In re Kaelin

• Decision Date: 21 October 2002
• Docket Number: No. 02-1119.,02-1119.
• Parties: In re: Kenneth L. KAELIN, Debtor. Kenneth L. Kaelin, Appellant, v. Daniel Bassett, Patricia Bassett, John V. LaBarge, Jr., Appellees.
• Court: U.S. Court of Appeals — Eighth Circuit

308 F.3d 885

In re: Kenneth L. KAELIN, Debtor Kenneth L. Kaelin, Appellant, v. Daniel Bassett, Patricia Bassett, John V. LaBarge, Jr., Appellees.

No. 02-1119.

United States Court of Appeals, Eighth Circuit.

Submitted: June 13, 2002.

Filed: October 21, 2002.

Rehearing and Rehearing En Banc Denied: December 3, 2002.

COPYRIGHT MATERIAL OMITTED

John C. Maxwell, argued, St. Louis, MO, for appellant.

Scott Greenberg, argued, St. Louis, MO (Bryan P. Cavanaugh, on the brief), for appellee.

Before RILEY, BEAM, and MELLOY, Circuit Judges.

MELLOY, Circuit Judge.

In this involuntary bankruptcy proceeding, Appellant/Debtor Kenneth Kaelin (Kaelin) sought to amend his listing of exempt property-Schedule C-Property Claimed as Exempt-to include an action for professional malpractice against his attorneys in a related tort action. The bankruptcy court denied Kaelin's motion to amend Schedule C-Property Claimed as Exempt and he appealed to the Bankruptcy Appellate Panel (BAP) for the Eighth Circuit. The BAP affirmed the decision. For the reasons stated herein, we reverse and remand to the bankruptcy court to allow Kaelin to amend Schedule C.

I.

While driving drunk, Kaelin rear-ended a snow plow driven by Appellee Daniel Bassett. Bassett was injured in the accident. When Kaelin's insurer, IGF Insurance Company, failed to settle Bassett's claims, Bassett and his wife retained counsel. Further attempts by the Bassetts to negotiate a settlement with IGF were unavailing. A final offer to settle the entire claim within Kaelin's $25,000 liability policy limit was made by the Bassetts' counsel on September 2, 1997. The offer stated it would remain open until September 19, 1997. IGF did not accept the Bassetts' offer to settle the claim for $25,000. As a result, the case went to trial and the Bassetts obtained a jury award of $1,553,000 in damages, including $500,000 in punitive damages. Kaelin was represented at the personal injury trial by attorneys Jerome Duff and Tom McDonnell.

The Bassetts' attorney believed that Kaelin had a viable bad faith failure to settle claim against IGF. The Bassetts offered Kaelin an opportunity to limit his personal liability in exchange for his assignment of, or cooperation in pursuing, a bad faith claim against IGF. Kaelin refused the Bassetts' offer. Shortly thereafter, the Bassetts filed an involuntary petition in bankruptcy court against Kaelin, in which Appellee John LaBarge was appointed Chapter 7 Trustee. Pursuant to 11 U.S.C. § 523(a)(9), a debt that results from driving while intoxicated may not be discharged. The Bassetts sought and received an order from the bankruptcy court ruling that Kaelin's debt to the Bassetts was a non-dischargeable debt.

In his bankruptcy schedule, Kaelin listed the bad faith claim against IGF as exempt. The Bassetts and the Trustee objected, but prior to a hearing on the issue the parties reached a settlement. The settlement released Kaelin from the judgment if the Bassetts recovered in the bad faith suit against IGF. If the Bassetts did not recover, they would not garnish Kaelin's wages until his daughter turned eighteen. The bankruptcy court was informed of the settlement and a consent order was entered providing that Kaelin's bad faith refusal to settle claim against IGF was non-exempt property.

The Trustee moved for, and was granted, an application to employ counsel for the bad faith claim. Later, the Trustee filed an amended application to expand the scope of his counsel's employment to include the pursuit of a claim of legal malpractice against Kaelin's personal injury attorneys, Jerome Duff and Tom McDonald. Prior to the filing of this amended application by the Trustee, Kaelin had no knowledge of a potential claim against his personal injury attorneys. However, within a week of learning of this potential asset in the bankruptcy estate, Kaelin amended his bankruptcy schedule and filed a motion for leave to amend Schedule C to exempt this legal malpractice claim. Kaelin also sought to set aside the consent order sustaining the objection to exemption and to rescind the consent agreement because Kaelin believed that the Bassetts had negotiated in bad faith by not disclosing the potential claim against his attorneys and their desire to pursue it.

