Houston Judges Find Method to Avoid Unnecessary Filing of Means Testing Form in Cases That Have Mostly Business Debt

While means testing is supposed to be self-effectuating, Congress failed to specify a clear mechanism for separating those debtors required to pass through the analysis and those who were exempt. In a new opinion, Judges Marvin Isgur and Wes Steen have developed a test to help debtors navigate the straits between Scylla and Charibidis (complete with a footnote explaining who Scylla and Charibidis were). No. 06-37157, In re David Michael Beacher, (Bankr. S.D. Tex. 1/26/07) and No. 06-35550, In re Michael Antonio Pena (Bankr. S.D. Tex. 1/26/07).


Means testing is one of the hallmarks of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). It was meant to ensure that debtors who could afford to pay their debts did not take the easy way out by filing chapter 7. Means testing only applies to debtors with "primarily consumer debts." This may have been because Congress figured that business debtors would fail in a big way so that they wouldn't be able to repay their debts or it might have been intended to promote entrepreneurship or it just may have been a consequence of the fact that BAPCPA was championed by the consumer credit lobby. Whatever the reason, means testing applies to individuals with primarily consumer debts but not other individuals.

Means testing is enforced through a regime which requires debtors to file a statement of current income and expenditures, which in the case of an individual debtor with primarily consumer debts must include a calculation to determine whether the presumption of abuse arises. See 11 U.S.C. Sec. 521(a)(1) (requiring filing of statement of income and expense unless the court orders otherwise) and 11 U.S.C. Sec. 707(b)(2)(C) (requiring additional calculation if primarily consumer debts are involved). If a debtor fails to file the information required by Sec. 521 within 45 days, then the case is subject to mandatory dismissal. 11 U.S.C. Sec. 521(i)(1).

Form 22A contains a detailed analysis of income and expenditures under the means test. However, judges have disagreed on whether it must be filed by all chapter 7 debtors or just those with consumer debts. Compare In re Moates, 338 B.R. 716 (Bankr. N.D. 2006)(only consumer debtors need file the form) with In re Copeland, 2006 Bankr. LEXIS 2200 (Bankr. S.D. Tex. 2006)(all debtors must file).

Judges Isgur and Steen disagreed with their Southern District colleague and ruled that requiring all debtors to file the form was neither "reasonable or acceptable." They cited Lord Coke for the maxim that "The law requires no one to do vain or useless things." 5 Coke 21.

With that out of the way, the judges had to decide what to do if a debtor failed to file the form. If the debtor was required to file the form but did not do so, then mandatory dismissal was the penalty. On the other hand, if the debtor was not required to file the form, they could hardly complain about its absence. The two cases consolidated in their opinion illustrate two different ways to approach the problem. In the first case, the debtor filed a motion to be excused from filing Form 22A on the ground that it was not required. In the second case, the court issued a show cause order as to why the case should not be dismissed for failure to file the form. When the debtor did not respond, the case was dismissed, leading to a motion to reconsider. In both cases, someone, whether the debtor or the court, had to take a proactive step to tee up the issue.

Further, the consequences of guessing wrong were serious, since they would result in automatic dismissal. In the Beacher case, the debtors contended that 58% of their debts resulted from their failed business. However, what if it turned out that only 49% fell in the business category? If the decision was made 46 days into the case, they would be dismissed.

To solve this problem and avoid "vain and useless expenditure of resources," the judges have developed a new form for requesting waiver of the requirement to file Form 22A. Based on the certification of the debtor and counsel that debts are not primarily consumer, the court will issue a provisional order excusing the form. If no party objects to the order within 90 days, it will become final and compliance will be excused. According to an email from the Southern District, Judges Bohm, Isgur, Schmidt and Steen plan to use the form.

It is good to see judges who care about making the system work. This is a case where Congress drafted an extensive statutory scheme but failed to address an important detail as to its practical application. There may have been a simpler answer however. Form 1, the Voluntary Petition, requires debtors to indicate whether their debts are primarily business or consumer. The form is signed by the debtor under penalty of perjury and is also signed by counsel. As a result, it contains basically the same information as the new form. When a debtor checks the business box it should presumptively excuse the debtor from filing Form B22A unless a party objects. Of course, there is no rule which says this. As a result, there is no time frame for objecting. Therefore, checking the petition box does not eliminate the 45 day dismissal problem. This distinction may be the factor which commends the new Southern District procedure.

