In the United States Bankruptcy Court

for the Northern District of Iowa


LARRY ROBERT LAWRENCE and
KATHY JEANNE LAWRENCE
Bankruptcy No. L-86-02849C
Debtor(s). Chapter 7

Ruling Re: Application to Sell An Asset of the Bankruptcy Estate


The trustee's application to sell an asset of the bankruptcy estate came on for hearing on June 11, 1992. The following appearances were entered: Debtor, Larry Robert Lawrence - attorney Peter C. Riley; David Grinde - attorney Randall Ney; Childers & Vestle, P.C., f/k/a Dumbaugh & Childers, P.C. - attorney David Grinde; Chapter 7 trustee - attorney Thomas G. McCuskey.

The trustee has filed a motion to sell the trustee's interest in a lawsuit which is presently pending in this Court as Adversary No. L-92-0007C. The adversary complaint was originally filed in the Iowa District Court in and for Linn County and captioned as: Larry Lawrence v. David Grinde, R. Fred Dumbaugh, Childers & Vestle, P.C., f/k/a Dumbaugh & Childers, P.C., Law No. LA21478. Defendants have removed the case to this Court as a proceeding related to the Lawrences' bankruptcy. There is a separate pending motion to abstain or remand the case back to the Iowa District Court; that motion is the subject of a separate order to be entered by this Court.

The issue the Court must determine is whether the trustee has any interest in the lawsuit to sell as an asset of the estate. For purposes of deciding this issue, the parties have stipulated to certain facts which form the basis of the Lawrence v. Grinde, et al., lawsuit. The stipulated facts are as follows:

1. The debtor, Larry Lawrence, filed a Chapter 7 bankruptcy petition on December 24, 1986. Lawrence was represented by the law firm of Dumbaugh & Childers, P.C.. The voluntary petition under Chapter 7 was signed by David E. Grinde, a member of the Dumbaugh & Childers law firm.

2. The financial schedules and statement of affairs were signed by the debtors on January 13, 1987, and filed with the Clerk of the bankruptcy court the same day.

3. The schedules and statement of affairs did not disclose a transfer in the amount of $10,000 which Larry Lawrence made to Opal Bradley, his mother-in-law.

4. In June, 1991, the United States of America indicted

Larry Lawrence for bankruptcy fraud. The indictment charged Lawrence with making false statements in the Statement of Affairs by failing to disclose the $10,000 payment to Opal Bradley. The criminal charge proceeded to a jury trial. The trial resulted in Lawrence being acquitted of the charges.

5. One of the arguments Lawrence raised as a defense in the criminal proceeding was that he had disclosed the opal Bradley transfer to his attorneys. More specifically, Lawrence alleged that the files and records of Dumbaugh & Childers, P.C., revealed that he had prepared written work sheets for the attorneys which disclosed the transfer.

6. The present civil lawsuit was originally filed in the Iowa District Court and removed to this Court as Adversary No. L-92-0077C. It is a legal malpractice lawsuit in which Lawrence seeks judgment against David Grinde, R. Fred Dumbaugh, and Childers & Vestle, P.C., f/k/a Dumbaugh & Childers, P.C. ("the defendants"), for negligently preparing the schedules and statement of affairs and for causing him damage. The specific damages Lawrence requests are: reimbursement of the attorney's fees he incurred in connection with defense of the criminal proceeding in the United States District Court and any damage to his reputation which may have occurred by reason of the criminal indictment and trial.

7. The underlying bankruptcy case had been closed as a no asset case on March 14, 1988. The case was reopened by the defendants to the state court litigation on March 30, 1992. Shortly, thereafter, the defendants removed the state court litigation to this Court. The defendants have argued that the cause of action Lawrence filed in the Iowa District Court and removed to this Court, is an asset of the bankruptcy estate and should be sold by the trustee.

Conclusions of Law & Discussion

The legal issue the Court must resolve is whether under

S 541(a) of the Bankruptcy Code the Lawrences' chapter 7 bankruptcy estate has any interest in Lawrence's cause of action against the defendants. "Section 541 (a) (1) of the Bankruptcy Code provides that the estate is comprised of all legal or equitable interests of the debtor in property, wherever located, as of the date the case is commenced." In re N.S. Garrott & Sons, 772 F.2d 462, 465 (8th Cir. 1985) (citing 541(a)(1)). Under 541(a), with some limited exceptions not applicable here, the chapter 7 bankruptcy estate consists only of property the debtor holds before and at the time the debtor files for bankruptcy. The property interests which a chapter 7 bankruptcy debtor acquires after filing the petition generally become property of the debtor and are available to provide the debtor a fresh start.

