The Virginia Supreme Court has underscored the right of a defendant to seek bankruptcy protection amid civil litigation.
In McNally v. Rey, No. 070522, (Va. April 18, 2008), Virginia's highest court considered whether a trial lawyer was subject to sanctions for continuing to comply with pre-trial obligations and preparing a matter for trial when the litigator also was counseling the defendant concerning the possibility of filing for bankruptcy protection. When the defendant filed for bankruptcy on the eve of trial, the plaintiffs sought to hold the defendant's lawyer responsible for all pretrial expenses incurred.
The facts in this case are not unlike many litigations when a defendant suffers financial stress. The defendant was defending an action pending in state court, which was litigated through the pre-trial stage to the eve of trial. The defendant engaged in discovery and its trial counsel complied with all necessary pre-trial matters, including presenting pre-trial filings to the court on the eve of trial. Despite the defendant's ongoing compliance with pre-trial matters, defendant's trial counsel also counseled the defendant on the merits of filing for bankruptcy.
The defendant did indeed file a bankruptcy case on the eve of trial, and defendant's trial counsel appeared at trial, advising the trial court that the automatic stay prevented the case from going forward. Immediately, plaintiffs' trial counsel sought to hold the defendant's trial counsel liable for sanctions to offset the costs incurred by the plaintiffs in preparing for trial.
The plaintiffs argued that the defendant's trial counsel breached the state equivalent of Federal Rule of Civil Procedure 11 by continuing to execute documents related to pre-trial procedures, when counsel had knowledge that the defendant intended to file for bankruptcy and preclude trial. After procedural motions, the trial court entered an order imposing sanctions on the defendant's trial counsel, requiring reimbursement of all plaintiffs' pre-trial costs plus court costs associated with impaneling a jury.
The Bankruptcy Option
On appeal, defendant's trial counsel continued to assert that his actions did not violate state law, and were necessary to preserve bankruptcy as an appropriate option available to the defendant in the exercise of its federal rights.
The Virginia Supreme Court agreed and overturned the lower court's sanction. The court ruled that the defendant's trial counsel's pre-trial compliance did not result in increased costs for the plaintiffs. The court noted that there were no factual inaccuracies in the presentations filed and concluded that reserving a "litigation strategy" is not sanctionable.
The court held that the imposition of sanctions on trial counsel for counseling his client on the eve of trial would "have a chilling effect on the rights of litigants and their attorneys when such litigants seek to avail themselves of their statutory rights set forth in the federal bankruptcy code."
This case is instructive because it highlights the right of a civil defendant to avail itself of the protections under the United States Bankruptcy Code. Although filing for bankruptcy on the eve of trial certainly frustrates a plaintiff's day in the court of its choice, the Virginia Supreme Court concluded that preservation of a defendant's federal right overshadows the "inconvenience" imposed on the plaintiffs by virtue of a pre-trial bankruptcy filing.
The plaintiffs nonetheless still will have an opportunity to present their claims for determination (through the claims-resolution process in the defendant's bankruptcy case). The holding in McNally, however, reinforces the principal that the plaintiffs' selection of forum does not trump the defendant's ability to avail itself of its federal bankruptcy rights.
This article is presented for informational purposes only and is not intended to constitute legal advice.
