Ethical Problems in Bankruptcy
| Publication year | 1985 |
| Pages | 2147 |
1985, December, Pg. 2147. Ethical Problems in Bankruptcy
Every area of law is governed by various ethical considerations, and bankruptcy is no exception. In addition to being subject to the ethical standards prescribed by the Code of Professional Responsibility ("CPR"), the bankruptcy practitioner must comply with the ethical standards contained in the Bankruptcy Reform Act of 1978 ("Code") itself.(fn1) The interaction between the CPR and the Code presents some interesting ethical problems for bankruptcy practitioners.
Ethical considerations arising in bankruptcy focus on four general areas: (1) the attorney-client privilege; (2) failure to proceed; (3) abuse of process and vexatious litigation; and (4) conflict of interest. This article discusses each of these areas by comparing the applicable CPR Canons and Code sections and analyzing relevant current case law. For the purposes of this article, the wording of the ABA model CPR is used, although Colorado's Code varies slightly.
One of the major areas of concern in bankruptcy cases in the past few years has been the extent of the attorney-client privilege. This privilege is contained in both statute and case law.(fn2) Also, CPR Canon 4 provides that "[a] lawyer should preserve the confidences and secrets of a client."
The issue arises because of the existence of a successor to the bankrupt and the trustee. The issue centers on who the privilege runs to, and who can invoke it in the context of a bankruptcy proceeding.
When the bankruptcy case involves an individual debtor, or a debtor-in-possession, the scope and protection of the attorney-client privilege remains intact.(fn3) However, when the debtor is a corporation and a trustee is appointed, the situation becomes complicated. Does the privilege shift to the trustee, allowing the trustee to waive it, or does the privilege remain with the directors of the bankrupt corporation?
The first case to address this problem was Matter of Amjoe.(fn4) The court in Amjoe held that the order of adjudication divested the officers of the corporation of the power to invoke the attorney-client privilege and vested it in the trustee.(fn5) The court felt that to refuse the trustee the right to waive the privilege would frustrate and hinder his ability to conduct the duties required of him.(fn6) Since then, some courts followed the lead of the Amjoe court,(fn7) whereas others held that the privilege remains with the corporation and its directors.(fn8)
On April 30, 1985, the Supreme Court handed down its decision in Commodity Futures Trading Com'n v. Weintraub,(fn9) settling this issue in favor of the trustee. The court held that the trustee of a bankrupt corporation has the power to waive the corporation's attorney-client privilege with respect to pre-bankruptcy communications. The court reasoned that the power to waive the attorney-client privilege of a corporation belongs to its management.(fn10)
The powers and duties of a bankruptcy trustee are extensive, and tantamount to management. Among other things, all property passes to the estate, which the trustee controls.(fn11) The trustee is accountable for all property and has a duty to maximize the value of the estate.(fn12) The trustee investigates the debtor's finances(fn13) and has the power to run the debtor's business.(fn14) Because the debtor retains "virtually no management" powers under the Code, the court concluded:
[V]esting in the trustee control of the corporation's attorney-client privilege most closely comports with the allocation of the waiver power to management outside of bankruptcy without in any way obstructing the careful design of the Bankruptcy Code.(fn15)
The U.S. Supreme Court's decision in Weintraub(fn16) makes it clear that the bankrupt corporation's pre-petition attorney may be compelled to give confidential information to the trustee, if it is requested, and that the attorney can give the trustee such information without breaching the confidentiality ethic of CPR Canon 4.
As in other areas of practice, failure to proceed in a bankruptcy case is a violation of the canons of ethics. Although there is no CPR Canon expressly making failure to proceed a breach of ethics, it is implied from Canons 1, 6 and 7, and Ethical Consideration ("EC") 1-1. Canon 1 requires lawyers to maintain the integrity and competence of the legal profession, as does EC1-1. Canon 6 requires
lawyers to represent their clients competently; Canon 7 requires them to represent their clients zealously within the bounds of the law. Failing to proceed in a case that requires progress is neither competent nor zealous, making a failure to proceed a violation of the CPR.
Failure to proceed has arisen most frequently in reported Chapter 13 cases.(fn17) This is so because many Chapter 13 cases arise where individual debtors with few debts face a mortgage foreclosure,(fn18) and usually its protection is sought on the eve of foreclosure. When sanctions are imposed by a bankruptcy court for failure to proceed, the courts will require the attorney, at a minimum, to return any fees paid by the client.(fn19)
In Matter of Rivera,(fn20) a debtor lost his house because of repeated failures by his attorney to proceed properly with his duties under Chapter 13. The debtor was awarded both the return of his fees and damages for expenses attending the foreclosure. In awarding money damages against the attorney, the court noted the attorney's failure to perform legal services on an acceptable plane of professional behavior.(fn21)
Similarly, in In re Mattocks,(fn22) the court ordered a law firm to return a client's money when the firm's delay in filing a petition for relief caused the debtors to lose the opportunity to save their home from foreclosure. In addition, the court chastised the attorneys for filing a Chapter 13 petition after the progress of foreclosure had made the relief prayed for moot.(fn23)
Although failure to proceed does not occur frequently,(fn24) the bankruptcy practitioner should be aware of the problems and heavy sanctions it entails.
Vexatious litigation is seen as a willful abuse of the judicial process.(fn25) Section 1927 of the United States Code is used in connection with Bankruptcy Rule 9011 to curb such abuses of the bankruptcy system. Section 1927 states:
Any attorney or other person admitted to conduct cases in any court of the United States or any Territory thereof who so multiplies the proceedings in any case unreasonably and vexatiously may be required by the court to satisfy personally the excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct.(fn26)
Such conduct is also a violation of CPR Canon 7, as it exceeds the "bounds of the law" set by the Canon as being permissible advocacy. Bankruptcy Rule 9011 states that sanctions shall be imposed on the person who signs a bankruptcy document in violation of this Rules' provisions.
Among other things, Rule 9011 provides that the signature of an attorney constitutes a certificate by him that he has read the document; to the best of his knowledge it is warranted and submitted in good faith; and "that it is not interposed for any improper purpose, such as to harass, to cause delay, or to increase the cost of litigation."(fn27)
The major problem that has caused the bankruptcy courts to impose monetary sanctions against attorneys pursuant to § 1927 and Rule 9011 is unnecessary multiplication of proceedings.(fn28) In In re Villareal,(fn29) the court imposed sanctions of $500 on the debtor and his attorney for filing a Chapter 7 case after filing two Chapter 13 cases. The debtor derived no benefit from the case, other than delaying foreclosure, because he had no creditors with unsecured claims.(fn30) The court was especially disturbed by the involvement of the attorney in the frivolous filings since "[a]s officers of the Court, counsel owe a duty to the judicial system not to abuse it."(fn31)
The sanctions imposed in Villareal were relatively mild. Usually, the court will require the attorney who vexatiously multiplies proceedings to pay the expenses and attorney's fees incurred by the party his actions harm. For example, in In re Perez,(fn32) the court required debtor's counsel to pay the attorney's fees and expenses incurred by a secured creditor in its...
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