Cadle Co. sued James Moore, Brunswick Homes and others in state court alleging that Moore used Brunswick to shield assets and to avoid paying debts to Cadle. The causes of action included a state-law fraudulent transfer action. Moore subsequently filed Chapter 7 bankruptcy. Cadle removed the state case to the bankruptcy court (Judge Jernigan) as an adversary proceeding. Cadle and Brunswick both filed proofs of claim in the bankruptcy case. Cadle thereafter permitted the Chapter 7 Trustee to asset the estate’s claims as plaintiff in the adversary proceeding. Cadle’s counsel (Bell Nunnally & Martin “BNM”)) was retained by the Chapter 7 Trustee as special counsel. BNM’s employment application indicated that it was representing the Trustee on a contingency fee basis and also that BNM owed fiduciary duties to the Trustee, not Cadle. It later became clear that Cadle separately agreed to pay BNM’s fees and that such fees would be refunded to Cadle in the event of a successful outcome.
BNM also began representing Cadle in a separate action objecting to Moore’s discharge. BNM later sought to withdraw as special counsel to the Trustee, alleging that the Trustee failed to pay certain expenses. The bankruptcy court denied the motion to withdraw on the grounds that there was no evidence the Trustee agreed to pay the expenses.
In the avoidance adversary proceeding, Cadle subsequently obtained new counsel and BNM remained as special counsel to the Trustee. The Trustee later sought approval of a settlement of the avoidance adversary proceeding whereby the defendants would make a settlement payment to the Trustee. Cadle objected to the settlement and sought to buy back its claim. It became clear at the hearing on the settlement that Cadle had paid $60,000 to BNM related to BNM’s representation of the Trustee. The bankruptcy court approved the settlement. The matter was appealed and the 5th Circuit remanded on the grounds that the bankruptcy court had failed to consider the option of the sale of the claims for an amount greater than the settlement payment. The bankruptcy court then held an auction of the claims and Cadle purchased them.
The conflict of interest issue then came up again in a subsequent hearing before the bankruptcy court. A Cadle employee testified that Cadle continued to pay BNM’s fees for a year following Cadle becoming adverse to the Trustee on the settlement issue. The payments were stopped when a Cadle manager realized the situation. Moore and Brunswick filed a motion to dismiss the adversary proceeding on the grounds of abuse of judicial process. The bankruptcy court held a three-day evidentiary hearing and then dismissed the adversary proceeding based on its inherent power to sanction a party for abuse of process. The district court affirmed.
On appeal, Cadle first argued that the bankruptcy court lacked constitutional authority to enter a final order in the adversary proceeding. The 5th Circuit noted that Cadle’s state law avoidance claim would necessarily be resolved in the claims allowance process and that such claims by creditors are the very reason the claims process exists. Thus, Stern issues did not apply.
Cadle also argued that the bankruptcy court erred by not abstaining from hearing the avoidance action under the mandatory abstention provision of 28 U.S.C. § 1334(c)(2). The 5th Circuit noted that the Stern arguments made on appeal did not qualify as a motion requesting abstention and therefore there was no timely abstention motion. The court also held that the matter was “core” and therefore not eligible for mandatory abstention under § 1332(c)(2).
Finally, the 5th Circuit addressed the sanctions. The court noted that a court may invoke its power to sanction only upon a showing of clear and convincing evidence of bad faith or willful abuse of the judicial process. The 5th Circuit analyzed the various conflict of interest allegations and held that, while things suggest an “unpleasant odor” in the adversary proceeding, there were not sufficient facts to show – by clear and convincing evidence – of bad faith or willful abuse. The 5th Circuit therefore reversed and remanded to the bankruptcy court.