United States Court of Appeals
For the First Circuit
No. 00-1517
CADLE COMPANY,
Plaintiff, Appellant,
v.
JAN RICHARD SCHLICHTMANN,
Defendant, Appellee.
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APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. George A. O’Toole, Jr., U.S. District Judge]
__________________________
Before
Torruella, Circuit Judge,
Campbell, Senior Circuit Judge,
and Schwarzer,* Senior District Judge.
_____________________
Scott L. Machanic, with whom Cunningham, Machanic, Celtin &
Johnson, LLP, appeared on brief, for appellant.
Jan Richard Schlichtmann for appellee.
__________________
*
Of the Northern District of California, sitting by designation.
October 4, 2001
__________________
2
Schwarzer, Senior District Judge. This appeal presents
the questions of whether a security interest in the accounts receivable
of a law firm--including an account arising from a contingent fee
agreement--survives the firm’s dissolution and the bankruptcy of one of
its partners and, if it does, whether it attaches to a post-bankruptcy
payment of the fee. We hold that it does and reverse the judgment.
FACTUAL AND PROCEDURAL BACKGROUND
From 1990 to early 1991, the law firm of Schlichtmann,
Conway, Crowley and Hugo (the firm) represented plaintiffs in certain
environmental litigation in the Middlesex Superior Court, Coble v. FL
Aerospace Corp., Civil No. 89-76530, (the Groton matter). Among the
firm’s accounts receivable was a contingency fee agreement, the fee to
be paid to the firm at the conclusion of the litigation. The firm had
borrowed funds from the Boston Trade Bank (the Bank) and to secure
those loans, the firm and its partners had signed a series of notes,
guaranties, security agreements and UCC filings. By virtue of these
documents, the Bank held a security interest in the Groton fee
receivable. Before any part of this fee became payable, the Bank
failed and the FDIC sold its assets--including the firm’s notes and the
security agreements--to Cadle Company (Cadle).
In December 1990, Jan Schlichtmann wrote to the Bank on
behalf of the firm, reporting on the status of the outstanding loan
accounts and on the progress of the Groton settlement. In the letter,
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Schlichtmann stated that “This letter serves as an additional security
interest of the bank in all Groton fees received by this office.”
In June 1991, the Superior Court approved the Groton
settlement agreement, under which $825,000 was deposited into an escrow
account, with distribution subject to the settlement’s approval by the
Massachusetts Department of Environmental Protection. In October 1991,
Schlichtmann filed for bankruptcy under Chapter 7 of the Bankruptcy
Code, causing the firm’s dissolution pursuant to Massachusetts General
Laws ch. 108A § 31 (1922) (“Causes of Dissolution”). In January 1992,
the Bankruptcy Court issued a “Discharge of Debtor” order, releasing
Schlichtmann from all his dischargeable debts.
Following Schlichtmann’s bankruptcy and the firm’s
dissolution in 1991, Schlichtmann continued to work on the Groton
matter until its final resolution in May 1995. In June 1995, $300,000
from the Groton settlement was deposited into Schlichtmann’s escrow
account. Of this amount, he distributed $100,000 to his former
partners and $200,000 to himself ($110,000 of which he shared with
Thomas Kiley, a former co-defendant who was dismissed from this case).
Cadle received no part of the Groton fee settlement.
Cadle then filed this action against Schlichtmann, his former
partners, and Kiley in June 1995. After considerable skirmishing,
Schlichtmann/Kiley and Cadle filed cross-motions for summary judgment.
On July 14, 1999, the district court denied both motions. The court
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concluded that because Schlichtmann’s post-bankruptcy work on the
Groton matter was not performed on behalf of the dissolved partnership,
he was entitled to a portion of the Groton fee to compensate for the
work he performed in his individual capacity. Whether the two-thirds
portion of the Groton fee retained by Schlichtmann was a proper
division between Schlichtmann and his former partners was to be
resolved at trial.
The case went to trial in November 1999.1 Cadle advanced two
theories: First, that Schlichtmann’s retaining $200,000 of the Groton
fee and distributing $100,000 to his former partners constituted
conversion of funds in which Cadle had a security interest; and,
second, that Cadle was entitled to the entire Groton fee, having
forborne enforcing the notes it held in reliance on Schlichtmann’s
promise to deliver the fee when received. Cadle’s request for a jury
instruction on promissory estoppel was denied. The jury returned a
verdict for defendant.
Cadle appeals on two grounds: First, that because it held
a security interest in the entire Groton fee, the court should have
granted its motion for summary judgment; and, second, that the court
erred in refusing to instruct the jury on promissory estoppel.
Because we conclude that Cadle was entitled to the portion of the
Groton fee retained by Schlichtmann, we do not reach the promissory
1
Defendants other than Schlichtmann were dismissed before trial.
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estoppel issue.
