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Walking the Fine Line Between “Legitimate Zeal of Attorneys Representing their Client” and “Dilatory or Aggressive Litigation Practices” That May Lead to Sanctions

In re Prosser, No. 14-1633, 2015 WL 305523 (3d Cir. Jan. 26, 2015)

This precedential Opinion should serve as a warning to practitioners—a bankruptcy court can (and will) impose sanctions under 28 U.S.C. § 1927 for litigation tactics that rise to the level of bad faith.  On appeal, the United States Court of Appeals for the Third Circuit (the “Third Circuit”) reversed an order entered by the District Court of the Virgin Islands (the “District Court”) vacating the imposition of sanctions by the District Court of the Virgin Islands, Division of St. Thomas and St. John, Bankruptcy Division (the “Bankruptcy Court”) under 28 U.S.C. § 1927, which requires a finding that an “attorney has (1) multiplied proceedings; (2) in an unreasonable and vexatious manner; (3) thereby increasing the cost of the proceedings; and (4) doing so in bad faith or by intentional misconduct.”  To impose sanctions under the statute, the court must find bad faith, but such a finding need not be explicit.

A brief recitation of the facts is necessary to understand the facts and circumstances surrounding the sanctionable conduct.  In a converted chapter 7 bankruptcy case, the trustee (the “Trustee”) and others initiated an adversary proceeding seeking denial of the individual debtor’s discharge under section 727 of the Bankruptcy Code.  In connection with that adversary proceeding, counsel for the debtor (“Prosser Counsel”) deposed a third-party witness in an attempt to undermine unfavorable testimony given earlier in the bankruptcy case.  At the deposition, at which the bankruptcy judge presided, Prosser Counsel inquired into the payment of the deponent’s legal fees and his prior contacts with the Trustee.  As a result of certain innocuous remarks made by the deponent—and a comment made by counsel that the Trustee had no prior contact with the deponent—the debtor filed numerous pleadings alleging that the deponent was provided gratis legal services in exchange for his previous unfavorable testimony and that counsel for the Trustee (“Trustee Counsel”) misrepresented the Trustee’s contacts with the deponent.  Shortly after the deposition, Prosser Counsel filed a motion for an evidentiary hearing into the purported bribery scheme and Trustee Counsel’s misrepresentations.  At a hearing on another matter, Trustee Counsel corrected the inaccurate information previously provided to the bankruptcy judge, stating that it was not a knowing misrepresentation, and subsequently filed a written certification to that effect.  Thereafter, and notwithstanding the corrected record, Prosser Counsel issued a press release and filed several additional pleadings, including an adversary complaint against the Trustee and his counsel, separate objections to each of the fee applications of the Trustee and his counsel, and a motion for a hearing regarding an alleged conflict of interest between the Trustee and his counsel, all of which related to the alleged bribery scheme.

The Bankruptcy Court dismissed the motion for an evidentiary hearing as against Trustee Counsel and denied the conflicts motion, finding that there was no disputed issue with regard “to the veracity of the representation” of the Trustee.  Following that ruling, Prosser Counsel voluntarily dismissed the claims against the Trustee and withdrew the fee objections.  After all of the pleadings were either dismissed or withdrawn, the Trustee moved for legal fees and expenses against Prosser Counsel under 28 U.S.C. § 1927.  The Bankruptcy Court granted the fee motion, finding that litigation against Trustee Counsel should never have been initiated as the initial comment was a mistake that was promptly corrected.  The Bankruptcy Court found that Prosser Counsel had “unreasonably and vexatiously multiplied proceedings in bad faith” under section 28 U.S.C. § 1927 by filing the adversary complaint, fee objections and conflicts motion and awarded the Trustee $137,024.02 for the expenses associated with the filings.

Prosser Counsel appealed the sanctions award to the District Court.  On appeal, the District Court vacated the order and remanded, finding that the Bankruptcy Court erred by imposing sanctions.  The District Court held that the adversary complaint and fee objections could not have “multiplie[d] the proceedings” under 28 U.S.C. § 1927 because the statute does not apply to a filing that initiates a proceeding and the fee objections were filed in the bankruptcy case, not the adversary proceeding.  According to the District Court, the Bankruptcy Court failed to explain how counsel’s actions were in bad faith, noting that the litigation was of limited duration and that “while some evidence in the record suggested bad faith, other evidence suggested [counsel’s] actions were not the result of ‘dilatory or aggressive litigation practices, but rather the legitimate zeal of attorneys representing their client.’”

Trustee Counsel appealed to the Third Circuit.  Applying an abuse of discretion standard, the Third Circuit reversed the District Court order vacating the Bankruptcy Court’s imposition of sanctions, remanding with instructions that the District Court reinstate the sanctions order.  First, the Third Circuit held that the District Court erred in focusing only on the adversary complaint (and ignoring the “barrage of other filings” submitted) and holding that the filing of the adversary complaint could not constitute sanctionable conduct under 28 U.S.C. § 1927.  To the contrary, the filing of an adversary complaint may multiply the proceedings in a bankruptcy case.  Second, the Third Circuit held that the Bankruptcy Court’s factual finding of bad faith was not clearly erroneous and the Bankruptcy Court did not abuse its discretion by imposing sanctions under 28 U.S.C. § 1927.  Considering the relevant pleadings filed in both the bankruptcy case and the adversary proceeding, the record supports the Bankruptcy Court’s finding that Prosser Counsel had “unreasonably and vexatiously multiplied and increased the cost of the proceedings in bad faith.”  “[A]lthough the Bankruptcy Court’s reasons for its finding of bad faith could have been more explicit, its finding was supported by both ‘the entire record’ and its use of ‘the very words of the statute.’”  Notably, the District Court “exceeded its appellate function by essentially substituting its view of the facts, rather than reviewing whether the Bankruptcy Court’s factual findings were unsupported.”