Opinion
Case No. 97-13628-SSM, Adversary Proceeding No. 97-1298
May 29, 1998
Gerald F. Ragland, Jr., Esq., The Mandell Law Firm, P.C., Vienna, VA, of Counsel for the plaintiff
Bennett A. Brown, Esq., Fairfax, VA, of Counsel for the debtor
MEMORANDUM OPINION
This matter is before the court on the plaintiff's amended complaint to establish a constructive trust against certain funds owed to the debtor, or, in the alternative, for recognition of a valid attorney's lien. The funds in question are an award of attorney's fees against the debtor's former husband in domestic relations litigation in which the plaintiff, a law firm, represented the debtor. At a pre-trial conference held on February 3, 1998, the parties agreed to submit the case on a stipulation of facts. The parties subsequently filed briefs in accordance with an agreed briefing schedule, and the matter is now ripe for determination. For the reasons stated, the court concludes that imposition of a constructive trust is not appropriate, but that the plaintiff law firm has a valid lien that survives the debtor's bankruptcy.
Facts and Procedural Background
Efrosine Robic (the "debtor") filed a voluntary petition under chapter 7 of the Bankruptcy Code in this court on May 14, 1997. She received a discharge of her dischargeable debts on September 4, 1997, and the case was closed on October 6, 1997.
The Lewis Law Firm, P.C. (the "law firm") filed this adversary proceeding on August 22, 1997. The stipulation recites that on December 20, 1995, the debtor retained the law firm to represent her in domestic relations matters before two state courts. Relevant to the present controversy, the retainer agreement, attached as exhibit 1 to the stipulation, provides that:
You [the debtor] hereby expressly grant and assign to The Lewis Law Firm, A Professional Corporation, an attorney's charging lien, in the amount of any unpaid fees and costs advanced pursuant to this agreement, against your case and any judgment, settlement, amount due, or to be paid or become due to you pursuant to your case.
At the conclusion of the law firm's representation of the debtor, she owed the firm $74,000, which is reflected in Schedule F ("Creditors Holding Unsecured Nonpriority Claims"). On December 12, 1996, while the state court litigation was still on-going, the state court awarded the debtor $28,087.40 in attorney's fees against her former spouse, James Robic. The parties have stipulated that the law firm was owed at least that amount when the debtor received the award, and that the award arose from the firm's representation of the debtor.
The debtor listed the $28,087.40 award of attorney's fees as an asset in schedule B ("Personal Property"). She did not, however, claim any part of the award as exempt. The chapter 7 trustee elected not to administer the property and filed a report of no distribution on July 31, 1997.
Although the stipulation recites that the trustee abandoned the claim, there is nothing in the file that reflects an express abandonment under § 554(a), Bankruptcy Code, which permits a trustee, after notice and a hearing, to abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate. Nevertheless, under § 554(c), any property that is listed on the debtor's schedules and not otherwise administered at the time of the closing of the case is abandoned to the debtor.
The plaintiff's original complaint in this action sought to impose a constructive trust against the debtor's interest in the award of attorney's fees and, although not explicitly pleaded, to hold its claim non-dischargeable under § 523(a)(15), Bankruptcy Code. By order entered October 29, 1997, the complaint was dismissed for failure to state a claim upon which relief could be granted, with leave to file an amended complaint. On November 13, 1997, the amended complaint presently before the court was filed. It asserts various alternative theories of recovery, with its primary thrust being that this court should impose a constructive trust in its favor against the award of attorney's fees. Alternatively, the law firm asks that the debt not be discharged or that the law firm be determined to have a valid lien against the judgment.
Specifically, the court held a debtor's obligation to her own attorney, not imposed by court order, arising out of a divorce action was not excepted from discharge under § 523(a)(15), Bankruptcy Code.
This alternative prayer for relief — that the plaintiff's debt not be discharged — is simply an attempt to resurrect the § 523(a)(15) claim that was previously dismissed. No facts have been alleged in the amended complaint that would bring any portion of the fees owed by the debtor to the law firm within any of the categories of debts excepted from discharge by § 523(a), Bankruptcy Code. Accordingly, the court will not further discuss the dischargeability issue.
