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By Diane Davis
Dec. 31 --The U.S. Bankruptcy Court for the Central District of California Dec. 11 held that sanctions of $5,000 under Federal Rule of Bankruptcy Procedure 9011 are appropriate against a law firm for filing a “baseless” and frivolous adversary complaint against a Chapter 7 debtor, and failing to conduct a “reasonable and competent inquiry” prior to filing the proceeding (Target Nat'l Bank v. Nelson (In re Nelson), 2013 BL 342730, Bankr. C.D. Cal., No. 6-12-ap-01480, 12/11/13).
Concluding that “sunlight is the best disinfectant” in cases such as this one, Judge Scott C. Clarkson determined that monetary sanctions alone would not be effective in meeting the deterrence goals of Rule 9011 and that true deterrence calls for “both a monetary sanction and for the exposure of this pattern and practice” by Weinstein, Pinson & Riley (WPR).
The court found that the adversary complaint filed by WPR against debtor Elizabeth Blanche Nelson was “baseless” within the meaning of Rule 9011 because there was no evidence that could reasonably support the adversary complaint under Bankruptcy Code Section 523(a)(2)(C), which applies to purchases of luxury goods or services prepetition.
According to the court, the adversary complaint falls below the minimum standards of competence and reasonableness and WPR failed to conduct discovery and investigate the underlying nature of the fraud charges under Section 523(a)(2)(A). There was also no evidence that could reasonably support WPR's allegation concerning the debtor's alleged “credit card kiting” under Section 523(a)(2)(A), the court said. WPR had ample time and resources to conduct an appropriate investigation, but failed to do so, the court said.
While WPR contended that the pleadings were “all filed in good faith,” Rule 9011 “makes no exception for a pure heart, empty head,” the court said, quoting Zaldivar v. City of Los Angeles, 780 F.2d 823 (9th Cir. 1986). The court also found that WPR had been sanctioned in other similar cases such that there was a pattern or practice of activity with this law firm.
Target referred the account to WPR and provided them with a referral sheet. The referral sheet indicated that the debtor had incurred only two charges on the account, and had made regular payments well above the minimum payments due on the account up until shortly before filing for bankruptcy. One charge was made 82 days prior to the petition date in the amount of $2,294 at a Sears Roebuck store, and the other charge was in the amount of $1,948 at a Jennifer Convertible store.
WPR attorney Richard Ralston, who has since retired, claimed that he reviewed the debtor's statements and the account, and concluded that based on the debtor's use of the card, there was a basis to believe that the charges were nondischargeable under Section 523(a)(2).
Ralston subsequently resigned from WPR and retired from law practice. Lourdes Slinsky, Ralston's successor, engaged in settlement negotiations with the debtor's counsel, but later resigned. Josh Harrison, Slinsky's successor, attended the status conference and the court entered a scheduling order. Harrison later moved to extend the discovery cutoff date but failed to serve any exhibits or file or serve any witness lists 14 days before trial as required by the scheduling order. As a result, the bankruptcy court denied the motion to extend.
Subsequently, Gail A. Rinaldi started working for WPR and filed an appearance on behalf of Target. She appeared on behalf of Target at the trial on the adversary complaint but the debtor did not appear. Rinaldi said she was unprepared to proceed at trial because she lacked the necessary documentation, and the court dismissed the adversary complaint.
The bankruptcy court sua sponte issued an order to show cause why sanctions should not be imposed against WPR under Rule 9011.
Under Rule 9011, the court explained, a bankruptcy court may impose sanctions in three situations -- “where papers are submitted demonstrate factual frivolity, legal frivolity, or where papers are submitted for an 'improper purpose.'”
WPR argued that because the debtor made the Sears charge within 90 days of the petition date, a rebuttable presumption of nondischargeability under Section 523(a)(2)(C)(i)(l) applied. The court rejected this argument, saying that Section 523(a)(2)(C)(i)(l) applied to purchases for “luxury goods or services” as opposed to “goods or services reasonably necessary for the support or maintenance of the debtor or a dependent of the debtor.”
WPR failed to provide any admissible evidence substantiating that the goods purchased by the debtor for the Sears charge were “luxury goods,” the court said. At the order to show cause hearing, William Weinstein of WPR represented for the first time that the Sears charge was for a washer/dryer, but he failed to provide any admissible evidence or sufficient argument otherwise as to why a washer/dryer is a “luxury good,” the court said.
The court found that WPR failed to conduct any meaningful investigation prior to filing the adversary complaint. WPR argued that the adversary complaint was justified based on purported settlement negotiations that took place with debtor's counsel after the filing of the adversary complaint. This type of “post hoc justification” for filing the adversary complaint falls below the minimum standards of competence and reasonableness set forth in Rule 9011, the court said. According to the court, WPR had several months under the scheduling order to conduct discovery to investigate the underlying nature of these charges but failed to do so.
Based on the “dearth of evidence,” the allegations and other factual contentions “wholly lacked evidentiary support” and were not based upon a reasonable and competent inquiry by WPR, the court said. According to the court, WPR had ample time and resources to conduct an appropriate investigation. For example, the court said, WPR could have: “(1) questioned the debtor at the 341(a) hearing; (2) sought to extend the dischargeability deadline, or (3) conducted a 2004 exam, and (4) subpoenaed records from Sears.” Instead, WPR merely sent the inquiry letter, then filed an adversary complaint and attempted to settle the matter with debtor's counsel before any trial on the merits, the court said.
The court noted that the inquiry letter threatened a 2004 examination of the debtor, which would have been appropriate, but WPR never followed up on this threat and never conducted a 2004 exam of the debtor. Further, after the adversary complaint was filed, WPR failed to propound any discovery on the debtor, despite anticipating the need for such discovery, the court said.
WPR violated Rule 9011, the court said, by filing the adversary complaint because the underlying complaint lacked an objectively reasonable basis and WPR failed to conduct an objectively reasonable investigation into the facts and circumstances surrounding the allegations contained in the adversary complaint. “While WPR contends that the pleadings were 'all filed in good faith,'” Rule 9011 makes no exception for a “pure heart, empty head” defense, the court said.
At the order to show cause hearing, WPR represented that they use a computer program called FAST (Fraudulent Activity Screening Technology) to analyze many indicia of fraud that are identical as factual elements of objective intent to commit fraud. It is unreasonable to delegate this legal decisionmaking process to a non-attorney, let alone a computer system, the court said. “No matter how advanced the FAST program has become, the Court believes that they are an insufficient substitute for due diligence in this respect,” the court said.
The court determined that “sunlight is the best disinfectant.” “[T]rue deterrence calls for both a monetary sanction and for the exposure of this pattern and practice by WPR,” the court said.
Weinstein and WPR are jointly and severally liable for $5,000 for bringing the frivolous proceeding, the court said, and Weinstein is required to report this sanction to the State Bar of California.
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