Creditors with otherwise meritorious claims were thrown out of court because they pulled off a scheme to have the debtor arrested in the midst of mediation.
Bankruptcy Judge Mark S. Wallace of Santa Ana, Calif., said in his Feb. 14 opinion that the creditors shocked the conscience of the court by sabotaging settlement talks for the pleasure of seeing the debtor humiliated in front of his family, his counsel, and the trustee.
It’s not to say, however, that the debtor was without guilt. The facts reflect the bitterness that often accompanies the failure of both a business and a marriage.
The debtor was in business with his brother-in-law. The brother-in-law accused the debtor of misappropriating business assets for his own use. Around the same time, the marriage fell apart, and the couple embarked on divorce proceedings.
Among the siblings and the debtor, there were five lawsuits, including the divorce. In the divorce action, the debtor forged his wife’s signature on a prenuptial agreement. The forgery ended up costing him $750,000 in sanctions and judgments meted out by a state court in Oregon.
Meanwhile, the debtor filed a chapter 7 petition, prompting his estranged wife and her brother to file suit in bankruptcy court to declare debts non-dischargeable and to decide which assets belonged to the debtor’s estate and which were the wife’s property. Judge Wallace ordered the parties into judicial mediation before Bankruptcy Judge Meredith A. Jury.
While the litigation was being bitterly fought in bankruptcy court in California, counsel for the wife was secretly encouraging prosecutors in Oregon to indict the debtor for forgery. Ultimately, the grand jury handed down a sealed forgery indictment.
Prosecutors were reluctant to incur the expense of arresting the debtor in California and extraditing him to Oregon. Urging the authorities to act, the wife’s lawyer eventually persuaded the Oregon prosecutors to arrest the debtor during the mediation in California.
Without having told the debtor he had been indicted or giving him an opportunity to turn himself in, the wife’s counsel and Oregon prosecutors arranged for the debtor to be arrested in the courthouse by U.S. Marshals during the mediation.
After the mediation had been ongoing for several hours, Judge Jury was notified of the impending arrest only minutes before it took place. Judge Wallace reported that Judge Jury was “flabbergasted.” She terminated the mediation after the arrest.
Eventually, the debtor was tried and convicted of forgery in Oregon, but the story doesn’t stop there.
Back in bankruptcy court, Judge Wallace on his own motion held a hearing on whether sanctions should be imposed on the wife and her brother for unclean hands. The result was the judge’s 47-page opinion laying out the facts copiously and tracing the equity powers of the bankruptcy court back to the Middle Ages in England.
Judge Wallace found no statutes or common law “specifically addressing the duty of a party . . . to refrain from sabotaging the mediation.” He therefore analyzed whether “equity provides any relief where mediation sabotage has occurred.” The judge said that bad acts by a plaintiff occurring during litigation can be taken into account in deciding whether the doctrine of unclean hands applies.
Judge Wallace said that mediation “serves an important public interest.” One of the few duties of parties to mediation, he said, is to refrain from action “expected to cause the collapse of mediation prior to its conclusion.” The “most striking” evidence, he said, was the lack of “any effort . . . to arrange the arrest in such a manner that the mediation would not be scuttled.”
Judge Wallace said it was “more important” for the wife’s lawyer to “humiliate and embarrass” the debtor in front of his family, his counsel, and the trustee. The lawyer, he said, “didn’t care one whit that the mediation was ruined.”
Judge Wallace conceded that the debtor had been guilty of bad acts, but unlike the wife and her brother, the debtor had been punished already by conviction of a felony, loss of his real estate license, and the cost of years of litigation.
In deciding whether to sanction, an important factor evidently was prejudice visited on the trustee by the collapse of the mediation, where she had hoped to wrap up the bankruptcy.
The litigant’s conduct “shocks the moral sensibilities of the court,” Judge Wallace said, because it was undertaken “for the express purpose” of humiliating the debtor, prejudiced the trustee, adversely affected public interest in encouraging mediation, and “fatally undermined the mediation order of this Court.”
Judge Wallace therefore dismissed the wife’s and her brother’s claims in two pending litigations, while reserving judgment on whether he would impose sanctions for infecting the entire bankruptcy case.
Judge Wallace included a finding in his opinion that may have a telling effect should the wife sue her lawyer for malpractice. He said that the “full responsibility for the mediation’s collapse rests . . . on the shoulders [of the wife’s lawyer] because he knew or reasonably should have known that the course of action on which he embarked was virtually certain to scuttle the mediation.”