Seventh Circuit Sends a Warning to Trustee/Plaintiffs

What follows is a discussion of the case of Andrew J. Maxwell v. KPMG, LLP, 2008 WL 746849, C.A.7 (Ill.), March 21, 2008 (NO. 07-2819) (Maxwell). Bankruptcy lawyers should have a unique appreciation for the facts and holding of Maxwell.

Andrew Maxwell was (and possibly still is) the chapter 7 trustee of the estate of a company known as marchFIRST.  MarchFIRST was a high-profile victim of the dot.com bust of the early 2000s. The trustee brought suit against KPMG, LLP, alleging that its negligence (to a predecessor of marchFIRST) made it liable to the marchFIRST estate for an amount in excess of $ 600 million. After trial, the district court ruled for KPMG. See Maxwell v. KPMG, LLP, Slip Copy, 2007 WL 2091184 (N.D.Ill., 2007). The Seventh Circuit affirmed.

The facts of the lawsuit can be over-simplified as follows: In 1999, a company known as Whittman-Hart (Whittman) wanted to acquire an Internet service company known as US Web/CKS (US Web). Whittman in fact acquired US Web on March 1, 2000, and the new entity was known as marchFIRST. Shortly thereafter, the tech bubble burst and, inextricably tied together, down they all went. MarchFIRST filed bankruptcy 13 months later.

The defendant, KMPG, performed auditing services for Whittman. In its suit against KPMG, the trustee alleged that in the fourth quarter of 1999, KPMG certified certain earnings reports of Whittman (the acquiror) that were false. The trustee then alleged (remember, this is over-simplified) that KPMG's negligence was the cause of the demise of marchFIRST. The district court granted summary judgment for KPMG, holding that KPMG did not cause the merger and did not cause the merger to fail.

The Seventh Circuit assumed for all purposes that the earnings reports were false and that KPMG was negligent. However, the court was mystified as to how that negligence "caused" Whittman to acquire US Web. Further, even if KPMG somehow caused Whittman to make that fatal decision, it did not cause the tech bubble to burst.

The Seventh Circuit also took umbrage with the trustee's proof of damages. Since the court found no liability, the damages discussion is probably dicta — but it plays a role in the case nonetheless. The trustee sought damages well in excess of $600 million. A large part of his proof was expert testimony to the effect that had Whittman not acquired US Web, it would have had a market value of $535 million on the day it filed bankruptcy. Without belaboring the details of this speculative damage theory, the Seventh Circuit called this evidence outlandish. In short, the Seventh Circuit found that KPMG had no liability and that the damages sought were absurd.

However, the court then went on to invite sanctions motions against the trustee at both the trial and appellate level, and pointedly suggested that they be directed at him personally, not the estate (but don't worry; the court went on to state that it was not prejudging any such motions).

Frankly, no bankruptcy attorney is likely to be surprised that a bankruptcy trustee initiated a lawsuit against a deep pocket on an "aggressive" theory of liability and "optimistic" theory of damages. What is startling is that a circuit level court took such pains to assure that this trustee was punished for it. After some brief discussion, the court states rather simply, "But frivolous suits are forbidden." The court then declared that "if the probability [of success in a lawsuit] is very low, the suit is frivolous; really that is all that most courts, including ours, mean by the word," citing Murray v. GMAC Mortgage Corp., 434 F.23rd 948, 952 (7th Cir. 2006).

One of the most striking elements of the court's analysis was an appreciation for the inhibitions, vel non, that affect a trustee's litigation judgment. There are precious few. A trustee of a failed enterprise has no need to maintain future relations with vendors, customers, creditors or other entities with whom it might have to deal in the future. The court also seems to imply that a trustee has little concern for the expense of litigation, "aggressive" or otherwise, since that expense is (usually) borne by the creditors, not the trustee. (Lastly, although not mentioned by the court, trustees are almost never the subject of counterclaims, since they are usually not a party to the transaction being sued upon; real litigants don't always have that luxury.)

Although not necessarily the holding of the case, in its discussion of sanctions, the court states, "Judges must be vigilant in policing the litigation judgment exercised by trustees in bankruptcy, and in an appropriate case must give consideration to imposing sanctions for the filing of a frivolous suit."

While many might applaud the result in Maxwell, one must consider the flip side. There is some concern that Maxwell could be read as chilling the ability of bankruptcy trustees to vigorously pursue claims for the benefit of the estate. Moreover, as hedge funds and other aggressive parties take more active roles in bankruptcy cases, trustees may be subject to the opposite of Maxwell, that is being sued by creditors for not pursuing "aggressive" claims aggressively.

One commentator has opined that a trustee faced with the "to sue or not to sue" conundrum could move to abandon the cause(s) of action under § 554. Assuming notice is proper, any party who disagrees with the abandonment is free to object, purchase the claim or otherwise have its day in court, such that the trustee's exposure is effectively eviscerated.