Highlights from the National Conference of Bankruptcy Judges Day 3

I only attended two panels today before heading for the airport, so this post will be considerably shorter than the previous ones.

Ethics

The panel on To Tweet or Not to Tweet: Ethical Issues in Utilizing Social Networking Tools provided the all important ethics credit. They walked through a series of hypotheticals. Some of the more interesting were whether it is ethical to use a tracking device on your associate’s phone to locate him, whether a second chair lawyer should tweet during trial and whether a judge should be Facebook friends with an attorney appearing in her court. The answers were: yes, if it is a real emergency and you have given prior notice; no, the associate should be paying attention to the trial, not divulging confidential information; and maybe, so long as you really are friends and you are prepared to recuse yourself.

The panel felt that you should not blog about a client’s case without their consent. This is a sensitive issue. I have blogged about a few of my cases, but only if they resulted in a published opinion which would not be embarrassing to the client. I am planning to blog about my experiences in an unusual case that is ongoing, but not until it is over.

Now you can claim self-study ethics credit for reading this post.

Supreme Court Review

This was a very interesting panel featuring Judge Margaret Mahoney, Eric Brunstad and Brett Weiss. I am not going to discuss the cases themselves, since I have already written about them, but will summarize some of the larger conclusions.

The panel was unsure whether Milavetz prohibited advice on pre-petition planning, such as buying a more expensive car to tip the means test. However, they did say that the opinion allow counsel to have “full and frank and robust discussions” with the client. So perhaps the line is that you can talk about it, but not recommend it.

The Lanning case proved that the Supreme Court can make for some unusual alliances. The Chapter 13 trustee, who argued for a mechanical approach to determining projected disposable income, was supported by NACBA, while the Debtor was supported by the United States.

Brett Weiss was kind enough to quote the following passage from this blog:

The majority wants the Bankruptcy Code to make sense. Justice Scalia is willing to be a minority of one for the proposition that when Congress passes laws that are foolish or just plain wrong, that the courts have an obligation to throw their words back at them and yield a foolish judgment

Then he said thank goodness the Supreme Court did not follow Justice Scalia.

Lanning showed the victory of pragmatism over formalism. The panel encouraged lawyers to take the time to educate appellate judges with how bankruptcy actually works because the way bankruptcy works in fact is more unspoken than in other areas of the law.

Schwab v. Reilly was dismissed as a case that could be overcome through better software. Justice Thomas said that the problem with the debtor’s claim of exemption was that she claimed a specific dollar value rather than saying she was claiming 100% of the value. Apparently the Rules Committee is considering a change to the Official Form to allow this. In the meantime, software vendors are already responding to the decision.

Espinosa was considered to be in line with other Supreme Court opinions on finality of confirmation orders. The issue to be considered in litigating these cases is notice. Did they clearly say what they were trying to accomplish? Did the creditor receive actual notice? The Court appeared to be saying that deviant plan provisions were not a major risk because courts would exercise their independent duty to review plans and weed out the bad ones even where there wasn’t an objection. The panel thought this ignored the practical realities of a bankruptcy judge’s docket.

Finally, a cute story to end with. The first time that Eric Brunstad argued before the Supreme Court, he brought his six year old daughter with him. She brought her teddy bear. However, the marshals would not allow a teddy bear in the Supreme Court and took the stuffed bear into custody. After the argument, his daughter ran up to him and said, “Teddy’s in prison. The Martians have him.” When you receive a bad ruling, you can always say “The Martians got my case.”

District Court Reverses Sanctions Ruling in Legal Technology Case

A U.S. District Judge found that it was an abuse of discretion for a bankruptcy court to award sanctions against two attorneys and a law firm in a case involving the NewTrak legal technology system. In re Taylor, No. 09-cv-2479-JF (E.D. Pa. 2/18/10). The opinion can be found here. Last year, I wrote a posting about a lengthy opinion by Judge Diane Weiss Sigmund who sought to "”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” While the District Court noted that "the frustrations of the Bankruptcy Court are understandable," it found that the rather creative sanctions imposed by the Bankruptcy Court were not appropriate.

What Happened

The Taylor case involved debtors in a chapter 13 case who got behind on their mortgage payments because of a disputed charge for flood insurance. The creditor firm filed an inaccurate motion which alleged that the debtors had not been making their post-petition payments. The debtor's attorney filed an untimely and inaccurate response indicating that the debtors were making the payments but that they had been refused by the creditor. Upon being presented with proof of payments, the young associate representing the mortgage company insisted on going forward with the motion based upon deemed admissions.

The Bankruptcy Court denied the motion for relief from stay, while noting its displeasure. The following exchange took place.

The Court: I understand the position of local counsel to, you know--I understand. But you can pass it up the line that I was not pleased with this motion for relief.

Mr. Fitzgibbon: Thank you, your Honor.

The Court: And--and--and so that they'd better act in good faith because I'm cutting them a break this time. Because I really find this motion to be in questionable good faith.

District Court Opinion, p. 3, n. 1.

