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

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

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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.

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

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,2 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:

(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:
(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.

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:

(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.

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,3 "[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 In re Fuller4 (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,5 (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.6 (discussing appropriate use of confidential client information in action to attach client property in connection with the fee claim); In re Jordan,7 (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.8 (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.9 (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).

Okay, What Can I Do to That Deadb___ er, Distinguished Former Client?

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's10 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 courts11 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 11 U.S.C. §523 or to deny the debtor a discharge under 11 U.S.C. §727 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,12 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.13 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 11 U.S.C. §727 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:

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.14

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 11 U.S.C. §523. 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 SA15 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 11 U.S.C. §1129(e)(3) 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.16 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.17 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.18 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:

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" (11 U.S.C. §1103(c)(2)); 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."19
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,20 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 11 U.S.C. §341 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.21

In the similar case of In re French,22 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.


1 Board-certified in business bankruptcy by the American Board of Certification. Return to article

2 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). Return to article

3 709 F.2d 1043, 1050 (5th Cir. 1983). Return to article

4 621 N.W. 2d 460 (Minn. 2001). Return to article

5 406 So. 2d 459 (Fla. 1981). Return to article

6 409 F.Supp. 1220 (S.D.N.Y. 1976). Return to article

7 712 P.2d 97 (Or. 1985). Return to article

8 ____ P.3d ___ 2003 WL 22175989 (Utah 2003). Return to article

9 709 F.2d at 1043. Return to article

10 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). Return to article

11 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). Return to article

12 225 B.R. 180. Return to article

13 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. Return to article

14 225 B.R. at 183. Return to article

15 148 B.R. at 478. Return to article

16 Id. at 480. Return to article

17 25 B.R. at 183. Return to article

18 Id. at 642. At the time of the Featherworks decision, bankruptcy courts appointed the members of creditors' committees. Return to article

19 Id. at 645. Return to article

20 201 B.R. at 592. Return to article

21 201 B.R. at 597. Return to article

22 145 B.R. at 991. Return to article

Journal Date: 
Saturday, November 1, 2003