In Stanley v. Mason (In re BCB Contracting Services, LLC), BAP No. AZ-21-1254-BSF (April 21, 2022), the Bankruptcy Appellate Panel (“BAP”) held that sanctions are a proper exercise of the bankruptcy court’s inherent authority. To impose sanctions under its inherent authority, a bankruptcy court must find either bad faith, conduct tantamount to bad faith, or recklessness with an additional factor such as frivolousness, harassment, or an improper purpose. A court may also sanction under its inherent authority a party who has engaged in bad faith conduct over the course of a case.
In Stanley, BCB Contracting Services, LLC (“Debtor”) entered into state court litigation with Payam Khoshbin (“Khoshbin”), a creditor and former member of the Debtor. While this litigation was pending, Brian Stanley, who was an attorney for the Debtor, advised Barbara Holbrook (“Holbrook”), the sole member and manager of the Debtor, to create a successor company known as BCB Excavating Services, LLC (“BCB Excavating”) through which Holbrook could continue the same business as she did through the Debtor. The Debtor’s equipment was transferred to BCB Excavating for use in its business operations without providing anything of value to Debtor in exchange. Shortly after, Khoshbin obtained a judgment against Debtor and served subpoenas on BCB Excavating and Holbrook seeking information about Debtor’s assets and any transfers made to BCB Excavating. Stanley advised Holbrook to file bankruptcy for the Debtor to avoid compliance with the Khoshbin subpoenas.
The Debtor proceeded with filing a Chapter 7 bankruptcy petition and Anthony Mason was appointed as the Chapter 7 trustee (“Trustee”). The Trustee’s investigation revealed that not all the Debtor’s equipment had been reported on its Schedules and that certain transfers of funds from the Debtor to BCB Excavating were also unreported. After the Trustee’s discovery, the Schedules were amended to reflect the Debtor’s unreported equipment, but the Statement of Financial Affairs was never amended to include the unreported transfers. Additionally, the Debtor, BCB Excavating, Holbrook, and Stanley also resisted the Trustee’s investigative efforts by failing to provide requested information, failing to attend the Section 341(a) meeting of creditors, and failing to appear at Rule 2004 examinations. Stanley then filed a special action in state court in an attempt to withdraw Holbrook as a member of the Debtor retroactively – meaning that Holbrook was not a member of the Debtor when the bankruptcy petition was filed. Stanley failed to inform the Trustee of the special action. The Trustee then moved for sanctions against Stanley under Rule 9011 and the court’s “inherent authority under 11 U.S.C. § 105(a).”
The bankruptcy court entered an order sanctioning Stanley and awarding Trustee his attorney’s fees and costs of $15,523.31, but it declined to award any the Trustee’s requested $50,000 in sanctions. Focusing on its findings under 11 U.S.C. § 105(a), the court found that Stanley acted in bad faith: (1) by initiating the Chapter 7 case for the improper purpose of gaining a tactical advantage over Khoshbin in the state court litigation; (2) by his reckless misstatements of fact in the schedules and statement of financial affairs; and (3) by his conduct throughout the proceeding.
Ultimately, the BAP affirmed the bankruptcy court’s decision holding that sanctions are a proper exercise of the bankruptcy court’s inherent authority. Specifically, the BAP reasoned that the bankruptcy court did erroneously rely on 11 U.S.C. § 105(a) to sanction Stanley, but the error was harmless because the bankruptcy court applied the correct law and made the appropriate findings, including a finding of bad faith and the additional findings of frivolous and recklessness with an improper purpose, which allowed the bankruptcy court to impose sanctions under its inherent authority. Additionally, the BAP also reasoned that since much of Stanley’s bad faith conduct did not consist of a writing filed with the court, and Rule 9011 does not reach such conduct, the court’s reliance on its inherent power was appropriate.
Thus, according to the BAP, sanctions are a proper exercise of the bankruptcy court’s inherent authority. This is particularly true when sanctions are appropriate for bad faith conduct over the course of a case and sanctions under Rule 9011 and 11 U.S.C. § 105(a) are not applicable.