Note: All of this discussion pertains to chapter 7 debtors only. While the means test obviously does not apply to chapter 11 or chapter 13 debtors, they are still required to complete an Official Form of income and expense which can be used to determine amounts payable under a plan. Fed.R.Bankr. Pro. 1007(b)(5)requires chapter 11 debtors to file the appropriate Official Form setting forth their current monthly income. Rule 1007(b)(6) requires chapter 13 debtors to file the Official Form reflecting their monthly income, and if their income exceeds the median, they must also file a calculation of disposable income as set out in Sec. 1325(b)(3).

Judge Rejects Defense of The Computer Made Me Do It

A volume creditors' practice is facing sanctions after the court rejected its explanation that faulty computer coding caused it to file erroneous pleadings. The opinion illustrates the tension between the requirements of Rule 9011 and the need to rely on automation in a volume practice. While the final sanctions to be awarded have not yet been decided, the court in this case was clearly exasperated.

The Plan and the Original Objection

A debtor filed chapter 13 and included a debt with respect to a property he was leasing to his brother. The debtor's schedules plainly stated that the property was NOT the debtor's principal residence. The debtor's counsel also claimed to have informed the lender's counsel of this fact prior to bankruptcy.

The debtor proposed a plan which sought to pay the lender the value of its collateral plus interest through the plan. The payments to be made to the lender under the plan exceeded the amount of the rents being received by the debtor. The creditor filed a proof of claim in which it adopted the debtor's valuation of the property.

The lender's attorney filed an objection to confirmation which the court characterized as "grossly erroneous, and to anyone familiar with bankruptcy law, the objection is clearly legal nonsense." Among other things, the objection claimed that:

* The debtor's attorney, rather than the debtor had executed the note;
* That the plan did not pay the arrearages in full (despite the fact that the plan proposed a cram-down rather than a cure of arrearages);
* That the plan impermissibly modified a loan on a principal residence;
* That the lender's administrative claim was deferred over 36 months (despite the fact that the lender did not have an administrative claim); and
* That the plan impermissibly proposed to pay interest on the lender's non-dischargeable unsecured claim (despite the fact that the lender did not have a non-dischargeable claim).

The Debtor responded and pointed out the errors in the objection.

The First Hearing

At the first hearing on confirmation on October 3, local counsel for the lender argued that the plan impermissibly modified a loan on a principal residence. When the debtor responded that the property was not the debtor's principal residence, "local counsel replied that he had been instructed by (the lender's counsel) to ask for a continuance if Debtor made that contention."

This choice of tactics was not good. As the court later found, the objection relating to the principal residence violated Rule 9011 because the lender had no evidence that the debtor's statements were wrong. However, it got worse.

"As clear as that violation as, it is even more egregious that Countrywide continued to advocate that position in open court on October 3, notwithstanding Debtor's written response on September 28. Countrywide obviously had considered Debtor's response, knew that the argument had no validity, and was prepared to abandon the argument by asking for a continuance to implement 'Plan B,' which apparently had not yet been devised. . . . (T)he court believes that the request for a continuance was not made in good faith but was intended simply for delay."

Of course, the Court had not made these findings yet on October 3. However, the court did warn the lender's counsel that it should scrutinize its position in light of Rule 9011.

The Lender Withdraws Its Objection But "Discovers" A New One

After the hearing, Debtor's counsel sent the lender's counsel a letter demanding that the lender cure the violation of Rule 9011. In response, the lender filed a withdrawal of its objection. Unfortunately, this pleading violated Rule 9011 as well. The withdrawal stated that the lender was withdrawing its objection because the Debtor had filed an amended plan which proposed to cure the arrearage. Of course, this was just plain wrong. The Debtor had not filed an amended plan and was still seeking to cram-down the value on the rental property.

