Just as a bank robber cannot use the loot to wage the best defense money can buy...so a swindler...cannot use the victims' assets to hire counsel who will help him retain the gleanings of crime.²

While those who stand accused of criminal conduct in the United States unquestionably have a right to the aid of legal counsel to defend against the charges directed at them, the foregoing observation illustrates the point that they do not necessarily have an unqualified right to retain their counsel of choice. "[A] defendant may not insist on representation by an attorney he cannot afford."³

A criminal defendant's right to retain counsel is, in many contexts, impacted by procedural limitations on his ability to use assets once under his control. For example, the accused can be prohibited from using the proceeds of his crime 'or other assets subject to forfeiture'to pay for a defense attorney,⁴ and a defendant cannot use administratively frozen assets to pay for his criminal defense.⁵

In a bankruptcy context, it seems clear that a debtor in a voluntary bankruptcy case generally cannot use property of the estate to finance his criminal defense.⁶ However, bankruptcy courts have not published any decisions concerning the limits the Bankruptcy Code places on a debtor's use of estate funds to pay for his criminal defense in an involuntary bankruptcy proceeding. This article explores that issue, and concludes that the Code does not permit estate funds to be used in this manner.

Overview of Involuntary Bankruptcy Law

Involuntary bankruptcies are rare. Section 303 of the Code sets forth many of the rules that govern involuntary bankruptcy filings. Section 303(a) explains that an involuntary bankruptcy can only be filed under chapter 7 or 11.⁷ While an involuntary case can be brought against an individual, partnership or corporation,⁸ it cannot be brought against a governmental unit, a farmer, family farmer or eleeymosynary institution, such as a nonprofit corporation.⁹ An involuntary bankruptcy against a person may only be started by the filing with the bankruptcy court of a petition by a statutorily-eligible creditor or group of creditors.¹⁰

The Code permits a group of three or more creditors, each of which is either a holder of a claim against a debtor that is "not contingent as to liability or the subject of a bona fide dispute as to liability or amount, or an indenture trustee representing such a holder," provided the claims at issue aggregate at least $12,300 "more than the value of any lien on property of the debtor securing such claims held by the holders of such claims."¹¹ In other words, the groups of creditors must have a total of unsecured claims over $12,300.

In addition, if there are less than 12 such creditors,¹² one or more specified creditors that hold in the aggregate at least $12,300 of eligible claims can petition for involuntary relief. To file such a petition under 11 U.S.C. §303(b)(2)(b)(2), a creditor must hold a claim that is not contingent nor subject to a bona fide dispute, and cannot be an employee, insider or transferee of an avoidable transfer.

The debtor can contest an involuntary petition.¹³ After any trial on a contested petition, the court shall order relief against the debtor only if—

1. the debtor is generally not paying such debtor's debts as such debts become due unless such debts are the subject of a bona fide dispute as to liability or amount, or
2. within 120 days before the date of the filing of the petition, a custodian, other than a trustee, receiver or agent appointed or authorized to take charge of less than substantially all of the property of the debtor for the purpose of enforcing a lien against such property, was appointed or took possession.¹⁴

The petitioner has the burden of proving that the case is eligible for involuntary bankruptcy.¹⁵

Even though an involuntary case is governed by some unique rules, the filing of such a case nevertheless creates a bankruptcy estate,¹⁶ consisting of all legal and equitable interests in property that a debtor held before the date of filing¹⁷ and causes
the automatic stay to go into effect.¹⁸ Consequently, all property owned by a debtor in an involuntary case is property of the estate, even during the gap period between the date of filing and the date relief is granted.

When enacting §303, Congress took into consideration the effect various provisions of the Code might have on the operation of a business against which an involuntary petition was sought. For example, Congress wanted to ensure that the limitations on the use of estate proper set forth in §363 did not unfairly burden a debtor during the time period between the date of filing and when the petition was ruled on. Thus, it enacted §303(f), which provides:

Notwithstanding §363 of this title, except to the extent that the court orders otherwise, and until an order for relief in the case, any business of the debtor may continue to operate, and the debtor may continue to use, acquire or dispose of, property as if an involuntary case concerning the debtor had not been commenced.

