Supreme Court Affirms Espinosa on Procedural Grounds Without Endorsing Discharge by Declaration

Consistent with several prior rulings, a unanimous Supreme Court held that a creditor could not use a Motion under Rule 60(b)(4) to attempt to set aside a chapter 13 confirmation order which included a controversial "discharge by declaration" provision." United Student Aid Funds, Inc. vs. Espinosa, No. 08-1134 (U.S. 3/23/10).

Background

Espinosa involved a chapter 13 debtor who included a single student loan debt in his chapter 13 plan and provided that upon payment of the principal amount, the debt would be discharged. The plan violated 11 U.S.C. Sec. 523(a)(8) because it sought to discharge a student loan debt without a finding of undue hardship. However, the creditor did not object to the plan, the plan was confirmed and the debtor received a discharge after completing his payments. Several years after discharge, the student loan creditor began collection efforts. The debtor asked the bankruptcy court to enforce the discharge order, while the creditor asked the court to declare the order to be void under Rule 60(b)(4). The Bankruptcy Court and the Court of Appeals ruled that the orders were not void and could not be challenged at such a late date.

I have previously written about Espinosa here, here and here.

All About Voidness

Justice Thomas, writing for a unanimous Supreme Court, authored an opinion affirming the Ninth Circuit on finality grounds, while pointing out that inappropriate orders could be policed through other methods than declaring them void.

Justice Thomas explained that in order to set aside a judgment as void, there must be a jurisdictional defect or failure to afford due process.

“A judgment is not void,” for example, “simply because it is or may have been erroneous.” (citation omitted). Similarly, a motion under Rule 60(b)(4) is not a substitute for a timely appeal. (citation omitted). Instead, Rule 60(b)(4) applies only in the rare instance where a judgment is premised either on a certain type of jurisdictional error or on a violation of due process that deprives a party of notice or the opportunity to be heard. (citation omitted). The error United alleges falls in neither category.

Opinion, pp. 8-9.

Voiding a judgment for lack of jurisdiction is "reserved . . . only for the exceptional case in which the court that rendered judgment lacked even an 'arguable basis' for jurisdiction." Opinion, at 9. Section 523(a)(8)'s requirement that a court find undue hardship to discharge a student loan debt is a precondition for discharge, but is not a limitation on the court's jurisdiction. Similarly, the procedural requirement of an adversary proceeding and a summons is not jurisdictional.

Justice Thomas also found that failure to initiate an adversary proceeding did not deprive the student loan creditor of due process.

Espinosa’s failure to serve United with a summons and complaint deprived United of a right granted by a procedural rule. (citation omitted). United could have timely objected to this deprivation and appealed from an adverse ruling on its objection. But this deprivation did not amount to a violation of United’s constitutional right to due process. Due process requires notice “reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.” (citation omitted). (“[D]ue process does not require actual notice . . .”). Here, United received actual notice of the filing and contents of Espinosa’s plan. This more than satisfied United’s due process rights. Accordingly, on these facts, Espinosa’s failure to serve a summons and complaint does not entitle United to relief under Rule 60(b)(4).

Opinion, p. 10.

No Expansion of Voidness Concept

The Supreme Court also rejected an attempt to expand the concept of voidness to embrace statutory defects.

Unable to demonstrate a jurisdictional error or a due process violation, United and the Government, as amicus , urge us to expand the universe of judgment defects that support Rule 60(b)(4) relief. Specifically, they contend that the Bankruptcy Court’s confirmation order is void because the court lacked statutory authority to confirm Espinosa’s plan absent a finding of undue hardship. In support of this contention, they cite the text of §523(a)(8), which provides that student loan debts guaranteed by governmental units are not dischargeable “ unless ” a court finds undue hardship. 11 U. S. C. §523(a)(8) (emphasis added). They argue that this language imposes a “ ‘self-executing’ limitation on the effect of a discharge order” that renders the order legally unenforceable, and thus void, if it is not satisfied. (citation omitted). In addition, United cites §1325(a)(1), which instructs bankruptcy courts to confirm only those plans that comply with “the … applicable provisions” of the Code. Reading these provisions in tandem, United argues that an order confirming a plan that purports to discharge a student loan debt without an undue hardship finding is “doubly beyond the court’s authority and therefore void.” (citation omitted).