To further complicate matters, just four business days prior to the re-scheduled hearing, the lender filed a new objection which asserted that it just "discovered" that it held an absolute assignment of rents and that because the rents belonged to Countrywide, the Debtor could not use them in the plan. The absolute assignment of rents theory used to be a standard weapon used by lenders in single asset real estate cases during the 1980s and caused a lot of controversy at that time. However, the theory had major practical difficulties (such as how the rents could be conveyed to the lender without reducing the debt) and has not been seriously advocated for many years.

The First Opinion

At the continued hearing on November 14, lender's counsel abandoned all of its original objections and argued the absolute assignment of rents. Debtor's counsel objected that she had been sand-bagged. This was a legitimate complaint because the local rules required any objections to be filed five business days before confirmation. As a result, the court continued the hearing once again. However, at this point, the court's displeasure took written form. On November 28, the Court wrote the first of three written opinions in the case. Case No. 06-60121, In re James Patrick Allen (Bankr. S.D. Tex. 11/28/06)(Order for Memoranda and for Rule 7016 Conference And Order for Hearing on Sanctions Under Rule 9011). In this opinion, the court required the parties to brief the absolute assignment of rents issue and to advise the court as to the witnesses and exhibits they planned to introduce. The court also stated that it appeared that the lender's counsel had violated Rule 9011. The court required both local counsel and lender's primary counsel to attend the hearing.

The Second Opinion

After the pre-trial conference on the absolute assignment of rents issue, the court concluded that there were not any disputed issues of fact. The court wrote its second opinion which concluded that the assignment of rents was intended for purposes of security rather than as an absolute assignment. No. 06-60121, In re James Patrick Allen (Bankr. S.D. Tex. 12/20/06)(Memorandum Opinion Findings of Fact and Conclusions of Law Concerning Order Denying Motion for Turnover & Accounting And Concerning Confirmation of Chapter 13 Plan). As a result, the court confirmed the plan. The court reserved the issue of sanctions for a subsequent opinion.

The Third Opinion

After all of this prologue, the court finally reached the issue of sanctions in a hearing on December 13. No. 06-60121, In re James Patrick Allen (Bankr. S.D. Tex. 1/9/07)(Memorandum Opinion Regarding Sanction of Creditor's Attorneys). Prior to this hearing, the Court was aware of what had happened. The important factual issue was why it happened, and whether this would serve to mitigate or explain away the erroneous pleadings. The testimony received on December 13th provided a window into the internal workings of a volume practice.

The initial attorney who handled the file testified that she recognized that the property was not the debtor's homestead. Based on this determination, none of the pleadings raising homestead-related issues should have been filed. Despite this conclusion, a clerical person apparently coded the file as a homestead case. Under the law firm's computer system, certain codes are entered which are then used to generate pleadings. In this case, a clerical employee apparently entered the wrong codes which then generated the wrong pleadings. Thus, garbage in, garbage out. The Court concluded that no meaningful review was given to the computer generated pleadings.

"There was no testimony that anyone at (lender's counsel) reviews the computer-generated pleadings (with the level of care required by FRBP 9011) before they are filed. It was the Court's sense of the testimony that either there is no review, or else the review is so superficial that it is meaningless."

The firm's response to the Court's initial warning about sanctionable conduct was also dictated by the computer system. When local counsel contacted the initial lawyer about the Court's concerns, she testified that she "could not believe the document that was filed under [her] password." However, because the file was coded as a homestead case, the instruction to withdraw the objection generated a pleading geared to a homestead case. The frightening thing is that the computer generated a pleading which might have been appropriate in a particular type of homestead case. However, the pleading would not be appropriate in all circumstances. Thus, even without the erroneous coding, the pleading could well have been wrong.

The Inconclusive Result

The Court found that the lender's principal law firm should be sanctioned for its conduct in the case. However, the Court did not enter a sanction at this time. The Court noted with frustration that he had previously reprimanded the firm and had ordered it to address quality control issues. Two other judges in the Southern District had published opinions about the firm's conduct, including one case where the firm was required to pay $65,000. The Court noted that sanctions under Rule 9011(c)(2) should be sufficient to deter further repetition of the conduct. The Court went on to state:

"Although the Court has concluded that there is sanctionable conduct, after two warnings and a $65,000 monetary sanction, the Court is at a loss to determine the appropriate sanction in this case. If the prior warnings and sanction have not worked, what will?"

