They Filed Bankruptcy on Me Ethical Issues for Attorneys Collecting Pre-petition Legal fees for Bankruptcy Proceedings

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Nov 2003

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A couple of years ago, I was in my office talking to
a non-bankruptcy lawyer friend, and the administrator in charge of our accounts
receivable brought me a notice of bankruptcy involving a former client of the
firm. This former client had filed chapter 11 owing my firm several thousand
dollars. I assured my office manager that the bankruptcy group would take care
of filing the proof of claim, but that the collection in this case was probably
a hopeless cause. On hearing this discussion, my friend smiled at me and said,
"a bankruptcy lawyer receiving a notice of bankruptcy on one of his
debts, is either supreme irony or perfect justice."

In this installment of Straight & Narrow, I do not intend to answer my
client's interesting philosophical question, but rather discuss a more
mundane and perhaps more important issue of the ethical limitations facing an
attorney attempting to collect pre-petition legal fees from a current or
former client who has filed bankruptcy.

<h3>Hey, That's My Money We're Talking About: Ethical Limitations and Attorney's Ability to Collect</h3>

At
the heart of the relationship between attorneys and their clients is the
attorney/client privilege. The rules relating to the attorney/client privilege
vary in some detail from state to state,<a href="#2" name="2a">2</a> so attorneys must consult their local
ethical rules on this issue. However, nearly all definitions of the
attorney/client privilege follow some form of Model Rule of Professional
Conduct 1.6, which states:

<blockquote>
(a)
A lawyer shall not reveal information relating to the representation of a client
unless the client gives informed consent, the disclosure is impliedly
authorized in order to carry out the representation or the disclosure is
permitted by paragraph (b).
 (b)
A lawyer may reveal information relating to the representation of a client to
the extent the lawyer reasonably believes necessary:

<blockquote>
(1) to prevent reasonably certain death or substantial bodily harm;
 (2) to secure legal advice about the lawyer's compliance with these rules;
 (3) to establish a claim or defense on behalf of the lawyer in a controversy
between the lawyer and the client, to establish a defense to a criminal charge
or civil claim against the lawyer based upon conduct in which the client was
involved, or to respond to allegations in any proceeding concerning the lawyer's
representation of the client; or
 (4) to comply with other law or a court order.
</blockquote>
</blockquote>

Further, the protection of client confidences and secrets extends not only to current,
but also to former, clients. An attorney's duties to former clients is
reflected in Model Rule of Professional Conduct 1.9, which provides:

<blockquote>
(a) A lawyer who has formerly represented a client in a matter shall not thereafter
represent another person in the same or a substantially related matter in which
that person's interests are materially adverse to the interests of the
former client unless the former client gives informed consent, confirmed in
writing.
</blockquote>

However,
the protection of client confidences and secrets is not unlimited. Of
particular interest to attorneys, it is generally recognized, as reflected in
Model Rule of Professional Conduct 1.6(b)(3), that an attorney may reveal
confidences and secrets "to establish a claim or defense on behalf of the
attorney in a controversy between lawyer and the client..." (Claims or
Defense Exception) This exception has generally been held to permit an attorney
to disclose confidential information provided by the client in actions seeking
to collect the fees that said client owes the attorney. As noted by the Fifth
Circuit, the case of Doe v. A Corp,<a href="#3" name="3a">3</a>

"[a] lawyer...does not forfeit his right simply because to prove them he
must utilize his confidential information. Nor does the client gain the right
to cheat the attorney by imparting confidences to him."

However,
even under the Claims or Defense Exception, courts have held that there are
limits to an attorney's ability to use confidential information. While
there is very little case law on this issue, courts that have considered the
Claim or Defense Exception to attorney/client privilege have limited the
exception under three general theories.