Conclusions of Law I.
As a threshold matter, although neither party has raised a challenge to the court's jurisdiction, the court has considered on its own motion whether it has subject matter jurisdiction over this controversy. See, Poplar Run Five L.P. v. Virginia Electric Power Co. (In re Poplar Run Five L.P.), 192 B.R. 848, 854-55 (Bankr. E.D. Va. 1995) (Bostetter, C.J.).
Under 28 U.S.C. § 1334 and 157(a) and the general order of reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984, this court has jurisdiction over bankruptcy cases, proceedings "arising under" the Bankruptcy Code, and proceedings "arising in" or "related to" a bankruptcy case. As Chief Judge Bostetter of this court has explained,
Like other federal courts, bankruptcy courts are courts of limited jurisdiction, and as such, they "must be alert to overstepping their limited grants of jurisdiction." At any stage of a litigation . . . subject-matter jurisdiction may be questioned. By failing to do so, the parties cannot confer jurisdiction by consent. If the court perceives the defect, it is obligated to raise the issue sua sponte. "It is to be presumed that a cause lies outside this limited jurisdiction, and the burden of establishing the contrary rests upon the party asserting jurisdiction."
Poplar Run, 192 B.R. at 854-55 (internal citations omitted). For a case to "arise under" the Bankruptcy Code, either bankruptcy law must create the cause of action or the plaintiff's right to relief must necessarily depend on resolution of a substantial question of bankruptcy law. Id. Proceedings "arising in" a bankruptcy case are those that "are not based on any right expressly created by [the Bankruptcy Code], but nevertheless would have no existence outside of the bankruptcy." Bergstrom v. Dalkon Shield Claimants Trust (In re A. H. Robins Co., Inc.), 86 F.3d 364, 372 (4th Cir. 1996), cert. denied, — U.S. —, 117 S.Ct. 483, 136 L.Ed.2d 377 (1996). Finally, the "related to" category of proceedings is "quite broad and includes proceedings in which the outcome could have an effect on the estate being administered." Id., citing Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3rd Cir. 1984) (a matter is "related to" a bankruptcy case if "the outcome of that proceeding could conceivably have any effect on the estate being administered" or if it "could alter the debtor's rights, liabilities, options, or freedom of action."). Nevertheless, the "related to" category is not so broad as to encompass litigation of state law claims that will not have an effect on the bankruptcy estate, simply because one of the litigants has filed a petition in bankruptcy. Compare In re McLean Square Assocs., G.P., 200 B.R. 128 (E.D. Va. 1996) (Ellis, J.) (litigation between tenant and chapter 11 debtor-landlord over lease in shopping center that was debtor's sole asset had potential effect on debtor's reorganization plan and plainly qualified as non-core "related" proceeding) with Lux v. Spotswood Construction Loans, 176 B.R. 416 (E.D. Va. 1994) (after chapter 7 case was closed, adversary proceeding brought by debtor challenging a foreclosure was not "related to" his bankruptcy case), aff'd, 43 F.3d 1467 (4th Cir. 1994) (table).
In its complaint, the plaintiff asserts that this is a "core" proceeding under 28 U.S.C. § 157(b)(2)(O) as "affecting the liquidation of the assets of the estate or the adjustment of the debtor-creditor or the equity security holder relationship." However, it plainly does not have any connection with "liquidation of the assets of the estate." The debtor's right to the attorney's fee award, although it became property of the bankruptcy estate under § 541(a), Bankruptcy Code, has been abandoned and is no longer property of the estate. Put another way, there is no present contest between the law firm and the bankruptcy estate concerning those funds. The only parties who now have an interest in the claim are the debtor, her ex-husband, and the law firm, and the resolution of the dispute can have no effect on distribution to creditors. Whether the present action falls within the broad rubric of a proceeding "affecting . . . the adjustment of the debtor-creditor relationship" is a closer question. The debtor has received a discharge of her personal liability to the plaintiff. Although § 524, Bankruptcy Code, bars enforcement of a discharged debt as a personal liability of the debtor, valid pre-petition liens, unless affirmatively set aside in the course of the bankruptcy, are unaffected by the discharge and may be enforced in rem against the collateral. Vested pre-petition property interests are likewise unaffected by discharge. The determination of whether specific property of the debtor is subject to a valid pre-petition lien or whether a party other than the debtor has an interest in that property is not, strictly speaking, an "adjustment" of the debtor-creditor relationship. It is a pure question of state law, the determination of which not only has no effect on the administration of the bankruptcy estate, but has only a tenuous relationship to the debtor's fresh start. The debtor, as part of her fresh start, is entitled to retain exempt property free and clear of the claims of most creditors. § 522(b) and (c), Bankruptcy Code. The debtor here, however, did not claim her interest in the attorney fee award as exempt.
