Schwab et al v. Oscar, Esq. et al

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UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF OHIO
EASTERN DIVISION
IN RE:
SII LIQUIDATION COMPANY,
Debtor.
______________________________
DAVID A. SCHWAB, et al.,
Plaintiffs,
v.
LAWRENCE E. OSCAR, ESQ., and
HAHN LOESER & PARKS, LLP,
Defendants.
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CHAPTER 11
CASE NO. 10-60702
ADV. NO. 12-6035
JUDGE RUSS KENDIG
MEMORANDUM OF OPINION
(NOT FOR PUBLICATION)
This adversary is a malpractice action by shareholders (“Plaintiffs”)1 of the consolidated
debtors (“Debtors”)2 against Debtors’ lead bankruptcy counsel. 	Plaintiffs advance individual
counts, alleging an attorney-client relationship between themselves and Defendants, as well as
1 Plaintiffs are David A. Schwab, Donna L. Schwab and Jerry A. Schwab.
2 The consolidated Debtors are Schwab Industries, Inc.; Medina Cartage Co.; Medina Supply Company; Quality
Block & Supply, Inc.; O.I.S. Tire, Inc.; Twin Cities Concrete Company; Schwab Ready-Mix, Inc.; Schwab Materials,
Inc.; and Eastern Cement Corp.
time and date indicated, which may be materially different from its entry on the record.
of this court the document set forth below. This document was signed electronically at the
The court incorporates by reference in this paragraph and adopts as the findings and orders
Dated: 11:28 AM September 20, 2012
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derivative counts as shareholders of Debtors. 	Two motions to dismiss were filed in response to
the amended complaint. 	The first was filed by the creditor trustee, John B. Pidcock (“Creditor
Trustee”), on May 24, 2012. 	The second was filed on June 12, 2012 by defendants Hahn Loeser
& Parks LLP (“Hahn Loeser”) and Lawrence E. Oscar (“Oscar”) (collectively “Defendants”).
Plaintiffs responded to the motions and oppose dismissal. 	None of the parties requested oral
hearing on the motions.
28 U.S.C. § 1334(a) provides the district court with original and exclusive jurisdiction of
the underlying chapter 11 bankruptcy case. 	The court has original, but not exclusive, jurisdiction
of the civil proceeding pursuant to 28 U.S.C. § 1334(b). 	In accordance with 28 U.S.C. § 157(a),
the district court conferred its jurisdiction to the bankruptcy court by General Order 2012-7, the
general order of reference, dated April 4, 2012. 	Under 28 U.S.C. § 1409, venue in this district and
division is proper.
This opinion is not intended for publication or citation. 	The availability of this opinion, in
electronic or printed form, is not the result of a direct submission by the court.
FACTUAL BACKGROUND
On February 28, 2010, Oscar, an attorney with Hahn Loeser, filed chapter 11 petitions for
Schwab Industries, Inc. and several related entities, collectively the “Debtors.” 	Debtors were
closely-held companies. 	Plaintiffs were shareholders and directors of Debtors.
On May 15, 2012, Plaintiffs filed an amended complaint for malpractice against
Defendants in individual and derivative capacities. 	The specific counts include professional
negligence/legal malpractice, fraudulent inducement, and negligent misrepresentation. 	Counts I,
III and V are the derivative claims, Counts II, IV and VI are Plaintiffs’ individual claims.
Plaintiffs allege that they consulted Defendants to represent both their interests as
shareholders and to represent Debtors in a chapter 11 case. 	They insist that an attorney-client
relationship existed between Defendants and them individually, as well as between Defendants
and Debtors, and that Defendants owed duties to both Debtors and them. 	Plaintiffs contend that
they were not advised of Oscar/Hahn Loeser’s conflict with a creditor and never authorized
employment of additional counsel to manage the conflict. 	They state they were not aware that
liquidation was a possibility and filed a chapter 11 petition with the sole intent of reorganization
and restructuring. 	Plaintiffs also complain specifically that Defendants failed to represent their
interests and the interests of Debtors when it appeared that a favorable ruling from a state court
increased the value of a substantial asset. 	Both the Creditor Trustee and Defendants moved to
dismiss the amended complaint.
The application to employ Hahn Loeser as Debtors’ bankruptcy counsel was filed
contemporaneously with the petition. 	Paragraph forty-five of application identifies the following
conflict:
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Specifically, as noted herein and as reported to Debtors,
Hahn Loeser has represented and does represent BAL
Global Finance, LLC (“BAL”) which is an affiliate of Bank
of America, N.A., a secured lender of Debtors (“BofA”)
in matters unrelated to Debtors. 	Debtors have been advised
of Hahn Loeser’s representation of BAL, and Debtors have
engaged, subject to court approval, the Brouse McDowell
law firm, to represent them in matters adverse to BofA.
Under present circumstances Hahn Loeser will not represent
Debtors or BofA in this engagement on matters where Debtors
and BofA are directly adverse.
