In re McConathy

1

IN RE: Patrick L. McConathy Patricia Chapman McConathy Debtors

No. 90-13449

United States Bankruptcy Court, W.D. Louisiana, Shreveport Division

May 20, 2022

Chapter 7

MEMORANDUM OF DECISION

JOHN S. HODGE UNITED STATES BANKRUPTCY JUDGE

Patrick L. McConathy^[1] filed bankruptcy over 30 years ago but failed to disclose valuable mineral rights that he owned in Kansas. Decades after his bankruptcy case was closed, he filed suit in Kansas asserting claims related to the undisclosed property. The lawsuit seeks millions of dollars in damages from oil companies which drilled and produced oil on lands encumbered by the mineral rights. As a matter of law, the undisclosed assets remain as property of the bankruptcy estate even though the bankruptcy case was closed decades ago.

Debtor's lawyers were clearly aware of the need to determine whether the mineral rights had been listed in the bankruptcy schedules. Instead of making that determination, they just hauled off and filed a lawsuit seeking relief for claims that belong exclusively to the estate. To make matters worse after the lawsuit was filed, they concealed critical facts about the bankruptcy case from the defendants and misled the state court about the need to obtain consent of the trustee.

This court is generally reluctant to impose sanctions against attorneys or their clients, but clear and convincing evidence in this case showed that Debtor's counsel acted in bad faith and willfully abused the judicial process by violating the automatic stay. Sanctions are appropriate.

Before the court are two motions. First, the state court defendants seek an order: (a) declaring that the Kansas lawsuit is invalid because it violated the stay, and (b) awarding $315 000 for civil contempt sanctions to compensate them for the costs incurred in defending the suit. Second, certain non-debtor parties in the Kansas litigation filed a motion to annul the stay.

For reasons that follow, the court concludes that: 1) the claims asserted by Debtor in the Kansas lawsuit are voidable and are therefore invalid and without effect, 2) the motion for contempt should be granted in part, and 3) the motion to annul the stay should be denied. Monetary sanctions against Debtor's counsel will be awarded after the court determines the reasonableness of attorneys' fees.

Background

Pursuant to Fed.R.Bankr.P. 7052, made applicable to contested matters by virtue of Fed.R.Bankr.P. 9014, the court makes the following findings:

1. On December 31, 1990, Patrick L. McConathy and Patricia Chapman McConathy commenced this case under chapter 7 of the Bankruptcy Code. Thereafter, they received a discharge. A final decree closing this case was entered on October 25 1994.

2. On April 15, 1996, Debtors reopened their case to disclose overriding royalty interests in Texas that were not listed in their bankruptcy schedules. The court issued a second final decree closing this case on January 7, 1997.

3. On July 3, 2006, this case was reopened yet again when Brammer Engineering, Inc. filed a motion to reopen to correct a prior conveyance of certain properties. A third final decree was entered on October 9, 2006.

4. Debtors did not disclose in their bankruptcy schedules that they owned undivided working interests and leasehold rights covering over 3, 000 acres in various tracts in Kearny County, Kansas (the "mineral rights").

5. Long after the bankruptcy case was closed for the third time, American Warrior, Inc., Heartland Oil, Inc. and Mid-Continent Resources, Inc. (collectively "AWI") filed a partition action in state court in Kearny County, Kansas, case no. 15-CV-08 (the "Partition Lawsuit") against various owners of working interests in mineral leases covering lands located in that county. One of the defendants in the Partition Lawsuit was McConathy Production Company, Inc. In the Partition Lawsuit, AWI obtained a default judgment which resulted in it obtaining 100% ownership of the leases at issue.

Thereafter, the default judgment was entered, and AWI drilled and produced oil from those leases, collecting more than $7 million from the production.

6. Later, some of the defendants in the Partition Lawsuit retained Kansas lawyers Jeffery L. Carmichael ("Carmichael") and Jonathan Schlatter ("Schlatter") to determine if they could challenge the default judgment on the basis that they did not receive proper notice of the lawsuit. They also wanted to assert a claim for damages for the value of the minerals extracted from the properties after the default judgment was entered.

