Patrick McConathy filed bankruptcy over 30 years ago but failed to disclose valuable mineral rights that he owned in Kansas. Decades after his bankruptcy case was closed, he filed suit in Kansas for millions of dollars asserting claims relating to the undisclosed property. Judge Hodge found that although McConathy’s lawyers were clearly aware of the need to determine whether the mineral rights had been listed in the bankruptcy schedules, they simply hauled off and filed a lawsuit seeking relief for claims that belong exclusively to the estate. The defendant in the Kansas mineral rights action, American Warrior Inc., eventually uncovered the existence of the previous bankruptcy, and sought to enforce the stay. AWI also sought $315,000 in civil contempt sanctions to compensate them for the costs incurred in defending the Kansas suit.
The Bankruptcy Court concluded that, irrespective of AWI’s standing as a party falling within the ‘zone of interest’ protected by the statutes at issue, the court is empowered under 11 U.S.C. §105(a) to fashion an appropriate remedy for an injury caused by a violation of the stay. “In addition, a bankruptcy court has the inherent power to enforce its own orders and to craft an appropriate remedy when its orders have been violated.”
In this particular case, “Debtor argues that he was acting in good faith and at all times relied upon the advice of his counsel. Debtor’s counsel assert that they too acted in good faith and in the best interests of their client and the estate by filing the lawsuit to prevent the claims from becoming time-barred under state law. From their viewpoint, there was no harm in filing the lawsuit to preserve the claims as they believed they had a right to substitute the trustee as the real party in interest if it was later determined that the bankruptcy estate owned the claims. There are several problems with these defenses. First, willfulness is not an element of civil contempt. That means good faith is not a defense to civil contempt. Second, reliance on the advice of counsel is not a defense to civil contempt. Third, the evidence shows a lack of good faith on the part of Debtor’s counsel as they made no effort to obtain copies of the bankruptcy records to determine if the automatic stay applied before they filed the lawsuit and for 16 months thereafter. Debtor testified that he bluntly told his lawyers before they filed the lawsuit that ‘these aren’t my interests.’ Thus, at the time they filed the lawsuit, counsel had reason to believe that the bankruptcy estate owned the mineral rights and the causes of action related to those rights. Yet they failed to take reasonable steps to determine if the mineral rights had been listed in the bankruptcy schedules, thereby triggering the applicability of the stay. Once a party learns of the bankruptcy filing, he or she is under a duty to seek further information which should reveal the applicability and scope of the automatic stay. The court notes that Debtor’s counsel also represented parties in the litigation who claimed to hold an unrecorded ‘net profits interest’ which, if enforceable, would have burdened the interests held by Debtor or the estate. This fact is important because had Debtor’s counsel determined that the trustee was the real party in interest who should have been substituted as a plaintiff in the litigation, they could not have represented the trustee in that action. A trustee is not permitted to employ an attorney who represents any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed. Despite this conflict (which could not have been waived by the trustee), Debtor’s counsel tried to schedule a mediation to settle all claims asserted in the lawsuit. Such actions violated the automatic stay….
“With respect to the imposition of monetary sanctions, the court will not treat Debtor and his counsel the same. The evidence shows that Debtor’s counsel engaged in most of the misconduct in this case. By contrast, Debtor told his lawyers up front that ‘these aren’t my interests.’ He thought that litigation recoveries would benefit his creditors. He relied upon the advice of counsel before he engaged in any action which violated the stay. While reliance on the advice of counsel is not a defense to contempt, the Fifth Circuit has held that it is relevant for the determination of an appropriate sanction.”
In conclusion, the Bankruptcy Court: 1) declared the claims asserted by Debtor in the Kansas lawsuit voidable, and therefore invalid and without effect; 2) granted, in part, the motion for contempt; and 3) denied the motion to annul the stay. Monetary sanctions against Debtor’s counsel would be awarded after the court determines the reasonableness of attorneys’ fees incurred by AWI.
In re Patrick McConathy, No.90-13449, 2022 WL 1612447 (W.D.La. May 20, 2022).