We are not persuaded that a failure to find undue hardship in accordance with §523(a)(8) is on par with the jurisdictional and notice failings that define void judgments that qualify for relief under Rule 60(b)(4). As noted, §523(a)(8) does not limit the bankruptcy court’s jurisdiction over student loan debts. (citation omitted). Nor does the provision impose requirements that, if violated, would result in a denial of due process. Instead, §523(a)(8) requires a court to make a certain finding before confirming the discharge of a student loan debt. It is true, as we explained in Hood , that this requirement is “ ‘self-executing.’ ” (citation omitted). But that means only that the bankruptcy court must make an undue hardship finding even if the creditor does not request one; it does not mean that a bankruptcy court’s failure to make the finding renders its subsequent confirmation order void for purposes of Rule 60(b)(4).

Given the Code’s clear and self-executing requirement for an undue hardship determination, the Bankruptcy Court’s failure to find undue hardship before confirming Espinosa’s plan was a legal error. . . . But the order remains enforceable and binding on United because United had notice of the error and failed to object or timely appeal.

United’s response—that it had no obligation to object to Espinosa’s plan until Espinosa served it with the summons and complaint the Bankruptcy Rules require, . . .is unavailing. Rule 60(b)(4) does not provide a license for litigants to sleep on their rights. United had actual notice of the filing of Espinosa’s plan, its contents, and the Bankruptcy Court’s subsequent confirmation of the plan. In addition, United filed a proof of claim regarding Espinosa’s student loan debt, thereby submitting itself to the Bankruptcy Court’s jurisdiction with respect to that claim. (citation omitted) . United therefore forfeited its arguments regarding the validity of service or the adequacy of the Bankruptcy Court’s procedures by failing to raise a timely objection in that court.

Rule 60(b)(4) strikes a balance between the need for finality of judgments and the importance of ensuring that litigants have a full and fair opportunity to litigate a dispute. Where, as here, a party is notified of a plan’s contents and fails to object to confirmation of the plan before the time for appeal expires, that party has been afforded a full and fair opportunity to litigate, and the party’s failure to avail itself of that opportunity will not justify Rule 60(b)(4) relief. We thus agree with the Court of Appeals that the Bankruptcy Court’s confirmation order is not void.

Opinion, pp. 11-14.

The Court's Independent Duty

However, the Supreme Court did chastise the Ninth Circuit for finding that Bankruptcy Courts were under an obligation to confirm plans containing improper "discharge by declaration" language absent objection.

As Espinosa concedes. . . a Chapter 13 plan that proposes to discharge a student loan debt without a determination of undue hardship violates §§1328(a)(2) and 523(a)(8). Failure to comply with this self-executing requirement should prevent confirmation of the plan even if the creditor fails to object, or to appear in the proceeding at all. (citation omitted). That is because §1325(a) instructs a bankruptcy court to confirm a plan only if the court finds, inter alia , that the plan complies with the “applicable provisions” of the Code. (citation omitted). Thus, contrary to the Court of Appeals’ assertion, the Code makes plain that bankruptcy courts have the authority—indeed, the obligation—to direct a debtor to conform his plan to the requirements of §§1328(a)(2) and 523(a)(8).

Opinion, pp. 14-15.

Deterring Bad Behavior

Finally, the Supreme Court reinforced its holding in Taylor v. Freeland & Kronz that deterring bad behavior is not a sufficient reason to allow untimely objections.

United argues that our failure to declare the Bankruptcy Court’s order void will encourage unscrupulous debtors to abuse the Chapter 13 process by filing plans proposing to dispense with the undue hardship requirement in the hopes the bankruptcy court will overlook the proposal and the creditor will not object. In the event the objectionable provision is discovered, United claims, the debtor can withdraw the plan and file another without penalty.

We acknowledge the potential for bad-faith litigation tactics. But expanding the availability of relief under Rule 60(b)(4) is not an appropriate prophylaxis. As we stated in Taylor v. Freeland & Kronz , 503 U. S. 638 (1992) , “[d]ebtors and their attorneys face penalties under various provisions for engaging in improper conduct in bankruptcy proceedings,” (citation omitted). The specter of such penalties should deter bad-faith attempts to discharge student loan debt without the undue hardship finding Congress required. And to the extent existing sanctions prove inadequate to this task, Congress may enact additional provisions to address the difficulties United predicts will follow our decision.