Good
Faith. One line of cases, which has limited
the claim defense exception to attorney/client privilege, holds that the
exception can only be invoked by attorney's "good faith."
These cases usually involve rather extreme facts. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=F…
re Fuller</a><a href="#4" name="4a">4</a> (attorney wrote
letter to more than 25 individuals and government agencies, including Vice
President Al Gore, accusing a client of chemical dependency, fraud,
intimidation and murder) and Florida Bar v. Ball,<a href="#5" name="5a">5</a> (sanctioning attorneys who pressured clients to pay fees in an
adoption matter by informing adoption agency clients might be financially
unstable due to their inability to pay his fees).

Limited Scope. The second line of authority
limiting the Claim or Defense Exception to the attorney/client privilege
governs the scope of use of the privileged information and the relationship the
use of information has to the attorney's collection and/or defense
activities. In general, these courts have held that the Claim or Defense
Exception will only apply in actions that are closely related to the collection
of the attorney's fees or defense of a client claims against the
attorney. Attorneys will not be allowed to use their confidential information
in actions that are not in some way directly related to the collection of the
fees by an attorney or the defense of a claim brought against the attorneys. See
Nakasian v. Incontrade Inc.<a href="#6" name="6a">6</a> (discussing
appropriate use of confidential client information in action to attach client
property in connection with the fee claim); In re Jordan,<a href="#7" name="7a">7</a> (use of confidential information not permitted by
attorneys where fee claim was incidental to suit for damages filed by attorney
on behalf of one client against another client).

Reasonableness of Use. Finally, some courts look to
whether the use or disclosure of confidential information is
"reasonable" in determining whether an attorney can use
confidential information to recover a claim against a former client. Not
surprisingly, these courts give little guidance as to what is a reasonable use
of confidential information. Compare Spratley v. State Farm Mutual
Automobile Insurance Co.<a href="#8" name="8a">8</a> (former in-house
counsel for insurance company, the employer's former client was permitted
to use confidential information against the insurance company to the extent
reasonably necessary to establish their claims for wrongful discharge against
the company) with Doe v. A Corp.<a href="#9" name="9a">9</a> (approving serious limitation in class
action lawsuit brought by former in-house legal counsel against former
employee/client for pension claims enjoining in-house counsel from involvement
in similar suits on behalf of any other client, inducing other parties to sue
the former client or using confidential information gained during employment).

<h3>Okay, What Can I Do to That Deadb___ er, Distinguished Former Client?</h3>

When
a client files bankruptcy, there are numerous legal options available to a law
firm relating to the collection of its fee ranging from merely filing a proof
of claim to intensive litigation against the debtor. Decisions concerning an
attorney's<a href="#10" name="10a">10</a> ability to use the Claims or Defense Exception in a bankruptcy
proceeding have reached a variety of often contradictory conclusions.

Proofs of Claims and Claim Litigation. Initially,
it is important to note that all courts<a href="#11" name="11a">11</a> that have considered the Claims or
Defense Exception have found it perfectly appropriate for creditors to file
proofs of claim and otherwise defend their claims in debtors' bankruptcy
proceedings. In fact, given the openness of the claims-resolution process in
bankruptcy proceedings, clearly any limitation on the use of confidential
information in filing and defending a proof of claim would be tantamount to
depriving the lawyer of his right to assert a claim in standard bankruptcy.

Non-dischargeability Action. Although actions to determine the
dischargeability of debt under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U… U.S.C.
§523</a> or to deny the debtor a discharge under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §727</a> are generally considered by most bankruptcy practitioners
to be directly related to collection of a claim in bankruptcy, the Ninth
Circuit, in the case of In re Rindlisbacher,<a href="#12" name="12a">12</a> held that such actions are not directly related to the collection of
a claim, and therefore an attorney cannot invoke the Claims of Defense Exception
to the attorney/client privilege and use privileged information to attack the
debtor's right to a discharge in a bankruptcy proceeding.