The district court had jurisdiction under 28 U.S.C. § 1332,
and this court has jurisdiction under 28 U.S.C. § 1291.
DISCUSSION
In its order denying Cadle’s motion for summary judgment, the
court acknowledged that the motion “hinges on its contention that the
former law partnership . . . had a right to the entire $300,000 legal
fee derived from the second Groton escrow account.” The Cadle Co. v.
Schlichtmann, Conway, Crowley & Hugo, 1999 WL 527715, at *1 (D. Mass.
1999). The court then reasoned that “[t]he only way it could
potentially lay claim to this amount is if all compensable legal work
required to gain access to the second escrow account had been completed
at the time of the law firm’s dissolution in October 1991.” Id. The
court observed that the settlement agreement required additional work
by plaintiffs’ lawyers post-bankruptcy, Schlichtmann performed that
work, and he performed it in his individual capacity, rather than on
behalf of the firm. He was, therefore, entitled to compensation. See
id. The court concluded that “Cadle’s security interest only extends
to that portion of the Groton fee, if any, that belongs to the
dissolved partnership.” Id.
The fundamental error in this analysis is that it ignores the
source of Schlichtmann’s entitlement to the Groton fee. The fee to
which Schlichtmann laid claim came out of the distribution from the
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Groton settlement and became payable by reason--and only by reason--of
the fee agreement between the (now dissolved) firm and the Groton
plaintiffs. The Distribution of Settlement Proceeds form clearly shows
an allocation of 32.24% attorneys’ fees (plus 4.02% for litigation
consultation). It is unquestioned that this amount became payable by
reason of the fee agreement between the firm and the plaintiffs. Thus,
when Schlichtmann began to work for the plaintiffs after the
dissolution, he simply took over the firm’s work and carried out what
the firm had agreed to do, for which it was to be compensated.
That the firm no longer existed is immaterial to Cadle’s
claim. It had a security interest in the entire Groton fee; as
Schlichtmann wrote in December 1990, “I want to assure you of the
bank’s security in these anticipated fees in the Groton case.”2 And
2
In this letter, Schlichtmann represented to the Bank that
$800,000 was then being held in escrow by the Bank to secure the
first part of the settlement, out of which $200,000 in fees
would be paid to the firm, and that release of the funds was
awaiting settlement of the co-defendant's share representing an
additional $825,000, out of which the firm expected a second
payment of $206,000. Schlichtmann went on to state:
I want to assure you of the Bank's security
in these anticipated fees in the Groton
case. First, you should know that the case
has been reported to the court by the
parties as being settled. The court has
ordered the pa4ties to appear before it as
soon as practical in January so that it may
approve of the distribution of the funds.
Out of the first payment we will pay off the
$45,000 note. This letter serves as an
additional security interest of the bank in
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that Schlichtmann may have taken over the Groton engagement and
completed the work cannot operate to wipe out Cadle’s acknowledged
security interest in the fee from that work without the secured party’s
written consent; indeed, the security agreement specifically bars
disposal of any collateral without the secured party’s prior written
consent.
Schlichtmann concedes that Cadle holds a security interest
in the firm’s accounts receivable which encompasses any Groton fee
received by the firm. However, he contends that after the firm
dissolved, the firm terminated its representation of the Groton
clients, and thus left Cadle with a security interest in only the fees
related to the work the firm performed on the matter prior to its
dissolution. Agreeing with the district court, Schlichtmann
characterizes his post-dissolution efforts on the Groton case as work
performed in his individual capacity, not on behalf of the firm.
However, that the post-dissolution work on the Groton matter
was performed by Schlichtmann does not alter Cadle’s rights as a
secured creditor. Partners cannot eliminate a security interest in the
partnership’s anticipated fees by transferring (without the creditor’s
all Groton fees received by this office. We
also anticipate making arrangements with the
bank for an appropriate schedule to pay down
the credit line.
The letter makes clear that the parties intended an assignment
of a security interest in sums in escrow, not in future fees.
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written consent) the client files, whether by dissolution of the
partnership or otherwise. In PNC Bank, Delaware v. Berg, 1997 WL
527978 (Del. Super. Ct. 1997), the court held that a bank could assert
its security interest under Article 9 of the Uniform Commercial Code in
contingent fee agreements that had been transferred before having
matured. There, Tighe, Cottrell, and Logan--partners in a firm called
Berg, Tighe, Cottrell & Logan--withdrew from the firm and opened a new
firm called Tighe, Cottrell & Logan (“Tighe”). The partners in the new
firm took with them many client files, including the active files on
which Tighe, Cottrell, and Logan had themselves been working. See id.