An application to employ Brouse McDowell, LPA (“Brouse”) as special counsel was also filed on
February 28, 2010. 	It states that Brouse’s services will be “generally limited to matters that Hahn
Loeser is unable to perform due to unavoidable conflicts.” 	(Appl. To Employ Brouse McDowell
¶ 33, Main Case ECF No. 8) 	A Corporate Resolution, filed contemporaneously with the petitions,
was executed on February 26, 2010 and signed by Plaintiffs J.A. Schwab, Donna L. Schwab, and
D.A. Schwab as directors, and acknowledges and authorizes employment of Brouse McDowell as
“conflicts and special counsel relating to the Corporation’s chapter 11 case.” 	(Corporate
Resolution p. 2, Main Case ECF No. 2) 	David R. Exley, Vice President of Administration for
Debtors, swore out an affidavit on February 28, 2010 acknowledging conflicts. 	(Aff. of David R.
Exley In Support of Ch. 11 Petitions and First Day Motions ¶¶ 39-41, Main Case ECF No. 23)
The application to employ Hahn Loeser was approved on March 24, 2010 and the order approving
Brouse’s representation was entered on March 29, 2010.
Debtors encountered further financial turmoil and progress of the case resulted in the sale
of substantially all of Debtors’ assets via auction. 	The court entered a sale order on May 28, 2010.
Subsequently, the court confirmed a liquidation plan. 	(Order Confirming Ch. 11 Plan, Main Case
ECF No. 698) 	Through the sale and plan, a creditor trust was established for the benefit of the
unsecured creditors and John B. Pidcock was designated Creditor Trustee. 	(Notice – Plan
Proponents Notice of Designation of Creditor Trustee, Main Case ECF No. 690)
Hahn Loeser submitted two fee applications, a first interim and a second interim/final
application. 	The former was approved on August 9, 2010 and the latter was approved on March
11, 2011.
DISCUSSION
The Creditor Trustee and Defendants’ motions are brought under Federal Rule of Civil
Procedure 12 as adopted into bankruptcy practice by Federal Rule of Bankruptcy Procedure 7012.
They specifically rely on Rule 12(b)(1) and (6). 	In one argument, they claim that Plaintiffs’
claims have been foreclosed by previous events, specifically the adoption of an exculpation clause
in the confirmation order and the res judicata effect of orders awarding fees, thereby destroying the
court’s subject matter jurisdiction. 	Plaintiffs oppose dismissal on this ground, arguing that the
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court does have subject matter jurisdiction because the claims are not “inescapably frivolous” and
deny the applicability of res judicata. 	In a separate argument, Creditor Trustee and Defendants
contend that the Plaintiffs have no standing because the claims belong to the estate/Creditor
Trustee. 	Plaintiffs’ counter-argument questions the standing of the Creditor Trustee because he
declined to pursue the claims.
I. 	Authority and Standards of Review
A. Bankruptcy Court Authority
None of the parties discussed the court’s jurisdiction. 	In the amended complaint,
Plaintiffs allege this is a non-core proceeding. 	While the court has no desire to create a primer on
bankruptcy jurisdiction, the court must determine its authority to hear this proceeding as required
by 28 U.S.C. § 157(b) and (c). 	Under 28 U.S.C. § 157(b), a bankruptcy court “may hear and
determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case
under title 11.” 	The court is granted authority to enter orders and judgments, subject to appellate
review. Id. 	In non-core actions, absent the parties’ consent to the contrary, a bankruptcy court
may hear a case, but “shall submit findings of fact and conclusions of law” for entry of a final
judgment by the district court. 	11 U.S.C. § 157(c)(1).
Circuit appellate courts generally find that malpractice actions against professionals
employed by a bankruptcy debtor are proceedings that “arise in” a title 11 case, providing a
bankruptcy court with the authority to enter final orders and judgments. 	See, e.g., Baker v.
Simpson, 613 F.3d 346 (2 nd Cir. 2010); Geruschat v. Ernst Young LLP (In re Seven Fields Dev.
Corp.), 505 F.3d 237 (3rd Cir. 2007); Grausz v. Englander, 321 F.3d 467 (4th Cir. 2003); Southmark
Corp. v. Coopers & Lybrand (In re Southmark Corp.), 163 F.3d 925 (5 th Cir. 1999); HMT Inv.
Corp. v. Kupetz (In re Kahlenberg Lumber Co., Inc.), 103 F.3d 138 (9th Cir. 1996) (unpublished).
Several common threads run through the decisions. 	First, most recognize that bankruptcy
malpractice claims, even though based on state law, would not exist outside of the bankruptcy
case. 	Second, several courts link a malpractice claim against a bankruptcy professional as a
matter concerning the administration of the estate, thereby creating a core claim under 28 U.S.C.
§ 157(b)(2)(A). 	Third, they point to the court’s duty to oversee professionals employed during
the case, as well as the court’s obligation to maintain the integrity of the bankruptcy system.
