On Sept. 9, in In re Schaefer Salt Recovery Inc., the 3rd U.S. Circuit Court of Appeals published a precedential opinion on two issues of first impression. The first issue was whether, in light of the Pensiero supervisory rule, sanctions may be imposed under 28 U.S.C. Section 1927 after the entry of final judgment. The second issue was whether a bankruptcy court has the power to impose sanctions under 28 U.S.C. Section 1927, an issue which the circuit courts of appeal have not uniformly decided. As discussed below, the 3rd Circuit answered both questions in the affirmative.

Factual And Procedural Background

On May 4, 2004, Schaefer Salt Recovery Inc., or SSR, was incorporated as a business entity. Eight days later, it filed a "bare-bones" petition under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of New Jersey. SSR's only assets were mortgages on three properties which were each the subject of pending tax lien foreclosure actions. By virtue of the automatic stay provisions of Section 362 of the Bankruptcy Code, the foreclosure actions were stayed. On June 10, 2004, the foreclosing creditor moved the bankruptcy court to dismiss SSR's Chapter 11 petition for cause pursuant to sections 1112(b) and 105(a), arguing that the petition was filed in bad faith, i.e., the sole purpose was to hinder, delay and frustrate the foreclosure proceedings. On July 6, 2004, the bankruptcy court granted the foreclosing creditor's motion and dismissed SSR's Chapter 11 petition. Following the dismissal, the foreclosure actions were reinstated.

On Aug. 13, 2004, on the motion of the foreclosing creditor, the state court struck SSR's answers to the foreclosure complaints, finding that the answers set forth no genuine issue of material fact and no legally sufficient defense. Immediately thereafter – on that same day, to be precise – SSR filed another bankruptcy petition, this time under Chapter 7 of the Bankruptcy Code. The foreclosing creditor moved the bankruptcy court to dismiss SSR's Chapter 7 petition for cause, this time pursuant to sections 717(a) and 105(a) of the Bankruptcy Code, and again arguing that the petition was filed in bad faith solely to hinder, delay and frustrate the foreclosure proceedings. The hearing on the motion was scheduled for Aug. 24, 2004. However, on the date of the hearing, SSR informed the bankruptcy court that SSR had consented to the dismissal of its Chapter 7 petition and saw no need to appear at the hearing. After expressing its dissatisfaction with SSR's use of the bankruptcy court as a litigation tool, the bankruptcy judge entered an order granting the creditor's motion to dismiss SSR's Chapter 7 case.

Nine days after its motion was granted, the foreclosing creditor moved under Rule 9011 of the Federal Rules of Bankruptcy Procedure and the bankruptcy court's inherent power to recover its costs and attorney fees from SSR and the individual who served as SSR's attorney and vice president. On Sept. 27, 2004, after oral argument, the bankruptcy court ordered SSR's counsel to pay the foreclosing creditor's fees and costs related to the second filing, pursuant to 28 U.S.C. Section 1927. However, on Aug. 24, 2005, the bankruptcy court reversed the award of sanctions: It concluded that the foreclosing creditor's request for sanctions was untimely under the supervisory rule adopted by the 3rd Circuit in Mary Ann Pensiero Inc. v. Lingle, which provides that all motions for Rule 11 sanctions must be filed before the entry of a final judgment where such motions arise out of conduct that occurred before the entry of final judgment. The bankruptcy court found that the Pensiero supervisory rule was a bright line rule and opined that the 3rd Circuit would likely apply it to sanctions awarded under 28 U.S.C. Section 1927.

Thereafter, the foreclosing creditor moved for reconsideration and the bankruptcy court "regretfully denied" the request, although not without expressing how fervently it wished it had the ability to sanction SSR's counsel. The foreclosing creditor appealed the denial of its motion for sanctions and its motion for reconsideration to the U.S. District Court for the District of New Jersey. After careful consideration, the district court affirmed both of the bankruptcy court's orders. The district court concluded that, although the 3rd Circuit had not yet extended the Pensiero supervisory rule to sanctions under Bankruptcy Rule 9011 or 28 U.S.C. Section 1927, it saw no reason why Bankruptcy Rule 9011 and 28 U.S.C. Section 1927 sanctions should be treated differently than sanctions under Rule 11 of the Federal Rules of Civil Procedure. The foreclosing creditor appealed the district's court's decision.

