In re R & R Associates of Hampton

• Decision Date: 31 March 2005
• Docket Number: No. 04-1610.,04-1610.
• Citation: 402 F.3d 257
• Court: U.S. Court of Appeals — First Circuit
• Parties: In re R & R ASSOCIATES OF HAMPTON, Debtor. Dennis Bezanson, Trustee of the Estate of R & R Associates of Hampton, Appellant, v. Thomas J. Thomas, Jr., et al., Appellees.

402 F.3d 257

In re R & R ASSOCIATES OF HAMPTON, Debtor Dennis Bezanson, Trustee of the Estate of R & R Associates of Hampton, Appellant, v. Thomas J. Thomas, Jr., et al., Appellees.

No. 04-1610.

United States Court of Appeals, First Circuit.

Heard October 4, 2004.

Decided March 31, 2005.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

William S. Gannon, for appellant.

Robert M. Daniszewski, with whom Danis Lewis Law Office was on brief for appellees.

Before LIPEZ, Circuit Judge, COFFIN and CYR, Senior Circuit Judges.

CYR, Senior Circuit Judge.

Dennis Bezanson, chapter 7 trustee for the bankrupt estate of R & R Associates of Hampton ("R & R"), appeals from a bankruptcy court ruling that counsel who previously had served as chapter 11 counsel to R & R, notwithstanding a disqualifying conflict of interest, nonetheless were not liable in damages, either for malpractice or breach of fiduciary duty. We vacate the judgment and remand for the entry of judgment for Bezanson.

I BACKGROUND

Reginald L. Gaudette and Richard V. Choate are the general partners of R & R, and at all times were personally liable for the partnership debts. See N.H.Rev.Stat. Ann. § 304-A:15. The commercial real estate located at 81 Ocean Boulevard in Hampton, New Hampshire, constituted the only significant asset of R & R.

In the fall of 1990, Gaudette retained a law firm, comprised of partners Thomas J. Thomas, Jr., Mitchell P. Utell, Marc L. Van DeWater, and Glenn C. Raiche (hereinafter: "the Thomas law firm" or "the defendants"), to arrange for the transfer of approximately $700,000 worth of Gaudette's individually-owned property to several family limited partnerships ("FLPs") for the admitted purpose of safeguarding those assets from attachment by Gaudette's creditors. See, e.g., FLP 1 Agreement ¶ 6.2 ("The earnings of the Partnership shall be distributed at least annually except that earnings may be retained by the Partnership and transferred to Partnership capital for the reasonable needs of the business as determined in the sole discretion of the General Partner."); id. ¶ 9.3 ("The General Partner may terminate the interest of a Limited Partner and expel him ... if ... his [FLP] interest becomes subject to attachment."). Moreover, acting on the advice of Gaudette, and with defendants' assistance, Choate transferred a substantial, though unspecified, quantity of individually-held assets into FLPs. The defendants represented Gaudette and Choate in state court litigation as well. During this same time period, while the FLPs were being established, Gaudette and Choate consulted the defendants regarding whether to initiate chapter 11 petitions in behalf of the financially troubled R & R and 81 Ocean Boulevard.

Ultimately, in April 1991, the defendants initiated voluntary chapter 11 proceedings in behalf of R & R in the United States Bankruptcy Court for the District of New Hampshire, and R & R, qua debtor-in-possession, sought authorization from the bankruptcy court to retain defendants as general counsel. The Retention Agreement, which was signed by defendant Thomas, vouchsafed to the bankruptcy court, inter alia, that the Thomas law firm possessed "considerable experience" in bankruptcy matters, was "well qualified" to represent R & R, and "ha[d] no connection with the Debtor ... or any party in interest ... nor d[id] this attorney represent or hold any interest adverse to the Debtor-In-Possession or the [chapter 11] estate." See Bankruptcy Code § 327(a). In their supporting affidavit, see Fed. R. Bankr.P.2014, defendants again stated that they had "no connection with the debtor in this matter," stated that they were "disinterested persons," and opined that they could "undertake representation of the Debtor in Possession in this case without any type of restriction." Defendants failed to disclose their ongoing legal representation of Gaudette and Choate individually, including their ongoing diversion of their personal assets into new FLPs. In reliance on the information provided, the bankruptcy court approved the Retention Agreement without notice or hearing.

The defendants submitted a Statement of Financial Affairs to the bankruptcy court which estimated that the R & R real estate (viz., 81 Ocean Boulevard) was worth approximately $1.25 million, and that its liabilities thus exceeded its total assets by approximately $150,000. The Statement of Financial Affairs made no mention of any contingent "contribution" claims of the debtor estate against its general partners pursuant to N.H.Rev.Stat. Ann. § 304-A:15.

