Legal Malpractice

What Powers does the Bankruptcy Trustee have in Legal Malpractice?

By (Andrew Lavoott Bluestone)

In this Federal Case, Cobalt Multifamily Investors I, LLC v. Shapiro, 06 Civ. 6468, Decided March 28, 2008 ,District Judge Kimba M. Wood
U.S. DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK  

The Court ultimately determined that under the Wagoner rule trustee lacks standing, and that the bankruptcy trustee's powers are limited.

"The court-appointed receiver (the "Receiver") for Plaintiffs Cobalt Multifamily Investors I, LLC, and its related, defunct entities (collectively, the "Cobalt entities"), filed this lawsuit against three individuals alleged to have been the principals of the Cobalt entities, and three sets of attorneys who provided professional services to the Cobalt entities at various times during their active corporate lives. The three individuals named as defendants are Defendants Mark A. Shapiro, Irving J. Stitsky, and William B. Foster (collectively, the "Individual Defendants"). The three sets of attorneys named as defendants are Defendants Robert F. Cohen and his firm, Cohen & Werz LLC (the "Cohen Defendants"); Martin P. Unger and his firm, Certilman Balin Adler & Hyman LLC (the "Certilman Defendants"); and Philip Chapman and his firm, Lum, Danzis, Drasco & Positan LLC (the "Lum Defendants") (collectively, the "Law Firm Defendants").

The Complaint alleges that the Individual Defendants engaged in a massive fraud on the investing public by setting up the Cobalt entities, and persuading members of the public to invest millions of dollars in these same entities through various misrepresentations and cold-calling schemes. (Compl. §§4, 51-87.) The Individual Defendants then allegedly misappropriated the majority of the funds invested in the Cobalt entities for their own personal use. (Compl. §§83-85.) The Complaint alleges that the Law Firm Defendants assisted the Individual Defendants in committing this investor fraud, and in subsequently looting the Cobalt entities of corporate assets. (Compl. §§94-137"

A. The Wagoner Rule.

In challenging the Receiver's standing, the Law Firm Defendants rely principally on the line of decisions beginning with Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991) ("Wagoner"), which addresses the issue of standing in the bankruptcy context. (Report 32-37.) In Wagoner, the Second Circuit stated the "well settled" principle that a bankruptcy trustee has standing to assert only those claims held by the bankrupt corporation. Id. at 118 (citing Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 434 (1972)). A bankrupt corporation lacks standing to assert fraud claims against third parties where those third parties assisted corporate managers in committing the alleged fraud.6 Wagoner, 944 F.2d at 120; In re CBI Holding Co., Inc., 311 B.R. 350, 368-69 (S.D.N.Y. 2004) ("CBI Holding I"). Thus, under Wagoner, a bankruptcy trustee also lacks standing to assert such fraud claims against third parties. See In re Bennett Funding Group, Inc., 336 F.3d 94, 99-100 (2d Cir. 2003).

In Hirsch v. Arthur Anderson & Co., 72 F.3d 1085 (2d Cir. 1995), the Second Circuit applied the Wagoner rule to also preclude a bankruptcy trustee from asserting certain claims against third parties that are based in fraud, but are denominated as claims other than fraud (e.g., malpractice or breach of contract). See Hirsch, 72 F.3d at 1094-95 (applying Wagoner rule to preclude bankruptcy trustee's malpractice claim where the claim was based on allegations that the defendant assisted corporation managers in defrauding the corporation); see also In re CBI Holding Co., Inc., 318 B.R. 761, 766 (S.D.N.Y. 2004) ("CBI Holding II") (applying Wagoner rule to bar plaintiff's breach of contract, negligence, and fraud claims against defendant accounting firm where the claims were "premised on allegedly deficient auditing by [defendant] that failed to discover fraudulent acts committed by certain members of [corporate] management"); Breeden v. Kirkpatrick & Lockhart, LLP, 268 B.R. 704, 709 (S.D.N.Y. 2001) (applying Wagoner rule to preclude plaintiff's various claims against defendant professionals where the claims alleged that defendants' misconduct "allowed the [corporate principals] to perpetuate their fraudulent scheme"). "

Full post as published by New York Attorney Malpractice Blog on April 07, 2008 (boomark / email).