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Ruined, Missing Wine leads to Million Dollar Hangover for Debtor

Old wine bottles in a wooden crate.

A Chapter 7 debtor’s failure to comply with a bankruptcy court order to preserve a $2 million dollar-plus collection of fine wines has led to the imposition of sanctions of over $1 million, most of which could be charged against the debtor’s otherwise exempt property.

The wine in question, after three years of litigation, was determined to be part of the bankruptcy estate of Jeffrey Prosser.  Prosser used to own companies that provided telephone, internet and cable television service to the U.S. Virgin Islands.  Both he and his companies filed bankruptcy in 2006.  A recent, 66-page opinion from the U.S. District Court in the Virgin Islands sets forth this saga of the wine collection in great detail; if you are taken to oenophilia, be ready to despair.  See In re Jeffery L. Prosser, Bankruptcy Case 2006-3009, Civil Action 3:2013-0087 (February 23, 2017, Doc. No. 58).

In its opinion, the district court largely upheld orders by the U.S. Bankruptcy Court of the Virgin Islands holding both Prosser and his wife, Dawn, in contempt for allowing the dissipation and destruction of the wine collection, but reversed an order of the bankruptcy court that would have empowered the trustee to sell real property held by the Prossers to satisfy a $528,086 monetary sanction that would reimburse the trustee for his expenses in prosecuting the contempt action.  The property in question, held by the Prossers as tenants by the entireties (the “TBE Property”), had previously been adjudicated as exempt under 11 U.S.C. § 522(b)(3)(B).

The district court held that a sanction intended to reimburse the estate for attorney’s fees and expenses constituted an administrative expense and was barred by 11 U.S.C. § 522(k).  However, the district court refrained from ruling on whether exempt property could be ordered sold to satisfy a separate contempt sanction in the amount of $419,136, which was the lost value of the wine collection.  Further briefing was ordered.

Background

The Prossers’ wine collection was initially appraised at $2.1 – $2.3 million; Dawn Prosser claimed that that she owned at least a 50-percent interest in the wine.  In December 2008, the bankruptcy court approved a stipulation under which one-half of the wine collection would be turned over to the trustee for sale and the other half retained in Dawn Prosser’s possession until her interest in the wine was adjudicated.

The bulk of the wine was stored (climate controlled, of course, or so everyone thought!) the Prossers’s homes Florida and the U.S. Virgin Islands. The wine had been inventoried in January 2008.  Since December 2007, the Prossers (along with their children) had been subject to a preliminary injunction that required them to “safeguard certain property that the trustee contended was part of the bankruptcy estate in secure locations and to protect the property from destruction, damage, theft, removal or transfer pending its turnover to the trustees.”  The Prossers were further forbidden to “spend, consume, damage, dispose of, sequester, abscond with, secrete or transfer the property” without written consent of the trustees.  The stipulation that allowed Dawn Prosser to retain possession of half the wine collection specifically stated that the preliminary injunction continued in force.

In February 2011, three years since the wine was inventoried, the bankruptcy court determined Dawn Prosser had no interest in the wine and so her half of the collection was to be turned over to the Chapter 7 trustee.  One month later, the wine stored in Palm Beach was inspected, and four months after that, the wine at the Virgin Islands residence was inspected.  What was found was not good; if any of you have ever taken a vacation with the kids left in charge of the house, and then checked the liquor cabinet upon your return, then you know what is coming next.

At the Palm Beach residence, only 459 of the 939 bottles inventoried in 2008 were still in storage. At the U.S. Virgin Islands residence, only 527 bottles remained of the original 980.  Furthermore, at the U.S. Virgin Islands residence, the air conditioners were no longer operating and the room had been given over to storage of “miscellaneous household junk.”  Mold and insect damage was noted.  Most of the labels were damaged and of six bottles sampled, none remained in a condition suitable for sale (although we at The Bankruptcy Cave will drink anything, so we are trying to obtain a bottle).  The expert who inspected the wine opined that “the entire collection has been destroyed by careless or willfully negligent storage.” The wine stored at the U.S. Virgin Islands residence was eventually sold “as is, where is” for just $15,739. Total loss of value to the wine collection was $419,136.

