Criminal Bankruptcy Attorneys The Hard Road from Dealing with Troubled Clients to Living with Troubling Cellmates Part I

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Feb 2003

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This case sadly illustrates the peril of practicing law in an unfamiliar subject area, for, as one
attorney has learned, ignorance of the law does not excuse an offense. 
—U.S. v. Parkhill.<a href="#1" name="1a">1</a>
</blockquote>

The ultimate "rules" of bankruptcy ethics are not found in Title 11 of the U.S. Code and related case law, but in Title 18, the laws governing federal crimes.<a href="#2" name="2a">2</a> The principal criminal statutes regulating attorney behavior are found at 18 U.S.C. §§152-157, which are the federal statutes directly relating to bankruptcy crimes. 18 U.S.C. §157 relating to "bankruptcy fraud" is a recent and very broad addition to the federal criminal statutes and should be read by any attorney who plans to represent a debtor in bankruptcy proceedings. This article will present an overview of caselaw that highlights various situations where attorneys have found themselves faced with criminal liability for their actions in connection with bankruptcy cases.<a href="#3" name="3a">3</a>

<h3>Casing the Joint: An Overview of Criminal Bankruptcy Issues</h3>

Initially, it is important to note that unlike ethical violations that might arise from a mistake or
neglect, criminal liability will only be imposed if the attorney in question had the requisite criminal intent,
which ranges from the "knowing" standard of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §154</a>,<a href="#4" name="4a">4</a> the "fraudulent" standard of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C.
§157</a> and the "knowing and fraudulent" standard of other key sections, including <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152</a>.<a href="#5" name="5a">5</a> These
standards are not easily met. For an interesting and detailed discussion of the degree of proof necessary to
support a criminal conviction for fraud related to a bankruptcy case, review the case of U.S. v. Heavrin,<a href="#6" name="6a">6</a>

which discussed the directed judgment of acquittal of the general counsel of a bankrupt restaurant chain
accused of numerous bankruptcy-related offenses.<a href="#7" name="7a">7</a>

However, while the government has a difficult burden of proving an attorney guilty of a bankruptcy crime,
it is clear the Department of Justice is very alert for criminal conduct by attorneys. Indeed, an excellent
bargaining chip for debtors indicted for bankruptcy or other crimes<a href="#8" name="8a">8</a> is to "offer up" an attorney who
assisted the debtor in his or her bankruptcy crimes. For whatever reason, as the cases briefly reviewed
below indicate, attorneys have run afoul of the law in a number of situations.

<h3>The Rap Sheet</h3>

The problem of "criminal" bankruptcy attorneys is not a new issue. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7… States v. Grundy
and Thornburgh, 7 U.S. 337 (1806)</a> (discussing advice on denying ownership of a vessel); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…. v.
Switzer, 252 F.2d 139 (2nd Cir. 1958)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… v. U.S., 147 F.2d 235 (8th Cir. 1945)</a>. Nor is it confined
to inexperienced or "poor" practitioners. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…. v. Goodstein, 883 F.2d 1326 (7th Cir. 1989)</a> (attorney
with 40 years of bankruptcy experience). While thankfully there are not many reported cases involving
attorneys who have been convicted of "bankruptcy crimes," there are a significant number of cases where
attorneys have strayed from the straight and narrow.

<h3>Crimes of the Sofa</h3>

The bankruptcy case of Sofa Gallery Inc. is infamous in the annals of bankruptcy crime, as it
generated at least three appeals court opinions<a href="#9" name="9a">9</a> addressing the convictions of the principals of the debtor,
three of their attorneys and their accountants. The facts of this case present a number of very stark lessons
to attorneys practicing bankruptcy law, particularly those who practice in small firms. In this case, at least
some of the lawyers for the debtor entered into a conspiracy with the principals of the debtor to assist the
debtor's principals (1) to obtain and conceal illegal kickbacks from the liquidator of the debtor's business;
(2) to loot the corporation's pension plan to establish a new corporation for the principals' personal benefit;
and (3) in the destruction of their business records.<a href="#10" name="10a">10</a>

While the convictions of the partner in the law firm and the associate primarily responsible for the
representation of the debtors and the debtors' principals in this matter are not surprising, far more troubling
is the case of United States v. Zimmerman,<a href="#11" name="11a">11</a> where an attorney was convicted at trial of conspiracy to
commit criminal fraud in connection with the debtors and the principal's bankruptcy cases, where the
attorney's involvement with those bankruptcy cases can best be described as minimal.<a href="#12" name="12a">12</a> The Zimmerman

case demonstrates the ever-present but unusual problem of "peripheral involvement with a bankruptcy
case," especially when high-risk and possibly unknown strategies are being undertaken.<a href="#13" name="13a">13</a>