7. To investigate the claims, Carmichael and Schlatter reviewed the chain of title for various leases and then compared that information to the list of named parties in the Partition Lawsuit to see if there were any inconsistences or issues that needed to be addressed. Carmichael and Schlatter became aware that title to a portion of a relevant leasehold interest was held in the name of McConathy Oil & Gas Company, a Louisiana Partnership (the "Partnership"), rather than "McConathy Production Company, Inc." which was the entity named in the Partition Lawsuit.

8. As part of his investigation, Carmichael was able to locate Debtor. Carmichael spoke with Debtor by telephone in May of 2019 to inquire about McConathy Oil & Gas Company and McConathy Production Company, Inc.

9. Thereafter, Carmichael and Debtor had multiple telephone calls. During one of these calls, Debtor explained that he is the sole partner of the Partnership, having acquired all remaining interests from his former partners.

10. At some point, Debtor and Carmichael discussed the possibility of Debtor hiring Carmichael to establish that Debtor or the Partnership owned mineral rights that were improperly partitioned by AWI in 2018.

11. During his first conversation with Carmichael, Debtor disclosed that he had filed for bankruptcy in 1990. Importantly, Debtor told Carmichael that he did not know whether he owned any mineral rights in Kansas, but if he did he would have owned them prior to his bankruptcy case. Debtor understood that the mineral rights, together with any claims or causes of action which resulted from them, were conceivably property of his bankruptcy estate.

12. After Debtor made this important disclosure to Carmichael, they negotiated a contingency fee arrangement. As part of the negotiations, Debtor asked for a lower percentage fee because he wanted the creditors of his bankruptcy estate to recover as much as possible. Carmichael and Schlatter, on the other hand, wanted a higher percentage because of the extra work required of them to handle the bankruptcy "wrinkle" (Schlatter's term). The parties eventually reached an agreement after the following sequence of events:

a. On May 23, 2019, Schlatter and Carmichael sent an email (docket no. 312-1) to Debtor regarding an engagement letter which proposed a contingency fee arrangement of 40% of any amount recovered, increasing to 50% if an appeal is filed. The email stated:

Pat,

Great talking to you again yesterday. Attached are a proposed engagement letter and contingent fee agreement.

As we discussed on the phone yesterday, McConathy Oil & Gas Co. appears to have owned substantial working interests of record in Kearny County, Kansas, that were improperly partitioned by American Warrior. American Warrior thereafter proceeded to drill several producing wells on some of this leasehold, the revenues from which your company should be entitled. Once the paperwork is returned to your office, we will begin pursing this claim on behalf of you and McConathy Oil & Gas Co.

Jon Schlatter

b. On May 26, 2019, Debtor replied to the email by stating:

Gentlemen,

I have read the attached docs and my only real comment is that 30% seems fair versus the %s in the agreements. If all this was something that would only benefit me, I would have no problem with the higher %. However, since it could benefit my old creditors, I would need to get the maximum benefit to them.

Thanks

Patrick McConathy

c. On May 29, 2019, Schlatter and Carmichael sent an email to Debtor which stated:

Pat,

We can meet you half way on that request, and change the fee to 35%. We can also lower the percentage on appeal from 50% to 40%. We'll be advancing the expenses of the case, and have the added wrinkle of dealing with the bankruptcy court which will increase our costs. These are items we have to account to our partners for. If that sounds good, I'll paper it up and send it to you.

Jon d. On May 29, 2019, Debtor replied to that email: "Sounds good. Thanks for your flexibility." Thereafter, Debtor executed the engagement letter and contingency fee agreement on or about May 29, 2019.

13. The contingency fee agreement contained an express reference to Debtor's bankruptcy case and an acknowledgment of the need to obtain consent and authorization from the bankruptcy trustee to pursue the claims:

"Clients hereby also authorize Attorneys to obtain the consent and authorization of the bankruptcy trustee, Case No. 90-13449, Western District of Louisiana, to pursue said claims on behalf of Pat McConathy. Clients understand that all or a portion of any funds that may be recovered may first become property [of] said bankruptcy estate for distribution to creditors."

14. Debtor testified in his Rule 2004 Examination (docket 285-1 at 62:7-63.5):

Q. And you thought it was okay to pursue these claims in Kansas that you owned prior to the time you filed bankruptcy based on your sworn testimony in the Kansas litigation. You thought it was okay to pursue those on your own behalf even though they were not disclosed in connection with your bankruptcy case?

A. I didn't say anything about them being pursued on my own behalf. I said all along when I got called, these aren't my

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