Opinion, pp. 16-17.

Summing It Up

This opinion is consistent with both Taylor v. Freeland & Kronz and last summer's opinion in Travelers Indemnity Co. v. Bailey, 557 U.S. ____ (2009) that deadlines have meaning and that untimely attacks on orders will not be allowed merely because the orders were unwise or unwarranted. At the same time, the Supreme Court stressed the obligation of the Bankruptcy Court to perform its own independent review to determine that only proper orders are entered and to use Rule 9011 to police parties who openly flaunt the rules in the hopes that they won't get caught. The Supreme Court's approach emphasizes the necessity for all parties to follow the rules but to do so in a timely fashion. The debtor's attorney has an obligation to include only arguable plan provisions; the court has an obligation to independently review the plan before approving it; and the creditor has an obligation to make a timely objection or else lose its complaint.

Kudos to Bankruptcy Judge Keith Lundin who correctly predicted this result at the State Bar of Texas Bankruptcy Bench-Bar Conference in June 2009.

Creative Debtor Not Allowed to Finance His Appeal From U.S. Treasury

Judge Leif Clark has authored a new opinion which belongs in a Payment Systems textbook. In re Rhett Webster Pease , No. 09-54754 (Bankr. W.D. Tex. 3/12/10) involved a debtor who filed a Notice of Appeal but neglected to include the filing fee. When informed that his appeal would be dismissed, he submitted a "Certified Money Order."

Judge Clark described the instrument submitted for payment as follows:

The document purports to be a form of money order, and states at the bottom that “This negotiable instrument is authorized and backed by the full faith and credit of the United States Govern-ment.” The body of the document does contain negotiable instrument language -- it says “Pay to the Order of:” However, from there on, the document is an entire work of fiction.

First, the purported negotiable instrument purports to be “drawn on” the United States Treasury Account, “Prepaid Account” followed by what appears to be the debtorʼs social security number (not reproduced here, of course). An address follows -- 1500 Pennsylvania Avenue, NW, Washington, D.C. (that is the physical address of the Department of the Treasury).

Next, the purported negotiable instrument directs the drawee to pay to the order of “U S Treasury.” This is similar to writing a check drawn on a bank, directing that the bank pay itself out of an account maintained by the drawer at that bank. The amount shown to be paid is, of course, $255.00.

Next, the document is signed by Rhett Webster Pease (the court recognizes his signature) beneath the legend “Drawer as Agent for the Secretary.” It is not clear exactly what Secretary the debtor means, though one could infer that this is intended to refer to the Secretary of the Treasury. Beneath the signature line is the identifier “Authorized Signature of Agent.”

Finally, there is a “Certification of Signatory” executed by a notary (one Paula M. Boyd), to the effect that Mr. Webster “acknowledged to me that he was the authorized signatory for the above mentioned account and that he executed this instrument as an agent for the Secretary under this account.”

The net effect of all of this verbiage is that Mr. Pease evidently believes that (a) he can write checks on what he claims to be his social security account, as though it were a checking account, (b) that he can issue a check right back to the treasury, since the filing fee is payable ultimately to the US government anyway, and (c) that he can act as the self-appointed agent for the Secretary of the Treasury. In this way, he claims to have satisfied his obligation to the clerk of court to pay the filing fee.

Order Dismissing Notice of Appeal, pp. 1-2.

Judge Clark patiently explained why Mr. Pease could not simply write a check upon his social security account, concluding:

Mr. Pease clearly has some strongly held beliefs about the role of government,the legitimacy of the monetary system in the United States, and perhaps even the legitimacy of government itself. The court will not waste its time attempting to dissuade Mr. Pease of his strongly held beliefs. Suffice it to say that this court does not subscribe to those beliefs.

