Whether Gross Negligence by an Attorney is Cause Not to Convert a Chapter 11 to a Chapter 7? (Recent Oral Argument - 9th)

The 9th Circuit recently heard oral argument on a case involving alleged gross negligence on the part of a Chapter 11 attorney who failed to file a budget and the Debtor utilized approximately $16,000 in cash collateral without an order.  The case was converted to a Chapter 7 based upon the Debtor's failure to comply with a variety of court orders and the unauthorized use of the cash.  The Debtor blamed his counsel and retained new counsel.  Despite the retention of new counsel, the case was converted to a Chapter 7. 




On reconsideration by the Bankruptcy Court, the court also found as a legal matter that inadequate legal advice is no defense to a § 1112(b) dismissal or conversion. As the court noted, mistaken legal advice generally does not relieve a client of the consequences of acts or omissions. See Link v. Wabash R. Co., 370 U.S. 626, 634, 82 S. Ct. 1386, 8 L. Ed. 2d 734 (1962) (dismissal of adversary proceeding for failure to appear at scheduled status conference); Cannon-Stokes v. Potter, 453 F.3d 446, 449 (7th Cir. 2006) (failure to schedule employment cause of action in bankruptcy schedules resulting  [14] in judicial estoppel barring claims); In re DePugh, 409 B.R. 84, 107 n.13 (Bankr. S.D. Tex. 2009) (failure to attach assignments to Proofs of Claim). Accordingly, any failure by counsel to raise the cash collateral issue would not excuse the debtor or mitigate the existing cause for converting the case.


During oral argument the 9th Circuit seemed to agree that the inadequate legal advice is no defense.  I presume that the Court will affirm the District Court but if the gravity of the attorney's actions were so severe, I am hopeful that the Court will provide an analysis on what the Bankruptcy Court should do when it faces such a situation.  My take is that Debtors are also responsible for their actions (i.e. utilizing cash without an order) and their agents' actions or inactions are imputed on them.  The end result could be a malpractice action.






Oral Argument - 9th Circuit - in re: Augustine Pena, III, et al v. Trudi Manfredo




District Court citation:
Pena v. Manfredo, 2013 U.S. Dist. LEXIS 127655

United States District Court for the Eastern District of California

September 5, 2013, Decided; September 6, 2013, Filed

Case No. 12-cv-01233-AWI