Proceed Carefully in Bankruptcy Law
Sidebars:
by Anne Massie Nelson
EVEN DURING THIS TIME OF record personal wealth, the
waiting rooms of bankruptcy lawyers are full of people who can no longer
escape the bill collectors. Hat in hand, they come to the lawyer
wondering which chapter of the bankruptcy code comes after "The End."
Bankruptcy gives people a chance at a fresh start, but few emerge
from the process completely satisfied. When debts outlive the bankruptcy
or property is lost, clients look for someone to blame, "and they rarely
look in the mirror," says Mark Bromley, whose practice with Kinney &
Urban, in Lancaster, is about 50 percent bankruptcy.
Lawyers who practice in other areas and suggest bankruptcy as a
remedy to a client or who take a bankruptcy case to accommodate a
long-term client are flirting with danger. Legal malpractice claim
statistics show that lawyers who do not routinely practice bankruptcy
law are more likely to make mistakes.
"Before you advise someone to take the cleansing waters of
bankruptcy, you had better know where the pitfalls are," says Paul G.
Swanson of the Oshkosh firm of Steinhilber, Swanson, Mares, Marone &
McDermott.
Ann Massie
Nelson is secretary and director of communications at Wisconsin
Lawyers Mutual Insurance Co.
To reduce your liability, Bromley and Swanson recommend that you
become knowledgeable about bankruptcy law and its many nuances, educate
clients about the process and their responsibilities, and document all
information exchanged between the client and your firm.
Perhaps the most important skill you can develop is knowing when to
ask for advice or when to refer the matter to an experienced bankruptcy
practitioner. "Bankruptcy law is of sufficient complexity that even
those of us who practice it daily have to study the code and apply it to
the facts. If you apply the same law to different facts, the outcome
will be different," Bromley says.
Become Knowledgeable
The traditional methods of developing competency - attending
continuing legal education seminars, consulting reference manuals, using
client questionnaires and checklists, reading specialty publications -
apply to the complex and continually changing area of bankruptcy law.
Lawyers who concentrate their practices in other areas need to know
enough about bankruptcy law to competently advise clients who are
considering bankruptcy.
"For example, if you tell a divorce client, 'Don't worry about the
property settlement, you can wipe that out in bankruptcy,' you need to
know that the way you handle something now may make it a
nondischargeable asset later," Swanson says.
Lawyers and their clients fall into traps when they:
1) Neglect to properly convert assets to exempt assets before
filing bankruptcy. "If you don't advise clients to convert
nonexempt assets to exempt assets, you could be accused of not zealously
representing your clients. On the other hand, the actions of clients who
maximize exemptions will be closely scrutinized," Bromley points out.
"Exemption planning is like the difference between tax avoidance and tax
evasion. You are walking on thin ice."
Failing to perfect the asset conversion also can cause problems. For
example, if clients purchase a home but don't live in it, they could
lose the $40,000 homestead exemption allowed by law.
2) Undervalue exempt assets or fail to list assets.
In Payne v. Woods, 13 BCD 991, the debtors undervalued their
exempt household goods. When a fire destroyed the items, the insurance
company paid the actual cash value of the items. The bankruptcy court
held that the debtors were entitled only to the value they claimed, with
the balance going to their bankruptcy estate to pay debts.
Undervaluing or failing to list assets is a client error rather than
the lawyer's error, at least in theory. Proving that the lawyer was not
colluding with the client could be difficult if a question arises
later.
3) Overlook tax obligations when planning for
bankruptcy. Taxes become dischargeable debts two years after
the tax return is filed, but not until three years after the date
(including extensions) the taxes are due. "Debtors who must sell
business assets often will incur capital gains taxes. You may need to
advise them to wait three years to file bankruptcy. Otherwise, the
unpaid tax obligation will outlive the bankruptcy," says Bromley.
Educate Clients
Paradoxically, as you become more proficient in a complex area of
law, you may need more frequent reminders to speak in terms your clients
can understand. The language you use every day is not easily
comprehended nor retained by the person who has never filed bankruptcy
and never plans to again.
Here are some points you need to communicate to clients:
1) You must tell the whole truth. Clients need to
know that falsifying bankruptcy documents they sign under oath is
perjury. Deceptively converting assets, tricking creditors into delaying
debt collection, or deliberately converting assets to create insolvency
is bankruptcy fraud. Using credit to acquire exempt assets or converting
assets after entry of a large judgment is suspect and will lead to
closer scrutiny, according to Bromley.
