15‐4185‐cv
Brown Media Corporation v. K&L Gates, LLP
In the
United States Court of Appeals
For the Second Circuit
_________________________
August Term, 2016
(Argued: November 4, 2016 Decided: April 14, 2017)
Docket No. 15‐4185‐cv
_________________________
BROWN MEDIA CORPORATION, ROY E. BROWN,
Plaintiffs‐Appellants,
v.
K&L GATES, LLP, EDWARD M. FOX, ERIC T. MOSER,
Defendants‐Appellees.
________________________
Before:
HALL, LIVINGSTON, Circuit Judges, AND GARAUFIS, District Judge.*
________________________
On appeal from an order of the United States District Court for the Eastern
District of New York (Spatt, J.), granting the defendants’ motion to dismiss
under Fed. R. Civ. P. 12(b)(6) on the grounds that res judicata bars plaintiffs’
claims for breach of fiduciary duty, tortious interference with contract and
Judge Nicholas G. Garaufis, of the United States District Court for the Eastern District of New
*
York, sitting by designation.
common law fraud against defendant law firm and attorneys who represented
plaintiffs in connection with their proposed purchase of the assets of a debtor in
bankruptcy. Because the plaintiffs’ claims are not of the sort that should have
been raised in the underlying bankruptcy proceedings nor do they implicate the
validity of the asset sale confirmed in the bankruptcy proceedings, res judicata
does not bar them. The judgment of the district court is vacated.
VACATED AND REMANDED.
DANIEL ABRAMS, Law Office of Daniel L. Abrams,
PLLC, New York, NY, for Plaintiffs‐Appellants.
ANTHONY C. ACAMPORA, Silverman Acampora
LLP, Jericho, NY, for Defendants‐Appellees.
HALL, Circuit Judge:
The plaintiffs appeal from an order of the United States District Court for
the Eastern District of New York (Spatt, J.), dismissing their action asserting
claims for breach of fiduciary duty, tortious interference, and common law fraud
against the law firm K&L Gates, LLP and two of its former partners. The
plaintiffs, unsuccessful bidders in a bankruptcy proceeding, alleged that the
defendants used their prior representation of the plaintiffs to undermine the
plaintiffs’ attempt to acquire assets in a bankruptcy sale. The district court
granted the defendants’ motion to dismiss on res judicata grounds, reasoning
that the plaintiffs could have raised their claims during the course of the
2
bankruptcy proceedings and that allowing the plaintiffs’ action to go forward
would call into question the integrity of the bankruptcy court’s final orders.
On appeal, the plaintiffs argue that they could not have brought their
claims during the bankruptcy proceedings, and this present action will not
disturb the orders of the bankruptcy court. We agree. For the following reasons
we REVERSE the district court’s decision, VACATE the judgment, and
REMAND the case for further proceedings consistent with this opinion.
BACKGROUND
I. Factual Background
K&L Gates (“K&L”), a large international law firm, and its former partners
Edward Fox and Eric Moser (collectively, “the defendants”), represented Brown
Publishing Company, Brown Media Holdings Company, and their affiliates
(collectively, “Brown Publishing”) in Brown Publishing’s Chapter 11 bankruptcy.
Plaintiff Roy Brown was the former Chief Executive Officer, as well as a
former shareholder, manager, and director of Brown Publishing. Brown and
other Brown Publishing insiders owned and controlled plaintiff Brown Media
Corporation (“Brown Media” and, together with Brown, “the plaintiffs”), which
they formed to purchase Brown Publishing’s assets in a bankruptcy auction. The
3
plaintiffs’ action arises out of events that occurred just prior to and during Brown
Publishing’s bankruptcy proceeding.
Because we are reviewing the dismissal of plaintiffs’ complaint, we draw
the following facts from the complaint and present them in the light most
favorable to the plaintiffs. See Carpenters Pension Tr. Fund of St. Louis v. Barclays
PLC, 750 F.3d 227, 232 (2d Cir. 2014).
A. Pre‐Bankruptcy
Before entering bankruptcy, Brown Publishing was a closely‐held
corporation controlled by Roy Brown, his brother Clancy Brown, their parents—
Bud and Joyce Brown; Brown Publishing’s former General Counsel Joel
Dempsey, and Joe Ellingham (collectively, the “Managers”). At an unspecified
time, Brown Publishing received financing from a company known as
Windjammer Capital (“Windjammer”), with an equity option as part of the
financing arrangement.
In late 2008, the Managers grew concerned that Windjammer was on the
verge of exercising its option, which might have resulted in the Managers losing
control of Brown Publishing. The Managers decided to seek legal advice. To
that end, Dempsey sent a memorandum to K&L and Fox requesting legal advice
4
regarding, inter alia, the following: (a) “the legal ramifications of a proposed
transaction whereby the Managers create a new LLC and Managers Roy,
Dempsey and Ellingham acquire the assets of Brown Publishing through the new
LLC,” a transaction that would “take place outside of bankruptcy”; (b) “what
actions to take, if any, with regards to Windjammer Capital”; (c) “possible
successor liability related to the proposed transaction”; (d) “what state would be
an advantageous one for incorporation of the new LLC”; (e) “the tax
consequences to the Managers”; and (f) “other issues pertaining to Brown
Publishing’s lenders.” App’x 14.
