In chapter 7, the retainer that an individual debtor pays to his or her lawyer likely will not require the lawyer to defend adversary proceedings, such as those attacking the dischargeability of a debt. With an impecunious debtor unable to pay a lawyer for defense, a lender might be tempted to file a dischargeability complaint, thinking that the debtor who is unable to defend will default, settle or reaffirm the debt.

The Ninth Circuit Bankruptcy Appellate Panel affirmed a decision by Bankruptcy Judge Christopher M. Klein of Sacramento, Calif., who imposed prefiling review as a sanction when a lender filed a dischargeability complaint with no evidence of fraud.

In his opinion last year, Judge Klein found that the law firm had filed an identical complaint in six other cases. He said that the “boilerplate complaint” was “a case of sue first and ask questions later.” Golden One Credit Union v. Fiedler (In re Fiedler), 654 B.R. 787, 790 (Bankr. E.D. Cal. Nov. 2, 2023). To read ABI’s report, click here.

The Loan and the Complaint

The debtor owed $12,500 on a high-interest credit card and went to a bank, where the lending officer advised her not to consolidate the credit card loan with another lender. She accepted the bank’s offer of a $9,000 loan to pay off some of the credit card debt.

After taking the loan, the debtor realized it didn’t solve her financial problems and filed a chapter 7 petition 43 days after receiving the $9,000 loan.

The lender neither attended the Section 341 meeting nor listened to the recording. Not taking discovery under Rule 2004, the lender didn’t even call the debtor’s lawyer to learn about the debtor’s circumstances.

Seven days after the creditors’ meeting and 63 days before the deadline for an objection to dischargeability, the lender filed a complaint alleging that the debt was nondischargeable under Section 523(a)(2) for money obtained by fraud.

As described in the BAP’s May 13 opinion, the complaint only alleged two relevant facts: (1) the debtor took down the loan but (2) never intended to repay the loan. Although allegations of fraud require pleading with particularity, there were no other facts alleged in the complaint.

The debtor answered pro se, because her lawyer wasn’t required to represent her in adversary proceedings. Judge Klein scheduled a quick trial. Before the trial, the lender moved for dismissal, which Judge Klein granted.

Sua sponte, Judge Klein issued an order directing the lender and its counsel to show cause why they should not be found to have violated Bankruptcy Rule 9011(b) and why they should not be sanctioned.

At the show cause hearing, the attorney for the lender admitted there was “minimal to no investigation” before filing the complaint. Judge Klein found a violation of Rule 9011. Rather than impose monetary sanctions, he required a prefiling review before filing a nondischargeability complaint anywhere in the district.

The lawyer appealed, to no avail.

Rule 9011 Was Violated

In the per curiam, nonprecedential opinion on May 13, the BAP found no abuse of discretion in the prefiling sanction.

Reviewing the record, the BAP recited how Judge Klein “found the entire Complaint frivolous [and that] the record demonstrates that the bankruptcy court determined that [the lawyer’s] conduct was particularly egregious, not merely negligent.” The bankruptcy court had also found that the complaint was filed for “an improper purpose.”

Furthermore, the record demonstrated how Judge Klein “determined that the Complaint did not have a sufficient factual or legal basis, and therefore, [the lawyer’s] inquiry was not reasonable under the circumstances.”

Finding that “the evidence amply supports the bankruptcy court’s determination that the Complaint was both factually and legally ‘baseless’ and made without a ‘reasonable and competent inquiry,’” the BAP decided that “the bankruptcy court did not abuse its discretion in finding the Complaint to be ‘frivolous and thus sanctionable under Rule 9011.”

Egregious Conduct

Having found a violation of Rule 9011, the BAP turned to the question of whether the sanction was an abuse of discretion. Because the sanction was made sua sponte, the BAP said that the conduct must be “akin to contempt,” which requires “egregious conduct” or a finding of “bad faith.”

Although the bankruptcy court had not applied the proper standard, the BAP decided that “the bankruptcy court’s findings, combined with the record, sufficiently support the court’s decision to sanction [the lawyer] under Rule 9011.” As the BAP read the record, “the bankruptcy court impliedly found that by filing a Complaint wholly lacking in both a factual and legal basis, [the lawyer’s] conduct was tantamount to bad faith, thus satisfying the required heightened standard.”

Admonishment Wasn’t Enough

Aiming to counter the prefiling review, the lawyer argued that the bankruptcy court should have done nothing more than admonish, given that the lawyer had withdrawn the complaint before trial.

The BAP countered by citing law for the proposition that sanctions are limited to that which is necessary to deter repetition of the conduct. In that regard, the BAP noted how the bankruptcy court found that “admonishment was insufficient because [the lawyer] had demonstrated a pattern of filing frivolous complaints” and that “a district-wide prefiling requirement of limited duration would sufficiently deter [the lawyer] from filing such a frivolous complaint again.”

The BAP affirmed, finding that the sanction was “not an abuse of discretion.”