In Rindlisbacher, the attorney represented
the debtor in a pre-petition marital dissolution action. During the trial of
the dissolution case, the debtor denied on the stand that he received rental
income from property that the debtor and his spouse owned. During a recess in
the trial, the debtor informed the attorney that he had lied under oath.<a href="#13" name="13a">13</a>
Sometime after the dissolution trial, the debtor filed a chapter 7 petition
owing his attorney approximately $24,000. In the debtor's chapter 7
bankruptcy schedules, the debtor also failed to list his rental income. The
debtor's former attorney, using the knowledge he gained of the
debtor's perjury in the state court dissolution trial, filed a complaint
to deny the debtor a discharge due to his failure to reveal his rental income
on his statement of financial affairs, his failure to account for the rental
income and his failure to keep accurate books and records. The attorney also
questioned the debtor about the rental income at depositions taken during the
bankruptcy case and in interrogatories relating to the rental income.

After
discovery was complete, the debtor moved for summary judgment, arguing that the
attorney had improperly used confidential client information in bringing the <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §727</a> denial-of-discharge proceeding. The bankruptcy court
agreed and granted the debtor's motion for summary judgment, and the
attorney appealed.

In its decision, the Ninth Circuit Bankruptcy Appellate Panel (BAP) noted that an
attorney can use confidences and secrets for the collection of the attorneys
fees or to defend a charge brought by the client against the attorney. However,
the BAP also held that the claim or defense exception did not apply in
non-dischargeability actions, ruling that:

<blockquote>
A debtor's pursuit of a discharge is not a breach of the duty to pay; it is
a right provided by the Bankruptcy Code. By seeking a discharge, the client
does not in any way call into question the validity of the attorney's
fee or the attorney's actions. He merely seeks to obtain a benefit that
the law allows. Because there is no breach of duty by the client, and no claim
against the attorney which the attorney must in fairness be permitted to
defend, the exception to the confidences rule for disclosure of communications
necessary to allow the attorney to collect a fee does not apply.<a href="#14" name="14a">14</a>
</blockquote>

The
reasoning of the BAP's decision—that a non-dischargeability action
does not relate to an attorney's efforts to collect a
debt—represents a very strict interpretation of the Claims or Defense Exception
to the attorney/client privilege and one that will severely limit an
attorney's effective ability to collect debts from clients in bankruptcy
proceedings. It is important to note, however, that the Ninth Circuit BAP did
not address the question of whether the Claims or Defense Exception would apply
in non-dischargeability actions under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §523</a>. Further, the extreme facts of Rindlisbacher, where the attorney used the debtor's
misconduct solely to his own advantage, may limit its holding to the rather
unique facts of the case.

The
Filing of a Creditor's Plan. While the Rindlisbacher court took a
very narrow view of the claims or defense exception to the attorney/client
privilege, the bankruptcy court in In re Burton Securities SA<a href="#15" name="15a">15</a> takes a far more expansive view of the extent of
the claims or defense exception to the attorney/client privilege. In Burton
Securities, an attorney represented Burton
Securities in two bankruptcies prior to Burton Securities's own chapter
11 in which Burton Securities sought to regain possession of a valuable vessel.
The attorneys were not paid for their efforts in representing Burton Securities
in prior bankruptcies. After Burton Securities filed its own chapter 11
petition, their former attorneys filed a creditor's reorganization plan.
The creditor's plan was approved by an overwhelming vote, but was
challenged by the debtor on the grounds it was not proposed in good faith as
required by <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1129(e)(3)</a> because their former attorneys were the
proponents of the plan, and due to the attorney/client privilege, those
attorneys could not actively participate in the reorganization of the debtor.

The Burton Securities court rejected the
arguments of the debtor, finding that (1) the attorneys did not use client
confidences in drafting the creditors' disclosure statement or
creditors' plan, and (2) even that if confidential information had been
used in drafting the creditors' disclosure statement and plan, those
actions would not have run afoul of the Texas Rules of Professional Conduct due
to the Claim or Defense Exception to the attorney/client privilege set forth
therein.<a href="#16" name="16a">16</a> The Burton Securities court also found no impropriety in the former attorney basically using the
bankruptcy process to force a reorganization plan on the debtor over the
objections of its former client.