In response to the memorandum, K&L and Fox “provided advice directly
to Roy and Dempsey,” advising them that “unless Brown Publishing was
brought through a bankruptcy process, successor liability could flow to the
shareholders of the new LLC.” App’x 14. K&L and Fox, however, further
advised Roy and Dempsey that, if the transaction took place outside of a
bankruptcy, steps could be taken to reduce these concerns. K&L billed the
Managers for the time devoted to providing these legal services.
By March 2009, Brown Publishing was on the verge of defaulting on its
loan from Windjammer, prompting the Managers to take a series of actions to
5
protect Brown Publishing’s assets. Later that month, the Managers followed the
advice of K&L and entered into an agreement to execute a non‐bankruptcy
transaction similar to that contemplated in the memorandum Dempsey had
provided to K&L. When the transaction did not have the desired result,
Dempsey again sought the advice of Fox, who advised the Managers that a sale
of Brown Publishing’s assets in bankruptcy was the best way to retain control of
the company. K&L also advised Roy and Dempsey that they could purchase
Brown Publishing’s assets through a sale pursuant to 11 U.S.C. § 363, which
authorizes the bankruptcy court to conduct a sale of the bankruptcy debtor’s
assets even outside the ordinary course of business. See generally In re Lionel
Corp., 722 F.2d 1063, 1070–71 (2d Cir. 1983) (discussing the circumstances
permitting the bankruptcy court to conduct a § 363 sale process). The Managers
rescinded the March 2009 transaction and, pursuant to K&L’s advice, ushered
Brown Publishing into bankruptcy.
In June 2009, K&L notified Roy and Dempsey that the firm was interested
in representing Brown Publishing in its bankruptcy proceeding. K&L, however,
did not seek or obtain a waiver or consent from the Managers to do so. In July
2009, Brown Publishing retained K&L as counsel.
6
In August 2009, K&L and Dempsey began preparing a “’stalking horse”1
asset purchase agreement (the “APA”), which was designed to “further the
ultimate goal of being able to obtain the assets with the blessing of the
bankruptcy court.” App’x 16. K&L also allegedly “continued to serve as the
Managers’ counsel, despite having been retained by Brown Publishing.” App’x
16. In addition to preparing the APA, K&L advised the Managers on how to
maximize the chances that a bankruptcy court would approve their bid at a
bankruptcy sale. K&L also advised the Managers with respect to forming Brown
Media (the company that would make the “stalking horse” bid), and assisted the
Managers in their effort to convince Brown Publishing’s lenders to finance the
Managers’ purchase. With the help of K&L, the Managers obtained a funding
commitment through Guggenheim Partners to support their purchase offer.
Shortly before Brown Publishing filed for bankruptcy, K&L did urge the
Managers and Brown Media to obtain new counsel. On Fox’s recommendation,
the plaintiffs hired Richard Levy, Fox’s friend and former partner. By the time
Levy was hired, however, Brown Media had been formed and much of the APA
had been drafted.
1 A “stalking horse” contract “is a first, favorable bid strategically solicited by the bankrupt
company to prevent low‐ball offers.” In re WestPoint Stevens, Inc., 600 F.3d 231, 239 n.3 (2d Cir.
2010).
7
B. The Bankruptcy Filing
In April 2010, Brown Publishing filed for Chapter 11 bankruptcy. As part
of the bankruptcy court’s approval of K&L as Brown Publishing’s counsel, the
firm submitted a disclosure statement which did not reveal K&L’s prior
representation of the Managers or the extent of its relationship with members of
the PNC Bank Group, a rival bidder for Brown Publishing’s assets.
After the bankruptcy filing, Brown Publishing received a credit bid from
the PNC Bank Group. That bid, however, was rejected as inferior to the
Managers’ stalking horse bid. Thus, in May 2010, Brown Publishing, advised by
K&L, executed the APA and sought the bankruptcy court’s approval of the sale
of its assets to the Managers through Brown Media. The bankruptcy court
approved the Managers’ bid, and, at the same time, approved procedures for the
eventual sale of Brown Publishing’s assets should an auction become necessary.
Although the Managers had retained Levy to represent them, K&L
“continued to treat them like clients,” advising Roy on how to answer questions
at a creditors meeting and gathering with some of the Managers to discuss issues
relating to the bankruptcy, all without Levy present. App’x 20.
8
C. The Foreclosure Action and the Defendants’ Alleged Fraudulent Scheme
CRJ Investments, an affiliate of Brown Publishing, was owned by Roy,
Dempsey, and Roy’s brother. “CRJ owned the real estate which housed all of
[Brown Publishing’s] manufacturing operations and a substantial majority of [its]
profit generating operations.” App’x 21. Importantly, Brown Media’s bid had
been deemed superior, in part because, under the APA, Brown Media agreed to
assume Brown Publishing’s leases with CRJ.