These connections to the bankruptcy case lead the courts to conclude that malpractice claims
against professionals are intrinsically connected to the bankruptcy case and have their existence
only through the case. 	Consequently, the claims “arise in” the case, pursuant to 28 U.S.C. §
157(b), providing the jurisdictional foundation for a bankruptcy court to hear and enter final
judgments on the claims.
The majority of cases cited above involve an action by a debtor against a bankruptcy
professional, making those cases facially distinct from the present action. 	The distinction is
clearly without merit with respect to the derivative actions. 	Derivative actions are merely “suits
by shareholder[s] to enforce a corporate cause of action.” 	Price v. Gurney, 324 U.S. 100, 105
(1945). 	Since Plaintiffs are pursuing causes of action on behalf of the corporate debtors, the
action is essentially one by Debtors against their attorneys, making the facts indistinguishable.
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Consequently, there is no basis to deviate from the reasoning outlined above with respect to the
derivative claims.
Plaintiffs’ complaint also contains individual, non-derivative counts, direct actions by
Plaintiffs, as shareholders, against Defendants. 	Plaintiffs, as the shareholders of Debtors, contend
they had an attorney-client relationship with Defendants and sought advice from Defendants both
on their own behalf and on behalf of the Debtors. 	The question is whether there is any basis to
find that these claims do not “arise in” the bankruptcy case, thereby eliminating the basis for core
jurisdiction.
Of the cases cited, Seven Fields is the most factually analogous. 	In Seven Fields, several
creditors filed a professional malpractice action against the debtor’s accountants in state court.
Following removal to the bankruptcy court, the bankruptcy court determined that remand was not
appropriate. 	The Third Circuit agreed, determining that the claims arose in the bankruptcy case.
First, the claims the conduct alleged occurred during progress of the bankruptcy case. 	Second,
the claims impugned the entire bankruptcy process and could not be severed from the bankruptcy
case. 	The court ultimately concluded that
it is clear to us that a malpractice action against an
accountant for misconduct during the bankruptcy on
which the bankruptcy judge relied in confirming the
plan of reorganization, and in reliance on which the
bankruptcy court approved the fees to the accountants,
and on which appellants' representatives relied to their
detriment in selling the assets to pay their claims, in a
manner that contravenes the terms of the reorganization
plan, constitutes a core proceeding, more specifically a
proceeding “arising in” the bankruptcy, which is subject
to federal jurisdiction and the final adjudicative authority
of the bankruptcy court.
Seven Fields at 262-63 (footnote omitted).
Although the law in the Sixth Circuit is not as direct as the cases above, the court finds that
Sixth Circuit case law compels the same conclusion. 	The Sixth Circuit also looks at the nature of
the claims to determine whether they arise in a bankruptcy case. 	Mich. Emp’t Sec. Comm’n v.
Wolverine Radio Co., Inc. (In re Wolverine Radio Co.), 930 F.2d 1132, 1144 (6th Cir. 1991) (citing
1 Collier on Bankruptcy ¶ 3.01[1][c][v]) (15th ed. 1990)). 	While state law provides the
substantive law for the claims, this alone is not dispositive. 	11 U.S.C. § 157(b)(3). 	Wolverine
Radio advises courts to look at “both the form and substance of the proceeding to determine
whether core status exists.” 	Wolverine Radio, 930 F.2d at 1144 (citing Wood v. Wood (In re
Wood), 825 F.2d 90, 97 (5th Cir. 1987)). 	When a claim cannot exist but for the bankruptcy, it will
be deemed to be core. 	Sanders Confectionery Products, Inc. v. Heller Fin., Inc., 973 F.3d 474 (6th
Cir. 1992).
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The form of the action creates a façade for a non-core determination. 	The complaint is
based on state law. 	The claims do not arise under the bankruptcy code, nor do they depend on
bankruptcy law for their outcome. 	Both Plaintiffs and Defendants are non-debtor parties. 	If
Plaintiffs are successful on their individual claims, no benefit with inure to the estate. 	However,
these facts ignores the reality of the situation. 	At its core, this action is a collateral attack on the
bankruptcy case. 	Plaintiffs allege that the entire filing was based on a misrepresentation and
misunderstanding of how the case would progress. 	They allege that Defendants failed to disclose
a conflict, thereby impugning Defendants’ employment as counsel. Another allegation suggests
that the sale of Debtors’ assets did not fully recognize the value of those assets based on a
late-developing fact. 	The factual underpinning of the claims depends on the bankruptcy case,
making it difficult to comprehend how a malpractice action against bankruptcy counsel would not
be deemed to “arise in” the bankruptcy case. 	Plaintiffs would not have any claims without the
bankruptcy case. 	This nexus, where claims are “inextricably bound” to the bankruptcy case,
establishes core status. 	See Lowenbraun v. Canary (In re Lowenbraun), 453 F.3d 314 (6th Cir.
2006).
