Overzealous Multiplication

In light of the Third Circuit’s recent decision in In re Prosser,[1] bankruptcy practitioners in the Third Circuit (which includes the highly trafficked District of Delaware) should have a heightened awareness of the line between zealous advocacy and abusive and vexatious conduct. If an attorney crosses this line through filings that “multiply” the bankruptcy proceedings, he or she, like debtor’s counsel in Prosser, may be subject to sanctions under 28 U.S.C. § 1927.[2]

In Prosser, the chapter 7 trustee commenced an adversary seeking a denial of the debtor’s discharge based on testimony given by the debtor’s former personal assistant earlier in the main case. Trying to discredit the former assistant’s earlier testimony, debtor’s counsel deposed the former assistant. While being deposed, the former assistant testified that he had made an arrangement with the trustee’s counsel to pay for his legal fees in a separate but related chapter 11 case, and that he had dinner with the trustee long before he gave his initial testimony. Hearing this testimony, trustee’s counsel advised the bankruptcy court[3] that the trustee had no interactions with the former assistant outside of the prior testimony. However, upon learning that the trustee had in fact once dined with the former assistant, trustee’s counsel promptly corrected its misstatements both at a hearing in open court and through writing submitted to the court.[4]

Notwithstanding the correction to the record, debtor’s counsel seized upon the adversary’s misstatement and launched a multi-faceted litigation campaign against the trustee and his attorneys. First, debtor’s counsel issued a press release stating that the debtor was “the target of [an] alleged bribery scheme” through which the former assistant provided testimony in exchange for free legal services.[5] In subsequent days, debtor’s counsel filed (1) an adversary complaint alleging that, by failing to report the supposed bribery scheme, the trustee ignored his duty under applicable federal law[6] while his attorneys “violated their duty of candor to the Court,” and further requesting an evidentiary hearing for possible sanctions, disqualification or referral for further disciplinary proceedings;[7] (2) objections (the “fee objections”) to the quarterly fee applications filed by the trustee and his counsel on account of their purported dubious conduct; and (3) a motion (the “conflict motion”) in the debtor’s main case for a hearing on an alleged conflict of interest between the trustee and his counsel stemming from the payment of the former assistant’s legal fees.

The bankruptcy court dismissed the request for an evidentiary hearing, noting that the trustee’s counsel’s prompt correction of their misstatement mooted any potential issue in dispute. The bankruptcy court also denied the conflict motion, both because debtor’s counsel failed to identify any specific conduct that would warrant an evidentiary hearing and because counsel had based its motion on Sixth Amendment law generally applicable only in criminal proceedings. Debtor’s counsel thereafter withdrew the fee objections and dismissed its claims in the adversary complaint.

The trustee then moved for sanctions against debtor’s counsel under 28 U.S.C. § 1927. Finding in favor of the trustee, the bankruptcy court sanctioned debtor’s counsel $137,024.02, based on a finding that the pleadings filed by debtor’s counsel were “patently meritless” and “vexatiously filed” to multiply the proceedings, thereby impeding the court from addressing the merits of other issues.[8] The bankruptcy court further emphasized that debtor’s counsel’s concerns could have been resolved through a simple phone call to trustee’s counsel.

The district court reversed the bankruptcy court, holding that 28 U.S.C. § 1927 was inapplicable to filings in a debtor’s main case (such as the conflict motion and the fee objections), and inapplicable to filings that initiate a proceeding (the adversary complaint). The district court additionally found that the bankruptcy court failed to explain how the actions of debtor’s counsel were in bad faith and that there was evidence to suggest that the conduct was the product of “legitimate zeal.”[9] With this ruling, the district court in effect ruled that the only filings in a bankruptcy context that could be sanctionable under 28 U.S.C. § 1927 were those that multiply an already-commenced adversary proceeding.

The Third Circuit disagreed with the district court’s narrow reading of 28 U.S.C. § 1927. In reversing the lower court, the Third Circuit held that, given that the statute’s purpose is to deter lawyers from multiplying proceedings in bad faith in “any court of the United States,” this necessarily included issues related to the adjudication of a debtor’s main case and adversary proceedings before a bankruptcy court.[10]

The Third Circuit went on to apply a four-part test to determine whether the bankruptcy court abused its discretion in awarding sanctions. The test assesses whether an attorney has “(1) multiplied proceedings; (2) in an unreasonable and vexatious manner; (3) thereby increasing the cost of the proceedings; and (4) doing so in bad faith or by intentional misconduct.”[11] The determination of bad faith can be made implicitly and may be indicated by “findings that the claims advanced were meritless, that counsel knew or should have known this, and that the motive for filing the suit was for an improper purpose such as harassment.”[12] Using the foregoing factors, the Third Circuit determined that it was reasonable for the bankruptcy court to conclude that the conduct of debtor’s counsel, which multiplied the bankruptcy proceedings through several filings attempting to infer nefarious motives into an unremarkable event and without reasonable inquiry to ensure that the allegations had a factual basis, merited the imposition of sanctions.[13]

Although debtor’s counsel in Prosser, through its litany of aggressive filings rooted in the same seemingly minor allegations, may be an extreme example of overzealousness, the Third Circuit’s decision should serve as a cautionary reminder for attorneys to remain conscious of the bounds of reason and good sense, in both a debtor’s main case and in any related adversary proceedings.