John J. Thomas, Bankruptcy Judge.
A request by Debtors/Defendants, Christopher and Michele Paige, has been made for sanctions against Lerner Master Fund, LLC, (LMF), attorneys under the provisions of 28 U.S.C. § 1927, which reads:
28 U.S.C.A. § 1927
This sanction should only be used in instances of serious disregard of the judicial process. In re Prosser, 777 F.3d 154, 161 (3rd Cir. 2015).
A bankruptcy court is authorized to issue sanctions under § 1927. Id.
The Paiges have suggested that virtually every document filed by LMF's counsel was designed to harass the Debtors. The original Complaint filed by LMF objected to the discharge of the Debtors and also the dischargeability of a debt allegedly owing LMF from the Paiges. To impose § 1927 sanctions, a court must find counsel to have "(1) multiplied proceedings; (2) in an unreasonable and vexatious manner; (3) thereby increasing the cost of the proceedings; and (4) doing so in bad faith or by intentional misconduct." In re Prudential Ins. Co. Am. Sales Practice Litig. Agent Actions, 278 F.3d 175, 188 (3rd Cir. 2002). A strong indication of bad faith is whether the claims advanced were meritless, whether counsel should have known this, and whether the purpose of the litigation was harassment. Id.
I have, heretofore, preliminarily ruled in favor of the Paiges on the merits of the underlying Complaint. Attached hereto and incorporated herein as an Appendix is my Opinion
LMF filed proofs of claim in this case against each of the Paiges for an unsecured amount in excess of $6,500,000. See Proofs of Claim Nos. 2 and 3. It was those claims which LMF sought a finding of nondischargeabilty. In the case of Michele Paige, there existed an underlying state court judgment in the amount of $6,568,400. See Proof of Claim No. 2 at Exhibit A (Order of Court filed August 26, 2011, C.A. No. 5502-CS). In the matter of Christopher Paige, an explanatory note from the Delaware State Court preceding the entry of final judgment strongly hints of a finding of liability against Christopher Paige but for pleading shortcomings. See Proof of Claim No. 3 at Exhibit B (Letter dated August 24, 2011).
If the claim was meritorious, it could not be frivolous. The minimum standard for a meritorious claim can be found in Federal Rules of Bankruptcy Procedure 9011(b)(2)and (3).
Fed. R. Bankr. P. 9011.
Since the Complaint and the Amended Complaint survived Motions to Dismiss under Federal Rule of Bankruptcy Procedure 7012, I can assume that the allegations of the Complaints were at least likely to have evidentiary support after a reasonable opportunity for further investigation or discovery, unless counsel had no reason to make those allegations in the first instance.
The Delaware Court found Michele Paige liable for a breach of the fiduciary duty she owed LMF. Paige Capital Mgmt., LLC v. Lerner Master Fund, LLC, 2011 WL 3505355 at 43 (Del. Ch. Aug. 8, 2011). In an earlier Opinion issued in this case on the issue of liability, I wrote:
In re Paige, No. 5-12-ap-00067-JJT, Slip Copy, 2016 WL 959018 at 6 (Bankr. M.D. Pa. Mar. 11, 2016).
It is clear that, at the time of the initial Complaint, LMF had quite sufficient reason to argue that Michele Paige should not be discharged from her obligation to LMF. The Bullock Opinion certainly increased the burdens placed on LMF so as to prevail under 11 U.S.C. § 523(a)(4), but that is not to say that Bullock eliminated the reasonableness of LMF's action under that subsection. The degree with which a fiduciary deviates from their responsibility before the fiduciary commits a nondischargeable act is still a rather vague standard and may be considered even more problematic after the United States Supreme Court decision in Husky Int'l Elecs., Inc. v. Ritz, ___ U.S. ___, 136 S.Ct. 1581, 194 L.Ed.2d 655 (2016), which appears to have expanded the term "actual fraud" as used in § 523(a)(2) on nondischargeabilty so as not to require a false representation.
Addressing allegations in the Amended Complaint that the Paiges' dischargeability should be denied as a willful and malicious injury under § 523(a)(6), what appears to have been alleged is that the Paiges drained funds from the invested accounts with actual knowledge of their wrongdoing. While this was never established at trial, the specific question critical here was whether this allegation was "likely to have evidentiary support after a reasonable opportunity for further investigation or discovery." There was, in fact, testimony from Christopher Paige that raised significant concerns. Among the various roles he played in the Paiges' enterprises was as a financial manager, and his testimony indicated that business funds were used to pay personal expenses. I referenced these events as "sloppy bookkeeping" in my earlier Opinion. In re Paige, No. 5-12-ap-00067-JJT, Slip Copy, 2016 WL 959018 at 5 (Bankr. M.D. Pa. Mar. 11, 2016). While I found no improper motivation for the failure to honor corporate formalities, the commingling of business and personal expenses was a serious compromise of accepted business practice.
