Sanctions imposed on a creditor and its lawyers for violating the automatic stay and the discharge injunction may not be the end of the story. As demonstrated in a March 29 opinion by Bankruptcy Judge Christopher M. Klein of Sacramento, Calif., the client and the lawyers may also have liability under Rule 9011 for misrepresenting the facts and the law in a failed attempt at fending off sanctions for running afoul of Sections 362 and 524.
The teachings of Judge Klein’s new decision are threefold: (1) Clients and lawyers must ’fess up to the indisputable facts of stay violations; (2) they must not misrepresent the law that’s staring them in the face, and (3) when they’re already in an ethical bind, they shouldn’t make matters worse by ignoring (1) and (2).
LeGrand I
Two years ago in an opinion we shall refer to as LeGrand I, Judge Klein imposed $25,000 in punitive damages and about $9,900 in actual damages on a law firm and its client, an outfit that purchases and collects defaulted debt.
Judge Klein found “clear and convincing evidence” of “willful” violations of the automatic stay that morphed into violations of the discharge injunction. He characterized the actions as “callous disregard of the law and the rights of the debtor.” In re LeGrand, 612 B.R. 604, 612, 616 (Bankr. E.D. Cal. Feb. 6. 2020). To read ABI’s report on LeGrand I, click here.
In LeGrand I, Judge Klein said that the creditor’s counsel, whom he called “expert debt collectors,” attempted to avoid the imposition of sanctions by misrepresenting the facts and California’s garnishment law. LeGrand I at 611, 616.
On his own motion after LeGrand I, Judge Klein directed the creditor and its lawyers to show cause why they should not be found to have violated Rule 9011 for having misrepresented the facts and California law when defending the original motion for sanctions. The upshot was Judge Klein’s LeGrand II opinion on March 29.
Collection lawyers and their clients should read LeGrand II in full text. It’s a treatise on the liabilities of the lawyer and the lawyer’s client when there has been a Rule 9011 violation. That is to say, the opinion explains when a client can be liable for the lawyer’s transgression of Rule 9011.
In LeGrand II, Judge Klein has two principal teachings:
[For a company in the business of collecting debts,] the creation of an appropriate structure for responding to bankruptcy situations can protect against rogue local counsel so long as the structure is actually implemented and enforced.
and
Any lawyer tempted to dissimulate with a court ought to leave this decision with the messages that lack of candor with a court is a bad idea and that the continuing duty of Rule 9011(b) to recede from positions that lack merit has teeth.
The Stay and Discharge Violations
Here are the facts:
The creditor had a judgment for about $21,000 and turned the judgment over to a local law firm for collection. The firm served papers on the judgment debtor’s employer to garnish wages.
When the garnishment hit, the employee already had an outstanding garnishment for child support. Under California law, the employee’s wages at the time were not high enough to require the employer to withhold on account of both child support and the $21,000 judgment.
After the garnishment, the employee filed a chapter 7 petition and gave notice to the collection firm. However, the firm did not withdraw the garnishment. Evidently, the firm did not tell the client about the bankruptcy.
While in bankruptcy, the debtor’s wages rose to a level where the employer was required to withhold on account of the $21,000 judgment. As a result, the debtor’s wages were garnished in violation of the automatic stay twice before the debtor received his discharge.
The law firm also had notice when the debtor received his discharge, but the firm did not withdraw the garnishment. Consequently, the debtor’s wages were garnished five more times after discharge.
After the third garnishment following discharge, the debtor’s lawyer faxed a letter to the law firm demanding the return of the garnished funds and withdrawal of the garnishment. The law firm ignored the letter, according to Judge Klein. The law firm also ignored several telephone calls and messages from the debtor’s lawyer to the collection firm.
After the seventh garnishment, the debtor’s lawyer filed a motion asking Judge Klein to impose sanctions. The debtor served the contempt motion on both the lawyer and client. Judge Klein found that the service of the motion was the first time that the client knew about the bankruptcy.
Evidently on instructions from the client, the collection firm withdrew the garnishment three days after service of the contempt motion, but after almost $900 had been withheld from the debtor’s wages. The garnishment was withdrawn 19 days after the debtor’s counsel had faxed the letter to the firm demanding that the garnishment be lifted.
As we said earlier, Judge Klein imposed $25,000 in punitive damages and about $9,000 in actual damages jointly and severally on the law firm and its client. He left it to the creditor and its lawyers to decide who would pay the monetary sanctions. As we also said earlier, Judge Klein sua sponte directed the creditor and its lawyers to show cause why they had not violated Rule 9011 by misrepresenting the facts and California law.
