This case sadly illustrates the peril of practicing law in an unfamiliar subject area, for, as one attorney has learned, ignorance of the law does not excuse an offense.
—U.S. v. Parkhill.¹

The ultimate "rules" of bankruptcy ethics are not found in Title 11 of the U.S. Code and related case law, but in Title 18, the laws governing federal crimes.² The principal criminal statutes regulating attorney behavior are found at 18 U.S.C. §§152-157, which are the federal statutes directly relating to bankruptcy crimes. 18 U.S.C. §157 relating to "bankruptcy fraud" is a recent and very broad addition to the federal criminal statutes and should be read by any attorney who plans to represent a debtor in bankruptcy proceedings. This article will present an overview of caselaw that highlights various situations where attorneys have found themselves faced with criminal liability for their actions in connection with bankruptcy cases.³

Casing the Joint: An Overview of Criminal Bankruptcy Issues

Initially, it is important to note that unlike ethical violations that might arise from a mistake or neglect, criminal liability will only be imposed if the attorney in question had the requisite criminal intent, which ranges from the "knowing" standard of 18 U.S.C. §154,⁴ the "fraudulent" standard of 18 U.S.C. §157 and the "knowing and fraudulent" standard of other key sections, including 18 U.S.C. §152.⁵ These standards are not easily met. For an interesting and detailed discussion of the degree of proof necessary to support a criminal conviction for fraud related to a bankruptcy case, review the case of U.S. v. Heavrin,⁶ which discussed the directed judgment of acquittal of the general counsel of a bankrupt restaurant chain accused of numerous bankruptcy-related offenses.⁷

However, while the government has a difficult burden of proving an attorney guilty of a bankruptcy crime, it is clear the Department of Justice is very alert for criminal conduct by attorneys. Indeed, an excellent bargaining chip for debtors indicted for bankruptcy or other crimes⁸ is to "offer up" an attorney who assisted the debtor in his or her bankruptcy crimes. For whatever reason, as the cases briefly reviewed below indicate, attorneys have run afoul of the law in a number of situations.

The Rap Sheet

The problem of "criminal" bankruptcy attorneys is not a new issue. See United States v. Grundy and Thornburgh, 7 U.S. 337 (1806) (discussing advice on denying ownership of a vessel); U.S. v. Switzer, 252 F.2d 139 (2nd Cir. 1958); Coghlan v. U.S., 147 F.2d 235 (8th Cir. 1945). Nor is it confined to inexperienced or "poor" practitioners. See U.S. v. Goodstein, 883 F.2d 1326 (7th Cir. 1989) (attorney with 40 years of bankruptcy experience). While thankfully there are not many reported cases involving attorneys who have been convicted of "bankruptcy crimes," there are a significant number of cases where attorneys have strayed from the straight and narrow.

Crimes of the Sofa

The bankruptcy case of Sofa Gallery Inc. is infamous in the annals of bankruptcy crime, as it generated at least three appeals court opinions⁹ addressing the convictions of the principals of the debtor, three of their attorneys and their accountants. The facts of this case present a number of very stark lessons to attorneys practicing bankruptcy law, particularly those who practice in small firms. In this case, at least some of the lawyers for the debtor entered into a conspiracy with the principals of the debtor to assist the debtor's principals (1) to obtain and conceal illegal kickbacks from the liquidator of the debtor's business; (2) to loot the corporation's pension plan to establish a new corporation for the principals' personal benefit; and (3) in the destruction of their business records.¹⁰

While the convictions of the partner in the law firm and the associate primarily responsible for the representation of the debtors and the debtors' principals in this matter are not surprising, far more troubling is the case of United States v. Zimmerman,¹¹ where an attorney was convicted at trial of conspiracy to commit criminal fraud in connection with the debtors and the principal's bankruptcy cases, where the attorney's involvement with those bankruptcy cases can best be described as minimal.¹² The Zimmerman case demonstrates the ever-present but unusual problem of "peripheral involvement with a bankruptcy case," especially when high-risk and possibly unknown strategies are being undertaken.¹³

Creative Documentation and Lack of Candor Equals Criminal Problems

Attorneys are always attempting to use creative documentation to preserve assets for their clients. However, the case of United States v. Center¹⁴ shows there is a limitation to the use of this strategy. In this case, Center was the attorney for a debtor entity known as Foxcliff South Inc. At the time of its bankruptcy, the debtor was owed $130,000 by another entity, Summitt, which was owed by Foxcliff's owner. At that time, Foxcliff owed its owner approximately $226,000. In an effort to prevent Summitt from having to pay Foxcliff the money it owed, Center prepared documents and made entries on Foxcliff's and Summitt's books to transfer the debt that Foxcliff owed its owner to Summitt and to backdate that transaction so the liabilities could be used as a setoff. These fraudulent entries were discovered, as well as Center's failure to properly disclose the debt owed to Foxcliff by Summitt. Center was convicted of various counts of fraud related to these activities.