However, at the next hearing, which was on the Debtor's Objection to Claim, the young associate told the court that he had requested a payment history by opening an inquiry with the NewTrak system, but that he had not received a response from his client. He also indicated that he was not permitted to contact the client directly.

As a result of this hearing, the Bankruptcy Court issued an order for the creditor and its attorneys to appear for a hearing the purpose of which is "twofold: (1) to address the Objection to HSBC's claim and (2) to investigate the practices employed in this case by HSBC and its attorneys and agents and consider whether sanctions should issue against HSBC, its attorneys and agents."

After conducting several days of hearings, the Bankruptcy Court made the following rulings:

1. The young associate was not sanctioned despite pressing a motion based on deemed admissions which he knew were incorrect because "I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career."

2. The head of the bankruptcy section of the firm was sanctioned because "she failed to observe her duty to make reasonable inquiry of the two documents she signed." She was ordered to take additional continuing legal education courses in ethics.

3. The head of the firm (who had not signed any pleadings or appeared at any of the hearings in question) was sanctioned because he "sets the tone and establishes [the firm's] culture." He was ordered to obtain training in how the NewTrak system worked and conduct a training session for all firm members.

4. HSBC, the creditor, was ordered to send a copy of the Bankruptcy Court's opinion to all of its attorneys.

While the actual sanctions assessed were mild, the rebuke from the Bankruptcy Court carried quite a sting. The Udren firm and its two sanctioned attorneys brought an appeal to the U.S. District Court. The U.S. Trustee's Office defended the appeal.

The District Court's Ruling

The District Court reversed the sanctions award.

The Bankruptcy Court imposed sanctions pursuant to Federal Rule of Bankruptcy Procedure 9011, the counterpart of Federal Rule of Civil Procedure 11. The decision is reviewed under the abuse of discretion standard. (citation omitted). After a careful review of the record, I am constrained to hold that it was an abuse of discretion for the Bankruptcy Court to impose sanctions on the appellants here.

The frustrations of the Bankruptcy Court are understandable; delays caused by a lack of accurate information are unfair to debtors, to creditors, and to the courts. However,I am persuaded that the sanctions were inappropriate in this case, for two reasons: First, because the conduct of the debtors’ counsel was at least equally responsible for the difficulties in resolving the status of the mortgage payments, and second, because the record leaves the indelible impression that the appellants were sanctioned less for their specific failings than for the Bankruptcy Court’s desire to “send a message” regarding systemic problems in the litigation of bankruptcy cases and the reliance on computer databases in mortgage disputes.

The actions of the debtors’ counsel materially contributed to the difficulties in resolving the status of the Taylors’ mortgage. In an order relating to counsel fees, the Bankruptcy Court held that the debtors’ counsel provided legal services that “were below the level of competency required to handle this Chapter 13 case effectively.” Order of April 15, 2009 (Document No. 195). Although the errors of the debtors’ counsel do not relieve the appellants of their duty to comply with Rule 9011, they are relevant to a finding of sanctionable conduct. Had the debtors’ counsel responded to the requests for admissions, or submitted a timely request for a complete accounting, the appellants would have been on notice of the payment disputes and the delays may have been minimized or avoided.

Given the overall posture of this case, I cannot agree that the conduct of the appellants was sanctionable in its own right. As noted above, the Bankruptcy Court had determined at the May 1, 2008 hearing that sanctions would not be imposed based
on the Stay Motion. Only Mr. Fitzgibbon (who was not sanctioned)appeared in court for the later hearing. After a close reading of the transcript of the hearings, I am persuaded that the Bankruptcy Court objected to general practices in bankruptcy
mortgage disputes, rather than the specific conduct of the appellants. By way of example, the Bankruptcy Court stated in the hearings that:

"I do not have any adverse views about Mr. Fitzgibbon. You know, this is not about Mr. Fitzgibbon. This is about when attorneys stand up in this Court and they’ve been asked to provide loan histories and they can’t get it. And it’s not just – if it was one young attorney who was having a problem that would be one thing. We wouldn’t have done all this if it was one young attorney who didn’t know that he could do this. But I have attorneys that stand here week after week and can’t get loan histories. I’ve just sat through an hour and a half of this system which is telling me that they should be able to get it not in thirty days, which is the time your attorneys always ask for, but they should be able to get it the next day."

N.T. Oct. 23, 2008 at 107-08 (emphasis added). There is nothing in the record to support a finding that any of the other attorneys referenced are from the Udren firm; to the contrary, the system used by many law firms representing many mortgage holders in bankruptcy cases appears to be at fault. As the Bankruptcy Court stated, “[t]he bottom line from my perspective is that I just want to know when a lawyer stands up in court and says, I want to continue this, I can’t get a document. I want to know why. I want to be able to move these cases.” N.T. Oct. 23, 2008 at 148.

