Texas Court Holds Third-Party Claims “Related to” Bankruptcy Case

In Lone Star State Bank of West Texas v. Waggoner, et al. (In re Waggoner Cattle, LLC), Adv. P. No. 18-02003 (RLJ) (Bankr. N.D. Tex. Nov. 19, 2018), the United States Bankruptcy Court for the Northern District of Texas reminded us that creditor’s claims against third parties can confer jurisdiction on a bankruptcy court when the claims could have a conceivable effect on the bankruptcy estate.

Lone Star State Bank of West Texas (Lonestar), a secured creditor of several debtors (Debtors), initiated an adversary proceeding in the Debtors’ bankruptcy cases against several defendants for alleged professional malpractice in performing accounting and auditing services for the Debtors.

The defendants moved to dismiss the adversary proceeding, arguing that the Bankruptcy Court lacked subject-matter jurisdiction, because the third-party claims were not sufficiently “related to” the Debtors’ cases.

Lonestar countered that any recovery against defendants would reduce Lonestar’s claims against the Debtors and thus potentially enhance the recovery for other creditors in the bankruptcy cases.

Generally, jurisdiction over bankruptcy cases and proceedings is conferred on federal district courts under 28 U.S.C. § 1334. U.S. Brass Corp. v. Travelers Ins. Grp. (In re U.S. Brass Corp.), 301 F.3d 296, 303 (5th Cir. 2002). But, section 1334(b) provides that district courts have “original but not exclusive jurisdiction” over “arising” and “related to” civil proceedings under title 11. 28 U.S.C. § 1334(b). Such proceedings are assigned to the bankruptcy courts pursuant to 28 U.S.C. § 157.

The Fifth Circuit has held that in order to determine bankruptcy subject-matter jurisdiction “it is only necessary to determine whether a matter is at least ‘related to’ the bankruptcy.” U.S. Brass, 301 F.3d at 304. A proceeding is “related to” a bankruptcy case when its outcome “could conceivably have any effect on the estate being administered in bankruptcy.” Id. (emphasis added). Put another way, “an action is ‘related to’ bankruptcy if the outcome could alter, positively or negatively, the debtor’s rights, liabilities, options, or freedom of action or could influence the administration of the bankruptcy estate.” TMT Procurement Corp. v. Vantage Drilling Co. (In re TMT Procurement Corp.), 764 F.3d 512, 526 (5th Cir. 2014).

A bankruptcy court must decide whether a matter before it is a “core” (arising under) matter or a “non-core” (related to) matter. 28 U.S.C. § 157(b), (c); Exec. Benefits Ins. Agency v. Arkinson, 134 S.Ct 2165, 2171 (2014). This determination dictates the bankruptcy judge’s authority over the matter. 28 U.S.C. § 157(b), (c).

In Waggoner Cattle, the Bankruptcy Court relied heavily on the Fifth Circuit’s opinion in Randall & Blake, Inc. v. Evans (In re Canion), 196 F.3d 579 (5th Cir. 1999) and Third Circuit’s opinion in Nuveen Municipal Tr. v. WithumSmith Brown, P.C., 692 F.3d 283 (3d Cir. 2012), in making its determination of whether it held “related to” jurisdiction.

In Canion, a judgment creditor of the debtor initiated an adversary proceeding against third-party defendants—the debtor’s friends, relatives, business associates and employees—seeking monetary and injunctive relief for various tort claims. 196 F.3d at 581-82. On appeal, the Fifth Circuit upheld the bankruptcy jurisdiction because the claims could have had a conceivable effect on the bankruptcy estate, as any amount collected would have reduced the creditor’s claims against the estate and thus allow other unsecured creditors to receive distributions that would otherwise have been paid to the judgment creditor. Id. at 586. Significantly, the Fifth Circuit also found that there is no requirement that the effect on the estate be certain for jurisdiction to lie. Id. at 585.

In Nuveen, a lender sued the debtor’s accounting firm for certain auditing reports that it had prepared, “contending that the audit report . . . concealed problem aspects of [the debtor’s] financial condition, and had [the lender] known about the financial issues, it would not have entered into the [loan] transaction.” 692 F.3d at 287. The Third Circuit upheld “related to” jurisdiction under 28 U.S.C. § 1334(b), because the lender’s recovery against the accounting firm could have had some “conceivable” effect on the bankruptcy estate. Id. at 294. The conceivable effect was the potential impact on “the pool of assets available for distribution to [the debtor’s] creditors.” Id. 298-99.

Both Canion and Nuveen also instructed that the timing of when jurisdiction is decided is important. The long-standing rule is that “related to” jurisdiction is assessed at the time of the bankruptcy filing.” See Grupo Dataflux v. Atlas Glob. Grp., L.P., 541 U.S. 567, 582 (2004). But, “related to” jurisdiction cannot extend to third-party disputes after a bankruptcy estate has been fully administered, because any subsequent third-party recovery could have little or no effect on the bankruptcy estate. Canion, 196 F.3d at 586 n. 27; Nuveen, 692 F.3d at 297.

In Waggoner Cattle, the Bankruptcy Court held that the facts supported “related to” jurisdiction, not only because of the conceivable effect on the estate, but also because the bankruptcy cases were in their early stages, with no distributions to creditors.

Takeaway-if a creditor is choosing a bankruptcy venue to litigate its disputes against third parties, it would behoove the creditor to make that election early in the case, especially if the case stands to be administered quickly. Otherwise, the creditor risks losing “related to” jurisdiction. In Waggoner Cattle, it also helped the creditor that it had not previously commenced a proceeding in another venue. Thus, there was no alternative venue where the bankruptcy court could send the lawsuit on permissive abstention grounds.