Under Burton, as opposed to Rindlisbacher, the bankruptcy court took a far broader and more
lenient view of the ability of attorneys to pursue their claims in bankruptcy
proceedings. The Burton decision
seems far more in line with the rationale behind the Claims or Defense
Exception as it permits an attorney to continue to attempt to collect its fee
from a former client in bankruptcy without the former client being able to hide
behind the attorney client privilege to the detriment of the attorney.

Serving on an Unsecured Creditors Committee. Perhaps the most aggressive position taken by a law firm that was approved by a
bankruptcy court in an attempt to collect their fees in a bankruptcy proceeding
is found in the case of In re Featherworks Corp.<a href="#17" name="17a">17</a> In Featherworks, a law firm represented the debtor prior to
bankruptcy in litigation involving the debtor's largest non-insider
unsecured creditor. The law firm was terminated as debtor's counsel prior
to the bankruptcy filing and was owed approximately $33,000 at the time the
bankruptcy case commenced. Prior to the bankruptcy filing, the law firm
negotiated for the debtors a deed of trust in favor of the creditor in the face
amount of $256,000, which could be repaid and satisfied in full by a payment of
$125,000 over a five-year period at 10 percent interest. The face amount of the
deed of trust eliminated most of the equity in the debtor's real estate.

As part of the bankruptcy, the debtor's former attorney moved to be added to
the creditors' committee.<a href="#18" name="18a">18</a> The bankruptcy court, in a lengthy and
thoughtful opinion, ultimately reversed its earlier oral decision not to add
pre-petition attorneys to the creditors' committee, stating:

<blockquote>
Because the court was aware from the Hudson proceeding that Kerwin and Elliott had been the debtor's attorneys, the
court, in the exercise of its discretion, did not appoint that firm to the
creditors' committee. To the court, it seemed that to include a
debtor's former attorneys in the creditors' committee might result
in a conflict of loyalties. On the one hand, the debtor's creditors would
depend on the committee and its members for guidance in such matters as whether
to "investigate the acts, conduct, assets, liabilities and financial
condition of the debtor, the operation of the debtor's business and the
desirability of the continuance of such business, and any other matter relevant
to the case or to the formulation of a plan" (<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1103(c)(2)</a>); on the other hand, the attorney might be
inhibited from giving such guidance by his obligation to preserve the
confidences and secrets of his client. It seems unfair to Kerwin and Elliott to
place them in a position where their duty to the debtor's creditors might
conflict with the duty they owed their former client to preserve the
confidences and secrets to which they became privy in their position as
attorneys. Furthermore, the court did not deem it necessary for Kerwin and
Elliott to be members of the creditors' committee in order to establish
or collect their fee. Accordingly, the court did not include Kerwin and Elliott
on the creditors' committee."<a href="#19" name="19a">19</a>

</blockquote>

It is important to note that the debtors did not object on the grounds of
attorney/client privilege to the addition of their pre-petition attorneys to
the creditors' committee, and that the Featherworks case committee was not functional and it was
unlikely, given the status of the case, that it would ever be functional.

The
second action taken by the debtor's pre-petition attorney in the Featherworks case was to move to subordinate the claim of the
debtor's ultimate owner. The basis for the subordination motion was the
confidential information the pre-petition attorneys obtained relating to the
$256,000 deed of trust given by the debtors to secure a $125,000 debt. Although
the court did allow the attorneys to present whatever evidence they had
available relating to this issue, the court reserved the right to have that
evidence sealed should it adversely affect the debtor's attorney/client
privilege.