Section 303(f) does not permit a debtor to dismantle his business during the gap period.¹⁹ For §303(f) to apply, however, the debtor must be operating a business and must use the property in question to continue the operation of the business. Conversely, an involuntary debtor is not authorized under §303(f) to use its property for purposes unrelated to its pre-petition business.²⁰

Section 502²¹ of the Code similarly restricts how estate property can be used to compensate creditors for work done between the date of filing and entry of the order of relief, otherwise known as the "gap period."²² Section 502 generally governs the allowance of claims or interests in bankruptcy. The answer to how the unpaid gap-period claim of a debtor's criminal defense counsel must be treated is contained in 11 U.S.C. §502(f):

In an involuntary case, a claim arising in the ordinary course of the debtor's business or financial affairs after the commencement of the case but before the earlier of the appointment of a trustee and the order for relief shall be determined as of the date such claim arises, and shall be allowed under subsection (a), (b) or (c) of this section or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.

Section 502(f) was designed to protect creditors that transact business with an involuntary debtor during the gap period, "such as lessors, trade creditors and similar parties, consistent with §303(f)'s specific grant to the involuntary debtor to conduct its business in ordinary fashion" while its financial future is unresolved.²³ Thus, in cases where a bankruptcy court is asked to permit payment of a debtor's "gap period" criminal defense fees from the estate, the plain meaning of the statute limits its application to cases where the "gap period" costs of the debtor's criminal defense counsel were in the "ordinary course of the debtor's business or financial affairs."²⁴ While no published case law currently addresses the propriety of granting a "gap period" claim for the services of criminal defense counsel, both legal precedent and common sense support the proposition that such legal work is not within the scope of §502(f).

Criminal Defense Work Is Not in the Ordinary Course of a Debtor's Business or Financial Affairs

U.S. Bankruptcy Judge Nancy C. Dreher was among the first bankruptcy jurists to decide how to interpret the phrase "ordinary course of the debtor's business" in §502(f) in In re Hanson Industries Inc., 90 B.R. 405 (Bankr. D. Minn. 1988).²⁵ Hanson Industries remains a seminal case in §502(f) law.

The debtor in Hanson Industries had made false statements to obtain, or in connection with, pre-petition financing.²⁶ Further, the Hanson Industries involuntary debtor "chose to vigorously defend the petition for involuntary bankruptcy."²⁷ After the involuntary petition was granted, the debtor's bankruptcy counsel requested payment from the estate of $86,128.81 for his work, with $23,394.09 arising pre-petition and $62,734.71 arising during the post-petition gap period.²⁸ Judge Dreher analyzed whether the claim before her could be allowed under the standards set forth in 11 U.S.C. §502(f).²⁹

The Hanson Industries §502(f) analysis first explained the purpose of the statute.

Section 502(f) was intended to protect the creditors who deal with an involuntary debtor during the gap period, such as lessors, trade creditors and similar parties, consistent with §303(f)'s specific grant to the involuntary debtor to conduct its business in ordinary fashion while its status is resolved.³⁰

Within this framework, Judge Dreher next examined whether the work performed by the debtor's attorney was an allowable claim as an expense rendered in the "ordinary course of the debtor's business" during the "gap period."

There was little to no case law interpreting §502(f) when Hanson Industries was decided. Thus, the decision looked to how other courts had interpreted the phrase "ordinary course of business" under other parts of the Code, such as §363 or 364. Though noting that the term "ordinary course of business" had both vertical and horizontal dimensions as used in §363(c)(1),³¹ Judge Dreher reduced her analysis to a concise inquiry: "Under either test, an examination of the transaction vis-a-vis either the debtor's business or the industry, the size, nature or both, of the transaction may be disposative on the issue of ordinariness."³² The Hanson Industries court also noted that in the context of preference actions, the phrase "ordinary course of business" had been held to contemplate "normal credit transactions, such as the sale of goods for a business supplier on account."³³ Within this framework, the Hanson Industries court did not allow the claim for most of the fees requested by the debtor's attorney because "much of the time for which [the attorney sought] second priority status [fell] outside the ordinary nature of things."³⁴ A claim of approximately $12,000 was approved, however, for "fees and expenses incurred in connection with general corporate matters" and business litigation.³⁵

Hanson Industries essentially requires bankruptcy courts to examine whether the nature of the claim at issue is for work typically performed in the debtor's pre-petition business or in the debtor's industry. If the work is "extraordinary," it falls outside the scope of §502(f) and cannot be allowed. Other courts have reached similar conclusions.³⁶

Application of §502(f) and the Hanson Industries test to the facts of most "gap period" requests for payment of criminal defense fees from the estate would seemingly compel a bankruptcy court to deny such a claim.

