Bankruptcy Court Lacked Jurisdiction Over State Law Dispute Between Non-Debtors as Dispute had no "Conceivable Effect" on Bankruptcy Estate

By Karl Johnson posted 09-12-2018 13:43

Karl J. Johnson, Hellmuth & Johnson, PLLC
Jeffrey D. Klobucar, Bassford Remele, P.A.

 Contributing Editor: Natasha Wells, Dorsey & Whitney LLP
McDougall v. AgCountry Farm Credit Servs. (In re McDougall), 587 B.R. 87 (B.A.P. 8th Cir. 2018) (Schermer, J.)

The Eighth Circuit Bankruptcy Appellate Panel remanded a proceeding to the bankruptcy court for dismissal, holding that the bankruptcy court lacked jurisdiction to consider the state law dispute between non-debtors and a mortgagee. 

The debtors filed an adversary proceeding against non-debtor individuals and a mortgagee concerning a mortgage and an ownership interest in land that was not property of the estate as of the petition date. The non-debtors answered, asking the bankruptcy court to invalidate the mortgage based on fraud, but the non-debtors filed no cross-claim against the mortgagee and no counterclaim against the debtors. The bankruptcy court ruled that the mortgage was enforceable and entered judgment for the mortgagee and against the debtors. The ruling effectively also determined the nature of the non-debtors’ rights in the mortgaged property. The non-debtors appealed, challenging the judgment on the basis of state law fraud and challenging the validity of the mortgage. 

On appeal, the BAP initially recognized its independent duty to examine bankruptcy court jurisdiction. “Bankruptcy courts, by reference from the district courts, have ‘original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.’”  Acknowledging that the non-debtors brought no cross-claim or counterclaim in the matter, the BAP determined that the bankruptcy court had no “arising under” or “arising in” jurisdiction over the non-debtors’ state law claim, which was not created under the Bankruptcy Code and could exist outside of bankruptcy. 

The BAP then examined “related to” jurisdiction. To determine “related to” jurisdiction, courts in the Eighth Circuit apply the “conceivable effect” test, which “is whether the outcome of that proceeding could conceivably have any effect on the estate being administered in the bankruptcy. . . . An action is related to bankruptcy if the outcome could alter the debtor’s rights, liabilities, options, or freedom of action . . . and which in any way impacts upon the handling and administration of the bankruptcy estate.” Applying the “conceivable effect” test for “related to” jurisdiction, the BAP determined that the alleged dispute was between non-debtors about property that was never property of the bankruptcy estate and that the outcome of the dispute would have no effect on the bankruptcy estate. The BAP remanded the matter to the bankruptcy court with instructions to dismiss for lack of jurisdiction.