2009 Chapter 11 Recent Developments (Part I)

Facts: Mr. Orville Moe formed Washington Motorsports, Ltd. ("WML"), a limited partnership, for the purpose of having a racetrack in Spokane. Moe was also a majority stockholder in Spokane Raceway Park, Inc. ("SRP"), which was a general partner in and managed WML. SRP's and WML's finances were interwoven. LeMaster & Daniels, PLLC ("L&D") were accountants to Moe, SRP and WML. Prepetition, SRP was placed into a receivership and ceased to be responsible for managing WML. In the receivership action, L&D filed a claim against WML to recover fees, including attorneys' fees (the "Fees") that it had incurred in participating in the state court receivership actions. The basis for L&D's fee request was an indemnification letter. In 2006, SRP filed a chapter 11 bankruptcy and a chapter 11 trustee was appointed. L&D filed a proof of claim asking for the Fees in the bankruptcy and the trustee filed an adversary proceeding to liquidate the proof of claim. L&D then filed a third-party complaint against WML in the adversary based on the indemnification letter and WML moved to dismiss.

Issues:

(1)

Whether the bankruptcy court has subject matter jurisdiction - related to jurisdiction or supplemental jurisdiction - over the third-party complaint filed by L&D against WML.

(2)

Assuming jurisdiction, should the bankruptcy court abstain from hearing the third-party complaint?

Rules:

(1)

Ninth Circuit has adopted the Pacor test; related to jurisdiction includes actions that "could alter the debtor's rights, liabilities, options, or freedom of action, either positively or negatively, and which in any way impacts upon the handling and administration of the bankruptcy estate..." and encompasses

a.

"Causes of action owned by the debtor which become property of the estate;"

b.

"Suits between third-parties which have an effect on the bankruptcy estate."

(2)

Under 28 U.S.C. § 1367(a), "district courts have supplemental jurisdiction over state law claims which are related to the federal claims in an action pending in federal court." The Ninth Circuit has said that the statute also allows bankruptcy courts to exercise supplemental jurisdiction. The requirement is that there be a "strong factual relationship between the state and federal claims presented... State law claims of indemnity against a third-party which arise from the transaction or occurrence giving rise to a federal cause of action against the original parties have been held to be subject to supplemental jurisdiction."

(3)

Under 28 U.S.C. § 1367(c), under which abstention is not mandatory, the district court can abstain from hearing claims if (a) the claim raises novel or complex issues of state law, (b) the state claim substantially predominates, (c) the district court has dismissed all the claims over which it has original jurisdiction, (d) other compelling reasons exist to abstain.