It has been a while since I wrote about the risks associated with bankruptcy work. Back in 2009, when I last discussed this area of practice in this column, we were still in the midst of the recession that hit in 2007. The number of bankruptcy filings was soaring. The most common filings, Chapters 7 and 13, were up in 2009 by more than 25 percent from the previous year.
The trend has changed since then, as bankruptcy filings have fallen in the last few years. But that does not make bankruptcy work for lawyers less risky. In fact, Attorney David Krekeler of Krekeler Strother SC, Madison, says bankruptcy practice is more complex now than ever before.
Increasing Responsibilities for Bankruptcy Lawyers
“The burdens and duties on bankruptcy lawyers have increased over the years,” says Krekeler. “The bankruptcy scheme imposes numerous short-term deadlines, which create time pressures on lawyers. Lawyers often create their own fee pressures by working on a flat fee basis, which does not allow, or does not encourage, spending the necessary time on each case.”
According to Krekeler, Office of Lawyer Regulation (OLR) reports indicate a number of claims in which lawyers took a relatively small flat fee, one as low as $110, and the grievance reported that work was not fully completed. “It is important to charge enough for your services so that you remain fully engaged in the case and have no incentive, not even a subconscious one, to not be working on it.”
Another burden, says Krekeler, is the sheer volume of the information to process and analyze. The volume continues to grow with each revision of the schedules, the Bankruptcy Code, and the Bankruptcy Rules. The changes that took effect in 2005 are still being felt as the courts interpret the statutes. Krekeler says, “In general, the changes added significantly more paperwork to the process, making the filing of a bankruptcy case more onerous and more expensive. The bankruptcy rules seem to change every couple of years or so, and we just recently began using a whole new set of schedule forms. The case law continues to grow.”
According to Krekeler, some disciplinary proceedings involving bankruptcy lawyers relate to the failure to file a reaffirmation agreement. The time limit for doing so set by the Code is before the discharge is granted, and problems arise if the reaffirmation agreement is not timely filed. Krekeler says that unfortunately, many creditors do not cooperate in this process, which results in lawyers having to expend significant time and resources on what should be a relatively simple matter.
Bankruptcy is a relatively new area of practice for some lawyers. But “dabbling” in an area of law in which you have never previously practiced can be dangerous. Doing it in a complex area such as bankruptcy heightens the risk. Attorney Ryan Blay, who also practices at Krekeler Strother, says bankruptcy is extremely detail oriented, so lawyers who haven’t done it before, or don’t do it very often, run the risk of committing avoidable mistakes.
“The schedules submitted by debtors in even a routine case are likely to exceed 50 pages in length. This of course affords substantial opportunity for errors. Most errors can be readily corrected by amendment, but there are some which could leave a client at a loss or cause a lawyer embarrassment or worse.”
Blay cautions, “One of the most serious recurring errors we see is mistakes in calculating when income taxes might become dischargeable. Also, a failure to properly calculate and calendar can result in taxes which could have been discharged remaining as a non-
Blay adds that the requirements for discharge are somewhat complex, and he says, “they must be understood and complied with to avoid facing an angry client and a malpractice claim.”
Bankruptcy lawyers work both inside and outside the courtroom. They therefore need both litigation and transactional skills. As Krekeler points out, bankruptcy lawyers engage in a great deal of direct client contact. He says skills in analysis, negotiation, math, and logic are all valuable. “The issues we face are constantly changing, and rapidly, as our practice is based upon a code which is less than 40 years old.”
Here are a few of the current issues identified by Krekeler and Blay that lawyers doing bankruptcy work must be aware of:
The Definition of Fraud is Evolving. In May, the U.S. Supreme Court issued a decision in Husky International Electronics Inc. v. Ritz, holding that a debt might be nondischargeable in bankruptcy for having been obtained by actual fraud, even when there was no false representation. Krekeler says, “Many of us had learned years ago that fraud required false representation, but the Supreme Court found that the overall scheme itself was sufficient to constitute fraud within the meaning of Section 523 of the Bankruptcy Code.”
File Claims on Time, or Else. In 2015, the U.S. Court of Appeals for the Seventh Circuit held that the failure to file a proof of claim in a Chapter 13 case within the deadline set through the Bankruptcy Rules bars that claim, even when the creditor is secured (In re Paijan).
According to Blay, “Standard practice before this decision was that a secured creditor could file its claim at any time. The rationale was that the lien would survive the bankruptcy in any case and that failure to allow secured claims to be filed, even if untimely, would harm both the debtor and the creditor. Imagine a debtor who thought he was paying off his car loan through his Chapter 13 plan, only to discover that all the payments went to unsecured creditors and that he still owes the secured debt.
“This is an important decision for both debtors’ lawyers and creditors’ lawyers. Courts in other circuits are split on this issue, but here in the Seventh Circuit, make sure that all necessary or wanted claims are timely filed.”