In an interesting postscript, the Center case also led to a bankruptcy crimes case against Richard and Judith White, former clients of Center. After Center was convicted, in an apparent effort to gain a reduced sentence, Center provided evidence, including obtaining files from his former law firm, in order to support the prosecution of his former clients for bankruptcy crimes that occurred in personal bankruptcies Center filed for them prior to his criminal conviction.¹⁵ The White case is interesting reading because it shows that while, as a general rule, it is clients who turn upon their attorneys in cases involving bankruptcy crimes committed by attorneys, in a few limited cases attorneys can turn upon their clients.¹⁶

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[W]hile the government has a difficult burden of proving an attorney guilty of a bankruptcy crime, it is clear the Department of Justice is very alert for criminal conduct by attorneys.

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Offshore Follies—the Danger of Hiding Client Assets

While normally a plot device for fiction writers, the case of U.S. v. Knoll¹⁷ shows that attempts to use offshore bank accounts to hide assets often occur in real life. In this case, Knoll, an attorney, assisted his client in concealing more than $600,000 in assets in offshore Cayman Island bank accounts as part of a scheme to prevent his client's soon-to-be-former spouse from obtaining any portion of his client's assets. Knoll then had his client file bankruptcy, but failed to list the offshore account in his client's bankruptcy petition. The attorney's conviction for filing false statements in a bankruptcy proceeding was overturned on the grounds that the proceeding was brought after the expiration of the applicable statute of limitations, but his other convictions were upheld on related crimes.

It is interesting to note that the principal evidence used by the U.S. Attorney's Office in convicting the attorney in this case came from a third-party's burglary of the attorney's office and that party's turnover of the stolen documents to the U.S. Attorney's Office. The Circuit Court found the U.S. Attorney's Office did not sanction the burglary and therefore could use the evidence obtained from it, and affirmed the convictions of Knoll and his client.

Proofs of Claim Can Be Hazardous to One's Health

While debtors' attorneys are normally the parties subject to criminal prosecution, in the case of United States v. Connery,¹⁸ counsel for a creditor who directly assisted in the preparation of a false proof of claim was convicted of aiding and abetting in the filing of a false bankruptcy claim against the debtor corporation.

Prior to the filing of the claim, the attorney had worked for the debtor corporation. After the filing of the debtor corporation's chapter 11, he changed jobs to work as general counsel for another entity controlled by the party that controlled the debtor.

At the time the proof of claim was filed, the attorney had directed the accounting department of the creditor to restate the creditor's books to delete an approximate $626,000 balance owed to the debtor corporation by the creditor company and to instead replace it with an approximately $473,000 claim against the debtor. As a part of the proof of claim, the creditor denied owing any money to the debtor. The attorney also assisted in changing other corporate records to support this fraudulent claim.

Lying About One's Creative Legal Work Is Not a Good Idea, Either

As noted above, many attorneys, including attorneys who have experience in bankruptcy, believe that clever corporate restructuring can eliminate the need for a client to repay debts. While a certain amount of corporate planning is legitimate to protect the assets of either a corporation or an individual that owns the corporation, hyper-aggressive and undisclosed corporate planning can be a one-way ticket to jail. The case of United States v. Bartlett¹⁹ illustrates this point. In this case, the attorney, prior to bankruptcy, assisted the debtor in fraudulently concealing property with the intent to defeat the bankruptcy laws. Further, the attorney was convicted of giving false testimony in a bankruptcy hearing. In this case, the attorney who was convicted of bankruptcy fraud had acted as the criminal defense attorney for the principal of the debtor, who was also convicted of bankruptcy fraud in connection with the same case.