CRJ’s sole lender was Huntington Bank, which also happened to be a
member of the PNC Bank Group. As noted above, PNC Bank Group had
submitted a last‐minute competing offer for Brown Publishing’s assets.
Huntington Bank was also a creditor of Brown Publishing and a sometime client
of K&L.2 In June 2010, Huntington Bank filed a foreclosure action against CRJ in
an Ohio state court, a move designed to reduce the value of Brown Media’s
assumption of the CRJ leases, thereby undermining the plaintiffs’ bid for Brown
Publishing’s assets.
The foreclosure action violated the bankruptcy stay, and Dempsey, in his
capacity as Brown Publishing’s General Counsel, directed K&L promptly to file a
The plaintiffs did not allege in their complaint that the defendants represented Huntington
2
Bank in either the bank’s role as a creditor of Brown Publishing or member of the PNC Bank
Group.
9
motion to enforce the automatic stay. Through its representation of the plaintiffs,
K&L “was well aware” that the leases owned by CRJ were “a critical component
of the Managers’ strategy, and of considerable importance to Guggenheim,
[which] was funding the Managers’ bid.” App’x 21. K&L, however, deliberately
delayed filing the stay motion until after the final review of the bids for Brown
Publishing’s assets so that the PNC Bank Group would be the successful bidder.
In light of these events, K&L declared the PNC Bank Group’s bid to be the
superior bid, which necessitated an auction of Brown Publishing’s assets.
D. The Auction
In July 2010, K&L’s New York office hosted an auction for Brown
Publishing’s assets. Because Brown Media’s financing had fallen through in the
wake of the foreclosure action, the PNC Bank Group was successful in acquiring
most of Brown Publishing’s assets. Following the auction, K&L successfully
moved in the Huntington Bank foreclosure action to enforce the automatic
bankruptcy stay. By then, however, it was too late for the plaintiffs to salvage
their bid.
10
II. Procedural Background
Alleging the facts set forth above, the plaintiffs filed this lawsuit asserting
the following causes of action: (1) breach of fiduciary duty based on the
defendants’ (a) failure to secure a waiver of the conflict of interest presented by
their dual representation of the Managers and Brown Publishing, (b) failure to
disclose their relationship with members of the PNC Bank Group, and (c) use of
confidential information gleaned from K&L’s representation of the plaintiffs to
manipulate the bidding process in favor of the PNC Bank Group; (2) tortious
interference with prospective economic advantage based on the defendants’
interference with the relationship between the Managers and Brown Publishing;
and (3) common law fraud based on the defendants’ breach of their duty to
disclose potential conflicts of interest. The plaintiffs sought an unspecified
amount of damages. In connection with their claim for breach of fiduciary duty,
however, the plaintiffs asserted that damages would “include a calculation based
in part on the value of the assets [they] were unable to purchase due to [the
defendants’] breach of fiduciary duty, and where [the plaintiffs] would have
been financially with respect to the assets had they succeeded in obtaining the
assets as contemplated in the APA.” App’x 25.
11
The defendants moved to dismiss the complaint under Rule 12(b)(6) for
failure to state a claim, arguing, inter alia, that the plaintiffs’ claims were barred
by res judicata and, in particular, by the preclusive effect of three final orders of
the bankruptcy court: (1) the “Sale Procedures Order,” which approved
procedures for the eventual sale of Brown Publishing’s assets; (2) the “Sale
Approval Order,” which authorized the sale of Brown Publishing’s assets, and
(3) the “Confirmation Order,” which confirmed the Third Amended Joint
Chapter 11 Plan of Liquidation of Brown Publishing and its affiliates (“the
Liquidation Plan”).
The district court granted the defendants’ motion on res judicata grounds.
It noted that the parties disputed only one prong of the res judicata analysis:
“whether the causes of action were the same, and if not, whether the claims
asserted by the Plaintiffs in this action could have been brought in the prior
proceeding.” Special (“Sp.”) App’x 23. The court explained that, because none
of the three bankruptcy orders cited by the defendants’ in their motion to dismiss
“directly or sufficiently addresse[d] the causes of action asserted in this case,”
“there [was] no indication that [K&L’s] allegedly improper dual representation,
12
the issue which dominate[d] the entire complaint in this action, was raised at the
time of the [b]ankruptcy [o]rders.”3 Sp. App’x 23.
The court observed, however, that whether the plaintiffs could have
asserted their present claim in the bankruptcy court was “a closer question.” Sp.
