Sanctions Imposed for Failure to Adequately Investigate in Stay Violation Proceedings

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Smith Debnam Narron Drake Saintsing & Myers, LLP

In a recent case from the Bankruptcy Court for the District of South Carolina, Defeo v. Winyah Surgical Specialists, P.A., AP No. 21-80011 (In re Defeo, C/N 20-03738) (September 27, 2021), Bankruptcy Judge John E. Waites imposed sanctions under Federal Bankruptcy Rule 9011(c)(1)(A) against counsel for “failing to conduct an investigation or inquiry that was reasonable under the circumstances” before filing an Adversary Proceeding seeking damages for violation of 11 U.S.C. §362(k).  The 28-page opinion thoroughly reviews the standard for investigation of claims and the potential consequences for failure to meet those standards.

Background

Defendant, Winyah Surgical Specialists, P.A., was a creditor in the Defeo Chapter 13 Bankruptcy case filed in October 2020. Winyah was not initially listed in the Debtor’s Schedules and was not served with the filing notice.  In November 2020, Winyah mailed an invoice for medical services in the amount of $910 to the Debtor.  Debtor’s counsel contacted Defendant by telephone in December and advised Winyah of the filing, provided the Chapter 13 case number, and obtained an address for Winyah for the mailing matrix.  Later that month, Debtor’s counsel amended the Schedules to include Winyah as a creditor, listed the $910 debt as unsecured, and served the Amended Schedules on the Winyah.  In February 2021, Winyah mailed a second invoice which included the statement, “Your account is in default and could be sent to a collection agency. Please call.” Winyah admitted it had received notice of the filing but indicated that the invoice was automatically sent by its computer system in error. No other correspondence was sent, and Winyah made no collection efforts or contacts. The Debtor received the invoice on February 9th and commenced an adversary proceeding seeking damages for violation of the stay. No attempt to contact Winyah was made by either the Debtor or its counsel before filing the Complaint.

Complaint for Violating the Automatic Stay

The Complaint sought to enjoin Winyah from all collection efforts as well as actual and punitive damages pursuant to 11 U.S.C. §§105 and 362(k).  The caption included the following statement “ACTUAL AND PUNITIVE DAMAGES: $50,000.00.”   The Complaint also included specific allegations indicating Winyah contacted the Debtor “with the specific intent to violate the bankruptcy laws,” that Winyah “illegally attempt[ed] to collect a $910 debt listed in the bankruptcy case” and further alleged that even with notice of “monetary exposure” Winyah “chose to flagrantly, wantonly and with gross disdain and disregard violate[d] the bedrock of the bankruptcy process.”  The Complaint went on to paint Winyah as a party “that does not hesitate to engage in overly aggressive, devious, deceptive, manipulative, oppressive, abusive and illegal collection” activities by “willfully, deliberately and intentionally” ignoring the Code’s stay provisions and that “Winyah’s actions were “done with the express intent to annoy, threaten, cause harm, abuse, intimidate or harass” the debtor.

Motion for Sanctions

Counsel for the Defendant served a copy of a Motion for Sanctions on counsel for the Debtor asserting a violation of Rule 9011(b) for failing to conduct a reasonable investigation or inquiry into the Complaint allegations that had no evidentiary support prior to filing the Complaint.  The Motion further asserted that the Complaint was filed for an improper purpose, namely “to needlessly increase expenses and to seek a payment rather than to stop a stay violation.”  Defendant’s counsel requested that the Complaint be withdrawn within 21 days, or the Motion would be filed with the Court.  Debtor’s counsel failed to withdraw the Complaint, and Defendant’s counsel filed the Motion for Sanctions.

Judge Waites carefully and thoroughly reviewed the standards for pleading generally and the relief available under Rule 9011 and found that Debtor’s Counsel failed to make any reasonable inquiry into the allegations as required by the Rule finding “multiple, deliberate factual allegations included in the Complaint for which Debtor’s Counsel had no factual basis to allege.”  Though the Court found that the action “appear[ed] to have been filed for the reasonable purpose of seeking to enforce Debtor’s rights under the Bankruptcy Code,” it also seemed to have been filed for “the additional purpose of obtaining a substantial award or settlement” which the Court also noted, “may be unjustified under the circumstances of this case.”  The Court  pointed out that the prominent inclusion of actual and punitive damages in the caption itself and on the front page of the Complaint and the “extreme characterization of the Defendant’s conduct” was “indicative of Debtor’s Counsel’s desire to threaten and intimidate the Defendant.”  The Court also noted that Debtor’s counsel had filed another adversary proceeding seeking similar relief against another creditor in the same case and cited numerous other cases filed by Debtor’s counsel seeking similar relief based on similar facts.  Nevertheless, Judge Waites found it unnecessary for the Court to determine the issue of whether the pleading was filed for an improper purpose though it highlighted several facts that might provide such a basis for relief.

Conclusion

After conducting a review of case law as to the proper measure of damages, the Court sanctioned Debtor’s counsel and awarded $10,000.00 in damages to Winyah and struck the disputed and unfounded allegations from the Complaint.  The Court’s ruling clearly shows that counsel’s obligation under Rule 9011 is not a matter to be taken lightly, and under the facts of this case, failing to meet the requirements of this Rule will not be tolerated.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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