Bankruptcy - Seventh Circuit Urges Sanctions for Frivolous Lawsuits
The Seventh Circuit has just issued an opinion that strikes at the heart of the “liquidate and litigate” protocol that prevails in many liquidating Chapter 11 cases, where suits of dubious merit seeking inflated damages are filed against the debtors’ lenders, professional advisors, and other rich targets. In that opinion, the Seventh Circuit affirmed the dismissal of a chapter 7 trustee’s malpractice action against the debtor’s pre-bankruptcy accountants. The major significance of the opinion is not the discussion of the merits of the action, but the Seventh Circuit’s description of what makes a lawsuit frivolous and its admonishing bankruptcy courts to “be vigilant in policing the litigation judgment exercised by trustees.” The Seventh Circuit suggested that when frivolous litigation is brought, the bankruptcy court should consider imposing sanctions, such as denying attorney’s fees to the trustee or awarding the defendant attorney's fees, to be paid by the trustee personally. Maxwell v. KPMG LLP
No. 07-2819, 2008 U.S. App. LEXIS 5896, 2008WL 746849 (7th Cir. March 21, 2008). Click here
to retrieve opinion.
In Maxwell, large damages were sought. Claims against the estate totaled $57 million, but the damages sought were $626 million. The Court of Appeals noted that it was particularly
disturbed by the damages claim, not only because it was groundless, but because its size made it intimidating. Even though the magnitude of damages sought created settlement value, that value did not save the suit from being
frivolous. The Court concluded that frivolousness did not depend on whether settlement value could be created by the magnitude of the damages sought, but on the probability of the suit’s succeeding. If that probability
is low, the suit is frivolous. Without prejudging the outcome, the Court noted that the defendant in Maxwell could file a motion to recover attorneys’ fees from the trustee
personally.