Understandably, something needs to be done when the bankruptcy courts cannot obtain timely and accurate information. According to the Bankruptcy Court’s opinion, the problem of inaccurate mortgage payment information is less likely to arise in the United States Bankruptcy Court for the District of New Jersey because the local rules of that court require that the client certify the truth and accuracy of the averments. Opinion at n.21. Clarity in the rules would benefit all counsel and litigants.

The sanctions imposed in this case were an abuse of discretion, as the Bankruptcy Court already had determined that the Stay Motion did not merit sanctions, and Mr. Fitzgibbon’s failure to obtain the accounting (the only event after the denial of the Stay Motion) was an insufficient basis for the imposition of sanctions against the appellants.

District Court Opinion, pp. 5-9.

What It Means

The Bankruptcy Court's opinion was an example of what could be called inquisitorial justice. The Bankruptcy Court observed what it perceived to be an abuse and conducted an investigation under the guise of awarding sanctions under Rule 9011. However, as the District Court opinion points out, Rule 9011 does not provide a good vehicle for addressing systemic problems.

The Bankruptcy Court's opinion was blogworthy because it was a searching inquiry into the relationship between professionalism and technology. However, the District Court opinion points out that there are technical elements which must be met in order to proceed under Rule 9011. Rule 9011(b) requires that there be a paper which is presented to the court "whether by signing, filing, submitting or later advocating." Thus, it would never have been possible to sanction the head of the firm for setting the tone and establishing the firm culture. Rule 9011 just doesn't get there.

The reversal of the sanction against the head of the bankruptcy section is more problematic. In that case, the Bankruptcy Court granted sanctions for failure to perform an adequate pre-filing investigation. The District Court's ruling is largely non-responsive to this issue. For example, the argument that Debtor's counsel contributed to the problem, while accurate, does not address the review which took place prior to filing the pleadings. However, the District Court may have concluded that when the bankruptcy court initially announced that it was "cutting them a break" on the motion for relief from stay, that it could not go back later and award sanctions.

The important point to take away from the District Court opinion is that sanctions awards under Rule 9011 must flow from the specific conduct identified in the rule. While the Court may also award sanctions under Sec. 105 or its inherent powers, these remedies have their own requirements which must be observed.

Hat tip to Jonathan Bart who sent me the opinion.

Pennsylvania Judge Writes Epic Opinion on Technology and Professional Responsibility

Technology has dramatically changed the practice of law. Thanks to Westlaw and Lexis, it is no longer necessary to keep large expensive libraries. PACER and ECF have made court filings and filing documents available 24/7. I recently observed a case where the parties used GoToMeeting to handle thousands of pages of exhibits electronically. All of these developments have made the practice of law more efficient. However, a recent opinion from Judge Diane Weiss Sigmund highlights that professionals must be masters of the technology rather than being mastered by it. In re Taylor, No. 07-15385 (Bankr. E.D. Pa. 4/15/09).

The Taylor case started with a simple question that comes up frequently in consumer bankruptcy cases: Why couldn’t the creditor’s lawyer get a payment history? The answer given to this question prompted Judge Sigmund to launch a one year investigation into the technology behind the case and how it was being used and to award some very creative sanctions. The Judge authored a 58 page opinion ”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” Opinion, p. 30.

What Happened

Taylor involved a chapter 13 filing to try to keep a house. Two firms appeared on behalf of HSBC, the mortgage holder. A national firm filed a proof of claim, while a local firm filed a motion for relief from stay and responded to an objection to claim. All three documents were defective. The proof of claim attached the wrong mortgage and listed the wrong payment amount. The motion for relief from stay recited that the debtors had failed to make their post-petition payments for three months, when in fact they had been making the payments, but at a lower amount due to a dispute over flood insurance. According to the Court, “at the time the Stay Motion was filed, the Debtors were short $360 for payments more than 60-days overdue, a fact not clear from the canned pleading prepared by a paralegal from New Trak screens. The Debtors were charged $800 for the cost of the motion.” Opinion, p. 14. The motion also recited that the debtors had no equity in the property which the attorney later attributed to being part of a boilerplate form. The response to the objection to claim said that the claim was just fine when it was not.

The Debtor’s attorney did not do much better. She filed a late response, which incorrectly stated that the debtors had made all of their payments but they had been returned by HSBC. The Debtor’s attorney also failed to respond to requests for admission tendered with the motion, incorrectly believing that her response to the motion was sufficient.

Upon receiving the Debtor’s attorney’s response, HSBC’s local counsel continued the hearing for further investigation. The Debtor’s lawyer then filed an amended response, which included copies of the checks for the months of September through January with both front and back and the checks for February and March with just the front. The amended response alleged that the payments for September through March had all been made. As it turns out, the reason that there were only copies of the front side of the February and March payments was because the Debtor’s counsel was still in possession of these checks which had not yet been tendered. Debtor’s counsel erroneously mailed these checks to the person at HSBC’s attorney’s office who handled Sheriff’s Sales rather than to the Bankruptcy Department. The person in the Sheriff’s Sale department sat on the checks and did not inform the Bankruptcy Department that they had been received. The Debtor’s counsel also requested a payment history.