In August 2011, the trustee filed a “Motion to Enforce Turnover Order, for Contempt and for Sanctions” against both Jeffrey and Dawn Prosser. The motion sought, among other things, a finding of contempt, sanctions in the form of all legal fees and expenses associated with the trustee’s investigation and liquidation of the wine, and an order permitting the trustee to collect the value of the missing and damaged wine.  In a series of orders in 2013, the bankruptcy court ordered the Prossers to pay the estate $528,086 to reimburse it for legal fees and costs associated with obtaining turnover of the wine collection and the related contempt proceedings (“Fee Sanction”) and $419,136 for the diminished value of the wine (“Loss of Value Sanction”).

When the Prossers failed to pay, the bankruptcy court once against found them in contempt and entered an order requiring the Prossers to pay the Fee Sanction by way of 60 monthly payments of $8,801. If they failed to make the required payments, the Prossers were further ordered to convey title to the TBE Property to the trustee.  The Prossers never made a single monthly payment and then refused to convey the TBE Property to the trustee.

Upon the trustee’s motion, the bankruptcy court next entered an order pursuant to Rule 70 of the Federal Rules of Civil Procedure (the “Rule 70 Order”) directing the trustee to execute quit claim deeds and any other documents required to transfer the TBE Property to the bankruptcy estate. The property, which had been valued at approximately $2.2 million, was to be sold and the proceeds first applied to the Fee Sanction, with any surplus then applied to the Loss of Value Sanction.

The Prossers appealed everything. The district court upheld the decisions of the bankruptcy court, except for the Rule 70 Order, which was partially reversed, with further briefing ordered on a single issue.  Among the district court’s holdings:

  • The Prossers’ argument that the bankruptcy court lacked subject matter jurisdiction to impose the injunction was untimely and should have been filed when the order commanding turnover of the wine (and making the preliminary injunction permanent) was entered in 2011.  Consequently, subject matter jurisdiction had been established as the law of the case.
  • The bankruptcy court did not err as a matter of law nor abuse its discretion in finding the Prossers in civil contempt for violating the injunction regarding the preservation of assets.
  • That the imposition of sanctions against the Prossers was not barred due to the trustee’s failure to insure the wine (which the Prossers had maintained was not property of the estate).
  • The bankruptcy court’s rejection of a Daubert challenge to the trustee’s wine expert was affirmed. The expert, Mary Ewing-Mulligan, is the author of “Wine for Dummies.” The district court also noted that one argument made by the Prossers, that the expert was not qualified because she had not previously been qualified to provide expert testimony, if accepted would create a world without experts, as every expert witness has to have a first time.
  • The bankruptcy court did not err in denying the Prossers’s motion that the ruined wine be abandoned as an asset of the estate, noting that it would set an unfortunate precedent if a debtor was allowed to destroy a valuable estate asset in violation of a court order and then seek to compel the trustee to abandon the ruined asset.
  • That the as-is, where-is auction of the damaged wine was not commercially unreasonable, an argument the Prossers supported in part by claiming the trustee’s prosecution of the contempt proceeding created bad publicity that disparaged the wines throughout the Virgin Islands.

In all, the district court rejected 12 of 13 arguments made by the Prossers.  However, by reversing (at least in part) the bankruptcy court’s Rule 70 Order, the district court has so far preserved the exemption of the TBE Property.  The district court rejected two arguments for affirming the Rule 70 Order made by the trustee.

First, the trustee took the position that the TBE Property was no longer exempt property because by obtaining sanctions against the Prossers, he had become a creditor of both the husband and wife. Under Virgin Island law, property held as tenants by the entireties is not exempt from process as to creditors of both spouses. The district court held that the bankruptcy estate was created upon the filing of the case and, at that time, the TBE Property was exempt and remained so despite the Prossers having incurred a joint, post-petition debt to the estate.