The facts of this case are easily distinguishable from those in Browning v. Levy, 283 F.3d
761 (6th Cir. 2002). 	There, an action by the successor-in-interest to the chapter 11 debtor against
debtor’s former counsel was deemed to be non-core. 	They key difference was that the
malpractice action against former counsel was not directly tied to the bankruptcy case. 	Rather,
the alleged malpractice occurred during representation of the debtor in a pre-petition agreement
resolving a dispute about control and ownership of the corporation. 	The malpractice was
discovered during the bankruptcy, but was otherwise unconnected. 	Consequently, the court
concluded “as claims of the successor-in-interest to the debtor against a non-creditor third party,
they are not among the core proceedings arising under the Bankruptcy Code . . . .” 	Id. at 773.
Unlike here, there was no argument that the claims actually arose in the bankruptcy case, nor were
there inseverable ties between the malpractice action and the case. 	For this reason, Browning is
not persuasive. 	Seven Fields is more representative of the facts of this case, providing a
compelling analysis for jurisdiction.
Additionally, 28 U.S.C. § 1334(e)(2) provides a district court with exclusive jurisdiction of
11 U.S.C. § 327 issues. 	This strongly suggests that the employment of professionals in a
bankruptcy case were matters that Congress thought were the sole responsibility of the appointing
court. 	No grant or reservation of jurisdiction was provided to any other court, thereby
establishing the preeminence of jurisdiction to the district court and, through the order of
reference, to the bankruptcy court.
The sum of the above inescapably leads to the conclusion that both the derivative and
individual claims set forth in the amended complaint arise in the bankruptcy case, thereby
invoking the court’s powers under 11 U.S.C. § 157(b)(1). 	Consequently, the court can enter final
orders and judgments in this proceeding.
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B. Standard of Review
As previously stated, Creditor Trustee and Defendants’ motions to dismiss are brought
under Federal Rule of Civil Procedure 12(b)(1), for lack of subject matter jurisdiction, and
12(b)(6), for “failure to state a claim upon which relief can be granted.” 	Relief under Rule
12(b)(1) is rare because a court must conclude that “the allegations of a complaint are totally
implausible, attenuated, unsubstantial, frivolous, devoid of merit, or no longer open to discussion.”
Apple v. Glenn, 183 F.3d 477, 479 (6th Cir. 1999) (citing Hagans. v. Lavine, 415 U.S. 528, 536-37
(1974)). 	The Sixth Circuit recognized that ‘most complaints will not be so clearly insufficient as
to warrant dismissal under Rule 12(b)(1), but instead should be handled under Rule 12(b)(6).’
Wagenknecht v. U.S., 533 F.3d 412, 417 (quoting Apple, 183 F.3d at 480).
To avoid dismissal under Rule 12(b)(6), 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) (citing Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007)). 	The
reviewing court accepts the allegations as not only true, but also views them in the light most
favorable to the plaintiffs. 	Gold v. Deloitte & Touche LLP (In re NM Holdings Co., LLC), 622
F.3d 613, 618 (6th Cir. 2010) (citation omitted). 	Legal conclusions are not entitled to similar
countenance. 	Iqbal, 556 U.S. at 678.
Under Rule 12(d), if a 12(b)(6) motion contains “matters outside the pleadings that are
presented and not excluded by the court, the motion must be treated as one for summary judgment
under Rule 56.” 	Fed.R.Civ.P. 12(d). 	This is pertinent because Hahn Loeser advocates the
court’s consideration of the prepetition engagement letter between Debtors and Hahn Loeser,
attached to Hahn Loeser’s motion to dismiss as exhibit A. 	Certain matters outside the pleadings
are ripe for consideration:
“In determining whether to grant a Rule 12(b)(6) motion,
the court primarily considers the allegations in the com-
plaint, although matters of public record, orders, items
appearing in the record of the case, and exhibits attached
to the complaint, also may be taken into account.” Nieman
v. NLO, Inc., 108 F.3d 1546, 1554 (6th Cir.1997) (quota-
tion omitted) (emphasis added). This circuit has further “held
that ‘documents that a defendant attaches to a motion to
dismiss are considered part of the pleadings if they are
referred to in the plaintiff's complaint and are central to her
claim.’” Weiner v. Klais & Co., 108 F.3d 86, 89 (6th Cir.
1997) (quoting Venture Assocs. Corp. v. Zenith Data Sys.
Corp., 987 F.2d 429, 431 (7th Cir.1993)).
Amini v. Oberlin College, 259 F.3d 493, 503 (6th Cir. 2001). 	Hahn Loeser posits that the
engagement letter is referenced in the amended complaint, but the court disagrees. 	A review of
Plaintiffs’ amended complaint reveals no direct reference to the prepetition engagement letter.