App’x 23. The court determined that the plaintiffs’ action was “a thinly
disguised collateral attack on the [b]ankruptcy [o]rders.” Sp. App’x 25 (internal
quotation marks and citation omitted). The court reasoned that the plaintiffs
sought “to challenge the result of the § 363 sale by placing themselves in the
same position as if they had been the successful bidders of Brown Publishing’s
assets,” as evidenced by their “demand for compensation to restore them to
where [they] would have been financially with respect to these assets had they
succeeded at the auction.” Sp. App’x 25–26 (internal quotation marks omitted).
In the district court’s view, obtaining this relief would “call into question the
integrity” of the final bankruptcy orders, a result that “would impair, destroy,
challenge, or invalidate the enforceability or effectiveness of the original
reorganization plan, whether the sale [was] unwound or not.” Sp. App’x 26
(internal quotation marks omitted). The court observed further that the
3 The district court took judicial notice under Rule 12(d) of the relevant bankruptcy court
orders.
13
plaintiffs, as unsuccessful bidders who were “complaining about fraudulent
collusion among the sale participants,” had standing to raise the issue of
collusion during the auction. Sp. App’x 27 (internal quotation marks and
alteration omitted).
The court explained that, ultimately, the plaintiffs’ action was “so
inextricably linked” to the underlying bankruptcy proceeding that the relief
sought by the plaintiffs would require the court “to effectively overrule” the
bankruptcy court’s orders. Sp. App’x 29. According to the district court, any
policy interest in allowing the plaintiffs to proceed with their action was
“outweighed by the longstanding policy favoring the finality of sale orders
issued by bankruptcy courts.” Sp. App’x 29–30.
This appeal followed.
DISCUSSION
I.
We review de novo a grant of a motion to dismiss pursuant to Rule 12(b)(6),
“accepting the complaint’s factual allegations as true and drawing all reasonable
inferences in the plaintiff’s favor.” Carpenters Pension Tr. Fund, 750 F.3d at 232
(quoting Steginsky v. Xcelera Inc., 741 F.3d 365, 368 (2d Cir. 2014)). “To survive a
14
motion to dismiss, a complaint must contain sufficient factual matter, accepted as
true, to ‘state a claim to relief that is plausible on its face.’” Ashcroft v. Iqbal, 556
U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)).
A district court’s application of res judicata is also reviewed de novo.
TechnoMarine SA v. Giftports, Inc., 758 F.3d 493, 498 (2d Cir. 2014).
II.
“The doctrine of res judicata, or claim preclusion, holds that ‘a final
judgment on the merits of an action precludes the parties or their privies from
relitigating issues that were or could have been raised in that action.’” Monahan
v. N.Y.C. Dep’t of Corr., 214 F.3d 275, 284 (2d Cir. 2000) (quoting Allen v. McCurry,
449 U.S. 90, 94 (1980)). “To determine whether the doctrine of res judicata bars a
subsequent action, we consider whether 1) the prior decision was a final
judgment on the merits, 2) the litigants were the same parties, 3) the prior court
was of competent jurisdiction, and 4) the causes of action were the same.” In re
Layo, 460 F.3d 289, 292 (2d Cir. 2006) (quoting Corbett v. MacDonald Moving Servs.,
Inc., 124 F.3d 82, 87–88 (2d Cir. 1997)). “Whether or not the first judgment will
have preclusive effect depends in part on whether the same transaction or series
of transactions is at issue, whether the same evidence is needed to support both
15
claims, and whether the facts essential to the second were present in the first.”
Monahan, 214 F.3d at 285 (quoting NLRB v. United Techs. Corp., 706 F.2d 1254,
1260 (2d Cir. 1983)).
“In the bankruptcy context, we ask as well whether an independent
judgment in a separate proceeding would impair, destroy, challenge, or
invalidate the enforceability or effectiveness of the reorganization plan.” In re
Layo, 460 F.3d at 292 (quoting Corbett, 124 F.3d at 87–88); see also Sure‐Snap Corp.
v. State St. Bank and Tr. Co., 948 F.2d 869, 874 (2d Cir. 1991) (“Also dispositive to a
finding of preclusive effect, is whether an independent judgment in a separate
proceeding would ‘impair or destroy rights or interests established by the
judgment entered in the first action.’” (quoting Herendeen v. Champion Int’l Corp.,
525 F.2d 130, 133 (2d Cir. 1975)). A party cannot avoid the preclusive effect of res
judicata “by asserting a new theory or a different remedy.” Sure‐Snap Corp., 948
F.2d at 875 (quoting Matter of Howe, 913 F.2d 1138, 1144 n.10 (5th Cir. 1990)).
“The burden is on the party seeking to invoke res judicata to prove that the
doctrine bars the second action.” Comput. Assocs. Int’l v. Altai, Inc., 126 F.3d 365,
369 (2d Cir. 1997).
16
A.
As below, the plaintiffs focus their argument on whether the causes of
action they are advancing against the defendants were addressed in the
bankruptcy proceeding and whether, in any event, they could have brought their
present claims during the bankruptcy proceedings. For the reasons stated below,
we vacate the judgment and remand for further proceedings.