If a debtor cannot, under §502(f), use estate funds to pay his bankruptcy counsel for an unsuccessful "gap period" defense against an involuntary petition, it is difficult to fathom how he can use estate funds to pay for his personal defense against criminal charges during the "gap period." If the ordinariness of such claims are assessed under the Hanson Industry standards, it is clear that they cannot be incurred in the "ordinary course of the debtor's business." Few'if any'legitimate businesses require a debtor to ordinarily hire criminal defense counsel. Such fees are not "trade" expenses that have to be incurred to keep a business afloat. It is unlikely that similar businesses in a particular trade or industry ordinarily have a need for criminal defense counsel. And it is simply difficult to conceive of any legitimate business that retains the services of criminal defense counsel in the ordinary course of its ongoing commercial affairs. Under the Hanson Industry test, a "gap period" claim of a debtor's criminal defense counsel is simply not within the scope of claims that can be allowed under §502(f).

Approval of such a "gap period" claim would not only violate §502(f) but would circumvent fundamental principles of federal bankruptcy law. American bankruptcy laws are intended to give "the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt."³⁷ The Code was crafted to "protect those in financial, not moral, difficulty. The bankruptcy courts were not created as a haven for criminals."³⁸ The bankruptcy court's responsibility in administering the estate is to achieve a fair and equitable distribution of assets to the creditors and to "relieve the honest debtor from the weight of oppressive indebtedness and permit him to start afresh."³⁹ Allowing a "gap period" claim of a debtor's criminal defense counsel would inequitably benefit a dishonest debtor by allowing him to use estate assets to pay a personal post-petition bill, incurred outside the ordinary course of business, and thereby avoid having the funds used to make a fair and equitable distribution to his creditors, including, perhaps, victims of his crime. The Code should not be interpreted to allow a debtor to escape his obligation to pay the victims of his pre-petition criminal activities under the Mandatory Criminal Restitution Act.⁴⁰ The drafters of the Code certainly did not intend for §502(f) to authorize a convicted criminal to use estate property to fill the coffers of his defense counsel at the expense of his victims and other creditors.

Application of §502(f) in this manner may mean that a debtor's criminal defense counsel cannot recover payment from the estate for "gap period" work performed. Under §§507(2) and 502(f), allowed gap period claims are given second priority among unsecured claims. However, there is no statutory authority for a bankruptcy court to allow payment of a denied claim from the bankruptcy estate.⁴¹

Conclusion

The foregoing discussion illustrates why criminal defense counsel should carefully consider the impact that a bankruptcy filing'either voluntary or involuntary'can have on the ability of their clients to compensate them from assets of a bankruptcy estate. Section 303(f) of the Code may not permit an involuntary debtor to use estate property for nonbusiness purposes, such as paying criminal defense counsel. In addition §502(f) may, after the involuntary petition has been granted, not allow criminal defense counsel to be paid for "gap period" work from the bankruptcy estate. In summary, criminal defense counsel's failure to explore the effect of bankruptcy on a client's ability to pay his attorneys fees during an involuntary bankruptcy may unexpectedly transform an anticipated profit-making case into a large pro bono endeavor.

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Footnotes

¹ Assistant U.S. Attorney, Southern District of Iowa; J.D. (1989) Washington University; M.A. (1986-sociology) and B.A. (1984-journalism) Eastern Illinois University; former law clerk (1989-91) to the late Hon. Frank W. Koger, U.S. Bankruptcy Judge, W.D. Mo. The views expressed in this article are solely those of the author and should not be attributed to the U.S. Department of Justice, the U.S. Attorney for the Southern District of Iowa or any other person or entity associated with him. Return to article

² Securities Exchange Commission v. Quinn, 997 F.2d 287, 289 (7th Cir. 1993) (citations omitted). Return to article