The Court ordered the managing attorney of the firm's Houston office to appear at a hearing to be held and to "report to the Court what sanctions would deter further repetitions of this conduct."

This Order places the firm in an unusual position. It is being asked to recommend its own punishment. If the firm suggests too light of a sanction, it may invite severe penalties for failure to appreciate the gravity of its actions. But what is sufficient?

While the Court may well consider monetary sanctions, and will likely award attorney's fees to debtor's counsel, the Court appears to be looking for more of a structural solution. The problem here appears to be a law firm subservient to its computer system. In an atmosphere where codes entered by clerical employees can generate nonsensical pleadings, it is difficult to comply with the responsibilities of a professional. In this case, even the attempt to withdraw an erroneous pleading generated another factually defective document. Perhaps Judge Steen, like another judge before him, will sanction the computer. However, it seems more likely that he will order the humans to take control of the computer. Failing that, he may require that all future pleadings be written with a quill pen and bear the cursive penmanship of the attorney submitting the pleading.

Post-script: Local counsel, who had the unenviable task of presenting the flawed pleadings to the court, escaped sanctions. Although Local Rule 11.2 required local counsel to be fully informed and prepared, the court noted that this rule had not been strictly enforced in the past. Based on the hope that local counsel had "a much greater appreciation of his responsibilities to the Court," the Court declined to assess sanctions against him.

Southern District Judge Gets Judicial Estoppel Right

Judicial estoppel is intended to protect the integrity of the bankruptcy system by encouraging parties to play straight with the court. Parties who successfully convince the court to take one position can not come back later with an inconsistent position. While the doctrine is intended to preserve the integrity of the court, it is frequently used by litigants as a get out of court free card. In a recent opinion by Judge Wesley Steen of the Southern District (and current president of the American Bankrutpcy Institute), the court declined to enforce judicial estoppel against the bankruptcy trustee based on the debtor's failure to disclose an asset.

A Common Fact Pattern

In James Lewellyn Miller, II (Case No. 04-31214 Bankr. S.D. Tex. 8/7/06), the debtor filed for chapter 7 and failed to disclose a cause of action against Merck relating to the drug Vioxx. The Trustee issued a no asset notice after the creditors' meeting. Subsequently, the debtor remembered that he had a claim and filed suit in state court. The vigilant trustee, upon learning that his asset was being hijacked by the debtor, asked the court to re-open the case. Merck did not want to be sued, so it asked Judge Steen to reconsider his order re-opening the case. Merck argued that it would be futile to re-open the case because judicial estoppel would prevent the trustee from pursuing the case. Thus, while this was ostensibly about whether to re-open a case, the underlying issue was whether judicial estoppel would apply. However, it was not Merck's day.

Standing?

First, Judge Steen questioned whether Merck even had standing to question the re-opening. Judge Steen pointed out that Merck was not a creditor and had not participated in the case prior to it being closed originally. He rejected the notion that being sued gave Merck standing.

"The Court understands that Merck is a party to a state court lawsuit. Merck has cited no authority that being a defendant in a lawsuit brought by the Trustee, without more, makes Merck a party in interest that has a right to be heard on bankruptcy case administration. Estates are administered for the benefit of creditors and the debtor(s), not for the benefit of entities who may owe money to the estate.

* * *

"Giving Merck a voice in whether the chapter 7 trustee can sue Merck is a very strange idea, a little like putting the fox in charge of the hen house. The Court sees no authority for that in the Bankruptcy Code. Merck is not a party in interest merely on showing that the Trustee will sue Merck."

Slip op. at 4.

Juducial Estoppel

However, the Court did not stop there. It proceeded to analyze the merits of Merck's judicial estoppel arguments and found them wanting. Thus, Merck got the worst of both worlds. The court rejected its standing to appear in bankruptcy court but also ruled on the merits of the argument that it didn't have standing to make in the first place. (However, as explained later, the Court did limit the extent of its ruling).

