FOR THE NORTHERN DISTRICT OF CALIFORNIA
DANIEL and BARBARA DIERINGER, No. 1-83-01017
KLAUS SCHEFTNER and ROLF
v. A.P. No. 91-1154
B. SCOTT FOSTER, et al.,
Memorandum of Decision
The debtors filed a Chapter 11 petition in 1983, with defendant B. Scott Foster acting as
their attorney. Plaintiffs Klaus Scheftner and Rolf Rheinschmidt were the principal creditors
of the debtors.
The debtor's Chapter 11 plan was confirmed in 1986. It provided, in pertinent part, that
Foster was to be the disbursing agent for the payments to be made under the plan. It also
Prior to the expiration of the Plan, the Debtors
will, with the approval of Court, secure a loan to
pay off the balance of the claims of the Class C
creditors [unsecured creditors, including plaintiffs],
or will, with approval of Court, liquidate Debtors'
stock in the Four Forty Club, Inc., and pay off
such unpaid balance. B. Scott Foster, Debtor's
attorney, will hold said stock in trust until all
claims have been truly paid.
In January, 1991, citing inability to perform under their plan, the debtors converted the case
to Chapter 7. In July, 1991, plaintiffs commenced this action in state court against Foster and
the law firm with which he was associated. Defendants removed the action to bankruptcy court.
The court, having determined that the basis for the suit is Foster's liability under the plan, has
accepted jurisdiction over the action and now proceeds to rule on defendants' motions for
For purposes of this motion only, the court accepts the facts as alleged by plaintiffs. They
are that they first opposed the plan, but agreed to go along with it on Foster's representations
that the stock was unencumbered and had a value sufficient to pay all claims in full. After the
plan was confirmed, Foster continued to assure the plaintiffs that the stock made it certain that
they would eventually be paid. Meanwhile, Foster allowed the debtors to make withdrawals
from the business operated by the corporation and allowed them to incur tax liabilities so that
when the case was finally converted the stock was essentially worthless.
Based on the above facts, plaintiffs have made the following claims:
1. The plan created an express trust for their benefit with Foster as trustee. He breached his
fiduciary duty to them by failing to check the debtors and by failing to disclose to plaintiffs
what was happening.
2. Foster breached a contract by failing to check the debtors.
3. Foster is liable to them for negligently failing to check the debtors.
The flaw in plaintiffs' theories of liability is apparent in paragraph 18 of their complaint:
18. FOSTER further breached his fiduciary duties of
said trust by placing his loyalty to his clients, the
Debtors, above and before his duty and loyalty to
Plaintiffs, who are the beneficiaries of said trust
and by otherwise failing to provide for or correct
such conflict in interest in acting as trustee.
In fact, as attorney for the debtors, who were debtors in possession, Foster had only one
fiduciary duty and that was to the bankruptcy estate. The language in the plan did indeed make
Foster a trustee, but the sole beneficiary of the trust was the estate, and not the debtors
personally or the plaintiffs. Thus, there was no conflict of interest and the breach of trust
claims must fall because plaintiffs were not the beneficiaries.
Because Foster had no fiduciary duty to plaintiffs, it is not necessary to determine if Foster
breached a fiduciary duty. However, the court notes that the plan only required him to hold the
stock, not take action to preserve its value. Had the plan named an escrow company instead of
Foster to hold the stock, the escrow company would have taken no action beyond placing the
stock in its safe. There is no basis, under the terms of the plan, for the allegation that Foster's
duties as trustee included supervision of the business operated by the corporation.
Breach of Contract
The complaint alleges that the plan constituted a written contract, which Foster breached by
failing to check the debtors. This claim fails because the plan was not a contract between
Foster and plaintiffs and because no provision of the plan requires Foster to monitor or police
The complaint raises two issues regarding negligence. The first is whether a debtor's
attorney in a Chapter 11 case is liable for damages if he allows the debtor to dissipate estate
assets. The second is whether such an action can be brought by an individual creditor. Because
the court resolves the first issue in the negative, it need not resolve the second.
The parties have cited no case dealing with the liability of a debtor's attorney for acts taken
by the debtor during a bankruptcy proceeding, nor has the court found any such authority.
