Opinion ID: 4555771
Heading Depth: 1
Heading Rank: 3

Heading: bankruptcy court proceedings on failures to

Text: DISCLOSE In October 2017 SEPH filed a motion seeking disgorgement of Mr. Welch’s fees and the denial of future compensation for violation of his disclosure obligations under § 329(a) and Rule 2016(b). SEPH cited precedent within (and outside of) the Tenth Circuit that such strong medicine was appropriate for violations like Mr. Welch’s. SEPH also argued that it was entitled to the money received by Mr. Welch because it had a security interest in the Neverve funds or, alternatively, they were property of the estate. 9 It accused Mr. Welch of “conceal[ing] the fact that he was in possession of assets that belonged to either the Estate or to SEPH and then [] convert[ing] those assets to pay himself legal fees.” Aplt. App., Vol. 13 at 3105. SEPH also pointed out that Mr. Welch had never said that he failed to disclose “because of ignorance of the law or because of oversight.” Id. at 3106. To excuse his failure to disclose some of the payments, Mr. Welch argued that his contingency fees did not need to be disclosed because they were “earned for services not in connection with the bankruptcy case.” Id. at 3194; see 11 U.S.C. § 329(a) (requiring reporting of compensation for services in connection with the bankruptcy case). He did not otherwise seek to justify his failures to disclose even after SEPH’s accusations. Instead, he argued that he had not taken property of the estate to pay his fees. He also requested that the bankruptcy court consider the beneficial work he had done for the estate. In reply, SEPH again argued that Mr. Welch’s payments were from estate property and that in any event his violations warranted full disgorgement and denial of his fees. The bankruptcy court did not conduct a hearing on the motion for disgorgement. In its written order it found to be meritless Mr. Welch’s argument that the contingency fee was not for services rendered “in connection with” the bankruptcy case because he applied the BP funds to his bankruptcy fees. It found Mr. Welch to be in clear violation of § 329(a) and Rule 2016(b). The bankruptcy court said it was “incredulous” that such an able and experienced bankruptcy practitioner as Mr. Welch would commit such misconduct. In re Stewart, 583 B.R. 775, 784 (Bankr. W.D. Okla. 2018). It lamented 10 that the concealment of Mr. Welch’s fees, in light of the lack of candor and veracity of the debtors, 1 generated even more suspicion and mistrust in the already contentious bankruptcy proceedings. And it doubted that Mr. Welch would ever have made the requisite disclosures without being ordered to do so. The bankruptcy court recognized that Mr. Welch’s violations allowed it to order disgorgement of all his fees. But it did not choose that path. Relying in part on a case involving sanctions against attorneys under Federal Rule of Civil Procedure 11, the bankruptcy court applied “the overriding principle in applying sanctions that ‘the appropriate sanction should be the least severe sanction adequate to deter and punish’ the offender and deter future violations of the rules.” Id. at 786 (quoting White v. Gen. Motors, Inc., 908 F.2d 675, 684 (10th Cir. 1990)). Also, the court agreed with Mr. Welch that his services had benefited the bankruptcy estate. Notably, it deviated from the parties’ briefing to consider mitigating factors never raised by the parties: • “[T]o this Court’s knowledge, Welch has not been previously sanctioned.” • “It appears that he has not had much experience representing debtors in Chapter 7 in which court approval is not required for either employment or payment of counsel.” 1 For example, the Trustee brought a fraudulent-transfer proceeding to recover property given by the Stewarts to their children and to a trust for which David Stewart was the primary beneficiary. The bankruptcy court found that the transfers took place after SEPH had commenced litigation against the Stewarts and were made without consideration, that the Stewarts’ personal tax returns continued to claim losses with respect to the property, that financial statements provided to lenders continued to claim personal ownership, and that David Stewart retained control over the companies. 11 • “It may well be that Welch . . . overlooked the attorney fee disclosure requirements imposed upon counsel in all chapters of the Bankruptcy Code.” • “The Court also believes that ordering disgorgement of all fees as sought by SEPH (or even a substantial portion of such fees) would be financially catastrophic to someone as Welch engaged in a largely solo practice.” Id. at 786–87. In addition, the court expressed its view that it lacked authority to require Mr. Welch to pay funds to the debtors’ estate, which never had an interest in them, so it would have to order repayment to the entities that paid him and the entities would then likely simply repay him. The bankruptcy court ordered Mr. Welch to pay $25,000 to the Trustee for the benefit of the estate. It said that this disgorgement and the court’s public chastisement of Mr. Welch would adequately deter him from future misconduct. Unsatisfied with only a 7% reduction in Mr. Welch’s fee, SEPH moved to alter or amend the bankruptcy court’s order. It argued that the bankruptcy court’s sua sponte consideration of mitigating circumstances lacked an evidentiary basis in the record because the parties themselves had not anticipated that such mitigating circumstances would be applied. SEPH also asked the bankruptcy court to clarify whether it concluded that the BP funds were property of the estate. The bankruptcy court declined to alter the $25,000 sanction. It justified its sua sponte consideration of mitigating factors in light of the bankruptcy judge’s common sense and 30 years of experience in bankruptcy private practice. The only specific argument it addressed on that score was its agreement that Mr. Welch never raised the issue of his ability to pay. But the bankruptcy court maintained that “it was appropriate for the Court to not require specific evidence as to Welch’s net worth, but to exercise its 12 significant discretion in determining the amount of sanctions . . . subject to the principle that the sanction should not be more severe than reasonably necessary to deter repetition of the conduct by the offending person or comparable conduct by similarly situated persons.” In re Stewart, Bankr. No. 15-12215-JDL, 2018 WL 3388925, at  (Bankr. W.D. Okla. July 10, 2018). Although the bankruptcy court had appeared to say in its initial order that the BP proceeds were not property of the estate, it clarified that it had not decided the issue. SEPH appealed to the BAP, which affirmed the $25,000 sanction and the denial of SEPH’s motion to alter or amend as within the bankruptcy court’s discretion. See SE Prop. Holdings, LLC v. Stewart (In re Stewart), 600 B.R. 425, 436 (B.A.P. 10th Cir. 2019). It stated that the sanction fell under the bankruptcy court’s inherent power and should be exercised with restraint. Although it acknowledged that the Tenth Circuit had not previously recognized the mitigating factors relied on by the bankruptcy court, the BAP saw no problem with the bankruptcy court’s considering them in deciding on its sanction. It did not address SEPH’s argument that the bankruptcy court’s sua sponte assessment of mitigating factors was without evidentiary basis.