Fifth Circuit Clarifies De Novo Sufficiency Review for Inherent-Power Bad-Faith Sanctions in Bankruptcy and Reaffirms “But-For” Fee Causation

I. Introduction

NexPoint Real Estate Partners, L.L.C. (formerly HCRE Partners) appealed from a sanctions order entered in the Chapter 11 case of Highland Capital Management, L.P. The dispute arose out of “Project Unicorn,” a large residential real-estate acquisition financed in part through SE Multifamily Holdings, LLC, whose membership interests were set by an Amended LLC Agreement signed by James Dondero on behalf of both Highland and HCRE.

After Highland’s bankruptcy filing and governance overhaul, HCRE—through Dondero—filed a Proof of Claim asserting that Highland’s conduct prevented HCRE from receiving distributions and seeking effectively to reallocate SE Multifamily membership via reformation of the Amended LLC Agreement. Years of litigation followed, including a successful motion to disqualify HCRE’s counsel (Wick Phillips) and a late attempt by HCRE to withdraw its claim on the eve of officer depositions.

The key issues on appeal were: (1) whether the bankruptcy court properly invoked its inherent power to sanction HCRE for bad faith, under the Fifth Circuit’s “clear and convincing evidence” requirement; (2) the correct appellate standard of review for the sufficiency of evidence supporting a bad-faith finding; and (3) whether the fee award was causally tied to the sanctionable conduct (i.e., not impermissibly punitive).

II. Summary of the Opinion

On rehearing, the Fifth Circuit denied the petition, withdrew its prior opinion, and substituted an opinion affirming the sanctions. The court held:

  • Bad faith was supported by clear and convincing evidence because HCRE (i) filed a baseless Proof of Claim without investigation and with an ulterior purpose, and (ii) litigated in bad faith by misrepresenting facts in opposing disqualification and by attempting tactical withdrawal to avoid discovery while preserving claims for another forum.
  • Appellate review requires probing the record “without deference” to ensure the legal sufficiency of evidence to meet the clear-and-convincing threshold; the court rejected Highland’s attempt to add a “clear error” overlay to that sufficiency inquiry.
  • The fee-shifting amount was causally related to HCRE’s misconduct, including fees incurred after the withdrawal motion, because HCRE’s own conduct drove the continued litigation, and the merits judgment supplied the “ironclad” preclusion Highland sought.

III. Analysis

A. Precedents Cited

1. Background/Context Decisions in the Highland Bankruptcy

  • In re Highland Cap. Mgmt., LP (Highland I), 48 F.4th 419 (5th Cir. 2022)
    Cited to frame Highland’s Chapter 11 background and the governance changes that followed. While not a sanctions holding in this opinion, it anchors the broader bankruptcy context in which the contested claim and discovery disputes occurred.
  • Dondero v. Highland Cap. Mgmt., LP (Highland II), 105 F.4th 830 (5th Cir. 2024)
    Used to show Dondero’s prior interference with the bankruptcy and the Fifth Circuit’s willingness to uphold sanctions tied to violations of bankruptcy-court protective orders. This history informs the court’s assessment of the plausibility of tactical maneuvering and inconsistent positions in the present sanctions record.
  • The Charitable DAF Fund, LP v. Highland Cap. Mgmt., LP (Highland III), 98 F.4th 170 (5th Cir. 2024)
    Central to the opinion’s fee-causation analysis. Highland III distinguished between compensatory fee shifting tied to misconduct and punitive sanctions that exceed permissible authority—particularly disallowing shifting fees incurred litigating the sanctions motion itself. The court relied on Highland III as a general guide but emphasized that, here, the bankruptcy court did not award fees for the sanctions motion.
  • In re Highland Cap. Mgmt., LP (Trial Ord.), No. 19-34054, 2023 WL 3185266 (Bankr. N.D. Tex. Apr. 28, 2023)
    Provides the factual findings from trial: no evidence supported reformation; the Amended LLC Agreement reflected the parties’ intent. Those merits findings undercut the credibility of the Proof of Claim and support the inference of bad faith in filing and maintaining it.
  • In re Highland Cap. Mgmt. (Sanctions Ord.), No. 19-34054, 2024 WL 959335 (Bankr. N.D. Tex., Mar. 5, 2024)
    The appealed sanctions decision. The Fifth Circuit evaluated whether its bad-faith findings were supported by clear and convincing evidence and whether the fee award was causally linked to the misconduct.

