Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Bankr. E.D. Ken.: Attorney counterclaim against franchisee client might be nondischargeable in bankruptcy, (Apr 25, 2014)

By John W. Arden, J.D., LL.M.

A lawyer and law firm charged with malpractice in representing franchisees against pizza franchisor Noble Roman’s Inc. raised sufficient claims for nondischargeability of their counterclaim against a bankrupt franchisee that they represented, according to the federal bankruptcy court in Covington, Kentucky (In re: Dunn, April 22, 2014, Wise, T.). However, they were not authorized to pursue dismissal of the malpractice claim, sanctions for noncompliance with discovery orders, or the counterclaims unless the debtor franchisees prosecuted the malpractice action, which had been abandoned by the trustee in bankruptcy.

On June 19, 2008, attorney David Duree filed a complaint against Noble Roman’s Inc. on behalf of 34 franchisees, including the debtors John W. Dunn and Mariann G. Dunn, in Indiana state court. The complaint asserted common law fraud claims. On March 30, 2009, the state court revoked David Duree’s pro hac vice admission to practice before it. The reason does not appear in the record. Substitute counsel was retained.

Noble Roman’s filed a motion for partial summary judgment, which was granted on December 23, 2010, as to some of the franchisees, including the debtors. The debtors and some other plaintiffs filed various unsuccessful post-judgment motions and unsuccessfully appealed the grant of summary judgment. In May 2011, the substitute counsel filed a malpractice claim against David Duree and David M. Duree & Associates on behalf of the debtors and other franchisees. The Durees filed a counterclaim, seeking more than $19,000 in out-of-pocket expenses, and filed a motion to dismiss the malpractice action. The malpractice action was pending at the time of the debtors’ bankruptcy petition and was pending at the time of this decision.

In their original petition in bankruptcy, the debtors failed to schedule the Durees as creditors with respect to the counterclaim and failed to schedule the malpractice action as an asset of their estate. The Durees charged that these failures justified the denial of debtors’ discharge of the counterclaim. The Durees further asserted a claim against the debtors that the filing of the malpractice action was malicious prosecution and/or abuse of process and that their claim was nondischargeable as a willful and malicious injury caused by the debtors.

Nondischargeability of claim

Failure to disclose creditors, schedule claim. The Durees alleged that the debtors’ failure to schedule them as creditors and failure to schedule the malpractice action as an asset justified a finding of nondischargeability with regard to the counterclaims. In order to deny debtors’ discharge under 11 U.S.C. §727(a)(4), a plaintiff must prove (1) that the debtor made a statement under oath; (2) the statement was false; (3) the debtor knew the statement was false; (4) the debtor made the statement with fraudulent intent; and (5) the statement related materially to the bankruptcy case.

While the factual arguments by the Durees were "skimpy" at best, they were sufficient to state a claim for relief from discharge under 11 U.S.C. §727(a)(4), the bankruptcy court found. The motion to dismiss the claim was denied.

Willful and malicious injury. The Durees further claimed that the Dunns were not entitled to discharge of debts because they caused willful and malicious injury, under 11 U.S.C. §523(a)(6). The Dunns filed a motion to dismiss.

To survive a motion to dismiss this claim, the Durees must have pleaded sufficient factual content to allow the court to draw a reasonable inference that (1) the Duress sustained an injury, (2) the injury was caused by the debtors, and (3) the injury was both willful and malicious. However, their complaint did not contain sufficient factual matter on each necessary element to state a claim to relief under §523(a)(6) that was plausible on its face, the court found.

The Durees allege that the filing of the malpractice action itself was the injury. The Dunns admitted that they filed the action intentionally. However, an intentional act that leads to an injury is insufficient to state a claim under §523(a)(6), according to the court. The Durees’ claim was totally devoid of any other allegations that the debtors intended to cause—or that the Durees suffered—an injury. "For instance, there are no allegations that the filing of the Malpractice Action was intended to, or resulted in a loss of clients, loss of income, embarrassment, emotional distress, or any other injury that was substantially certain to occur. The Court cannot determine the willfulness of an injury where none is alleged."

The complaint also fell short as to allegations of malice, in the court’s view. It asserted that the Dunns acted in concert with multiple other plaintiffs, pursuant to a common scheme and design, when they filed the malpractice action without probably cause or justification. The Durees believed that the court would grant their pending motion to dismiss the malpractice action as a sanction based on the Dunns’ failure to comply with discovery orders and that the action was filed for the ulterior motive of using the Durees as scapegoats in the event that the underlying Noble Roman’s action was not successful.

"The mere fact that the Durees have defenses to the Malpractice Action does not allow this Court to a draw reasonable inference that the Dunns (and other plaintiffs) lacked probably cause or justification to file the Malpractice Action or that the Debtors filed the Malpractice Action with knowledge it was wrongful," the court held. The allegations in the willful and malicious injury claim allowed the court to infer no more than the mere possibility of misconduct. Thus, the motion to dismiss the claim was granted.

Relief from automatic stay. The Durees sought permission to lift the automatic stay of proceedings in order to continue prosecuting their dismissal motion in the malpractice action as a contempt sanction for the Dunns’ failure to comply with discovery orders. However, the court found that the Trustee in bankruptcy had filed a notice of abandonment of the malpractice action. Once that abandonment was effective, the debtors could pursue the action at their sole discretion, the court explained. If the malpractice action were pursued by the Dunns, the Durees were free to defend without further permission by the court, including the pursuit of contempt sanctions. Absent prosecution of the malpractice action, the Durees would not be authorized to pursue contempt sanctions because the pursuit of the contempt sanction was tantamount to continuing litigation against debtors to collect a prepetition debt, the court concluded.

The case is No. 13-21795.

Attorneys: David Maxwell Duree (David M. Duree and Associates, PC) for David M. Duree and David M. Duree & Associates, PC. Michael L. Baker (Michael Baker International LLC) for John W. Dunn.

Cases: FranchisingDistribution KentuckyNews