"Telling clients 'You could go to jail or pay a fine if you lie'
usually gets their attention," he says.
2) You may not keep income that is not yours. Once
the bankruptcy petition is filed, all assets become part of the client's
estate, just as though he or she had died. The bankruptcy trustee is the
only person with access to the assets, including accounts receivable or
other money owed to the petitioner before the filing. "This can be a
problem for small business owners who are tempted to use receivables
from the business to pay bills," Bromley notes. In rare cases, the court
allows the bankruptcy petitioner to continue farming or operating a
business to preserve the value of the estate; however, profits from the
ongoing concern go to the trustee.
3) Even a windfall can be bad news. An inheritance,
property settlement from a divorce, proceeds from a life insurance
policy, or any significant gifts received within 180 days of filing the
bankruptcy petition must be reported to the bankruptcy court and
trustee. "You need to ask your client if he or she has any reason to
expect an inheritance or gift," advises Bromley.
For example, if the client is filing for reorganization under
chapters 12 or 13, assets acquired in this way while the plan is in
effect are included in the bankruptcy. "The client may then question why
you did not recommend filing for liquidation under Chapter 7, where the
client would be in and out of bankruptcy and could keep any inheritance
or gift received after 180 days," Bromley says.
Document Your Work
Get the client's statement of financial affairs in writing. Require
clients to complete and sign a questionnaire, listing all known assets
and liabilities. The questionnaire should include a statement that the
information is factual and complete, to the best of the clients'
knowledge. Bromley uses a questionnaire that closely follows the
bankruptcy schedule plus some specific questions he has developed during
20 years of practice.
Send clients an informed consent letter. "In the medical malpractice
context, 'informed consent' requires that the physician recommending a
procedure disclose the significant risks known to reasonably
well-qualified practitioners, the probability of success, alternative
procedures, and any other information needed for a reasonable person to
make an informed decision," Bromley explains.
Lawyers recommending bankruptcy procedures need to make similar
disclosures to avoid being held liable for damages. For a sample
informed consent letter, see the accompanying sidebar.
Confirm in writing when you refer a client to another attorney. This
letter should clearly state that you are no longer representing the
client. For example, you might write: "Thank you for meeting with me
recently to discuss your financial situation. I have referred you to
Attorney Smith, who is knowledgeable about bankruptcy, which may be an
appropriate course for you to consider. Please let me know if I can
assist you with other matters in the future."
Trustees Also Have Risks
Trustees in bankruptcy actions confront challenges different from
advocates' risks, according to Paul G. Swanson, a bankruptcy panel
trustee and partner in Steinhilber, Swanson, Mares, Marone &
McDermott, Oshkosh.
Swanson advises bankruptcy trustees to:
Tell people "I'm not your lawyer." Bankruptcy
trustees frequently receive phone calls from unrepresented debtors who
need advice and mistakenly believe the trustee is their lawyer. "You
need to give people enough information to help them through the process,
but you must scrupulously avoid giving them legal advice," Swanson
notes.
Follow up these conversations with a nonengagement letter to avoid
any confusion about your responsibilities. (See "Letters Protect You
When You PART Ways or PASS on Representation," Wisconsin Lawyer, March
1995, available online at www.wilmic.com/rman/march95.html.)
Create a written waiver for conflicts of interest.
Swanson says trustees often find themselves in the middle between
creditors and debtors with whom they or members of their firm have a
history. "One New York attorney intentionally withheld information from
the court about a conflict of interest between the debtor he was
representing and a group of creditors with a perceived adverse interest.
The attorney ended up in prison," Swanson says.
Check for potential conflicts of interest before you accept the case.
If the petitioner and the other party acknowledge and accept the
potential conflict, ask them to sign and return a written waiver.
Protect your own financial interests. "The
bankruptcy court has the responsibility to approve trustees'
professional fees," Swanson notes. "You can do a lot of work and be
denied fees because the court determined you made an error or had a
conflict of interest."
For example, trustees in bankruptcy actions need to carefully analyze
income tax liabilities resulting from the sale of assets. "Conceivably,
the trustee can be assessed personally for the estate's tax liability.
Minimally, the trustee's fees will be reduced because the available pool
to pay debts will be diminished pro rata," he says.
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