2. Standard of Review for Inherent-Power Sanctions

  • Kreit v. Quinn (In re Cleveland Imaging & Surgical Hosp., LLC), 26 F.4th 285 (5th Cir. 2022)
    Supplies the governing framework: inherent-power sanctions are reviewed under a “closer” standard—affirmance only if (1) bad faith or willful abuse is found and (2) that finding is supported by clear and convincing evidence; then the sanction amount is reviewed for abuse of discretion.
  • Cadle Co. v. Moore (In re Moore), 739 F.3d 724 (5th Cir. 2014)
    Reaffirmed the “high threshold” and the requirement that bad faith be supported by clear and convincing evidence; also used for the two-step structure: sufficiency of evidentiary support, then abuse-of-discretion review of the sanction imposed.
  • Crowe v. Smith (Crowe II), 261 F.3d 558 (5th Cir. 2001) and Crowe v. Smith (Crowe I), 151 F.3d 217 (5th Cir. 1998)
    These cases do the heavy lifting on what “clear and convincing” requires and how appellate courts must review it: the evidence must be “direct and weighty,” and appellate courts must ensure the “legal sufficiency” of the underlying facts supporting the generalized bad-faith finding. The opinion cites them to justify a searching, non-deferential sufficiency review and to reject reliance on unclear circumstances or contradictory testimony.
  • Vikas WSP, Ltd. v. Econ. Mud Prods. Co., 23 F.4th 442 (5th Cir. 2022)
    Cited for the proposition that the record is probed “without deference” when evaluating evidentiary sufficiency for inherent-power sanctions.
  • Carroll v. Abide (In re Carroll), 850 F.3d 811 (5th Cir. 2017)
    Highland urged this case to graft clear-error review onto the “clear and convincing” sufficiency inquiry. The court declined, interpreting In re Carroll’s “clearly erroneous” language as tied to review of a prefiling injunction (reviewed under ordinary abuse-of-discretion principles), not as altering the Fifth Circuit’s established inherent-power sanctions review.

3. Withdrawal of Proofs of Claim and Preclusion/Causation

  • Manchester, Inc. v. Lyle (In re Manchester), No. 08-30703-11, 2008 WL 5273289 (Bankr. N.D. Tex. Dec. 19, 2008)
    Quoted for the general rule that withdrawal of a proof of claim should be permitted unless it results in prejudice to the nonmoving party—supporting the bankruptcy court’s decision to deny withdrawal given the procedural posture and concerns about tactical harm.
  • Fed. R. Bankr. P. 3006(a)
    Establishes that once an objection is filed, a claimant cannot withdraw without court permission—undermining HCRE’s argument that post-withdrawal-motion fees were self-inflicted by Highland.
  • Lafayette v. Baudoin (In re Baudoin), 981 F.2d 736 (5th Cir. 1993)
    Used to show why Highland’s continued litigation had concrete value: an order resolving a proof of claim is a “final judgment” for claim/issue preclusion. This supported the conclusion that the post-withdrawal litigation produced the “ironclad” protection Highland sought.
  • Clem v. Tomlinson (In re Clem), 124 F.4th 341 (5th Cir. 2024)
    Cited for issue preclusion: HCRE cannot relitigate issues necessary to the bankruptcy court’s judgment. This further supports causation and the non-punitive nature of the fee award.

B. Legal Reasoning

1. The court’s clarified approach to reviewing inherent-power sanctions

The opinion’s most precedent-facing contribution is its refusal to dilute the Fifth Circuit’s “clear and convincing” safeguard by adding deference at the evidentiary-sufficiency step. The court held that it must independently ensure the record contains “direct and weighty” facts sufficient to yield a “clear conviction” of bad faith, and it must do so “without deference.” It treated In re Carroll as not changing that approach, because that case involved a prefiling injunction (where clear-error review of factual findings fits within ordinary abuse-of-discretion review).

2. Bad faith in filing: lack of investigation plus knowledge of baselessness plus improper purpose

The court affirmed the bankruptcy court’s finding that HCRE filed its Proof of Claim in bad faith because:

  • Dondero signed under penalty of perjury without recalling any due diligence or review of documents.
  • At trial, both Dondero and McGraner admitted the Amended LLC Agreement’s membership allocation matched expectations/intent—negating any genuine basis for reformation.
  • Trial testimony supported an ulterior motive: using the claim to protect SE Multifamily assets from Highland’s creditors after the bankruptcy filing prevented easy amendment to dilute Highland.

