E-Alert Case Updates

Suit Against Law Firm Retained by Bankruptcy Trustee Not Permitted Without Bankruptcy Court Approval

James Mark McDaniel, et al. v. John M. Blust, et al.
Case No.: 10-1776 (U.S. Court of Appeals for the Fourth Circuit, February 9, 2012)
by Eric M. Leppo, Associate
Semmes, Bowen & Semmes (www.semmes.com)

In this recently issued opinion from the United States Court of Appeals for the Fourth Circuit, the Court affirmed the U.S. District Court for the Middle District of North Carolina’s dismissal based on lack of subject matter jurisdiction.

This lawsuit relates to the bankruptcy proceeding of EBW Laser, Inc. (“EBW”), a company that filed bankruptcy in 2005, in the Middle District of North Carolina. The Plaintiffs in this case, James McDaniel, Jr. and C. Richard Epes, are former officers of EBW. The bankruptcy case was converted to a Chapter 7 proceeding, where Charles Ivey was appointed by the Court as Trustee. As Trustee, he retained the Law Firm of Ivey, McClellan, Gatton, Talcott, LLP (“IMGT”), to serve as the trustee’s counsel and prosecute an adversary proceeding against McDaniel and Epes. It was alleged in this adversary proceeding that the Plaintiffs had preferentially transferred and/or fraudulently conveyed assets of EBW worth hundreds of thousands of dollars prior to the bankruptcy filing.

The Plaintiffs contended that the law firm IMGT damaged them with various tortious activities while pursuing the adversarial proceeding. Plaintiffs filed suit in a North Carolina State court alleging civil obstruction of justice, conversion, invasion of privacy, and breach of fiduciary duty. These claims were based upon several distinct actions allegedly committed by IMGT, during the litigation, including presenting documents claimed to be tax returns of EBW (that were not EBW’s tax returns), obtaining Mr. McDaniel’s personal income tax records despite a bankruptcy court ruling that they were irrelevant, and the manner in which those records were obtained from Mr. McDaniel’s accountant.

IMGT removed the case from state court to the Middle District of North Carolina, and sought dismissal pursuant to Rule 12(b)(6). The District Court dismissed the case for lack of subject matter jurisdiction as Plaintiffs had failed to obtain leave of the Bankruptcy Court to file an action against IMGT, the Trustee’s legal counsel. The dismissal was based on the Supreme Court decision in Barton v. Barbour, 104 U.S. 126 (1881).

The Supreme Court established in Barton that before another court can obtain subject matter jurisdiction over a suit filed against a receiver for acts committed in his official capacity, Plaintiff must obtain leave from the court that appointed the receiver. That principle has since been extended to include bankruptcy trustees. The Fourth Circuit noted that in determining whether the Barton doctrine applies, a court must consider the nature and function of the trustee, and his counsel, and determine whether the acts were performed within the context of their role of recovering assets for the estate. This is because the Barton doctrine is designed to protect the Trustee as an officer of the court once appointed. Moreover, the doctrine allows Bankruptcy Courts to monitor the work of the Trustee they have appointed.

Plaintiffs/Appellants claimed that the Barton doctrine should not apply because Mr. Ivey did not specifically direct the actions alleged to be committed by IMGT; however, the Court held that Ivey retained IMGT to prosecute the adversarial proceeding, and there was no question that the subject activities occurred within their efforts to prove the adversarial action against McDaniel and Epes. As such, the Fourth Circuit held that such activities were within IMGT’s role as counsel for the Trustee, and could not be pursued without Bankruptcy Court approval.

The Appellants also argued that the Barton doctrine should not apply because they claimed intentional misconduct and fraud. The Court noted, however, “Bankruptcy trustees and their counsel required protection against suits that are based on unfounded allegations regardless of whether there is a claim that has alleged wrong doing was intentional.” In re Linton, 136 F.3d 544-546. Therefore, the Fourth Circuit ruled that the District Court was correct in dismissing the action as filed without approval from the Bankruptcy Court.