damage occurred post-petition, it had its roots in pre-petition conduct and therefore entered the bankruptcy estate under section 541(a). That section encompasses “all legal or equitable interests of the debtor in property as of the commencement of the case” regardless of “wherever located and by whomever held.”
The court held that mere pre-petition conduct is not enough to root the cause of action pre-petition; there must be a pre-petition violation even if the debtor was not aware of the violation at the time. The court turned to the crux of the case: “Does the violation occur when the duty is breached or when the damage is incurred?” The court observed that Tennessee used to follow the common law rule that a malpractice cause of action accrues upon the wrongful act rather than upon the resulting injury. The Tennessee Supreme Court changed that in Teeters v. Currey, 518 S.W.2d 512, 517 (Tenn. 1974), when it held, in the medical malpractice context, that a cause of action accrues when a patient discovers the resulting injury. The Sixth Circuit has since applied Teeters in the legal malpractice context as well.
The court found, in this case, that the debtors were unaware of the attorneys’ conduct until they were denied discharge. Because that event was post-petition, the cause of action did not enter the bankruptcy estate and the bankruptcy court correctly found it to be the debtors’ property.
The court affirmed.
Tags: Property of Estate