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Although the complaint contains statements regarding the engagement, employment and hiring of
Defendants (Am. Compl. ¶¶ 9, 40, 46, Adv. Case ECF No. 6), the court finds these references are
non-specific and not sufficient to provide a basis for the court’s consideration of the letter as part
of the pleading. 	Consequently, the court hereby excludes that exhibit from consideration,
electing to proceed strictly under Rule 12(b)(6) and not convert the motions to dismiss into
motions for summary judgment. 	The court, however, will take judicial notice of the record in this
adversary and the main case under the above authority.
II. 	Decision
A. Plaintiffs lack Standing
Creditor Trustee, joined by Defendants, and Plaintiffs challenge one another’s standing to
pursue the claims asserted in the amended complaint. 	Plaintiffs claim that the Creditor Trustee
does not have standing to seek dismissal of the complaint on two grounds. 	First, he declined to
pursue the claims and should not be permitted to thwart their efforts to do so. 	Second, it is outside
the scope of his duties as the Creditor Trustee to attempt to dismiss a claim that could benefit the
estate. 	The Creditor Trustee, in turn, contends that Plaintiffs do not have standing because the
claims belong to the estate. 	Additionally, he argues that Plaintiffs did not suffer a particularized
injury because the Debtors held the attorney-client relationship, not Plaintiffs.
The Supreme Court frames standing as “whether the plaintiff has ‘alleged such a personal
stake in the outcome of the controversy’ as to warrant his invocation of federal-court jurisdiction
and to justify exercise of the court's remedial powers on his behalf.” 	Warth v. Seldin, 422 U.S.
490, 498-99 (1975) (footnote omitted) (citing Baker v. Carr, 369 U.S. 186, 204, 82 S.Ct. 691, 703,
7 L.Ed.2d 663 (1962)). 	The foundations of standing are “proof of actual injury, causation and
redressability.” 	NicSand, Inc. v. 3M Co., 507 F.3d 442, 449 (6th Cir. 2007) (citing Lujan v.
Defenders of Wildlife, 504 U.S. 555, 560-61 (1992)).
In the bankruptcy context, the first component for standing, the nature of the injury, is
important because it often also serves to separate estate claims from non-estate claims. 	See
Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d 838 (6th Cir. 2002). 	When the harm is
specific to debtor, it is an estate claim that belongs to a trustee, who ‘stands in the shoes of the
bankrupt corporation and has standing to bring any suit that the bankrupt corporation could have
instituted had it not petitioned for bankruptcy.’ 	Ahcom, Ltd. v. Smeding, 623 F.3d 1248, 1250
(9th Cir. 2010) (quoting Smith v. Arthur Andersen LLP, 421 F.3d 989, 1002 (9th Cir. 2005) (
citation omitted)). 	‘Conversely, if the cause of action does not explicitly or implicitly allege harm
to the debtor, then the cause of action could not have been asserted by the debtor as of the
commencement of the case, and thus is not property of the estate.’ 	Cannon, 277 F.3d 838, 854
(citing Honigman v. Comerica Bank (In re Van Dresser Corp.), 128 F.3d 945, 947 (6th Cir. 1997)
(quoting Schertz-Cibolo-Universal City Indep. Sch. Dist. v. Wright (In re Educators Grp. Health
Trust), 25 F.3d 1281, 1284 (5th Cir. 1994))). 	Plaintiffs do not have authority to pursue estate
claims, so to maintain this action, they must establish the claims do not belong to the estate.
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Here, no one disputes that the claims originally belonged to Debtors and that the claims
became property of the bankruptcy estate upon filing under 11 U.S.C. § 541. 	Nor do the parties
challenge the Creditor Trustee’s right to pursue the claims on behalf of the estate. 	The question is
whether any of the claims are not property of the estate and therefore claims that can be pursued by
Plaintiffs.
Generally, a shareholder does not have the ability to maintain an independent action under
the “shareholder standing rule,” the ‘longstanding equitable restriction that generally prohibits
shareholders from initiating actions to enforce the rights of the corporation unless the
corporation’s management has refused to pursue the same action . . . .” 	Harker v. Troutman (In re
Troutman Enter., Inc.), 286 F.3d 359 (6 th Cir. 2002) (citing Franchise Tax Bd. of Calif. v. Alcan
Aluminum Ltd., 493 U.S. 331, 336 (1990) (other citations omitted)). 	An exception exists when
‘the complaining shareholder is injured in a way that is separate and distinct from [the] injury to
the corporation.’ 	B. & V. Distrib. Co., Inc. v. Dottore Co., LLC, 278 Fed.Appx. 480, 485-86
(quoting Crosby v. Beam, 47 Ohio St.3d 105 (1989) (other citations omitted)); see also Goldin v.
Primavera Familienstiftung, Tag Assoc., Ltd. (In re Granite Partners, LP), 194 B.R. 318 (Bankr.
