Sixth Circuit Affirms Sanctions for “Indisputable” Creditor Misconduct

         Concluding long and contentious litigation, the Sixth Circuit Court of Appeals recently affirmed a determination by the U.S. Bankruptcy Court for the Southern District of Ohio awarding sanctions against a creditor and its counsel who engaged in sanctionable, bad-faith misconduct during the prosecution of a chapter 11 bankruptcy case.[1]

          In In re Bavelis, the debtor issued a $14 million pre-petition promissory note to Quick Capital (“Lender”), an entity owned by the debtor’s friend and business associate (“Lender Principal”). After the debtor filed its chapter 11 bankruptcy, he and Lender Principal became embroiled in litigation concerning their various business dealings. Among other actions, Lender filed a proof of claim on account of the $14 million note, but thereafter sold and assigned its claim to an unrelated entity (“Assignee”) in exchange for $1.8 million. However, Lender Principal and his counsel (“Lender Counsel”) intentionally concealed the assignment from the debtor and the bankruptcy court, believing that doing so could force a settlement of the various pending litigations or otherwise maximize Assignee’s recovery on the note.

         Soon enough, the debtor discovered the assignment in unrelated litigation and brought it to the bankruptcy court’s attention. The bankruptcy court found that Lender Principal and Lender Counsel made false representations regarding Lender’s status as a creditor in the case, failed to identify the assignment in discovery propounded by the debtor (where the assignment was clearly responsive), and generally frustrated the debtor’s efforts to settle the cases under the pretext that Lender remained a creditor. The bankruptcy court determined that these actions, among others, constituted egregious, bad-faith conduct on the part of Lender Principal and Lender Counsel.

         As to Lender Counsel and Lender Principal, the bankruptcy court relied on its inherent equitable powers under 11 U.S.C. § 105 to sanction. As to Lender Counsel specifically, the bankruptcy court found its authority to sanction in 28 U.S.C. § 1927, which permits a court to order an attorney to “satisfy personally the excess costs, expenses, and attorneys’ fees incurred” where the attorney “so multiplies the proceedings in any case unreasonably and vexatiously….”[2] Based on Lender Counsel’s conduct in, among things, concealing the assignment, his conduct “‘objectively fell far short of [his duty of candor to the court]” and his actions constituted unreasonable and vexatious litigation tactics under § 1927.[3]

         Following the presentation of evidence regarding the amount of sanctions to be imposed, the bankruptcy court awarded the debtor attorneys’ fees and expenses jointly and severally against Lender Principal and Lender Counsel and separately ordered Lender Counsel to pay excess fees and costs incurred in light of his unreasonable and vexatious conduct under 28 U.S.C. § 1927. In so doing, the bankruptcy court recognized the recent opinion of the U.S. Supreme Court in Goodyear Tire & Rubber v. Haeger, which limits a federal court’s inherent authority to sanction bad-faith conduct by a litigant to the fees incurred by the innocent party solely attributable to the misconduct.[4] The bankruptcy court found that the debtor established that approximately half of the requested fees and expenses would not have been incurred but-for Lender Principal’s conduct and, under Haeger, awarded the debtor that amount. On immediate appeal, the district court affirmed.

         On appeal, the Sixth Circuit found that in determining an award of sanctions against a litigant for bad-faith conduct, Haeger’s “but-for” test is the applicable standard and “[t]hat is precisely the approach employed by the bankruptcy court here.”[5] The Sixth Circuit found that the bankruptcy court “individually assessed each category” of claimed behavior and “explained at length why the evidence of the record either did or did not support a finding of but-for causation in each category.”[6] In so concluding, the Sixth Circuit summarized:

Ultimately, this appeal boils down to [Lender Principal’s] back-door attempt to relieve themselves of any responsibility for the misconduct in which they indisputably engaged. They do not directly challenge the bankruptcy court’s determination that they engaged in sanctionable misconduct. The bankruptcy court, following a hearing and looking to an extensive factual record, rejected [Lender Principal’s] characterization of events and concluded that their bad-faith conduct caused [the debtor] to incur over $250,000 worth of unnecessary costs and fees. That “judgment[ ], in light of the [bankruptcy] court’s superior understanding of the litigation, [is] entitled to substantial deference on appeal.[7]