Filing a Bankruptcy Proof of Claim May Be Dangerous if the Statute of Limitation Has Run. “Bankruptcy can be perilous for debtors and their counsel, but can also pose risks for creditors,” Krekeler says. In a 2014 case, Crawford v. LVNV Funding, the 11th Circuit Court of Appeals held that a creditor who filed a proof of claim after the state statute of limitation had run could be subject to claims under the Fair Debt Collections Practices Act for abusive debt-collection practices. This was true even though the debtor and trustee did not initially challenge the claim. Other courts around the country have ruled the opposite, that the Bankruptcy Code provides the sole legal remedy for debtors.
Krekeler explains, “Wisconsin is unique in that it is one of only two states in the country that holds a debt extinguished when the statute of limitation expires. Other states allow the statute of limitation to be used as an affirmative defense.”
Using Exemptions on Annuities. An annuity involves an investor paying an insurance company a sum of money in exchange for a series of future payments. Annuities are exempt using Wisconsin’s state-asset exemptions. However, the statute requires that the annuity contract comply with the provisions of the Internal Revenue Code or is employer created. Whether debtors with self-created annuities can use the exemption to protect the annuity in full is an issue currently before the Seventh Circuit Court of Appeals, in In re Koenig. According to Krekeler, “Exemption laws are sometimes ambiguous and have to be read with care.”
How to Structure Chapter 13 Plans. “Chapter 13 plans require that secured creditors be paid in ‘equal monthly amounts’ if being paid in periodic payments. This is true even if a transfer of money from the debtor into an escrow for the purpose of a future single lump payment is proposed,” Blay says. This was the holding in an Eastern District of Wisconsin case, Ehiorobo v. Talmer Bank & Trust, in 2015.
The literal definition of payment involves funds tendered to creditors, Blay points out. In Ehiorobo,the debtor argued that the proposed escrow deposits were not payments because the creditor would not receive them until the lump-sum payment was made. The district court said that structuring deposits into an account assigned for this purpose would circumvent the intent of the Bankruptcy Code and lead to ludicrous results, because the proposal would be rejected if proposed as traditional monthly payments through the plan.
What Happens to Payments Held by a Trustee When a Case Converts from Chapter 13? Krekeler explains that Chapter 13 trustees receive funds from debtors and pay creditors according to a plan confirmed by the Bankruptcy Court. In a 2015 case, Harris v. Viegelahn,the U.S. Supreme Court held that if the case is converted from Chapter 13 to a Chapter 7, funds held by the trustee must be returned to the debtor. According to Krekeler, this likely would also hold true if a bankruptcy was dismissed after a plan was confirmed.
Understanding what happens with fees held may affect whether a debtor should convert, dismiss, or stay in an active bankruptcy, and may also affect the ability of debtor’s counsel, along with creditors, to be paid from funds held by the trustee.
Dischargeability of Tax Debts. Blay says that occasionally, debtors do not file income tax returns on time. When this happens, income tax liabilities to the IRS or a state taxing authority cannot be discharged in a bankruptcy filing. The 10th Circuit Court of Appeals addressed this issue in the 2014 decision In re Mallo. If the IRS or taxing authority files a return on behalf of the taxpayer (sometimes referred to as a Substitute Tax Return), then no “return” is filed, even if the debtor later submits a return. The 7th Circuit Court of Appeals, which includes Wisconsin, has ruled similarly on a related issue.
“If no returns are deemed filed, Section 523 of the Bankruptcy Code precludes discharge of the tax debt. It is critical to know exactly when tax returns were filed and processed and whether any substitute returns were filed on the taxpayers’ behalf in order to advise whether this debt will be eliminated through a bankruptcy filing,” Blay says.
As in any area of law, lawyers who take bankruptcy cases must be diligent in their representation. Make sure you are careful about the clients you take on, research the law, and seek guidance from a colleague or mentor if you need assistance.
Fortunately for lawyers in Wisconsin, Krekeler says, there are ample opportunities to keep up with the law. The State Bar of Wisconsin’s Bankruptcy, Insolvency & Creditors’ Rights Section and the U.W. Law School put on annual seminars with the participation of many of the state’s bankruptcy judges. Susan Kelley, Chief Judge of the Eastern District U.S. Bankruptcy Court, created the Lou Jones Breakfast Club, and the Milwaukee Bar Association regularly features bankruptcy topics. The Western District Bankruptcy Bar Association has a monthly luncheon with CLE credits.
And, Krekeler agrees that lawyers should be cautious if dabbling in bankruptcy work. “It is far too complex and requires practitioners to stay abreast of the law and the changes. The code itself has numerous requirements for the filing of a case, including reasonable diligence in investigation by the debtor’s counsel. Bankruptcy is likely the practice area where attorney fees are scrutinized the most closely by both the courts and the government, so we each have an economic incentive to be well-informed.”