The Delaware Opinion made clear that Michele and Christopher operated as a team in this hedge fund enterprise. It was certainly conceivable that LMF might have been able to fashion some sort of feasible argument supporting liability by both Paiges either on a conspiracy theory, (Gilbert v. El Paso Co., 490 A.2d 1050, 1058 (Del.Ch. 1984), or a participation theory, (Walsh v. Alarm Sec. Grp., Inc., 95 Fed.Appx. 399 (3rd Cir. 2004) (not precedential)).
Just as in the Delaware case, the Paiges argued before me that LMF had a "personal antipathy to injure Michele Paige." The Delaware Chancellor found no support for that argument despite a chain of tasteless emails among LMF associates. Paige Capital Mgmt., LLC v. Lerner Master Fund, LLC, 2011 WL 3505355 at 6-7 (Del. Ch. Aug. 8, 2011). I, too, cannot find evidence in this trial of a personal antipathy against the Paiges.
I recognize that filings in both the main case and the adversary may be relevant. In re Prosser, 777 F.3d at 162. I wish to focus on the adversary action. Statistically there were numerous filings by both Plaintiff and Defendants. Generally, the Paiges filed approximately four times as many documents as LMF.
Rule 9011 requires parties and their counsel to comply with certain standards when filing documents. Those requirements are set forth in Federal Rule of Bankruptcy Procedure 9011(b), as follows:
"The imposition of Rule 11 sanctions
The Paiges argue that the allegations made in the Amended Complaint have no basis in fact or law and that counsel violated Rule 9011 by filing and later pursuing that Complaint against them.
I again turn to the lengthy Delaware State Court Opinion which outlines an intricate strategy by the Paige enterprises to prevent LMF from accessing its funds. The fact that the evidentiary record of the proceeding before me did not support the conclusion that any debts owing LMF were nondischargeable is of no moment since, a failure to prevail does not "trigger" a Rule 11 violation. Gaiardo v. Ethyl Corp., 835 F.2d 479, 483 (3rd Cir. 1987). The allegations in the Amended Complaint appeared likely to have evidentiary support when filed and later advocated.
It is clear that this was not a case where a creditor lost in state court and then attempted to pursue a claim in bankruptcy court. Landon v. Hunt, 977 F.2d 829 (3rd Cir. 1992). LMF successfully prosecuted its claim against Michele Paige and was strongly encouraged by the Delaware Court to pursue a claim against Christopher Paige should its judgment not be
The Paiges would also have me utilize the inherent power of this Court to sanction LMF and its counsel arguing that the record is replete with evidence of bad faith. The inherent power of the court is typically utilized when other sanctioning authorities do not cover the conduct at issue. Chambers v. NASCO, Inc., 501 U.S. 32, 50, 111 S.Ct. 2123, 2135, 115 L.Ed.2d 27 (1991).
The inherent power of the court must be exercised with great restraint and discretion. Chambers v. NASCO, Inc., 501 U.S. at 44, 111 S.Ct. 2123. It oftentimes is used to address the disruption of court proceedings. Illinois v. Allen, 397 U.S. 337, 90 S.Ct. 1057, 25 L.Ed.2d 353 (1970). That would not apply here where LMF counsel has, at all times, acted professionally in court proceedings.
To the extent that the Paiges maintain that advancing the Amended Complaint requires the imposition of sanctions under the Court's inherent power, that request must be denied since I have heretofore concluded that the Complaint did not violate the Rule 9011 standard of objective reasonableness and, therefore, by definition was not in bad faith. Gillette Foods, Inc. v. Bayernwald-Fruchteverwertung, GmbH, 977 F.2d 809, 814 (3rd Cir. 1992). If the Paiges are relying on LMF's trial conduct as a basis for the Court exercising its inherent authority, that too would fall short since, as indicated, LMF counsels' behavior through the course of the proceedings was quite restrained.
I believe the essence of the Paiges' argument supporting this claim is that LMF advanced the Complaint with as weak a case as it manifested at trial. That argument returns me back to 28 U.S.C. § 1927 which addresses vexatious proceedings, but not weak cases. "Sanctions under Section 1927 are appropriate for attorneys who engage in serious and studied disregard for the orderly process of justice and not simply those who bring weak cases." Tr. of Bankr. Estate of Monique Faulkner v. Dowson Holding Co., 859 F.Supp.2d 722, 725 (D.V.I. 2012), citing Ford v. Temple Hosp., 790 F.2d 342, 347 (3rd Cir. 1986).
