Bankruptcy Newsletter

Contempt for Violating Court's Oral Pronouncement
A bankruptcy court had the remedial civil contempt power to hold a party incontempt for defying the court's injunction against disposing of certain trust assets, even though the terms of the court's oral pronouncement had not yet been reduced to writing, the Fifth Circuit Court of Appeals held.

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A bankruptcy court had the remedial civil contempt power to hold a trustee of a trust containing debtor assets in contempt for defying the court's injunction against disposing of certain trust assets, notwithstanding that the injunction's terms, although known through the court's oral pronouncement, had not yet been formalized in written form as required by procedural rules at the time the defiance occurred, the Fifth Circuit Court of Appeals has ruled as a matter of apparent first impression in the circuit.

The Chapter 7 trustee brought an adversary proceeding to reach the assets of a trust that had been established prepetition for the debtor's benefit, on the theory that the corpus of the trust consisted of or was traceable to property that the debtor owned prepetition and was thus a self-settled trust not protected under Texas law from the claims of the debtor's creditors. This proceeding was consolidated with other proceedings that also raised the question of whether the debtor had transferred his assets into the trust in an effort to conceal them from the claims of his creditors. Prior to trial, the bankruptcy court enjoined the trustee of the trust from transferring property or money of the trust to himself or to entities controlled by him or represented by the debtor's attorney. That injunction expired at the trial's conclusion, at which point the trustee began making preparations to sell significant trust assets, including certain real estate.

Seeking additional protection against the trustee's disposal of trust assets, the Chapter 7 trustee and creditors filed a joint motion to maintain the status quo pending the court's final ruling in the adversary proceeding. At the hearing on the motion, which was attended by the trustee's attorney but not the trustee, the bankruptcy court informed the parties that it would enter an injunction somewhat narrower than that requested, and it described the assets that would be subject to the injunction. The court instructed the trustee's attorney to take the lead in drafting a corresponding order, which was submitted to the court approximately four weeks after the hearing. Thus, the bankruptcy court's written injunction was not entered until nearly a month after the hearing, by which time the trustee had effected the sale of trust assets and had dispersed the sale proceeds to various entities controlled by the trust, himself, and the debtor.

Creditors and the Chapter 7 trustee moved to hold the trustee in civil contempt and for an award of sanctions based on his alleged violations of the injunction. Eventually, a trial was held. The bankruptcy court rejected the trustee's testimony that he did not know about the injunction until the court issued its final written order. Instead, the court determined that the trustee, while considering himself bound by the "oral injunction," had transferred $317,953.53 to related entities in violation of said injunction and in contempt of court, and it imposed sanctions against the trustee personally and against the trustee's successor, jointly and severally, for the entire amount. The district court affirmed. The Chapter 7 trustee subsequently settled with the trustee, personally, and the successor trustee appealed the contempt order and sanctions.

The trustee's main argument was that the bankruptcy court's oral pronouncements at the hearing were not enforceable by contempt until commemorated in a written order that complied with F.R.C.P. 65. In support of his argument, the trustee cited two Seventh Circuit decisions, Bates v. Johnson, 901 F.2d 1424 (C.A.7-Ill. 1990), and Hispanics United of DuPage County v. Village of Addison, 248 F.3d 617 (C.A.7-Ill. 2001). Those cases, however, stood for the proposition that an injunction that is not reduced to writing is not a valid, appealable injunction, and this case arose in a different context and presented different circumstances, the Fifth Circuit explained. Moreover, in contrast to the district courts in the Seventh Circuit cases, the bankruptcy court followed its oral command with a materially identical written injunction, and the trustee was held in contempt for violating an order he considered to be binding and which, in any case, would shortly become binding upon him.

The Court of Appeals began its contempt analysis by determining that the proceeding in the bankruptcy court was a "compensatory" or "remedial" civil contempt proceeding, not a criminal contempt proceeding. The bankruptcy court held the trustee liable to the bankruptcy estate rather than imposing a fine payable to the court. In so doing, the court remedied the consequences of the trustee's defiant conduct, rather than punishing the defiance per se. If this were criminal contempt, the Court of Appeals commented, it would have had little difficulty concluding that the court's contempt power reached the trustee's conduct, as 18 U.S.C.A. § 401, which governs criminal contempt in the federal courts, allows punishment of "[d]isobedience or resistance" to a court's lawful command.

Whether a court's remedial civil contempt power extends to defiance of a bankruptcy court injunction whose terms are known but have not yet been formalized as required by procedural rules was a question that the court's precedents did not appear to have addressed, the Fifth Circuit stated. Although the court's precedents had often recited the elements of civil contempt, including (1) that a court order was in effect, (2) that the order required certain conduct by the respondent, and (3) that the respondent failed to comply with the court's order, "this formulation does not reflect any holding that civil compensatory contempt is unavailable in a circumstance like the one that confronts us here."

For guidance, the Court of Appeals looked to the nature of the contempt power. Although criminal contempt is limited by statute, civil contempt remains a creature of the federal courts' inherent power. While it is to be used sparingly, the courts' civil contempt power is described in broad terms, as it is a necessary and integral part of the courts' independence and is essential to the performance of their duties.