S.D.N.Y. 1996). 	This specific harm to a shareholder creates a basis for an independent cause of
action by the shareholder. 	Here, Plaintiffs have failed to identify a distinguishing injury or harm
that is particular to them. Instead, the sum of their allegations points to an undervalued liquidation
of Debtors’ assets as the overriding injury, which harmed the corporation and merely flowed
through to the shareholders and creditors. 	The harm was not specific to Plaintiffs. 	The failure
to demonstrate a particularized injury creates a prudential limitation on a court’s exercise of
jurisdiction. 	Cannon, 277 F.3d 838, 853 (citing Valley Forge Christian Coll. v. Americans United
for Separation of Church & State, Inc., 454 U.S. 464, 474-75 (1982)).
Plaintiffs contend that since the Creditor Trustee waived pursuit of the claims, the door is
now open for them to take up the claims. 	Plaintiffs offer no support for their position. 	Once a
cause of action vests in a trustee, the debtor loses standing to pursue the action. 	Waldschmidt v.
Commerce Union Bank (In re Bauer), 859 F.2d 438 (6th Cir. 1988) (citing Spence v. Pontack (In re
Torvik), 83 B.R. 450, 456 (Bankr. W.D. Mich. 1988)); see also Bezanson v. Thomas (In re R & R
Assoc. of Hampton), 402 F.3d 257 (1st Cir. 2005). 	In order for the cause of action to re-vest in
another party, a trustee must abandon the claim. 	Mgmt. Investors v. United Mine Workers of
Am., 610 F.2d 384 (6th Cir. 1979). 	Plaintiffs have not sought, nor has the court directed,
abandonment. 	See Seinfeld v. Allen, 169 Fed.Appx. 47 (2nd Cir. 2006) (unreported); In re West
Pointe Prop., L.P., 249 B.R. 273 (Bankr. E.D. Tenn. 2000). 	As a result, pursuit of estate claims
rests with the Creditor Trustee, not Plaintiffs.
Further, Plaintiffs did not seek authority to maintain derivative claims on behalf of the
corporation. 	The District Court for the Northern District of Ohio recognized that derivative
actions like the one maintained by Plaintiffs are rare because the action does not belong to
Plaintiffs. 	Maloof v. BT Commercial Corp., 2008 WL 650325 (N.D. Ohio 2008) (unpublished).
Relying on Federal Rule of Bankruptcy Procedure 7023.1 and quoting Collier’s on Bankruptcy,
the court stated:
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[A]ny right of action or claim that the corporation has at
the time the case is commenced will become part of the
debtor’s estate. 	The trustee or debtor in possession will
normally be the sole person entitled to enforce that claim.
Shareholders of the corporation would not be able to
institute a derivative action without prior authorization
from the court, which authorization would not be forth-
coming unless there were a clear showing that a request
had been made to the trustee or debtor in possession and
that the trustee or debtor in possession had unjustifiably
refused to seek to enforce the claim or had abandoned it.
Id. at * 2 (emphasis original) (citing 10 Collier on Bankruptcy ¶ 7023.1.03 (15 th ed. rev. 2007)
(footnotes omitted)). 	Since these claims do not belong to them, Plaintiffs need permission to
pursue the claims. 	See Kemper v. Am. Broad. Co., Inc., 365 F.Supp. 1272, 1274 (S.D. Ohio
1973) (stating “[w]here a receiver or trustee has been appointed, as here, the trustee is an
indispensable party to a shareholder’s derivative suit, and the shareholder must therefore make
demand on the receiver or trustee and also obtain the consent and authorization of the bankruptcy
or receivership court to bring suit.”) (citing Fields v. Fid. Gen. Ins. Co., 454 F.2d 682 (7th Cir.
1971); Bayliss v. Rood, 424 F.2d 142 (4th Cir. 1970); Stutts v. Waldrop, 377 F.2d 275 (5th Cir.
1967) (other citations omitted)). 	Permission was neither requested nor granted.
The amended complaint contains one paragraph addressing Plaintiffs’ authority to pursue
claims: 	“[n]o action was made by or on behalf of the Plaintiffs in an attempt to obtain the action
desired from the directors or shareholders prior to bringing this action, as it would be futile where
the company is defunct and the only other shareholder, Mary Lynn Schwab, is currently being sued
by the Plaintiffs in a different matter.” 	(Am. Compl. ¶ 36, Adv. Case ECF No. 6) 	This allegation
is typical of the lack of understanding that permeates Plaintiffs’ complaint and arguments: 	they
do not appreciate or comprehend the line between where their personal interest ends and the
interest of the Debtors, and now the Creditor Trustee, begins. 	As shareholders of the closely held
Debtors, they demonstrate little awareness of the concept of Debtors as separate legal entities.
Plaintiffs’ allegation proves they do not realize that claims belong to the estate and that the
Creditor Trustee controls the claims. 	Their failure to make a demand on the Creditor Trustee
before instituting this action was imprudent. 	Plaintiffs do not have standing to pursue the
derivative claims.
