Sixth Circuit Holds that Section 303(i) Authorizes Reimbursement of Costs and Fees Incurred in Collateral Proceedings, but Bankruptcy Courts Lack Authority to Impose “Serious” Noncompensatory Punitive Damages
The U.S. Court of Appeals for the Sixth Circuit recently held that bankruptcy courts lack general statutory power to impose noncompensatory punitive damages that are considered “serious.” In Adell v. John Richards Homes Building Co., L.L.C.1, the Court specifically considered: (1) whether bankruptcy courts are permitted to award fees that were incurred in collateral proceedings after dismissal of the underlying involuntary petition, and (2) whether a bankruptcy court had the authority to impose multi-million dollar noncompensatory punitive damages.
Kevin Adell and John Richards Home Building Co. (JRH) were involved in litigation throughout various courts around the country for years with each party making claims against the other. The initial dispute arose out of a contract entered into between the parties in 2001, under which JRH was to build a home for Adell in Michigan.
Adell proceeded to initiate litigation in state court. Then, while the state court proceedings were active, Adell filed an involuntary bankruptcy petition against JRH, asserting a claim for $800,000. JRH responded with the defense that the “claim” was not undisputed and also filed a request for fees, costs and damages under § 303(i). The Court sided with JRH and dismissed the involuntary petition because a bona fide dispute remained as to the petitioning creditor’s claim against the alleged debtor – in other words, it was unclear which party breached the contract, and/or who breached first. Having rejected the sole petitioning creditor, the bankruptcy court ruled that it could not permit the joinder of other putative creditors. After discovery, the bankruptcy court granted JRH’s § 303(i) motion, finding that Adell filed the involuntary petition in bad faith and entering a $6.4 million judgment in favor of Adell including punitive damages of $2 million.
While Adell appealed the bankruptcy court’s decision, he liquidated his assets in Michigan and purchased a $2.8 million dollar home in Florida. Later, it became apparent that this maneuver was undertaken in order to avail himself of the unlimited homestead exemption in Florida. Adell also went on to file for bankruptcy in Florida in 2003 – imposing another hurdle on JRH’s ability to collect on its $6.4 million judgment. Litigation went on for years until the U.S. Court of Appeals for the Sixth Circuit eventually affirmed the Michigan bankruptcy court’s judgment against Adell, and Adell then paid the $6.4 million judgment in full on April 3, 2006.
JRH then filed two motions in the Eastern District of Michigan Bankruptcy Court for: (i) additional punitive damages, and (ii) a second application for compensation of attorneys’ fees and expenses (the $2 million in fees were allegedly incurred during the time between the award of the $6.4 million judgment and the time Adell finally paid in satisfaction of the judgment). The bankruptcy court initially denied the application, based on split authority surrounding the issue of whether § 303(i) authorizes a bankruptcy court to award fees and costs beyond those directly incurred in defending the involuntary petition. The District Court for the Eastern District of Michigan reversed, and upon remand, the bankruptcy court granted approximately $1.8 million in additional attorneys’ fees and costs and $2.8 million in additional punitive damages.
The initial question which was presented to the U.S. Court of Appeals for the Sixth Circuit was: “does § 303(i) permit a bankruptcy court to award costs and attorneys’ fees when those fees were incurred in collateral proceedings after dismissal of the underlying involuntary petition?” The Sixth Circuit relied heavily on the analogous case of In re Landmark Distrib., Inc.2, and upon legislative intent, to support its holding that § 303(i) authorizes bankruptcy courts to award fees and costs for services rendered after an involuntary petition has been dismissed. Adell argued that it is each court’s prerogative to regulate their own proceedings and, therefore, that the award of fees and damages by the bankruptcy court for litigation that occurred in other courts was improper.
The underlying theme cited by the court in upholding the award of attorneys’ fees and costs is that the fee-shifting provision of § 303(i) is meant to hold losing creditors liable for costs imposed upon debtors by virtue of the burden to defend an involuntary petition, which is created by the creditor who files the involuntary petition.
The second question the Sixth Circuit faced was whether the bankruptcy court’s award of punitive damages was proper and/or authorized. The record supported findings that Adell committed perjury on several occasions, undertook sophisticated financial moves to evade the collection of his debts and abused the bankruptcy process in more than one respect.
The Sixth Circuit discussed that Federal Courts have held that under § 105(a), bankruptcy courts may impose a variety of sanctions in response to litigants’ wrongful conduct before the court. Sanctions are an effective method for the court to regulate conduct during litigation. The Sixth Circuit went on to discuss the universal acceptance of these precepts, which encompass bankruptcy courts’ power to award punitive damages. The concern raised by the Sixth Circuit, was what limit, if any, restricts this authority.
The ultimate line drawn by the Sixth Circuit can be stated as follows: while bankruptcy courts have the inherent power, under § 105(a), to use punitive sanction powers, those powers are limited to only what is necessary or appropriate to enforce the Bankruptcy Code, and as a result, the Sixth Circuit held that bankruptcy courts lack general statutory power to impose noncompensatory punitive damages that are considered “serious.” The Sixth Circuit declined to define “serious,” because $2.8 million is “serious under any definition.” No discussion was given to the initial $2 million in punitive damages, awarded as a part of the first judgment of $6.4 million, perhaps because the issue was not specifically raised in the appeal of that judgment.
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1 Adell v. John Richards Homes Building Co., L.L.C., Nos. 12-2012, 12-2013, 12-2014 and 12-2015, at 8 (6th Cir. Nov. 20, 2013) (unpublished).
2 In re Landmark Distrib., Inc., 195 B.R. 837, 846 (Bankr. D. N.J. 1996).