It is for these reasons that the sanction requests of the Debtors-Defendants must be denied.
My Order will follow.
For those reasons indicated in the Opinions filed this date and on March 11, 2016, (Doc. #303), on the issue of liability,
On the issue of sanctions,
Attorneys and Law Firms
Christopher Howard Paige, Skytop, PA, pro se.
Michele Anna Paige, Skytop, PA, pro se.
*1 Lerner Master Fund, LLC, (hereinafter "LMF"), has filed a multi-count Amended Complaint, (Doc. # 81), against the joint Debtors, Christopher and Michele Paige, (hereinafter "Debtors"). The seven Count Complaint advances the following causes of action:
Count I: § 523(a)(4) Dischargeability exception against Michele Paige;
Count II: § 523(a)(6) Dischargeability exception against Michele Paige;
Count III: § 523(a)(4) Dischargeability exception against Christopher Paige;
Count IV: § 523(a)(6) Dischargeability exception against Christopher Paige;
Count V: § 727(a)(2)(A) Objection to Discharge of All Debts of Christopher and Michele Paige;
Count VI: § 727(a)(3) Objection to Discharge of All Debts of Christopher and Michele Paige;
Count VII: § 727(a)(5) Objection to Discharge of All Debts of Christopher and Michele Paige.
After ten days of trial, LMF has rested. The Debtors have countered with a Motion under Rule 52 seeking judgment in their favor on partial findings. In advancing its case, LMF has called both Debtors and the female Debtor's sister as their only witnesses.
This Court will initially focus its attention on Counts V, VI, and VII. Those Counts allege that discharge should be denied under
(a) The court shall grant the debtor a discharge, unless —
(2) the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed —
(A) property of the debtor, within one year before the date of the filing of the petition;
. . .
(3) the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case;
. . .
(5) the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities;
*2 The discharge is central to Chapter 7 bankruptcy relief. As such it should be construed liberally in favor of the debtor. Rosen v. Bezner, 996 F.2d 1527, 1531 (3rd Cir. 1993).
The operative facts of this complex relationship between the parties are known to the parties and will only be summarized in a cursory fashion for the benefit of the readers. Findings of fact pivotal to the outcome will be identified.
Both Debtors are highly educated individuals. Michele Paige has secured an undergraduate degree from Brown University where she graduated magna cum laude, a post graduate Masters degree from Harvard, and a law degree from Yale. Tr. # 287 at 38-39. She was also an instructor at both Yale Law School and Yale School of Management. Tr. # 274 at 153 and Tr. # 287 at 41. In addition, she has clerked for a Federal Circuit Judge. Tr. # 250 at 16. Christopher Paige has earned an undergraduate degree from the University of Virginia, a Masters degree from New York University, and a law degree from Yale. Tr. # 261 at 7 and Tr. # 287 at 44. Michele's unique talents allowed her a certain success as a hedge fund manager which provided the opportunity to establish her own hedge fund entities.
The relationship between Michele and LMF eventually soured, with LMF expressing a desire to withdraw from the fund. The parties appear to agree that withdrawal was not possible until the conclusion of a three year "lock-up" contract provision expired. After that three year period, a "gate" provision in the governing instruments ostensibly limited LMF's annual withdrawal to 20% per year. A contest over the applicability of that provision spilled over into the Delaware Chancery Court which found that enforcing the gate provision was a breach of fiduciary responsibility on behalf of Michele.
*3 While the Debtors were initially represented by counsel, their relationship with counsel deteriorated, and, on February 13, 2012, they dismissed their lawyer and elected to proceed pro se. Doc. # 70. Although without any bankruptcy law experience, they have resolutely been proactive in this case utilizing their innate intelligence as well as their legal acumen in defending the Complaint. Their defense has included multiple and repetitive pleadings and objections presumably advanced to prevent any possible "waiver" of their rights to appellate review should the outcome be less than favorable to them. The trial was marked by a constant stream of interruptions by Michele Paige, some of which were legitimate objections, but most appeared to emanate from a desire to supplement the witness's testimony at inappropriate times. The Debtors exercised every opportunity to inject sarcasm into their comments, clearly venting their conclusion that the proceeding was a vindictive assault on their integrity. While the Debtors were manifestly indignant, I cannot find that they acted with an intent to be vexatious. Nevertheless, the trial stands as a testament to the deficiencies of representing oneself.
