Bankruptcy Court Powers to Sanction Lawyers and Others Expanded in New Appeal Ruling

Although it has long been recognized that bankruptcy courts have the power to sanction attorneys and litigants under Rule 9011 of the Bankruptcy Rules (a rule which is almost identical in substance to Rule 11 of the Federal Rules of Civil Procedure), a recent appellate decision clarifies and expands the power and authority of bankruptcy courts to sanction attorneys and litigants based on the inherent power of the bankruptcy court as well as the broad authority granted by Section 105(a) of the Bankruptcy Code.

On April 21, the Bankruptcy Appellate Panel for the Ninth Circuit (the equivalent of the United States District Court’s bankruptcy appeal decision in the Eleventh Circuit) ruled in the case of In D BCB Contractual Services, (BAP No. AZ-21-1254-BSF) that the sanctioning power of the bankruptcy court derives from three separate sources: Bankruptcy Rule 9011, statutory authority for civil contempt under Rule 105(a) of the Bankruptcy Code and the inherent sanctioning authority enacted by the United States Supreme Court in the case Law versus Siegel, 571 US 415 (2014). This is extremely important as a bankruptcy court has a virtual “cafeteria of choice” in order to impose sanctions on lawyers and litigants as the case may be.

For those unfamiliar with Section 105 of the Bankruptcy Code, it was originally known as the “All Writs Act” of the Bankruptcy Code where the bankruptcy court has the statutory authority to issue any order, proceeding or judgment that is necessary or appropriate to enforce the provisions of the Bankruptcy Code. Section 105 has been interpreted broadly by bankruptcy courts and appellate decisions to permit and authorize bankruptcy judges to create whatever relief may be necessary in a particular situation, even if there is no no legal authority or specific provisions in the rules of bankruptcy procedure.

Significantly, notwithstanding the broad scope of Section 105, the Bankruptcy Appeals Board held that the bankruptcy court has inherent power to sanction abusive court practices, which inherent power is not limited in any way to the legal scope of Section 105 or the penalty proceedings in Bankruptcy Rule 9011. The United States Court of Appeals for the Ninth Circuit has previously clarified that there is an important distinction between the legal power and the inherent power to sanction abusive practices, and emphasized that they are not interchangeable, where it was stated:

“Civil contempt authority allows a court to remedy a breach of a specific order (including “automatic” orders, such as an automatic injunction to stay or release). The inherent sanctioning authority allows a bankruptcy court to deter and indemnify a wide range of improper litigation tactics. To see Knupfer v. Linblade (In re Dyer), 322 F. 3d 1178, 1196 (9th Cir. 2003).

The court went on to state that the inherent power to sanction bad faith conduct is broader than the sanctions in Rule 9011 and extends to a full range of abuse of litigation. This means that the court may sanction under its inherent power even when the same conduct may also be punishable under another sanctioning law or rule, such as Bankruptcy Rule 9011.

To further clarify the matter, the court stated that in order to impose sanctions under its inherent authority, the bankruptcy court must find either bad faith, conduct amounting to bad faith, or recklessness with additional factors such as frivolity, harassment, or improper purpose. It has been held that counsel’s objective of gaining a tactical advantage in another case is sufficient to support a finding of bad faith and improper design. Additionally, the court found that a party who engaged in bad faith conduct during the case is subject to penalties.

Although this decision cannot be considered “innovative”, it clarifies the broad power of the bankruptcy court to sanction the inappropriate behavior of lawyers and litigants. With rising consumer and business bankruptcy cases as the economy reacts to inflation and rising interest rates (a reported 34% increase in new cases filed from February to March this year ), and with the continued expansion of the small business bankruptcy provision of the Bankruptcy Code to encompass businesses with debts of less than $7.5 million, the expanded and clear power of the bankruptcy court to sanction and to punish bad behavior is a welcome and necessary clarification.

Charles M. Tatelbaum, director at Tripp Scott in Fort Lauderdale, leads the firm’s bankruptcy practice and Corey D. Cohen is associated with the firm.

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