³ Wheat v. United States, 486 U.S. 153, 159 (1988). Return to article

⁴ Caplin & Drysdale Chtd. v. United States, 491 U.S. 617, 631 (1989) (neither the Fifth nor the Sixth Amendment requires Congress to permit a defendant to use assets adjudged to be forfeitable to pay the defendant's legal fees); United States v. Monsanto, 491 U.S. 600, 616 (1989) (no constitutional violation occurs when, after probable cause is adequately established, the government obtains a pre-trial restraining order barring a defendant from dissipating forfeitable assets, including assets he hopes to use to pay for his defense). Return to article

⁵ United States v. Spiegel, 995 F.2d 138 (9th Cir. 1993) ("Spiegel is in no different a position than any other criminal defendant whose assets are tied down by a lien, a prejudgment attachment or a bankruptcy court order. In all such cases, the freezing of defendant's assets may interfere with his ability to pay a lawyer, but this does not empower the district court to interfere with the bankruptcy proceeding or to lift the lien or attachment imposed by another court, state or federal"). Return to article

⁶ "The estate moneys cannot be used to pay the debtor's attorney in representing him when he has been charged with a crime." In re Pajarito American Indian Art Inc., 11 B.R. 807, 811 (Bankr. D. Ariz. 1981); In re Engel, 124 F.3d 567 (3rd Cir. 1997); Matter of Jack Winter Apparel Inc., 119 B.R. 629 (E.D. Wis. 1990); In re Duque, 48 B.R. 965 (S.D. Fla. 1984); In re French, 139 B.R. 485 (Bankr. D. S.D. 1992); In re Dixon, 143 B.R. 671 (Bankr. N.D. Tex. 1992); In re Stoecker, 114 B.R. 965 (Bankr. N.D. Ill. 1990); In re Moore, 57 B.R. 270 (Bankr. W.D. Okla. 1986); See, also, Gaumer, Craig Peyton and Griffith, Paul R., "Presumed Indigent: The Effect of Bankruptcy on a Debtor's Sixth Amendment Right to Criminal Defense Counsel," 62 UMKC L. Rev. 277 (1993). Return to article

⁷ 11 U.S.C. §303(a). Return to article

⁸ 11 U.S.C. §303(a) and §101(41) (defining "person"). Return to article

⁹ 11 U.S.C. §303(a). Return to article

¹⁰ 11 U.S.C. §303(b). Return to article

¹¹ 11 U.S.C. §303(b)(1). Return to article

¹² See 11 U.S.C. §303(b)(2). Matter of Rassi, 701 F.2d 627 (7th Cir. 1983). Return to article

¹³ 11 U.S.C. §303(d). Return to article

¹⁴ 11 U.S.C. §303(h). Return to article

¹⁵ In re Byrd, 357 F.3d 433 (4th Cir. 2004). Return to article

¹⁶ In re McGinnis, 306 B.R. 279, 284 (Bankr. W.D. Mo. 2004). Return to article

¹⁷ 11 U.S.C. §541(a)(1). Return to article

¹⁸ E.E.O.C. v. McLean Trucking Co., 834 F.2d 398, 399 (4th Cir. 1987) (automatic stay is created upon filing of either voluntary or involuntary bankruptcy petitions); Matter of Eugene L. Pieper P.C., 202 B.R. 294, 297 (Bankr. D. Neb. 1996) ("The automatic stay is triggered by the act of filing an involuntary petition pursuant to 11 U.S.C. §303, not by the entry of an order for relief by the court"). Return to article

¹⁹ In re DiLorenzo, 161 B.R. 752, 754 (Bankr. S.D.N.Y. 1993) ("an alleged debtor should remain in control of his assets unless it is shown that he may attempt to abscond with assets, dispose of them at less than their fair market value, or dismantle his business, all to the detriment of [his] creditors.") citing H.R.Rep. 95-595, 95th Cong., 1st Sess. 323 (1977); Senate Rep. No. 95-989, 95th Cong., 2d Sess. 33 (1978), U.S. Code Cong. & Admin.News 1978, 5787, 6279, 5819. Return to article

