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, an 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, HCRE filed a proof of claim asserting that the amended agreement mistakenly understated HCRE’s interest and should be reformed. Following extensive discovery, a dispute that resulted in HCRE’s counsel being disqualified, and HCRE’s unsuccessful attempt to withdraw its claim shortly before depositions of Dondero and another HCRE officer, the bankruptcy court rejected the claim after trial. It later found that HCRE had filed and litigated the claim in bad faith 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. It held that clear and convincing evidence supported the bankruptcy court’s finding that HCRE acted in bad faith. Dondero filed the proof of claim without conducting 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 record also supported the finding that the claim was intended to protect assets from Highland’s creditors.
The court further held that HCRE litigated in bad faith by misrepresenting its law firm’s prior role in the underlying transactions while opposing disqualification and by attempting to withdraw the claim to avoid discovery while preserving the underlying dispute for another forum. The full fee award was permissible because HCRE’s conduct caused Highland’s litigation expenses, including fees incurred after the attempted withdrawal. A merits judgment gave Highland preclusive protection against future litigation that an inadequately defined withdrawal would not have provided.
Key Takeaways
- A bankruptcy court may use its inherent authority to impose attorney-fee sanctions when clear and convincing evidence shows bad faith or willful abuse of the judicial process.
- The Fifth Circuit independently reviews whether the evidence is legally sufficient to satisfy the clear-and-convincing standard; it does not merely review that determination for clear error.
- A fee-shifting sanction may include expenses incurred after an attempted claim withdrawal when the sanctioned party’s own conduct caused continued litigation and the resulting judgment supplied protection the proposed withdrawal did not.
Why It Matters
The decision confirms that filing a proof of claim without investigation and then using misleading arguments or tactical withdrawal efforts can expose a creditor to substantial inherent-power sanctions. Losing the underlying claim alone is not enough, but knowing misrepresentations and litigation gamesmanship may establish the required bad faith.
The opinion also clarifies the Fifth Circuit’s demanding review framework: bad faith must rest on clear and convincing evidence, and the appellate court examines the record without deference for legal sufficiency before reviewing the sanction’s substance for abuse of discretion.