Obligations of Counsel When Your Client Is a Bad Actor

By Hon. D. Sims Crawford, Kelley M. Tynes and Jenna Jacobik

The time to plan for an emergency is not during an emergency. My father, a former Navy pilot, has often repeated this phrase, and this seems like an appropriate way to begin our discussion. In that vein, the best time to consider your ethical obligations is before you realize that you are representing a bad-acting client, not after.

Although client misconduct can vary widely and may contain gray areas, a step-by-step approach should help to address these situations. Along those lines, the references and reminders discussed herein seek to offer guidance if such a dilemma develops with one of your clients.

Troubling Scenarios

A difficult situation might arise with your client — one that you never expected but are forced to address nonetheless. Perhaps the debtor’s principal produced several documents during discovery, they are now marked as exhibits, and you realize that they are fraudulent only one day before the preference AP goes to trial. Maybe you learn, during your preparation for the hearing on first-day motions, that some of the debtor’s financial records are false, resulting in a highly unrealistic (at best) or a sorely misleading (at worst) budget and an unsubstantiated request to use cash collateral.

Debtor’s Obligations Under the Bankruptcy Code and Rules

In practice, client misconduct is not always obvious, truth is often stranger than fiction, and vision is nearly perfect in hindsight. As you navigate the nuances of representing a challenging client in bankruptcy, a solid starting point can provide direction. While not exhaustive, the following list of Bankruptcy Code sections provides a path for delineating your client’s expectations and underscoring the hefty disclosure and reporting obligations that accompany bankruptcy relief:

• 11 U.S.C. § 308: Debtor reporting requirements mandate additional reporting requirements for small business debtors.
• 11 U.S.C. § 521(a)(1): Debtor’s duties, which is the duty of filing a list of creditors, a schedule of assets and liabilities, and a statement of financial affairs.
• 11 U.S.C. § 1106: Duties of the trustee (applicable to a debtor-in-possession (DIP), per 11 U.S.C. § 1107).
• 11 U.S.C. § 1107: Rights, powers and duties of a DIP place a DIP “in the shoes of a trustee in every way,” as shown in the legislative history to § 1107.1
• 11 U.S.C. § 1116: Duties of the DIP in small business cases.

Given the disclosure requirements imposed by the Bankruptcy Code and Federal Rules of Bankruptcy Procedure, the notion that a “debtor’s duty to disclose is essential to the bankruptcy system” is not surprising.2 To that end, “one of the most important duties of the debtor’s attorney [is] preparing the debtor’s schedules and statement of affairs.”3 Thus,

The attorney should carefully investigate the affairs of the debtor and make certain that the attorney has all the information needed to prepare full and complete schedules, for it is the duty of the debtor to present intelligible and true schedules. Although, depending on the sophistication of the debtor, it may be possible to have the debtor, especially a business debtor, prepare a first draft of the schedules, the attorney for the debtor has a responsibility to review [the] schedules to ensure that they are complete and in compliance with the Code and the Federal Rules of Bankruptcy Procedure.4

As noted by one bankruptcy court, disclosure is not subjective. It “requires full disclosure of the precise nature of all of a debtor’s assets and liabilities. Neither a debtor nor his attorney is entitled to omit information or provide partial information simply because, in their view, the information provided is sufficient to allow the trustee to determine the value of a debtor’s estate.”5 Further, the duty to disclose is a continuing one that obligates the debtor to “ensure the accuracy and completeness of his schedules ... throughout the bankruptcy case.”6

A debtor’s failure to disclose or properly report can prove sanctionable,7 and the duty of disclosure does not “fall on the debtor alone.”8 Counsel “has an independent obligation to ‘review [the schedules] with his client before they become a part of the public record.’”9 Ultimately, it boils down to this: “Counsel is obligated both ethically and as an officer of the court not to file schedules and other disclosure documents that the counsel believes inaccurate, let alone motions. Thus, courts have cautioned that before filing a petition, schedules, etc., it is incumbent upon counsel to ‘take all possible steps to assure himself that the information listed in his client’s petition is correct ... inquire as to amounts owed ... and to explain the requirements of full disclosure.’”10

Counsel’s Obligations Under the Bankruptcy Code and Rules, and Rules of Professional Conduct

Given the confluence of obligations under the Bankruptcy Code, Bankruptcy Rules and Rules of Professional Conduct, it is no wonder that “[m]any lawyers find the relevant ethical guidelines difficult to understand and apply, even when counseling and litigating on behalf of only one client. Problems [may] increase for counsel for a [DIP] or trustee.”11 While there is no instruction manual to resolve this difficulty, an awareness of certain ethical obligations and the applicable rules of professional conduct may ease the burden.

Maybe it is the fiduciary aspect of representation that gives the ethical dilemmas in bankruptcy a sharper edge. Chapter 11 debtors are “quasi-trustees with fiduciary duties to their creditors.”12 As debtors’ counsel, attorneys have “ethical duties to guide and counsel” their chapter 11 clients.13 Moreover, counsel’s duty of disclosure under 11 U.S.C. § 329 “is that of a fiduciary,” requiring counsel to lay bare all their dealings regarding compensation.14 With these fiduciary obligations in play, it is easy to anticipate the tension that can develop between counsel’s duties to a client and counsel’s duties to the court. In that regard, it is important to remember that the duties of good faith, competency, candor and accuracy required under the Model Rules of Professional Conduct (MPRC) are paramount. As In re Grasso reminds:

[I]t is important to reaffirm, on a general basis, the principle that lawyers, who serve as officers of the court, have the first line task of assuring the integrity of the process.... It is without note, therefore, that we recognize that the lawyer’s duties to maintain the confidences of a client and advocate vigorously are trumped ultimately by a duty to guard against the corruption that justice will be dispensed on an act of deceit.15

Accordingly, “attorney[s] must preserve client confidences, but not to the extent of implicitly sanctioning illegality.”16 Further, counsel must be mindful of their obligations pursuant to Bankruptcy Rule 9011, which requires that “every petition, pleading, written motion, and other paper ... shall be signed by at least one attorney of record.”17 Such a signature is a representation to the court that the information provided is accurate to the best of a person’s knowledge.18 An attorney’s signature further serves as acceptance of the fiduciary duties that accompany the representation, which may extend beyond the arguments made to the court on a client’s behalf.

