Metropolitan News-Enterprise


Tuesday, September 11, 2018


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Bankruptcy Appellate Panel:

Suspension of California Attorney Did Not Contravene Ban on Punishing Nonpayment of Dischargeable Debt


By a MetNews Staff Writer


The Ninth U.S. Court of Appeals’s Bankruptcy Appellate Panel has affirmed a determination that there was no affront to federal law when an attorney was suspended from practice in California courts based, in part, on his delay in refunding unearned fees where his debt to the ex-clients was one that was dischargeable in bankruptcy.

In a separate decision, rendered on Friday, the panel declared that the chief bankruptcy judge for the Central District of California used the wrong legal standard in imposing contempt sanctions exceeding $400,000 on a company that foreclosed on real property notwithstanding a bankruptcy stay. It held that such a penalty was improper absent clear and convincing evidence of an intentional violation.

The decision in the disciplinary case came Wednesday in a memorandum opinion in response to an appeal by suspended California attorney Michael Bruce Stone. Stone, who declared bankruptcy in 2012, is relying on the Ninth Circuit’s 2016 opinion in Scheer v. State Bar for the proposition that a debt to former clients based on retention of unearned fees is dischargeable in bankruptcy, and on a statute saying that a license may not be withheld based on nonpayment of a dischargeable debt.

Three Disciplinary Proceedings

In connection with the first of three State Bar disciplinary actions against him, Stone in 2011 agreed, in a stipulation, to return unearned fees. The following year, he declared bankruptcy—not mentioning the fees in his petition—and received a discharge that year.

New disciplinary charges were brought in 2013, in part being based on his failure to make restitution. It was stipulated that he would be suspended for two years, with the suspension stayed, a condition of which was his actual suspension for 90 days—and a further proviso being that he return the unearned fees and attest, in a declaration, to having done so.

The California Supreme Court ordered entry of judgment in conformity with the stipulation, declaring that Stone must pay up and file his declaration, warning: “Failure to do so may result in disbarment or suspension.”

Compliance was due by Oct. 31, 2013. Stone did not comply by the deadline.

By Feb. 20, 2014, he had made repayments of the unearned fees (to ex-clients or to the State Bar’s Client Security Fund), but on Feb. 21 of that year, the third set of charges was filed based on his delay in complying. The State Bar Court determined that he should be actually suspended for two years or until he proved he had been rehabilitated; the Review Department affirmed.

Intervening Case Law

Stone’s suspension was set to take effect on July 8, 2016. But then came the April 14, 2016 decision in Scheer.

There, Circuit Judge John Owens, writing for a three-judge panel, said that appellant Marilyn Scheer’s “performance as an attorney leaves much to be desired, and it is unsettling that she can use bankruptcy to avoid refunding her client’s improperly collected fees,” but that the state of the law dictates that result.

Stone, who has moved to Las Vegas, took the position that both he and the State Bar had assumed that debts to former clients in the form of unearned fees were nondischargeable but that, in light of the opinion showing that assumption to be wrong, he could not be lawfully be disciplined for tardiness in refunding fees he was not legally obliged to repay.

The California Supreme Court declined to remand the matter to the State Bar for a redetermination, ordering on June 8, 2016, that Stone be placed on probation for three years and “be suspended from practicing law for at least two years.” The suspension remains in effect.

Stone then reopened the bankruptcy proceeding and brought an adversary complaint against the California Supreme Court, State Bar, and the State Bar Court. His action was dismissed with prejudice.

Federal Statute

Stone invoked 11 U.S.C. §525(a)(5) which provides that “a governmental unit may not deny, revoke, suspend, or refuse to renew a license to...a person that is or has been a debtor under this title...solely because such...debtor...has not paid a debt that is dischargeable in the case under this title.”

However, the appeals panel pointed to the U.S. Supreme Court’s 2003 opinion in FCC v. NextWave Personal Communications Inc. in which it was held that “Section 525 means nothing more or less than that the failure to pay a dischargeable debt must alone be the proximate cause of the cancellation—the act or event that triggers the agency’s decision to cancel, whatever the agency’s ultimate motive in pulling the trigger may be.”

Failure to pay such a debt was not “alone” the basis of the 2014 disciplinary charges, the panel found, noting that the State Bar also charged that Stone had failed to file the required declaration of having made payment by the due-date.

Consent to Pay

The opinion goes on to say that assuming Stone’s debt to his ex-clients was, in fact, discharged in the 2012 bankruptcy proceeding, his complaint against the State Bar and other defendants “does not present a plausible claim for relief under §525(a) because Stone consented post-discharge to the treatment he now questions,” explaining:

“After his 2012 discharge, he negotiated conditions of discipline with the State Bar. As part of those negotiations (perhaps in exchange for concessions from the State Bar and as an alternative to other sanctions), Stone stipulated that he would repay unearned fees to former clients—that is, he agreed that he would make restitution. Nothing prevents chapter 7 debtors from voluntarily repaying debts despite a discharge of personal liability….So Stone breached his stipulated agreement with the State Bar by not punctiliously adhering to the conditions of his probation—the conditions that he, after receiving a discharge, agreed to comply with. Unsurprisingly, the State Bar instituted new disciplinary proceedings, resulting in Stone’s suspension.”

Differentiating the present case from that involving Scheer, the opinion says:

“Here, the State Bar brought disciplinary charges against Stone and suspended him because of professional misconduct. Stone’s obligation to pay restitution arose out of the disciplinary case where he, post-discharge, agreed to pay restitution as a condition of his discipline. In In re Scheer, by contrast, the State Bar suspended the attorney in an enforcement or collection capacity, and the debt ‘was not disciplinary.’ ”

Stone declined to comment on the opinion.

Contempt Sanction

Friday’s opinion reversing a $400,000 contempt sanction says that Chief Bankruptcy Judge Sheri Bluebond’s action against a trustee’s agent, RESS Financial Corporation, for conducting a foreclosure proceeding despite a bankruptcy stay, was inappropriate absent required findings. There was evidence that REES, which learned of the stay on or about Dec. 20, 2012, acted pursuant to legal advice that the stay did not preclude the actions it proceeded to take.

The opinion sets forth that Bluebond “applied an incorrect legal standard in finding RESS in contempt from and after December 20, 2012, and in applying a preponderance of the evidence standard to the issues of RESS’s knowledge and willfulness.”

The opinion says:

“A plaintiff seeking contempt sanctions must show by clear and convincing evidence that the contemners violated a specific and definite order of the court….The clear and convincing standard applies not only to whether the stay has been violated but also to knowledge and intent….

“The bankruptcy court found that there was clear and convincing evidence of a stay violation, but it construed the relevant authorities as requiring application of a preponderance of the evidence standard to the question of whether RESS knew of the stay and that its conduct was willful. Therefore, the bankruptcy court’s determination of RESS’s knowledge and willfulness was erroneous as those determinations were apparently made under the lesser standard of the preponderance of the evidence and not the applicable clear and convincing standard.”

Decisional Law

Under decisional law, the opinion points out, “a good faith belief that the stay does not apply precludes a finding of contempt, even if the creditor’s belief is unreasonable,” adding:

“Moreover, the bankruptcy court’s findings as to good faith are confusing and, to some extent, appear to conflate reasonableness and good faith.”

The opinion also says that Bluebond appears to have ordered payment of attorney fees and costs unrelated to the foreclosure proceedings.

“We must therefore remand this matter to the bankruptcy court for application of the appropriate legal tests and recalculation of damages if warranted,” the opinion sets forth.


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