SC Lawyer, November 2012, #5. Navigating the Nexus between Bankruptcy and Common Pleas.

• Author: By Nathan A. Earle

South Carolina BAR Journal

2012.

SC Lawyer, November 2012, #5.

Navigating the Nexus between Bankruptcy and Common Pleas

South Carolina LawyerNovember 2012Navigating the Nexus between Bankruptcy and Common PleasBy Nathan A. EarleFederal bankruptcy questions have been a permanent feature of American debtor-creditor law since 1898. For lawyers representing creditors in state trial courts, the possibility that today's common pleas defendant might become tomorrow's bankruptcy debtor lends an element of uncertainty to even the most routine collection action. While it may not be possible to predict which defendants will file for bankruptcy, it is certain that many will do so.

The number of bankruptcies filed in the United States each year has risen sharply over the last three decades. A temporary lull followed the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, but filings have crept back to their pre-reform levels. More than 1.3 million cases were opened in the United States between July 1, 2011, and June 30, 2012, of which 8000 were filed in the District of South Carolina. See www.uscourts.gov/statistics. Eight thousand is a tiny number compared to the national total, but it represents roughly eight percent of the common pleas cases filed annually in South Carolina. See www.sccourts.org/trends. Since a state-court legal challenge often triggers a defendant's decision to file for bankruptcy, attorneys representing creditors in common pleas can expect to encounter bankruptcy on a regular basis.

An adverse party's bankruptcy usually brings a civil lawsuit to a screeching halt. By preparing clients for that possibility, and by being prepared themselves, litigators can protect their clients' interests and avoid potential sanctions. This article will suggest ways to avoid being blind-sided by a defendant's bankruptcy.

Bankruptcy considerations at the time of engagement

Before agreeing to represent a creditor in a collection matter- before drafting a demand letter or making a phone call-an attorney should take two bankruptcy-related precautions. First, the attorney should determine that no prospective defendant is a debtor in a bankruptcy case. Second, the attorney should discuss the scope of representation with the client to establish clear expectations about the attorney's role in the event that an adverse party seeks bankruptcy protection during the course of the representation.

Screen prospective defendants

Perhaps ironically, one of the first steps an attorney must take before filing a lawsuit in a state trial court involves federal bankruptcy law. In addition to checking for conflicts of interest and locating the defendant, the attorney must confirm that the debt in question was not previously discharged in bankruptcy and that the putative defendant is not currently a debtor in a bankruptcy proceeding. Since most actions undertaken by a creditor against a debtor's estate run afoul of the automatic stay, failure to take this precaution exposes the attorney (and the client) to the possibility of sanctions. See 11 U.S.C. 362(a) (2006) and Section 11, below.

Clients are a good source of information regarding a defendant's bankruptcy status. When a debtor has filed or has threatened to file for bankruptcy, rumors often circulate quickly among the affected creditors. Of course, the attorney should also conduct an independent inquiry.

Preliminary information about a defendant's bankruptcy status can be obtained over the telephone through the bankruptcy court's voice case information system (VCIS). VCIS can be searched using a debtor's name, social security number or tax identification number. VCIS searches cover only one district at a time, which can produce incomplete results when the defendant's domicile or state of incorporation is unknown. However, for defendants known to reside in South Carolina, one search may suffice since South Carolina has only one federal district.

More thorough information about bankruptcy filings is available through the PACER system, accessible at www.pacer.gov. Unlike VCIS, PACER searches cover multiple districts at once and therefore yield faster and more comprehensive results. PACER also produces visual, reproducible results, which can be retained in the case file as evidence of a good faith effort to avoid violating the automatic stay.

Address bankruptcy in the fee agreement

Once the attorney ascertains the prospective defendant's bankruptcy status and decides to take the case, bankruptcy should also factor into the fee agreement discussion. A viable claim in common pleas can suddenly be transformed into an unsecured, non-priority claim in bankruptcy, at once increasing the creditor's collection costs and reducing the prospects for eventual recovery. A brief discussion of this possibility with the client at the outset of the representation will help the client to make an informed decision about litigation and may also help to temper expectations.

At a minimum, the lawyer should inform the client that all bankruptcy matters are outside the scope of representation, see Rule 1.2(c), RPC, Rule 407, SCACR, and include language to that effect in the fee agreement, see Rule 1.5(b), RPC, Rule 407, SCACR. However, mere knowledge that bankruptcy could derail a client's lawsuit will not necessarily prepare the client for the consequences of an adverse party's bankruptcy. Additionally, even though Rule 1.2(c) expressly allows lawyers to limit the scope of representation in a particular matter, the rule conditions this permission on the requirement that the limitation must be "reasonable under the circumstances" and that "the client gives informed consent." Informed consent, in the context of representing a creditor in a common pleas collection action, would seem to require an attorney wishing to exclude bankruptcy matters first to ensure that the client has a basic understanding of how bankruptcy could impact the client's case. The client should understand that one or more defendants may file for bankruptcy at some point during the litigation and that, if this should happen, the client could be required to obtain separate bankruptcy counsel to pursue claims against the debtor.