There are three elements to judicial estoppel:

1. The party took a clearly inconsistent position.
2. The court accepted that position.
3. The party took the prior position intentionally and not inadvertently.

The Court did not get past the first element in finding that judicial estoppel would not apply, since the Trustee did not take an inconsistent position.

"It is not clear what 'contrary position' Merck asserts as the operative 'contrary position' that might judicially estop the Trustee. Possibly Merck contends that Debtor's failure to list the claim against Merck is a 'contrary position.' If that is Merck's contention, then judicial estoppel might apply to the Debtor. but the party seeking to reopen this bankruptcy case is the Trustee, and the Trustee did not make the statement about which Merck complains. The Trustee did not file the schedules. The Trustee is not judicially estopped from reopening the case by a 'contrary position' taken by the Debtor."

Slip Op. at 6.

The Court rejected Merck's argument that the Debtor and the Trustee were essentially the same party, stating:

"Merck asserts ... that ... the distinction between Debtor and the Trustee is a distinction without a difference. But there is a vast difference between a trustee in a chapter 7 case and a debtor in a chapter 7 case. The trustee acts as representative of creditors. The debtor represents no one but himself."

Slip Op. at 9.

The Court contrasted its case with In re Walker, 323 B.R. 188 (Bankr. S.D. Tex. 2005), an opinion by his colleague Judge Bohm. In Walker, it was the Debtor who sought to reopen the case and the Trustee was nowhere to be found. In that case, the Court was concerned that the Trustee would simply abandon the asset back to the Debtor and noted that the result would likely be different if the Trustee were likely to pursue the claim. In Miller, on the other hand, it was the Trustee who sought to reopen the case and who was already taking steps to pursue the asset.

The Court makes a very important distinction here. The Trustee and the Debtor are different parties who serve different roles. Indeed, in the case of Debtor misconduct or failure to perform his duties, the Trustee is an adverse party to the Debtor. Thus, it is particularly insidious to suggest that the creditors (who are the Trustee's constituency) should be punished for the Debtor's failure to file an accurate set of schedules. This is a case where the integrity of the system demands that the cause of action be disclosed to the Trustee so that it may be pursued for the benefit of the creditor body. To say that judicial estoppel should apply against the Trustee (and by extension the creditors) in order to preserve the integrity of the bankruptcy system is a bit like burning down a village in order to save it.

Judge Steen also addressed the possibility that Merck was contending that the Trustee took an inconsistent position by filing the no-asset report. The Court pointed out that since the Trustee did not know about the lawsuit at the time he filed the no-asset report, it would not count as an intentional inconsistent position so that judicial estoppel would not apply.

After having addressed judicial estoppel at some length, the Court clarified the scope of its ruling. The Court stated that it was merely determining that the Trustee was not judicially estopped from reopening the case and that Merck could assert judicial estoppel in response to a suit brought by the Trustee. While the Court prudentially saved the ultimate issue for another day (and perhaps another court), the logic would seem to apply equally to the merits as to the procedural issue determined here.

Practice Tip

The best way to avoid judicial estoppel claims is to make sure that potential claims and causes of action are properly scheduled in the first place. Of course, the next best thing is to amend the schedules when the issue first arises (and preferably well before any state court action is filed). However, assuming that the issue doesn't surface until way down the road, there is likely to be a race to the courthouse between the debtor-plaintiff and the defendant. If the plaintiff is willing to fall on his sword and surrender the cause of action to the trustee and the trustee is willing to pursue that cause of action for the benefit of the creditors, then judicial estoppel should not apply. The Debtor may still be able to benefit from the Trustee's pursuit of the claim if a portion of the claim is exempt, if there are excess proceeds or if part of the claim arose post-petition and is not property of the estate. On the other hand, if the defendant is able to raise the issue before the debtor realizes that the claim is in peril, then the defendant may prevail. Once the trustee is involved, the defendant would be well served by trying to settle directly with the trustee rather than pursuing a scorched earth policy. If the state court lawsuit is large and the claims in the bankruptcy case are small, then the trustee might be willing to settle for an amount which will pay the claims.