Nevertheless, the relationship between discharge of a debt — which is also part of the debtor's fresh start — and a creditor's assertion of a right to have a constructive trust imposed to enforce collection of that debt sufficiently implicates a right arising under the Bankruptcy Code so as to bring the present controversy within the court's jurisdiction. See Dorfman v. Moorhous (In re Moorhous), 180 B.R. 138 (Bankr. E.D. Va. 1995), aff'd 108 F.2d 51 (4th Cir. 1997). In Moorhous, a pre-petition creditor asserted that an assignment of military retired pay survived the debtor's discharge and sought to impose a constructive trust on that pay in the debtor's hands in the event that the assignment itself proved unenforceable against the United States. In that case, this court found that the pleaded causes of action likely fell within the definition of a "core" proceeding, but if not, was at least "related to" the debtor's bankruptcy case, and that the assertion and admission by the parties of "core" status in their pleadings constituted consent under 28 U.S.C. § 157(c)(2), to entry of a final order or judgment by a bankruptcy judge. Id. at 146; see also In re McLean Square Assocs., 200 B.R. at 134 (party who fails to object to bankruptcy court's jurisdiction in non-core related matter until after entry of final order has impliedly contented to the court's power). In the present action, the parties have likewise asserted and admitted core status in their pleadings. Accordingly, consistent with this court's prior holding in Moorhous, the court concludes that it has subject-matter jurisdiction under 28 U.S.C. § 1334 and 157(a).
II. A.
Having determined that this court has subject matter jurisdiction over this proceeding, the court now turns to the merits of the plaintiff's action. The court will first address whether it should impose a constructive trust against the debtor's award of attorney's fees from her former spouse.
It is well-established that under Virginia law, a court may impose a constructive trust upon real or personal property that a party obtains by fraud, misrepresentation, or other improper means, or if the circumstances render it inequitable for the party holding title to retain it. Old Republic National Title Insurance Co. v. Tyler (In re Dameron), 206 B.R. 394, 401 (Bankr. E.D.Va. 1997) (Tice, J.); Moorhous, 180 B.R. at 151; Prime Construction Corp. v. Riverside Development Joint Venture, (In re Prime Construction Corp.), 156 B.R. 176, 179 (Bankr. E.D. Va. 1993) (Tice, J.); Citizens Federal Bank v. Cardian Mortgage Corp. (In re Cardian Mortgage Corp.), 122 B.R. 255, 259 (Bankr. E.D. Va. 1990) (Tice, J.); Richardson v. Richardson, 242 Va. 242, 245, 409 S.E.2d 148, 150 (1991); Leonard v. Counts, 221 Va. 582, 588-89, 272 S.E.2d 190, 195 (1980) As explained by the Supreme Court of Virginia,
Constructive trusts arise, independently of the intention of the parties, by construction of law, being fastened upon the conscience of him who has the legal estate, in order to prevent what would otherwise be a fraud. They occur not only where property has been acquired by fraud or other improper means, but also where it has been fairly and properly acquired, but it is contrary to the principles of equity that it should be retained, at least for the acquirer's own benefit.
