Bankruptcy Litigation Committee

ABI Committee News

Volume 6, Number 1 / January 2009

In This Issue

The Availability and Application of Civil Sanctions in Bankruptcy Court

by: Jeffrey A. Carlino
Goldberg Segalla LLP; Buffalo, N.Y.

The Bankruptcy Code allows judges to impose civil sanctions. A number of recent decisions have addressed (1) when civil sanctions are authorized, (2) who has standing to seek civil sanctions and (3) the applicable burden of proof. These decisions have created contrasting rules of law among districts.

The source of bankruptcy court authority to impose civil sanctions was considered in the case in In re Rivera, 369 B.R. 193 (Bankr. D. N.J. 2007). In Rivera, the bankruptcy court sua sponte confronted a mortgage lender found to have been prosecuting foreclosure actions with certification practices that fell short of the requirements of local and other applicable rules and orders, including Bankruptcy Rule 9011. The court initially issued what it considered to be a nonmonetary sanction: An injunction to the lender that also prospectively admonished all those who practice in that court from using noncomplying certification practices. Essentially, the "prospective directive" compelled litigants to obey the various rules governing certification, and warned of consequences upon the failure to do so.

The lender appealed the injunction and, following multiple procedural anomalies, the bankruptcy court eventually found itself reviewing its own earlier decision on remand and issuing an instructive, but nonbinding, decision.

As justification for its initial decision, the court noted specific authority to sanction under Bankruptcy Rule 9011 and 11 U.S.C. 105(a), as well as a broader source of its authority: The "inherent authority" of courts to "fashion an appropriate sanction for conduct which abuses judicial process," as recognized in Chambers v. NASCO Inc., 501 U.S. 32 (1991). After relying upon the majority holding in Chambers to support the court's "inherent authority" to sanction, the bankruptcy court also cited dicta from Chambers to support its view that a finding of bad faith is not a prerequisite to the imposition of sanctions. Upon this framework, the court stood by its earlier determination that it had authority to impose the prospective injunction-and "without the need for extended hearings."

Another court-the U.S. District Court, Southern District of Texas-recently reviewed the issue of civil sanctions in bankruptcy court under somewhat similar circumstances, but with a disparate result. In In re Parsley, 384 B.R. 138 (S.D. Texas, March 5, 2008), the district court-as in Rivera-considered a situation of apparent misconduct by a mortgage lender and, more specifically, its counsel. Imposition of sanctions was sought by the U.S. Trustee, who, the court expressly held, had standing to seek civil sanctions by virtue of the extremely broad authority conferred upon trustees by 11 U.S.C. §307 to "raise and may appear and be heard on any issue in any case or proceeding under this title..."

After multiple show-cause orders, numerous hearings and extensive testimony, the district court, like Rivera, found sanctioning authority both by virtue of inherent authority (see Chambers supra) and authority arising under 11 U.S.C. §105(a). Unlike Rivera, however, the court noted that the imposition of sanctions requires a "specific finding of bad faith," i.e., conduct that is "vexatious or wanton," or that is undertaken for "oppressive reasons" or in an "attempt to abuse process." The standard for imposing sanctions, the court noted, is clear and convincing, and the imposition of sanctions must be supported by evidence that is "so clear, direct, weighty and convincing as to enable the fact finder to come to a clear conviction, without hesitancy..."

Upon its review of the extensive evidence, the court found clear and convincing evidence supporting an imposition of sanctions against a particular attorney and his law firm. Notwithstanding, the court took the sanctions analysis a step further, pulled back on the reins and noted that "because of their very potency, inherent powers must be exercised with restraint and discretion" and "the [c]ourt must impose the least onerous sanction that addresses the situation." Since the individual attorney vulnerable to sanctioning had already been terminated and his professional reputation sullied, and the offending law firm had taken remedial actions to correct its otherwise sanctionable conduct, the court determined that no additional sanction was necessary to "address the situation" and refrained from imposing any sanctions.

In AmeriQuest Mortgage Co. v. Jaclyn S. Nosek, Nos. 07-2173, 07-2174, 2008 WL 4445707 (1st Cir. Oct. 3, 2008), the appeals court addressed and ultimately vacated an award of punitive damages that had been entered by the Bankruptcy Court for the District of Massachusetts and affirmed by the district court. In that case, the chapter 13 debtor commenced an adversary proceeding against its lender alleging that the lender's unconventional accounting practices violated both the terms of her chapter 13 plan and 11 U.S.C. §322(b). Finding for the debtor, the bankruptcy court awarded damages for emotional distress as well as $500,000 in punitive damages. When the district court affirmed, the lender appealed to the First Circuit.

In the First Circuit's view, the authority granted by 11 U.S.C. §105(a) only allows the imposition of sanctions upon a direct violation of the Code or a court order. On this premise, the court analyzed debtor's adversary claims and concluded that the lender had not violated §1322(b)-a provision of the Code "provides flexibility" for chapter 13 debtors but does not impose affirmative obligations on lenders. The court also noted that the lender's application of payments did not violate any express term of the debtor's chapter 13 plan. Accordingly, since no violation of the Code or any court order had occurred, the circuit court held that relief under §105(a) was inappropriate.

In Walton v. Countrywide Home Loans Inc., Ch. 13 Case No. 01-42230, Adv. Proc. No. 08-1176 (Bankr. S.D. Fla. Oct. 2, 2008), addressed issues concerning the imposition of sanctions-and in a manner that is at odds, at times, with the decisions in Rivera and Parsely.

In Walton, the U.S. Trustee commenced an adversary proceeding against a mortgage lender seeking an award of "appropriate monetary sanctions" and also an injunction-similar to the injunction granted in Rivera-enjoining the lender from engaging in "bad faith" and "abusive practices" in the "preparation, verification, filing and prosecution of pleadings," "proofs of claim" and state court "foreclosure actions..." The lender moved to dismiss on several grounds including Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief can be granted.

Upon considering the trustee's request for "appropriate monetary sanctions, the court distinguished between "compensatory sanctions" (available only to the "original parties") and punitive sanctions (which "seek relief on behalf of the public"). Compensatory sanctions were not available, the court held, because the original parties-the debtors-were not the parties seeking sanctions. Contrary to the Texas District Court's holding in Parsely, the Florida District Court held that the trustee lacked statutory authority to seek punitive sanctions via an adversary proceeding. Such powers, the court held, were vested not in the U.S. Trustee, but rather in the U.S. Attorney.

After dismissing the claims for monetary sanctions, the request for injunctive relief was considered. Injunctions, the court noted, require a demonstration of a "real and immediate threat of future injury" accompanied by a "continuing, present adverse effects," and must not merely command that a party "obey the law." The court noted that the conduct that the U.S. Trustee sought to enjoin-"bad faith and abusive practices"-was already prohibited by Fed. R. Bankr. P. 9011. Contrary to the holding in Rivera, the court declined to grant what it noted could be an improper and unconstitutional "obey the law" injunction.