Key Points

  • The Fifth Circuit affirmed $825,940.55 in bad-faith sanctions against NexPoint Real Estate Partners (formerly HCRE Partners) for filing a bankruptcy claim its officers admitted at trial was baseless.
  • The court found HCRE moved to withdraw its claim two business days before depositions as 'gamesmanship' to avoid discovery while preserving claims for another forum.
  • HCRE's opposition to a counsel disqualification motion was 'classic bad faith' because it misrepresented the law firm's prior representation of Highland.
  • The court reviews the legal sufficiency of evidence supporting bad-faith findings 'without deference,' rejecting Highland's attempt to add a clear error standard.
  • Fees incurred after the withdrawal motion were causally connected to sanctionable conduct because HCRE's failure to propose acceptable withdrawal terms caused the denial.

The Fifth Circuit on Wednesday affirmed an $825,940.55 bad-faith sanction against NexPoint Real Estate Partners, finding clear and convincing evidence that the fund filed a bankruptcy claim it knew was baseless, then moved to withdraw it two business days before its principals were scheduled to be deposed.

Judge James E. Graves Jr., writing for a panel that also included Judges Stewart and Wilson, held that the bankruptcy court properly invoked its inherent power to sanction what it called litigation "gamesmanship" in the Chapter 11 case of Highland Capital Management LP.

The ruling, issued on a petition for rehearing that prompted the court to withdraw and substitute its earlier opinion, centers on a proof of claim that James Dondero filed on HCRE Partners' behalf in April 2020. Dondero, who controlled both Highland and HCRE at the time, later admitted at trial that he conducted no due diligence before signing the claim under penalty of perjury.

"HCRE filed a claim that its officers knew to be baseless, and spent the following years litigating this claim in bad faith," Judge Graves wrote for the court. The opinion marks the latest chapter in Dondero's fraught relationship with Highland's bankruptcy, which has already produced two prior sanctions that the Fifth Circuit affirmed.

The underlying dispute arose from Project Unicorn, a 2018 venture in which Dondero-affiliated companies, including Highland and HCRE, sought to purchase 26 residential properties for approximately $1.1 billion. To execute the deal, the entities created SE Multifamily Holdings LLC and divided membership between them, with HCRE holding 51 percent and Highland holding 49 percent.

After a third-party investor, BH Equities, contributed $21 million, the parties amended the LLC agreement to dilute both stakes. Highland's share dropped to 46.06 percent and HCRE's to 47.94 percent. Dondero signed the amended agreement on behalf of both entities.

When Highland filed for bankruptcy in 2019, Dondero clashed with the independent board that creditors had installed to overhaul the company's governance. In April 2020, he filed a proof of claim on HCRE's behalf, asserting that HCRE "may be entitled to distributions out of SE Multifamily" that Highland had failed to make. The claim sought reformation of the amended LLC agreement, arguing the membership allocation was a mistake.

At trial, however, both Dondero and HCRE Vice President Matt McGraner undermined that theory. Dondero testified that the membership allocation in the amended agreement "comport[ed] with [his] expectations when [he] signed [it]." McGraner could not identify any provision that failed to reflect the parties' intent.

The trial also revealed what the bankruptcy court found to be an ulterior motive. McGraner testified that the real "mistake" was Dondero's decision to file Highland's bankruptcy, which prevented them from freely amending the organizational documents to dilute Highland's membership. McGraner called the prospect of Highland's creditors reaching SE Multifamily's assets "crazy and unjust."

The court found additional evidence of bad faith in HCRE's opposition to Highland's motion to disqualify Wick Phillips, the law firm HCRE retained in October 2020. In its response, HCRE claimed that Wick Phillips's prior representation of Highland "was limited to the negotiation and drafting of the [Key Bank] [l]oan." But McGraner later admitted he "personally knew that Wick Phillips represented both HCRE and Highland jointly" in drafting the original LLC agreement, the Key Bank loan, and the amended LLC agreement.

"McGraner's admission shows that HCRE misrepresented Wick Phillips's role in the underlying transaction, a misrepresentation that took six months of expensive litigation to disprove," Judge Graves wrote. "This goes beyond opposing a motion and losing; this is knowingly raising, then standing by, a frivolous argument—classic bad faith."

HCRE argued that reliance on an ethics expert who opined that the conflict did not require disqualification showed it had not taken a frivolous position. The court rejected that defense, noting the expert "assum[ed]" HCRE's factual claims were true, which they were not.

The bankruptcy court also focused on the timing of HCRE's August 2022 motion to withdraw its claim—filed two business days before Dondero's and McGraner's depositions, and one day after HCRE produced 4,000 documents in discovery. In the motion, HCRE said it "simply wishe[d] to no longer pursue a claim," but offered no explanation for the timing.

The bankruptcy court grew concerned that HCRE was trying to avoid its discovery obligations while preserving its underlying claims for another forum. It gave HCRE a choice: accept denial of the withdrawal, or submit a proposed dismissal order that would prevent it from raising similar claims elsewhere. The court ordered HCRE to confer with Highland and report back.

HCRE never submitted a proposed order and never notified the court of any discussions with Highland. The bankruptcy court denied the motion, finding the withdrawal would unfairly prejudice Highland. After a bench trial in November 2022, the court disallowed the proof of claim on the merits.

On appeal, Highland urged the court to review the bankruptcy court's factual findings for clear error. The Fifth Circuit declined, explaining that it must "probe the record in detail" and review the legal sufficiency of the evidence "without deference." The court distinguished an earlier case, In re Carroll, that had used clear error language, construing that language as applying to a prefiling injunction rather than to inherent-power sanctions.

HCRE also argued that fees incurred after it moved to withdraw should not be included in the sanction because they were not causally connected to its conduct. The court rejected that argument, noting that HCRE's own failure to propose acceptable withdrawal language caused the denial of its motion.

"Had HCRE proposed terms that would achieve this, further litigation would have been unnecessary," Judge Graves wrote, explaining that the trial resulted in "an ironclad" guarantee that HCRE cannot challenge Highland's interest in SE Multifamily in any forum. An order resolving a proof of claim is a final judgment for preclusion purposes, the court noted.

The bankruptcy court did not include fees related to its own sanctions motion, the court observed, distinguishing a 2024 Fifth Circuit decision, Highland III, that had vacated a portion of an earlier sanction against Dondero for including such fees.

The $825,940.55 sanction adds to Dondero's mounting losses in Highland-related litigation. The Fifth Circuit previously affirmed a nearly $500,000 sanction against him for violating a temporary restraining order by communicating with Highland's legal team to coordinate strategy against the company. It also partially affirmed a sanction for filing a vexatious motion to add an independent director as a defendant in violation of a bankruptcy court order.

The case is NexPoint Real Estate Partners LLC v. Highland Capital Management LP, No. 25-11185, in the U.S. Court of Appeals for the Fifth Circuit.