At the outset, as other courts have observed, the standard res judicata
analysis can be an awkward fit when applied to bankruptcy proceedings. See,
e.g., In re Piper Aircraft Corp., 244 F.3d 1289, 1299 (11th Cir. 2001) (noting that,
given the unique nature of bankruptcy proceedings, “different res judicata
considerations may come into play when the first case is a bankruptcy
proceeding”); see also HSBC Bank USA v. Adelphia Commc’ns Corp., No. 07‐CV‐
553A, 2009 WL 385474, at *12 (W.D.N.Y. Feb. 12, 2009), affʹd sub nom. In re
Adelphia Recovery Tr., 634 F.3d 678 (2d Cir. 2011) (“Because a bankruptcy case is
fundamentally different from the typical civil action, comparison of a bankruptcy
proceeding with another proceeding is not susceptible to the standard res judicata
analysis. Rather, the Court must scrutinize the totality of the circumstances in
each action and then determine whether there is identity of causes of action.”)
17
(citing Oneida Motor Freight, Inc. v. United Jersey Bank, 848 F.2d 414, 419 n.5 (3d
Cir. 1988)). Unlike a typical lawsuit, where one party brings an action against
another, a bankruptcy proceeding provides a forum for multiple parties—
debtors, creditors, bidders, etc.—to sort out how to allocate, among other things,
a debtor’s assets. In other words, a bankruptcy court’s foremost concern is
maximizing the value of the debtor’s estate. See In re Piper Aircraft Corp., 244 F.3d
at 1300 (observing that when confirming a debtor’s Chapter 11 plan, a
bankruptcy court is “primarily determining whether the plan, as presented,
[meets] the literal requirements and policy objectives of the Bankruptcy Code by
maximizing the value of [the debtor’s] estate”). In the bankruptcy context,
therefore, instead of examining whether a subsequent lawsuit asserts claims that
could have been included as part of a previous lawsuit, courts have assessed
whether a new action seeks to bring claims that could have been raised and
litigated within the scope of the bankruptcy proceeding. See, e.g., Sure‐Snap, 948
F.2d at 873–75 (noting the fact that plaintiffs “could have brought [their] actions”
during the bankruptcy proceeding was “germane to a finding of res judicata,
since that doctrine bars re‐litigation not just of those claims which were brought
in a prior proceeding, but of any other admissible matter which could have been
18
brought, but wasn’t” (internal quotation marks omitted)). We are tasked here
with resolving this question.
It is undisputed that the plaintiffs did not inform the bankruptcy court of
the defendants’ alleged conduct prior to the confirmation of the Liquidation
Plan. The issues surrounding the defendants’ alleged conduct were thus not
litigated or explored during the course of the bankruptcy proceedings.4 The
district court was, therefore, correct that the issues had not been fully and fairly
litigated prior to the bankruptcy orders identified by the defendants as having
preclusive effect.
The district court nonetheless identified at least one way in which the
plaintiffs could have vindicated their rights against the defendants in bankruptcy
court. It posited that the plaintiffs, as unsuccessful bidders, “likely would have
had standing” to assert their claims in similar fashion to the plaintiffs in In re
Colony Hill Assocs., 111 F.3d 269 (2d Cir. 1997). Sp. App’x 28. In Colony Hill, a
disqualified bidder was denied an opportunity to place a bid at a bankruptcy
sale because the next highest bidder had fraudulently colluded with the other
sale participants to exclude the disqualified bidder. 111 F.3d at 271–72. We held
4 It appears the bankruptcy court was not made aware of K&L’s potential conflict until
approximately one year after the Liquidation Plan was confirmed, when Roy Brown moved to
disqualify K&L as counsel for the liquidating trust.
19
that the disqualified bidder had standing to challenge whether the successful
bidder was a “good faith purchaser” because the alleged conduct by the
successful bidder, “if proven, would call into question the ‘intrinsic fairness’ of
the sale hearing.” Id. at 274. We explained that, “when collusion occurs between
a debtor, creditors and a successful bidder, the unsuccessful bidder may be the
only party with an interest in exposing such inequitable conduct.” Id.
We do not view the gravamen of the complaint here as alleging the type of
collusion at issue in Colony Hill. Rather, the plaintiffs focus the vast majority of
their allegations on the conduct of K&L, and Fox in particular. To be sure, there
are isolated allegations that suggested a semblance of collusion. The plaintiffs
allege, for example, that Huntington Bank, a member of the PNC Bank Group,
filed the foreclosure action against CRJ to ensure that the PNC Bank Group’s bid
would prevail at the bankruptcy sale. However, although the plaintiffs alleged
that K&L was “well aware” that CRJ’s leases were of strategic importance to the
Managers’ bid, the plaintiffs did not assert that Huntington Bank’s foreclosure
action was orchestrated by the defendants or done at their behest. App’x 21.
