Before: JONES, NORRIS, and MOORE, Circuit Judges.
NATHANIEL R. JONES, Circuit Judge.
ELECTRONIC CITATION: 1996 FED App. 0393P (6th Cir.)
On Appeal from the United States District Court for the Western District of Kentucky
Decided and Filed December 19, 1996
This is a bankruptcy case. During the course of Chapter 11 proceedings, the bankruptcy court imposed sanctions against the debtors' attorney, Charles Friedman, and his firm, Mapother and Mapother ("Mapother"), for failure to disclose Friedman's fee arrangement in accordance with the Bankruptcy Code and Rules of Bankruptcy Procedure. The bankruptcy court further denied the motion of the trustee and Southern American Insurance Company ("SAIC") to sanction Friedman under Federal Rule of Bankruptcy Procedure 9011 for filing a motion to convert the debtors' petition to a Chapter 7 petition. The district court affirmed the bankruptcy court in all respects. We affirm in part and reverse in part the decision of the district court.
This case has a long and intricate history, so we will recite only the facts pertinent to the immediate appeals. Hardscrabble Farms, Inc., a dairy farm owned by debtor Joseph P. Downs, filed a Chapter 11 reorganization petition in 1986, listing approximately $3.3 million of indebtedness. In an attempt to reorganize, Hardscrabble entered into a loan with SAIC. Mr. Downs eventually defaulted on the loan payments, causing the fiduciary relationship between Hardscrabble and SAIC to fall apart.
After the attempt to reorganize Hardscrabble failed, Downs and his wife, Helen P. Downs, filed a Chapter 7 bankruptcy liquidation petition on July 17, 1990. The Downses' petition listed 100% stock ownership in Hardscrabble, valued at zero, as an asset. The petition also listed as an asset the Downses' pending lender liability suit against SAIC in Nelson County Circuit Court. Hardscrabble Farms, Inc., et al. v. Southern American Ins. Co., Case No. 89-0608l(A) (Nelson County Kentucky Circuit Court filed July 25, 1989). Attorney August Klapheke represented the Downses in the Chapter 11 proceedings. The Downses pledged full ownership of the Hardscrabble stock to Klapheke as consideration for his services. Despite the fact that he held a security interest in the stock, Klapheke proceeded to solicit bids for purchase of the stock. Eventually, an entity known as P & Y submitted a bid. After learning of Klapheke's interest, however, the bid was withdrawn. Thereafter, SAIC offered to purchase the stock in settlement of the Downses' state court claim. The Trustee filed motions in the bankruptcy court to determine the status of Klapheke's security interest in the stock, to sell the stock, and to settle Downses' claims against SAIC.
In April 1991, Klapheke became incapacitated by what was later discovered to be a brain tumor. As a result, the president of Heaven Hill, Inc., a creditor of the Downses and Hardscrabble Farms, contacted Friedman and asked him to replace Klapheke as the Downses' counsel. Friedman agreed, and Mr. Downs paid Friedman a $40,000 retainer. Mr. Downs had received this money from Bourbon-Aid Feed, a company owned by his children. Bourbon-Aid, however, had acquired the money from Heaven Hill.
On June 17, 1991, Friedman entered an appearance on behalf of the Downses at the hearing on the Trustee's settlement motions. At the hearing, Friedman moved to convert the Chapter 7 case to a Chapter 11 reorganization case pursuant to 11 U.S.C. Section(s) 706, and posted a $16,500 appeal bond with the bankruptcy court. In August 1991, Friedman received an additional $6,000 from Bourbon-Aid Feed.
On August 20, 1991, the bankruptcy court granted the Trustee's settlement motion. Furthermore, the bankruptcy court denied the Downses' motion to convert, reasoning that reorganization was impossible. In so doing, the bankruptcy court concluded that the Downses' motion was filed in bad faith, in light of the fact that the debtors' bankruptcy had been pending for over one year and the motion to convert was filed on the "very eve, on the very day, almost a moment before the trustee was going to consummate a sale that the Court had been contemplating and working with for over six months." J.A. at 175 (Transcript of Hearing of 8/20/91). The court also noted that the motion was filed "solely for the purpose of delaying the sale." Id. The Downses appealed, and the district court reversed and remanded the case to the bankruptcy court to determine "[w]hether the Downs[es] can propose a viable reorganization plan and have the ability to proceed under Chapter 11. . . ." J.A. at 351. In addition, the district court ordered that the Downses and/or Friedman be sanctioned if it appeared that their motion was in bad faith and there was no viable Chapter 11 plan.
On remand, the bankruptcy court held a four-day evidentiary hearing. In a June 3, 1992, Memorandum Opinion, the bankruptcy court found that "from the evidence concerning the financial condition of the Downs [sic] and [Hardscrabble] and Mr. Downs' admission that no plan had been reviewed, evaluated, or formulated until well after the initial conversion motion was filed, that the motion to convert this case to Chapter 11 was filed in objective bad faith and that on this ground the motion to convert should be denied." J.A. at 217. Furthermore, the bankruptcy court directed the Downses and Friedman to disclose all information relating to the retainer. Id. at 218. Accordingly, Friedman filed a statement with the bankruptcy court on June 11, 1992, wherein he disclosed his fee arrangement with Heaven Hill and Bourbon-Aid Feed. J.A. at 856-59.
On August 28, 1992, SAIC filed a Motion for Sanctions, pursuant to Rule 9011 of the Rules of Bankruptcy Procedure, against the Downses and Friedman on grounds that the Section(s) 706 Motion was filed in bad faith. The Trustee subsequently joined SAIC's Motion, alleging that 1) Friedman had failed to disclose his fee arrangement with Heaven Hill under Bankruptcy Rule Section(s) 2016, and 2) Friedman had failed to disclose a potential conflict of interest arising out of his Chapter 7 representation of the Downses in violation of 11 U.S.C. Section(s) 101(14). Friedman responded with 1) a Motion for Sanctions against the Trustee for failure to notify the ...