Tuesday, April 24, 2012

Death Penalty Sanctions Applied in Case of Double-Dealing Attorneys

In a disturbing 52-page opinion, Judge Stacey Jernigan has administered “death penalty” sanctions against The Cadle Company based on double-dealing and non-disclosures by Cadle’s long-time attorneys who also represented the trustee.     The Cadle Company, LLC v. Brunswick Homes, LLC, Adv. No. 06-3417 (Bankr. N.D. Tex. 4/23/12).  The opinion may be found here.    The Court went so far as to state that “the entire Adversary Proceeding has been tainted and the temple of justice has been defiled.”   Opinion, p. 5.  
  
The Cadle Company is a sophisticated party that purchases and collects debts.    It is known for its aggressive tactics in collecting debts from parties in bankruptcy.   Many of the leading Fifth Circuit cases involving Section 727 were brought by The Cadle Company.    (Disclosure:    I represented the debtor in Bobby D Associates v. Walsh (In re Walsh), 143 Fed.Appx. 580 (5th Cir. 2005), a case brought by a Cadle affiliate).     I have previously written about the Cadle Company here, here and here.

In this particular case, The Cadle Company succeeded in having the debtor’s discharge denied and made new law with regard to a trustee’s ability to settle rather than settle claims, see Cadle Co. v. Mims (In re Moore), 608 F.3d 253 (5th Cir. 2010).    However, their trail of successes in the case came to a screeching halt when the Court found out that Cadle had been simultaneously paying the attorneys for both sides to a dispute without making disclosure of that fact.    

What Happened

The Cadle Company several large debts against James H. Moore, III.   In an attempt to collect those debts, it filed a suit in state court against several entities related to the debtor seeking to hold them liable as transferees or alter egos of the debtor.    When the debtor filed bankruptcy in 2006, the state court action was removed to bankruptcy court.    The Cadle Company recognized that the claims now belonged to the trustee and arranged for the trustee to be substituted in as plaintiff.

Cadle’s long-time attorneys, Bell, Nunnally & Martin, LLP offered to represent the trustee on a contingent fee basis.   This appeared to be a good deal for the trustee since Bell Nunnally was familiar with the file and agreed to take the case on a contingent fee basis.    Bell Nunnally signed an engagement agreement with the trustee which was incorporated into an application to be employed as special counsel.    The application and the engagement agreement represented among other things:

That BNM had previously represented the Cadle Company but understood “that it represents and owes fiduciary duties only to the Trustee in the Action and not the Cadle Company.”

“Compensation to BNM, if any, will be paid only upon recovery of money or property of value in connection with the Adversary Action on behalf of the estate and will be subject to the Court’s approval of a fee application to be filed by BNM at the conclusion of the Adversary Action.”

“No promises have been made to BNM or any of its partners or associates as to compensation in connection with this case other than in accordance with the provisions of the Bankruptcy Code.”

The application to employ was filed on August 22, 2006.    

Three days later, on August 25, 2006, Bell Nunnally filed an adversary proceeding objecting to the debtor’s discharge on behalf of Cadle.   

On October 23, 2006, the Court held a hearing on the application to employ.    The Court noted that “there was no disclosure of any special arrangements whereby the Creditor-Cadle might pay BNM’s fees and expenses in connection with the Veil-Piercing Action.”    Opinion, p. 14.

Just two weeks later, on November 6, 2006, Bell Nunnally entered into a letter agreement with the Cadle Company that was, according to the Court “the proverbial smoking gun.”    In the letter agreement, Cadle confirmed that it would pay Bell Nunnally for both its work on behalf of the Trustee and in the adversary proceeding to deny discharge.   The letter stated:

The Cadle Company has agreed to pay our firm’s fees related to the prosecution of the adversary proceeding [the Veil-Piercing Action] as well as to the representation of The Cadle Company’s interests as a creditor in the main case and its unrelated action to deny discharge.   At the conclusion of the case, assuming a positive result, we will request payment of the fees and expenses incurred by our firm in the prosecution of the [Veil-Piercing Action].    Upon receipt of payment from the Trustee, this firm will reimburse Cadle for the fees and expenses it has actually paid our firm in connection with the adversary proceeding.

This side agreement was problematic, since the firm had previously represented under oath that it had no other agreements for compensation.    Besides constituting a false oath (something the firm knew much about since it often filed actions under section 727(a)(4)), it created a possible conflict between its two masters.   As determined by the Court, that possible conflict matured into an actual conflict.

