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Criminal Bankruptcy Attorneys - Part II The Hard Road from Dealing with Troubled Clients to Living with Troubling Cellmates

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In the case of United States v. Dolan,1 the attorney was convicted for conspiracy to conceal property from the bankruptcy estate by his actions in representing an individual in his chapter 11 proceedings.

In this case, Dolan, the attorney, testified that he filled out the debtor's admittedly inaccurate bankruptcy schedules to the best of his ability, but that the debtor initially failed to give him correct information concerning the ownership of various assets, including stock in certain companies, which were ultimately discovered to have been owned by the debtor. However, attorney Dolan's problems, which ultimately led to his criminal convictions, arose from his treatment of two assets of which he had extensive knowledge: a 1981 Ferrari, and a lawsuit that the debtor had against a third party. In regard to the Ferrari, Dolan attempted to have the bank, which held a security interest in the Ferrari, change the title over to the debtor's son after the bankruptcy had been filed. When that suggestion was rejected by the bank's counsel, Dolan then suggested the debtor would be willing to agree to relief from the stay and a third party paying off the balance owed the bank, some $27,000, if the bank would cooperate in this matter. Knowing that the Ferrari was worth more than $85,000, the bank's counsel refused to go along with what he characterized as a scheme to remove equity from the bankruptcy estate. Dolan never revealed the existence or value of the Ferrari in the debtor's schedules.

The lawsuit matter was far more serious. After the filing of the bankruptcy case, another attorney who was litigating the lawsuit for the debtor against a third party negotiated a settlement of that lawsuit for $1.9 million. Dolan received $50,000 of this settlement as a personal bonus, which he did not disclose to the bankruptcy court.


[W]hether the extent of such abuses are real...is unimportant compared to the fact that even the mere perception of such legal chicanery has led to proposals for significant restrictions on attorney representation of debtors, as well as to a general mistrust of bankruptcy attorneys.

When required to amend the debtor's bankruptcy schedules to reflect the ownership of stock in certain corporations, Dolan failed to list either the Ferrari or the settlement proceeds of the lawsuit in the amendments he prepared to the debtor's bankruptcy schedules. Dolan testified he failed to disclose these matters because he had been instructed by his client, the debtor, not to make any such disclosure and, after an independent review of the Code of Professional Responsibility, Dolan believed that he was not required to disclose the settlement or Ferrari against his client's orders, and he was not required to withdraw from his representation of the debtor in light of this fraud. Both the district and appeals courts were unimpressed with Dolan's defenses, and he was convicted of two counts of bankruptcy fraud.

One of the critical pieces of evidence against Dolan in this case was his continued representation to creditors throughout the chapter 11 proceeding that the debtor had no funds with which to make payments to them and that they should accept a very low percentage payout plan under chapter 11 when, at the time, Dolan knew of the $1.9 million settlement and the ownership of the Ferrari. Such affirmative misrepresentations, the courts found, fell well outside the bounds of zealous representation and into the dark arena of criminal conspiracy.

It's Not Nice to Fool Bankruptcy Trustees

In the case of United States v. Rosen,2 an attorney, Rosen, represented the owners of an entity known as New England Tri-State Development Corp. (Tri-State) and Tri-State's owners. In 1992, Tri-State filed a voluntary chapter 11 petition. In the winter of 1993 through 1994, Tri-State's owners informed Rosen that an individual was interested in purchasing their Maine property for $1 million, to be paid in installments. In March 1994, prior to the consummation of this transaction, the Tri-State case was converted to a chapter 7 liquidation. During the chapter 7 case, Rosen appeared as Tri-State's attorney, falsely stated that Tri-State had received an offer of $500,000 for the main property and further stated that Tri-State believed the property was worth at least $750,000.

At numerous times during the chapter 7 case, Rosen indicated to the trustee that he believed he could find a buyer for the debtors' Maine property for approximately $500,000 in cash. Incorrectly trusting Rosen, the trustee allowed him to pursue this possible deal. However, at the same time, Rosen was attempting to sell Tri-State's Maine property for $1 million with $500,000 of that price being transferred to Tri-State's owners in the form of consulting fees and/or employment agreements.

