Houston Judges Continue Inquiry Into Practices of Prominent Creditors' Firm

Proceedings involving a prominent Houston creditors’ firm (hereafter referred to as the Firm)* heated up recently as two bankruptcy judges considered sanctions issues arising out of the Firm’s extensive bankruptcy practice. The Firm feuded publicly with the U.S. Trustee’s office while seeking to demonstrate the sincerity of its repentance. While a significant amount of information was added to the public record, no resolution is likely until mid-summer.

Background

The firm in question operates a high volume foreclosure and bankruptcy practice. Its recent spate of difficulties began on February 3, 2006, when U.S. Bankruptcy Judge Marvin Isgur assessed sanctions of $65,000 against the Firm in connection with its requests for attorney’s fees in connection with motions for relief from stay. In re Porcheddu, 338 B.R. 729 (Bankr. S.D. Tex. 2006). In the opinion, the court estimated that the firm filed 5,000 motions for relief from stay per year in the Southern District of Texas alone and estimated the Firm’s revenues from motions for relief from stay at $125,000 every two weeks.

U.S. Bankruptcy Judge Wesley Steen issued a series of orders arising out of objections to a chapter 13 plan filed by the Firm on behalf of its client, Countrywide Home Lending, Inc., which culminated in an opinion finding that sanctions should be assessed against the Firm. In re Allen, 2007 Bankr. LEXIS 231 (Bankr. S.D. Tex. 1/9/07). See “Court Rejects Defense of The Computer Made Me Do It” (1/10/07). The Court bemoaned the fact that prior warnings and the Porcheddu sanction had not caused the firm to change its behavior. The Court scheduled a hearing at which the Firm was ordered to appear and report what sanctions would deter future repetition of the conduct.

Meanwhile, Judge Jeff Bohm issued his own show cause order after the Firm filed a motion for relief from stay and then withdrew it following allegations that it was based on a flawed payment history. In re Parsley, No. 05-90374 (Bankr. S.D. Tex. 2/12/07). This case involved Countrywide as well. (Note: The specific allegations regarding the accuracy of the pay history are disputed. Apparently the debtor would have been in default even if the two disputed payments were disregarded). Judge Bohm scheduled a hearing for March 5, 2007.

Thus, by the end of February 2007, one Houston judge had assessed sanctions against the Firm, a second Houston judge was preparing to assess sanctions and a third Houston judge was considering whether sanctions should be imposed. The stage was set for March madness.

The Parsley Hearing

Judge Bohm’s case was the first to be scheduled for a hearing. On March 2, 2007, the U.S. Trustee appeared and submitted a nine page Statement. The U.S. Trustee suggested that the Court should investigate whether Countrywide and its counsel had engaged in similar conduct in the past and should consider that information when deciding whether to assess sanctions. The U.S. Trustee concluded that “additional inquiry is needed to determine with certainty whether conduct at issue involves bad faith.” On the day of the hearing, the Firm's counsel filed an Emergency Motion to Strike, or in the alternative to Limit Issues and/or to Continue Hearing. The Firm objected that the U.S. Trustee had “at the eleventh hour” requested that the Court’s inquiry “be exponentially expanded.” The Firm also questioned the trustee’s ability to participate and criticized its failure to confer prior to filing its Statement.

The Bankruptcy Court declined to strike the U.S. Trustee’s Statement. The Court heard some testimony and then continued the remainder of the hearing until June 26, 2007. Some of the testimony received at the hearing related to the relationship between the Firm and its client. Specifically, testimony was received which indicated that Countrywide Home Lending, Inc. did not allow the Firm to communicate directly with it, but instead required that all communications be routed through another law firm.

In a post-hearing brief, the Firm argued that it had acted simply as local counsel for the referring law firm and had acted reasonably in relying upon the information provided to it.

The Allen Hearing

Shortly after the Parsley hearing, Judge Steen invited the U.S. Trustee to submit a statement in his case as well. When the U.S. Trustee submitted its statement one week later, it had grown to 35 pages and included selections from the transcript of the Parsley hearing. The U.S. Trustee suggested that the court expand its inquiry to examine the relationship between the Firm, Countrywide Home Lending and the national firm identified as the go-between. The U.S. Trustee pointed to specific statements by the Firm which referenced direct communications with Countrywide and suggested that these statements could not be correct if the Firm were not allowed to speak directly with its client.

The Firm's attorneys were not amused by the U.S. Trustee’s comments. They stated, “It is at once poignant and disturbing to witness the U.S. Trustee – in connection with a Rule 9011 sanction hearing – file a pleading containing reckless and untrue allegations concerning (the Firm) and third parties.” The Firm's counsel sent a Rule 9011 safe harbor letter to the U.S. Trustee demanding that it withdraw its allegations and attached a copy to its response. Apparently, there were only certain types of loans where Countrywide required that all of its law firms communicate through a single law firm. The Parsley case involved a no direct contact case, where the Allen case apparently involved a case where direct contact was allowed. The bemused U.S. Trustee pointed out that it had simply quoted from the transcript in the Parsley case.