III. 	Plaintiffs’ Claims are Barred by Res Judicata
Relying on previous orders approving fee applications filed by Defendants, Creditor
Trustee and Defendants argue that the court does not have subject matter jurisdiction over the
claims because they are barred by res judicata. 	They request dismissal of the complaint under
Rule 12(b)(1). 	Plaintiffs disagree, maintaining that res judicata cannot bar the current claims
because they didn’t know of the alleged malpractice and therefore could not have raised their
claims at the time of the fee application.
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Four elements must be established in order for the malpractice claim to be precluded by the
order awarding compensation: 	‘(1) a final decision on the merits by a court of competent
jurisdiction; (2) a subsequent action between the same parties or their “privies”; (3) an issue in the
subsequent action which was litigated or which should have been litigated in the prior action; and
(4) an identity of the causes of action.’ Browning, 283 F.3d at 771-72 (quoting Bittinger v.
Tecumseh Prods. Co., 123 F.3d 877, 880 (6th Cir.1997)). 	Plaintiffs do not challenge the elements
of res judicata. 	Instead, they argue that “even when all of the elements of res judicata are
satisfied, a malpractice claim remains viable unless a party could and should have brought the
causes of action in a former proceeding.” 	(Plaintiffs’ Responses to Motions to Dismiss, p. 5, Adv.
Case ECF Nos. 17 and 39) (relying on Penthouse Media Grp., Inc. v. Pachulski Stang Ziehl &
Jones LLP, 406 B.R. 453 (S.D.N.Y. 2009)). 	According to Plaintiffs, they only learned of the
potential malpractice claim upon consulting current counsel and therefore could not have brought
their claims at the time of either the first interim or second/final fee applications. 	Plaintiffs’
actual knowledge of their right to pursue a malpractice claim does not drive the determination.
Capitol Hill Grp. v. Pillsbury, Winthrop, Shaw, Pittman, LLC, 569 F.3d 485 (C.A. D.C. 2009).
“Rather than considering whether [Plaintiffs] knew of the precise legal contours of their
malpractice claim at the time of the fee application, we must instead determine whether they knew
of the factual basis of that claim.” 	Iannochino v. Rodolakis (In re Iannochino), 242 F.3d 36,
49-50 (1st Cir. 2001).
Three different events purportedly underlie Plaintiffs’ malpractice claims. 	First, they
contend that they were unaware, until after the bankruptcy case was filed, that there was a conflict
with a creditor. 	(Am. Compl. ¶ 16, Adv. Case ECF No. 6) 	The court rejects this argument
outright. 	The Corporate Resolution signed by Plaintiffs, J.A. Schwab, Donna L. Schwab, and
David A. Schwab prior to the bankruptcy filing contains a resolution authorizing the employment
of Brouse McDowell as conflicts counsel. 	(Corp. Resolution, p. 2, Main Case ECF No. 2) 	The
conflict is disclosed in both the application to employ Hahn Loeser and the application to employ
Brouse. 	Debtors’ Vice President of Administration also acknowledged conflicts in an affidavit
filed in support of the petitions and first day motions, executed on February 28, 2010. 	Plaintiffs’
argument that they were not informed of the conflict is not plausible.
Alternatively, Plaintiffs argue that they were not informed that liquidation was a possible
outcome of the bankruptcy filing. 	(Am. Compl. ¶ 32, Adv. Case. ECF No. 6) 	Additionally, they
contend that Defendants failed to adequately represent their interests in this bankruptcy
proceeding. 	According to Plaintiffs, three days before the sale of Debtors’ assets, they received
good news from a Florida court which positively affected the value of their assets and that
Defendants failed to do everything possible to have this new information considered by creditors
or the court. 	(Am. Compl. ¶¶ 23-32, Adv. Case ECF No. 6) 	Even accepting these allegations at
face value, Plaintiffs’ arguments suffer a timing problem.
Defendants’ second and final fee application was filed in January 2011 and served to
Debtors, at the Dover headquarters, on January 14, 2011. 	All of the actions cited by Plaintiffs as
grounds for malpractice occurred either before or at the time of the sale of Debtors’ assets,
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approved by the court on May 28, 2010.3 “Debtors’ homegrown enterprise was sold off, piece by
piece leaving nothing but completely defunct corporations” (Am. Compl. ¶ 31, Adv. Case ECF
No. 6) months before the final fee application. 	In spite of their dissatisfaction, Plaintiffs did not
lodge an objection with the court.4 Plaintiffs knew, at the time of the final fee application, of the
alleged facts underlying a potential malpractice claim. 	See Grausz v. Englander, 321 F.3d 467
(4th Cir. 2003).