The Featherworks case stands in stark contrast to the Rindlisbacher case of the Ninth Circuit BAP in that the bankruptcy court in Featherworks gave the debtor's attorneys wide latitude in
using confidential information in actions that were not directly related to the
collection of their claims against the debtor. It is important to note that
although the pre-petition attorneys were appointed to the committee, the
bankruptcy court did this with a great deal of reluctance, recognizing the
possibility of the serious conflicts such an appointment would place on the
pre-petition attorneys, and clearly made this ruling in part from its belief
that the committee would never function in this chapter 11 proceeding. Featherworks is clearly the best case that an attorney can cite
to when attempting to use confidential client information to collect his
pre-petition claims in bankruptcy.

2004 Discovery. It is important to note that in
light of the Claims or Defense Exception to the attorney/client privilege that
other parties have attempted to force an attorney to use the Claims or Defense
Exception in an effort to get otherwise privileged information in a 2004 exam.
In the case of In re Stoutamire,<a href="#20" name="20a">20</a>
the chapter 13 trustee attempted to make an attorney for a chapter 13 debtor
testify about his bankruptcy intake process, and the questions he asked the
debtor related to a lawsuit settlement that the debtor received after filing
chapter 13 but failed to reveal in the bankruptcy schedules and <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §341</a> meeting of creditors. The chapter 13 trustee sought
to question the attorney's paralegal, who worked primarily on the
debtor's schedules arguing that the Claims or Defense Exception of the
attorney/client privilege would permit testimony in order to defend the
attorney from a claim of improper behavior. The bankruptcy court rejected this
interpretation, noting that no malpractice claim had been brought against the
attorney, nor was there an accusation of wrongful conduct within the meaning of
the applicable Georgia Rules of Professional Conduct.<a href="#21" name="21a">21</a>

In the similar case of In re French,<a href="#22" name="22a">22</a> the
Farmers Home Administration filed a motion for a 2004 examination of the
debtor's counsel's certified legal assistant concerning an omission
of $50,000 from the debtor's bankruptcy schedules in the petition. The
Farmers Home Administration had previously questioned the debtor about the
omission from the schedules, and the debtor had testified that he had disclosed
the $50,000 to the certified legal assistant for inclusion in his bankruptcy
schedules in his petition. The Farmers Home Administration argued that the
debtor's testimony constituted either a waiver of the attorney/ client
privilege or claims against the attorney that involved the Claim or Defense
Exception to the attorney/client privilege, and would permit the
attorney's certified legal assistant to testify about the debtor's
statement to her for inclusion in the schedules.

The bankruptcy court, while recognizing the broad scope of Rule 2004, held that
questioning an attorney's certified legal assistant was tantamount to
questioning the attorney himself and that the attorney/client privilege
prevented the certified legal assistant from testifying about the information
that the debtors gave to her as part of the preparation of the debtor's
schedules in the petition. The court determined that the Claim or Defense
Exception to the attorney/client privilege did not apply in this case and that
no waiver of the attorney/client privilege had occurred by the debtor's
previous testimony. The bankruptcy court therefore exercised its discretion to
deny the request for the 2004 exam in French.

Conclusion. From a review of the above-discussed bankruptcy
precedents, it is obvious there is no coherent rule as to when the Claim or
Defense Exception to the attorney/client privilege can be invoked in bankruptcy
proceedings other than in the context of filing a proof of claim or in defense
of that claim from the debtor's objections. The court decisions range
between the Ninth Circuit BAP's very narrow view of the Claim or Defense
Exception in Rindlisbacher and
the extremely liberal and expansive view of the claims or defense exception
articulated by the bankruptcy court in Featherworks. In the event this issue should arise, attorneys
should carefully weigh their options, consult with professionals who are
skilled in the ethical rules of the applicable state and, if they decide to use
confidential information against their former client, should take care to limit
that use to the extent necessary to prove their claim or defend against a
lawsuit. The bankruptcy courts, like other courts considering the claim of
defense excep-tion, have shown a great willingness to allow attorneys to
collect on their claims, but show far less willingness in allowing attorneys to
proceed in "collateral actions" relating to their fees. Therefore,
an attorney should exercise great care in attempting to collect their claims
from bankruptcy proceedings lest they go from the status of a creditor to the
status of an asset of the estate.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Board-certified in business bankruptcy by the American Board of Certification. <a href="#1a">Return to article</a>

