Henry Grausz, M.D. v. Bradford F. Englander Linowes and Blocher, L.L.P.

Citations: 321 F.3d 467; 289 B.R. 467; 50 Collier Bankr. Cas. 2d 515; 2003 U.S. App. LEXIS 3945; 40 Bankr. Ct. Dec. (CRR) 267; 2003 WL 755690Docket: 01-2317

Court: Court of Appeals for the Fourth Circuit; March 6, 2003; Federal Appellate Court

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Henry Grausz, M.D. filed a professional malpractice lawsuit against his law firm, Linowes and Blocher, LLP, and attorney Bradford F. Englander, following his Chapter 11 bankruptcy case. The United States Court of Appeals for the Fourth Circuit affirmed the district court's jurisdiction under 28 U.S.C. § 1334, determining that the malpractice claim arose in the context of the bankruptcy proceedings. The court upheld the district court's grant of summary judgment for the law firm, citing res judicata based on a prior bankruptcy court ruling.

Grausz filed for Chapter 11 bankruptcy on December 29, 1997, with Englander representing him. One of his main creditors, John F. Sampson, had obtained a substantial judgment against Grausz shortly before the bankruptcy filing. Grausz negotiated a settlement with Sampson, approved by the bankruptcy court, which included withdrawing the appeal of the California judgment and agreeing to a reduced claim of $4 million in bankruptcy. Grausz also agreed to file amended schedules of assets and liabilities, warranting their accuracy. However, the amended Schedule B, which listed his personal property, failed to include community property and was based on a packing list prepared by others. Grausz believed this list was sufficient and was assured by Englander that no further verification was necessary.

Grausz alleges that Englander did not inform him of the necessity to disclose community property interests in his amended schedules. In October 1999, an inventory of Grausz's storage unit, conducted by the unsecured creditors' committee led by Sampson, identified missing valuable items. In January 2000, the committee objected to Grausz's disclosures due to inaccuracies in the listing of household goods. On February 18, 2000, the Linowes firm requested interim fees for their bankruptcy counsel work up to November 30, 1999, which Grausz did not contest. On March 6, 2000, Sampson initiated an adversary proceeding against Grausz, seeking a declaration that his claim was nondischargeable and to deny Grausz's discharge based on alleged breaches of the settlement agreement, including an incomplete list of personal property. Grausz inquired about the defense costs from Englander but refused to pay the requested retainer of $25,000, subsequently accusing Englander of incompetence in the settlement negotiations. Englander suggested Grausz hire new counsel if he had lost confidence in him. The bankruptcy court approved the Linowes firm's interim fee application for nearly $250,000 on April 26, 2000. On May 18, 2000, Englander moved to withdraw as Grausz's counsel, which the court granted on May 25, 2000. The Linowes firm later filed a second fee application, which Grausz did not contest, resulting in a final fee order on October 23, 2000, approving additional fees of about $15,000. The court trial regarding Sampson's claim occurred on March 6 and 7, 2001, and concluded with findings that Grausz breached the settlement warranty by failing to adequately disclose community property, and his ambiguous explanations for missing assets were insufficient. Consequently, the court denied Grausz's discharge, which he claims results in liabilities around $30 million. Following this ruling, Grausz filed a legal malpractice suit against the Linowes firm on June 21, 2001, in the Circuit Court for Prince George's County, Maryland.

Grausz alleges that the Linowes firm was negligent in two respects: failing to advise him to list his community property interests on his amended Schedule B and not advising him to verify the accuracy of the packing list attached to that schedule. He contends that this negligence led to a breach of the full disclosure warranty in his settlement agreement, resulting in a nondischargeability order against him and liability to creditors. The Linowes firm removed the case to the U.S. District Court for the District of Maryland, claiming bankruptcy jurisdiction under 28 U.S.C. § 1334. They filed a motion to dismiss or for summary judgment, arguing that res judicata barred Grausz's malpractice claim due to a final fee order from the bankruptcy court. Grausz moved to remand the case to state court, asserting a lack of federal subject matter jurisdiction.

The district court ruled that res judicata barred the malpractice claim and granted the Linowes firm's motion for summary judgment, deeming Grausz's remand motion moot. Grausz appealed, arguing that the district court lacked subject matter jurisdiction. The court found that Grausz's malpractice claim arose from the Linowes firm's work in his bankruptcy case, thus falling under the "arising in" jurisdiction of the bankruptcy court as defined in A.H. Robins Co. v. Dalkon Shield Claimants Trust. It determined that the claim would not exist without the bankruptcy context, affirming that federal jurisdiction existed under 28 U.S.C. § 1334(b), regardless of whether the claim belonged to Grausz or the bankruptcy estate.