In preparation for the Allen hearing, the Firm's attorneys filed several pleadings designed to show the sincerity of the Firm's repentance. In response to an order from Judge Steen requiring it to disclose “all similar occurrences and proceedings involving the firm” in the prior five years, the Firm submitted a list of nine proceedings which it contended were directly relevant (including Porcheddu, Allen and Parsley), as well as five other incidents which it contended were not directly relevant but were submitted in the interest of full disclosure.

The Firm also submitted a Response in which it accepted responsibility for its actions. It suggested that the Court consider the damage to the Firm’s reputation in assessing a sanction** and detailed a list of actions taken subsequent to the Porcheddu opinion. Among other things, the Firm stated through its counsel that:

• It had hired an experienced Managing Bankruptcy Attorney in April 2006;
• It had retained former bankruptcy judge Bill Brister as an independent “legal” auditor;
• It had conducted in-house trainings, including training in ethics and attorney due diligence as well as the specific issues raised by the Allen case;
• It had required additional CLE for its staff;
• It made 211 changes to its software during 2006;
• It had developed new payment tracking software;
• It had required that its motions include payment histories certified by its clients;
• It had required greater involvement and review by senior attorneys; and
• It had terminated two attorneys.

The Firm estimated the compliance costs which it had incurred at over $2 million.

On March 22, 2007, Judge Steen conducted a hearing on the sanction to be imposed. However, he did not make a ruling at that time. Instead, he entered an Order for Continuance, Supplemental Report, and Discovery. The Court made the following rulings:

• It required the U.S. Trustee and the Firm to confer about whether discovery was required with regard to the Certificate of Conference attached to the Firm’s first objection to plan confirmation;
• It allowed the U.S. Trustee to file a revised Statement based upon the testimony received and the discussion regarding the Certificate of Conference;
• It allowed the Firm to respond to the U.S. Trustee’s revised Statement and to respond to issues addressed in open court with regard to Case No. 04-50312; and
• It stated that it might enter an order stating that it would rule without any further hearings or it might hold a hearing to consider an update from Judge Brister and to determine the issues surrounding the Certificate of Conference.

The Court’s order indicates concern in two specific areas. The objection to confirmation contained a Certificate of Conference which recited that “I, (Attorney), an attorney employed by the offices of (the Firm) made a good faith effort to negotiate a settlement of the dispute with Debtor’s counsel. Resolution of this dispute was not successful and the filing of this Objection to Confirmation is therefore necessary.” If the parties had conferred and the Debtor’s counsel failed to raise the issue subsequently raised in its response, then the mistakes in the subsequent pleadings would be more innocent. On the other hand, if no conference occurred, then the subsequent errors would appear more serious. A false certificate combined with an erroneous pleading would be more serious than an erroneous pleading standing alone.

The Court also focused attention on prior proceedings in In re Cordova. Cordova was a case in which an objection to confirmation had been filed and then withdrawn. On January 12, 2005, Judge Steen issued an Order Continuing Hearing and Requiring Attendance at Hearing to Show Case Why Sanctions Under Rule 9011 Are Not Appropriate. According to the docket, Judge Steen admonished the Firm, but declined to issue sanctions at that time. Curiously, the Cordova case was not mentioned by the Firm in its self-disclosure of “similar occurrences and proceedings” despite the fact that Judge Steen's Allen opinion had specifically referred to a prior instance in which he had admonished the Firm.

What Does It All Mean?

In the short-term, there has been a lot of attention focused on the Firm without any resolution of the issues. However, the cases raise several important questions.

How does a firm handle a high volume of cases and still satisfy its professional obligations? That seems to be the question raised by the Houston judges. It is also seems to be the issue which the Firm has addressed in its responses.

There is also a question as to the extent that the Firm must assume responsibility for the information provided by its clients. In the Parsley case, the Firm apparently submitted inaccurate information which it received from its client (although the extent to which the information was inaccurate is a matter of dispute). To what extent should the Firm be responsible for policing the accuracy of the information received from its clients? Under the new procedure proposed by the Firm, the Firm’s clients must certify as to the accuracy of its pay histories. At what point does any attorney have an affirmative obligation to question the information being provided by his client?

What is the Firm’s obligation to disclose that it is merely acting as local counsel and does not have direct contact with its client? In at least the Parsley case, it appears to be undisputed that the Firm accepted referrals from another law firm on the condition that all communications go through that law firm. However, the Firm filed pleadings in which the identity of the other firm was not disclosed. If a Firm files pleadings on behalf of a client, is it representing that it has had direct contact with that client?

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*The identity of the firm involved is widely known. However, it is this blog’s policy not to specifically name attorneys involved in sanctions issues.
**In a separate pleading, the Firm stated that “The spoken and written comments by the Court are widely read, blogged, and commented on by practitioners and other courts as well as clients and potential clients.”