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Footnotes

1 775 F.2d 612 (5th Cir. 1985). Return to article

² Common cases that may be involved in prosecutions for bankruptcy crimes include concealment of assets: 18 U.S.C. §152(1); false oaths, accounts and declarations: 18 U.S.C. §152(5) and (3); false claims: 18 U.S.C. §152(4); receiving property with the intent to defeat the Bankruptcy Code and bribery: 18 U.S.C. §152(5) and (6); fraudulent pre-bankruptcy transfers: 18 U.S.C. §152(7); concealment or destruction of records: 18 U.S.C. §152(8) and (9); embezzlement against estates: 18 U.S.C. §153; adverse interest or conduct of officers: 18 U.S.C. §154; fee agreements in bankruptcy and receivership cases, general bankruptcy fraud: 18 U.S.C. §157; aiding and abetting: 18 U.S.C. §352, 353, 354; conspiracy: 18 U.S.C. §371; false statements: 18 U.S.C. §§1001, 1014, 1032; mail, wire and/or bank fraud: 18 U.S.C. §1341-1344; obstruction of justice: 18 U.S.C. §1503; perjury: 18 U.S.C. §1621-1623; Racketeer Influenced and Corrupt Organization (RICO) acts: 18 U.S.C. §1962; and money laundering: 18 U.S.C. §1956. Return to article

³ Although regretfully common, this article will not discuss cases where attorneys, who are themselves debtors, commit bankruptcy crimes. See U.S. v. Goodstein, 883 F.2d 1362 (7th Cir. 1989). Return to article

⁴ 18 U.S.C. §154 prohibits judges, trustees and other "officers of the court" from, among other things, purchasing property of the estate of debtors who are before them. In certain large chapter 11 cases, this statute prevents bankruptcy judges and court staff from being customers of a significant number of businesses. Return to article

⁵ See, generally, U.S. v. Smithson, 49 F.3d 138 (5th Cir. 1995), for a discussion of criminal intent. Return to article

⁶ 144 F. Supp. 2d 769 (W.D. Ky. 2001). Return to article

⁷ See, also, Ogier and Williams, "Bankruptcy Crimes and Bankruptcy Practice," 6 Am. Bankr. Inst. L.R. 317 (1998), for a more complete discussion of the technical aspects of bankruptcy criminal statutes. Return to article

⁸ See U.S. v. Webster, 125 F.3d 1024 (7th Cir. 1997) (attorney indicted due to debtor's cooperation with prosecutors after guilty plea to bankruptcy criminal charges); U.S. v. Franklin, 837 F. Supp. 916 (W.D. Ill. 1993) (debtor agreed to cooperate in an investigation of his bankrupt attorney after his arrest for drug trafficking). Return to article

⁹ United States v. Levine, 970 F.2d 681 (10th Cir. 1992); United States v. Brown, 943 F.2d 1246 (10th Cir. 1991); United States v. Zimmerman, 943 F.2d 1204 (10th Cir. 1991). Return to article

¹⁰ See United States v. Brown, 943 F.2d at 1250-1253. It is important to note that Brown was an associate working on the bankruptcy case who was convicted of numerous bankruptcy crimes, although he claimed he was merely following the direction of his partners. His claims of innocence were most likely defeated by the revelation that during the principals' bankruptcy he reviewed and destroyed the principals' financial records because he found them "insignificant." Return to article

¹¹ 943 F.2d 1204. Return to article

¹² Indeed, from a review of the appeals court opinion, Zimmerman's involvement with the debtor and the debtor's principals seems to have been limited to (1) an initial client meeting, (2) a hallway discussion of the use of the firm's trust account to deposit the proceeds of the liquidation sale of the debtor's assets, (3) a meeting with a lessor to convince them to allow their equipment to be used in the debtor's liquidation sale, (4) a "0.5 hr. conference with client" noted on Zimmerman billing records, (5) the signing of a check from the escrow account to pay part of the liquidation sale proceeds and (6) the defense of a lawsuit against his law firm by a secured creditor arguing the firm was improperly paid with proceeds of the collateral. Return to article

¹³ In a side note, both Zimmerman and Brown's convictions were overturned and new trials were ordered because the prosecutors introduced the testimony and/or written opinions of the bankruptcy court concerning their law firms' actions in the bankruptcy cases. Return to article

¹⁴ 853 F.2d 568 (7th Cir. 1988). Return to article

¹⁵ United States v. White, 879 F.2d 1509 (7th Cir. 1989). Return to article

¹⁶ The White decision is somewhat controversial as Center, while working for the government as an informer, obtained confidential attorney/client records from his former law firm and turned them over to the government for use in its case against the Whites. See 879 F.2d at 1514-18 (J. Will dissenting). Return to article

¹⁷ 16 F.3d 1313 (2d Cir. 1994). Return to article

¹⁸ 867 F.2d 929 (6th Cir. 1989). Return to article

¹⁹ 633 F.2d 1184 (5th Cir. 1981). Return to article