Restructuring

Contributed by Rich Mullen
Lawyers can be a feisty bunch, and it is not uncommon for opposing counsel to throw around some passive aggressive legal trash-talk.  Sometimes the denigration can get to a point where the party on the receiving end might think, “Hey, that’s defamation!”  But even if such statements amount to defamation, are they actionable?  In a recent decision in In re Potomac Supply Corp., the United States Bankruptcy Court for the Eastern District of Virginia ruled that a plaintiff’s defamation claims against debtor’s counsel must be dismissed because the alleged defamatory statements were protected by the absolute judicial privilege arising under Virginia law.
In Potomac Supply, the debtor, a sawmill and building supply company, sought to auction substantially all of its assets and, as is typical, bids were required to be submitted by a certain date.  After the bid deadline, however, the debtor, its counsel, the debtor’s largest secured creditor, and the unsecured creditors’ committee each believed that all bids were “woefully inadequate.”  Accordingly, debtor’s counsel made a supplemental filing stating that the auction would be adjourned without date.
The day after the supplemental filing, the debtor entered into an asset purchase agreement with Chesapeake Bay Enterprise, Inc. (CBE) that was subject to certain closing conditions, and pursuant to this agreement CBE wired a $500,000 purchase deposit to debtor’s counsel, which deposited the funds in a trust account.  The sale did not close, however, and less than two months later the debtor’s assets were sold to a different buyer.
There was litigation concerning, among other things, the $500,000 purchase deposit, and the bankruptcy court entered an agreed order providing for distribution of the funds received from the liquidation of the debtor’s assets, including the $500,000 purchase deposit.  The order provided that the debtor’s interest in the $500,000 would be assigned to the debtor’s counsel subject to certain terms.  Subsequently, the debtor’s chapter 11 case was converted to a chapter 7 case, and the order converting the case stated that the conversion would not affect the parties’ rights as set forth in the agreed order.
Next, the trust initiated an adversary proceeding against CBE alleging that it was entitled to retain the $500,000 purchase deposit and that CBE was required to pay an additional $500,000 pursuant to the purchase agreement.  CBE filed its answer, a motion to withdraw the reference from the bankruptcy court, and a third-party complaint against debtor’s counsel and the debtor’s largest secured creditor alleging, among other things, that an email sent by debtor’s counsel to CBE’s counsel was defamatory and the contents of the email were repeatedly published before and after the email was transmitted, and that “additional malicious statements” were made by debtor’s counsel.  The email provided:

Subject: PSC

Larry

I hope this finds you well.

We have received motions that you filed on behalf of your clients last night.

The reconsideration motion was missing two exhibits— (1) the $15 million APA, and (2) a statement showing proof of funds in a bank account titled in the name of Chesapeake [Bay].

Just so that I can say I professionally analyzed the motion and assessed its likelihood of success, I would appreciate your sending me these exhibits.

In the meantime, I can send you all of the fraudulent financing proposals we received from your client if you would like. Something tells me they didn’t share those with you, or information on the other government contracting fraud problems that folks in the group had with the Feds.

Either way, please send the omitted exhibits so that I can do my job appropriately.

Best.

Patrick

Debtor’s counsel argued that the defamation claims must be dismissed because, among other reasons, the statements were protected by the absolute judicial privilege (under Virginia law), i.e., the alleged defamatory statements were made in connection with a judicial proceeding and were relevant to the judicial proceeding.  CBE countered that the absolute judicial privilege does not apply to written correspondence such as the email sent by debtor’s counsel, the defamatory statements were gratuitous and irrelevant to the judicial proceeding, and the statements were published to parties other than those interested in the judicial proceeding.
The bankruptcy court recognized that debtor’s counsel was correct in that, under Virginia law, the absolute judicial privilege applies to alleged defamatory statements made in connection with a judicial proceeding and that are relevant to the judicial proceeding.  Additionally, the bankruptcy court rejected CBE’s assertion that such statements could not be published to third parties, and noted that, in any event, the alleged defamatory statements were made solely to “parties in interest,” as that term is defined under the Bankruptcy Code.
The bankruptcy court then reasoned that absolute judicial immunity did apply to the alleged defamatory statements because the statements were clearly made in connection with multiple ongoing judicial proceedings and it could not be said that debtor’s counsel’s comments about his experience with “fraudulent financing proposals” was irrelevant, improper, or palpably unrelated to the proceeding because the underlying motions specifically stated that certain financing was in place.  Citing cases from the Northern District of West Virginia, Eastern District of New York, and the Sixth Circuit, the bankruptcy court also stated that Virginia was not unique in its application of the absolute privilege to all forms of communication during litigation.
Judicial privilege is recognized by states throughout the country and serves to protect attorneys and litigants and encourage zealous representation.  As Potomac Supply reminds us, defamation claims may be defeated easily when the alleged defamatory statements are made in connection with a bankruptcy case or other judicial proceeding.  Counsel should keep in mind, however, that there are also codes of civility and ethics that proscribe certain behaviors and that may be applicable when disparaging statements are made.  It may be wise to keep the trash-talk to a minimum.