Houston Judges Crack Down on Attorney Conduct

At the beginning of each episode of Hill Street Blues, the Sergeant used to admonish the officers "Let's be careful out there." The same can be said for practicing law in the Houston bankruptcy courts. Over the past 15 months, the Houston judges have written at least six opinions dealing with attorney conduct and sanctions, including one where a firm was sanctioned $65,000 and another which drew a criminal referral. There are some new judges in Houston and they apparently don’t like some of what they are seeing.

Bad News For Creditors’ Lawyers

There are three recent cases dealing with attorney fees on motions to lift stay.

In the case of In re Nair, 320 B.R. 119 (Bankr. S.D. Tex. 2005), Judge Marvin Isgur determined that it was sanctionable for a creditor's lawyer to include attorney's fees in an agreed order on a motion to lift stay where the creditor was undersecured and would not be entitled to fees under Sec. 506(b). This opinion from March 2005 is a bit surprising, not for the result, but for the way it came up. Under Sec. 506(b), undersecured creditors are not generally entitled to recover their fees and costs. However, this had been a common practice for many creditors’ attorneys and debtors’ lawyers had not been challenging. Arguably, it could be justified as a quid pro quo for allowing the stay to remain in effect following a default, especially where the creditor could have argued for a full lifting of the stay. Instead, the court imposed sanctions on its own motion. However, despite writing a harsh opinion concerning the attorney, the court decided not to impose monetary sanctions.

Judge Isgur stated:

"The Court has considered whether monetary sanctions are appropriate in this case. To be sure, this matter has taken substantial court time and monetary sanctions could be imposed to reflect the use of judicial resources and court time. Nevertheless, the Court believes that monetary sanctions need not be imposed in this case. The proposed order was an agreed and the Court believes that should ameliorate the sanctions to be imposed. Moreover, the Court does not believe that mild monetary sanctions would serve to protect against future violations or that this violation justifies severe monetary sanctions.

"Rather than imposing monetary sanctions, the Court merely requires that Mr. (Attorney) discontinue practices that violate his duties under Fed. R. Bank. P. 9011."

In re Nair, at 129.

While the Nair attorney got off with a bad scolding, an entire firm was taken to task and sanctioned in In re Porcheddu, 338 B.R. 729 (Bankr. S.D. Tex. 2006). If a creditor is entitled to recover attorney's fees on a motion to lift stay and is seeking over $500, local practice in the Southern District requires that the creditor's lawyer submit a fee statement justifying its fees. However, if a creditor's firm chooses to do this, they need to be very forthcoming about how they kept their time and how they calculated the fees. In Porcheddu, a large law firm which engages in a substantial amount of lift stay practice asked for attorney’s fees. The opinion does not state how much they requested. However, by the time the case was over, the law firm ended up paying.

When the question of fees came up, the initial attorney to appear for the firm stated that time records were kept contemporaneously and that she was the custodian of records. Something did not smell right and the court sought more information. After additional hearings, the court concluded that while project records were kept contemporaneously, that fee statements were only created after the fact if there was a need to apply to the court for approval.

The court stated:

"Taken as a whole, (the firm) designed a system that was intended to create after-the-fact time entries--and to present those time entries to the Court as business records. (Trial attorney) is an integral part of (the firm’s) team of lawyers. Following this Court's October 1, 2004 announcement, (the firm) could have chosen to come forth and advise the Court that it did not maintain contemporaneous time records but that it believed that its fees should nevertheless be approved. It did not do so. Instead, it devised a "template" that looked like a fee statement. The Court concludes that (the firm) and (the attorney) presented the template (time and again) for the purpose of having the template accepted as a (firm) business record."

In re Porcheddu, at 740.

The court found that the firm determined what a reasonable fee would be and then created time records to support that conclusion. Judge Isgur found that this procedure was backwards and undermined the entire process of court review of fees. The Court found that the law firm and its attorney had violated Rule 9011 and assessed sanctions of $65,000. The court calculated this amount much like the jury did in awarding exemplary damages against McDonald's in the notorious coffee burn case. The court concluded that the firm recovered approximately $125,000 in attorney's fees on motions to lift stay every two weeks. The court found that this was the starting point for assessing sanctions. The court cut the sanction in half because the firm behaved responsibly in the fast majority of its cases (although it had been the subject of several negative published opinions) and because the firm's reputation had already been damaged by the case. As a result, the court reduced the sanctions award to $65,000. The individual attorney was sanctioned $1,000.

