Ninth Circuit Strikes Down Sanction Award, Limiting Awards under Local Rules

In Pham v. Golden,[1] the Ninth Circuit Bankruptcy Appellate Panel (BAP) reversed an award of sanctions against the debtors and their counsel for discovery abuses in an adversary in which the debtors were not parties. In doing so, the court limited or invalidated several local rules that provided the basis for the bankruptcy court’s award of sanctions.

Background

The case involved the trustee’s efforts to recover four properties conveyed to defendants Phat The Bui and Thuan Tran. The debtors were not parties to the fraudulent transfer adversary, but both were subpoenaed as witnesses pursuant to Fed. R. Civ. P. 45 (Fed. R. Bankr. P. 9016), commanding them to appear for depositions and to produce documents. The description of the resulting events is detailed and disputed, ultimately leading to the trustee’s motion to compel and for sanctions against the debtors and their counsel. The motion argued that debtors’ counsel had failed to provide information for a joint discovery stipulation required by Local Bankruptcy Rule (LBR) 702601(c)(3), and that sanctions were available pursuant to LBR 1001-1(f), 7026(1)(c) and 9011-3.

Bankruptcy Judge Catherine E. Bauer agreed, finding that debtor’s counsel had failed to comply with the rules, leading to a hearing that should not have been necessary.  The bankruptcy court granted the motion to compel and awarded sanctions in the form of attorneys’ fees in the amount of $17,515 against the debtors and their counsel. Debtors thereafter complied with the discovery, and the appeal was limited to the sanction award. 

The Decision

The BAP held that sanctions were not available under the cited local rules, then delved into the rule-making process. “Congress delegated to the [U.S.] Supreme Court the power to make and enforce general bankruptcy rules. 28 U.S.C. § 2071.”[2] Fed. R. Bankr. P. 9029(a)(1) permits district courts (or, if delegated by the district court, bankruptcy courts) to make and adopt local rules that are consistent with federal law and the Federal Rules of Bankruptcy Procedure (FRBP). However, LBRs may not modify substantive rights,[3] and any local rule that is inconsistent with federal law or the Federal Rules must be held invalid.

Central District of California LBR 9011-3 provides that a violation of the FRBP or the local bankruptcy rules may subject the offending party or its counsel to penalties, including monetary sanctions in the form of payment of the opponent’s costs and attorneys’ fees. Any application of this rule to discovery was held by the Pham court to be inconsistent with Fed. R. Bankr. P. 9011(d), which provides that sanctions under 9011(a)-(c) are inapplicable to discovery.[4] Similarly, an effort to impose sanctions pursuant to LBR 7026(1)(c)(4), which provides for an award of fees for failure to cooperate in disclosure or discovery, was inappropriate for application to a non-party.[5]

However, the BAP went further, concluding that since Fed. R. Bankr. P. 7026 “does not expressly provide for sanctions for discovery abuse, in particular attorney’s fees with respect to a motion for a protective order, opposition thereto, or a motion to compel, neither can LBR 7026-1.”[6] For the same reason, and with potentially far-reaching effect, the court held LBR 1001-1(f), which provided a “catch all” rule authorizing an award of attorneys’ fees for the failure of counsel or a party to comply with any of the local, the Federal Rules of Civil or Bankruptcy Procedure, or any order of the bankruptcy court, to be inconsistent with Fed. R. Bankr. P. 1001 since that rule does not expressly authorize sanctions for violating other federal rules. Since LBR 1001-1(f) grants sanction authority not provided for in the parallel bankruptcy rule, it is inconsistent therewith, and therefore invalid.[7] This reasoning is potentially applicable to any local rule that provides for an award of attorneys’ fees or other sanction where the national rule does not provide an explicit authorization for such an award.[8]

Takeaway

The court also discussed what could have been an appropriate basis for the court’s award. Fed. R. Civ. P. 37(a)(5), incorporated into Fed. R. Bankr. P. 3037, authorizes (and, in some cases, mandates) an award of attorneys’ fees when a motion to compel attendance at a deposition is granted (or to the deponent when the motion is denied). Fed. R. Civ. P. 30(d)(2) and (3)(C), incorporated into Fed. R. Bankr. P. 7030, provide for sanctions where a person impedes, delays or frustrates the fair examination of the deponent, or on a motion to terminate or limit a deposition. However, with respect to the production of documents by a non-party pursuant to subpoena, the rules are different. As held in In re Plise,[9] the failure to produce documents by a non-party pursuant to a subpoena under Rule 45 cannot be the basis of Rule 35(a)(5) sanctions. “A nonparty served with a subpoena has three options: it may (1) comply with the subpoena, (2) serve an objection on the requesting party in accordance with Civil Rule 45(c)(2)(B), or (3) move to quash or modify the subpoena in accordance with Civil Rule 45(c)(3).”[10] Once objections are raised, the responding party has no duty to produce documents, “or even search for them,” until the propounding party obtains an order for compliance.[11] Where the non-party timely objects or files a motion to quash or modify the subpoena, sanctions cannot be awarded unless the court orders compliance and thereafter the documents are not produced.[12] (A motion for contempt must also be filed and heard as a precondition to such an award.)[13] The court said that a “bankruptcy court also could not impose sanctions under its ‘inherent authority’ for abuse of the judicial process, absent a showing and finding of bad faith.”[14]

Conclusion   

While the trustee had a colorable basis for relying on the local rules, the ruling below did not clearly follow the path laid down in the Federal Rules that would be applicable to non-parties. (In fact, the bankruptcy court made multiple statements to the effect that the debtors were “parties” when, in the context of the adversary proceeding, the debtors were third-party witnesses.) Further, the BAP noted that the bankruptcy court failed to enter findings and conclusions, required because the motion to compel was a contested matter and therefore, pursuant to Fed. R. Bankr. P. 9014(c) subject to the requirements of Fed. R. Civ. P. 7032(a) (via Fed. R. Bankr. P. 7032) to make separate findings of fact, either verbally on the record or in writing. The outcome might have been different if the movant had more carefully traversed the procedural minefield, identifying the basis in both the local rules and the federal rules for the requested sanctions, citing only rules relating to non-parties, and preparing appropriate findings of fact and conclusions of law to support the imposition of the fee sanction.