Grausz contends that even if the district court had subject matter jurisdiction over his malpractice claim, it incorrectly granted summary judgment to the Linowes firm, asserting that the bankruptcy court's final fee order barred his claim under res judicata. Upon de novo review, the court determined that Grausz's malpractice claim is indeed barred by res judicata. The court applied principles from prior case law, noting that a later claim is precluded if: 1) the previous judgment was final, on the merits, and from a competent court; 2) the parties are identical or in privity; and 3) the claim arises from the same cause of action.

The court agreed with the district court that the bankruptcy court's fee order constitutes a final judgment on the merits. While Grausz claimed he was not a "party in interest" in the fee application proceeding, the court found otherwise. Grausz's interests were affected by the fee applications since reducing the legal fees would allow more funds for nondischargeable priority claims, thereby reducing his personal liability. Thus, he had a pecuniary interest, establishing an identity of parties between the fee proceeding and the malpractice case.

Finally, the court addressed whether the malpractice claim arose from the same cause of action as the fee proceeding. It acknowledged the absence of a straightforward test for this determination but stated that claims share the same cause of action if they stem from the same transaction or core facts. The analysis reaffirms that Grausz's malpractice claim is barred by res judicata.

The actions of the fee application proceeding and the malpractice claim against the Linowes firm share a "core of operative facts," both centering on the legal services provided to Grausz during his bankruptcy case. The bankruptcy court had to assess the quality of these services under 11 U.S.C. § 330(a)(3) before approving the Linowes firm's final fee application, which implied the court found the services acceptable. Grausz’s malpractice claim, alleging negligence in advising him on disclosure requirements, pertains to the same services for which fees were sought.

Although the formal elements for claim preclusion are met, additional considerations arise. Specifically, it must be determined whether Grausz was aware or should have been aware of a potential malpractice claim before the fee proceeding concluded, and whether that proceeding offered an effective forum for him to litigate the claim. By the time the final fee order was entered on October 23, 2000, Grausz had knowledge of circumstances indicating a likelihood of a malpractice claim, including a non-dischargeability suit filed against him and his dissatisfaction with the Linowes firm’s services.

Grausz contends he could not foresee a malpractice claim until after the final fee order was entered, arguing that the allegations against him at that time did not hint at a community property breach that would necessitate such a claim. However, the bankruptcy court had already referenced the inadequacy of his packing list in its decision, suggesting Grausz should have recognized the potential for a malpractice claim related to the Linowes firm's advice on disclosure issues.

Grausz's malpractice complaint alleges negligence by the Linowes firm for allowing the use of an unverified packing list in the amended Schedule B. By the time the final fee order was entered, Grausz was aware of issues with the packing list and expressed dissatisfaction with the firm’s work. He recognized that the firm had advised him on the packing list's use and that Sampson had cited its inadequacy in claiming breach of a settlement agreement. Grausz believed that Englander had inadequately negotiated the settlement. Therefore, he knew or should have known of a potential malpractice claim against the Linowes firm before the final fee order was issued.

Grausz had the opportunity to object to the fee application and raise his malpractice claim, which could have transformed the matter into an adversary proceeding under bankruptcy rules. He argued, however, that this process would infringe on his right to a jury trial. Yet, claims of malpractice in bankruptcy court can be tried before a jury if authorized by the district court and consented to by the parties. Should a jury trial be necessary, an adversary proceeding could be transferred to the district court.

Grausz contended that his malpractice claim was not mature until he sustained damages post-final fee order, specifically after a nondischargeability trial. However, damages were arguably present before the order, as he had not settled the $250,000 interim fee payment for what he perceived as substandard work. The potential recovery of those fees could have reduced his personal liability regarding nondischargeable debts. Grausz could have requested a stay of the fee proceeding until the nondischargeability issue was resolved.

His malpractice complaint, filed after the nondischargeability order, claims damages that remain "yet to be finally determined." Winning a malpractice case now could jeopardize the final fee order, which awarded $265,000 to the Linowes firm, as bankruptcy courts can require professionals to return previously awarded fees. This scenario poses a risk of conflicting decisions and undermines the principle of res judicata, which aims to prevent inconsistent rulings and promote reliance on judicial determinations.

Consequently, all elements of res judicata are present, and no practical barriers exist to apply it fairly. Grausz's malpractice claim is therefore barred by the final fee order in the bankruptcy case. The district court's jurisdiction is affirmed, and its summary judgment barring Grausz's malpractice action based on res judicata is upheld.