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Brown Media Corporation v. K&L Gates, LLP

United States Court of Appeals, Second Circuit

April 14, 2017

BROWN MEDIA CORPORATION, ROY E. BROWN, Plaintiffs-Appellants,
v.
K&L GATES, LLP, EDWARD M. FOX, ERIC T. MOSER, Defendants-Appellees.

          Argued: November 4, 2016

         On appeal from an order of the United States District Court for the Eastern District of New York (Spatt, J.), granting the defendants' motion to dismiss under Fed.R.Civ.P. 12(b)(6) on the grounds that res judicata bars plaintiffs' claims for breach of fiduciary duty, tortious interference with contract and common law fraud against defendant law firm and attorneys who represented plaintiffs in connection with their proposed purchase of the assets of a debtor in bankruptcy. Because the plaintiffs' claims are not of the sort that should have been raised in the underlying bankruptcy proceedings nor do they implicate the validity of the asset sale confirmed in the bankruptcy proceedings, res judicata does not bar them. The judgment of the district court is vacated.

          Daniel Abrams, Law Office of Daniel L. Abrams, PLLC, New York, NY, for Plaintiffs-Appellants.

          Anthony C. Acampora, Silverman Acampora LLP, Jericho, NY, for Defendants-Appellees.

          Before: Hall, Livingston, Circuit Judges, and Garaufis, District Judge. [*]

          Hall, Circuit Judge

         The plaintiffs appeal from an order of the United States District Court for the Eastern District of New York (Spatt, J.), dismissing their action asserting claims for breach of fiduciary duty, tortious interference, and common law fraud against the law firm K&L Gates, LLP and two of its former partners. The plaintiffs, unsuccessful bidders in a bankruptcy proceeding, alleged that the defendants used their prior representation of the plaintiffs to undermine the plaintiffs' attempt to acquire assets in a bankruptcy sale. The district court granted the defendants' motion to dismiss on res judicata grounds, reasoning that the plaintiffs could have raised their claims during the course of the bankruptcy proceedings and that allowing the plaintiffs' action to go forward would call into question the integrity of the bankruptcy court's final orders.

         On appeal, the plaintiffs argue that they could not have brought their claims during the bankruptcy proceedings, and this present action will not disturb the orders of the bankruptcy court. We agree. For the following reasons we REVERSE the district court's decision, VACATE the judgment, and REMAND the case for further proceedings consistent with this opinion.

         BACKGROUND

         I. Factual Background

         K&L Gates ("K&L"), a large international law firm, and its former partners Edward Fox and Eric Moser (collectively, "the defendants"), represented Brown Publishing Company, Brown Media Holdings Company, and their affiliates (collectively, "Brown Publishing") in Brown Publishing's Chapter 11 bankruptcy.

         Plaintiff Roy Brown was the former Chief Executive Officer, as well as a former shareholder, manager, and director of Brown Publishing. Brown and other Brown Publishing insiders owned and controlled plaintiff Brown Media Corporation ("Brown Media" and, together with Brown, "the plaintiffs"), which they formed to purchase Brown Publishing's assets in a bankruptcy auction. The plaintiffs' action arises out of events that occurred just prior to and during Brown Publishing's bankruptcy proceeding.

         Because we are reviewing the dismissal of plaintiffs' complaint, we draw the following facts from the complaint and present them in the light most favorable to the plaintiffs. See Carpenters Pension Tr. Fund of St. Louis v. Barclays PLC, 750 F.3d 227, 232 (2d Cir. 2014).

         A. Pre-Bankruptcy

         Before entering bankruptcy, Brown Publishing was a closely-held corporation controlled by Roy Brown, his brother Clancy Brown, their parents- Bud and Joyce Brown; Brown Publishing's former General Counsel Joel Dempsey, and Joe Ellingham (collectively, the "Managers"). At an unspecified time, Brown Publishing received financing from a company known as Windjammer Capital ("Windjammer"), with an equity option as part of the financing arrangement.

         In late 2008, the Managers grew concerned that Windjammer was on the verge of exercising its option, which might have resulted in the Managers losing control of Brown Publishing. The Managers decided to seek legal advice. To that end, Dempsey sent a memorandum to K&L and Fox requesting legal advice regarding, inter alia, the following: (a) "the legal ramifications of a proposed transaction whereby the Managers create a new LLC and Managers Roy, Dempsey and Ellingham acquire the assets of Brown Publishing through the new LLC, " a transaction that would "take place outside of bankruptcy"; (b) "what actions to take, if any, with regards to Windjammer Capital"; (c) "possible successor liability related to the proposed transaction"; (d) "what state would be an advantageous one for incorporation of the new LLC"; (e) "the tax consequences to the Managers"; and (f) "other issues pertaining to Brown Publishing's lenders." App'x 14.

         In response to the memorandum, K&L and Fox "provided advice directly to Roy and Dempsey, " advising them that "unless Brown Publishing was brought through a bankruptcy process, successor liability could flow to the shareholders of the new LLC." App'x 14. K&L and Fox, however, further advised Roy and Dempsey that, if the transaction took place outside of a bankruptcy, steps could be taken to reduce these concerns. K&L billed the Managers for the time devoted to providing these legal services.

         By March 2009, Brown Publishing was on the verge of defaulting on its loan from Windjammer, prompting the Managers to take a series of actions to protect Brown Publishing's assets. Later that month, the Managers followed the advice of K&L and entered into an agreement to execute a non-bankruptcy transaction similar to that contemplated in the memorandum Dempsey had provided to K&L. When the transaction did not have the desired result, Dempsey again sought the advice of Fox, who advised the Managers that a sale of Brown Publishing's assets in bankruptcy was the best way to retain control of the company. K&L also advised Roy and Dempsey that they could purchase Brown Publishing's assets through a sale pursuant to 11 U.S.C. § 363, which authorizes the bankruptcy court to conduct a sale of the bankruptcy debtor's assets even outside the ordinary course of business. See generally In re Lionel Corp., 722 F.2d 1063, 1070-71 (2d Cir. 1983) (discussing the circumstances permitting the bankruptcy court to conduct a § 363 sale process). The Managers rescinded the March 2009 transaction and, pursuant to K&L's advice, ushered Brown Publishing into bankruptcy.

         In June 2009, K&L notified Roy and Dempsey that the firm was interested in representing Brown Publishing in its bankruptcy proceeding. K&L, however, did not seek or obtain a waiver or consent from the Managers to do so. In July 2009, Brown Publishing retained K&L as counsel.

         In August 2009, K&L and Dempsey began preparing a "'stalking horse"[1]asset purchase agreement (the "APA"), which was designed to "further the ultimate goal of being able to obtain the assets with the blessing of the bankruptcy court." App'x 16. K&L also allegedly "continued to serve as the Managers' counsel, despite having been retained by Brown Publishing." App'x 16. In addition to preparing the APA, K&L advised the Managers on how to maximize the chances that a bankruptcy court would approve their bid at a bankruptcy sale. K&L also advised the Managers with respect to forming Brown Media (the company that would make the "stalking horse" bid), and assisted the Managers in their effort to convince Brown Publishing's lenders to finance the Managers' purchase. With the help of K&L, the Managers obtained a funding commitment through Guggenheim Partners to support their purchase offer.

         Shortly before Brown Publishing filed for bankruptcy, K&L did urge the Managers and Brown Media to obtain new counsel. On Fox's recommendation, the plaintiffs hired Richard Levy, Fox's friend and former partner. By the time Levy was hired, however, Brown Media had been formed and much of the APA had been drafted.

          B. The ...


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