Having determined that the TBE Property remained exempt, the district court next considered whether the bankruptcy court’s sanction authority under 11 U.S.C. § 105(a) allowed, after a finding of contempt, exempt property to be sold to reimburse the trustee for administrative expenses incurred in the contempt litigation and reimburse the bankruptcy estate for the lost value of the wine.

At least with regard to the administrative expenses that were to be reimbursed under the Fee Order, the district court held that the bankruptcy court lacked authority to order the sale of the TBE Property, relying on a 2014 U.S. Supreme Court decision in Law v. Siegal, 134 S. Ct. 1188 1188.  In Law, the Supreme Court reversed a decision that allowed a trustee to surcharge a debtor’s homestead exemption to recover fees and expenses incurred in overcoming a lien the debtor had fraudulently created in an effort to preserve equity in his home beyond the statutory exemption.

The Supreme Court held that the powers created under 11 U.S.C. § 105(a) did not include the power to override an explicit mandate in another section of the Bankruptcy Code. The Supreme Court held that the prohibition contained in 11 U.S.C. § 522(k), which provides that exempt property “is not liable for payment of any administrative expense,” precluded the surcharge. The district court held the Law case to be applicable here; the Fee Sanction constituted an administrative expense and therefore exceeded the authority provided under 11 U.S.C. § 105(a).

Finally, the district court stated that the effect of Law upon the Loss of Value Sanction, which called for the Prossers to reimburse the estate for losses caused by their contemptuous actions, was less clear.  Noting that Law was issued after briefing on the Prosser appeal had been concluded and that neither party subsequently brought the case to the district court’s attention, the parties were ordered to provide additional briefing on the issue.  Pursuant to a schedule established by the district court, the additional briefing should be concluded by April 6, 2017.

Certainly, this is a sad tale, a complete loss of value and waste of money, and the Prossers come out of this tale with red grape stains running down their formal wear.  By the same token, we are surprised that the trustee did not insure the wine collections, or follow up on their storage.  The case is a helpful reminder to all of the need to really pay attention to collateral or other assets that are so easily moved, spoiled, or drank and celebrated.

 

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Being Sued by the Client You Never Knew You Had

Attorneys with secured lenders for clients may one day find themselves in the following hypothetical scenario: An attorney represents a secured lender in the workout of a loan that is owed by a small distressed borrower. The borrower finds a buyer for its assets (either in a § 363 sale or out-of-court short sale), and the borrower and buyer agree upon the basic terms of the sale transaction. However, the borrower’s counsel does not have the experience, time or resources to draft the sale transaction documents, so the responsibility to “just get it done” falls on the secured lender’s attorney, whose client has the biggest economic stake because it will likely receive most of the sale proceeds.

After the deal closes, it turns out that the borrower is subject to tax claims that could have been avoided if the sale had been done another way, or the borrower is stuck with some pre-closing liabilities that it (mistakenly) thought the buyer was taking, or some other liability that counsel for the borrower should have addressed prior to or at the closing, but that the attorney did not care about or missed. The borrower sues — and the target of the suit is the attorney for the secured lender.
Many of us have been in this situation. The client, the secured lender, is very interested in finding a way to get the deal done. But the borrower’s counsel is slow, perhaps is not being paid, and likely does not have the resources of a larger firm to quickly move the matter along. This article will explore the liability issues raised in the aforementioned hypothetical scenario and provide practical advice for attorneys who find themselves in this or a similar situation.

Over the years, courts have held that a nonclient party may have standing to sue an attorney for malpractice, even though there is no privity of contract. Even absent fraud or collusion, courts have found that a mistake by an attorney, to the detriment of the nonclient party, could result in a viable claim — or at least a claim that will survive a motion to dismiss and likely a motion for summary judgment. Depending on the context, those courts have found that a nonclient party has the standing through the following theories of law: multi-criteria balancing test,1 third-party beneficiary theory,2 secondary implied privity theory, and voluntary or gratuitous agency theory.

