In re Midland Props. Ii, LLC, CASE NO. BK16-80487
| Decision Date | 29 June 2016 |
| Docket Number | CASE NO. BK16-80487 |
| Parties | IN THE MATTER OF: MIDLAND PROPERTIES II, LLC, Debtor(s). |
| Court | U.S. Bankruptcy Court — District of Nebraska |
Hearing was held on May 9, 2016, on the motion for sanctions (Fil. No. 24) and motion for disgorgement of fees (Fil. No. 26) filed by creditor First State Bank. David G. Hicks appeared for the debtor, Craig A. Knickrehm and Andrew R. Biehl appeared for First State Bank, Edward Brink appeared for Cass County Bank, Jeffrey Silver appeared for Charter West Bank, and Jerry Jensen appeared for the United States Trustee.
After obtaining dismissal of this bankruptcy case and a related predecessor Chapter 11 case in the face of overwhelming evidence that this case was filed in bad faith for the sole purpose of hindering secured creditor First State Bank from enforcing its security interest, First State Bank is pursuing sanctions and disgorgement against the debtor and its counsel. Evidence was admitted, post-hearing briefs were filed, and the matter is now ready for decision.
For the reasons stated below, the motions are granted.
Jerry J. Morgan, Sr., served as the sole and managing member of Midland Properties, L.L.C., an entity which owned a number of rental properties in the Omaha area. Several banks held mortgages or other security interests in these properties. First State Bank was one of those creditors and was owed more than $1 million as of the petition date. Mr. Morgan and Midland Properties filed Chapter 11 petitions in 2013 and the cases were jointly administered. A plan was confirmed in March 2015 under which First State Bank's claims would be paid over a term of five years and unsecured creditors would receive quarterly distributions of$5,000.00 for five years. Midland Properties quickly defaulted on its plan payments to First State Bank, and after filing and withdrawing several motions for relief, First State Bank ultimately obtained relief from the automatic stay on October 27, 2015, to proceed with its state-law remedies. The debtors appealed that order but did not request a stay pending appeal. First State Bank proceeded with the foreclosures of its deeds of trust, with sales of eight of the properties scheduled for April 6, 2016, and two more scheduled for April 14, 2016. The bank filed quiet title actions regarding other properties, and obtained the appointment of receivers to collect rents.
After the automatic stay had been lifted and while First State Bank was moving forward to liquidate its security interests and foreclose its deeds of trust, Mr. Morgan deeded the properties from Midland Properties, L.L.C., to Midland Properties II, L.L.C. (hereafter "MPII"), which was formed on February 8, 2016. The deeds were executed on January 2, 2016, and recorded on February 29, 2016. MPII then filed a Chapter 11 petition on April 4, 2016, just days before the bank's scheduled trustee sales. In the meantime, Mr. Morgan and his attorney proceeded with the Midland Properties appeal and an adversary proceeding against First State Bank in the normal course, as if the Midland Properties plan was still viable and ongoing. At the § 341 meeting in the MPII case on May 2, 2016, counsel for First State Bank first learned that the debtor had acquired all of its property from Midland Properties in exchange for a purported assumption of the secured debt. MPII did not assume Midland Properties' unsecured debt.
First State Bank quickly moved to dismiss the MPII bankruptcy petition for cause because the debtor's actions left the transferring entities with no assets and no way to pay unsecured creditors pursuant to the confirmed Chapter 11 plan of Midland Properties and because the filing was clearly in bad faith. The United States Trustee also moved for dismissal of Midland Properties' bankruptcy case, asserting that because of the transfer of all assets to MPII, Midland Properties had no reasonable likelihood of rehabilitation, had failed to make its plan payments and file necessary reports, and was being grossly mismanaged. First State Bank also filed these motions for sanctions and for disgorgement of legal fees, arguing that this bankruptcy petition was filed in bad faith to delay and frustrate the legitimate efforts of creditors to enforce their rights against the debtor. All four motions were heard on May 9, 2016, whereupon the court dismissed both bankruptcy cases for cause and took the sanctions and disgorgement motions under advisement.
Order of May 10, 2016, at ¶ 2 (Fil. No. 50).
Meanwhile, the appeal by Mr. Morgan and Midland Properties remained pending before the Bankruptcy Appellate Panel, which did not learn until late April 2016 that all of the debtors' assets had been transferred to MPII and that MPII was now a debtor. The appellate court was advised in May 2016 that both bankruptcy cases had been dismissed and the appeal was moot. First State Bankfiled a motion for sanctions in the appeal, based on the debtors' pursuit of a moot appeal. The Bankruptcy Appellate Panel found that the appeal became moot on January 2, 2016, when the debtors executed quit-claim deeds transferring all the properties to MPII. Nevertheless, debtors' counsel briefed the appeal in February and March without notifying the appellate court or First State Bank of the transfers. The Bankruptcy Appellate Panel ruled that the appeal was frivolous as well as moot and sanctioned the debtors for First State Bank's costs and attorney fees incurred in pursuing the appeal after it became moot on January 2, 2016. Because debtors' counsel was not involved in the transfers but did not inform the bank's attorneys or the appellate court after he became aware of the transfers on March 8, 2016, the court sanctioned him for the bank's fees incurred after that date. By judgment entered on June 3, 2016, the Bankruptcy Appellate Panel imposed monetary sanctions of almost $25,000.00 against the debtors and their attorney for pursuing a frivolous and moot appeal.
First State Bank's motion for sanctions was brought under Federal Rule of Bankruptcy Procedure 9011(b)1 and (c)(1)(A)2 and the court's general authority under 11 U.S.C. § 105(a). Thecourt may impose sanctions under the auspices of Federal Rule of Bankruptcy Procedure 9011(c), which forbids frivolous, improper, or unsupported filings, as well as § 11 U.S.C. 105(a), which authorizes the court to take action to prevent an abuse of process. Young v. Young (In re Young), 507 B.R. 286, 291-92 (B.A.P. 8th Cir. 2014).
Rule 9011 is the bankruptcy version of Federal Rule of Civil Procedure 11. It requires that every petition, pleading, written motion, and other paper be signed by an attorney. Fed. R. Bankr. P. 9011(a). The signature constitutes a certification that to the best of the attorney's knowledge, information, and belief, "formed after an inquiry reasonable under the circumstances," the petition, pleading, motion, or paper "is not being presented for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of the litigation" and that the legal contentions therein are warranted by law. Fed. R. Bankr. P. 9011(b)(1) and (2). Nett v. Manty (In re Yehud-Monosson USA, Inc.), 472 B.R. 795, 805 (D. Minn. 2012).
An award of sanctions involves a consideration of three types of issues: factual, legal, and discretionary. First, a court must consider factual questions regarding the nature of the attorney's inquiry prior to filing the pleading and the factual basis for the pleading. Next, a court must consider legal issues to determine if the pleading is warranted by existing law or a good faith argument for a change in the law and whether the attorney's conduct violated Rule 9011. Finally, if a court determines that sanctions are warranted, it must exercise discretion to ensure the sanction is appropriately tailored to the situation.
The Court of Appeals for the Eighth Circuit recently explained the gravity of an attorney's duty to the bankruptcy court under Rule 9011:
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