Plaintiffs’ reliance on the Penthouse case is misplaced because the facts make it easily
distinguishable. 	In Penthouse, the debtors filed bankruptcy in September 2003 and confirmed a
plan in August 2004. 	The plan required the debtors to serve notice of a rejection claims bar date
to employees to protect the debtors from payment of severance packages under prepetition
employment contracts. 	Counsel for debtors failed to timely send the notice. 	The debtors’
counsel final fee application was approved on November 30, 2004, approximately one month after
a severed employee first demanded $320,000. 	The appellate court found “no evidence that [the
debtors] made a ‘link’ between [the employee’s] demand for severance and a potential malpractice
claim . . . until six months after the fee hearing, when [the employee] first raised the issue of
notice.” 	Penthouse, 406 B.R. at 463. 	The court pointed out that counsel had affirmatively
represented to the debtors that the notice had been properly served. 	The import of these findings
was that the debtors did not have constructive knowledge of the malpractice claim at the time of
the final fee application. 	The court cannot reach the same conclusion in this case.
Not only is the court convinced that Plaintiffs reasonably should have known of their
potential claims by the time the final fee application was filed, but is equally convinced, based on
Plaintiffs’ allegations, that Plaintiffs reasonably should have known of the alleged claims earlier in
the case. 	By their own statements in the first day motions, Debtors filed because they were
experiencing a liquidity “crisis.” 	(M. Jt. Admin. ¶ 26, Main Case ECF No. 6) 	They filed
intending to secure post-petition financing in order to continue operations. 	(Corporate
Resolution, pp. 3-4, Main Case ECF No. 2) 	However, Debtors’ request for post-petition
financing was denied on March 22, 2010, largely based on the court’s valuation of Debtors’
Florida citrus grove/limestone quarry. 	At this point, Debtors did not have funding to continue
operations because any cash served as collateral, (Agreed Order Authorizing Limited Use of Cash
Collateral ¶ K, Main Case ECF No. 202), and use of the cash collateral was contested. 	Paragraph
nineteen of the amended complaint recognizes the situation: 	“[a]s the bankruptcy case
proceeded, the financial situation of the Debtors began to deteriorate as the creditors denied
opportunities to reconcile debt and denied possible financing options.” 	The final order authorized
use of cash collateral only through June 21, 2010. 	(Final Agreed Order Authorizing Limited Use
of Cash Collateral, Main Case ECF No. 280) 	Consequently, Debtors’ options were extremely
limited and a motion for sale of Debtors’ assets via an auction was filed on April 5, 2010. 	That
document was served to Debtors at their Dover headquarters. 	(Cert. of Service, Main Case ECF
No. 250) 	On or about May 2, 2010, Plaintiff David Schwab, as president of the individual
debtors, signed the asset purchase agreement with the stalking horse bidder. 	(Notice of
3 The court does recognize that the first fee application was filed very shortly after the court approved the sale of
Debtors’ assets.
4 Defendants contend that Plaintiff David Schwab approved the fees but failed to substantiate this statement.
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Designation of Stalking Horse Bidder, Main Case ECF No. 346-1) 	Clearly, one of the Plaintiffs
not only had knowledge of the impending liquidation, but was working in tandem with counsel
toward liquidation. 	Plaintiffs also were actively involved in the auction process. 	There is a
disconnect between the facts and Plaintiffs’ arguments. 	Plaintiffs clearly should have known of
any potential malpractice issues they had against Defendants when the fee applications were filed.
Any dissatisfaction with Defendants’ services should have been litigated during the fee application
process. 	Plaintiffs’ current attempts to raise malpractice claims is an impermissible attack on the
final orders approving the fee applications and therefore is barred under the doctrine of res
judicata.
CONCLUSION
Malpractice claims against a debtor’s bankruptcy counsel are causes of action that “arise
in” a bankruptcy case and the bankruptcy court is therefore granted authority to enter final orders
and judgments on those claims. 	The claims are property of the estate and therefore must be
pursued by and on behalf of the estate. 	In this case, that torch has been passed to the Creditor
Trustee. 	As shareholders of Debtors, Plaintiffs did not identify any particularized injury to
separate their claims from the corporate claims now part of the estate. 	Further, Plaintiffs did not
request or obtain authority to maintain any action. 	The amended complaint will be dismissed
based on Plaintiffs’ lack of standing.
Even if Plaintiffs had standing, the court finds that the claims presented are barred by res
judicata. 	Plaintiffs’ argument that they were not aware of the claims in time to contest the fee
applications is not well-taken. 	Looking at the facts in the light most favorable to Plaintiffs, and
accepting each as true, Plaintiffs had, or should have had, constructive knowledge of the claims in
time to contest the fee applications. 	Their failure to do so bars the claims now.
The court grants Creditor Trustee’s and Defendants’ motions to dismiss. 	An order will be
entered immediately.
# 	# 	#
Service List:
Jon D. Parrish
Parrish Lawhon & Yarnell
3431 Pine Ridge Road
Suite 101
Naples, FL 34109
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Carrie M Brosius
John Winship Read
Vorys Sater Seymour&Pease LLP
2100 Cleveland Center
1375 E Ninth St
Cleveland, OH 44114-1724
Thomas R. Fawkes
Freeborn & Peters LLP
311 S. Wacker Drive
Suite 3000
Chicago, IL 60606
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