On May 1, a young associate appeared for HSBC and insisted on prosecuting the motion even though he had been provided with proof of payments. The young attorney sought to proceed based on the deemed admissions even though he knew they were not accurate. The court denied the motion and instructed the debtor to escrow the disputed flood insurance premiums while the parties worked through the issue.

One month later, the parties appeared on the claims objection and things rapidly escalated. The young associate (he had been licensed a few months at the time) stated that he could not get a payment history from his client. He explained that he had submitted a request for a payment history through an electronic system, but that he was forbidden to speak directly with the client. This statement caused the Court to issue a show cause order.

In response to the Court’s Show Cause Order, HSBC retained new counsel and the problem with the claim was quickly settled. As noted by the Court, “What could not be accomplished for six months through the use of electronic communication was finalized in an hour the old way, by people sitting down with all relevant information and talking to each other.” Opinion, p. 19.

While the contested matters were quickly settled, the Court was not satisfied. It launched an inquiry which brought the technology center stage.

The Technology and Professional Responsibility

The technology involved was the NewTrak system developed and operated by Lender Processing Services, Inc. f/k/a Fidelity Information Services, Inc. To its credit, LPS was “extremely cooperative” with the court’s inquiry and “provided a detailed demonstration of how NewTrak works in a hypothetical case.” Opinion, p. 9, n. 15. As a result, the Court had a substantial knowledge base to draw on when writing her opinion. NewTrak is an automation system which allows lenders and attorneys to communicate with each other. The lender uploads its information onto the system which then generates a referral to an attorney on the approved list. The attorney receives the information and generates the proof of claim, motion for relief from automatic stay or other pleading. The system also allows the attorney to request information from the client by opening an issue on the system. Another system called the mortgage servicing platform handles routine mortgage servicing. According to LPS, it was used by 39 of the 50 largest banks in 2007 and processed approximately 50% of the loans in the United States.

While NewTrak provides a flow of information between attorney and client, it is not meant to prohibit direct contact between the parties. The Default Services Agreement specifically provides that “The Firm will never be prohibited from directly contacting any client where, in the professional opinion of the Firm such contact is necessary.” Opinion, p. 34, n. 45. As a result, the agreement contemplates that the Firm will exercise professional judgment. However, the Court found that when an attorney mechanically uses the system “the attorney abandons any pretense of independent judgment to the greater goal of expeditious and economical client service.” Opinion, p. 31.

The Court contrasted the benefits of using the technology with its pitfalls when a matter is not routine.

It is a regrettable reality, especially in this economic climate, that many homeowners are defaulting on their mortgages. While bankruptcy affords an opportunity to save the family home through a Chapter 13 plan that stretches the payments of mortgage arrears, it also requires debtors to maintain current payment on their mortgages. (citation omitted). This obligation is beyond the capability of many debtors who use a bankruptcy to forestall the inevitable. It seems reasonable that a mortgage lender should be able to avail itself of economic and expeditious means of collecting defaulted loans through the use of technology and delegation of tasks to lower cost labor. In many cases, the motions are granted by default, the debtors, or often more accurately their attorneys, filing no answer or making no appearance, where there is simply no defense to the relief sought. However, where, as here, the debtor contests the relief sought, the flaws in the automated process become apparent. At this juncture, an attorney must cease processing files and act like a lawyer. That means she must become personally engaged, conferring with the client directly and abandoning her reliance on computer screens as an expression of her client’s will. This did not happen in this case until the Court became involved. It should not have taken judicial intervention to bring the Claim Objection to its conclusion.

Opinion, p. 32 (emphasis added).

In this case, the court found that professional judgment was not used.
The attorney for the national firm which filed the proof of claim testified that he reviewed only a representative sample of 10% of the claims which were electronically signed with his name. He did not review the specific claim in this case and as a result, did not find the mistakes in it.

The president of the local firm which utilized NewTrak testified that he delegated the administrative aspects of the firm’s practice and was unaware of how NewTrak worked.

The head of the bankruptcy section of the firm electronically signed all of the pleadings in the matter, but delegated all of the court appearances to an attorney who had been licensed for only one month when the initial pleading was filed. The court found that the head of the bankruptcy section failed to supervise the young attorney and asked the rhetorical question, “Could it be with ten lawyers and 130 paralegals and processors, a young attorney is expected to figure it out himself?” Opinion, p. 42.

The Court also found that the client had restricted the firm’s authority.

The Udren Firm’s authority from HSBC allowed them to take only three actions: (1) seek a continuance; (2) settle with Motion with an agreement for a six month maximum cure of the mortgage arrears with an agreement for stay relief upon certification of default of any future payment; and failing either of the foregoing; (3) press the motion. (citation omitted). No consultation with HSBC was expected nor occurred during the pendency of the contested matter.

Opinion, p. 37, n. 49.