On April 18, 19 and 25, 2007, the Court conducted a trial on the objection to discharge, which ultimately resulted in denial of discharge.   While this trial was pending, Bell Nunnally filed a motion to withdraw as the trustee’s counsel in the Veil-Piercing Action for a reason that aroused the Court’s suspicion.   In the Motion to Withdraw, Bell Nunnally stated that its agreement with the trustee was that its fees would be contingent, but The Cadle Company would pay its expenses.   The firm further represented that as of April 5, 2007, it had “it had learned definitively that Cadle was not willing to pay any expenses to assist Mims Trustee.”   

In one pleading, the firm managed to contradict both its own Engagement Agreement with the Trustee (which did not include any reimbursement of expenses from The Cadle Company) and its November 6, 2006 agreement with Cadle (which provided for payment of both fees and expenses.    It was also false in that Cadle continued to pay fees and expenses until February 2009.

The Court was not pleased.    At the hearing on the motion to withdraw on May 15, 2007, expressed surprise that there was an agreement for Cadle to pay expenses.   At one point, the Court asked, “If there was an agreement, show me the agreement.”    Notwithstanding the Court’s request, the firm did not disclose the November 6, 2006 letter.    The Court denied the motion, finding that the trustee would be prejudiced.   The Court denied the motion without prejudice to being re-urged, but added that if it did so, the Court expected that the firm would “present some proof that there was an agreement that The Cadle Company would pay the ongoing expenses of BNM in pursuing this matter.”    

Bell Nunnally succeeded in defeating a motion for summary judgment filed by one of the defendants.   However, the Court’s opinion highlighted the difficulties the plaintiff would have in ultimately proving its case.
On the eve of trial, the Trustee reached an agreement with the defendants to settle for $37,500.   This is when the conflict matured from possible to full-blown.   The Cadle Company, acting through other lawyers, objected to the settlement, stating that it would pay $50,000 to purchase the causes of action.    The Court ruled that the Trustee was entitled to settle the claims rather than auction them.   

At the hearing on the settlement, Cadle’s representative testified that there was no agreement to pay Bell Nunnally’s expenses, but that Cadle had paid “some bills” totaling $50,000-$60,000 towards the litigation.    The Trustee was not pleased to learn that his ostensible lawyer was being paid by the other side and demanded that the attorneys amend their disclosures to the Court.   They did not.

Cadle appealed the Court’s order.   For reasons that are not clear in the opinion, the Trustee continued to retain Bell Nunnally to represent him on the appeal.    This meant that for a period of time, Cadle was footing the bills for both sides to the appeal.   (Cadle stopping paying Bell Nunnally in February 2009, about nine months into the appeal).    This conflict was even more serious because Bell Nunnally was sending invoices to Cadle for its trustee representation which referenced privileged communications with the trustee.    The trustee, however, neither knew that Cadle was receiving the invoices or saw them himself.  

The day before oral argument in the Fifth Circuit, the principal attorney who had been representing the trustee left Bell Nunnally for another firm.    Although the oral argument had been scheduled for six weeks, the lawyers at Bell Nunnally apparently had not planned for this contingency.    The departing lawyer declined to handle the oral argument.  Instead, the firm sent a first year lawyer to the Fifth Circuit.     This later raised suspicions that the firm had intentionally taken a dive on the appeal to curry favor with Cadle.     (Note:    The Fifth Circuit’s opinion in Cadle Co. v. Mims was solidly reasoned so that sending a more experienced lawyer probably would not have made a difference.    However, the appearance was not good).    The Court found that “the surrounding circumstances here give every indication of the Chapter 7 trustee having been treated like the proverbial ‘hot potato.’”    Opinion, p. 34.

After the Cadle Company prevailed on the appeal, the trustee conducted an auction sale of the cause of action.    Cadle was the high bidder at $41,500, an amount just $4,000 more than had been offered by the defendants to settle and $8,500 less than it had previously indicated that it was willing to pay.    The Court commented:   “A marvelous result?   Hardly.”    Opinion, p. 36.

At this point the plot thickened.   As recounted by Judge Jernigan:

At the April 11, 2011 sale hearing, in the midst of this lackluster result, Attorney BA appeared—purportedly on behalf of the Chapter 7 Trustee—seeking a continuance of the trial date in the Veil-Piercing Action.    At that point, the bankruptcy court raised questions as to whom exactly Attorney BA considered himself to be representing?   On the one hand, Attorney BA had apparently not felt like he could represent the Chapter 7 trustee at the Fifth Circuit oral arguments—because he had gone to a new firm.    Now, suddenly, Attorney BA was filing pleadings for the Chapter 7 Trustee.    But the Chapter 7 Trustee indicated that he had not instructed Attorney BA to seek a continuance or even talked to him about it.    Attorney BA’s actions had all the appearance of him seeking a continuance for the benefit of Creditor-Cadle, which had just newly purchased the claims in the Veil-Piercing Action.