The Pensiero Supervisory Rule

The Pensiero supervisory rule is a 3rd Circuit "rule" which provides that all motions for Rule 11 sanctions must be filed before the entry of a final judgment where such motions arise out of conduct that occurred prior to final judgment. The Pensiero supervisory rule came into existence in 1988 and has since been extended by the 3rd Circuit to a court's imposition of sanctions sua sponte as well as to sanctions awarded under a court's inherent powers.

The Court's Analysis

• The Pensiero supervisory rule does not apply to 28 U.S.C. Section 1927 sanctions in bankruptcy proceedings. After a substantive discussion regarding the interplay between Rule 11 sanctions, Bankruptcy Rule 9011 sanctions and the Pensiero supervisory rule, the 3rd Circuit turned its attention to the first issue before it: whether the Pensiero supervisory rule applied to 28 U.S.C. Section 1927 sanctions. 28 U.S.C. Section 1927 provides: "Any attorney or other person admitted to conduct cases in any court of the United States or any Territory thereof who so multiplies the proceedings in any case unreasonably and vexatiously may be required by the court to satisfy personally the excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct."
  
  The court explained that, before sanctions may be imposed under Section 1927, a court must find that an attorney: has multiplied proceedings; has done so in an unreasonable and vexatious manner; has thereby increased the cost of the proceeding; and has acted in bad faith or with intentional misconduct.
  
  Both the bankruptcy court and district court believed that the appellate court would apply the Pensiero supervisory rule to sanctions under 28 U.S.C. Section 1927. However, the 3rd Circuit pointed out an important distinction between Rule 11 and Bankruptcy Rule 9011 on the one hand, and 28 U.S.C. Section 1927 on the other, which distinction "makes a difference." Unlike Rule 11, which requires scrutiny usually of an initial pleading, "Section 1927 explicitly covers only the multiplication of proceedings that prolong the litigation of a case and likely not the initial pleading, as the proceeding in a case cannot be multiplied until there is a case." As a result, the 3rd Circuit held that 28 U.S.C. Section 1927 sanctions are not untimely if sought or imposed after final judgment. However, the 3rd Circuit stressed that such sanctions must be sought within a "reasonable" time.
• Bankruptcy courts have the power to impose sanctions under 28 U.S.C. Section 1927. In Schaefer Salt Recovery, the 3rd Circuit also took the opportunity to address whether bankruptcy courts have the power to impose sanctions under 28 U.S.C. Section 1927. This was an issue of first impression, and one about which the circuit courts of appeals are split. Noting that "the answer [to the] question typically [turns] on the question of whether, in the words of § 1927, a bankruptcy court is a jurisdictionally separate 'court of the United States' or whether, for jurisdictional purposes, there is only one court — the district court — of which the bankruptcy court is an arm, a unit," the court of appeals aligned itself with those circuit courts that adhere to the latter school of thought and answered in the affirmative: a bankruptcy court is not a "court of the United States." However, the appellate court reasoned that the bankruptcy court is a unit of the district court, which is a "court of the United States." Consequently, it held that the bankruptcy court does have the authority to impose sanctions under Section 1927.

Conclusion

The Schaefer Salt Recovery case allowed the 3rd Circuit to resolve two issues of first impression. It also serves as a reminder to practitioners that they should think twice before filing an untenable bankruptcy petition or engaging in behavior which results in the unreasonable multiplication of proceedings.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. He is a member of the American Bankruptcy Institute, the American Bar Association and its business law section, the Commercial Law League of America, the Pennsylvania Bar Association and the business law section of the Philadelphia Bar Association.

Sommer L. Ross practices in the area of business reorganization and financial restructuring. Admitted to practice in Delaware, Pennsylvania and New Jersey, Ross is a 2004 graduate of Rutgers University School of Law, where she was a member of the Rutgers Law Journal, and a graduate of the University of Delaware.

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