The combination—no investigation, admissions undermining the claim’s factual predicate, and a strategic purpose inconsistent with a good-faith claim—was treated as clear and convincing proof of bad faith.

3. Bad faith in litigation: misrepresentation in disqualification opposition and tactical withdrawal

The court agreed with two litigation-conduct grounds:

  • Frivolous opposition to disqualification: HCRE claimed Wick Phillips’s prior representation of Highland was limited to the Key Bank loan, but McGraner admitted knowledge that Wick Phillips jointly represented both entities on the original LLC agreement, the loan, and the Amended LLC Agreement. The court characterized this as knowingly advancing and maintaining a frivolous factual position that required six months of costly litigation to unwind.
  • Gamesmanship in withdrawal: HCRE moved to withdraw two days before Dondero’s and McGraner’s depositions and immediately after producing 4,000 documents. The bankruptcy court offered a path to withdrawal with language preventing future relitigation in another forum, but HCRE never submitted a proposed order or reported discussions. The Fifth Circuit treated the timing and the failure to cure the court’s reasonable concerns as supporting a bad-faith finding.

4. Fee causation: post-withdrawal fees remained “because of” the misconduct

Applying Highland III’s requirement of a causal link (to avoid punitive sanctions), the court held the fees were properly shifted because:

  • After Highland objected, Rule 3006(a) required court permission to withdraw; HCRE could not unilaterally end the dispute.
  • The bankruptcy court denied withdrawal due to prejudice and unresolved concerns about preserving the claim for another forum—concerns HCRE failed to address when it ignored the court’s invitation to propose protective dismissal language.
  • The merits judgment created claim and issue preclusion under In re Baudoin and In re Clem, delivering the comprehensive protection Highland sought (“an ironclad guarantee”).
  • Unlike Highland III, the bankruptcy court did not award fees for litigating the sanctions motion itself.

C. Impact

The decision has three practical effects in Fifth Circuit bankruptcy practice:

  1. Sharper appellate scrutiny at the “clear and convincing” step: Parties defending inherent-power sanctions can cite this case to resist attempts to reframe sufficiency review as “clear error.” Conversely, sanctioned parties face a court that will independently examine whether the record truly meets the heightened evidentiary threshold.
  2. Bad-faith exposure for strategic proofs of claim: Filing a proof of claim without investigation—especially where officers later admit the claim’s predicate is untrue—can support inherent-power sanctions, particularly if testimony reveals creditor-avoidance or asset-shielding motives.
  3. Withdrawal gamesmanship can expand fee exposure: Tactical withdrawal efforts aimed at dodging discovery, or withdrawal that leaves open re-litigation in other fora, can justify both denial of withdrawal and fee shifting through trial when the continued litigation is a “but-for” consequence of the claimant’s conduct.

IV. Complex Concepts Simplified

  • Inherent power (sanctions): A court’s built-in authority—independent of specific rules—to police abuse of the judicial process, used sparingly and typically requiring a strong showing such as bad faith.
  • “Clear and convincing evidence”: A higher burden than “more likely than not.” The proof must be strong enough to create a firm belief or “clear conviction,” not merely a plausible inference.
  • Fee-shifting vs. punitive sanctions: Fee-shifting is compensatory (repays costs caused by misconduct). If fees are not tied to the misconduct, the sanction becomes punitive—often beyond bankruptcy courts’ limited authority as framed by circuit precedent.
  • Withdrawal of a proof of claim (Rule 3006): Once an objection is filed, the claimant needs permission to withdraw—because withdrawal can prejudice the estate or other parties and can be used tactically.
  • Claim preclusion / issue preclusion: If a court finally decides a claim (or a necessary issue), the losing party generally cannot bring the same claim again (claim preclusion) or relitigate decided issues (issue preclusion), even in a different court.

V. Conclusion

NexPoint v. Highland affirms a substantial inherent-power sanction where clear and convincing evidence showed a baseless proof of claim filed without investigation and litigated through misrepresentation and tactical maneuvering. The Fifth Circuit’s substituted opinion also clarifies that appellate courts must independently test the legal sufficiency of the record to meet the clear-and-convincing standard—rejecting efforts to dilute that inquiry with a clear-error overlay. Finally, it reinforces that compensatory fee awards may include post-withdrawal-motion fees when continued litigation is a “but-for” consequence of the sanctioned party’s gamesmanship and when a merits judgment supplies the preclusive finality the opposing party legitimately sought.