at 2. PNC Bank claimed a continuing security interest in the
contingent fee files. In its defense, Tighe argued that the security
interest was lost as a result of the agreement between Berg and Tighe
in which Berg surrendered any interest in the client files in return
for Tighe’s relinquishing its interest in the Berg firm. See id. at
10. The court rejected the argument, holding that unless PNC Bank
authorized this transfer, it retained the right under Uniform
Commercial Code § 9-306 to follow the collateral, the contingent fee
files. See id. The court went on to reject the argument that Tighe
had invested eighteen months of effort and additional expense on the
assumption that the total of any contingent fee recoveries would be
theirs, concluding that this “has absolutely nothing to offer on the
issue of whether PNC Bank has a security interest.” Id. at 11. In
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denying Tighe’s motion for reargument, the court said that accepting
Tighe’s contention
would emasculate the protection which § 9-306(2)
affords secured creditors. Any debtor would be
able to destroy an existing Article Nine security
interest simply by transferring both the right to
payment and the performance due under the
contract to an assignee. Section 9-104(f) simply
does not countenance wiping out already-existing
security interests.
PNC Bank, Del. v. Berg, 1997 WL 817869 *2 n.1 (Del. Super. Ct. 1997).
The instant case is analogous. The firm dissolved and
Schlichtmann agreed with his former partners to take over the Groton
matter in exchange for one-third of any recovered attorney’s fee.
Schlichtmann’s departure from the firm and his assumption of
responsibility for the Groton matter does not wipe out Cadle’s right to
follow the collateral--the fee in the Groton case. We agree with the
court in PNC Bank, Delaware that to hold otherwise would allow “[a]ny
debtor . . . to destroy an existing Article Nine security interest
simply by transferring both the right to payment and the performance
due under the contract to an assignee.” PNC Bank, Del., 1997 WL 817869
at *2 n.1. Thus, Schlichtmann’s claim to have performed work on the
Groton matter in his individual capacity after the firm dissolved
cannot defeat Cadle’s rights as a creditor with a security interest in
the Groton fee.
Schlichtmann would distinguish PNC Bank, Delaware because
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it did not deal with the impact of bankruptcy on the entitlement of a
discharged debtor to his post-bankruptcy earnings. Such a discharge
extinguishes only in personam claims and generally has no effect on in
rem claims against property. See Doral Mortgage Corp. v. Echevarria,
212 B.R. 185 (B.A.P. 1st Cir. 1997). The June 7, 1991, settlement
agreement established the distribution of the settlement proceeds in
the Groton matter and determined the amount of the fee due to the firm
under the contingency agreement. This took place before Schlichtmann
filed for bankruptcy. Cadle’s security interest attached to this
amount and it has an in rem claim to it. While Schlichtmann’s post-
bankruptcy work on the Groton matter no doubt contributed to the
consummation of the settlement, the amount of the fee owed to the firm
and therefore to Cadle was established outside of Schlichtmann’s
bankruptcy. Cadle’s security interest in this property was not
affected by Schlichtmann’s bankruptcy.
Schlichtmann attempts to characterize his claim to the fee
as post-petition earnings, personal property acquired after his debts
were discharged. This argument is foreclosed by § 552 of the
Bankruptcy Code, which concerns the effect of pre-petition security
interests on post-petition earnings. See 11 U.S.C. § 552. “Its
purpose is to prevent a creditor’s pre-petition security interest in
’after-acquired property’ . . . from attaching to property acquired by
the estate or debtor-in-possession after the filing of a bankruptcy
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petition.’” See N.H. Bus. Dev. Corp. v. Cross Baking Co., 818 F.2d
1027, 1029 (1st Cir. 1987). Under 11 U.S.C. § 552(a), “[P]roperty
acquired . . . by the debtor after the commencement of the case is not
subject to any lien resulting from a security agreement entered into by
the debtor before the commencement of the case.” Section 552(b)(1),
however, carves out an exception to this rule:
[I]f the debtor and an entity entered into a
security agreement before the commencement of the
case and if the security interest created by such
security agreement extends to property of the
debtor acquired before the commencement of the
case and to proceeds, product, offspring, or
profits of such property, then such security
interest extends to such proceeds, product,
offspring, or profits acquired by the estate
after the commencement of the case to the extent
provided by such security agreement and by
applicable nonbankruptcy law, except to any
extent that the court, after notice and a hearing
and based on the equities of the case, orders
otherwise.
11 U.S.C. § 552(b)(1) (emphasis added).
Section 552(b)(1) applies because Cadle’s security interest
in the firm’s accounts receivable extends to proceeds from the Groton
matter including the contingency fee at issue. Schlichtmann’s December
27, 1990, letter to Boston Trade Bank compels that conclusion: “I want
to assure you of the bank’s security in these anticipated fees in the
Groton case. . . . This letter serves as an additional security
interest of the bank in all Groton fees received by this office.”
