The Third Circuit Issues a Warning to Lawyers: Do Not always accept everything your clients tell you.

In In re Taylor, 655 F.3d 274 (3d Cir. 2011), the Third Circuit Court of Appeals upheld sanctions imposed on lender’s counsel who too blithely and too blindly relied on inaccurate information from its client. In doing so, that Court helped better set the line that attorneys should not cross. The case is a warning to all attorneys about their professional obligations to verify and question what their clients are telling them. It is also as sign of our times, and the mortgage mess we are in.
The case arose from a Chapter 13 Bankruptcy filed by the Taylors. HSBC held the mortgage on their home. HSBC’s counsel, the Udren Law Firm, and its experienced managing attorney filed a request for relief from the automatic stay so as to permit HSBC to pursue foreclosure proceedings despite the bankruptcy filing. As a secured creditor, HSBC had filed a proof of claim. The Taylors filed an objection to that proof of claim. It was how HSBC’s attorneys handled these matters and the representations they made to the court that got them in trouble.

The Taylors had an ongoing payment dispute with HSBC. This arose when HSBC claimed that the Taylors’ home was in a flood zone, obtained "forced insurance" for the property and added the expense to the Taylors’ monthly mortgage payment. The Taylors disputed the additional cost but continued to make their previous regular payments. HSBC refused to acknowledge that the Taylors were making full monthly payments and instead treated them as partial payments, leaving the Taylors further in arrears each month.

After the bankruptcy filing, the managing partner for the Udren Law Firm, Doyle, filed a motion for relief from the automatic stay in which she stated that since the bankruptcy filing the Taylors had not made any payments. The attorney filing this motion relied on a computerized system called "NewTrak" that was processed through a third party. The information supplied to HSBC’s counsel through this system was limited to the loan number, the name and address, payment amounts, late fees and amounts past due. The attorneys initially proceeded with the motion without any knowledge or information that, in fact, there had been a pending dispute about the payments.

This was not the only problem with the motion filed by HSBC’s counsel. The monthly payment amount was inconsistent with the proof of claim HSBC had earlier filed through another firm. Also, the motion papers said that the Taylors’ home had "inconsequential or no equity", something that was later established to have had no basis in fact.

HSBC’s counsel did nothing to verify the information in the motion besides a check of the "screen prints" from the NewTrak information.

The Taylors responded to this motion with documents including cancelled checks which indisputably showed that HSBC’s papers were mistaken in important respects.

The Taylors also filed an objection to HSBC’s proof of claim which detailed the ongoing disputes over flood insurance and pointing out the obvious inaccuracies and inconsistencies in HSBC’s papers. Despite this clear documentation that HSBC’s papers were inaccurate, HSBC’s counsel nevertheless filed a pro forma response reiterating that all figures in the proof of claim were accurate and the charges claimed were contractually correct. While this was ongoing, HSBC’s counsel had served admission requests on the Taylors which they had failed to respond to within the required thirty day period. These requests for admissions sought an admission of statements that were clearly false, namely that the Taylors had made no mortgage payments and had no equity in their home.

When the matter came on for hearing, HSBC’s counsel sent a junior associate whose response to pointed questioning was to ask the court to rely on the Taylors’ failure to respond to the request for admissions. The associate initially sought to have the request for admissions admitted as evidence, even though he knew they contained falsehoods. The court initially directed that counsel obtain an accounting from HSBC. At the next hearing, the same junior associate admitted that he could not obtain any accounting from HSBC and was literally unable to contact it to verify information.

The bankruptcy court issued an Order to Show cause for potential sanctions against HSBC and its counsel, ordering the associate, his managing attorney who had filed the motions, the senior partner of the firm and others to appear and give testimony. After a hearing, the bankruptcy court imposed sanctions on HSBC, the law firm, the managing attorney, and the firm’s senior partner for violations of Rule 9011 (the bankruptcy analogue to Rule 11 of the Federal Rules of Civil Procedure). That Rule states that an attorney signing papers submitted to a court certifies that the allegations and factual contentions have evidentiary support or are likely to have such support. The Rule requires a reasonable inquiry under the circumstances.

On an initial appeal to the U.S. District Court, the bankruptcy court was reversed. The case then came before the Third Circuit Court of Appeals on an appeal filed by the United States Trustee. The Third Circuit reinstated most of the rulings of the bankruptcy court; the senior partner at the firm who had no apparent involvement or supervisory responsibility as to this matter was relieved of the sanctions, but for everyone else including HSBC (who had not been involved in the appeal) sanctions were reinstated (The junior associate got off with a requirement to obtain three CLE credits in professional responsibility.)

How the Third Circuit addressed these matters and the principles it applied are a cautionary tale for all attorneys. First, the court noted that statements by counsel that were "literally true" could still be sanctionable or misleading. Here, HSBC had overstated the amount of arrearages by only $540.00 out of a total of $4,367.00 claimed. The claim that the Taylors were actually behind on their mortgage was true, but this did not satisfy the Third Circuit. It was just as important in that court’s view that the bankruptcy court know that at least some partial payments had been made and that there was a dispute that might explain the remainder of the arrearages.

The first lesson therefore is that attorneys should be clear and complete in their recitations.

The more important lesson from this case is that attorneys cannot blindly rely on representations from their client. The inquiry by counsel has to be reasonable under all the circumstances. The factors the court cited include:

• The amount of time available to the signor for conducting factual and legal investigation;
• The necessity for reliance on a client for the underlying factual information;
• The plausibility of the legal position advocated;
• Whether the case was referred to the signor by another member of the bar; and
• The complexity of legal and factual issues implicated.  

The Third Circuit fleshed this out in the context of the case. First, "A lawyer need not routinely assume the duplicity or gross incompetence of her client in order to meet the requirements of Rule 9011. It is therefore usually reasonable for a lawyer to rely on information provided by a client, especially where that information is superficially plausible and the client provides its own records which appear to confirm the information." However, the court noted that here there was no reasonable reliance because there was no attempt to verify the facts especially where they came through an automated system. More importantly, counsel had an obligation to determine for herself what information was reasonable and relevant. The Third Circuit made clear that the attorney cannot allow the client to define what information she needs to have or she needs to supply to the court. Finally, counsel ran afoul of Rule 9011 by ignoring clear warning signs that important information was missing and the information supplied was inaccurate. A mechanical reaffirmation of facts from a previous filing is therefore second. Experienced attorneys all know that not everything a client tells them is accurate or reliable and that some degree of skepticism is necessary and warranted. In the bankruptcy context, attorneys routinely and regularly file detailed financial disclosures of assets, liabilities and previous transactions. In this author’s experience, the degree of due diligence actually exercised by such attorneys is highly variable. In the bankruptcy context, indeed, there is a statutory requirement that an attorney have exercised due diligence. Those who blindly accept the rudimentary information the clients give them without personally questioning and checking for inconsistencies to some degree or another are likely to await the same fate that fell HSBC’s counsel in Taylor.

Nothing in Taylor should be surprising to experienced counsel. However, a salutary reminder to all attorneys that a "pure heart and empty head" is not a valid defense in these types of cases. For more about our firm, visit our websites. http://www.nv-njlaw.com/ or our business oriented site,  http://southjerseybankruptcylaw.com/