At a status conference in August 1991, however, the defendants apprised the bankruptcy court that in the past four months their estimate of the value of 81 Ocean Boulevard had plummeted from $1.2 million to $500,000. When the court inquired of the defendants whether "[Gaudette's and Choate's] personal assets [were] going to be disclosed and be available to cover any shortfall," the defendants responded in the affirmative. The defendants have since conceded, however, that they had no knowledge as to the value of Gaudette and Choate's unencumbered personal assets, nor had they undertaken at any time to inquire into the matter.

The reputed value of the 81 Ocean Boulevard property continued its precipitous decline. In their May 1992 status report, the defendants disclosed that the estimated worth of the property had declined to a mere $265,000. Given the rapidly dwindling prospects of any successful reorganization, the R & R chapter 11 proceedings were converted to chapter 7 in June 1992, and Bezanson was appointed the chapter 7 trustee.

The defendants complied with Bezanson's request to provide the general partners' raw financial records, but neither notified Bezanson of the FLPs nor of their part in executing the FLPs. The Gaudette financial statements disclosed a negative net worth of approximately $4 million. In September 1996, Gaudette submitted a chapter 7 petition in his own behalf. The bankruptcy court awarded defendants $18,887 in attorney fees for their efforts as counsel to R & R. The value of its principal asset having been dissipated, the chapter 7 estate of R & R ended in a net deficit of $412,000.

Thereafter, in October 1998, Bezanson commenced the instant adversary proceeding against the defendants, alleging their negligent representation of R & R during the chapter 11 proceedings, and the breach of their respective fiduciary duties to the chapter 11 debtor. In addition, Bezanson demanded, inter alia, $412,000 in damages — the amount of the deficiency in the chapter 7 estate which might otherwise have been covered by Gaudette's and Choate's personal assets had those assets not been diverted into the FLPs with defendants' assistance.

A. The First Bankruptcy Court Decision

Following a seven-day trial, the bankruptcy court determined that the defendants' conceded failure to disclose their legal representation of Gaudette and Choate in connection with the FLPs violated the disclosure requirements prescribed by the Bankruptcy Code for the retention of counsel by a chapter 11 debtor, and that this failure to disclose their conflict of interest warranted disgorgement of the $18,887 in counsel fees defendants received as chapter 11 counsel. Bezanson v. Thomas (In re R & R Assocs. of Hampton), No. 91-10983-MVW, 2003 WL 1233047, at *5 (Bankr.D.N.H. Jan.31, 2003) (unpublished opinion); see generally Rome v. Braunstein, 19 F.3d 54, 58 (1st Cir.1994).

The bankruptcy court then stated:

The issue before this Court is not whether the legal services were performed properly, but whether the law firm failed to disclose adverse interests as required by section 327. Stated differently, the issue before this Court is whether the Law Firm Defendants complied with the requirements of sections 327 and 328, not whether the legal services performed were adequate, an inquiry which would properly be the subject of a subsequent malpractice suit.

Id. at 4 (emphasis added). In the course of treating the "other issues raised by the Trustee," the bankruptcy court determined that (i) counsel for a chapter 11 debtor has no duty to bring suit against the debtor's general partners to compel a contribution of their personal assets to defray a deficiency in the chapter 11 estate, due to the fact that Bankruptcy Code § 723, which prescribes such a contribution action, simply does not apply in chapter 11 cases; and (ii) the defendants credibly testified that they believed that R & R could be successfully reorganized without further capital contributions from Gaudette and Choate, and that Gaudette and Choate possessed "substantial financial wealth" which would be available should such capital contributions be required. Bezanson, 2003 WL 1233047, at *5.

The bankruptcy court further held that the defendants had not breached their fiduciary duty to Bezanson by providing him with "false" financial statements for Gaudette, given that the statements disclosed that Gaudette owned three limited partnership interests, and that Bezanson made no further inquiry either into the nature of or the circumstances in which Gaudette had acquired those interests. Id. Finally, the bankruptcy court rejected the Bezanson claim that the defendants' failure to disclose constituted fraud on the court, as it found no evidence that the failure to disclose was motivated by a "corrupt intent." Id. at 6. Bezanson timely appealed to the district court.

B. The First District Court Decision

On appeal, the district court vacated the bankruptcy court decision, noting that the bankruptcy court intimated that the trustee must litigate the adequacy of defendants' legal representation of the chapter 11 debtor in "a subsequent malpractice suit," and thus failed expressly to consider and resolve Bezanson's discrete claims for negligent legal representation and breach of fiduciary duties. Bezanson v. Thomas, No. 03-127-JD, 2003 WL 21434911, at * 4 (...