MEMORANDUM OF DECISION
JOHN
S. HODGE UNITED STATES BANKRUPTCY JUDGE
Patrick
L. McConathy[1] filed bankruptcy over 30 years ago but
failed to disclose valuable mineral rights that he owned in
Kansas. Decades after his bankruptcy case was closed, he
filed suit in Kansas asserting claims related to the
undisclosed property. The lawsuit seeks millions of dollars
in damages from oil companies which drilled and produced oil
on lands encumbered by the mineral rights. As a matter of
law, the undisclosed assets remain as property of the
bankruptcy estate even though the bankruptcy case was closed
decades ago.
Debtor's
lawyers were clearly aware of the need to determine whether
the mineral rights had been listed in the bankruptcy
schedules. Instead of making that determination, they just
hauled off and filed a lawsuit seeking relief for claims that
belong exclusively to the estate. To make matters worse
after the lawsuit was filed, they concealed critical facts
about the bankruptcy case from the defendants and misled the
state court about the need to obtain consent of the trustee.
This
court is generally reluctant to impose sanctions against
attorneys or their clients, but clear and convincing evidence
in this case showed that Debtor's counsel acted in bad
faith and willfully abused the judicial process by violating
the automatic stay. Sanctions are appropriate.
Before
the court are two motions. First, the state court defendants
seek an order: (a) declaring that the Kansas lawsuit is
invalid because it violated the stay, and (b) awarding $315
000 for civil contempt sanctions to compensate them for the
costs incurred in defending the suit. Second, certain
non-debtor parties in the Kansas litigation filed a motion to
annul the stay.
For
reasons that follow, the court concludes that: 1) the claims
asserted by Debtor in the Kansas lawsuit are voidable and are
therefore invalid and without effect, 2) the motion for
contempt should be granted in part, and 3) the motion to
annul the stay should be denied. Monetary sanctions against
Debtor's counsel will be awarded after the court
determines the reasonableness of attorneys' fees.
Pursuant
to Fed.R.Bankr.P. 7052, made applicable to contested matters
by
virtue of Fed.R.Bankr.P. 9014, the court makes the following
findings:
1. On December 31, 1990, Patrick L. McConathy and Patricia
Chapman McConathy commenced this case under chapter 7 of the
Bankruptcy Code. Thereafter, they received a discharge. A
final decree closing this case was entered on October 25
1994.
2. On April 15, 1996, Debtors reopened their case to disclose
overriding royalty interests in Texas that were not listed in
their bankruptcy schedules. The court issued a second final
decree closing this case on January 7, 1997.
3. On July 3, 2006, this case was reopened yet again when
Brammer Engineering, Inc. filed a motion to reopen to correct
a prior conveyance of certain properties. A third final
decree was entered on October 9, 2006.
4. Debtors did not disclose in their bankruptcy schedules
that they owned undivided working interests and leasehold
rights covering over 3, 000 acres in various tracts in Kearny
County, Kansas (the "mineral rights").
5. Long after the bankruptcy case was closed for the third
time, American Warrior, Inc., Heartland Oil, Inc. and
Mid-Continent Resources, Inc. (collectively
"AWI") filed a partition action in state
court in Kearny County, Kansas, case no. 15-CV-08 (the
"Partition Lawsuit") against various
owners of working interests in mineral leases covering lands
located in that county. One of the defendants in the
Partition Lawsuit was McConathy Production Company, Inc. In
the Partition Lawsuit, AWI obtained a default judgment which
resulted in it obtaining 100% ownership of the leases at
issue.
Thereafter, the default judgment was entered, and AWI drilled
and produced oil from those leases, collecting more than $7
million from the production.
6. Later, some of the defendants in the Partition Lawsuit
retained Kansas lawyers Jeffery L. Carmichael
("Carmichael") and Jonathan Schlatter
("Schlatter") to determine if they could
challenge the default judgment on the basis that they did
not receive proper notice of the lawsuit. They also wanted
to assert a claim for damages for the value of the minerals
extracted from the properties after the default judgment
was entered.
7. To investigate the claims, Carmichael and Schlatter
reviewed the chain of title for various leases and then
compared that information to the list of named parties in the
Partition Lawsuit to see if there were any inconsistences or
issues that needed to be addressed. Carmichael and Schlatter
became aware that title to a portion of a relevant leasehold
interest was held in the name of McConathy Oil & Gas
Company, a Louisiana Partnership (the
"Partnership"), rather than
"McConathy Production Company, Inc." which was the
entity named in the Partition Lawsuit.