Opinion, pp. 36-37.  

The Court granted the continuance but ordered that a representative of Cadle be present “to address some of the conflicts issues that had seemed to percolate to the surface.”    

At the next hearing, Cadle sent a representative who stated that it was not able to find any agreement to pay Bell Nunnally for representing the Trustee, but that they had paid $92,000 to the firm over a two year period anyway.   

Upon hearing this testimony, the defendants filed a motion to dismiss the adversary proceeding.     The Court conducted three days of hearings upon the motion and heard testimony from Cadle, Attorney BA (the former Bell Nunnally attorney) and the trustee.    The Court found the trustee’s testimony to be credible, while describing Attorney BA’s testimony as “cavalier” and “mostly devoid of any regret or concern.”    Opinion, pp. 39, 42.   

The Ruling

Employment of professionals is strictly regulated in bankruptcy.    In order to be employed as a professional, a person must “not hold or represent an interest adverse to the estate” and be a disinterested person.   11 U.S.C. Sec. 327.     In order to evaluate a professional’s eligibility, the Court relies upon the disclosures submitted.   As stated by Judge Jernigan:

If a proposed attorney for the trustee represents a creditor, and a party-in-interest objects (which, by the way, did happen in this case in 2006), the bankruptcy court must look to whether there is an actual conflict of interest.   Conflicts of interest are often a matter of degree. They are fact-intensive analyses.

So how does a bankruptcy court ascertain if there is an actual conflict of interest? Bankruptcy Rule 2014 is designed to help in this regard. Bankruptcy Rule 2014 states that an employment application for a professional person seeking to represent a trustee “shall state,” among other things, “any proposed arrangement for compensation” and “all of the person’s connections with . . creditors” and a verified statement of the person to be employed as to such connections. In other words, there are critical disclosures contemplated so that conflicts of interest can be identified and analyzed.

Opinion, p. 44.   

In a display of understatement, the Court described the firm’s disclosures as “amazingly inadequate.”    The Court recounted the various misrepresentations and failures to disclose discussed in the factual recitation discussed above.  The Court referred to the firm’s actions as “inexcusable and baffling” and that “the circumstances are highly suspect.”    The Court added:

Bankruptcy requires an open kimono when it comes to possible conflicts.    Here, there was no open kimono.   There was no transparency.   

Opinion, pp. 45-46.

The Court noted that “there is more that has happened here than simple nondisclosure.”   The Court noted that the conduct included breaching the duty to maintain confidences and disregarding the instructions of a client.  

However, the Court was not content to simply blame the attorneys.   The Court stated:

But the problematic behavior lies not merely at the feet of Attorney BA and BNM, but also at the feet of Creditor-Cadle. This is not just a case of rogue attorneys. Creditor-Cadle has some accountability in all of this. Creditor-Cadle is a sophisticated party that regularly hires lawyers to monetize assets. Here, as earlier stated, the bankruptcy court believes that the very temple of justice has been defiled. Here, there is not merely a situation of lawyers representing a bankruptcy trustee that were conflicted and compromised by loyalty to another client. Creditor-Cadle itself failed twice to testify candidly about the exact financial arrangements it had with BNM . . . . . Creditor-Cadle is, again, a sophisticated party. BNM and Attorney BA were Creditor-Cadle’s trusted lawyers. It appears that Creditor-Cadle was happy for a while to quietly pay BNM while BNM ostensibly represented the Chapter 7 Trustee. But then, after a year of paying both sides of litigation and an appeal, someone at Creditor-Cadle said “no more.”

            * * *
             
There is enough here to connect the dots. And it is not pretty. BNM and attorney BA had divided loyalties, and Creditor-Cadle was fine with that—it benefitted Creditor-Cadle having “its” lawyers on the other side of it in litigation. The various nondisclosures and conflicts of interest attributable to the Creditor-Cadle and its counsel (at both the bankruptcy court level and throughout much of a multi-month appeal) were so serious, so improper, and so demonstrative of callous indifference to applicable duties and ethical standards, that the entire Adversary Proceeding has been tainted. In the world of bankruptcy, lawyers are not only bound by the Rules of Professional Conduct, but lawyers and parties must abide by the Bankruptcy Code and Bankruptcy Rules. Bankruptcy Code section 327 and Bankruptcy Rule 2014 were totally side-stepped here.