Sanctions

The Court found that several parties to the case had violated their obligations under Rule 9011, including the obligation to make reasonable inquiry. However, the Court was also mindful that sanctions should be “limited to what is sufficient to deter a repetition of such conduct or comparable conduct by others similarly situated.” Rule 9011(c)(2). As a result, the Court granted some very creative relief.

As to the Udren Firm, which acted as local counsel, the Court found that the expense of having to hire counsel and defend itself and the productive time lost in attending to the matter was punishment enough. However, the Court devoted additional attention to the specific lawyers from the firm.

The Court found that the head of the Udren Firm’s bankruptcy section “may be so enmeshed in the assembly line of managing the bankruptcy department’s volume mortgage practice that she has lost sight of her duty to the court and has compromised her ethical obligations.” Opinion, p. 52. The Court ordered her to obtain 3 credits of CLE in professional responsibility/ethics in addition to her regular requirements.

The court declined to award sanctions against the young associate, finding that “I believe these proceedings have been very hard on this young lawyer and while lack of experience is not a defense to a Rule 9011 violation, I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career.” Opinion, p. 52.

The Court found that the head of the firm “sets the tone and establishes its culture. He notes his firm’s reliance on NewTrak and other such aids as essential to the economic structure of the law practice. However, he had little familiarity with the actual operation of NewTrak and did not appear to get involved in the ‘weeds’ of the bankruptcy practice.” Opinion, pp. 52-53. The Court found this lack of involvement to be troubling and ordered relief accordingly.

Mr. Udren may not be aware of the questionable practices imposed by his firm’s acquiescence to NewTrak and how little legal judgment is employed as a result or he may be aware and find it acceptable. To examine these practices in light of extant ethical obligations, I will direct him to obtain training in NewTrak and spend a day observing his bankruptcy attorneys, paralegals, managers and processors as they handle referrals. Since policy emanates from the top, I will also order Udren and (the head of the bankruptcy section) to conduct a training session for all members of the bankruptcy department in the appropriate use of the escalation procedure and the requirements of Rule 9011 with respect to pre-filing due diligence.

Opinion, p. 53.

The Court did not award sanctions against the national firm which prepared the proof of claim, but not because she found their conduct appropriate. The Court found that the record had not been fully developed with regard to this party, that the practices were national in scope and that the U.S. Trustee was investigating the firm. As a result, the Court left it to another day and another court to address these issues.

The Court found that some of the problems in the case resulted from the Udren firm's reluctance to contact its client directly and found that other firms used by HSBC might be under the same impression. As a result, the Court ordered HSBC “to prepare and transmit by mail and e-mail a letter to all the Network Firms outlining the escalation policy and encourage its use consistent with the Rules of Professional Conduct. HSBC should also advise the Network Firms that use of direct contact will not reflect adversely on the firm.” Opinion, p. 55.

The Court did not sanction LPS.

Based on the record, I find that sactions against LPS are not warranted. While it does appear from the limited screens that have been introduced in this case, that LPS’ involvement goes beyond passing data through their automatic system, I cannot conclude that it imposed restrictions on the Udren Firm’s handling of this case. (citation omitted). The Udren Firm entered into a contract with Fidelity which it viewed as advantageous to the business relationships with its mortgage lender clients and presumably its bottom line. As attorneys, the Udren Firm understood an attorney’s obligations under Rule 9011 to investigate and took a lesser approach. While NewTrak prescribed that approach, LPS did not dictate how they would handle cases referred to them when problems with the procedure were apparent. By misusing the resources made available to them, the Udren Firm, not LPS, was responsible for the Rule 9011 deficiencies in this case.

Opinion, pp. 55-56.

Conclusion

Judge Sigmund’s remarkable opinion demonstrates that she is no Luddite. Her opinion focuses on the need to exercise professional judgment in conjunction with technology rather than mindlessly bashing the technology itself. In her conclusion, she stated:

My research has disclosed no other published opinion that explains the NewTrak process that is utilized by so many consumer mortgage lenders seeking relief in bankruptcy cases. I have attempted to share my education in this Opinion. Finally, it is my hope that by bringing the NewTrak process to the light of day in a published opinion, system changes will be made by the attorneys and lenders who employ the system or at least help courts formulate the right questions when they have not. While NewTrak has many features that make a volume business process more efficient, the users may not abandon their responsibility for fairness and accuracy to the seduction of electronic communication. The escalation procedures in place at HSBC and the Udren Firm existed on paper only. When an attorney appears in a matter, it is assumed he or she brings not only substantive knowledge of the law but judgment. The competition for business cannot be an impediment to the use of these capabilities. The attorney, as opposed to a processor, knows when a contest does not fit the cookie cutter forms employed by paralegals. At that juncture, the use of technology and automated queries must yield to hand-carried justice. The client must be advised, questioned and consulted. Young lawyers must be trained to make those judgments as opposed to merely following the form manual. Until they are capable of doing so they should be supported and not left to sink or swim alone in an effort for the firm to be more profitable by leveraging the cheapest labor.