After considering the issue, the court can see little benefit and much detriment resulting from
making the debtor's counsel liable for the noncriminal and nontortious acts of the debtor, and
accordingly declines to find such liability.
It is not unusual for debtors in Chapter 11 cases to dissipate the assets of an estate, so that
a case which would have yielded a dividend to creditors if initially filed as a liquidation case
ends up a no-asset case after a futile attempt to reorganize. The estate often suffers from loss
of assets, creation of postpetition debts with priority over prepetition creditors, or both.
Nonetheless, it is the express will of Congress that reorganization be encouraged. In the
Bankruptcy Code, this intent is reflected in section 706(a), which gives the debtor the
unconditional right to convert a liquidation case to a reorganization case.
The court sees no justification for making the debtor's counsel a policeman of the debtor's
postpetition conduct. Under the Code, that role is left to the creditors' committee, individual
creditors, or the U.S. Trustee. So long as the attorney is not actively involved in illegal
conduct, his or her zealous efforts on behalf of the debtor should not be chilled by the threat of
suit from creditors if the reorganization fails. While excessive draws and failure to pay
postpetition taxes are grounds for conversion of the case or appointment of a trustee, they are
not the sort of illegal conduct for which an attorney who represents the debtor ought to be
Moreover, the court has adequate means for sanctioning a debtor's counsel who fails to act
diligently to protect the estate from dissipation by virtue of its complete control over the
attorney's compensation pursuant to section 329 of the Code. This control is adequate to insure
that attorneys do not knowingly assist debtors in abusing the bankruptcy laws; personal tort
liability is not necessary.
The court has found no bankruptcy cases dealing with the liability of debtor's counsel to
individual creditors. The closest bankruptcy case is Matter of Stockert Flying Service, Inc.
B.R. 704 (N.D.Ind.1987) in which the district court, sitting as an appellate court, held only that
such as suit was properly heard by the bankruptcy court. The court noted that a cause of action
by a creditor against a debtor's bankruptcy attorney was not a "traditionally recognized claim."
The court has found two state court cases dealing with issues similar to those now before
the court. In Associated Factors
v. O'Neil Detective Agency
, 537 N.Y.S.2d 212 (1989), a
factoring company sued an attorney for representing that certain accounts due to his client were
collectible. Summary judgment for the attorney was affirmed, the court holding that an attorney
is not liable to a third party creditor for negligence and that the creditor had produced no
evidence of actual fraud. In Callahan
, 514 N.Y.S.2d 819 (1987), a wife sued her
husband's lawyer for misrepresenting the value of marital property to her. The appellate court
held that the attorney could be liable to her for fraud. In California, the law is likewise that an
attorney is not liable to third parties for negligence but could be liable for fraud. Skarbrevki
v. Cohen, England & Whitfield
, 231 Cal.App.3d 692 (1991).
The court sees no reason why the above principles should not apply to liability of a debtor's
attorney to creditors in a bankruptcy case. Accordingly, the court holds that a debtor's attorney
is not liable to creditors for mishandling a bankruptcy except to the extent that his conduct was
fraudulent or otherwise intentionally wrongful.
Plaintiffs are not the beneficiaries of the trust created by the plan. Even if they were,
Foster's responsibilities under the trust were only to hold the stock, not assure that its value did
The plan did not constitute a contract between Foster and plaintiffs. Foster, as debtor's
counsel, had no responsibility to police the debtor's conduct and is not liable to anyone, let
alone an individual creditor, for the debtor's dissipation of their estate.
Interestingly, plaintiffs have not pleaded the only valid claim they may have against Foster.
An attorney who makes affirmative misrepresentations on behalf of his client, knowing that
they are false or having no reasonable basis for making the representations, may be liable for
fraud. If, as alleged, Foster continued to represent to plaintiffs that the stock was worth enough
to satisfy their claims while the debtors continued to take actions which rendered the stock
worthless, Foster may be liable to plaintiffs for any damages they suffered by forbearing.
for the foregoing reasons, defendants' motion to dismiss will be granted. Provided,
however, that plaintiffs shall have 20 days to file an amended complaint based solely on any
alleged fraud of Foster.
Counsel for defendants shall submit an appropriate from of order.
Dated: September 30, 1991 _______________________