Reported / Citable
Background
Highland Capital Management and HCRE Partners, now known as NexPoint Real Estate Partners, formed SE Multifamily Holdings as part of a real-estate investment project. 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 alleging that the amended agreement mistakenly stated the parties’ ownership interests and should be reformed. Following extensive discovery, a dispute that resulted in the disqualification of HCRE’s counsel, and HCRE’s unsuccessful attempt to withdraw its claim shortly before its officers’ depositions, the bankruptcy court rejected the claim at 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 power. The district court affirmed.
The Court’s Holding
The Fifth Circuit denied rehearing, withdrew its previous opinion, substituted this opinion, and 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 meaningful investigation, while trial testimony from Dondero and another HCRE officer showed that the amended agreement accurately reflected the parties’ intended ownership allocation. The record also supported the finding that the claim was intended to shield assets from Highland’s creditors.
The court further held that HCRE litigated in bad faith by misrepresenting its law firm’s 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 Fifth Circuit rejected Highland’s proposed clear-error standard, explaining that it independently reviews whether the evidence is legally sufficient to satisfy the clear-and-convincing threshold. It nevertheless concluded that the record met that standard.
Finally, the court held that the fee award was causally connected to HCRE’s misconduct. HCRE’s failure to propose withdrawal terms that would conclusively bar renewed litigation caused the case to proceed through trial, and the resulting merits judgment supplied the finality Highland sought. The bankruptcy court therefore did not abuse its discretion by including fees incurred after HCRE moved to withdraw its claim.
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 the legal sufficiency of the evidence supporting an inherent-power bad-faith finding, rather than applying clear-error review to that threshold question.
- Fees incurred after an attempted claim withdrawal may remain recoverable when the sanctioned party’s conduct made further litigation necessary to secure a conclusive merits judgment.
Why It Matters
The decision underscores that a proof of claim filed without adequate investigation can expose a creditor to substantial inherent-power sanctions, particularly when testimony shows that the creditor’s principals knew the claim lacked a factual basis. Misrepresentations during collateral disputes and tactical attempts to avoid discovery may reinforce a finding of bad faith.
The opinion also clarifies the Fifth Circuit’s review framework and the causation limits on fee-shifting sanctions. Although compensatory sanctions must be tied to misconduct rather than the expense of pursuing sanctions, they may encompass later merits litigation when the sanctioned conduct caused that litigation to continue.