At issue in these cases are the homes of poor and unfortunate debtors, more and more of whom are threatened with foreclosure due to the historic job loss and housing crisis in this country. Congress, in its wisdom, has fashioned a bankruptcy law which balances the rights and duties of debtors and creditors. Chapter 13 is a rehabilitative process with a goal of saving the family home. The thoughtless mechanical employment of computer-driven models and communications to inexpensively traverse the path to foreclosure offends the integrity of our American bankruptcy system. It is for those involved in the process to step back and assess how they can fulfill their professional obligations and responsibly reap the benefits of technology. Nothing less should be tolerated.

Opinion, pp. 57-58 (emphasis added).

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.

Don't Mess With Judge Bohm

This column has devoted several articles to lawyers behaving badly in Houston. The Houston judges have been very proactive in writing about unprofessional conduct lately. Before beginning, two important caveats are important. First, these cases generally deal with the bottom 1% of the bar and are not representative of the bar in general. Second, these cases are presently coming out of Houston, but they could happen anywhere. The latest installment of Lawyers Behaving Badly involves an attorney-debtor who filed cases in bad faith, ignored court orders, failed to appear, evaded the U.S. Marshals and could not count.

A Brief Trip to Bankruptcy Court

In In re David Ortiz, No. 05-39982 (Bankr. S.D. Tex. 10/13/06), the attorney debtor filed an initial chapter 7 petition in January 2005 to avoid being evicted from his law office. The case was assigned to Judge Isgur. The Debtor received only a short delay since the stay was lifted early on. Once the eviction was allowed to go forward, he lost interest in his case. The case was dismissed for failure to attend the 341 meeting on May 31, 2005. Judge Isgur dismissed the case with prejudice to refiling for 180 days. Unfortunately, because the Debtor failed to update his address (most likely the one that he had been evicted from), he claimed that he never received the notice.

Return to Bankruptcy Court

Less than one month later, on June 29, 2005, the Debtor filed his second case, which was assigned to Judge Bohm. This case was filed for the same reason as the first case. In the space of six months, the Debtor had managed to find another landlord, fall behind on the rent and receive eviction papers.

Things Start to Get Bad—The First Sanctions Order

The U.S. Trustee promptly moved for sanctions. The Debtor appeared and pleaded ignorance of the prior order. The patient Judge Bohm agreed to abate the U.S. Trustee’s motion long enough to allow the Debtor to return to Judge Isgur and seek a modification of the prior order. When the parties returned to Court, Judge Bohm found that the Debtor had not sought to modify Judge Isgur’s order. He also determined that the Debtor had failed to file accurate schedules and did not have a good reason for failing to appear at the 341 meeting in the first case. At that point, Judge Bohm ordered the Debtor to pay attorney’s fees of $1,875 to each of his landlords and continued the matter to consider whether other sanctions might be appropriate. The Debtor finally retained an attorney at this point. At the continued hearing, Judge Bohm ordered that the Debtor pay $1,000 in sanctions to the Clerk within 60 days and barred him from filing again for a year without prior permission.

Things Get Worse--The Bench Warrant(s)

By the time of the first sanctions order on November 17, 2005, the Debtor had angered a federal bankruptcy judge. However, his problems could have been solved by paying $4,750. It would have been a really good idea to comply with this order through whatever means possible. The Debtor didn’t get the message. Some four months later, the U.S. Trustee filed a Certificate of Non-Compliance indicating that the Clerk had not been paid. Judge Bohm scheduled yet another hearing, which was continued to May 10, 2006. Neither the Debtor nor his attorney appeared at this hearing. The Debtor also failed to accept service from the U.S. Trustee’s process server after agreeing to do so. Judge Bohm issued a bench warrant that day.

In response to the bench warrant, an attorney who said she was acting merely as an intermediary contacted the U.S. Marshal and promised to inform the Debtor about the bench warrant. She gave the Marshal a non-working number for the Debtor. When the Debtor could not be located at his home or office, Judge Bohm issued a bench warrant for the intermediary attorney. This bench warrant met with more success and the “intermediary” appeared and testified that the Debtor was aware that there was a bench warrant out for him, but wanted to meet with his attorney first. Judge Bohm ordered the intermediary to check in with the U.S. Marshal twice a day until the Debtor was apprehended.

Judge Bohm Tries to Get the Debtor’s Attention—The Second Sanctions Order

On May 16, 2006, Judge Bohm, who had no doubt progressed from furious to livid, issued a second sanctions order which required the Debtor to pay $500 per day for each day that he failed to surrender and to pay $250 per day for each day that he failed to pay the $1,000 sanction to the clerk. The Court ordered the Debtor’s attorney to appear two days later to report whether he had informed the Debtor of the second sanctions order.

Melt-Down—The Third Sanctions Order

On May 18, 2006, the Debtor appeared with a new attorney (a respected bankruptcy attorney) and paid the $1,000 owing to the Clerk. The Debtor claimed that while he was aware of the May 10 hearing, that his attorney was scheduled to be out of the country and assured him that he would get the hearing re-set. The attorney did not do this. However, when the Debtor contacted the attorney’s office to see if any arrangements had been made, he was told that they were not aware of any, but that that the attorney would not have left town without having done something. The Debtor also testified that when he learned of the bench warrant, he checked into a hotel to avoid being found.

