The 9th CIr. BAP erected a high bar for the imposition of monetary sanctions against counsel in its recent decision in Franz. Despite some ugly facts and imperfect lawyering, the BAP overturned $5000 in sanctions against a Chapter 13 debtor’s lawyer, finding counsel’s conduct did not rise to a level akin to contempt of court.
And interestingly, at the heart of the BAP’s decision was the very fact that BAP decisions are not binding.
Debtors struggle to the finish line
The debtors’ situation should resonate: they survived 14 motions to dismiss in a 78 month plan that provided for curing mortgage arrears on their first, and stripping off a totally unsecured $100,000 second. When they completed their payments to the trusteee, it came out that they had missed $52,000 in post petition payments to the holder of the first.
Nonetheless, Counsel filed debtors’ certificate that they had completed all the payments required by their confirmed plan. In the background, debtors had applied for a mortgage modification to address the post petition shortfall. The modification appeared to be headed for acceptance but was not final.
While the trustee filed a motion to dismiss, Counsel filed a declaration in support of finalizing the motion to avoid the junior lien, again alleging that debtors had completed the Chapter 13 plan. The court responded with an OSC directing counsel to show cause why sanctions should not issue under R. 9011, the court’s inherent sanction authority, and a local rule prohibiting “knowingly false statements.”
Only at the OSC hearing did Counsel articulate the contention that, despite a BAP ruling to the contrary, direct post petition payments to a mortgage lender were not payments “under the plan,” and thus the spotlighted pleadings were not knowingly false in the absence of 9th Circuit authority.
The argument failed with the bankruptcy court who expressed displeasure with Counsel’s failure to acknowledge “improper” conduct and issued sanctions of $5000. An appeal ensued.
A higher bar for sua sponte sanctions
Judge Farris, writing for the BAP, began by affirming the discretion of the bankruptcy court to sanction attorneys for misconduct and improper litigation tactics in order to deter baseless filings. However, for sanctions imposed sua sponte, the court must apply a higher standard akin to contempt. Ninth Circuit authority mandates restraint in applying R. 9011 because ‘effective representation often will call for innovative arguments.” Primus Auto. 115 F.3d 644, 649 (9th Cir. 1997).
While R. 9011 motions by opposing counsel provide for a safe harbor for a lawyer to withdraw the challenged pleadings, the rule provides no such option when the court initiates the motion. Thus judicial restraint is required.
Likewise, sanctions pursuant to the court’s inherent authority require willful actions plus an additional factor such as frivolousness, harassment or an improper purpose. A finding of bad faith must precede imposition of sanctions.
The bad faith analysis
On appeal, Counsel challenged the bankrutpcy court’s factual finding that Counsel knowingly made a false statement, with intent to mislead the court. Pointing to the standard for contempt of court, the BAP found the bankruptcy court’s finding to be error, since the finding of intent was predicated on the purely legal issue of whether direct payments were “payments under the plan”. Because the issue of whether a BAP decision such as Mrdutt, 600 B.R. 72 (B.A.P. 9th Cir. 2019) is controlling authority is unresolved in the 9th Cir. , circuit cases specifically recognize that R. 9011 sanctions cannot issue for seeking a result contrary to BAP case law.
Thus, as a matter of law, Counsel had a reasonable legal basis for the argument that debtors had made all the payments required by the plan and the sanction order was reversed. And Counsel escaped sanctions by the very skin of the teeth, though not without some unpleasant assessments of Counsel’s conduct as lacking in logic and candor.
From the perspective of my keyboard months after the events in question, it appears that this painful experience could have been avoided if Counsel had made explicit, early on, the contention that there was an unsettled legal question about payments “under the plan” including direct payments. The ensuing battle with the bench would have been fought on the issue of the law, rather than on Counsel’s integrity.