Indeed, referencing Huntington Bank’s foreclosure action simply provided
context for the true target of the plaintiffs’ claim: the defendants’ allegedly
20
conflict‐ridden decision to delay filing a motion in the foreclosure action to
enforce the bankruptcy stay.5
In our view, therefore, the complaint is fairly read to allege misconduct
only on the part of the defendants. Thus, because the plaintiffs are not alleging
collusion among the defendants and the PNC Bank Group (through Huntington
Bank’s foreclosure action) or Brown Publishing (through Carlson), it was not
incumbent on the plaintiffs to challenge in the bankruptcy court the “good faith
purchaser” status of the PNC Bank Group or, more generally, the “intrinsic
fairness” of the bankruptcy sale on grounds of collusion.
We acknowledge that, had the plaintiffs alerted the bankruptcy court to
defendants’ conduct during bankruptcy proceedings, the bankruptcy court likely
would have considered whether the defendants’ conflict of interest and other
mischief warranted their removal as Brown Publishing’s counsel. See, e.g., In re
Congoleum Corp., 426 F.3d 675, 686 (3d Cir. 2005) (observing in the bankruptcy
context that “the obligation to ensure that professional ethics are followed has
led courts to rule that counsel has standing to raise and challenge unethical
5 We note, however, that plaintiffs’ allegations with respect to the defendants’ decision to have
Brown Publishing hire Tom Carlson as an independent director for the duration of the
bankruptcy process and that Carlson did not perform adequately in that role touch, at their
core, on the adequacy of the defendants’ representation of the debtor in the bankruptcy
proceeding and thus cannot properly serve as the basis for plaintiffs’ suit here.
21
procedures on the part of opposing lawyers,” and that “[r]ules governing
professional conduct are often viewed as more necessary and applicable in
bankruptcy cases than in other contexts”). Removing the defendants as Brown
Publishing’s counsel, however, would have addressed only the defendants’
failure to disclose its conflict of interest to the court, either in its initial disclosure
statement or pursuant to an attorney’s obligations as an officer of the court. The
defendants’ removal would not have provided the plaintiffs a fair forum in
which to litigate fully the claims it now brings against them. These claims seek
to remedy not simply the fact of a conflict but the defendants’ effective
interference with the plaintiffs’ attempt to acquire the debtor’s assets. Although
consideration of the defendants’ potential conflict of interest may have prompted
the bankruptcy court to examine some of the facts necessary to support the
present claims, the factual overlap is limited by the proper framing of each claim.
Defendants point us to no case in which the fact of an attorney’s conflict in one
action will bar a subsequent action for malpractice or breach of fiduciary duty.
Thus, even if the plaintiffs objected to, and successfully blocked, the sale of
Brown Publishing’s assets to the PNC Bank Group, this would not have been
equivalent to asserting the present claims, which, as described above, are not
22
limited to the mere fact of a conflict of interest. See In re Piper Aircraft Corp., 244
F.3d at 1303 (observing that “[m]erely objecting to the [confirmation] plan would
not have been the equivalent of pursuing the [breach of fiduciary duty and
breach of agreement] claims [the plaintiff] asserts in state court” against the
successful plan proponent). Here, objecting to the plan “would not have
provided a complete substitute for the relief sought in the [instant] action.” Id. at
1304.
The defendants assert on appeal that bankruptcy courts have “arising in”
jurisdiction over “malpractice and similar claims against a debtor’s retained
professionals that occur during a bankruptcy because they are inseparable from
the bankruptcy context.” Defs.‐Appellees’ Br. 22. Thus, defendants contend the
bankruptcy court could have exercised jurisdiction over the plaintiffs’ claims.6
The defendants are referring to the “plenary jurisdiction” bankruptcy
courts enjoy “over ‘all cases under [T]itle 11 and all core proceedings arising
under [T]itle 11, or arising in a case under Title 11.’” Baker v. Simpson, 613 F.3d
6 The defendants did not mention “arising in” jurisdiction in their motion to dismiss, and the
district court did not address such jurisdiction in its order dismissing the plaintiffs’ action.
While we prefer not to speculate in the first instance as to whether the bankruptcy court had
“arising in” jurisdiction to consider the plaintiffs’ claim, we are not precluded from entertaining
the argument given that “[w]e are free to affirm on any ground that finds support in the record,
even if it was not the ground upon which the [district] court relied.” Headley v. Tilghman, 53
F.3d 472, 476 (2d Cir. 1995).
