The U.S. District Court for the Eastern District of Texas held Sept. 21 that a bankruptcy court did not abuse its discretion in sanctioning a Chapter 13 debtor's counsel for attempting to abuse the bankruptcy process by discharging debts his client could not in good faith challenge (In re Armstrong, E.D. Tex., No. 4:11-cv-00772-RC, 9/21/12).
Affirming the decision of the bankruptcy court imposing $500 in sanctions against debtor's counsel, Judge Ron Clark concluded that debtor's counsel engaged in an improper scheme to obtain the equivalent of a Chapter 7 discharge.
The court found that the record reflected that debtor's counsel participated in, or facilitated a scheme to improperly manipulate the bankruptcy process. Despite repeated warnings, debtor's counsel refused to modify his behavior, the court said. According to the court, debtor's counsel is an experienced attorney who chose a deliberate course of action designed to obtain benefits for his client to which she was not entitled. Further, counsel did not investigate the information his client had pertaining to creditor's claims and he failed to know and observe local rules of the court, the court said.
According to the court, the bankruptcy court's findings of fact are well supported by the record and are correct. Imposition of sanctions was warranted, the court said.
On her schedules, the debtor listed all of her credit card debts, and included the statement as follows: “Debtor listed the balance shown on last statement, debtor not presently able to determine if balance is correct and is uncertain if trade name is correct legal creditor.” Twelve creditors filed claims against the debtor totaling $17,400. The debtor's Chapter 13 plan proposed to make monthly payments for a period of 60 months that would result in full payment to all her general unsecured creditors.
No creditor objected to the plan, and the bankruptcy court entered an order confirming the plan.
Some claimants subsequently filed amended claims with additional documentation or provided debtor's counsel with additional documentation including billing statements and cardholder agreements. Debtor's counsel, however, filed seven certificates of no response to debtor's objections, notifying the court that these seven creditors had not responded to the debtor's lack of documentation objections.
In a second hearing, members of counsel's law firm appeared and testified that they believed the objections were sufficient because the creditors did not comply with Federal Rule of Bankruptcy Procedure 3001 and their claims were not prima facie valid. Subsequently, the bankruptcy court ruled that the proofs of claims substantially complied with Rule 3001, and sufficiently informed the debtor of the basis of the claims. The court then vacated the order confirming the debtor's plan on the grounds that the debtor acted in bad faith.
The bankruptcy court also addressed the ethical concerns raised by counsel's lack of personal knowledge of the debtor's debts, his failure to investigate, and to assure to the best of his ability that the schedules were complete and accurate before they were filed, and the failure to comply with the court's request to provide the court with more evidence in support of claim objections.
Armstrong also noted that courts were divided as to whether a claims objection can be based totally on lack of documentation. According to Armstrong, in Northern District practice, claimants who failed to respond to his lack of documentation objections were considered in default and his objections would be sustained. The Eastern District where this case is filed, however, does not follow this practice, the court noted. Armstrong then filed a legal brief in support of his argument that lack of documentation was a substantive objection under the Bankruptcy Code.
On Sept. 30, 2011, the bankruptcy court issued a memorandum finding that counsel engaged in an improper scheme to allow his client to obtain a quick discharge of her unsecured debt in violation of Rule 9011(b). The court then ordered Armstrong to pay a penalty of $500 to deter repetition of each conduct and comparable conduct by others similarly situated.
Armstrong appealed to the district court.
According to the court, there was no basis to claim that Armstrong's contentions were warranted by existing law. Attorneys must abide by the conduct set forth in the court's local rules, the court explained, citing Local Rule AT-3. The Eastern District does not allow debtors to object to claims a debtor has no basis to contest, merely on the basis of “insufficient documentation,” the court said. Armstrong did not argue that the Eastern District should change its rules to comply with those of the Northern District, but even if it had, he did not provide any authority for the proposition that the Northern District encourages automatic rejection of valid claims a debtor knows are properly owed, merely because of insufficient documentation, the court said.
A strong deterrence must be a consideration when a judge considers sanctions, the court said. After some claimants responded to counsel's demands for more and more proof, seven were left, the court noted, and the debtor attempted to obtain a Chapter 7 style discharge of their claims in the amount of $57,478. The sanction of $500 is less than one percent of that amount, the court said. “[T]he sanction will encourage counsel to conduct a proper investigation of each client's assertions, to read the Bankruptcy Rules and the local rules of court, and to refrain from pleadings that have no basis in law or fact,” the court said.
By Diane Davis
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