“Hypothetical jurisdiction” for a bankruptcy appeal?!
Who knew? I sure didn’t.
But it is, apparently, a thing . . . and it may even be real.
At U.S. Supreme Court
A newly filed Petition in the U.S. Supreme Court is Waleski v. Montgomery, McCraken, Walker & Rhodes, LLP, Case No. 22-914 (Petition filed 3/16/2023).
The Question Presented to the U.S. Supreme Court in Waleski v Montgomery is this:
- Whether a federal appellate court may assume “hypothetical” subject matter jurisdiction in a bankruptcy appeal.
–The Second Circuit’s Answer
Using “hypothetical jurisdiction” is appropriate in this case, the Second Circuit rules below, because:
- we have Article III jurisdiction over the dispute decided by the Bankruptcy Court;
- the statutory “arising in” jurisdiction issue, under which the Bankruptcy Court made its ruling, is novel, complex and difficult; and
- the Bankruptcy Court’s dismissal of Plaintiffs’ claims, on statute of limitations grounds, is obviously correct.
Such Second Circuit ruling is now before the U.S. Supreme Court on a Petition for writ of certiorari in Waleski v Montgomery.
Here’s what happened in the Waleski v Montgomery case.
–Starting In State Court
4,362 individual Plaintiffs sue Tronox, Inc., claiming they were poisoned by releases of creosote and other toxic chemicals from its plant in Avoca, Pennsylvania.
–Then In Bankruptcy Court
Tronox files bankruptcy, staying Plaintiffs’ lawsuits.
Plaintiffs hire the Montgomery law firm under a contingent fee agreement to protect their interests in the Tronox bankruptcy.
The Montgomery firm performs various services in the bankruptcy, including:
- preparing and filing proof of claims on Plaintiffs’ behalf in an amount identified as “unknown”; and
- drafting a Tort Claims Trust Agreement to govern how funds will be distributed to various types of personal injury claimants, including Plaintiffs, under a confirmed plan.
After plan confirmation, the Montgomery firm terminates its representation of Plaintiffs, they allege, “without notice and without the consent or agreement” of Plaintiffs or their state-court attorneys.
A fraudulent transfer lawsuit in the Bankruptcy Court provides the biggest potential source of funding for the Tort Claims Trust. Here’s what happens in that lawsuit:
- After a lengthy trial, the Bankruptcy Court rules that liability exists on the fraudulent transfer claim, pegging the damages amount somewhere between $5.1 and $14.1 billion;
- A bankruptcy claims report allows Plaintiffs’ claims in the total amount of $949 million;
- Then, parties to the fraudulent transfer lawsuit seek approval of a settlement of all claims against defendants for a payment of $5.15 billion;
- The Bankruptcy Court issues proposed findings and conclusions and a recommendation to the District Court for approval of the settlement—which the District Court adopts, and it approves the settlement; and
- From such settlement, each of the Plaintiffs receives a pro rata share of $329,693,120.
–Malpractice Claims in State Court
Disappointed with the amounts they receive from the bankruptcy Trust, Plaintiffs file a malpractice lawsuit in state court against the Montgomery firm—alleging breaches of contract in the performance of its professional duties on their behalf in the bankruptcy case.
The malpractice lawsuit includes these allegations of wrongful conduct by the Montgomery firm:
- improperly filing Plaintiffs’ claims in an “unknown” amount, instead of for $5.3 billion, resulting in reduced recoveries to Plaintiffs;
- having a conflict of interest (by representing one of the Plaintiffs as a member of the Official Creditors’ Committee) without proper disclosures to and knowing waivers from Plaintiffs; and
- improperly terminating its representation of Plaintiffs, prior to payment of the bankruptcy claims and without notice to Plaintiffs or their consent.
–Removal and Transfer
The Montgomery firm removes Plaintiffs’ state court malpractice lawsuit to federal District Court, which then transfers the removed malpractice lawsuit to the Bankruptcy Court that has been handling the Tronox case.
All of this happens over Plaintiffs’ objections and requests for remand to the state court.
“Arising In” Jurisdiction
Plaintiffs’ representative (Waleski) contends that the Bankruptcy Court lacks subject matter jurisdiction over the malpractice lawsuit.
The Bankruptcy Court disagrees and retains the malpractice lawsuit under its statutory “arising in” jurisdiction.[Fn. 1] Here’s why:
- The alleged wrongs involve the performance of bankruptcy-specific tasks and the assertion of bankruptcy-specific objections and rights;
- the dispute does not exist – and could not exist – outside of the context of the Tronox bankruptcy;
- the dispute implicates the integrity of the bankruptcy process;
- the dispute requires interpretation of prior orders and rulings of the Bankruptcy Court; and
- therefore, the Bankruptcy Court has “arising in” jurisdiction over the dispute and declines to abstain from hearing the dispute.
Expired Statutes of Limitations
Then, the Montgomery firm moves to dismiss the malpractice lawsuit due to expiration of the applicable statute of limitations.
Plaintiff’s representative argues in opposition that Plaintiffs are asserting contract claims, not tort claims, because:
- the two-year statute of limitations for tort claims might have expired; but
- the four-year statute of limitations for contract claims controls and has not expired.
The Bankruptcy Court determines that all Plaintiffs’ claims are barred by the applicable statute of limitations and dismisses the case.
Appeal to Second Circuit
Plaintiffs’ representative appeals to the Second Circuit Court of Appeals, arguing that (i) their claims against the Montgomery firm are contract claims, which are not barred by any statute of limitations, and (ii) the Bankruptcy Court has no jurisdiction to dismiss Plaintiffs’ claims.
–Second Circuit Affirms Under “Hypothetical Jurisdiction”
The Second Circuit rules on appeal that:
- it has “hypothetical jurisdiction” to the hear the appeal;
- Plaintiffs’ malpractice claims are clearly tort claims, not contract claims, because the allegations of malpractice are of failures to meet professional standards of care; and
- the Bankruptcy Court properly dismissed the case.
–Basis for “Hypothetical Jurisdiction”
The Second Circuit relies upon “hypothetical jurisdiction” for its ruling—and specifically avoids addressing the Bankruptcy Court’s “arising in” jurisdiction.
- the Second Circuit has jurisdiction over the dispute under Article III of the U.S. Constitution;
- the meaning of “arising in” jurisdiction under 28 U.S.C. §§ 157(a) & 1334(b) is less than clear—that’s because the “arising in” issue is novel, complex and difficult; but
- Plaintiffs’ claims fail on “obvious” statute of limitations grounds; and
- In such circumstances, the Second Circuit may “assume hypothetical jurisdiction in order to rule on those obvious grounds.”
The Petition for writ of certiorari in Waleski v Montgomery says that a circuit split exists on whether “hypothetical jurisdiction” is an actual thing that’s real.
It will be interesting to see what the U.S. Supreme Court does with the case.
Footnote 1. “Arising in” jurisdiction for a bankruptcy court exists under:
- 28 U.S.C. § 1334(b), which provides: “the district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11” (emphasis added); and
- 28 U.S.C. § 157(a), which provides: “Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments, subject to review under section 158 of this title” (emphasis added).
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