LMF's case consisted solely of certain findings made by the Delaware Chancery Court in connection with the judgment issued August 25, 2011, the testimony of the Debtors, Christopher and Michele Paige, and the testimony of Michele's sister, Jessica Paige. Completing its case was the admission of various exhibits, including Debtors' response to certain interrogatories. See Exhibit B to Doc. # 275.
I have heretofore concluded that Michele is collaterally estopped from challenging certain findings of the Delaware Chancery Court. Doc. # 16. My conclusions were made in response to a Bankruptcy Rule 7016 Motion filed by LMF and can be found at transcript found at Doc. # 66. At the time of the hearing, I emphasized that the Delaware Court's reference to "the Paiges" was subject to further dispute between the parties since the Delaware Court was sometimes inconsistent in its use. Doc. # 66 at 57.
The Plaintiff, LMF, has the burden of proof.
In re Kisberg, 150 B.R. 354, 356 (Bankr.M.D.Pa.1992).
In Count V, LMF makes the very specific allegation under
During the operation of the hedge funds, the Debtors had one personal account that they maintained jointly at Bank of America. Tr. # 260 at 96-97. The testimony was that if personal funds went into one of the Debtors' corporations, and was transferred from their personal funds, the source may have come from Michele's parents, a gift, or Michele's 401(k) account. Tr. 260 at 99-100. Inquiry into the timing of these transfers was rather vague but presumably occurred between the inception of the hedge fund operation and the Debtors' bankruptcy, a period from October 31, 2007 to August 29, 2011. Tr. # 260 at 104. Christopher Paige further testified that both business and personal expenses were paid from a corporate account and then reconciled at the end of the year with the help of their tax professionals. Tr. # 272 at 155-156. Transfers from one account to another were preceded by memorandums delivered to the prime broker and copied to the administrator.
*4 I am uncertain as to what funds were transferred to the Debtors during the year before their bankruptcy. The records have not been that specific. The Debtors, in their testimony, certainly did not acknowledge making any attempt to defraud creditors by moving assets. LMF's suggestion in its pretrial submission is that I seek "badges of fraud," but I simply came up empty.
In considering the disposition of the current
In order to survive the
*5
There were withdrawals culled from the Debtors' personal account admitted at trial. Those withdrawals in the form of check disbursements amounted to between $250,000 and $300,000 for the one year prior to bankruptcy. Exhibit # 62. Nevertheless, at the salary level of Michele, together with the unidentified income level of Christopher, expenses of that nature are hardly notable. LMF, in filings after the
I will move to consideration of LMF's claim under
*6 Turning to the second requirement that the lack of records makes it "impossible" to ascertain Debtors' financial condition and material business transactions, I observe there was no testimony to that effect. The Chapter 7 trustee did not testify and neither did any individual who had access to the records. No testimony was offered by the outside auditor charged with reviewing records of the hedge funds. No testimony was offered by the document storage company to whom all corporate records were delivered during the Delaware litigation. No testimony was offered by LMF to whom access was granted during the Delaware litigation. LMF simply has not met its burden in this regard and must fail on this Count.
Directing the parties' attention to Count VII which alleges that the Debtors have failed to explain satisfactorily a loss of assets or a deficiency of assets to meet their liabilities, I assume that the "asset" in question was the difference in the $40 million deposited by LMF in the hedge funds and the funds that were returned to LMF pursuant to the Delaware judgment. See Delaware Opinion. Despite the fact that the Debtors were on the stand for a combined ten days, I do not believe the question was ever specifically asked of them. Testimony was advanced that the monies in Michele's hedge fund corporations were directed either to the "tenant as a security deposit"
LMF fails to offer sufficient evidence to prevail on this Count. The Debtors are, therefore, entitled to their general discharge subject, however, to the disposition of the remaining Counts of this Complaint.
