Wednesday, June 28, 2006

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.

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