<a name="2">2</a> State law generally governs the scope of the attorney/client privilege in bankruptcy proceedings. See Fed.R.Evid 501; In re Rindlisbacher, 225 B.R.180 (BAP 9th Cir. 1998). See, also, In re Burton Securities SA, 148 B.R. 478, 480 (Bankr. S.D. Tex. 1992) (holding that "ethical rules announced by the national profession in light of the public interest" may also govern attorney/client privilege issues). <a href="#2a">Return to article</a>

<a name="3">3</a> 709 F.2d 1043, 1050 (5th Cir. 1983). <a href="#3a">Return to article</a>

<a name="4">4</a> 621 N.W. 2d 460 (Minn. 2001). <a href="#4a">Return to article</a>

<a name="5">5</a> 406 So. 2d 459 (Fla. 1981). <a href="#5a">Return to article</a>

<a name="6">6</a> 409 F.Supp. 1220 (S.D.N.Y. 1976). <a href="#6a">Return to article</a>

<a name="7">7</a> 712 P.2d 97 (Or. 1985). <a href="#7a">Return to article</a>

<a name="8">8</a> ____ P.3d ___ 2003 WL 22175989 (Utah 2003). <a href="#8a">Return to article</a>

<a name="9">9</a> 709 F.2d at 1043. <a href="#9a">Return to article</a>

<a name="10">10</a> It is important to note that if an attorney is prohibited from using confidential information against a client or former client in an action, any counsel employed by that attorney
will also be prohibited from using that information. See, generally, Spratley v. State Farm Mutual Automobile Insurance Co., ____ P.3d ____, 2003 WL 22176989 (Utah 2003). <a href="#10a">Return to article</a>

<a name="11">11</a> In re Rindlisbacher, 225 B.R. 180, 182 (9th Cir. BAP 1998); In re Stoutamire, 201B.R. 592, 597 (Bankr. S.D. Ga. 1996); In re Burton SA, 148 B.R. 478, 480 (Bankr. S.D. Tex.
1992); In re French, 145 B.R. 991, 993 (Bankr. D. S.D. 1992); In re Featherworks, 25 B.R. 634, 645-46 (Bankr. E.D.N.Y. 1982). <a href="#11a">Return to article</a>

<a name="12">12</a> 225 B.R. 180. <a href="#12a">Return to article</a>

<a name="13">13</a> There is an unanswered question as to why the attorney in Rindlisbacher did not disclose his client's perjury to the state court or withdraw as counsel in those proceedings. <a href="#13a">Return to article</a>

<a name="14">14</a> 225 B.R. at 183. <a href="#14a">Return to article</a>

<a name="15">15</a> 148 B.R. at 478. <a href="#15a">Return to article</a>

<a name="16">16</a> Id. at 480. <a href="#16a">Return to article</a>

<a name="17">17</a> 25 B.R. at 183. <a href="#17a">Return to article</a>

<a name="18">18</a> Id. at 642. At the time of the Featherworks decision, bankruptcy courts appointed the members of creditors' committees. <a href="#18a">Return to article</a>

<a name="19">19</a> Id. at 645. <a href="#19a">Return to article</a>

<a name="20">20</a> 201 B.R. at 592. <a href="#20a">Return to article</a>

<a name="21">21</a> 201 B.R. at 597. <a href="#21a">Return to article</a>

<a name="22">22</a> 145 B.R. at 991. <a href="#22a">Return to article</a>

Journal Authors

C. R. Bowles

Journal Date

Saturday, November 1, 2003 - 12:00

Bankruptcy Rule

2003