[1]Bankruptcy courts are vested with the inherent and statutory authority to sanction litigants for acting in bad faith and engaging in otherwise unreasonable or inappropriate conduct. Rule 9011 authorizes a bankruptcy court to impose sanctions upon attorneys, law firms or parties for the filing and prosecution of pleadings and other papers that are found to be frivolous under Rule 9011(b). There are both procedural and substantive requirements that a court is to consider prior to imposing Rule 9011 sanctions. Section 1927 of Title 28 of the U.S. Code authorizes all federal courts, including bankruptcy courts, to sanction an attorney “who so multiplies the proceedings in any case unreasonably and vexatiously,” and may require the offending attorney to personally pay the “excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct.”[2]
Recently, the U.S. Bankruptcy Court for the Southern District of Texas addressed both of these remedies in In re Harris[3] in the context of whether a party could be sanctioned for failing to timely withdraw a frivolous pleading. After reviewing the standards of both Rule 9011 and
§ 1927, the court held that once the chapter 7 trustee knew his malpractice lawsuit against debtor’s counsel was not legally viable, his failure to diligently withdraw the suit constituted unreasonable and vexatious behavior that warranted the imposition of sanctions pursuant to § 1927, but not under Rule 9011.
Facts
The debtor, Richard K. Harris, was a former assistant U.S. attorney who filed for chapter 7 bankruptcy protection on Oct. 15, 2013.[4] Harris was represented by Margaret McClure. Prior to his petition date, Harris entered into what may have been a sham divorce, as part of which he transferred substantially all of his material assets to his wife.[5] However, the debtor failed to disclose the divorce and the transfers in his filed schedules of assets and liabilities and statement of financial affairs. He informed McClure of his divorce and some but not all of the transfers, yet McClure omitted these from the Schedules and SOFA.[6] The debtor then falsely testified under oath about the transfers he had made pursuant to the divorce.
The trustee commenced an action to deny the debtor his discharge. The debtor placed the blame for his omissions on McClure, and filed an affidavit detailing the fact that he had fully informed his attorney of all of his assets and transfers. The debtor eventually consented to a voluntary waiver of his discharge.[7]
On June 30, 2014, the trustee commenced a lawsuit against McClure for legal malpractice for her representation of the debtor.[8] Prior to suing McClure, the trustee had reviewed McClure’s case file and discovered that the debtor in fact had informed McClure of the divorce and transfers.[9] McClure sent the trustee a Rule 9011(c)(1) “safe harbor” letter demanding that the lawsuit be withdrawn, along with a draft Rule 9011 sanctions motion.
Ultimately, McClure convinced the trustee that the trustee’s malpractice lawsuit lacked merit and should be dismissed, due to his inability to prove causation. Although McClure had actual knowledge of the purported divorce and had actual knowledge of the transfers made pursuant to the divorce, and McClure had filed false schedules and statements in her capacity as debtor’s attorney, the trustee conceded that he could not demonstrate that but for McClure’s actions Harris would not have lost his discharge, as opposed to Harris having forfeited his right to a discharge based on his own conduct.[10]
Rather than dismiss the suit against McClure, however, the trustee used it as a “placeholder” lawsuit and conditioned dismissal on McClure’s disgorgement of the $2,500 in attorney’s fees that the debtor had paid her.[11] Disgorgement, however, was not part of the relief sought in the suit, and McClure refused to disgorge her fees. The chapter 7 trustee failed to dismiss the suit by the expiration of the safe-harbor deadline (Aug. 15, 2014). Thereafter, McClure sought a summary judgment on the trustee’s claims and on her counterclaims under Rule 9011 and 28 U.S.C. § 1927. Several months later, on Oct. 29, 2014, the trustee moved to dismiss the suit against McClure, which the court granted on Jan. 20, 2015.
Discussion
The court first addressed whether the trustee’s initiation of the lawsuit was justified, and determined that it was justified for several reasons. First, McClure is a debt-relief agency as defined under 11 U.S.C. § 101(12A), providing bankruptcy assistance as defined under 11 U.S.C. § 101(4A), for which she charged a fee.[12] As such, under 11 U.S.C. § 526(a)(2), McClure was prohibited from assisting the debtor in making an untrue or misleading statement that based on a reasonable exercise of care she should have been known to be untrue. The court went on to state that McClure knew that the omission of the divorce proceedings constituted an untrue or misleading statement in response to Questions 4 and 10 of the SOFAS.[13] McClure argued that because the trustee could not prove causation, he should never have sued her in the first place. The court rejected this argument because at the time that the trustee signed and filed his lawsuit, he did not lack a good-faith belief that he could prevail.[14] That realization, however, did not occur until several months after the commencement of the suit. Therefore, the court concluded that the filing of the complaint was justified.
The court next addressed whether the chapter 7 trustee’s failure to withdraw the suit once he knew he could not prevail was sanctionable. The trustee did not sue for disgorgement, nor did he proceed with a separate disgorgement motion.[15] Because the court read Rule 9011 to address only the filing of pleadings, not the delayed withdrawal of pleadings, it found Rule 9011 unavailable to McClure, and therefore denied summary judgment as to McClure’s Rule 9011 claim.
However, the court granted sanctions under § 1927.[16] In order to justify fee-shifting under § 1927, the movant must demonstrate that the conduct of opposing counsel is both “unreasonable” and “vexatious.”[17] The court found that the trustee’s failure to withdraw the lawsuit against McClure met both § 1927 standards. First, the trustee’s failure to withdraw the lawsuit was not reasonable. Once the trustee concluded that he could not establish causation, the lawsuit should have been withdrawn, and such failure to withdraw was not reasonable.[18] Second, the failure to withdraw the complaint was vexatious. The only reason that the chapter 7 trustee refused to withdraw the lawsuit was to force McClure to disgorge her fees, yet this was not the relief that McClure had sought.[19]
The court, therefore, awarded McClure reasonable fees and costs incurred after Aug. 15, 2014 (the expiration date of the Rule 9011 safe-harbor deadline), in an amount to be determined.
Takeaways
Harris illustrates that a lawyer may have liability for failing to diligently withdraw a pleading once the lawyer has determined in good faith that he or she cannot prevail on the filed pleading.
[1] Jason I. Blanchard and Richard J. Corbi are law clerks to Hon. Alan S. Trust, U.S. Bankruptcy Judge for the Eastern District of New York. Messrs. Blanchard and Corbi appreciate Judge Trust’s assistance with this article. None of the statements contained in this article constitute the official policy or opinion of any judge, court, agency or government official or quasi-governmental agency.
[2] 28 U.S.C. § 1927.
[3] In re Harris, Case No. 13-36395 (MI), 2015 WL 2210339 (Bankr. S.D. Tex. May 8, 2015).
[4] Id. at *2.
[5] Id.
[6] Id.
[7] Id.
[8] The chapter 7 trustee also sued the debtor and his wife to recover some or all of the transfers made to the wife, asserting that the divorce and transfers were “sham transactions.” Because that matter was still pending, the bankruptcy court declined to express a view on the merits of those claims. Id. at *3 n.2.
[9] Id. at *3.
[10] Id.
[11] Id.
[12] Id. at *4.
[13] Id.
[14] Id. at *5.
[15] Id. at *5.
[16] Id. at *5.
[17] Harris, 2015 WL 2210339, at *6 (relying FDIC v. Calhoun, 34 F.3d 1291, 1300-01 (5th Cir. 1994)).
[18] Id. at *6.
[19] Id.