Judge Bohm was not amused. However, the order he entered was remarkably restrained. He ordered the Debtor to:

1. Write a letter apologizing to the U.S. Marshals for not turning himself in immediately;
2. Contact the Texas Lawyers Assistance Program to see if he would benefit from counseling;
3. Take 10 hours of bankruptcy continuing legal education (including three hours of ethics) if he ever planned to appear in the Southern District again;
4. Find other counsel for a client he was currently representing in a chapter 7 case; and
5. Either pay $750.00 or write “I will respect the judicial system, and such respect includes obeying all court orders” 750 times.

Judge Bohm gave the Debtor five days to comply.

When the Debtor returned five days later, he only tendered 700 sentences instead of 750, he had failed to pay the prior sanction to his landlords and he had failed to find alternate counsel for his client (whose case was subsequently dismissed by Judge Brown). However, he did complete his CLE.

The Judge gave the Debtor one more opportunity to comply and at the next hearing, he presented cashier’s checks to pay his landlords’ attorney’s fees and tendered the remaining 50 sentences. As a final sanction, the Court wrote a lengthy opinion chronicling the pattern of abuse which had led to his orders.

What Were They Thinking?

Attorneys make mistakes. Sometimes the difference between a good attorney and a disgraced attorney is the ability to engage in damage control. The attorney(s) here did not learn that lesson.

Mr. Ortiz’s motivations in filing bankruptcy to avoid eviction were not pure. Filing a second bankruptcy in violation of a court order that he arguably did not know about was bad but not fatal. At this stage, the Debtor/Attorney had a problem, but the court offered a way out (returning to Judge Isgur to modify the prior order of dismissal). This was a serious mistake.

When the Debtor missed his first opportunity to extricate himself, he could have begged or borrowed the money to pay the initial sanctions and limped away, humbled but not crushed. However, at the point that he failed to appear in court and then evaded the U.S. Marshal, he risked serious jail time. The fact that the ultimate consequences were so light may have been because the Debtor finally retained a competent bankruptcy attorney or perhaps because the court was happy just to have gotten his attention. However, it is clear that things could have been worse—much worse.

The Debtor’s first attorney and the “intermediary” attorney do not come off very well either. The opinion does not explain why the first attorney went off to Jordan without obtaining a continuance of the May 10 hearing. However, the attorney had to know that he was dealing with an extremely volatile situation. His absence caused a bench warrant to be issued for his client. The attorney who appeared only as an intermediary does not fare very well either. She was in contact with the Debtor on a regular basis, but somehow managed to provide the U.S. Marshal with a non-working number to contact him. The court found her testimony to be less than forthcoming.

When all was said and done, three attorneys found themselves named in an opinion which did not reflect well upon them. This opinion should be made required reading in legal ethics courses.

Judge Clark Attracts Attention With War on Terror Comments

Judge Leif Clark is a frequent source of colorful commentary. Whether he is skewering BAPCPA or illustrating the difficulty with multi-prong tests, his opinions make for interesting reading. He has even garnered the attention of NPR by quoting Adam Sandler in a footnote. He has been featured on NPR again, but this time, the subject is the war on terror. Judge Clark recently sent an email critical of comments by a Bush administration spokesman discussing enemy combatant rules. http://www.npr.org/templates/story/story.php?storyId=6195853. Now, according to an article carried in the Austin American Statesman, some are questioning whether Clark's comments went too far. See "Judge likens U.S. policy to that of Soviet Union," Austin American Statesman, October 10, 2006, p. B3.

The following email appears on NPR's web site:

'Can This Be America?'

Listening to John Yoo talk about this new legislation was chilling. I'm a federal judge, and have taught constitutional law for 16 years. The very idea of holding anyone without trial, without the right to see the evidence that was used to justify naming them an "enemy combatant," and depriving them of the ability to challenge why they are even there is so repugnant to a constitutional democracy that I am shocked that this man actually claims to be defending American values. These are the tactics of the old Soviet Union, not of a country that stands for freedom and the rule of law.

I also quibble with his contention that U.S. citizens still have the right to habeas review. I've read the law. The president can form his own tribunal, which can determine who is an "enemy combatant" (not just an alien enemy combatant), and the decision of that tribunal would not be subject to habeas review. Moreover, persons targeted by this tribunal would not even have access to the military tribunal trial created under this law.

How easy it would be for a president to use such a law to make his political enemies simply disappear. Can this be America? -- Leif Clark, San Antonio, Texas

According to the article carried in the American Statesman, some unnamed lawyers think that Judge Clark's "outburst" could subject him to discipline. Chief Judge Edith Jones of the Fifth Circuit acknowleged that "This is a very novel situation." Judge Jones said that she didn't know how the situation would be handled or if it would be handled at all.