Leonard, 221 Va. at 589, 272 S.E.2d at 195 (original source omitted). Simply put, constructive trusts are imposed by courts of equity whenever necessary to achieve the ends of justice. Richardson, 242 Va. at 245, 409 S.E.2d at 150.
In Cardian Mortgage Corp., the debtor was a mortgage servicing company, with the right to service various pools of mortgages. Id. at 257. The debtor would collect mortgage payments, and then remit them to the mortgage pool owners, for which it earned a fee. Id. Shortly before it filed its chapter 11 petition, a bank for which it serviced mortgages made several payments or remittances on behalf of the debtor, but through error, neglect, or simple failure to respond to requests, the debtor never reimbursed the bank for remittances made on its behalf. Id. at 257-58.
In response to an argument by the plaintiff that a constructive trust should be imposed for its benefit against property of the estate, the court reasoned:
The rule of constructive trusts in Virginia has virtually always been stated in terms requiring some kind of legal or equitable transfer of a res to the constructive trustee. In fact, Citizens has cited no case where a constructive trust was imposed without a transfer to the constructive trustee. There does not, therefore, appear to be any res upon which to impose a trust since Cardian did not obtain title to any funds from or on behalf of Citizens with respect to the unreimbursed remittances. The only event that arguably established a res was a failure to debit the account which, at best, merely created a debt from Cardian to Citizens. Mere failure to pay a debt does not give rise to a constructive trust.
Id. at 261 (emphasis added) (citations omitted); see also Moorhous, 180 B.R. at 151 (refusing to impose a constructive trust against military retired pay which was the subject of an unenforceable assignment to repay a debt, noting that "operation of the Bankruptcy Code does not in a legal sense result in unjust enrichment.") (original source omitted)); cf., Montavon v. United States, 864 F. Supp. 519, 527 (E.D. Va. 1994) (Ellis, J.) (refusing to impose a constructive trust for the benefit of the successful litigant's counsel on a successful recovery of attorney's fees under the Equal Access to Justice Act against the United States when the successful litigant is also subject to a superior, unsatisfied tax lien of the Internal Revenue Service because the Internal Revenue Code only allows such "super-priority" for an attorney's lien when the litigation is against a party other than the United States because to do so would render the applicable provision of the Internal Revenue Code meaningless).
As courts have observed, "[A] constructive trust is fundamentally at odds with the general goals of the Bankruptcy Code" and "should not be impressed cavalierly." XL/Datacomp, Inc. v. Wilson (In re Omegas Group, Inc.), 16 F.3d 1443 (6th Cir. 1994); Bush v. Taylor, 893 F.2d 962 (8th Cir. 1990) (declining to impose constructive trust to enforce a dischargeable debt). Having carefully considered the facts as stipulated by the parties, the court concludes that imposition of a constructive trust is not appropriate. First, the law firm's claim against the debtor for its own legal fees is a dischargeable debt. The client's mere failure to pay those fees, and their subsequent discharge in this case under applicable provisions of the Bankruptcy Code, does not in any legal sense result in unjust enrichment. The law firm here is in no different position than any other creditor holding a dischargeable claim, and who is barred by § 524(a), Bankruptcy Code, from enforcing it against the debtor. There is no evidence suggesting that the state court, in entering judgment for the debtor, did so for the benefit of the law firm rather than the debtor or intended that the debtor be a mere conduit of funds to the law firm. Nor is there any evidence suggesting that the debtor encouraged her attorneys to keep working knowing that she was going to file bankruptcy, or that she timed the filing of her bankruptcy specifically to keep the fee award for herself while stiffing her attorneys. Accordingly, the court declines to impose a constructive trust in favor of the law firm against the unpaid judgment for attorneys fees.
It may also be premature, since it does not appear from the stipulation of facts that the debtor has actually ever received payment on account of the award. Without an actual res, there is nothing upon which to impose a constructive trust. Cardian Mortgage Corp., 122 B.R. at 261. However, for the purpose of this ruling the court will assume, without deciding, that an uncollected judgment may be the subject of a constructive trust.
B.