During the hearing on these motions, Kaelin's counsel withdrew his attempt to rescind the consent agreement, but continued his efforts to exempt the malpractice suit. The bankruptcy court found, and the BAP affirmed, that it was the intent of Kaelin or his counsel to hinder or delay a possible recovery by the Bassetts and the Trustee in the legal malpractice claim and that Kaelin did not intend to preserve the asset for his own benefit. The court found that Kaelin was acting in bad faith in his attempt to exempt a claim he did not intend to pursue. The motion for leave to amend the exemption schedule was denied.¹

II.

This court reviews de novo conclusions of law made by the bankruptcy court. Fed. R. Bank. P. 8013; In re Martin, 140 F.3d 806, 807 (8th Cir.1998). We will not set aside the bankruptcy court's findings of fact unless those findings are clearly erroneous. Fed. R. Bank. P. 8013; In re Usery, 123 F.3d 1089, 1093 (8th Cir.1997). The bankruptcy court has the discretion to deny the amendment of exemptions if the amendment is proposed in bad faith or would prejudice creditors. In re Michael, 163 F.3d 526, 529 (9th Cir. 1998) (citing In re Doan, 672 F.2d 831, 833 (11th Cir.1982)). Bad faith and prejudice to creditors are findings of fact and therefore subject to review for clear error. See In re Arnold, 252 B.R. 778, 784 (9th Cir BAP 2000). "A finding is `clearly erroneous' when although there is evidence to support it ... the reviewing court is left with the definite and firm conviction that a mistake has been committed." Anderson v. Bessemer City, 470 U.S. 564, 573, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985) (quoting United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1948)).

III.

Bankruptcy Rule 1009(a) provides:

A voluntary petition, list, schedule, or statement may be amended by the debtor as a matter of course at any time before the case is closed. The debtor shall give notice of the amendment to the trustee and to any entity affected thereby. On motion of a party in interest, after notice and a hearing, the court may order any voluntary petition, list, schedule, or statement to be amended and the clerk shall give notice of the amendment to entities designated by the court.

The general rule allows liberal amendment of exemption claims. In re Harris, 886 F.2d 1011, 1015 (8th Cir.1989); see also In re Williamson, 804 F.2d 1355, 1358 (5th Cir.1986) ("[T]he general rule is to allow liberal amendment of exemption claims, absent bad faith, concealment of property, or prejudice to creditors."). However, the policy of freely allowing amendment, while the case is still open, is not an absolute and can be tempered by the actions of the debtor or the consequences to the creditors.

The two recognized exceptions to this rule are bad faith on the part of the debtor and prejudice to the creditors. See In re Doan, 672 F.2d at 833 ("[A] court might deny leave to amend on a showing of a debtor's bad faith or of prejudice to creditors."); In re Osborn, 24 F.3d 1199, 1206 (10th Cir.1994) (same); Lucius v. McLemore, 741 F.2d 125, 127 (6th Cir. 1984) (noting that courts may deny an amendment where the debtor has acted in bad faith or where property has been concealed). In denying the motion to amend, the bankruptcy court found both bad faith on Kaelin's part and prejudice to his creditors. The bankruptcy appellate panel affirmed both findings.

A. Bad Faith of Debtor

We review the BAP's finding of bad faith for clear error. See In re Cedar Shore Resort Inc., 235 F.3d at 379. Bad faith is determined by an examination of the totality of the circumstances. See id. at 379 (using bad faith totality of the circumstances test in assessing Chapter 11 petition). In finding that Kaelin exhibited bad faith in seeking to amend his schedule, the BAP cited: (1) the two year delay between the filing of the involuntary bankruptcy proceeding and the proposed amendment; (2) the continued attempts by Kaelin and his attorney to prevent the Bassetts from pursuing IGF on the bad faith claim: and (3) the fact that Kaelin did not want to prosecute the legal malpractice claim, which, in the BAP's view was tantamount to abandoning the asset.

We believe the BAP's characterization of the evidence to be clearly erroneous and conclude that Kaelin did not exhibit bad faith in seeking the amendment. The BAP concluded Kaelin delayed amending his schedules nearly two years because the BAP assumed that Kaelin was aware of the claim at the time the involuntary bankruptcy proceeding was initiated and the schedules filed. However, the evidence establishes that upon learning of the potential claim, Kaelin promptly sought to amend his schedules and moved to exempt the asset. The BAP also found that Kaelin's attempt to rescind the consent agreement was evidence of Kaelin's bad faith. However, the record reflects that Kaelin sought to rescind the agreement because Kaelin believed that the Bassetts had negotiated in bad faith by not disclosing the potential claim and their desire to pursue it. While Kaelin later withdrew the request to rescind the agreement, we do not think this belief and Kaelin's litigation strategy demonstrate bad faith.

According to the BAP, the most important factor in its...