All of these claims sound in tort, and as with all torts, in order to establish a claim, the plaintiff must show that the defendant owed a duty of care to the plaintiff.3 Of these theories, the “secondary implied privity” theory and the “voluntary or gratuitous agency” theory are most likely to be used by a borrower to establish a duty of care in the hypothetical scenario. The borrower is likely to raise the “secondary implied privity” theory because the attorney drafted the sale transaction documents for the borrower’s signature, which is something an attorney typically does for his/her own clients. Thus, or so the argument goes, it would be reasonable for the borrower to believe that the attorney represented the borrower’s interests too, creating an implied attorney/client relationship. In addition, the borrower is likely to raise the “voluntary or gratuitous agency” theory because the attorney offered to draft documents for the borrower, and in doing so, the attorney owed a duty of care to protect the borrower’s interest.

We are practitioners who occasionally deal with small, distressed borrowers, and we sometimes have to pick up the drafting pen more than is typical to move a transaction along with dispatch. As such, we think these theories are rubbish. Nonetheless, they exist.

Secondary Implied Privity Theory

Although lawyers are generally comforted by the principle that an attorney/client relationship arises only when there is privity of a contract between a lawyer and client, courts routinely find, as with other contracts, that the contractual relationship between a lawyer and client can be either expressed or implied.4 Such a relationship generally cannot be established absent evidence that the lawyer knew that the nonclient party assumed that the lawyer was representing him/her in a matter.5 In short, an attorney/client relationship may be implied from the conduct of the parties.6 In this situation, the question for the fact-finder is whether the attorney was aware, or should have been aware, that his/her conduct would have led a reasonable person to believe that the attorney was representing that person.7

In Kotzur, a purchaser in a real estate transaction claimed that the lawyer for the seller misled him into thinking that the title was being conveyed clear of all liens.8 The purchaser brought a legal malpractice claim against the lawyer, and the trial court granted summary judgment in favor of the lawyer, holding that the absence of an attorney/client relationship precluded a cause of action. The appellate court reversed, concluding that when (1) the lawyer admitted that he prepared all documents relating to the sale and that the transaction was done on a “family-type basis,” (2) a nonclient party testified that it was his impression that the lawyer was handling the documents for the transaction, and (3) the lawyer never told the nonclient party that he was not representing the nonclient party or to hire a separate lawyer, an issue of fact existed as to the nature of the relationship.

Similarly, in Burnap, lawyers were hired to represent a partnership in connection with the withdrawal of several partners.9 The matter included a mutual release and indemnity in favor of the withdrawing partners by Willard Burnap (who was one of the remaining partners). The lawyers had no direct contact with Burnap, but they did prepare numerous documents for Burnap’s signature. After the withdrawal was completed, Burnap’s indemnity was triggered, and he sued the lawyers for, among other things, professional malpractice. The trial court granted summary judgment for the lawyers, but, as in Kotzur, the appellate court reversed. The appellate court found that a question of fact existed as to whether an implied attorney/client relationship existed because the lawyers prepared numerous documents for Burnap’s signature, Burnap received no notice that the lawyers did not represent Burnap’s personal interests, and Burnap was never informed that his interests might be adverse to the interests of others involved.

In the hypothetical scenario, there is likely a question of fact as to whether the borrower reasonably believed that the attorney represented his interests, since the attorney drafted documents for the borrower’s signature for a sale transaction in which the attorney’s client was only indirectly involved (i.e., involved only to provide a lien release and to receive a check). The attorney also failed to notify the borrower that the attorney did not represent the borrower’s interests, even though he was acting on the borrower’s behalf.

