Responding to Automatic Stay Breaches: A Cautionary Tale for Overzealous Debtor Lawyers | Nelson Mullins Riley & Scarborough LLP

Filing a bankruptcy petition under any chapter of the Bankruptcy Code creates the “automatic stay,” which prevents creditors from taking any further action against the debtor or the debtor’s assets during the bankruptcy. Experienced bankruptcy attorneys know that a breach of automatic stay is a serious matter and as such, properly advise their clients on honoring or executing the stay. However, stay violations can occur inadvertently even when all reasonable and necessary precautions are taken. Large, sophisticated companies – with multiple addresses, departments, and employees – may still inadvertently contact or bill the debtor after bankruptcy is filed. For debtors’ attorneys, on this surface, this may seem like a golden opportunity to sue the offending creditor for a breach of stay with the goal (or hope) of producing a favorable monetary settlement. But, should the debtor’s lawyer first try to remedy the problem by non-judicial means? What are the attorney’s obligations under Federal Bankruptcy Rule 9011 (“Rule 9011”) before filing a lawsuit?[1] Made any residence violation give a debtor’s attorney free rein to ask for a big payday?

A recent 28-page order from the District of South Carolina Bankruptcy Court in the matter of In re James Defeo vs. Winyah Surgical Specialists, PA, Adv. Pro. Issue 21-80011-JW (September 27, 2021) – in which the Court fined debtor’s attorney $10,000 for violating Rule 9011 – provides guidance on these matters.

In Defoo, the debtor declared bankruptcy on October 2, 2020. The creditor-defendant sent the debtor an invoice for $910.00 on November 17, 2020. The debtor’s lawyer then called the defendant and informed him of the bankruptcy. On February 2, 2021, the defendant sent a second invoice to the debtor for the same debt. The defendant admitted that she had been notified of the bankruptcy when she sent the second invoice, but argued that the invoice had been sent automatically by her computer system in error. After realizing and correcting the error, the defendant made no further attempt to collect against the debtor. And the debtor’s attorney made no further effort to contact the creditor after receiving the second invoice and ultimately sued the creditor on February 15, 2021. The suit sought $50,000 in punitive damages and alleged, among other , that Defendant deliberately and intentionally violated the Remain and engaged in “excessively aggressive, underhanded, deceptive, manipulative, oppressive, abusive and unlawful collection”. On April 8, 2021, Defendant served (but did not file) a Motion for Sanctions (“Sanctions Motion”) against Debtor’s Counsel on the basis that Debtor’s Counsel violated Rule 9011 in (i ) failing to investigate or investigate the Complaint allegations that was reasonable in the circumstances and (ii) filing the Complaint for the improper purpose of obtaining a settlement payment. Counsel for the Debtor declined to withdraw or amend the Complaint in response to the Sanctions Motion, and after the execution of the 21-day safe harbor period, on May 3, 2021, the Defendant filed the Motion for sanctions with the Court.

The Court analyzed the debtor’s attorney’s conduct and determined that he violated Rule 9011. First, the attorney failed to conduct a reasonable investigation into the factual and legal grounds for the complaint, such as the requires rule 9011(b)(2). Specifically, the Court noted that the complaint contained several allegations regarding the defendant’s specific state of mind and intent, including that the defendant “chose to violate flagrantly, wantonly and with contempt and contempt flagrants the basis of the bankruptcy process“. However, the debtor’s attorney failed to investigate or inquire into the defendant’s intent, as the sole basis of the complaint was the second bill for $910 sent to the debtor. No witnesses were interviewed and the record showed that the debtor’s attorney did not uncover any other communications from the defendant to the debtor, such as threatening letters, emails, calls, text messages, visits personal or lawsuits. The Court also noted that the invoices sent to the debtor were (i) worded in moderate terms and contained no indication that the defendant intended to “annoy, threaten, harm, abuse, intimidate or harass the debtor” and (ii) did not, by itself, reasonably lead to the inference that Defendant engaged in “overly aggressive, underhanded, deceptive, manipulative, oppressive, abusive and unlawful collection”.

Second, the Court found that the complaint also violated Rule 9011(b)(1) because it was filed for the improper purpose of obtaining substantial damages or a settlement. The Court held that the prominent placement of the $50,000 demand on the first page of the complaint and the extreme characterization of the defendant’s conduct—which did not match the seriousness of the stay violation—were evidence that the complaint had been filed to intimidate and threaten the defendant. in a regulation.

Finally, the court determined that debtor’s attorney should be penalized $10,000 under rule 9011(c). The Court found that the $10,000 penalty was appropriate because the complaint included several allegations without factual basis and demanded an amount of damages that was not commensurate with the violation of the suspension. This exposed the defendant to high risk and contributed greatly to him spending substantial attorney fees to defend the complaint and pursue the motion for sanctions. The Court also noted that a monetary penalty was necessary to deter future misconduct by debtor’s attorney, who had shown a tendency to bring similar lawsuits. The lawyer had filed more than 100 adversarial lawsuits for alleged deliberate violations of the automatic stay over the years, many of which were based on sending simple collection letters or invoices.

the Defoo case, although a bit of an extreme example, is a cautionary tale for debtors’ attorneys. While the creditor in Defoo technically breached the automatic stay, he took reasonable and prompt steps to correct the problem and did not contact the debtor after he resolved the problem. On the other hand, the answer, requests and allegations of the debtor’s lawyer in the filed complaint had no basis in fact and were disproportionate to the violation of the stay. The court order in Defoo not only provides a good road map (and reminder) of how debtor’s attorneys can comply with Rule 9011 when investigating and responding to stay violations, but it also serves as a grim reminder that violations of Stays do not give attorneys a free pass to seek a substantial settlement.

[1] All attorneys appearing and filing documents in bankruptcy court have obligations under the Fed. R.Banker. P. 9011 during representations before the Court. Rule 9011 is the bankruptcy equivalent of Rule 11 of the Federal Rules of Civil Procedure.

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