Because the security agreement covered the firm’s accounts receivable--
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property acquired before the bankruptcy proceedings--and the resulting
security interest attached to the proceeds known as the Groton fee,
this security interest attached to the Groton fee received by
Schlichtmann post-bankruptcy.3
An analogous situation was before the court in United
Virginia Bank v. Slab Fork Coal Co., 784 F.2d 1188 (4th Cir. 1986).
Slab Fork, a coal company, entered into a contract with Armco, Inc. to
sell Armco coal it had mined. See United Va. Bank, 784 F.2d at 1189.
Before Slab Fork filed for bankruptcy, United Virginia Bank acquired a
security interest in Slab Fork’s contract and its proceeds. See id.
After Slab Fork shut down its mining operation and declared bankruptcy,
it made arrangements for another company to mine and supply coal to
Armco. See id. Armco continued to pay Slab Fork for the coal. See
id. Slab Fork argued that the cash it generated after it filed for
bankruptcy was not covered by the bank’s security interest. See id.
The court disagreed, holding that under 11 U.S.C. § 552(b), cash
proceeds generated under a pre-petition contract received post-petition
are subject to a pre-petition security interest in the contract and its
proceeds. See id. “It is true,” the court observed, “that coal had to
3
Under both Uniform Commercial Code § 9-306(1) and Massachusetts
General Laws ch. 106 § 9-306(1): “‘proceeds’ includes whatever is
received upon the sale, exchange, collection or other disposition of
collateral or proceeds.”See In re Mintz, 192 B.R. 313, 318-19 (Bankr.
D. Mass. 1996).
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be supplied to Armco by or for Slab Fork before any right to payment
arose, but that is true for all the payments under the contract,
whether generated pre-petition or post-petition.” Id. at 1190. The
court concluded that “No change in the right to payment under the Armco
contract was brought about by the filing of a bankruptcy petition,
where the underlying asset and all proceeds therefrom were subject to
a valid pre-petition security interest.” Id.
Similarly, Cadle held a security interest in the firm’s
contingency fee agreement relating to the Groton matter and the
proceeds from that agreement. That Schlichtmann performed much of the
work after the firm’s dissolution and his bankruptcy and before the
right to payment arose does not alter the fact that Cadle held a
security interest in that payment. We reject Schlichtmann’s argument
that the post-petition Groton fees were after-acquired personal
property, free of Cadle’s security interest.
The court recognizes that ordinarily post-petition earnings
belong to the petitioner who has sought bankruptcy protection and not
to the estate. See 11 U.S.C. § 541(a)(6). However, in this
instance, the firm, through Schlichtmann, gave the bank an unqualified
security interest in a specific fund ( i.e., the attorneys' fee share of
the settlement), half of which had already been paid into an escrow
account and the other half of which was paid into such an account well
before Schlichtmann declared bankruptcy. Nothing in the commitment by
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Schlichtmann suggested, so far as the bank was concerned, that the fees
or the security interest were contingent on the performance of
substantial further legal services from the firm or from Schlichtmann.
There is no reason why schlichtmann should be able to back away from
his own commitment.
Because we find that Cadle had a security interest in the
entire Groton fee, we hold that it was entitled to judgment as a matter
of law. We need not, therefore, reach the promissory estoppel issue.
It appears, however, that Cadle did not give notice of its
claim to the fee distribution until after Schlichtmann had received the
$300,000 and paid $100,000 to the other members of the former firm and
(perhaps) shared a portion of it with Kiley. Thus, Schlichtmann is not
liable for conversion of the $100,000 he distributed to the firm or of
the amount he gave to Kiley before receiving notice from Cadle. Under
Massachusetts law, the tort of conversion requires the plaintiff to
prove that the defendant intentionally or wrongfully exercised control,
ownership or dominion over personal property to which he had no right
of possession at the time of the alleged conversion. See Abington
Nat’l Bank v. Ashwood Homes, Inc., 19 Mass. App. Ct. 503, 507 (1985).
Cadle makes no claim that it made a specific demand on Schlichtmann for
the $100,000 portion of the fee before Schlichtmann sent it to his
former partners or for the amount he gave to Kiley, or that
Schlichtmann otherwise wrongfully exercised control, ownership or
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dominion over those amounts, or prevented Cadle from recovering them.
Because Cadle’s claim is based on a conversion theory, the evidence
falls short of permitting recovery of these amounts from Schlichtmann;
we express no opinion, however, with respect to any potential liability
of the former partners or Kiley. Cadle is therefore entitled to
judgment against Schlichtmann in the amount he retained after the
payments to his former partners and Kiley before having received notice
of Cadle’s claim. Because the present record does not enable us to
determine this amount, we remand to the district court to make that
determination and to enter judgment for Cadle in the appropriate
amount.
CONCLUSION
The judgment is reversed and the matter is remanded to the
district court for further proceedings consistent with this opinion.
SO ORDERED.
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