Trustee Lacks Standing to Assert Legal Malpractice Claims on Behalf of Debtors

The Massachusetts Bankruptcy Court (Panos, J.) dismissed an adversarial proceeding complaint brought against debtor’s counsel which alleged legal malpractice. The trustee alleged that debtor’s counsel committed malpractice and asserted that the legal malpractice claims are assets of the bankruptcy estate. Debtor’s counsel moved to dismiss. After a hearing, the Court granted the motion to dismiss, ruling that the alleged malpractice claims were not property of the bankruptcy estate and that the trustee therefore lacked standing to assert them.

In the adversarial complaint, the trustee alleged that because debtor’s counsel failed to instruct his client to record a declaration of homestead, the debtor was only able to claim a Massachusetts homestead exemption in the amount of $125,000. Had a declaration of homestead been recorded prepetition, the debtor would have been able to claim a $500,000 exemption, which would have immunized him from a judgment obtained by the bankruptcy trustee. The trustee further claimed that by converting the case from a chapter 13 to a chapter 7 bankruptcy rather than having the matter dismissed and re-filed, the debtor missed an opportunity to have additional debt discharged.

In addressing the issue of the homestead claim, the Court ruled that the trustee lacked standing to bring his claim where the claims are not property of the estate but rather post-petition property. The Court noted that Section 541(a)(1) provides that commencing a bankruptcy case “creates an estate [that includes] all legal or equitable interests of the debtor in property as of the commencement of the case." Therefore, until the debtor filed his chapter 13 petition, no purported malpractice had yet accrued where no harm had yet been suffered by the failure to record the declaration of homestead. Accordingly, the claim did not exist until after the estate was created and therefore was post-petition property belonging to the debtor.

Moving on to the claim arising from the conversion of the case from a chapter 13 to a chapter 7 bankruptcy case, the Court similarly held that the claim was also not the property of the estate. Here, the Court found that the negligence which occurred during the pendency of the bankruptcy case logically could not have existed before the bankruptcy case commenced. Therefore, the earliest this claim could have accrued was upon conversion. Consequently, the Court held that “this was not a claim rooted in any way in the pre-bankruptcy past” and that the harmed caused by the malpractice “is entangled with [the debtor’s] ability to make a fresh start.” The Court therefore concluded that the trustee lacked standing to pursue the legal malpractice claim.

This case should remind practitioners to carefully consider the issue of standing whenever analyzing an adversarial proceeding claim. It also serves as a good reminder to all counsel that homeowners should record a declaration of homestead to be eligible take advantage of the heightened exemption amount available under Massachusetts law if things go south.

Matthew Libby is an associate in Preti Flaherty's Litigation Group, practicing from the firm's Boston office. He represents clients in commercial litigation and bankruptcy matters.

Changes to Bankruptcy Rule 3002.1 Affect Mortgage Lenders

Almost every year, changes are implemented to the Federal Rules of Bankruptcy Procedure. On December 1, 2016, this year’s changes to the Bankruptcy Rules went into effect. The changes include revisions to Bankruptcy Rule 3002.1.

Bankruptcy Rule 3002.1 requires secured creditors with an interest in the debtor’s principal residence, such as mortgage lenders, to periodically file notices of payment change in Chapter 13 cases. The changes to Bankruptcy Rule 3002.1 clarify when a secured creditor must file a payment change notice. The amended rule requires that a secured creditor file a payment change notice on all claims secured by the debtor’s primary residence for which a debtor or Chapter 13 Trustee is making post-petition payments during the bankruptcy, regardless of whether the debtor is curing a pre-petition mortgage.

Additionally, the amendments to Bankruptcy Rule 3002.1 clarify that the obligation to file a payment change notice ceases once the creditor obtains relief from the automatic stay.

Preti Flaherty frequently represents creditors in bankruptcy cases in Maine, Massachusetts and New Hampshire. For assistance with claims in bankruptcy cases, contact Preti Flaherty’s Bankruptcy, Creditors’ Rights & Business Restructuring Practice Group.

Bodie B. Colwell practices as an associate with Preti's Bankruptcy, Creditors’ Rights and Business Restructuring group from the Portland office. She focuses on supporting bankruptcy, insolvency, and creditors’ rights clients.