A lawyer who allegedly helped judgment debtors hide their assets in his trust account got off scot-free under New York fraudulent transfer law combined with ethical rules governing a lawyer’s conduct.
Any lawyer tempted to act in a similar fashion should first consult her or his malpractice carrier before harboring a client’s assets, based on the comfort given by a decision by Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y.: The lawyer’s victory turned on the failure of proof, not on absolute immunity conferred by law.
The IOLA Account
A creditor had an unsatisfied judgment for about $370,000 against a group of judgment debtors. While the judgment was outstanding, the judgment debtors transferred some $250,000 from their bank accounts to a lawyer’s trust account, more accurately known in New York as an Interest on Lawyer’s Account, or IOLA. Funds in an IOLA are held by the attorney in a fiduciary capacity for the client.
Although he was their longtime counsel, the lawyer had not represented the clients in the lawsuit resulting in the judgment. He came onto the scene after entry of the judgment.
After receiving the deposits into his IOLA, the attorney disbursed all of the clients’ funds at the clients’ directions over time to them or to third parties.
The lawyer ended up in chapter 7, where the creditor filed a claim for $250,000 along with a complaint alleging that the debt was nondischargeable under Sections 523(a)(4) and (6).
The creditor alleged that the lawyer willfully and maliciously participated in a scheme with the judgment debtors to conceal their assets.
The Failure of Proof
Judge Grossman held a trial and wrote a decision on January 13 absolving the lawyer of liability. The result might have been different had the creditor called the judgment debtors as witnesses and relied on testimony from someone other than the lawyer.
Judge Grossman said the creditor had standing to bring a nondischargeability suit only if he were a creditor. To be a “creditor,” the creditor was relying on the New York Debtor & Creditor Law, or DCL, which proscribes fraudulent transfers.
To sustain claims under the DCL, Judge Grossman said the creditor was required to prove that the lawyer acted as a coconspirator, not as the judgment debtors’ attorney.
Judge Grossman turned to the ethical rules for lawyers contained in the New York Rules of Professional Conduct. He cited a section, among others, that requires a lawyer to deliver property “as requested by the client.”
“While it is not inconceivable that an attorney could venture beyond these duties to conspire with his or her client to injure the client’s creditor,” Judge Grossman said that “the record cannot support a finding that such a circumstance exists here.” He said the lawyer-debtor “had an affirmative duty” to follow the clients’ instructions about receipt and disbursement of funds in the IOLA.
Although the creditor alleged that the lawyer was part of a conspiracy to hide the clients’ assets, Judge Grossman said the creditor didn’t call the judgment debtors as witnesses. He said they were “the only parties who could confirm whether the [lawyer’s] conduct was motivated by a conspiracy to defraud the [creditor].”
Judge Grossman said that the “record precludes a finding that the [lawyer] acted as anything other than an attorney to the Judgment Debtors.”
Having found that the debtor was acting as a lawyer, Judge Grossman turned to the question of whether the debtor-lawyer violated the DCL in that capacity.
Judge Grossman cited the New York Court of Appeals, the highest state court in New York, for holding that the DCL does not even implicitly create a remedy for a fraudulent transfer against someone who was neither the transferee nor the beneficiary of a fraudulent transfer. In turn, status as a transferee under the DCL turns on whether the transferee exercised dominion and control over the transferred property.
Having followed the clients’ instructions, Judge Grossman found that the lawyer was not a transferee because he did not exercise dominion and control over the clients’ funds. Because the lawyer was not a transferee, the lawyer was not liable for a fraudulent transfer, and the judgment creditor was not a “creditor” of the lawyer.
Because the judgment creditor was not a “creditor” of the lawyer-debtor, the creditor did not have standing for the nondischargeability complaint.
Even if the judgment creditor was a “creditor,” Judge Grossman went on to rule that the lawyer was not acting in a fiduciary capacity toward the judgment creditor. Therefore, the judgment creditor didn’t have a claim under Section 523(a)(4) for defalcation while acting in a fiduciary capacity.
Similarly, Judge Grossman dismissed the judgment creditor’s claim under Section 523(a)(6), based on the notion that the lawyer willfully and maliciously injured the judgment creditor or its property.
In that regard, the debtor-lawyer had testified that he was following his clients’ instructions in holding and disbursing the funds in the IOLA. Having called no one as a witness other than the lawyer, the creditor failed to prove that the lawyer willfully intended to harm the judgment creditor. Rather, the lawyer-debtor only intended to follow his clients’ instructions. Likewise, there was no showing of malice.
A lawyer who allegedly helped judgment debtors hide their assets in his trust account got off scot-free under New York fraudulent transfer law combined with ethical rules governing a lawyer’s conduct.
Any lawyer tempted to act in a similar fashion should first consult her or his malpractice carrier before harboring a client’s assets, based on the comfort given by a decision by Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y.: The lawyer’s victory turned on the failure of proof, not on absolute immunity conferred by law.
The IOLA Account
A creditor had an unsatisfied judgment for about $370,000 against a group of judgment debtors. While the judgment was outstanding, the judgment debtors transferred some $250,000 from their bank accounts to a lawyer’s trust account, more accurately known in New York as an Interest on Lawyer’s Account, or IOLA. Funds in an IOLA are held by the attorney in a fiduciary capacity for the client.
Although he was their longtime counsel, the lawyer had not represented the clients in the lawsuit resulting in the judgment. He came onto the scene after entry of the judgment.
After receiving the deposits into his IOLA, the attorney disbursed all of the clients’ funds at the clients’ directions over time to them or to third parties.
The lawyer ended up in chapter 7, where the creditor filed a claim for $250,000 along with a complaint alleging that the debt was nondischargeable under Sections 523(a)(4) and (6).