The court now turns to whether the plaintiff has a valid lien against the attorney's fee award. As noted above, valid pre-petition liens, unless expressly set aside in the course of the bankruptcy, survive the debtor's discharge and may be enforced in rem against the collateral after the bankruptcy case is concluded. Johnson v. Home State Bank, 501 U.S. 78, 82-84111 S.Ct. 2150, 2153-54, 115 L.Ed.2d 66 (1991). The question, therefore, is whether Virginia law would recognize a valid lien in favor of the law firm against the fee award.
In support of its claimed lien, the law firm points to the Virginia statute providing an attorney with a lien against his or her client's cause of action. Under Va. Code Ann. § 54.1-3932,
Any person having or claiming a right of action sounding in tort, or for liquidated or unliquidated damages on contract, may contract with any attorney to prosecute the same, and the attorney shall have a lien upon the cause of action as security for his fees for any services rendered in relation to the cause of action or claim. When any such contract is made, and written notice of the claim of such lien is given to the opposite party, his attorney or agent, any settlement or adjustment of the cause of action shall be void against the lien so created, except as proof of liability on such cause of action. Nothing in this section shall affect the existing law in respect to champertous contracts.
(Emphasis added). Clearly, the purpose of the statute is to provide attorneys who are successful on their client's behalf some assurance and protection — both as against competing creditors and as against a client who may wish to renege on the fee agreement — that their fees will be paid. However, the statutory lien, by its plain language, applies only where the client has a right of action sounding in tort or contract. See Military Circle Pet Center #94, Inc. v. Docktor Pet Holdings, LTD (In re Military Circle Pet Center #94, Inc.), 181 B.R. 282, 287-88 (Bankr. E.D. Va. 1994) (Tice, J.) (noting that the statute is limited to actions in tort and contract, and concluding that a settlement reached on franchise agreements was one on a contract, and thus falling under the statute); Stevens v. Sparks, 205 Va. 128, 133, 135 S.E.2d 140, 144 (1964) (concluding that under § 54-70 (the present statute's predecessor, with nearly identical language) an attorney did not have a statutory lien for services rendered while challenging the amount the client would receive under a will). Here, the plaintiff represented the debtor in various domestic relation matters — none of which involved actions sounding in tort or in contract. Accordingly, the court concludes that § 54.1-3932 has no applicability to the present case.
This, however, does not end the inquiry with regard to whether the plaintiff has a valid lien. The retainer agreement executed by the parties expressly granted a lien "in the amount of any unpaid fees and costs advanced . . . against any judgment, settlement, amount due, or to be paid or become due to you." Under Va. Code Ann. § 8.9-201, "a security agreement is effective according to its terms between the parties, against purchasers of the collateral and against creditors[.]" Additionally, a security interest "attaches" and becomes enforceable when it the security agreement has been signed by the debtor, value has been given, and the debtor has rights in the collateral. Va. Code Ann. § 8.9-203. All three requirements are satisfied here. In short, the retainer agreement satisfies the requirements for an enforceable security agreement under state law. While there is no evidence before the court that the plaintiff perfected its security interest to enjoy priority over those persons specified in Va. Code Ann. § 8.9-301 (and, correspondingly, a bankruptcy trustee under § 544(a), Bankruptcy Code), perfection is irrelevant because the property was abandoned to the debtor and no other entity has asserted a superior right in the collateral. A security agreement which conforms with the requirements of the statute is effective between the parties even absent perfection. In re Felmey, 9 B.R. 331, 332-33 (Bankr. E.D. Va. 1981) (Bonney, J.); see also Military Circle Pet Center #94, Inc., 181 B.R. at 288 (noting that the attorney had a lien under § 54.1-3932, but since he failed to give notice to the opposite party as required by the statute, the lien was not perfected and was unenforceable against third parties); Metro Machine Corp. v. Berkley Shipbuilding Drydock Corp. (In re Ward), 32 B.R. 318, 322 (Bankr. E.D. Va. 1983) (Bostetter, C.J.) (same, under predecessor to § 54.1-3932); Saltarelli Steponovich v. Douglas, 46 Cal.Rptr.2d 683, 686-87 (Cal.Ct.App. 1995) (same, California law); 12A Michie's Jurisprudence, Liens, § 3 (1989) (noting that personal property may be made the subject of a lien at the pleasure of the parties); cf. Phelan v, Fleet Consumer Discount Co. (In re Rice), 133 B.R. 722, 728 (Bankr. E.D. Pa. 1991) (noting that a debtor in chapter 7, absent § 522(h), may not utilize the trustee's avoiding powers because a mortgage, even if not perfected, remains enforceable between the mortgagor and the mortgagee). Accordingly, this court concludes that the retainer agreement created a valid security agreement that established a lien against the collateral that survived the debtor's discharge and that, unless otherwise contrary to public policy, is enforceable by the law firm.
