What makes a bad bankruptcy client? A failure to follow the rules.
The Bankruptcy Code requires lots of things from people who file bankruptcy. One of those things is full disclosure of all assets, liabilities, and other details regarding the debtor’s financial circumstances. A failure to satisfy the full disclosure requirement creates problems of major proportions for the debtor. Such problems can include a loss of bankruptcy discharge and even criminal penalties for bankruptcy fraud.
So, failing to provide adequate and complete information to their attorney is a primary way that a debtor becomes a bad bankruptcy client.
In my experience, most errors in full disclosure are accidental. And this is to be expected, to some degree. After all, most bankruptcy disclosure documents are prepared under difficult time pressures and require a huge amount of information.
“Oops, I forgot to mention the [fill in the blank] asset and the [fill in the blank] creditor,” is a common refrain that every bankruptcy attorney hears but hates to hear.
Here are the documents that every bankruptcy debtor should provide to their attorney:
· tax returns for the past three years
· all promissory notes and security agreement documents
· latest statement from each credit card company and all unpaid invoices from each vendor
· list of all assets in a place of business or residence, prepared in a recent walk-through
· all certificates of title to personal property and deeds to all real estate
· all financial statements (including those provided to lenders) prepared over the past three years
· all bank statements and checks for the past year
· documents identifying all transfers outside the ordinary course of business in the past four years.
Failing to provide the required documentation to the attorney is a rest-assured way to become a bad bankruptcy client.
The too clever by half person is a know-it-all who thinks he or she has a clever strategy and then fudges on information provided to the attorney to advance that strategy.
An example is a rancher who has, for many years, been exaggerating the number of cattle on hand in financial statements to the bank. So now, at bankruptcy filing when the true number of cattle must be told, rancher tells the attorney that a bunch of cattle wandered off and were stolen or swept away during the recent flooding.
If that’s not the truth, then the attorney is in a terrible spot. The attorney cannot evaluate the true circumstances, which means the attorney cannot develop a legitimate strategy for dealing with the cattle numbers problem and protecting the debtor in the bankruptcy.
This is a recipe for disaster. The too clever by half debtor has become a really bad bankruptcy client.
Occasionally, debtors have engaged in criminal activity and fail to disclose that fact to their bankruptcy attorney. So, the bankruptcy attorney, unknowingly, enables that debtor to compound the problem by swearing to falsehoods to cover-up the original crime.
Here’s an example, a potential bankruptcy debtor is a hog farmer. The farmer provides information to the bankruptcy attorney on the number of hogs on hand. The attorney has a basic understanding of a farrow-to-finish hog operation (i.e., owning the breeding hogs and raising their progeny to market weight). With three months, three weeks and three days gestation period, and a standard period of time from birth to market weight, a farrow-to-finish hog operation should have a predictable number of hogs on hand at any given time.
The numbers of hogs provided to the attorney do not make sense. So the attorney asks the hog farmer to count the hogs again and provide updated numbers. When the new numbers don’t make sense either, the attorney goes back and forth with the farmer on the explanations being provided—but nothing makes sense.
Finally, the hog farmer’s accounting professional gets involved and insists to the attorney that the information being provided “is correct!” So, the attorney makes a huge mistake by allowing the hog farmer to sign bankruptcy documents under oath with those numbers and then filing those documents. Then, at the first meeting of creditors, the hog farmer testifies to the accuracy of those numbers.
It doesn’t take long, thereafter, for creditors to produce trucking receipts and invoices showing the hog farmer had taken hogs to a neighboring state where the creditors’ liens did not appear, sold them and plowed the proceeds from such sales back into the hog operation—instead of letting the secured creditor have the proceeds.
Had the hog farmer fessed-up to the attorney about what actually happened, the attorney could have developed a strategy to address the problem. But the hog farmer kept the attorney in the dark.
And the farmer ended up in federal prison—not because of the hog sales, but because of bankruptcy fraud. This example is the definition of a very bad bankruptcy client.
Another way to become a bad bankruptcy client is making a fraudulent transfer before seeking advice from a bankruptcy attorney.
A potential bankruptcy debtor walks into the attorney’s office, looking to file bankruptcy. The attorney asks for information on assets, and the debtor provides a lengthy list. The list does not include a residence, so the attorney asks, “Do you rent or own your home?”
“Neither,” is the reply. The explanation is that the debtor transferred the house to a spouse a year ago. “For love and affection and care in my old age,” is the answer to an inquiry on payment received for that transfer.
“This is a problem,” says the attorney. After some investigation, the attorney adds: “Your spouse already owned half of the house, and your share of the equity isn’t much more than the amount of your homestead exemption. You didn’t need to do that to keep your house.”
Then, the attorney adds, “But now, everyone will assume that the value of the house is much greater and that your intent was to hide substantial value from your creditors.” So, the attorney must figure out a strategy for minimizing the negative impact of that transfer.
That’s being a bad bankruptcy client.
There is a nasty downside to bankruptcy filing. It’s called “insider preferences.”
Here’s what that means: if a debtor makes a payment to a family member or other insider on a pre-existing debt within one year before the bankruptcy filing, that payment can be clawed back into the bankruptcy estate. Defenses may exist, but a clawback is a real risk.
So, a debtor needs to do an insider preference analysis before filing bankruptcy. That means looking back over the prior year to see if any payments or other transfers, of any type, were made to insiders on a pre-existing debt. If any such payments were made, those need to be disclosed to the attorney so the attorney can plan for and adapt strategies and tactics to deal with that issue.
It’s not that an insider preference is “wrong” in any moral or ethical sense. It’s merely a practical issue that needs to be addressed before a bankruptcy is filed.
There have been many family members, for example, surprised to find that they must return a payment they received from the debtor. And in some of those cases, if the debtor had waited to file bankruptcy for two days more, the clawback claim would never have existed.
So, a failure to do an insider preference analysis before filing bankruptcy is one more way to be a bad bankruptcy client.
Being or becoming a bad bankruptcy client usually has something to do with failing to provide adequate information to the attorney. That prevents the attorney from providing full and effective representation to and for the benefit of the bankruptcy debtor. And criminal prosecution is an extreme result that could follow.
Avoiding such failings, and being a good bankruptcy client, is something every bankruptcy debtor should strive to do.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Help, My Business Is in Trouble!]
Donald L. Swanson is an attorney with Koley Jessen P.C, L.L.O., in Omaha, Nebraska. Don hosts a blog promoting bankruptcy mediation: https://mediatbankry.wordpress.com/.
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