Ultimately, Rosen was able to negotiate an agreement with the purchaser whereby the bankruptcy estate would receive $500,000 for the property, and Tri-State's owners would receive $475,000, payable over four years, for their consulting services. Rosen would receive a $25,000 fee for his services in this matter.

Rosen disclosed part of this deal to the trustee and advised the purchaser not to disclose the employment consulting agreements to the trustee if he was contacted by trustee's counsel. The sale was ultimately approved by the bankruptcy court, with no mention being made of the side deal with the owners of Tri-State. It was only after the sale was approved by the bankruptcy court, and an attorney for the purchaser learned of the nature of the side deal, that all the terms of the sale were disclosed to the trustee and the court. Ultimately, the trustee was able to restructure the agreement with the purchaser, whereby the Tri-State estate would receive $730,000 for the Maine property, and the owners of Tri-State would receive nothing. Rosen was convicted of four counts of federal mail fraud stemming from the misrepresentations he made to the bankruptcy trustee in this case.

Representing Debtors in Complex Chapter 11s Is not the Way to Learn Bankruptcy Law

As noted in the introduction to this article, attorney Parkhill in the case of U.S. v. Parkhill was convicted of fraudulent concealment of assets and the improper transfer of assets from bankruptcy estates by virtue of a complex set of transactions. Specifically, after the conversion of an involuntary chapter 7 petition to a voluntary chapter 11 proceeding, Parkhill assisted the principal of the debtor in transferring various pieces of property and motor vehicles out of the name of the debtors to a third party for payments of $150,000, which the debtor's principal received and which were not disclosed in the debtor's bankruptcy case. Parkhill was not helped by his co-defendant in this case, the owner of the debtor corporations, who insisted that all of his actions were taken solely upon the advice of his attorney.3

Yes, Selling the Entire Business in a Chapter 11 Proceeding Does Require Bankruptcy Court Approval

The case of United States v. Edgar4 shows that forgetting "small" things, such as obtaining bankruptcy court approval for the sale of all of a chapter 11 debtor's assets, can cause an attorney significant criminal liability. In this case, the debtor, Dupli Tech Corp., had filed a chapter 11 bankruptcy. Edgar, acting as the debtor's owner's attorney, negotiated the sale of the chapter 11 debtor's assets for payments to be made directly to the owner, which the owner would "use" to pay off or compromise the bankruptcy claims against the debtor. The owner of the debtor was also given a lucrative employment agreement under the terms of the sale. Perhaps not surprisingly, the attorney structured the sale so that the assets and proceeds would be difficult to trace and the owner of the debtor did not use any of the proceeds to pay any of the Dupli Tech creditors.

After this "minor oversight" was uncovered, the subsequently appointed trustee sued the purchaser of the assets and settled for $300,000, the present value of the payments to be made under the sale agreement and, with the help of the FBI, obtained the indictment of the debtor's owner and Edgar for bankruptcy fraud. Given the blatentness of the fraud in this case, Edgar did not appeal the underlying merits of his conviction, but rather appealed only certain technical determinations of his sentencing under the U.S. Sentencing Guidelines.

How Not to Make 2014 Disclosures—the Most Infamous Bankruptcy Criminal Case

Although within the scope of this particular article, the case of U.S. v. Gellene5 has already been discussed in detail by a large number of commentators and will not be rehashed in any great detail in this article.6 The most important lesson that attorneys can take from this Gellene case is to compare the findings made by the jury in Gellenei.e., that Gellene (1) knew of his firm's representation of a secured creditor, (2) knew under Bankruptcy Rules and Code the representation had to be disclosed, and (3) deliberately failed to disclose this representation in order to conceal that information from the court—to the findings of the Seventh Circuit decision in Matter of Firstmark Corp.,7 where the Seventh Circuit found that the inadvertent failure to disclose a conflict warranted only a fine or a reduction in fees, not disgorgement and certainly not criminal sanctions. This distinction is at least some comfort to those, like this author, who have to conduct many of the conflicts checks in large chapter 11 representations, as it indicates that they will not go to jail if they merely make a mistake in their affidavits in support of their firm's retention. Gellene clearly shows that knowledge and intent to conceal are required for such severe sanctions.8

