In re 15375 Memorial Corporation, et al, 430 BR 142 (Bankr D Del May 17, 2010)

CASE SNAPSHOT

The Bankruptcy Court sanctioned the indirect parent corporation of the chapter 11 debtors and the indirect parent corporation’s counsel under its “inherent authority” and 28 U.S.C. section 1927 – but not Rule 9011 – after finding that the parent corporation abused the bankruptcy process by causing two of its subsidiaries to file bankruptcy petitions as a litigation tactic to shield itself from a $189 million liability in an environmental damage case.

FACTUAL BACKGROUND

This case concerned several corporate parties, all involved in oil and gas exploration. Bass Enterprises Production Company (Bass) and Santa Fe Minerals, Inc. (Santa Fe) were each in the chain of title for a mineral lease of land that was later found to be contaminated. 15375 Memorial Corporation (Memorial) was a holding company and immediate parent of Santa Fe. Entities Holdings, Inc. (EHI) was a holding company and the sole shareholder of Memorial. GlobalSantaFe Corporation (GSF) was the direct parent of EHI, and the indirect owner of both Memorial and Santa Fe. Bass was not affiliated with Santa Fe, Memorial, EHI, GSF, or any other party in this case.

Individuals affected by the contamination of the real property filed a state court complaint against Bass and Santa Fe. During discovery in this suit, the parties learned that Santa Fe, not Bass, was responsible for the contamination, and that it would take $189 million to remediate the property. Further, the individual plaintiffs made it known that if any defendant filed for bankruptcy, that defendant would be dismissed from the suit. In addition, as part of the state court suit, Bass asserted third-party claims against Santa Fe for damages done to the property, and asserted alter-ego claims against GSF.

In August 2006, EHI issued a demand note to Memorial, pursuant to which EHI provided a revolving line of credit to Memorial in exchange for Memorial’s: (i) acceptance of all liabilities; and (ii) agreement to defend and indemnify GSF from all claims relating to Santa Fe’s operations, regardless of whether those claims were based on alter-ego theories or other principles. Thereafter, Memorial and Santa Fe filed chapter 11 petitions, and the individuals’ claims against them in the state court suit were dismissed.

Ultimately, Bass settled the claims against it in the state court suit for more than $20 million. As part of this settlement, Bass was assigned the state court plaintiffs’ claims and rights against Santa Fe and GSF. Bass then filed proofs of claim against Santa Fe for assignment, contribution, indemnity and contamination of the property. Bass also sought relief from the automatic stay to pursue its alter-ego claims against GSF, but was denied this relief by the bankruptcy court on the theory that the alter-ego claims might constitute property of the bankruptcy estates.

COURT ANALYSIS

After years of litigation in the Bankruptcy Court between Bass, GSF and the debtors (with appeals up to the Third Circuit Court of Appeals, which resulted in the dismissal of the bankruptcy petitions for lack of good faith in their filing), Bass ultimately filed a motion for sanctions under Rule 9011 of the Federal Rules of Bankruptcy Procedure. The Bankruptcy Court denied this motion on the basis that the stringent standard of Rule 9011 requires “proof by the movant by clear and convincing evidence that no reasonable attorney could conclude that a debtor filed the case in good faith.” Noting that: (i) it was unaware of any misrepresentations that had been made by any party; and (ii) it is not a per se violation of Rule 9011 to file a chapter 11 petition lacking in good faith, the Bankruptcy Court found that the high bar for Rule 9011 sanctions had not been met.

This, however, did not end the court’s inquiry. Although the Rule 9011 request was denied by the Bankruptcy Court, the court did grant sanctions in excess of $2 million, on a joint and several basis, against GSF, EHI and their counsel. Specifically, the court recognized that it had inherent authority to impose sanctions for abuses in bankruptcy cases. In addition, it relied upon 28 U.S.C. secition 1927, which provides that “any attorney…who so multiplies the proceeding in any case unreasonably and vexatiously may be required…to satisfy personally the excess costs, expenses and attorneys’ fees reasonably incurred because of such conduct.”

In imposing these sanctions, the Bankruptcy Court held that it was clear that the sanctioned entities were in complete, direct control of Memorial and Santa Fe, and were dictating the filing and course of the bankruptcy cases. Further, the Bankruptcy Court held that GSF, EHI and their counsel improperly and intentionally used the bankruptcy process to thwart Bass’ efforts for relief in the bankruptcy cases, and that “at every turn [they] manipulated and side-tracked the bankruptcy process for their own benefit, as non-debtors, to keep [Bass] on the defensive.” The court found that GSF and its subsidiaries (which the court referred to as the “villains in these cases”) had misused the bankruptcy process, “which resulted in significant, foreseeable and intended harm to [Bass],” compelling the court to impose sanctions.

In granting the $2 million in sanctions, the court denied the requests of the sanctioned entities to take discovery from Bass’ attorneys regarding the attorneys’ fees and expenses incurred. Instead, the Bankruptcy Court relied on its own experience in approving attorneys’ fees requests, and determined that the attorneys’ fees incurred were fair, reasonable, and appropriate to the work necessary. In addition, the Bankruptcy Court noted its desire to prevent a “second major litigation” over the reasonableness of Bass’ fees. It did, however, reduce the sanctions award by an amount equal to Bass’ fees on the various appeals pursued by the parties, finding that sanctions related to those appeals must be heard by the courts that heard the appeals.

PRACTICAL CONSIDERATIONS

Generally speaking, courts are averse to awarding sanctions, seeking to avoid any chilling effect sanctions may have on vigorous legal representation. Where, however, conduct is so egregious and abusive of the legal process, courts are willing to impose sanctions. Parties, and their counsel, must be aware that a court has several weapons at its disposal to award sanctions, as the Bankruptcy Court in this case imposed sanctions under a non-bankruptcy provision of federal law.