A quick review of the Code of Conduct for United States Judges appears to support the judge's ability to speak out on legal issues. Canon 4(A) states that "A judge may speak, write, lecture, teach, and participate in other activities concerning the law, the legal system, and the administration of justice." To continue the theme, Canon 5(A) states that, "A judge may write, lecture, teach, and speak on non-legal subjects, and engage in the arts, sports, and other social and recreational activities, if such avocational activities do not detract from the dignity of the judge's office or interfere with the performance of the judge's judicial duties." Thus, the canons seems to protect the ability of a judge to write, lecture, teach or speak on legal or non-legal topics.

The canons which might limit judicial speech are more oblique when applied to this situation. Canon 1 requires a judge to uphold the "integrity and independence" of the judiciary, while Canon 2 requires a judge to obey the law and to "act at all times in a manner that promotes public confidence in the integrity and impartiality of the judiciary." Canon 7 states that a judge should refrain from political activity. However, the specifically prohibited conduct does not address speaking out on politically charged topics.

Thus, with all due respect to the anonymous lawyers quoted in the newspaper, and regardless of whether you agree with the substance of Judge Clark's statements, the judicial canons allow him to speak on both legal and non-legal topics so long as his comments do not detract from the dignity of his office. Unless it is considered just plain unseemly for a member of the judicial branch to criticize the executive branch, then it is hard to see how Judge Clark's comments detract from the dignity of his office.

The interesting thing here is because he is a bankruptcy judge, Judge Clark is unlikely to have these issues arise in his court. His email identified himself as a federal judge and constitutional law professor. However, because he is a very specialized federal judge, he has no jurisdiction over and thus no special expertise with respect to writs of habeas corpus. As a result, his status as a federal bankruptcy judge may be more of a red herring. Instead, his real standing to speak on the issue arises from his status as a private citizen and constitutional law professor. These are both capacities in which he should be free to speak his mind.

More Lawyer Problems in Houston

Judge Letitia Clark has added an entry to the growing list of opinions dealing with attorney problems in the Southern District of Texas. In In re John M. Diaz, No. 05-95123, 2006 Bankr. LEXIS 2008 (Bankr. S.D. Tex. 8/28/06), the Debtors' attorney in a chapter 13 case filed a fee application requesting $4,132.00 in fees and $301.50 in expenses. Apparently the Court had been tipped off as to problems with the case because both Debtors and several employees from the attorney's law firm testified at the fee application hearing. The picture painted by that testimony was not pretty.

According to the Debtors, they met with their attorney once for 30-40 minutes before filing the initial schedules and plan. They were not asked any questions about their budget. However, the documents filed under penalty of perjury included a detailed budget which contained just enough disposable income to pay secured claims and 7% to unsecured creditors. The Debtors then amended their plan and schedules five times with the result that under the final confirmed plan unsecured creditors were to receive a dividend of 100%. One of the amended schedules included an expense item of $800 per month despite the fact that the debtors had not made charitable contributions in several years. The Debtors testified that they did not understand the various changes to their schedules and plans and that all of their communications with the law firm were through secretaries and paralegals.

When Debtors' counsel realized that he was in trouble, he offered to reduce his fee to $500. However, the Court did not accept this offer. Instead, the court denied all fees. The court stated:

"In the instant case, (attorney) presented false schedules to the court, without adequately counseling his clients as to what the schedules represented, and without conducting any investigation into their veracity. It appears that the schedules contained figures invented by (attorney) or his subordinates, and filed for the improper purpose of evasion of Debtor's obligations to pay creditors. These services violated counsel's duty to instruct and supervise the Debtors, and violated (attorney's) ethical duty of candor to the tribunal. The services rendered by (attorney) and his subordinates were of zero value, no matter how much time was spent on such services, and irrespective of the ultimate confirmation of the plan in the instant case. In addition, (attorney) has imposed considerable burdens of time and detailed attention on his clients, the Trustee, and the court system, through his inadequate client counseling, filing of false documents, and lax supervision of staff."

Slip Op. at 13-14.

The facts of this case, if accurately found by the Court, are shocking. The Court found that the law firm made up numbers to minimize the Debtors' disposable income, did not bother to obtain actual expense figures and did not tell the Debtors what they were signing. It strains credibility a little bit to assume that Debtors making $11,000 a month were not sophisticated enough to know that something was not right with their filings, especially after the trustee requested amendments at the creditors meeting and filed several motions to dismiss based upon the inaccurate schedules. It also seems foolish at best that the attorney would risk being caught and exposed (as he ultimately was) just to earn a fee in a chapter 13 case.

On a certain level, this opinion is good because it points out that there are consequences for bad behavior. However, in a world of trial by anecdote, it gives fuel to the bankruptcy reformers who believe that all debtor's lawyers are unethical and out of control. This case is noteworthy precisely because it is an aberration. This was a case where the system worked. Therefore, it should not be viewed an an indictment of the system or the vast majority of the participants within that system.

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.