"Property rights under 541 are defined by state law." This Court finds that the Iowa Supreme Court's decision in Collins v. Federal Land Bank of Omaha, 421 N.W.2d 136 (Iowa 1988), defines the property rights in this case. In Collins, the Iowa Supreme Court determined the extent of a bankruptcy estate's interest in the debtors' legal malpractice action against their former bankruptcy attorney.

In order to resolve the question, the Collins court had to determine when the cause of action arose as a recognizable property interest under Iowa law. The debtors' cause of action asserted that their bankruptcy attorney improperly urged them to file a chapter 7 instead of a chapter 11. The debtors asserted that as a result of the attorney's advice to file chapter 7 they were forced to liquidate their farming operation and, therefore, they lost the opportunity to retain their farm through a chapter 11 reorganization.

The Iowa Supreme Court observed that "[u]nder Iowa law there must be actual loss to the interest of another before a cause of action accrues." 421 N.W.2d at 139 (citations omitted). In spite of the fact that the allegedly negligent act of the attorney occurred when the case was filed, the Iowa Supreme Court found that the cause of action did not exist until after the debtors filed bankruptcy because there was no discernable economic injury to the debtors resulting from the alleged negligence until after the bankruptcy filing. Id. The Iowa Supreme Court concluded that the debtors, not the bankruptcy trustee, were entitled to pursue that portion of the malpractice claim for their own benefit because the property interest arose post-petition.

Applying Collins as the relevant Iowa law, this Court concludes that the bankruptcy trustee has no interest in Lawrence's legal malpractice action. Lawrence's cause of action asserts that the defendants' failure to include certain information in his bankruptcy schedules and statement of affairs was negligent and resulted in his criminal indictment and prosecution. Lawrence seeks to recover as damages the attorney's fees he paid to defend against the criminal charges and compensation for damage to his reputation resulting from the criminal indictment and prosecution.

Under the Collins case, Lawrence's cause of action for legal malpractice accrued as a recognizable property interest under Iowa law when the allegedly wrongful act produced injury or actual loss to him, not at the time of the negligent act. 421 N.W.2d at 139. Here, the allegedly negligent act occurred when the documents were filed, but the injury or actual loss that Lawrence asserts occurred post-petition. He did not pay any attorney's fees to defend the criminal action nor did he sustain any damage to his reputation resulting from the criminal action until at least June of 1991 when he was indicted for bankruptcy fraud. Until that time, the allegedly negligent act had not produced the damages, he asserts and, therefore, the cause of action did not accrue under Collins until that time. Hence, applying Collins, this Court must conclude that Lawrence's cause of action arose after the bankruptcy petition was filed and is not property of the bankruptcy estate.

The defendants argue that the case of Millwright v. Romer, 322 N.W.2d 30 (Iowa 1982), stands for the proposition that Lawrence's cause of action is property of the estate. For the following reasons, this Court finds that Millwright does not apply here.

First, Millwright was a statute of limitation case. The issue in Millwright was whether plaintiffs could escape the statute of limitation on legal malpractice claims on the basis that they did not discover the negligence and damages until after the statute of limitation expired. Unlike Collins, the Millwright court only incidentally addressed the time at which the cause of action arose in discussing the effect of the statute of limitation and discovery rule.

Moreover, a critical factor in the Millwright analysis differs in this case. In ruling that the statute of limitation barred the malpractice action, the Millwright court held that as a general rule "the statute began to run on the date of the testator's death . . ." 332 N.W.2d. at 34. The Court then found that the "discovery rule" applied to legal malpractice actions and modified the general rule. The Iowa discovery rule provides that: "The limitation statute or statutes in malpractice cases do not start to run until the date of discovery, or the date when, by the exercise of reasonable care, plaintiff should have discovered the wrongful act." Id. at 33 (quoting Chrischilles v. Griswold, 260 Iowa 453, 462, 150 N.W.2d 94, 100 (1967).