<h3>Creative Documentation and Lack of Candor Equals Criminal Problems</h3>

Attorneys are always attempting to use creative documentation to preserve assets for their clients.
However, the case of United States v. Center<a href="#14" name="14a">14</a> shows there is a limitation to the use of this strategy. In
this case, Center was the attorney for a debtor entity known as Foxcliff South Inc. At the time of its
bankruptcy, the debtor was owed $130,000 by another entity, Summitt, which was owed by Foxcliff's
owner. At that time, Foxcliff owed its owner approximately $226,000. In an effort to prevent Summitt
from having to pay Foxcliff the money it owed, Center prepared documents and made entries on Foxcliff's
and Summitt's books to transfer the debt that Foxcliff owed its owner to Summitt and to backdate that
transaction so the liabilities could be used as a setoff. These fraudulent entries were discovered, as well as
Center's failure to properly disclose the debt owed to Foxcliff by Summitt. Center was convicted of
various counts of fraud related to these activities.

In an interesting postscript, the Center case also led to a bankruptcy crimes case against Richard
and Judith White, former clients of Center. After Center was convicted, in an apparent effort to gain a
reduced sentence, Center provided evidence, including obtaining files from his former law firm, in order to
support the prosecution of his former clients for bankruptcy crimes that occurred in personal bankruptcies
Center filed for them prior to his criminal conviction.<a href="#15" name="15a">15</a> The White case is interesting reading because it
shows that while, as a general rule, it is clients who turn upon their attorneys in cases involving
bankruptcy crimes committed by attorneys, in a few limited cases attorneys can turn upon their clients.<a href="#16" name="16a">16</a>

<blockquote><blockquote>
<hr>
<big><center>
[W]hile the government has a difficult burden of proving an attorney guilty of a bankruptcy crime, it is
clear the Department of Justice is very alert for criminal conduct by attorneys.
</center></big>
<hr>
</blockquote></blockquote>

<h3>Offshore Follies—the Danger of Hiding Client Assets</h3>

While normally a plot device for fiction writers, the case of U.S. v. Knoll<a href="#17" name="17a">17</a> shows that attempts
to use offshore bank accounts to hide assets often occur in real life. In this case, Knoll, an attorney,
assisted his client in concealing more than $600,000 in assets in offshore Cayman Island bank accounts as
part of a scheme to prevent his client's soon-to-be-former spouse from obtaining any portion of his client's
assets. Knoll then had his client file bankruptcy, but failed to list the offshore account in his client's
bankruptcy petition. The attorney's conviction for filing false statements in a bankruptcy proceeding was
overturned on the grounds that the proceeding was brought after the expiration of the applicable statute of
limitations, but his other convictions were upheld on related crimes.

It is interesting to note that the principal evidence used by the U.S. Attorney's Office in
convicting the attorney in this case came from a third-party's burglary of the attorney's office and that
party's turnover of the stolen documents to the U.S. Attorney's Office. The Circuit Court found the U.S.
Attorney's Office did not sanction the burglary and therefore could use the evidence obtained from it, and
affirmed the convictions of Knoll and his client.

<h3>Proofs of Claim Can Be Hazardous to One's Health</h3>

While debtors' attorneys are normally the parties subject to criminal prosecution, in the case of
United States v. Connery,<a href="#18" name="18a">18</a> counsel for a creditor who directly assisted in the preparation of a false proof
of claim was convicted of aiding and abetting in the filing of a false bankruptcy claim against the debtor
corporation.

Prior to the filing of the claim, the attorney had worked for the debtor corporation. After the filing
of the debtor corporation's chapter 11, he changed jobs to work as general counsel for another entity
controlled by the party that controlled the debtor.

At the time the proof of claim was filed, the attorney had directed the accounting department of
the creditor to restate the creditor's books to delete an approximate $626,000 balance owed to the debtor
corporation by the creditor company and to instead replace it with an approximately $473,000 claim
against the debtor. As a part of the proof of claim, the creditor denied owing any money to the debtor. The
attorney also assisted in changing other corporate records to support this fraudulent claim.

<h3>Lying About One's Creative Legal Work Is Not a Good Idea, Either</h3>

As noted above, many attorneys, including attorneys who have experience in bankruptcy, believe
that clever corporate restructuring can eliminate the need for a client to repay debts. While a certain amount
of corporate planning is legitimate to protect the assets of either a corporation or an individual that owns
the corporation, hyper-aggressive and undisclosed corporate planning can be a one-way ticket to jail. The
case of United States v. Bartlett<a href="#19" name="19a">19</a> illustrates this point. In this case, the attorney, prior to bankruptcy,
assisted the debtor in fraudulently concealing property with the intent to defeat the bankruptcy laws.
Further, the attorney was convicted of giving false testimony in a bankruptcy hearing. In this case, the
attorney who was convicted of bankruptcy fraud had acted as the criminal defense attorney for the principal
of the debtor, who was also convicted of bankruptcy fraud in connection with the same case.

