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by Ann Massie Nelson
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Proceed Carefully in Bankruptcy
Law
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.
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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