"We see no reason why the civil contempt power, as generally recognized in our courts, should not reach [the trustee's] conduct," the Court of Appeals concluded. "[T]he power is broad and pragmatic, reaching where it must – consistent with prudent court management and due process – to prevent insults, oppression, and experimentation with disobedience of the law." The trustee's "shell game" with the sale proceeds of the trust assets was the type of conduct targeted by contempt, the court reasoned, and there was no doubt that he received adequate notice and opportunity to be heard at all stages of the proceedings. The trustee's conduct had the effect of frustrating not only the injunction, but also the trial on the merits, by diverting funds from trust entities that the bankruptcy court would later rule belonged to the bankruptcy estate. "With proper procedures, this conduct could support a criminal contempt conviction," the Court of Appeals stated, and the trustee "provide[d] no reason why the result should be different merely because the contempt finding made [his predecessor] liable to the opposing party rather than imposing a fine payable to the court." Consequently, the court held that "the civil contempt power reaches [the trustee's] conduct despite the fact that it occurred before the written injunction was in force."

The context of the contempt proceedings in bankruptcy court provided further grounds to hold the trustee's conduct subject to remedial civil contempt sanctions, the Court of Appeals explained. Bankruptcy courts, as non-Article III courts, do not necessarily possess the inherent powers of such courts. "It is widely recognized, however, that they do possess civil contempt power." The Fifth Circuit has held that the source of the bankruptcy courts' civil contempt power is statutory, namely, § 105(a) of the Bankruptcy Code, which permits the court to issue "any order, process, or judgment that is necessary or appropriate to carry out the provisions" of title 11, and which expressly states that no provision of the title shall be construed to preclude the court from, sua sponte, "taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process." The contempt order in this case was both necessary and appropriate to carry out the provisions of the Code. "[W]e consider a contempt order restoring diverted property to be necessary and appropriate to implement the bankruptcy court's ultimate injunction, and to prevent abuse of process," the court stated.

The Fifth Circuit noted that its holding should not be read to encourage the use of "oral injunctions" in bankruptcy proceedings or otherwise. The court added that the injunction might have been a "poor candidate" to be assigned to the parties for drafting. "A court facing a similar situation may wish to expeditiously draft the order itself and promptly enter an appropriate judgment," the Court of Appeals suggested. In re Bradley, 2009 WL 3757006 (C.A.5-Tex.).

Those portions of a Chapter 7 debtor's attorney's "flat fee" or "no-look" fee contracted for prepetition which have not been paid prepetition constitute prepetition obligations of the debtor which are dischargeable, even though some services were to have been provided postpetition, a Tennessee bankruptcy court has ruled, noting a split of authority on the issue and following what it characterized as the majority view. Accordingly, bankruptcy counsel may not ask for and receive post-dated checks from debtors to be cashed postpetition as payment of those fees. The court declined to follow the Ninth Circuit's decision in In re Hines, 147 F.3d 1185 (C.A.9-Cal. 1998), that the postpetition rendition of legal services bargained for pursuant to a prepetition fee agreement entitles the attorney to recover the fees for those later services because an enforceable obligation only arises once the attorney actually renders the services. The Hines court essentially ignored Congress' intention that the scope of claims in bankruptcy cases be broadly interpreted, the bankruptcy court stated. In re Waldo, 2009 WL 3460712 (Bkrtcy.E.D.Tenn., Judge Stair).

An adversary complaint filed by a Chapter 7 trustee against, inter alia, a purported notary public, in which the trustee prayed for an order declaring that the purported notary's acknowledgment of the signatures of the debtor and his wife was void, was not a "direct proceeding" against the notary within the meaning of KRS § 61.060, the Kentucky statute governing when official acts may be attacked collaterally. Therefore, the trustee had not properly attacked the notary's acknowledgment, and he was prevented from avoiding the debtor's mortgage. The trustee's complaint did not seek recovery from the purported notary by reason of her dereliction, such as a suit on her bond, the Bankruptcy Appellate Panel (BAP) reasoned. In re Pelfrey, 2009 WL 3718554 (6th Cir.BAP-Ky.).

Under Mississippi law, in a proceeding to determine the validity, extent, and priority of liens against the net sales proceeds from the Chapter 7 debtor's residence, the refinancing lender's lack of knowledge of intervening judgment liens on the property to be refinanced resulted from its "culpable negligence," a bankruptcy court held. Thus, a loan servicer, as successor to the lender, was not entitled to be equitably subrogated to the first-priority position of the bank whose deed of trust lien had been paid off by the lender. The lender had actual notice that title to the property was in the name of a third party, as custodian for the debtor's minor daughter, pursuant to the Mississippi Uniform Transfers to Minors Act (MUTMA). The fact that the residence was not titled in the debtor's name when he sought a "cash-out" refinancing that would double the existing mortgage should have raised a "red flag" for the lender to investigate further. A reasonably prudent lender would have attempted to update the title opinion before the loan closing date and after the property's transfer back to the debtor. This lender, however, did not do so. An updated title examination in the debtor's name would have revealed the liens, the court noted. In re Shavers, 2009 WL 3400958 (Bkrtcy.S.D.Miss., Judge Olack).