<hr>
<h3>Footnotes</h3>

1 <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7… F.2d 612 (5th Cir. 1985)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> Common cases that may be involved in prosecutions for bankruptcy crimes include concealment of
assets: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152(1)</a>; false oaths, accounts and declarations: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152(5)</a> and (3); false claims:

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152(4)</a>; receiving property with the intent to defeat the Bankruptcy Code and bribery: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §152(5)</a> and (6); fraudulent pre-bankruptcy transfers: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152(7)</a>; concealment or destruction
of records: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §152(8)</a> and (9); embezzlement against estates: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §153</a>; adverse interest or
conduct of officers: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §154</a>; fee agreements in bankruptcy and receivership cases, general
bankruptcy fraud: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §157</a>; aiding and abetting: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §352, 353, 354</a>; conspiracy: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C.
§371</a>; false statements: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §§1001, 1014, 1032</a>; mail, wire and/or bank fraud: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C.
§1341-1344</a>; obstruction of justice: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §1503</a>; perjury: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §1621-1623</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=a…
Influenced and Corrupt Organization (RICO) acts: 18 U.S.C. §1962</a>; and money laundering: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C.
§1956</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> Although regretfully common, this article will not discuss cases where attorneys, who are themselves
debtors, commit bankruptcy crimes. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…. v. Goodstein, 883 F.2d 1362 (7th Cir. 1989)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §154</a> prohibits judges, trustees and other "officers of the court" from, among other things,
purchasing property of the estate of debtors who are before them. In certain large chapter 11 cases, this
statute prevents bankruptcy judges and court staff from being customers of a significant number of
businesses. <a href="#4a">Return to article</a>

<a name="5">5</a> See, generally, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…. v. Smithson, 49 F.3d 138 (5th Cir. 1995)</a>, for a discussion of criminal intent. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… F. Supp. 2d 769 (W.D. Ky. 2001)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> See, also, Ogier and Williams, "Bankruptcy Crimes and Bankruptcy Practice," 6 Am. Bankr. Inst. L.R.
317 (1998), for a more complete discussion of the technical aspects of bankruptcy criminal statutes. <a href="#7a">Return to article</a>

<a name="8">8</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…. v. Webster, 125 F.3d 1024 (7th Cir. 1997)</a> (attorney indicted due to debtor's cooperation with
prosecutors after guilty plea to bankruptcy criminal charges); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…. v. Franklin, 837 F. Supp. 916 (W.D. Ill.
1993)</a> (debtor agreed to cooperate in an investigation of his bankrupt attorney after his arrest for drug
trafficking). <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9… States v. Levine, 970 F.2d 681 (10th Cir. 1992)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9… States v. Brown, 943 F.2d 1246 (10th Cir.
1991)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9… States v. Zimmerman, 943 F.2d 1204 (10th Cir. 1991)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9… States v. Brown, 943 F.2d at 1250-1253</a>. It is important to note that Brown was an associate
working on the bankruptcy case who was convicted of numerous bankruptcy crimes, although he claimed he
was merely following the direction of his partners. His claims of innocence were most likely defeated by the
revelation that during the principals' bankruptcy he reviewed and destroyed the principals' financial records
because he found them "insignificant." <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9… F.2d 1204</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> Indeed, from a review of the appeals court opinion, Zimmerman's involvement with the debtor and the
debtor's principals seems to have been limited to (1) an initial client meeting, (2) a hallway discussion of
the use of the firm's trust account to deposit the proceeds of the liquidation sale of the debtor's assets, (3) a
meeting with a lessor to convince them to allow their equipment to be used in the debtor's liquidation sale,
(4) a "0.5 hr. conference with client" noted on Zimmerman billing records, (5) the signing of a check from
the escrow account to pay part of the liquidation sale proceeds and (6) the defense of a lawsuit against his
law firm by a secured creditor arguing the firm was improperly paid with proceeds of the collateral. <a href="#12a">Return to article</a>

<a name="13">13</a> In a side note, both Zimmerman and Brown's convictions were overturned and new trials were ordered
because the prosecutors introduced the testimony and/or written opinions of the bankruptcy court concerning
their law firms' actions in the bankruptcy cases. <a href="#13a">Return to article</a>

<a href="14">14</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… F.2d 568 (7th Cir. 1988)</a>. <a href="#14a">Return to article</a>

<a name="15">15</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… States v. White, 879 F.2d 1509 (7th Cir. 1989)</a>. <a href="#15a">Return to article</a>

<a name="16">16</a> The White decision is somewhat controversial as Center, while working for the government as an
informer, obtained confidential attorney/client records from his former law firm and turned them over to the
government for use in its case against the Whites. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… F.2d at 1514-18</a> (J. Will dissenting). <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… F.3d 1313 (2d Cir. 1994)</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… F.2d 929 (6th Cir. 1989)</a>. <a href="#18a">Return to article</a>

<a name="19">19</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6… F.2d 1184 (5th Cir. 1981)</a>. <a href="#19a">Return to article</a>

Journal Authors

C. R. Bowles

Journal Date

Saturday, February 1, 2003 - 12:00

Bankruptcy Rule

2003