Over dissent, the Fifth Circuit vacated $240,000 in sanctions, holding that the award was damages for criminal contempt which the bankruptcy court had no power to impose.

The appeal arose from the chapter 11 liquidation in Dallas of Highland Capital Management. In his April 4 opinion for the majority, Circuit Judge Andrew S. Oldham said that the “case has been full of” what he called “vexatious litigation.”

The Aborted Lawsuit

Like much of the litigation arising throughout the case, the controversy traced its roots to a stipulation with the creditors’ committee where the debtor’s chief executive gave up control. A chief restructuring officer took over.

To protect the CRO, Judge Oldham described how the bankruptcy court entered a “gatekeeping order” that prohibited anyone from suing the CRO without authorization from the bankruptcy court based on a “colorable claim” for willful misconduct or gross negligence. The order went on to say that the bankruptcy court “shall have sole jurisdiction to adjudicate any such claim for which approval of the Court to commence or pursue has been granted.”

Notwithstanding the gatekeeping order, two entities affiliated with the former CEO sued the debtor in federal district court, alleging that the debtor, through the CRO, engaged in self-dealing in connection with a settlement that had been approved by the bankruptcy court.

One week later, the plaintiffs filed a motion to amend the complaint to add the CRO as a defendant. The former CEO’s affiliates didn’t have the bankruptcy court’s approval to sue the CRO, but the plaintiffs reasoned that suing in the supervising district court “obviated this defect,” Judge Oldham said.

On procedural grounds, the district court dismissed the motion one day after it was filed.

After dismissal, the bankruptcy court granted the debtor’s motion for the former CEO’s affiliates and their counsel to show cause why they should not be held in contempt for violating the gatekeeping order.

After what Judge Oldman called “extensive discovery” and a “lengthy evidentiary hearing,” the bankruptcy court held the former CEO, his affiliates and their counsel in contempt and directed them to pay the debtor about $240,000.

The CEO, his affiliates and their counsel appealed, contending that the sanctions were criminal and beyond the power of the bankruptcy court. The district court affirmed, prompting an appeal to the Fifth Circuit.

The Majority Opinion

Judge Oldham began his opinion for the majority by reciting that bankruptcy courts are not Article III courts and lack inherent power to punish violations of their orders with criminal contempt. They “have only civil contempt powers because that is all Congress has given them,” he said.

Judge Oldham went on to say that the “civil contempt power is limited” and may not have a “primary purpose” of punishing or vindicating the authority of the court. Instead, he said that use of the civil contempt power must be “remedial” by coercing compliance or compensating the injured party for its actual loss.

Quoting the Supreme Court, Judge Oldham said that “a bankruptcy court may shift ‘only those attorney’s fees incurred because of the misconduct at issue.’” Goodyear Tire & Rubber Co. v. Haeger, 581 U.S. 101, 109 (2017).

Judge Oldham said that the only contumacious conduct was filing the motion in district court to add the CRO as a defendant. He said that the bankruptcy court and district court both “reasoned that the award was compensatory because it shifted expenses [that the debtor] reasonably and necessarily incurred in responding to the Motion [to add the CRO as a defendant].”

“Both courts were wrong,” Judge Oldham said. He saw the debtor as having “incurred virtually all its contempt-related expenses because the bankruptcy court permitted extensive discovery and conducted a marathon evidentiary hearing to unearth [the former CEO’s] role in filing the Motion [to add the CRO as a defendant].” He added that the former CEO’s intentions “were irrelevant to civil contempt.” [Emphasis in original.]

As Judge Oldham saw it, “The only question in civil contempt is whether and to what extent [the debtor] was damaged by [the former CEO’s affiliates’] choice to file the Motion in the wrong forum.”

Judge Oldham vacated the district court’s judgment and remanded with instructions

to limit any sanction award to the damages [the debtor] suffered because [the former CEO’s affiliates] filed the Motion in the wrong court—i.e., the expenses [the debtor] reasonably incurred in opposing the Motion in district court [to add the CRO as a defendant], less those it would have spent opposing the Motion had it been filed in bankruptcy court.

The Dissent

Circuit Judge James L. Dennis dissented, saying that he “sincerely disagree[s] with the majority” and “would affirm the bankruptcy court’s” award of $240,000 in “civil compensatory” sanctions.

Judge Dennis said that “the panel majority disregards the three applicable standards of review.” He said that “the majority selectively picks mere seconds of [the debtor’s] counsel’s oral argument as constituting an agreement that [the former CEO’s affiliates’] ‘only contumacious conduct’ was filing their motion in the wrong court, suggesting that the misfiling was a mere inadvertence.” [Emphasis in original.]

Judge Dennis said that the “record contains no facts or evidence indicating that [the debtor’s] counsel agreed to such an incorrect and rhetorically disadvantageous position.” He concluded that “the bankruptcy court and the district court committed no error of law, no clear error of fact, and no abuse of discretion.”

“I respectfully dissent from the majority’s reversal of the bankruptcy and district courts’ judgments,” Judge Dennis said.