However, does not the client affirm, under penalty of perjury, the accuracy of bankruptcy schedules or, for that matter, the information contained in a proof of claim? Yes, absolutely. Counsel has no affirmative duty to further investigate or verify the information provided by a client before its submission to the court or production to opposing counsel. However, as demonstrated by the opinions cited herein, it seems beneficial for a law practice to develop safeguards that promote complete disclosure and accurate reporting by clients. Once an attorney discovers that a client has committed misconduct, neither the representation nor counsel’s responsibilities will cease without decisive action and taking formal steps to end the representation.

Referrals Under Title 18

Certain actions or inactions by a client can raise serious concerns, with ramifications that go well beyond relief under the Bankruptcy Code. As debtor’s counsel, you might learn about a client’s misstep when a law enforcement official shows up and starts asking some pointed questions. As creditor’s counsel, you might observe something in a court filing that you strongly believe is fraudulent or that threatens the integrity of the bankruptcy system. Title 18 of the U.S. Code identifies certain acts and omissions that seriously undermine the bankruptcy process, and knowing these guardrails should help you advise your clients as they struggle with their financial difficulties.

Nearly all of the fraud-based statutes under title 18 that apply to bankruptcy cases focus on intent (“knowingly and fraudulently”).19 While many of the statutory sections concern post-petition conduct, they may also address pre-petition conduct in some instances. Much of the prohibited conduct is self-explanatory — concealing assets, making a false oath, presenting a false proof of claim, or making a bribe20 — but § 152 also includes the fraudulent receipt of estate property.21 These statutes are written broadly with an aim of protecting the bankruptcy system, and each of these bankruptcy-fraud-type offenses carries a penalty of a fine, imprisonment for not more than five years, or both.22

Perhaps you are wondering how such a referral begins. Where a judge, receiver or trustee has reasonable grounds for believing that a bankruptcy crime has been committed, or that an investigation of the same should be had, the official shall report it to the appropriate U.S. Attorney.23 The U.S. Trustee Program is also actively involved in the reporting of suspected bankruptcy fraud.24 While U.S. Attorneys and the Federal Bureau of Investigation are primarily responsible for bankruptcy investigations and enforcement, other agencies like the U.S. Secret Service, and even state prosecutors, may assist with bankruptcy fraud investigations and prosecutions.25

As counsel for a debtor or creditor, if you find yourself in a position where your client persists in a course of action that you reasonably believe is criminal or fraudulent, you may have the option of withdrawing from further representation.26 Please check the Rules of Professional Conduct for the state where you practice.27 Careful consideration of your ethical responsibilities is recommended here due to the serious nature of the decision. Depending on the circumstances, you may choose to refer your client to an attorney who specializes in criminal representation or bankruptcy investigations.

When Is Withdrawal from Representation Appropriate or Required?

While we hope that it never happens, there is a time when an attorney must ask whether withdrawing as counsel is appropriate — or required — in a given situation. By way of guidance, the MRPC provide an answer. The rule on declining representation specifically states that a lawyer shall withdraw from representing a client if “(1) the representation will result in violation of the Rules of Professional Conduct or law; ... or (4) the client or prospective client seeks to use or persists in using the lawyer’s services to commit or further a crime or fraud.”28 In these instances, the language is mandatory in nature. The attorney “shall withdraw” from further representation. However, depending on the language of the Rules of Professional Conduct that apply in your state, the attorney may have discretion to withdraw, or to continue the representation, where counsel reasonably believes that the client’s conduct is criminal or fraudulent.29 Also, many state bar associations offer advisory opinions to attorneys who inquire about ethical issues before acting, and these opinions may serve as safe harbors to any inquiry or criticism arising later.

When going through the process of terminating the representation of a client, an attorney must provide notice as required and must gain the approval of the court presiding over the client’s case.30 It is important to remember that the request to terminate representation is just that — a request. A court may deny an attorney’s request to withdraw as counsel, even when made for good cause.31 The likelihood that such a request may be denied increases in cases with protracted litigation or where a withdrawal request is filed shortly before trial.32 In some circuits, binding precedent may prevent corporate entities from appearing pro se in federal court, making withdrawal even more complicated.33 These challenges highlight the need for thoughtful analysis and careful planning if a situation arises where you believe it is best to withdraw from further representation of your client.

Closing

No attorney purposefully engages a client who, at the outset, refuses to abide by the Bankruptcy Code and Rules. Regardless, once you realize that your client is a bad actor, you continue to have responsibilities to both your client and the court. In appreciating these responsibilities, as well as the pitfalls that accompany their client’s actions, attorneys must make difficult decisions about the attorney/client relationship and how best to protect your law practice and your reputation with the court and the trustees.

Hon. D. Sims Crawford is a U.S. Bankruptcy Judge for the Northern District of Alabama in Birmingham. Kelley Tynes is the career law clerk, and Jenna Jacobik serves as a term law clerk, for Judge Crawford.