For filing a meritless proof of claim, Bankruptcy Judge Stacey G. C. Jernigan of Dallas imposed $826,000 in sanctions on a creditor, representing costs the chapter 11 debtor incurred over three years of litigation in beating the creditor’s claim.
The debtor and the creditor shared ownership of a nondebtor that owned valuable real estate. The documents showed the creditor as owning about 47%. The creditor was controlled by an individual who had been the debtor’s chief executive until he was removed a few months following the debtor’s chapter 11 filing.
The creditor filed a proof of claim asserting that the creditor owned most or all of the real estate company due to mutual mistake or other theories. The debtor objected, spawning “years of litigation,” Judge Jernigan said in her March 4 opinion.
On the eve of trial to resolve the claim objection, the creditor filed a motion to withdraw the claim under Bankruptcy Rule 3006. After an objection has been filed, the rule says:
[T]he creditor may not withdraw the claim except on order of the court after a hearing on notice to the trustee or debtor in possession . . . The order of the court shall contain such terms and conditions as the court deems proper.
Although Judge Jernigan might have allowed withdrawal of the claim, the creditor would not consent to withdrawal unless it were without prejudice, allowing the creditor to make the same claims later against parties related to the debtor. The debtor was insisting on withdrawal with prejudice, so the same claim would not arise later in a different context.
There having been no agreement on withdrawal of the claim, Judge Jernigan wrote an opinion denying withdrawal of the claim. She then proceeded with a hearing on the claim itself and sustained the objection in a separate, 39-page opinion. The creditor did not appeal the order expunging the claim, and it became final.
During the hearing on the claim objection, the debtor asked for sanctions. To accord due process, Judge Jernigan instructed the debtor to make a separate motion and itemize the legal work for which the debtor sought reimbursement.
Judge Jernigan granted the sanctions motion, finding that the creditor “acted in bad faith and willfully abused the judicial process in filing, prosecuting, and then pursuing an eleventh-hour withdrawal of its Proof of Claim.”
For authority to sanction, Judge Jernigan paraphrased the Fifth Circuit for saying that a “bankruptcy court may sanction a litigant for bad faith filing or litigation if the court makes specific findings, based on clear and convincing evidence, of bad faith or willful abuse of the judicial process.” She said that the “bankruptcy court’s power to sanction bad faith or willful abuse of the judicial process derives from its inherent authority under 11 U.S.C. § 105(a) to issue civil contempt orders.”
To justify her finding of bad faith, Judge Jernigan said:
The evidence overwhelmingly supports a finding that [the creditor’s principal] signed and authorized the filing of the Proof of Claim (that the court ultimately determined was lacking in any factual or legal support) without having even read it and without conducting any due diligence on, or investigation into, whether the statements made in the Proof of Claim were truthful and accurate, which supports a finding that [the creditor’s principal’s] signing and filing of the Proof of Claim on behalf of [the creditor] was done in bad faith and constituted a willful abuse of the judicial process.
Alluding to the creditor’s attempt at withdrawing the claim without prejudice on the eve of trial, Judge Jernigan said that she “expressly finds and concludes that [the creditor’s] litigation strategy and actions in prosecution of its Proof of Claim (including . . . its repeated and overt attempts to preserve the very claims upon which its Proof of Claim was based in connection with the Motion to Withdraw) demonstrates bad faith and a willful abuse of the judicial process on the part of [the creditor].” The “litigation strategy and actions taken in the course of prosecuting its Proof of Claim,” she said, “provide further support for a finding that [the creditor] engaged in bad faith and willfully abused the judicial process.” [Emphasis in original.]
Testimony on behalf of the creditor at trial provided further basis for sanctions. Judge Jernigan said that trial testimony by the creditor’s principal (the ousted CEO of the debtor) and another witness “revealed that [the creditor] had no factual basis to claim that a mistake was made by any of the parties” in apportioning ownership of the nondebtor real estate company. She went on to say that the creditor “was also unable to produce any evidence at Trial to support its factual allegation that there was a ‘lack of consideration’ or a ‘failure of consideration’ with respect to” apportionment of ownership of the real estate company.
In sum, Judge Jernigan said that the testimony at trial “made clear that [the creditor] never had a factual or legal basis for the Proof of Claim.”
As a sanction, the debtor was seeking recovery of $826,000 in legal fees and expenses. Judge Jernigan said, “Reimbursement of the opposing party’s fees and costs incurred in responding to a bad faith filing or willful abuse of the judicial process has been upheld [by the Fifth Circuit] as an appropriate form of sanctions.”
Citing the Supreme Court, Judge Jernigan said that an injured party can recover the fees it would not have incurred “but for” the bad faith. Overruling the creditor’s objection to the amount, she imposed a sanction of $826,000 on the creditor, representing everything sought by the debtor.
Notably, Judge Jernigan imposed no sanctions on any of the three law firms that had represented the creditor with regard to the proof of claim.
For filing a meritless proof of claim, Bankruptcy Judge Stacey G. C. Jernigan of Dallas imposed $826,000 in sanctions on a creditor, representing costs the chapter 11 debtor incurred over three years of litigation in beating the creditor’s claim.
The debtor and the creditor shared ownership of a nondebtor that owned valuable real estate. The documents showed the creditor as owning about 47%. The creditor was controlled by an individual who had been the debtor’s chief executive until he was removed a few months following the debtor’s chapter 11 filing.
The creditor filed a proof of claim asserting that the creditor owned most or all of the real estate company due to mutual mistake or other theories. The debtor objected, spawning “years of litigation,” Judge Jernigan said in her March 4 opinion.