Voluntary or Gratuitous Agency Theory

The doctrine of voluntary agency holds that when a professional (e.g., an attorney) gratuitously offers to perform a task, he/she owes a duty of care in completing that task.10 In brief, even when there is insufficient consideration for a promise to permit an action in contract, a promissor has a duty to fulfill the promise if he/she knows that his/her gratuitous promise has induced reasonable reliance.11 Reasonable reliance is required for this exception to the common law requirements of privity.

For example, in Wright v. Swint,12 the plaintiff purchased a parcel of real estate based on a defective title search performed by the lawyer for the lender. The plaintiff discovered this defect when he attempted to refinance, and when the plaintiff told this to the lawyer who originally closed the transaction, the lawyer gave “assurances” to the plaintiff that the defect was being cured. The trial court granted summary judgment for the attorney, concluding that the lawyer was never the plaintiff’s lawyer. The court of appeals reversed, however, holding that a jury could find that the lawyer owed the plaintiff a duty based on the lawyer’s assurances and purported attempt to fix the defective title.

Similarly, in Simmerson, the court determined that a lawyer who undertakes a task, even without payment, might be responsible for misfeasance, even though the lawyer would not have been liable had the lawyer never undertaken the task.13 Specifically, in Simmerson, after the closing, the lawyer for the seller told the purchaser that he would file all necessary papers evidencing the deal. The lawyer did so — but in the wrong county. Upon discovering the error, the purchaser sued the lawyer. The court of appeals reversed the trial court’s grant of summary judgment for the lawyer, finding that the lawyer was a voluntary agent and, as such, must “use a reasonable degree of care and skill, and … possess to a reasonable extent the knowledge requisite to a proper performance of the duties of his profession.”14

The particular relevance of Simmerson to even larger deals is when counsel for the secured lender undertakes to file UCC-3 termination statements upon confirmation of the receipt of funds from the buyer or new lender paying off the secured lender’s liens. In that instance, Simmerson is on all fours, and if the buyer or new lender is harmed by an untimely or incorrect UCC-3 filing by a secured lender’s lawyer, or the lawyer forgets to file it altogether, then watch out.

Applied to the hypothetical scenario, the borrower’s relationship with the attorney is foreseeable, as the attorney offered to draft, and indeed drafted, the sale transaction documents for the borrower’s benefit. Like the attorney in Wright who voluntarily offered to cure his prior defective title search, the attorney assured the borrower, albeit implicitly, that he would draft all of the necessary documents and would do so in a competent manner. Even though the attorney had no explicit duty to the borrower, having undertaken the task, the attorney was bound to draft the documents with the ordinary and reasonable skill of his profession. If the attorney misses something, then a claim for negligence is likely to follow, and the matter will likely go to trial in light of the cases above in which summary judgment for the defendant/attorney was denied.

How to Avoid Such Nonclient Liability

Because we now know that a court may find an attorney liable to a borrower for negligence under at least two theories, the next question is this: What steps should the attorney have taken to avoid such liability? The ABA Model Rules of Professional Conduct do not specifically address the hypothetical scenario presented in this article. A careful review of the ABA Rules, however, provides guidance to the hypothetical attorney. Comment [4] to ABA Rule 1.3 states that “[d] oubt about whether a client/lawyer relationship still exists should be clarified by the lawyer, preferably in writing, so that the client will not mistakenly suppose [that] the lawyer is looking after the client’s affairs when the lawyer has ceased to do so.” Rule 1.13 (f) (“Organization as Client”) affirmatively requires a lawyer to “explain the identity of the client” when the interests of a client organization are adverse to those of its constituents. Comment 10 to Rule 1.13 (f) (“Clarifying the Lawyer’s Role”) further directs the organization’s lawyer in such a situation to ensure that the constituent understands that “the lawyer for the organization cannot provide legal representation for that constituent individual.”

When in doubt, refer to the ABA Rules. Even though the ABA Rules do not address the exact hypothetical mentioned at the beginning of this article, they do provide guidance for similar situations, and the guidance consistently requires the attorney to clarify who he/she represents, preferably in writing.

