Background
Highland Capital Management and HCRE Partners, now known as NexPoint Real Estate Partners, formed SE Multifamily Holdings to acquire residential properties through “Project Unicorn.” After an outside investor joined, the amended LLC agreement assigned Highland a 46.06% interest and HCRE a 47.94% interest. James Dondero signed the agreement for both companies.
After Highland entered Chapter 11 bankruptcy, Dondero filed a proof of claim on HCRE’s behalf and later sought reformation of the amended LLC agreement. Following extensive litigation—including a dispute that resulted in HCRE’s counsel being disqualified—HCRE moved to withdraw its claim shortly before depositions of Dondero and another HCRE officer. The bankruptcy court denied withdrawal, rejected the claim after trial, and awarded Highland $825,940.55 in attorney fees under its inherent sanctioning authority. The district court affirmed.
The Court’s Holding
The Fifth Circuit affirmed, holding that clear and convincing evidence supported the bankruptcy court’s finding that HCRE filed and litigated the claim in bad faith. Dondero filed the proof of claim without reviewing documents or conducting recalled due diligence, while trial testimony from Dondero and HCRE officer Matt McGraner showed that the amended agreement accurately reflected the parties’ intended ownership allocation. The evidence also supported the finding that the claim was intended to shield assets from Highland’s creditors.
The court further concluded that HCRE acted in bad faith by misrepresenting its law firm’s prior role in the underlying transactions and by attempting to withdraw the claim to avoid discovery while preserving a possible challenge in another forum. The fee award was compensatory rather than punitive because the awarded fees—including those incurred after the withdrawal motion—were causally connected to HCRE’s conduct. HCRE’s failure to propose withdrawal terms that would foreclose future litigation made continued proceedings necessary.
Key Takeaways
- A bankruptcy court may use its inherent authority to shift fees when clear and convincing evidence shows that a party acted in bad faith or willfully abused the judicial process.
- The Fifth Circuit independently reviews the legal sufficiency of the evidence supporting an inherent-power bad-faith sanction, rather than applying clear-error review to that question.
- Fees incurred after an attempted claim withdrawal may remain recoverable when the sanctioned party’s conduct caused continued litigation and the award is limited to fees resulting from that conduct.
Why It Matters
The decision underscores that filing a proof of claim without investigation, pursuing a position contradicted by a party’s own officers, and using withdrawal as a tactical means to avoid discovery can support substantial inherent-power sanctions. It also clarifies the Fifth Circuit’s demanding but nondeferential review of whether clear and convincing evidence supports a bad-faith finding.
For bankruptcy practitioners, the ruling highlights the importance of proposing withdrawal terms that fully resolve potential prejudice, including possible litigation in other forums. A nominal offer to withdraw with prejudice may not end fee exposure if it leaves the underlying dispute open.