“The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” 11 U.S.C. § 105(a). Here, the court believes the evidence is clear and convincing that Creditor-Cadle and Attorney BA acted in bad faith and recklessly disregarded their duties.   Thus, the “death penalty” (i.e., dismissal with prejudice) in this Adversary Proceeding seems entirely fitting.     

Opinion, pp. 48-50.

 What Does It Mean?

     This is an opinion that should be discussed whenever ethics in bankruptcy is studied. This was not simply a case of crossing the line; the lines were obliterated. This opinion deserves more attention than I am capable of giving it. Therefore, I will limit myself to a few points

1. The court acted appropriately under its inherent authority.

There is a line of cases that holds a court possesses inherent authority to punish bad faith conduct which exists beyond 28 U.S.C. Sec. 1927 and Rule 11.   Chambers v. NASCO, Inc., 501 U.S. 32 (1991); In re First City Bancorporation, 282 F.3d 864 (5th Cir. 2002).   While sanctions under the court’s inherent power are usually levied against attorneys, there is no reason why they would not apply to a party as well.   

The court’s conclusion that the entire process had become tainted justified termination of the litigation.    Where the court did not otherwise have an adequate remedy, ending the court’s participation was appropriate.    Besides the blatant disregard of rules and ethical standards amply documented by the Court, there is another subtext.   This was a case in which Cadle paid one set of lawyers $92,000 to pursue claims on behalf of the trustee, paid a second set of lawyers to appeal the case to the Fifth Circuit and then offered only $41,500 for the claims themselves.  It seems hard to understand what economic motive The Cadle Company was pursuing.  

Lawyers of any experience will confirm that sometimes litigation is pursued not for legal or economic principles, but for vengeance, the ability to inflict punishment upon another human being.   I can’t say definitively that malice explains this case.    However, it does look that way to this jaded observer.    It is a good thing when courts have the ability to terminate spiteful litigation.   Courts should exist to resolve conflict rather than to magnify it.   In this case, Judge Jernigan aborted a lawsuit which had become hideously deformed.   

2. Disclosures matter.

The disclosures that attorneys file in order to be employed by a bankruptcy estate are signed under penalty of perjury.    Just because they are routine does not mean that they are unimportant.   John Gellene went to jail and lost his license for non-disclosures that were arguably far less egregious than those in this case.   See United States v. Gellene, 182 F.3d 578 (7th Cir. 1999).   In a recent case that I have not had time to blog about, a firm failed to disclose the source of its retainer and its prior connections with the debtor.   The court found that the firm was still disinterested notwithstanding the omitted information and that the omission was innocent.   Nevertheless, the court made the firm disgorge $135,000 in payments it had received.   Waldron v. Adams & Reese, LLP, 2012 U.S. App. LEXIS 6367 (5th Cir. 2012).

3. Bankruptcy requires a heightened awareness of conflicts.

Others have made the point better than I, but conflicts in bankruptcy are more complicated than conflicts in ordinary two party litigation.    Under section 327(e), a law firm that represented a creditor may represent the trustee as special counsel.    However, in doing so, they must always remember that their fiduciary duty is to the trustee and not to their original client.    As a practical matter, this may be difficult to manage when, as here, the creditor is a regular client of the firm and may have unrealistic expectations about counsel’s loyalties.   The same situation arises when counsel has represented a creditor and becomes counsel for the creditor’s committee.   In that situation, counsel cannot use the committee to provide his client with inside information or to advance the original client’s agenda.   When an attorney represents a debtor-in-possession, he represents the artificial construct of the Debtor-in-Possession, but must take direction from the flesh and blood human beings who constitute the debtor’s management.    

Update:

Judge Jernigan's opinion was reversed by the Fifth Circuit.   You can read about it here. 

5 comments:

bwunc said...

the judge didn't go far enough - the estate/trustee lost $35,000 it would have gotten from the settlement to pay OTHER unsecured creditors. Cadle/BNM/BA should have to pay this amount to the unsec creditors and any claims they have against the estate should be disallowed.

LonghornBuc said...

Agreed. I hope this is not over. All the dirty players here should have their bank accounts cleaned out.

Anonymous said...

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Phoenix Bankruptcy Attorney said...

It is a serious offense to get with double dealing attorneys. These issues should be dealt with very carefully.