I turn my attention to those Counts objecting to the dischargeability of the debt against the Debtors. Counts I through IV allege that under § 523(a)(4) and (6), both Debtors should not be discharged for their alleged obligations to LMF. While the general liability of Michele Paige to LMF has been adjudicated by the Delaware Court, Christopher's liability has not been adjudicated. The theory advanced by LMF to hold Christopher liable is unique inasmuch as it rests on an allegation of "aiding and abetting" to commit a breach of fiduciary duty apparently recognized by the Delaware Court of Chancery in Weinberger v. Rio Grande Indus., Inc., Del.Ch., 519 A.2d 116, 131 (1986). The allegation as to grounds under § 523(a)(4) against both Debtors (Counts I and III) has taken an interesting turn. That Section reads: "(a) A discharge under
When the original Complaint was filed in 2012, the courts were split as to the degree of culpability implicit in the term "defalcation." To some courts, a simple breach of fiduciary responsibility was sufficient. In re Sherman, 658 F.3d 1009, 1017 (9th Cir. 2011), In re Uwimana, 274 F.3d 806, 811 (4th Cir. 2001). Other courts concluded that there be a degree of scienter or recklessness present before one would lose the ability to discharge the debt. In re Bullock 670 F.3d 1160, 1162 (11th Cir. 2012), In re Baylis, 313 F.3d 9, 20 (1st Cir. 2002). In May of 2013, that issue was resolved when the United States Supreme Court decided Bullock v. BankChampaign, N.A., ___ U.S. ___, 133 S.Ct. 1754, 1757, 185 L.Ed.2d 922 (2013). The Supreme Court concluded that in order for a fiduciary to lose his or her right to discharge an obligation, there must be more than mere negligence or "innocent default." The Court required either an actual knowledge of wrongdoing or its equivalent or a reckless and conscious disregard that conduct will violate a fiduciary duty.
*7 Initially, it was not all that clear at the onset of the Delaware litigation between these entities that either Debtor was a fiduciary. Funds were held by various corporate and partnership entities presumably insulating the owner/manager from personal liability. It was only at the conclusion of the Delaware litigation when Michele Paige was found to have breached a fiduciary duty and the relationship between Michele and LMF was defined. I further find that there is no evidence either Debtor had a conscious understanding that their activities under the various contracts that bound the parties was wrongful. At best, the Delaware ruling could be interpreted such that Michele Paige conducted the hedge fund in a way to maximize her own self interest. Bullock, however, stands for the proposition that simple self dealing is not sufficient to support a loss of dischargeability under § 523(a)(4).
Michele as manager of the fund and Christopher as, at best, a key person, were strongly influenced to enforce the literal terms of the contracts between the parties, albeit for Michele's own benefit and not the fund. This is not a case where a fiduciary of superior knowledge, skill, and background bamboozled an investor with limited knowledge or resources.
This is where LMF has come up short. Michele's refusal to turn over the total fund to LMF at the end of a three year lock up was primarily motivated by her rather selfish desire that the hedge funds not be dissipated. While the fund remained under her control, she would continue to utilize it to fund expenses including her own income. This was the essential reason why the Delaware Court held her liable for breach of fiduciary responsibility. It was apparent, however, that Michele was not motivated by some malicious motive such as theft of funds, fraud on the principal, or some false pretense. She, rightly or wrongly, relied on a contractual provision allowing her company to "gate" the withdrawal so that only 20% of the investment could be withdrawn each year. This procedure has been recognized as a device to protect fund managers, not the investors. Tr. # 261 at 154. It so happens that LMF was by far the only significant investor and by acting in her own self interest and not that of the client, the Delaware Court found that Michele Paige breached her fiduciary responsibility. Nevertheless, on advice of counsel, both Christopher and an outside
It has been said that adherence to a contract does not violate a duty of good faith. See, for example, Creeger Brick & Bldg. Supply Inc. v. Mid-State Bank & Trust Co., 385 Pa.Super. 30, 560 A.2d 151, 154 (1989). Furthermore, a review of the rather detailed Delaware Court decision reinforces the conclusion that the issues litigated between the parties were certainly intense and acrimonious, but they turned on contractual provisions and not reckless or fraudulent conduct.
It should go without saying that unless Count I could be established against Michele Paige, then Count III alleging that Christopher "aided and abetted" her would also come up short. I find that LMF has failed to meet its burden of proof.
Turning to Counts II and IV alleging willful and malicious injury to LMF, I find that LMF failed to present evidence to support that argument. There is no lack of case law interpreting the meaning of § 523(a)(6). Debts arising from professional malpractice will not be considered "willful and malicious." Kawaauhau v. Geiger, 523 U.S. 57, 61, 118 S.Ct. 974, 977, 140 L.Ed.2d 90 (1998);
*8 Succinctly, LMF has simply not met its burden of proof in this Complaint, and a ruling is required in favor of the Debtors.
Inasmuch as there remains related sanction issues, I will defer entering a final judgment in favor of the Debtors until such time as those sanctions issues are disposed so that the appeal times may run concurrently.
All Citations
Slip Copy, 2016 WL 959018.