A filing fee must be paid using the recognized currency of the United States. The “Certified Money Order” submitted by Mr. Pease does not qualify either as recognized currency or a legal document that would result in the payment in the recognized currency of the United States. The document submitted is a complete work of fiction or fantasy at best, and a fabrication and a fraud at worst. In all events, it is ineffective as a means of payment.

Order, p. 3.

You really have to marvel at the audacity of some people. Judge Clark showed remarkable patience in dealing with this debtor.

(Note: The original post had a comment wondering whether Judge Clark had too much time on his hands. While meant to be a backhanded compliment referencing Judge Clark's tremendous capacity for writing opinions, it came off a little snarky, so I re-wrote the final paragraph.).

Supreme Court Upholds Constitutionality of Debt Relief Agency Provisions

A unanimous Supreme Court has ruled that attorneys are "debt relief agencies" and that the provisions prohibiting debt relief agencies to advise debtors to incur debt in contemplation of bankruptcy and the mandatory disclosures required are constitutional. United States v. Milavetz, Gallop & Milavetz, P.A., No. 08-1119 (3/8/10). However, in doing so, the Court adopted a narrow reading of the speech restriction, finding that it did not apply to advice to incur debt for a permissible purpose.

Justice Sotomayor delivered the opinion for the Court. Justices Scalia and Thomas filed opinions concurring in part and concurring in the judgment.

Lawyers As Debt Relief Agencies

The Court had no trouble finding that attorneys were debt relief agencies. Justice Sotomayor wrote:

In advocating a narrower understanding of that term, Milavetz relies heavily on the fact that Sec. 101(12A) does not expressly include attorneys. That omission stands in contrast, it argues, to the provision's explicit inclusion of "bankruptcy petition preparer[s]"--a category of professionals that excludes attorneys and their staff, see Sec. 110(a)(1). But Milavetz does not contend, nor could it credibly, that only professionals expressly included in the definition are debt relief agencies. On that reading, no professional other than a bankruptcy petition preparer would qualify--an implausible reading given that the statute defines "debt relief agency" as "any person who provides any bankruptcy assistance to an assisted person . . . or who is a bankruptcy petition preparer."

Opinion of the Court, pp. 6-7.

This is no great surprise.

Advising Assisted Persons to Incur Debt In Contemplation of Bankruptcy

Having concluded that attorneys were debt relief agencies, the court turned its attention to whether the restrictions on debt relief agencies were constitutional. The first provision considered was Sec. 526(a)(4), which prohibits a debt relief agency from advising an assisted person to "incur more debt in contemplation of such person filing a case under this title."

The Supreme Court rejected the Eighth Circuit's conclusion that this was a broad restriction which precluded an attorney from advising a prospective debtor to incur any debt while contemplating bankruptcy regardless of whether it was in the debtor's best interest. Thus, the issue was whether the phrase "in contemplation of" meant "while considering whether to file bankruptcy" or something more narrow. The Court stated:

After reviewing these competing claims, we are persuaded that a narrower reading of Sec. 526(a)(4) is sounder, although we do not adopt precisely the view the Government advocates. The Government's sources show that the phrase "in contemplation of" bankruptcy has so commonly been associated with abusive conduct that it may readily be understood to prefigure abuse. As used in Sec. 526(a)(4), however, we think the phrase refers to a specific type of misconduct designed to manipulate the protections of the bankruptcy system. In light of our decision in Pender and in context of other sections of the Code, we conclude that Sec. 526(a)(4) prohibits a debt relief agency from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose.

Opinion of the Court, pp. 12-13.

The Court went on to on its narrow construction, stating, "In context, Sec. 526(a)(4) is best understood to provide an additional safeguard against the practice of loading up on debt prior to filing." The Court further explained:

Covered professionals remain free to tal[k] fully and candidly about the incurrence of debt in contemplation of filing a bankruptcy case. (citation omitted). Section 526(a)(4) requires professionals only to avoid instructing or encouraging assisted persons to take on more debt in that circumstance. . . . Even if the statute were not clear in this regard, we would reach the same conclusion about its scope because the inhibition of frank discussion serves no conceivable purpose within the statutory scheme.

Opinion of the Court, p. 16.

Having concluded that the statute had a narrow focus, the Court found that it was constitutional.

Mandatory Disclosures

Section 528 requires debt relief agencies to make certain statements, such as:

"We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code."