This advice is consistent with the warnings from case law. For instance, in Fox, a legal malpractice case brought by an unrepresented party in a real estate transaction, the court noted that “neither appellants nor respondent specifically recall [the] respondent advising them to seek independent counsel, and there is no written notice or advice to such effect.”15 Thereafter, the Court made the following statement:

Attorneys in these circumstances are well advised to place a disclaimer in writing. A simple clause in the agreement stating that it was prepared by the attorney for the opposite party acting solely on behalf of that party’s interest, and advising the other parties to seek independent legal counsel to protect their own interest, might have prevented this action from being filed.

As another example, a North Carolina State Bar Ethics Opinion provides that in real estate transactions, an attorney may, with proper notice to the borrower, represent only the lender, and the lender may prepare the closing documents.16 The Ethics Opinion further explains that as long as the attorney clearly explains to the borrower that he/she represents only the lender and makes that disclosure far enough in advance of the closing so that the borrower can procure his/her own counsel, the attorney has no duty to notify the borrower of potential defects in the title. The Ethics Opinion also strongly suggests that the notice be in writing.

Practical and Easy Steps

If there is any potential ambiguity about whether the lawyer represents specific nonclient parties, the lawyer should send a “non-representation” letter to each of them. Consider using the following language:

This firm is representing [name your client] in [describe nature of the matter]. While you have not requested that we represent you, we want to make it clear that we do not represent you in this matter, and you should not look to us for protection of your interests in the matter. Given [describe client’s role in matter], however, the firm drafted [describe documents]. The [describe documents] were prepared solely in the interest of [name your client]. Our initial draft nor any future input shall create any implication that the firm represents anyone other than [name your client]. We recommend that you obtain other counsel

Such a letter should be sent certified mail with proof of mailing retained; it is the simplest way to avoid potential liability to nonclient parties while still pushing the deal forward for your secured lender client.


  1. See, e.g., Lucas v. Hamm, 364 P.2d 685, 688 (Cal. 1961) (factors include extent to which transaction was intended to affect plaintiff, foreseeability of harm to plaintiff, degree of certainty that plaintiff suffered injury, closeness of connection between defendant’s conduct and injury, policy of preventing future harm and extent to which profession would be unduly burdened by finding of liability).
  2. See, e.g., Flaherty v. Weinberg, 492 A.2d 618, 622 (Md. 1985) (nonclient party must allege and prove that intent of client to benefit nonclient party was direct purpose of transaction or relationship).
  3. See, e.g., Palsgraf v. Long Island R. Co., 162 N.E. 99 (N.Y. 1928) (absent duty owed by defendant to plaintiff, there can be no tort claim) (Cardozo, C.J.); Tarasoff v. Regents of Univ. of Cal., 551 P.2d 334, 343 (Cal. 1976) (“[A] duty of care may arise from ‘… a special relation … between the actor and the other, which gives to the other a right of protection.’”).
  4. See Fox v. Pollack, 226 Cal. Rptr. 532, 534 (Cal. Dist. Ct. App. 1986).
  5. See Burnap v. Linnartz, 914 S.W.2d 142, 148-49 (Tex. Ct. App. 1995).
  6. See Kotzur v. Kelly, 791 S.W.2d 254, 257 (Tex. Ct. App. 1990).
  7. See Burnap, 914 S.W.2d at 148-49.
  8. Kotzur, 791 S.W.2d at 257.
  9. Burnap, 914 S.W.2d at 145-46.
  10. See Simmerson v. Blanks, 254 S.E.2d 716, 718 (Ga. Ct. App. 1979).
  11. Id.
  12. 480 S.E.2d 878 (Ga. Ct. App. 1997).
  13. Simmerson, 254 S.E.2d at 719.
  14. Id. at 718.
  15. Fox v. Pollack, 226 Cal. Rptr. 532, 534 (Cal. Dist. Ct. App. 1986).
  16. N.C. Revised Rules of Prof’l Conduct RPC 40 (1989).
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