For the purpose of this ruling, the court need not decide whether perfection would have required the filing of a financing statement. Va. Code Ann. § 8.9-302.
So that there will be no confusion by the parties, the court stresses the court's holding does not in any manner affect the discharge of the debtor's personal liability to the law firm for its unpaid fees. The fact that the lien survives the discharge means only that the law firm may enforce its claim in rem against the collateral to the extent permitted by state law, but it may not seek a money judgment against the debtor.
C.
The debtor vigorously argues, however, that any attempt by the law firm to assert or enforce its claimed lien violates public policy as well as Virginia's ethical prohibition against a lawyer acquiring a financial interest in the client's property when representing a client in a domestic relations matter. Unquestionably, Virginia recognizes domestic relations law as a sensitive area where enforcement of an attorney's contractual right to be paid for his or her services may collide with the public policy favoring continuation of the marriage, support, and equitable distribution. For example, in Virginia, contingent fee agreements, except in extremely rare situations, are ethically improper in family law and domestic relations cases. Legal Ethics Opinion 189 (Va. 1984). It is similarly improper for an attorney to secure a promissory note made by the client for the attorney's fees by a deed of trust on the marital home when that home is the subject of an equitable distribution proceeding. Legal Ethics Opinion 1390 (Va. 1991). The policy behind such prohibitions is society's desire to preserve the sanctity of the marriage and to avoid the attorney's professional judgment from being clouded given the unique character of domestic relations cases. Legal Ethics Opinion 189. Given this backdrop, this court would not hesitate to declare invalid, as against public policy, an attorney's claimed lien against an award of alimony or child support. See Edl v. Kinast (In re Kinast), 207 B.R. 611, 617 (Bankr. W.D. Wise. 1997) (noting that an attorney's lien is enforceable against a property settlement, but that the debtor's interests "might well be protected" if the lien was against alimony); Campanello v. Mason, 571 P.2d 449, 451 (Okla. 1977) (holding that an attorney's lien can attach to property rights acquired under a property division in a divorce proceeding while expressly declining to decide whether such lien would attach to an award of alimony or child support). While the retainer agreement between the debtor and the law firm in this case is unquestionably overbroad in purporting to grant a security interest in " any judgment, settlement, amount due, or to be paid or become due to you pursuant to your case" (emphasis added), nevertheless to the extent that the lien is limited solely to the attorney's fees awards to the debtor, the court does not find that enforcement of such lien would be contrary to public policy, given that the award was presumably made to compensate the debtor for the extraordinary expense of attorney's fees she incurred during the course of the domestic relations litigation and not for basic support.
The court notes, however, that enforcement of the lien solely against the award of attorneys fees may present practical difficulties. It appears from the debtor's schedules that, in addition to the award of attorneys fees, she is entitled to child support from her former husband. Obviously, the law firm, in the guise of enforcing its lien against the attorneys' fee award, may not reach, or interfere with the debtor's receipt of, those support payments. Additionally, this opinion is not intended in any manner to limit the power of the state courts having jurisdiction over the domestic relations litigation from imposing any additional limitations on the enforcement of the claimed attorney's lien.
III.
A separate judgment will be entered consistent with this opinion denying the prayer for imposition of a constructive trust but recognizing the right of the law firm to enforce its security interest in the attorney's fee award.