“Arising In” Bankruptcy Jurisdiction Over A Malpractice Claim (Murray Energy Holdings)

These buildings are “arising in”? (Photo by Marilyn Swanson)

A bankruptcy court has jurisdiction to dismiss a legal malpractice claim of non-debtor plaintiffs against non-debtor attorneys.

That’s the ruling in Murray v. Willkie Farr & Gallagher LLP (In re Murray Energy Holdings Co.), Adv. Pro. No. 22-2007, Southern Ohio Bankruptcy Court (decided October 5, 2023, Doc. 89)—appeal is pending.

Summary of Issue and Ruling

Plaintiffs sue Defendants in state court for legal malpractice that occurred during and within in a bankruptcy case. Then, Defendants remove the malpractice case to the Bankruptcy Court that handled the bankruptcy.

A threshold issue is whether the Bankruptcy Court has subject-matter jurisdiction over the legal malpractice case.

Plaintiffs say, “No, it does not.” And they move to remand the malpractice case to the state court from whence it came

Defendants argue that the Bankruptcy Court has subject-matter jurisdiction over the malpractice case and should dismiss the case for failure to state a claim upon which relief can be granted.

The Bankruptcy Court dismisses the malpractice case because:

Plaintiffs’ malpractice claim is barred by an exculpation clause in the confirmed Chapter 11 Plan;
enforcement of Debtor’s confirmed Chapter 11 Plan and its exculpation clause is at issue—this fact grants subject matter jurisdiction to the Bankruptcy Court over the malpractice case; and
Plaintiffs’ malpractice case fails to state a claim upon which relief can be granted (because of the exculpation clause) and is, therefore, dismissed.

What follows is a summary of the Bankruptcy court’s rationale for its dismissal ruling.

Facts

Debtor is in the thermal coal business—an industry facing difficult financial times.

Debtor files for Chapter 11 relief in October of 2019. At that time, Debtor is the largest privately owned coal company in the United States, with:

13 active mines in six states and Columbia, South America; and
annual revenue of $2.5 billion.

In August 2020, the Bankruptcy Court confirms Debtor’s Chapter 11 Plan.

In February 2022, Plaintiffs file suit in state court asserting a single claim for legal malpractice against their bankruptcy attorneys, based upon legal representation during the bankruptcy.

Plaintiffs allege that Defendants committed malpractice by:

failing to negotiate the Chapter 11 Plan so that claims against Plaintiffs are released; and
failing to advise Plaintiffs that they are not being released by the confirmed Plan.

Defendants (i) remove the state court malpractice case to the Bankruptcy Court that confirmed the Chapter 11 Plan, and (ii) then ask that the malpractice case be dismissed for failure to state a claim, because of the Chapter 11 Plan’s exculpation clause.

In opposition, Plaintiffs ask the Bankruptcy Court to remand the case to state court, arguing:

the Bankruptcy Court lacks subject-matter jurisdiction over the malpractice case; and
the confirmed Plan’s exculpation clause does not bar the malpractice case.

Chapter 11 Plan Exculpation

The Chapter 11 Plan contains this exculpation clause:

“each Exculpated Party is hereby exculpated from any Cause of Action for any claim related to any act or omission based on the negotiation, execution, and implementation of any transactions approved by the Bankruptcy Court in the Chapter 11 Cases . . . except for claims . . . [for] actual fraud, willful misconduct, or gross negligence”; and
“Exculpated Party” includes “current . . . attorneys.”

Bankruptcy Court Jurisdiction

Statutes grant bankruptcy courts jurisdiction over all actions, matters or proceedings:

“arising under” the Bankruptcy Code;
“arising in” a case under the Bankruptcy Code; or
“related to” a case under the Bankruptcy Code.

–“Arising Under” Jurisdiction.

The phrase ‘arising under” title 11 (i.e., the Bankruptcy Code) describes proceedings that involve a cause of action created or determined by a provision in the Bankruptcy Code.

Proceedings “arising under” title 11 include actions:

to avoid fraudulent transfers or obligations under §§ 544(b) and 548;
to have a debt declared nondischargeable under § 523(a);
to oppose a debtor’s discharge under § 727; and
to hold a creditor liable for violating the discharge injunction.

–“Arising In” Jurisdiction.

“Arising in” proceedings are those that, by their very nature, could arise only in a bankruptcy case. A “but for” test for “arising in” jurisdiction is this: the claim would not exist “but for” the bankruptcy proceeding

Here’s an example: a motion asking a bankruptcy court to interpret or enforce its own order arises in the bankruptcy case (e.g., a contempt motion alleging violation of the court’s prior order).

–“Related To” Jurisdiction

The test for “related to” jurisdiction is whether the outcome of the proceeding could have any conceivable effect on the debtor’s bankruptcy estate—with the caveat that an extremely tenuous connection to the estate is not sufficient for jurisdiction.

After plan confirmation, a close nexus test allows for “related to” jurisdiction only when the claim affects an integral aspect of the bankruptcy plan or proceeding.