8. As part of his investigation, Carmichael was able to
locate Debtor. Carmichael spoke with Debtor by telephone in
May of 2019 to inquire about McConathy Oil & Gas Company
and McConathy Production Company, Inc.
9. Thereafter, Carmichael and Debtor had multiple telephone
calls. During one of these calls, Debtor explained that he is
the sole partner of the Partnership, having acquired all
remaining interests from his former partners.
10. At some point, Debtor and Carmichael discussed the
possibility of Debtor hiring Carmichael to establish that
Debtor or the Partnership owned mineral rights that were
improperly partitioned by AWI in 2018.
11. During his first conversation with Carmichael, Debtor
disclosed that he had filed for bankruptcy in 1990.
Importantly, Debtor told Carmichael that he did not know
whether he owned any mineral rights in Kansas, but if he did
he would have owned them prior to his bankruptcy case. Debtor
understood that the mineral rights, together with any claims
or causes of action which resulted from them, were
conceivably property of his bankruptcy estate.
12. After Debtor made this important disclosure to
Carmichael, they negotiated a contingency fee arrangement. As
part of the negotiations, Debtor asked for a lower percentage
fee because he wanted the creditors of his bankruptcy estate
to recover as much as possible. Carmichael and Schlatter, on
the other hand, wanted a higher percentage because of the
extra work required of them to handle the bankruptcy
"wrinkle" (Schlatter's term). The parties
eventually reached an agreement after the following sequence
of events:
a. On May 23, 2019, Schlatter and Carmichael sent an email
(docket no. 312-1) to Debtor regarding an engagement letter
which proposed a contingency fee arrangement of 40% of any
amount recovered, increasing to 50% if an appeal is filed.
The email stated:
Pat,
Great talking to you again yesterday. Attached are a proposed
engagement letter and contingent fee
agreement.
As we discussed on the phone yesterday, McConathy Oil &
Gas Co. appears to have owned substantial working interests
of record in Kearny County, Kansas, that were improperly
partitioned by American Warrior. American Warrior thereafter
proceeded to drill several producing wells on some of this
leasehold, the revenues from which your company should be
entitled. Once the paperwork is returned to your office, we
will begin pursing this claim on behalf of you and McConathy
Oil & Gas Co.
Jon Schlatter
b. On May 26, 2019, Debtor replied to the email by stating:
Gentlemen,
I have read the attached docs and my only real comment is
that 30% seems fair versus the %s in the agreements. If all
this was something that would only benefit me, I would have
no problem with the higher %. However, since it could benefit
my old creditors, I would need to get the maximum benefit to
them.
Thanks
Patrick McConathy
c. On May 29, 2019, Schlatter and Carmichael sent an email to
Debtor which stated:
Pat,
We can meet you half way on that request, and change the fee
to 35%. We can also lower the percentage on appeal from 50%
to 40%. We'll be advancing the expenses of the case, and
have the added wrinkle of dealing with the bankruptcy court
which will increase our costs. These are items we have to
account to our partners for. If that sounds good, I'll
paper it up and send it to you.
Jon
d. On May 29, 2019, Debtor replied to that email:
"Sounds good. Thanks for your flexibility."
Thereafter, Debtor executed the engagement letter and
contingency fee agreement on or about May 29, 2019.
13. The
contingency fee agreement contained an express reference to
Debtor's bankruptcy case and an acknowledgment of the
need to obtain consent and authorization from the bankruptcy
trustee to pursue the claims:
"Clients hereby also authorize Attorneys to obtain the
consent and authorization of the bankruptcy trustee, Case No.
90-13449, Western District of Louisiana, to pursue said
claims on behalf of Pat McConathy. Clients understand that
all or a portion of any funds that may be recovered may first
become property [of] said bankruptcy estate for distribution
to creditors."
14.
Debtor testified in his Rule 2004 Examination (docket 285-1
at 62:7-63.5):
Q. And you thought it was okay to pursue these claims in
Kansas that you owned prior to the time you filed bankruptcy
based on your sworn testimony in the Kansas litigation. You
thought it was okay to pursue those on your own behalf even
though they were not disclosed in connection with your
bankruptcy case?
A. I didn't say anything about them being pursued on my
own behalf. I said all along when I got called, these
aren't my
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