11 U.S.C. §363(n)—What's That?

The case of United States v. Zehrbach9 does not involve the criminal conviction of an attorney for bankruptcy fraud, but rather demonstrates a common issue chilling competitive bidding that is prohibited by 11 U.S.C. §363(n) and that often confronts attorneys. In Zehrbach, the principal defendant, a businessman knowledgeable in acquiring assets from bankrupt companies, entered into a series of agreements to "buy out" the bidding positions of various competitive bidders for the purchase of an airline manufacturing company from a bankruptcy trustee. After consulting with one of his attorneys, Zehrbach was informed that his course of action constituted a bankruptcy crime. Zehrbach dismissed that first attorney's opinion and sought a second attorney's opinion who, being informed by Zehrbach that the transactions were "joint ventures" for the purchase of the debtor's assets, opined that the transactions were, in fact, legal.

Unfortunately for Mr. Zehrbach, his first attorney was correct, and the sale was set aside under 11 U.S.C. §363(n); ultimately, Zehrbach was convicted of bankruptcy fraud. The important lesson from the Zehrbach case that bankruptcy attorneys should note is that the two attorneys involved in this case, the one who gave proper advice as to the criminality of Zehrbach's scheme and the other attorney, who carefully documented the facts given to him, thereby proving he had been lied to by Zehrbach, were absolved of criminal liability and did not become the subjects of a criminal prosecution.

Being Friendly with the Clerk's Office Is One Thing, But...

Perhaps the strangest bankruptcy-related crime an attorney has been convicted of is the crime of circumventing the blind case draw system of assigning judges to bankruptcy cases found in the case of U.S. v. August.10 In August, the attorney was having an affair with a bankruptcy court's "intake" clerk. The attorney conspired with the intake clerk to ensure that his cases were not assigned to a bankruptcy judge who was conservative in awarding attorney fees. While the crime in August is unlikely to be repeated, it does illustrate that any attempt to manipulate the bankruptcy system in a questionable manner could lead to federal criminal charges.

The Sentencing Report (Conclusion)

The above-discussed cases, while interesting reading—perhaps on the level of a lurid novel—for those attorneys who take legal ethics seriously, do represent a serious problem for our profession in that the public at large, politicians and some members of the federal judiciary increasingly believe that there is significant amount of corruption in the bankruptcy bar. This suspicion is not new and can be traced back to the early investigations of the alleged "bankruptcy rings" that were thought to control bankruptcy proceedings in the early part of the 1900s. However, whether the extent of such abuses are real, or merely a legal version of urban legends, is unimportant compared to the fact that even the mere perception of such legal chicanery has led to proposals for significant restrictions on attorney representation of debtors, as well as to a general mistrust of bankruptcy attorneys. The bankruptcy bar should work hard to ensure that the cases discussed in this article become even more of an aberration than they already are. Therefore, keep reading this column, and hopefully it will help you avoid involuntary vacations at federal government expense.


Footnotes

1 120 F.3d 856 (8th Cir. 1997). Return to article

2 130 F.3d 5 (1st Cir. 1997). Return to article

3 This defense did not help the owner defendant, as his convictions were affirmed by the Fifth Circuit. 775 F.2d at 617. Return to article

4 971 F.2d 89 (8th Cir. 1992). Return to article

5 182 F.3d 578 (7th Cir. 1999). Return to article

6 See, generally, Yochum, "When Conflicts Become Crimes: Professionals Representing Parties in Bankruptcy," 10 Jour. Bank. Law & Practice 235 (2001), Sept. 29, 1998; Bankruptcy Court Decisions New and Comment, "Special Issue on Conflicts on Conflicts: Why John Gellene Received the Sentence He Did." Return to article

7 132 F.3d 1179 (7th Cir. 1997). Return to article

8 However, significant losses of fees may be considered crimes by your firm's executive or compensation committee as a form of criminal activity. Return to article

9 47 F.3d 1252 (3rd Cir. 1995). Return to article

10 74 F.2d 400 (6th Cir. 1985). Return to article

Journal Date: 
Saturday, March 1, 2003

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