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Pre-petition ethical issues for bankruptcy attorneys

by Corey E. Stephenson
November 12, 2009

Bankruptcy attorneys face a host of ethical issues even before their clients file a petition for bankruptcy.

The goal is to preserve a nest egg or protect assets that might survive the bankruptcy process, but pre-petition planning requires a careful balance, said J. Scott Bovitz, a bankruptcy attorney at Bovitz & Spitzer in Los Angeles.

“Careful planning is appropriate and permitted in every circuit, but excessively aggressive planning gives rise to a possible block of the bankruptcy discharge under §727 or the potential for a claim of a fraudulent transfer under §547,” Bovitz said.

Actions like making sure an IRA is properly funded or taking full advantage of a state’s homestead exemption are permissible, but things like international asset protection are questionable.

Courts have wrestled with the line between what is appropriate and what isn’t for decades, noted O. Max Gardner III, a bankruptcy practitioner in Shelby, N.C.

“I’m not sure there is a good definition of what is proper pre-bankruptcy planning,” he said. “There is a very fine line between what is proper and ethical pre-bankruptcy planning and what could be an improper transfer of property.”

Issues to focus on
Gardner estimated that 95 percent of the time clients need to file their bankruptcy petitions immediately to receive the protection of the automatic stay before their house is sold in foreclosure or their car is repossessed. But when clients have a little leeway before having to file, here are a few issues lawyers should focus on, keeping in mind that “the closer you get to the filing, the more legal and ethical issues pop up,” according to Gardner.

• Avoid it altogether.
Conducting negotiations with creditors can sometimes result in an agreement that allows a client to avoid filing bankruptcy altogether, or leads to reducing the debt, Bovitz said. In turn, such negotiations minimize many ethical concerns for lawyers.

• Timing.
The Bankruptcy Code provisions on fraudulent transfers and preferential conveyances all have time limits, so planning ahead can allow a client to make a transfer if he or she can wait the requisite time period before filing a petition, Bovitz noted

In addition, the earnings look-back for the means test under Chapter 7 is six months, so by waiting or selecting a specific date to file, a petitioner can significantly impact the filing.

A high-income client who lost his job just two months ago might try to wait another few months “so that the means test figures would be more realistic,” Gardner suggested.

• Homestead and tithing.
If a client owes $200,000 to the bank for his or her mortgage and has $50,000 in a bank account, pay that to the bank and decrease the secured claim to $150,000, Bovitz suggested.

“There’s nothing wrong with that and then you have some equity in the house,” he said.

Gardner said he counsels clients that they can continue to tithe to their church or religious organization, as Congress recognizes that as a special exemption to the means test

• International asset protection.
For higher-end clients, “international asset protection [can be] a legitimate means of taking domestic assets and putting them somewhere else in a trust that controls the asset,” explained Bovitz.

However, this can be risky because it often results in a challenge to a fraudulent transfer or a creditor’s attempt to block a discharge, he said. “This is very interesting, cutting edge planning.”

• BAPCPA concerns.
In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act and almost immediately, bankruptcy lawyers filed legal challenges.

In December, the U.S. Supreme Court will hear oral arguments on two of the more controversial provisions of the Act, including whether or not bankruptcy attorneys are prohibited from advising debtors to incur more debt in contemplation of filing bankruptcy.

Advising a client to take on more debt – by re-financing a mortgage or trading in a car and getting a new loan, for example – is not uncommon. But until the Supreme Court deals with the issue, lawyers are prohibited from giving clients such advice.

Don’t be part of the problem
Most importantly for attorneys, “don’t become part of the problem,” Bovitz cautioned. “In an attempt to zealously represent the client, lawyers will sometimes want to assist the client in creating an artifice that assists the client in not quite telling the full truth.

Instead, lawyers should strive to create “an open book,” he said.

“My goal is that if a creditor or a trustee has any questions, I have created a plan that is an open book, and I can show it to them and say, ‘Here is exactly what we’ve done.’”

Clients themselves often don’t help – by the time they get to a lawyer’s office, they often have tried to fix the situation themselves and may have even ruined their chance to get a discharge, Bovitz said.

Gardner said his motto is “disclose, disclose, disclose and notice, notice, notice.” He sits down with each client for a one-on-one interview and once the paperwork is complete, he sits down again to go over every form and schedule.

While it may be time-consuming, he said he often ferrets out transactions or property that clients forgot about that could have been problematic had they not been caught.

In his area of North Carolina, for example, Gardner said people often inherit property that has been in the family for several generations. Despite the fact they own the property, they don’t consider it to be their own real estate and neglect to list it.

“I always follow up the question of whether they own real estate with ‘Do you have any property you got as an heir, or from an estate, or from your grandfather?’ and I get a different answer,” he said.

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