Bankruptcy courts have a powerful tool to police abuse of the bankruptcy process: the inherent power to sanction litigants who act in bad faith. On August 14, 2026, the U.S. Court of Appeals for the Fifth Circuit reaffirmed just how sharp that tool can be, upholding an $825,940.55 sanction against a claimant that filed a baseless claim and then litigated it in bad faith for years. In re Highland Capital Management, L.P., No. 25-11185 (5th Cir. Aug. 14, 2026), is worthwhile reading for any creditor, debtor, or litigant tempted to treat a proof of claim as a tactical maneuver.
How the Dispute Arose
The dispute grew out of “Project Unicorn,” a plan by entities affiliated with James Dondero to acquire roughly $1.1 billion in residential real estate. Two of those entities — Highland Capital Management and HCRE Partners (now NexPoint Real Estate Partners) — formed a jointly owned company, SE Multifamily Holdings, LLC. After an outside investor joined the venture, the operating agreement was amended to fix each member’s ownership stake, and Dondero signed that amendment on behalf of both companies.
When Highland later filed for Chapter 11 and an independent board pushed Dondero out, HCRE filed a proof of claim in the bankruptcy asserting that it might be entitled to distributions from SE Multifamily and asking the court to reform the amended agreement — in effect, to redraw the ownership percentages Dondero himself had signed. Highland objected, and years of litigation followed. HCRE ultimately lost at trial, the court disallowed the claim, and the bankruptcy court then sanctioned HCRE for bad faith. The district court affirmed, and HCRE appealed to the Fifth Circuit.
The Two Faces of Bad Faith
The Fifth Circuit found clear and convincing evidence that HCRE acted in bad faith in two distinct ways.
First, HCRE filed the claim in bad faith. The court noted that Dondero signed the proof of claim under penalty of perjury without investigating it — he could not recall doing any due diligence, reviewing documents, or even identifying who supplied the information. At trial, both HCRE officers effectively admitted the claim was baseless: the signed allocation matched their own expectations, and neither could point to anything in the agreement that failed to reflect the parties’ intent. The testimony revealed the real objective — shielding the company’s assets from Highland’s creditors. A claim filed without investigation, likely known to be false, and aimed at frustrating creditors fits the definition of bad faith.
Second, HCRE litigated the claim in bad faith. It opposed a motion to disqualify its counsel by misrepresenting the firm’s prior role — asserting that the firm’s earlier work for Highland was “limited to” a single loan negotiation, when one of HCRE’s own officers later admitted he knew the firm had jointly represented both sides across the very transactions at issue. That misrepresentation took six months of expensive litigation to unwind.
Withdrawal Won’t Rescue a Bad-Faith Claim
The most practical lesson concerns HCRE’s attempt to withdraw its claim. Two business days before its officers’ depositions — and one day after Highland produced 4,000 documents — HCRE moved to withdraw, saying only that it no longer wished to pursue the claim. The bankruptcy court saw gamesmanship: an effort to dodge discovery while keeping the underlying dispute alive for a different forum.
Critically, once Highland had objected to the claim, HCRE could not simply walk away. Under Federal Rule of Bankruptcy Procedure 3006(a), withdrawing a claim that has drawn an objection requires court permission, and the court can deny it where withdrawal would prejudice the objecting party. The court even offered HCRE a path: submit a dismissal order that would bar it from raising the same challenge elsewhere. HCRE never did — so the court denied withdrawal, the case went to trial, and HCRE lost. A litigant cannot manufacture an exit, ignore the court’s proposed cure, and then complain about the consequences.
The Standard of Review the Court Reaffirmed
The opinion also clarifies how these sanctions are reviewed on appeal — a point that cuts both ways. Inherent-power sanctions receive a closer look than ordinary bankruptcy rulings. The appellate court will affirm only if the bankruptcy court found bad faith and clear and convincing evidence supports that finding, and it reviews the sufficiency of that evidence essentially de novo, probing the record in detail without deference. The Fifth Circuit rejected an invitation to fold a more forgiving clear-error standard into that review. For anyone challenging or defending a sanction, the record itself must independently support a firm conviction of bad faith.
Fees Must Be Causally Linked — But They Were
Finally, a fee-shifting sanction must be causally tied to the sanctionable conduct; a sanction untethered from the misconduct becomes impermissibly punitive. HCRE argued that fees Highland incurred after the withdrawal motion were not caused by HCRE’s conduct. The court disagreed: HCRE’s own refusal to propose acceptable withdrawal terms caused the denial of withdrawal and everything that followed. And because an order disallowing a proof of claim is a final judgment for preclusion purposes, Highland ultimately obtained what it had sought all along — assurance that HCRE could not relitigate the ownership dispute in any forum. That outcome flowed directly from HCRE’s gamesmanship, so the fees were fair game.
Practical Takeaways
- A proof of claim is a sworn assertion. Investigate before filing; signing one without due diligence invites sanctions, not merely disallowance.
- A bankruptcy court’s inherent power to sanction bad faith is real and expensive — here, more than $825,000.
- Once an objection is filed, a claim cannot be withdrawn without court permission under Rule 3006(a), and suspicious, discovery-dodging timing will draw scrutiny.
- If a court offers a cure — such as a dismissal order that resolves the objecting party’s concerns — take it. Ignoring the offer can turn a graceful exit into a costly loss.
- An order disallowing a proof of claim carries preclusive effect. Creditors can use that finality to foreclose repeat litigation; claimants should assume they get one bite.
- On appeal, inherent-power sanctions receive searching review of the evidence — the record must clearly and convincingly show bad faith.
See In re Highland Capital Management, L.P., No. 25-11185 (5th Cir. Aug. 14, 2026).
This article is provided for general informational purposes only and does not constitute legal advice or create an attorney-client relationship. Outcomes depend on the specific facts of each matter; readers should consult qualified counsel about their particular circumstances. Murray | Lobb Attorneys PLLC has represented businesses, creditors, individuals, and Texas municipalities across Galveston County and coastal Texas since 1991.