The court’s monetary sanctions weren’t the only possible sanctions. Judge Klein said that his opinion imposing monetary sanctions required the firm to self-report to state bar disciplinary authorities.
The Misrepresentations
Responding to the OTSC, the lawyers argued nine times both in pleadings and at oral argument that they had acted “promptly” to withdraw the garnishment after the letter from the debtor’s lawyer.
Judge Klein said that the written and oral statements were misrepresentations because they did not admit the 19-day delay in lifting the garnishment. In terms of the law firm’s culpability, the misrepresentation also obscured the fact that the firm only lifted the garnishment after the client for the first time became aware of the bankruptcy and the stay and discharge violations.
In responding to the OTSC, Judge Klein also found that the firm misrepresented California law. He said the firm cited a general provision in state law that would tend to exonerate the firm from liability for failure to lift the garnishment.
However, Judge Klein said the firm failed to cite an exception to the general provision in state law that would obligate the firm to vacate the garnishment. Specifically, he said that the firm “materially misstated that law by way of selective citations.”
Rule 9011 Sanctions?
LeGrand II is an exegesis on the finer points regarding monetary and non-monetary sanctions that can be imposed on a lawyer or the lawyer’s client for Rule 9011 sanctions.
Judge Klein focused on the misrepresentations in the context of Rule 9011(b)(3). A written or oral representation, according to the rule, is a certification “that to the best of the person’s knowledge, information, and belief, formed after an inquiry reasonable under the circumstances . . . the allegations . . . have evidentiary support . . . after a reasonable opportunity for further investigation or discovery.”
Given the misrepresentations, Judge Klein analyzed Rule 9011 liability for the client and the attorney.
The client had protection from Rule 9011 sanctions because it had promulgated written guidelines that should have been followed by the lawyer. Judge Klein found that the lawyers failed to comply with the client’s guidelines in three respects: (1) The lawyers failed to vacate the garnishment when first learning about the bankruptcy; (2) the lawyers failed to respond to the debtor’s demand letter, and (3) the lawyers failed to notify the client about the debtor’s demands.
Of further exculpatory value, the client wasn’t aware of the stay and discharge violations until the client was served with the motion for sanctions. Once notified, the client evidently directed the lawyers to vacate the garnishment.
Of relevance to the question of whether he should sanction the firm for violating Rule 9011, Judge Klein said that the client required the firm to pay the previously assessed monetary sanctions for the stay and discharge violations. In addition, the partner in charge of the matter was barred from further work for the client. Also, the lawyers were required to self-report to the bar association.
Judge Klein said that he had “discretion” to impose both monetary and non-monetary sanctions on the client, as a “represented party,” under Rule 9011(b)(3) but only non-monetary sanctions under Rule 9011(b)(2).
Judge Klein said that the client had proper guidelines for its outside counsel that it “actually enforced.” He said that the client had “participated” only to the extent of directing the lawyers to vacate the garnishment and the “imposed negative consequences on its offending local counsel.”
Exercising discretion, Judge Klein decided that sanctions on the client were not warranted.
With regard to the firm, Judge Klein said that the client had “reined in” the firm by requiring the lawyers to pay the sanctions for the stay and discharge violations and by barring the partner from further work on the client’s matters.
Given the firm’s self-reporting to the bar association and the sanctions it paid, Judge Klein said that the firm would be “unlikely to be so cavalier in the future.”
The firm dodged a second bullet and was saddled with no more sanctions. Deterrence was being served, Judge Klein said, “by the issuance of this opinion without the need to inflict an additional specific penalty by this court” on the lawyers.
Sanctions imposed on a creditor and its lawyers for violating the automatic stay and the discharge injunction may not be the end of the story. As demonstrated in a March 29 opinion by Bankruptcy Judge Christopher M. Klein of Sacramento, Calif., the client and the lawyers may also have liability under Rule 9011 for misrepresenting the facts and the law in a failed attempt at fending off sanctions for running afoul of Sections 362 and 524.
The teachings of Judge Klein’s new decision are threefold: (1) Clients and lawyers must ’fess up to the indisputable facts of stay violations; (2) they must not misrepresent the law that’s staring them in the face, and (3) when they’re already in an ethical bind, they shouldn’t make matters worse by ignoring (1) and (2).