Ethics in Brief

Ethics in Brief is designed to present ethical issues that practitioners might well face on a daily basis. It is a service of the Legal Ethics Committee of the San Diego County Bar Association.

Looking to Expand Your Practice to Include Bankruptcy? Make Sure You Are Competent to Do So or Face Sanctions in Bankruptcy Court

As California attorneys, we are governed by the California Rules of Professional Conduct. Rule 3-110(A) provides that “a member shall not intentionally, recklessly, or repeatedly fail to perform legal services with competence.” We all know we can be disciplined by the State Bar, but the courts also have powers to discipline for a lack of competency. In bankruptcy court, judges identify their authority for issuance of an Order to Show Cause (OSC) and possible sanctions pursuant to the court’s inherent powers and Sections1 105, 329(b) and Rule2 9011(b) and (c) (akin to Civil Rule3 11).

In a 36-page published opinion, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (BAP) affirmed, in part, and reversed, in part, a bankruptcy court’s order sanctioning a debtor’s attorney for wide-ranging failures in representing the debtor and for taking unsupported legal positions throughout the case. Shalaby v Mansdorf  (In re Nakhuda), 544 B.R. 886 (9th Cir. BAP 2016).

During the bankruptcy case, the bankruptcy court, sua sponte, issued an OSC for Debtor’s attorney, Andrew Shalaby (Shalaby), to appear and show cause why he should not be required to disgorge the fees he had been paid or should not be otherwise sanctioned for his conduct in the case based upon a number of factual and legal positions Shalaby had taken as follows:

  1. He argued the Trustee’s objections to exemptions were not timely filed when they were;
  2. He took the position that his client’s four sole proprietorship laundromats could remain open after the Chapter 7 bankruptcy was filed;
  3. He argued that the value of assets scheduled had to be reduced by 50% as to the non-filing wife’s community property interest in the assets;
  4. He argued that a bank account was exempt as a tool of trade and that accounts receivable were exempt as earnings paid by an employer (ignoring debtor’s deposition testimony that he was not an employee);
  5. He claimed that the debtor had no obligation to turn over assets because assets were automatically removed from the debtor’s estate when they were listed in the bankruptcy schedules as having an inconsequential value; and,
  6. He filed documents with the electronic /s/ signature of his client, but had not obtained original “wet” signatures from the debtor (admitting that it was his practice to not have his debtor clients sign any of the papers filed on their behalf).

As a result of Shalaby taking positions without an adequate basis in law or fact, the court entered its Sanctions Order against debtor’s attorney for:

  1. Non-compensatory monetary sanctions for $8,000 payable to the bankruptcy court for violating Rule 9011 (b);
  2. Disgorgement of $4,000 that was paid to him by the debtor, which included the filing fee pursuant to Section 329;
  3. Suspension from the practice of law in the bankruptcy courts for the Northern District of California until he had completed 24 hours of continuing legal education in bankruptcy law and 3 hours of continuing legal education in ethics; and,
  4. Suspension of his e-filing privileges until he had completed the electronic case filing (ECF) training provided by the clerk’s office.

Shalaby appealed the Sanctions Order.

The BAP affirmed disgorgement of the attorney’s fees and court filing fees as appropriate under Section 329. The BAP also upheld suspending Shalaby’s e-filing privileges as appropriate under the local rules. However, the BAP reversed the Rule 9011 sanctions that imposed an $8,000 fine on the attorney and suspended his right to practice law before the court until he completed continuing legal education because the bankruptcy court applied the incorrect legal standard of “reasonableness.”

Objective reasonableness is the appropriate standard when sanctions are party-initiated. However, when the court initiates a Rule 9011 sanction proceeding, sua sponte, the higher standard of “akin to contempt” must be applied. The Court explained,

“When assessing sanctions sua sponte under Rule 9011(c)(1)(B) and under the law of this Circuit, the bankruptcy court is required to issue an order to show cause to provide notice and an opportunity to be heard and to apply a higher standard ‘akin to contempt’ than in the case of party-initiated sanctions. The reason behind the heightened standard is because, unlike party-initiated motions, court-initiated sanctions under Rule 9011(c)(1)(B) do not involve the 21-day safe harbor provision for the offending party to correct or withdraw the challenged submission.”

The “akin to contempt” standard requires conduct that is particularly egregious and similar to conduct that would be sanctionable under the standards for contempt.  Here, the attorney’s legal positions and arguments were objectively frivolous under the reasonableness standard.  But, there was no showing that the attorney “acted knowingly or intentionally.” Under the heightened standard of “akin to contempt,” the court had to find more than ignorance or negligence on the part of the attorney. 

Debtor’s counsel was saved from an additional $8,000 monetary sanction award only because it was the court that initiated sanctions under Rule 9011 (c)(1)(B), triggering the higher standard of “akin to contempt.”  If the Trustee had sought sanctions, the “reasonableness” standard adopted by the bankruptcy court would have been sufficient to uphold the monetary award as well as suspension from the practice of law in the bankruptcy courts for the Northern District of California because Shalaby would have had the benefit of the 21-day safe harbor provision to correct or withdraw the challenged submissions.

Nevertheless, debtor’s counsel did not serve his client well by practicing in a field of law where he lacked skill and experience and, as the bankruptcy court found, “lacked competence in the relevant substantive and procedural areas required to handle the case.” This case illustrates that an attorney cannot “dabble” in bankruptcy matters; it can only lead to dire consequences, not only for the attorney, but for the client as well.  This debtor lost valuable property because of his attorney’s failure to perform legal services with competence.

-- Radmila A. Fulton

1  “Section” references are to the United States Code, Title 11.

2  “Rule” references are to the Federal Rules of Bankruptcy Procedure.

3  “Civil Rule” references are to the Federal Rules of Civil Procedure.

**No portion of this summary is intended to constitute legal advice. Be sure to perform independent research and analysis. Any views expressed are those of the author only and not of the SDCBA or its Legal Ethics Committee.**