Surviving a motion to dismiss does not necessarily mean that counsel drafting a pleading will survive a motion for sanctions under Rule 9011 if they have not conducted a “reasonable inquiry” of the allegations and/or that the allegations the uninvestigated allegations in the pleadings will not be stricken or that counsel will not be ordered to pay sanctions.  In re Defeo, No. 4:21-CV-03263-SAL, 2022 WL 3691358, at *5 (D.S.C. Aug. 25, 2022).  According to a recent case heard by the South Carolina Bankruptcy Court, which was upheld by the South Carolina District Court, merely reciting the required elements of a claim in an adversary proceeding without first conducting a “reasonable inquiry” may be legally sufficient to meet the requirements to survive a motion to dismiss, but it also violates Bankruptcy Rule 9011 because different standards are applied to the motions.  Id.

“When considering a motion to dismiss, the Court examines the legal sufficiency of the Complaint and its inquiry is limited to whether the allegations constitute a short and plain statement of the claim showing that the pleader is entitled to relief. At the motion to dismiss stage, the allegations of the Complaint are accepted as true, no matter how skeptical the Court may be.”  In re Defeo, 632 B.R. 44, 55 (Bankr. D.S.C. 2021), aff’d, No. 4:21-CV-03263-SAL, 2022 WL 3691358 (D.S.C. Aug. 25, 2022).

On August 25, 2022, the Bankruptcy Court’s order for sanctions in the amount of $10,000[1] and striking uninvestigated allegations from the complaint in an adversary proceeding was affirmed by the District Court against David H. Breen and Matthew M. Breen, which also award awarded an additional $3,000 in sanctions against the Breens for filing a frivolous appeal under Bankruptcy Rule 8020 after they filed an adversary complaint against a medical office.  Id. at *9.  The adversary action, based on violations of the automatic stay, was filed against a medical office without conducting any prior investigation into the underlying facts – including failing to contact the medical office before filing the action –  and then they filed an appeal which mischaracterized and misrepresented many of the facts of the underlying case.  Id. at ­­­­*8.

Before receiving notice of the bankruptcy, the defendant sent an invoice to the debtor in the amount of $910.  Id. at *1. Debtor’s attorney contacted the defendant by phone to advise it about the bankruptcy, and subsequently provided it notice of the bankruptcy.  Id.  The defendant asserts it put its regular safeguards in place, but due to a computer error, another notice went out shortly after it received notice of the bankruptcy.  Id.  The invoice mildly stated, “Your account is in default and could be sent to a collection agency.  Please call.”  Id.

Debtor’s counsel never contacted defendant after the invoice was received but instead filed an adversary complaint demanding $50,000 in damages in the caption.  Id. at *2.  The adversary complaint contained a plethora of strongly worded allegations such as:

“[W]ith a specific intent to violate bankruptcy laws, [Defendant] contacted [Debtor] by mail dated February 3, 2021 illegally attempting to collect a $910.00 debt listed in [Debtor’s] bankruptcy case.” [Compl. ¶ 9 (emphasis added).]

“The Defendant’s acts, by and through its agents, servants and/or employees, establish this creditor as one that does not hesitate to engage in overly aggressive, devious, deceptive, manipulative, oppressive, abusive and illegal collection.” [Compl. ¶ 11 (emphasis added).]

Id. at *2.

Bankruptcy Rule 9011, like Rule 11, imposes duties on all attorneys filing documents and appearing in bankruptcy court, including the duty of candor to the Court.  Bankruptcy Rule 9011 provides, in part:

(b) Representations to the court:

By presenting to the court (whether by signing, filing, submitting, or later advocating) a petition, pleading, written motion, or other paper, an attorney or unrepresented party is certifying that to the best of the person’s knowledge, information, and belief, formed after an inquiry reasonable under the circumstances,

(1) it is not being presented for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation;

(2) the claims, defenses, and other legal contentions therein are warranted by existing law or by a nonfrivolous argument for the extension, modification, or reversal of existing law or the establishment of new law;

(3) the allegations and other factual contentions have evidentiary support or, if specifically so identified, are likely to have evidentiary support after a reasonable opportunity for further investigation or discovery; and

(4) the denials of factual contentions are warranted on the evidence or, if specifically so identified, are reasonably based on a lack of information or belief.

Fed. R. Bankr. P. 9011 (emphasis added). In re Defeo, No., 2022 WL 3691358 at *3.

Discovery may be used to “reveal additional facts to support claims which are well grounded in fact,” but attorneys are subject to sanctions for asserting frivolous claims in pleadings which are not supported by any factual support.  Id. at *6.

Debtor’s counsel had survived a motion under Rule 12(b)(6) in another almost identical adversary case they filed on behalf of other debtors, Waters v. McCleod Seacoast Hospital (In re Waters), C/A No. 19-05230, Adv. Pro. No. 19-80090, slip op., 2020 WL 1884191 (Bankr. D.S.C. Feb. 13, 2020), involving only collection letters in which they also did not call to investigate the allegations they raised in their complaint.  In re Defeo, 632 B.R. at 55.  Therefore, they argued, they had no duty to call the defendant prior to filing the adversary action.  Id.  In response, the Bankruptcy Court explained:

When considering a motion to dismiss, the Court examines the legal sufficiency of the Complaint and its inquiry is limited to whether the allegations constitute a short and plain statement of the claim showing that the pleader is entitled to relief. At the motion to dismiss stage, the allegations of the Complaint are accepted as true, no matter how skeptical the Court may be.

Id.

Due to the different standards of review, if an attorney is found to have failed to properly investigate or make a reasonable inquiry as to the facts or allegations set forth in the Complaint at the time the Complaint is signed, even if a complaint survives a Rule 12(b)(6) motion, the attorney, personally, could still be subject to sanctions under Bankruptcy Rule 9011(b)(3).  Violation of Bankruptcy Rule 9011(b)(3) can lead to monetary sanctions and/or the allegations which were not investigated could be stricken from the pleading.

[1] The offending party in this case had filed over 100 adversary proceedings for willful violation of the automatic stay based on simple collection letters.  In re Defeo, 632 B.R. at 62.  In awarding sanctions, “the least severe sanction” should be imposed.  Id. at 59.  The primary purpose is to “deter future litigation abuse.”  Id.  The Bankruptcy Court considered (1) the reasonableness of the attorneys’ fees; (2) the minimum to deter; (3) the ability of offending party to pay; and (4) other factors including the fact that the offending party had filed over 100 adversary proceedings for willful violation of the automatic stay based on the mailing of simple collection letters, the severity of the violation, the degree to which bad faith or malice contributed to the violation, and the risk of chilling this type of litigation. Id. at 61-63.

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