23
346, 350 (2d Cir. 2010) (quoting Mt. McKinley Ins. Co. v. Corning Inc., 399 F.3d 436,
447–48 (2d Cir. 2005)). We have indeed held that bankruptcy courts have
jurisdiction to consider, for example, a debtor’s malpractice (and related
conversion, negligence, fraud, and intentional misrepresentation) claims against
the debtor’s bankruptcy counsel because the adjudication of those claims was
“an essential part of administering the estate” and “implicate[d] the integrity of
the entire bankruptcy process.” Baker, 613 F.3d at 351 (internal quotation marks
omitted). As we observed in Baker, “while the meaning of the statutory language
‘arising in’ may not be entirely clear, it is clear to us that the bankruptcy court
has the ability to review the conduct of attorneys . . . who are appointed by the
court to aid a person in need of counsel in a proceeding pursuant to Title 11.” Id.
at 351 (internal citation omitted); see also Grausz v. Englander, 321 F.3d 467, 469,
471–72 (4th Cir. 2003) (holding that a professional malpractice claim, filed by a
Chapter 11 debtor against the firm that represented him in that proceeding,
“arose in the bankruptcy case”). The present case, of course, was not brought by
the debtor against his bankruptcy counsel, and the defendants do not contend
that the plaintiffs could have presented their claims in the posture described in
Baker. Rather, the defendants argue that the plaintiffs’ claims “are rooted in, and
24
would have no existence but for, the Debtor’s bankruptcy case.” Defs.‐
Appellees’ Br. 22–23. While we observed in Baker that the bankruptcy court had
“arising in” jurisdiction over the debtor’s malpractice and other claims against
his bankruptcy counsel, in part, because those claims “would have no practical
existence but for the bankruptcy,” Baker, 613 F.3d at 351 (internal quotation marks
omitted), we do not view this general principle as dispositive in the
circumstances before us here. First of all, the Baker court was wrestling with
whether a bankruptcy court was required to abstain from even considering the
debtor’s claims against counsel, not whether the debtor’s failure to raise an issue
in bankruptcy court meant that some third party was barred by res judicata from
bringing a later suit. Moreover, just because a bankruptcy court need not abstain
from exercising jurisdiction over a claim does not mean that failing to ask the
bankruptcy court to exercise its “arising in” jurisdiction necessarily precludes a
plaintiff’s future claim. In any case, as already explained, the plaintiffs’ claims
here do not involve the parties to the bankruptcy proceedings making the
jurisdictional nature of claims brought by parties to the bankruptcy proceeding
irrelevant.7
7 We observed in Baker that “[t]o hold that mandatory abstention barred the district court from
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For their part, the plaintiffs argue that they could have brought their
claims only through an adversary proceeding, over which the bankruptcy court
lacked jurisdiction. Courts, including ours, have held that “[a]lthough confirmed
plans are res judicata to issues therein, the confirmed plan has no preclusive effect
on issues that must be brought by an adversary proceeding.” Whelton v. Educ.
Credit Mgmt. Corp., 432 F.3d 150, 154 (2d Cir. 2005), abrogated on other grounds by
United Student Funds, Inc. v. Espinosa, 559 U.S. 260 (2010) (quoting Enewally v.
Wash. Mut. Bank, 368 F.3d 1165, 1173 (9th Cir. 2004)); see Cen‐Pen Corp. v. Hanson,
58 F.3d 89, 93 (4th Cir. 1995) (observing that confirmation of a bankruptcy plan
“is res judicata only as to issues that can be raised in a less formal procedure for
contested matters,” and confirmation “generally cannot have [a] preclusive effect
as to [matters] which must be resolved in an adversary proceeding”). We need
not resolve, however, whether an adversary proceeding was the only way in
which the plaintiffs could have litigated the claims in their present lawsuit. It is
enough to hold here that the circumstances did not demand that plaintiffs raise
their claims in the bankruptcy proceeding, and to note that the relevant issues
disposing of [the debtor’s] claims would undermine the efficient administration of bankruptcy
proceedings.” Baker, 613 F.3d at 351. Here, it would likely have been entirely inefficient for the
bankruptcy court to distract itself by dealing with a dispute that, as pleaded in the complaint,
did not involve the debtor, creditors, or the successful bidder.
26
were not litigated through an adversary proceeding or otherwise. See, e.g., In re
Piper Aircraft Corp., 244 F.3d at 1297 (“That the critical facts underlying [the
plaintiff’s] suit were never discussed by the bankruptcy court or litigated by the
parties is powerful evidence that the Chapter 11 case did not involve the ‘same
cause of action’ as the state court suit” for breaches of fiduciary and contractual
duties); Cen‐Pen Corp., 58 F.3d at 93 (observing that “if an issue must be raised
through an adversary proceeding it is not part of the confirmation process and,
unless it is actually litigated, confirmation will not have a preclusive effect”
(internal quotation marks and notations omitted)). In any case, it is the
defendants’ burden to prove that res judicata bars the second action, not the
plaintiffs’ to prove that they are not barred. Comput. Assocs., 126 F.3d at 369.
For the foregoing reasons we disagree with the district court that the
plaintiffs could have, and should have, raised their present claims in the
bankruptcy proceeding.
B.
The district court further concluded that the “practical effect of the relief
sought” by the plaintiffs would “call into question the integrity” of the
bankruptcy court’s orders, which would “invalidate the enforceability or
27
effectiveness of the original reorganization plan, whether the sale is unwound or
not.” Sp. App’x 26 (internal quotation marks omitted). We do not share this
view.