On the more mundane side is In re Valdez, 324 B.R. 296 (Bankr. S.D. Tex. 2005). In that case, Judge Isgur denied fees to a creditor's lawyer who lost a motion for relief from stay. The court ruled that merely because the creditor was oversecured and thus potentially able to recover fees did not mean that they would be automatically awarded. In order to recover fees, they had to be reasonable. Where the creditor only sought relief based on lack of equity and there clearly was equity, not only should the motion be denied, but the creditor was not entitled to fees either. While this can be viewed as an application of the rule that success is the most important factor in awarding fees, it is also a reminder that secured creditors do not automatically get everything they want.

Bad News for a Debtor’s Lawyer

A debtor's lawyer who was creative in scheduling IRS claims drew the wrath of Judge Wesley Steen. In In re Thomas, 337 B.R. 879 (Bankr. S.D. Tex. 2006), the debtor filed a tax return showing a liability of $4,661 and then paid it. The IRS then audited and assessed over $32,000 in taxes and penalties. The Debtor scheduled this claim variously at $0, $20,000 and $5,000. When the IRS did not file a claim, the debtor's lawyer filed one for it in the amount of $5,000 and obtained confirmation of a plan. When the IRS filed a late claim based on the audit, the Debtor objected. This was a bad move.

At the hearing on the claims objection, the court wanted to know why the debtor had listed the claim in several different amounts which had no relation to the assessed liability. The debtor's lawyer stated that the $20,000 figure was a rough average between the $32,000 figure claimed by the IRS on the audit and the $4,661 figure listed on the return. The attorney then said that the $5,000 claim was based on the amount listed on the return of $4,661. The attorney could not explain why he had rounded it up to an even $5,000 and stated that he was unaware that the amount listed on the return had been paid.

Judge Steen was not amused. He revoked confirmation of the plan based on fraud. He relied on his inherent powers under section 105 to get around the fact that confirmation orders may only be revoked within 180 days. He then assessed three-fold sanctions against the attorney. First, he ordered the attorney to obtain ten hours in tutoring in ethics from a law professor who teaches in this area. Then he referred the attorney to the State Bar. Finally, he made a criminal referral.

Unauthorized Practice of Law Is Not Good

Judge Jeff Bohm addressed unauthorized practice of law in the case of In re Zuniga, 332 B.R. 760 (Bankr. S.D. Tex. 2005) . In that case, a debt restructuring agency advertised on Spanish language TV. When prospective customers called, they would be referred to a law firm in the same building if they did not qualify for a repayment plan. That law firm would then collect the paperwork from the debtor and farm it out to local counsel. In this case, the local counsel they sent it to was practicing on a probationary license, did not speak Spanish and was not admitted to practice in the Southern District. The court found this to be unauthorized practice of law by both the referring counsel and the local counsel as well as improper fee splitting. Local counsel was ordered to disgorge fees of $500 and pay $5,000 to the clerk. The California firm was required to disgorge $699 in fees, pay his client $176 in damages and pay the trustee’s lawyer $2,022.

Finally, if your license is suspended and you are required to associate a "bankruptcy specialist," you should notify the court of this restriction, you should actually associate a bankruptcy specialist (defined as someone board certified or who regularly appears in bankruptcy court) and should not draft documents for your corporate client to file on a pro se basis. All of these faux pas earned the suspended creditor’s lawyer sanctions totaling $11,290.05 in In re Cash Media Systems, 326 B.R. 655 (Bankr. S.D. Tex. 2005).

Final Thoughts

Most of the infractions covered here were pretty obvious. Lying to the tribunal, as occurred in Porcheddu and Thomas, is a prescription for disaster. Unauthorized practice of law and improper fee splitting are similarly dangerous. Although bankruptcy court may seem informal at times, it is still a federal court. Incurring the wrath of a federal judge is likely to be costly, as the attorneys in this article discovered.