Applying the discovery rule, the Millwright court found that every citizen is presumed to know the law and, therefore, the plaintiffs should have discovered much earlier that the will violated the rule against perpetuities and was void upon admission to probate. In reaching that conclusion, however, the Iowa Supreme Court observed:

None of the reasons for application of the discovery rule to legal malpractice actions support an exception to the presumption of knowledge of the law in this present action based upon a negligently drafted will. one reason underlying the discovery rule in legal malpractice actions is that a client has a right to rely upon the superior skills and knowledge of his attorney. That reason does not apply here because defendant was never plaintiffs' attorney. He had no part in the administration of decedent's estate or trust, and had no prior or subsequent legal relationship with plaintiffs.

322 N.W. 2d at 34 (citations omitted). Hence, it was fundamental in the Millwright court's analysis that the legal malpractice plaintiffs were not suing their own attorney whose expertise they had relied upon. If they had been suing their own attorney the result may have been different under Iowa law. This case is clearly not subject to the Millwright analysis because Lawrence is suing his own bankruptcy attorney.

Furthermore, the defendants' arguments about accrual of the cause of action based on the irreversibility doctrine are misplaced. The defendant's contend that Millwright stands for the proposition that the cause of action accrued when the legal documents were filed because that is the date the harm became irreversible. Millwright, however, never mentioned irreversibility. The irreversibility analysis was introduced to the Iowa law after Millwright was decided in the case of Neylan v. Moser, 400 N.W.2d 538, 542 (Iowa 1987). Moser held that the date of injury in legal malpractice cases is the last possible date that the attorney's negligence becomes irreversible. Noting that a client has the right to rely on the attorney's knowledge and expertise throughout the entire course of the representation, the Supreme Court concluded that last date for irreversibility purposes is the final appeal date.

Because Moser was decided after Millwright, it is too speculative for defendant to assert that Millwright held that the filing of the will was the date that the negligence caused irreversible damage. (This is particularly true when the date of irreversibility under Millwright is probably more appropriately the testator's death.) Likewise, defendants engage in pure speculation by asserting that the any negligence of the defendant had to be irreversible at the time the bankruptcy petition was filed. It is equally plausible, if not more likely, that a timely amendment to the schedules to disclose the transfer, would have prevented the criminal prosecution altogether.

Finally, the Court finds that the Collins case is both factually and legally more similar to this case than the Millwright case. Both Collins and this case deal with the issue of negligence which occurred at the moment the bankruptcy petition was filed and both cases deal with damages which resulted from the alleged negligence in filing the petition. Millwright dealt with a legal malpractice claim in a probate case and focused on different legal issues than those arising here. The defendants' argument that the Court should apply Millwright is completely unavailing given the factual and legal similarities between this case and Collins.

In essence, the defendants have attempted to persuade this Court that the Iowa Supreme Court did not correctly decide Collins. A number of bankruptcy courts have concluded that legal malpractice claims of bankruptcy debtors against their former bankruptcy attorneys are property of the bankruptcy estate. One case even discussed the Collins case and rejected its rationale and conclusion. In re Dow, 132 B.R. 853, 859-60 (Bankr. S.D. Ohio 1991). The defendants and the trustee urge the Court to follow the Dow case and other cases which have held that legal malpractice claims are property of the estate.

However, this Court feels that it is bound by the holding of the Iowa Supreme Court. As previously discussed, property rights under 541 are defined by state law. N.S. Garrott, 772 F.2d at 466 (citing Butner v. United States, 440 U.S. at 55). Since property rights are defined by state law, this Court is bound to follow the determination of the highest court of this state regarding property rights under Iowa law. This is especially true in this case where there is an Iowa Supreme Court case squarely on point. Consequently, this Court will follow the Collins case and conclude that Lawrence's potential cause of action against his former attorneys is not property of the bankruptcy estate.

Conclusion

Lawrence's legal malpractice cause of action accrued post-

petition under Iowa law. The estate does not have an interest in the case under 541(a). Hence, the trustee's application to sell is denied.

O R D E R

IT IS THEREFORE ORDERED that the trustee's application to sell

property is denied.

DONE AND ORDERED this 29th day of July, 1992.

Michael J. Melloy
Chief Bankruptcy Judge