As explained above, “dispositive to a finding of preclusive effect, is
whether an independent judgment in a separate proceeding would ‘impair or
destroy rights or interests established by the judgment entered in the first
action.’” Sure‐Snap Corp., 948 F.2d at 874 (quoting Herendeen, 525 F.2d at 133).
Initially, although the plaintiffs did not formally seek rescission of the
bankruptcy orders, that fact alone does not end the inquiry. We have held that
though a subsequent lawsuit may “not technically ask[] the district court to
disturb” a final bankruptcy order, the subsequent action is barred by res judicata
when “appellants’ failure to raise these claims (if valid) when they should have,
almost certainly affected that prior judgment.” Sure‐Snap Corp., 948 F.2d at 876.
This is because “[h]ad the bankruptcy court found merit in appellants’”
challenge to an aspect of the proceedings, the bankruptcy court “would have
structured a different disposition.” Id.
Under the circumstances, we are not persuaded that, had the plaintiffs’
asserted their present claims in bankruptcy court or sought to litigate the issues
28
necessary to those claims, the bankruptcy court would have structured a
different disposition vis‐à‐vis the Liquidation Plan. Again, as explained above,
the plaintiffs’ allegations are not aimed at the parties subject to the bankruptcy
court orders—the PNC Bank Group, the creditors, and Brown Publishing—but at
K&L and two of its former partners. Because the factual allegations in the
complaint do not implicate the parties to the bankruptcy proceedings, the
plaintiffs’ failure to raise their claims against the defendants in bankruptcy court
did not “almost certainly affect” bankruptcy orders that pertained only to the
parties participating in the bankruptcy proceedings. Sure‐Snap Corp., 948 F.2d at
876. Likewise, even if the bankruptcy court had concluded that the defendants
failed to disclose a conflict of interest or had engaged in misconduct, still, as
concluded above, there was no basis for the bankruptcy court to have imputed
such conduct to the auction participants and the parties subject to the
Liquidation Plan.
Finally, a key component of the plaintiffs’ allegations is that, as a result of
defendants’ actions, plaintiffs’ financing fell through and they were unable to bid
effectively at the auction of Brown Publishing’s assets. In other words, by the
29
time the plaintiffs’ allegations were ripe, any hearing on these claims would not
have changed the outcome of the auction process.
For these reasons, we disagree that the plaintiffs’ action was “so
inextricably linked to the underlying bankruptcy proceeding that the relief the
Plaintiffs seek would require [the district court] to effectively overrule the
[b]ankruptcy [o]rders.” Sp. App’x 29. Indeed, a judgment against the
defendants will have no effect on the continuing validity of the bankruptcy
court’s order approving the sale of Brown Publishing’s assets to the PNC Bank
Group or the order confirming the Liquidation Plan.8 Cf. In re Brook Valley VII,
Joint Venture, 496 F.3d 892, 899 (8th Cir. 2007) (holding that a trustee’s action for
breach of fiduciary duty against the winning bidders, who were on both sides of
a bankruptcy transaction, was “not an impermissible collateral attack on a final
8 Although the plaintiffs did not denominate a quantum of damages in their complaint, they
asserted that damages for their claim for breach of fiduciary duty would be based, in part, “on
the value of the assets [they] were unable to purchase due to [the defendants’] breach of
fiduciary duty,” which would put them where they “would have been financially” if they had
“succeeded in obtaining the assets as contemplated in the APA.” App’x 25. By framing their
potential damages this way, they may have inadvertently invited the district court to view their
action as an attack on the final bankruptcy orders. While we decline to comment on the
appropriate measure of damages were the plaintiffs to prevail, we do not view the plaintiffs’
request for damages obtainable solely by way of a judgment and expectation against defendants
K&L, Fox, and Moser, as evincing any desire to attack the bankruptcy orders. We also note that
“res judicata turns primarily on the commonality of the facts of the prior and subsequent
actions, not on the nature of the remedies sought.” In re Piper Aircraft Corp., 244 F.3d at 1295
(emphasis in original).
30
sale” because the trustee sought “a remedy for an alleged breach of fiduciary
duty,” which “presume[d] the continued validity of the foreclosure sale itself”).
We are mindful that bankruptcy proceedings are “a forum where finality
of court orders is particularly important,” In re Lawrence, 293 F.3d 615, 621 (2d
Cir. 2002), and that a § 363 sale “protects the reasonable expectations of good
faith third‐party purchasers by preventing the overturning of a completed sale,”
In re Farmland Indus., Inc., 408 B.R. 497, 508–09 (B.A.P. 8th Cir. 2009). As the
plaintiffs’ lawsuit poses no threat to the finality of the bankruptcy court’s orders,
allowing that lawsuit to proceed will do no violence to these principles.
CONCLUSION
For the foregoing reasons, the district court’s decision to dismiss the case
on the basis of res judicata is REVERSED, the judgment is VACATED, and the
case is REMANDED to the district court for further proceedings consistent with
this opinion.
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