Recently, in In re Frantz,[1] the U.S. District Court for the District of Idaho affirmed the bankruptcy court’s assessment of $49,477.46 in sanctions against the debtors and their attorney for improper litigation tactics. The court held that evidence that the debtors delayed filing motions to disqualify Idaho Independent Bank’s (IIB’s) counsel and expert witnesses until shortly before trial was sufficient to support a finding of bad faith. Additionally, the court held that the debtors’ use of the disqualification motions to “vet a malpractice suit against [IIB counsel] in the hopes of manipulating a settlement with IIB [was] alone sufficient to support the Bankruptcy Court’s finding of bad faith.”[2]
Facts
Debtors filed a bankruptcy case in October 2011. In August 2013, creditor IIB filed an adversary proceeding seeking nondischargeability based on alleged fraud and conversion. The debtors hired their son, attorney Jonathon Frantz, to represent them as co-counsel in the bankruptcy and adversary proceeding. Son Frantz eventually became the debtors’ lead attorney in the adversary.
In December 2013, the bankruptcy court set a trial date on the adversary for December 2014, allowing additional time due to the complicated nature of the case. In October 2014, the debtors moved to continue the trial to allow more time for disclosure of expert witnesses. In the motion to continue, the debtors made vague allegations regarding the potential disqualification of IIB’s counsel, Hawley, Troxell, Ennis & Hawley, LLP (HT). After the court denied the motion to continue, the debtors filed motions to disqualify HT because an HT partner had served as an expert witness for the debtors in prior litigation. The debtors also moved to disqualify IIB’s expert witness, Rand Wichman, because Wichman had previously worked for the debtors as a consultant.
After considering the briefing and oral arguments, the bankruptcy court determined that “the showing by the defendants in their submissions was less than compelling or even preponderating and [was] not then adequate to justify granting the motions.”[3] However, because a ruling based on an inadequate showing “would leave a cloud hanging over the entire case and hanging over [IIB’s] law firm,” the bankruptcy court vacated the trial and set the disqualification motions for an evidentiary hearing. At the conclusion of the hearing, the court denied the motions to disqualify and noted that the motions “could well be viewed as strategic rather than meritorious and designed solely to gain the relief that the failed motion to continue the trial didn’t achieve.”[4] The trial could not be reset until the end of May 2015.
On May 1, 2015, the debtors signed a waiver of discharge as to all creditors and vacated the nondischargeability trial. On June 2, 2015, IIB filed a motion for sanctions for the actions taken by the debtors and their counsel, including filing the motion to continue on the eve of the discovery deadline and filing the motions to disqualify in bad faith after the motion to continue was denied. IIB noted that the debtors had recently filed a malpractice suit against HT in state court based on the same facts and claims that the bankruptcy court had rejected. In a supplement, IIB provided an email sent by Mr. Frantz to IIB in which Mr. Frantz suggested that IIB join the malpractice suit against HT to leverage a settlement and stated that “we pursued the disqualification case as a probe so that [the debtors’ malpractice attorney, Mr. Katz] could wrap his head around the issues and really understand what happened and to see how HT would defend themselves.”[5]
The bankruptcy court partially granted the motion for sanctions, finding a broad range of litigation tactics, including delaying or disrupting litigation and acting in the litigation for an improper purpose.
Discussion
Bankruptcy courts have inherent authority to sanction parties and their attorneys for improper conduct in bankruptcy proceedings, including improper litigation tactics such as delaying or disrupting litigation, vexatious conduct, bad faith, and acting in the litigation for an improper purpose or for oppressive reasons.[6] Such inherent powers must be exercised with discretion,[7] and sanctions can only be imposed upon the court’s explicit finding of bad faith or willful misconduct consisting of something more than mere negligence or recklessness.[8]
The debtors argued that a finding of bad faith requires that the motions to disqualify be both reckless and frivolous and claimed that because they employed due care prior to filing the motions, a finding of bad faith was not warranted even if the motions were frivolous. In affirming the bankruptcy court’s decision, the district court held that the finding of bad faith was based on something “more egregious than mere negligence or recklessness” and found ample support for the bankruptcy court’s finding of bad faith in the debtors’ egregious delay in filing the disqualification motions despite learning of the former relationship several months earlier. The district court cited In re Itel Sec. Litig.[9] for the proposition that the debtors’ use of the disqualification motions in order to gain an advantage in the state court litigation was “alone sufficient to support a finding of bad faith.”
In affirming sanctions against Attorney Frantz, the court held that consulting with a nationally recognized malpractice attorney before the disqualification motions were filed and then filing the state court malpractice suit soon after the motions were denied was evidence that Attorney Frantz acted in bad faith.
The district court noted that the burden of proof for findings of bad faith is not settled in the Ninth Circuit, but held that the bankruptcy court’s finding was supported by clear and convincing evidence.
Conclusion
The debtors and their attorney used litigation tactics to delay the trial and increase costs in an effort to manipulate a settlement. The motions to disqualify were found to be frivolous, but even if they were not, using the motions for the improper purpose of gaining an advantage in another case was sufficient for the court to find bad faith and impose sanctions.
[1] Idaho Independent Bank v. Frantz (In re Frantz), Case. No. 15-00460-EJL (D. Idaho Aug. 31, 2016).
[2] Id. at 22.
[3] Id. at 6.
[4] Id. at 9.
[5] Id. at 10.
[6] In re Lehtinen, 564 F.3d 1052, 1058 (9th Cir. 2009); In re McGuire, 2014 WL 4418549 at *4 (D. Idaho 2014).
[7] In re Lehtinen, 564 F.3d 1052, 1058 (9th Cir. 2009).
[8] In re Dyer, 322 F.3d 1178, 1196 (9th Cir. 2010).
[9] 791 F.2d 672 (9th Cir. 1986).