The Court found that this provision was aimed at preventing misleading commercial speech and thus was permissible so long as it was reasonably related to the government's interest in preventing deception of consumers. The Court addressed one of the most annoying aspects of the statute, the fact that attorneys must use the newly coined term "debt relief agencies."

Because Sec. 528 by its terms applies only to debt relief agencies, the disclosure are necessarily accurate to that extent: Only debt relief agencies must identify themselves as such in their advertisements. This statement provides interested observers with pertinent information about the adviser's services and client obligations.

Opinion of the Court, pp. 21-22.

In other words, because Congress defines consumer bankruptcy attorneys as "debt relief agencies," it is not misleading to make them state this fact. This analysis does not really address whether the term is demeaning or whether the reference to "agencies" is misleading. Perhaps the result would have been different if Congress had chosen a term which more obviously intended to insult. For example, if Congress had required consumer bankruptcy attorneys to state, "We are unethical, thieving sleazebags who you should be embarrassed to associate with," the result might be different. By choosing a relatively innocuous term, Congress was able to meet the low bar for being rationally related.

The Court also dismissed the argument that the statute could be construed to apply to firms which only represented creditors and thus would be misleading. The Court noted that it was in a section of the Code labeled "Debtor's Duties and Benefits."

In context, reading Sec. 528 to govern advertisements aimed at creditors would be as anomalous as the result of which Milavetz complains. Once again, we decline Milavez's invitation to adopt a view of the statute that is contrary to its plain meaning and would produce an absurd result.

Opinion of the Court, pp. 22-23.

The Concurrences

Justice Scalia wrote a three page concurring opinion expressing his disagreement with a footnote which relied upon the legislative history to BAPCPA. He stated:

Such statements tell us nothing about what the statute means, since (1) we do not know that the members of the Committee read the Report, (2) it is almost certain that they did not vote on the Report (that is not the practice), and (3) even if they did read and vote on it, they were not, after all, those who made this law. the statute before us is a la because its text was approved by a majority vote of the House and the Senate, and was signed by the President. Even indulging the extravagant assumption that Members of the House other than members of its Committee on the Judiciary read the report (and the further extravagant assumption that they agreed with it), the Members of the Senate could not possibly have read it, since it did not exist when the Senate passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. And the President surely had more important things to do.

The footnote's other source of legislative history is truly mystifying. For the proposed that "the legislative record elsewhere documents misconduct by attorneys" which was presumably the concern of Congress, the court cites a reproduction of a tasteless advertisement that was (1) an attachment to the written statement of a witness, (2) in a hearing held seven years prior to this statute's passage, (3) before a subcommittee of the House considering a different consumer bankruptcy reform bill that never passed. "Elsewhere" indeed.

Concurring Opinion of Justice Scalia, p. 2.

Justice Thomas wrote separately to disagree with the Court's analysis of the Sec. 528 advertising requirements, but not to disagree with the result. He stated, "I have never been persuaded that there is any basis in the First Amendment for the relaxed scrutiny this Court applies to laws that suppress nonmisleading commercial speech." He found that in order to regulate speech, there must be a showing that "the particular advertising is inherently likely to deceive or where the record indicates that a particular form of advertising has in fact been deceptive."

However, in this particular case, the specific advertisements used by the Milavetz firm were not in the record. Because there was at least one set of facts (ad promising to wipe away debts without mentioning bankruptcy) in which the law could be constitutionally applied, he refused to strike it down on its face.

Conclusion

BAPCPA has survived its first constitutional challenge. However, the Court's ruling emphasizes a narrow, reasonable construction, one which would avoid the theoretical parade of horribles which the statute could have unleashed. In the heady days of 2005 when this legislation was first passed, there was concern that it signaled open season on consumer bankruptcy and consumer bankruptcy lawyers. For a period of time, filings dropped to a record low. However, as time has passed, filings are on their way back up and lawyers have learned to live with the new law. As a result, the Supreme Court's upholding of the debt relief agency provisions reflects the fact that the statute has grown up to be more of a house cat than a devouring lion.

The other take away from this case is NEVER, EVER cite legislative history to Justice Scalia.

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.