Such matters typically include those affecting the interpretation, implementation, consummation, execution, or administration of the confirmed plan.

–“Core” v. “Non-Core” Proceedings

Core. Matters that arise-under title 11 and that arise-in cases under title 11, together, comprise the “core proceedings” under 28 U.S.C. § 157(b)(2), in which bankruptcy courts generally may enter final judgments.

Non-Core. Matters that are “related to” a bankruptcy case are non-core proceedings under that same 28 U.S.C. § 157:

absent consent of the parties, a bankruptcy court may hear proceedings “related to” a bankruptcy case but must submit proposed findings of fact and conclusions of law to the district court for final decision; and
with consent of the parties, a bankruptcy court may issue final orders in a “related to” proceeding.

“Arising In” Jurisdiction Over Plaintiff’s Malpractice Case

Plaintiffs’ malpractice case could not have existed “but for” the bankruptcy. The Court, therefore, finds that it has “arising in” jurisdiction over the malpractice case.

Here are two independent reasons why.

–Plan Negotiations

Plaintiffs’ alleged harm is based on Defendants’ role in negotiating and advising on the Chapter 11 Plan:

in Plan negotiations, Defendants allegedly failed to inform about or protect against billions of dollars of potential liability.

Accordingly, the malpractice case, which originated out of post-petition advice of counsel about the bankruptcy itself, falls within “arising in” jurisdiction.

–Interpreting and Enforcing Plan Provisions

The malpractice case involves interpretation and enforcement of the Chapter 11 Plan’s exculpation clause. And proceedings requiring courts to enforce provisions of a Chapter 11 plan “arise in” the bankruptcy.

The Plan’s exculpation clause is a defense against the malpractice claim—and such a defense may serve as the basis for “arising in” jurisdiction because the alleged malpractice acts:

occurred entirely during the bankruptcy case and in its context;
relate to bankruptcy-specific rights and tasks and could only have arisen in a bankruptcy context;
require consideration and interpretation of the Bankruptcy Court’s Plan confirmation order; and
directly implicate the integrity of the bankruptcy process by assuming that different Plan terms would have resulted . . . if only Defendants had acted properly.

Accordingly, the Bankruptcy Court concludes that it has “arising in” jurisdiction over Plaintiffs’ malpractice case.

Exculpation Clause & Dismissal Motion

Defendants ask the Bankruptcy Court to dismiss the malpractice case for failure to state a claim, based on the exculpation clause in the confirmed Chapter 11 Plan.

Exculpation clauses are an affirmative defense. Such clauses can provide dismissal grounds for failure to state a claim when undisputed facts conclusively establish the affirmative defense as a matter of law.

The Bankruptcy Court finds:

Defendants are exculpated parties under the Chapter 11 Plan;
the malpractice case relates to Defendants’ acts or omissions while negotiating the Chapter 11 Plan;
the exculpation clause raises the standard of Defendants’ liability to actual fraud, willful misconduct or gross negligence; and
Plaintiffs do not allege or argue any such thing.

Instead, Plaintiffs argue that their allegations of “actual malice” for punitive damages is equivalent to alleging gross negligence. This argument is misplaced because:

Plaintiffs’ “actual malice” allegation merely states a legal conclusion—it is not an allegation of fact and is, therefore, entitled to no weight;
Plaintiffs do not contend, anywhere, that Defendants acted with hatred, ill will, or a spirit of revenge, or engaged in reckless behavior or a conscious disregard for a great and obvious harm; and
Plaintiffs do not allege anything approaching gross negligence (i.e., a failure to exercise any or very slight care)—notably:
- an allegation of gross negligence must be more than a negligence allegation with the addition of a “vituperative epithet.”

The Bankruptcy Court finds that Plaintiffs have alleged nothing more than a garden-variety legal malpractice claim.

Dismissal with Prejudice

In a footnote in their response to the Dismissal Motion, Plaintiffs say:

“In the unlikely event that the Court enters an order granting [the Dismissal] Motion, . . . that it be without prejudice so that Plaintiffs may have an opportunity to file a motion for leave to amend and a proposed amended Complaint.”

In response, the Bankruptcy Court rules:

“Because Plaintiffs have not filed a motion to amend their complaint or a proposed amended complaint, dismissal will be with prejudice.”

Exculpation is NOT a Third-Party Release

The U.S. Supreme Court will consider whether third-party releases are appropriate—in the Purdue Pharma case.

The Bankruptcy Court, in its In re Murray Holdings opinion, distinguishes the Plan’s exculpation clause from third-party releases like this:

releases provide for the relinquishment of claims; whereas,
exculpation clauses establish the standard of care that will trigger liability in future litigation for acts arising out of a debtor’s restructuring; and
exculpation clauses are a fundamental protection that the Bankruptcy Code permits Chapter 11 plans to afford.

Conclusion

“Arising in” jurisdiction for a bankruptcy court to dismiss with prejudice the legal malpractice lawsuit is an interesting proposition. And the Bankruptcy Court’s rationale makes sense.

It will be interesting to see what happens on appeal.

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