Representing the Debtor: Counsel Beware!
| Publication year | 1994 |
| Pages | 539 |
1994, March, Pg. 539. Representing the Debtor: Counsel Beware!
The past twenty years have been marked by pronounced growth within the bar. Legions of legists now hold themselves out as proficient in virtually every field of the profession. Regrettably, too many of these individuals lack the training, experience and judgment necessary to serve as effective counselors. These shortcomings can sire more than unfavorable results for clients; increasingly, they expose advocates to professional discipline, damages, disqualification and criminal prosecution. This article concentrates on one branch of the vocation---the insolvency specialty---and explores some of the snares awaiting the incompetent, improvident and brash. Its general lessons, however, are broadly applicable across the spectrum of legal practice.
Each lawyer owes an ethical duty of competence to his or her clients.(fn1) "Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation."(fn2) Given the increasingly specialized nature of insolvency practice, an attorney who accepts the representation of the financially distressed without mastering debtor protection law, creditors' rights and bankruptcy may well invite disciplinary proceedings.(fn3)
Independent of ethical dictates, a practitioner may incur personal liability to clients if he or she fails to employ that degree of knowledge, skill and judgment ordinarily possessed by members of the legal profession at the time the task is undertaken.(fn4) More particularly, lawyers may be sued for injudiciously advising a client to seek bankruptcy relief,(fn5) for failing to advise a client to invoke bankruptcy,(fn6) for commencing a case under an inappropriate chapter of the Bankruptcy Code,(fn7) for mishandling a bankruptcy proceeding(fn8) or for forsaking the aid of an insolvency specialist under circumstances where a reasonably prudent practitioner would do so.(fn9) Moreover, since contested judicial proceedings are routine in insolvency practice, incompetent counsel risk exposure to third parties under a host of litigation statutes and procedural rules.(fn10)
Representation of the trustee or debtor-in-possession in bankruptcy proceedings implicates distinctive practice standards. The Bankruptcy Code prescribes that the Bankruptcy Court must "approve" the retention of any such professional.(fn11) Furthermore, the application which solicits approval for employment of counsel must state, among other things, the specific facts demonstrating the necessity for the retention, the reasons for the selection and the services to be performed.(fn12) Generally, remuneration cannot be paid from the estate unless the Bankruptcy Court has authorized both the employment and the scope of work prior to performance of the services.(fn13)
Although the Bankruptcy Court has ample statutory authority to decline to approve the employment of persons whom the court believes are not competent to handle the engagement,(fn14) that muscle is rarely flexed. More commonly, the Bankruptcy Court disallows some or all of the compensation sought in the lawyer's ensuing fee applications after determining that some or all of the services did not benefit the estate.(fn15) The bankruptcy judge's analysis is facilitated by the Local Bankruptcy Rules, which prescribe that all interim and final fee applcations contain detailed statements describing the nature of the services provided, the results obtained and the benefit to the estate.(fn16) In some cases, the court may direct counsel to disgorge prodigious amounts previously awarded on an interim basis.(fn17)
Assuming that a practitioner is competent to represent the beleaguered client, a plethora of conflict problems may arise. Some of the more recurrent conflicts involving fiscally troubled clients are discussed below.
One questionable practice arises when lawyers serve on the board of directors of an insolvent corporate client. Obviously, counsel to a corporation owe allegiance to the organization rather than to its creditors.(fn18) Conversely, however, the members of the board of directors of an insolvent company owe their fiduciary duties to the corporate creditors.(fn19) It should also be noted that lawyers who are officers or directors of the corporation, and those who have served as officers and directors within two years antecedent to a bankruptcy filing, are disqualified from serving as general bankruptcy counsel to the corporate debtor-in-possession or to its trustee.(fn20)
A number of other conflict problems stem from efforts by bar members to seek recompense for their services. One collection technique is to exercise a statutory "retaining lien" on the client's files and papers.(fn21) Although this attorney's lien is enforceable in bankruptcy,(fn22) the lawyer's right to retain the files and papers of a financially distressed client has been largely emasculated by ethics pronouncements which require members of the bar to forego the lien in those instances where the client is incapable of paying.(fn23)
Even absent lien rights, lawyers whose statements remain unsatisfied are likely to press their defaulting clients for payment. Both success and failure can foment difficulty in any future bankruptcy proceedings initiated by or against the client. To the extent that collection efforts succeed, counsel may be the target of litigation seeking to recover---as preferential---payments made within the ninety days antecedent to the filing.(fn24) Moreover, to the extent that any such claim is not specious, it may disqualify the lawyer from serving as general bankruptcy counsel to the fiduciary for the estate.(fn25) On the other hand, to the extent that the lawyer's efforts to collect unpaid billings fail, the outstanding indebtedness may disqualify the lawyer from serving as bankruptcy counsel for the trustee or debtor-in-possession. This result is possible because such counsel may be deemed to hold an interest adverse to the estate and to fail the "disinterestedness" standard contained in the Bankruptcy Code.(fn26) If so, any such lawyer who wishes to serve as bankruptcy counsel may be required to waive the prepetition claim.(fn27)
Counsel who seek to be employed as professionals for the debtor-in-possession or the bankruptcy trustee are unlikely to avoid scrutiny of their prepetition dealings with the debtor. The Federal Rules of Bankruptcy Procedure ("Bankruptcy Rules") expressly provide that such attorneys are required to furnish a verified statement setting forth all of their "connections with the debtor" in conjunction with any application seeking authorization for their retention.(fn28) Any shortcomings in the disclosures contained in the affidavit may be grounds for disallowance of compensation,(fn29) disgorgement of fees that have been previously paid,(fn30) assessment of costs and fees incurred in connection with disqualification proceedings(fn31) and potential criminal prosecution.(fn32)
Attempts by practitioners to assure payment for representation in connection with a client's forthcoming bankruptcy proceedings may introduce additional difficulties. For instance, some bankruptcy judges have refused to permit lawyers to represent the debtor in cases where arrangements have been made to have the legal fees paid or guaranteed by third parties whose economic interests...
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