²⁰ See In re Bankvest Capital Corp., 276 B.R. 12, 26 (Bankr. D. Mass. 2002) ("Section 303(f) refers to an involuntary debtor using its property to carry on its business"); In re Consolidated Partners Inv. Co., 156 B.R. 982, 984 (Bankr. N.D. Ohio 1993) ("Under §303(f), the debtor, as an involuntary debtor, was authorized to continue its business operations unrestrained by the provisions of §363 of the Code"); In re Omni Graphics Inc., 119 B.R. 641, 643 (Bankr. E.D. Wis. 1990) (bank's actions violated automatic stay, and §303(f) did not apply because sale of the assets "in no manner enabled the debtor to carry on its business operations. Quite to the contrary, the surrender agreement contemplated the debtor not engaging in business and was geared to a complete liquidation of all of the debtor's assets"); In re Greenwalt, 48 B.R. 804, 807 (D. Colo. 1985) (loan was "outside the ambit of transfers made in the ordinary course of business [under §303(f)] because the debtor was not in the business of providing financing to fledgling companies"). Return to article

²¹ The United States does not waive its prior assertion that the settlement is objectionable because it may have involved a transaction that is avoidable under 11 U.S.C. §549. Further, it reserves the right to argue that any allowed post-petition claim for the services of the debtor's criminal defense counsel should be equitably subordinated to those of general creditors of the estate, and particularly the victims of the debtor's crime, pursuant to 11 U.S.C. §510. Return to article

²² See In re Commonwealth Sprinkler Co. Inc., 295 B.R. 852 (Bankr. E.D. Va. 2003); In re Monarch Capital Corp., 163 B.R. 899 (Bankr. D. Mass. 1994); In re Manufacturer's Supply Co., 132 B.R. 127 (Bankr. N.D. Ohio 1991); In re Hanson Industries Inc., 90 B.R. 405 (Bankr. D. Minn. 1988). Return to article

²³ In re Hanson Industries Inc., 90 B.R. 405, 413 (Bankr. D. Minn. 1988) (citing S. Rep. No. 95-989, 95th Cong., 2d Sess. 65, reprinted in 1978 U.S. Code Cong. & Admin. News 5787, 5851); In re Manufacturer's Supply Co., 132 B.R. 127, 129 (Bankr. N.D. Ohio 1991). Return to article

²⁴ Cf. Hartford Underwriters Ins. Co. v. Union Planters Bank N. A., 530 U.S. 1, 6 (2000) ("when the statute's language is plain, the sole function of the courts...is to enforce it according to its terms") (citations omitted). Return to article

²⁵ Judge Dreher was placed in a predicament similar to that in which this court finds itself. She noted: "I have the rather unwelcome task of passing on requests for attorneys fees and costs arising out of...[an involuntary bankruptcy case]...without having the benefit of presiding at the time." Id. at 406. Though the task of passing judgment on whether attorney's fees may be paid from the estate can be an unwelcome experience, it is nevertheless necessary to ensure that the limited asset of a bankruptcy estate are fairly distributed in the manner provided by the Code. Return to article

²⁶ Id. at 407. Return to article

²⁷ Id. at 408. Return to article

²⁸ Id. at 412. Return to article

²⁹ Id. at 413-417. Return to article

³⁰ Id. at 413, citing 1978 U.S. Code Cong. & Admin. News 5787, 5851. Return to article

³¹ Id. at 414. Return to article

³² Id. Return to article

³³ Id. at 414-415, citing Kallen v. Litas, 47 B.R. 977 at 984 (N.D. Ill. 1985). Return to article

³⁴ Id. at 414. Return to article

³⁵ Id. at 417. Return to article

³⁶ See In re Commonwealth Sprinkler Co. Inc., 295 B.R. 852, 854-55 (Bankr. E.D. Va. 2003) (fees of debtor's counsel during gap period were not in ordinary course of debtor's business); In re Monarch Capital Corp., 163 B.R. 899, 905 (Bankr. D. Mass. 1994) (claim arising from arrangement prompted by the bankruptcy filing, and claim arising from sale of corporate subsidiary, were denied because they were out of the ordinary); In re Manufacturer's Supply Co., 132 B.R. 127 (Bankr. N.D. Ohio 1991). Return to article

³⁷ Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934). Return to article

³⁸ Barnette v. Evans, 673 F.2d 1250, 1251 (11th Cir. 1982); In re French, 139 B.R. 485, 489 (Bankr. D. S.D. 1992). Return to article

³⁹ In re Luongo, 259 F.3d 323, 330 (5th Cir. 2001) (citations omitted). Return to article

⁴⁰ 18 U.S.C. §3663A. Return to article

⁴¹ See, e.g., 11 U.S.C. §726 (distribution of property of the estate). Return to article