Of course, bankruptcy matters need not be excluded from the representation. However, total exclusion is the best approach for lawyers who do not regularly represent creditors in bankruptcy. Rule 1.1, RPC, Rule 407, SCACR, requires lawyers to provide competent representation, and while Comment 2 to Rule 1.1 acknowledges that "[a] lawyer can provide adequate representation in a wholly novel field through necessary study," this is a dangerous proposition for practitioners unfamiliar with bankruptcy. As one bankruptcy judge put it, "[m]any lawyers find themselves surprised by what can arise in an otherwise 'simple' bankruptcy." Matter of Chidi Egwim, 291 B.R. 559, 571 (Bkrtcy. N.D.Ga. 2003). Moreover, bankruptcy practice is sufficiently complex that the S.C. Supreme Court has deemed it a specialty area for certification.

Therefore, in order to avoid being drawn into representation for which the lawyer lacks adequate preparation or experience, the best practice is to obtain the client's informed consent to exclude all bankruptcy matters from the representation. If the lawyer later wishes to take some action in the bankruptcy proceedings, such as filing a proof of claim or attending a meeting of creditors, it is always possible to negotiate a separate agreement with the client narrowly and clearly defining the scope of the proposed bankruptcy representation. But before undertaking to represent creditors in bankruptcy proceedings, practitioners should be familiar with the provisions of SC LBR 9011-1 (b), which limits the application of Rule 1.2(c) in the context of bankruptcy proceedings:

Extent of an Attorney's Duty to Represent. Except as may be provided in an attorney's written agreement with a party concerning appeals and adversary proceedings, any attorney who files documents for or on behalf of a party in interest shall remain the responsible attorney of record for all purposes including the representation of the party at all hearings and in all matters that arise in conjunction with the case. (italics added). This rule seems mainly to have been drafted with debtors' attorneys in mind, see e.g., In re Marcia Y. Burton, 442 B.R. 421 (Bkrtcy. W.D.N.C. 2009), but attorneys representing creditors should know that it may not be as easy to get out of bankruptcy court as it is to get in.

Impact of a bankruptcy filing On pending litigation

Defendants commonly file for bankruptcy protection during the course of litigation-particularly as the date a trial or hearing approaches. Added to the inconvenience occasioned by the delay of pending state court matters, an adverse party's bankruptcy filing creates two existential threats to the creditor's case, one immediate and one long term. The immediate threat is the automatic stay. The more remote, but also more serious, danger is that the creditor's claim against the debtor will ultimately be discharged in bankruptcy.

Effects of the automatic stay

The filing of a bankruptcy petition automatically prohibits most collection efforts against the debtor actions on the part of creditors, including:

(1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the [bankruptcy] case. . . or to recover a claim against the debtor that arose before the commencement of the [bankruptcy] case. . . 11 U.S.C. 362(a)(1) (2006).

The automatic stay is extremely broad in scope and, once effective, "protects all property of the estate regardless of whether or not notice has been given of the pendency of the case." In re Weatherford, 413 B.R. 273, 283 (Bkrtcy. D.S.C. 2009). In the District of South Carolina, actions taken in violation of the automatic stay are void ab initio and have no legal effect. Id. Thus, for example, a state court judgment obtained against a debtor in violation of the automatic stay has no legal effect.

The stay has other teeth as well. Section 362(k)(1) provides that "[a]n individual injured by any willful violation of [the automatic stay] shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages. 11 U.S.C. 362(k)(1) (2006). In this context, the term "willful" does not require specific intent to violate the stay. In re Weatherford, 413 B.R. at 285 (internal quotes omitted). Rather, "a willful violation of the automatic stay occurs when 'a creditor knows of the pending bankruptcy petition and intentionally attempts to continue collection procedures in spite of it.'" Id. (internal cites omitted).

Certain collection efforts are exempted from the stay, such as actions to obtain possession of nonresidential real property after the debtor's lease of the property has expired. See 11 U.S.C. 362(b)(10) (2006). However, in most instances, creditors wishing to proceed against the debtor's collateral (e.g., to proceed with a foreclosure action) or otherwise to continue collection efforts against the debtor must petition the bankruptcy court to lift the stay.

Lifting the automatic stay

Any interested party may petition the bankruptcy court for relief from the automatic stay. Section 362(d) of the Bankruptcy Code provides that the court "shall grant relief from the [automatic] stay . . . such as by terminating, annulling, modifying, or conditioning such stay," if the court finds that one of four grounds is present. 11 U.S.C. 362(d)(1)-(d)(4) (2006). The broadest of these grounds is relief "for cause, including the lack of adequate protection of an interest in property. . . " See 11 U.S.C. 362(d)(1) (2006).

"A decision to lift the automatic stay under [11 U.S.C. 362] is within the discretion of the bankruptcy judge, and this decision may be