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Strategic, Ethical Implications Accompany Increased Bankruptcy Filings

By Katherine W. Wittenberg, Litigation News Associate Editor – February 19, 2009

More than one million bankruptcy cases were filed in federal courts during Fiscal Year 2008—an increase of more than 30 percent from the same period last year, according to statistics released last month by the Administrative Office of the U.S. Courts. (The federal judiciary’s fiscal year is the 12-month period ending September 30.) Of the 1,042,993 bankruptcy cases filed in FY2008, business filings increased by 49 percent (38,651 filings) and nonbusiness filings were up 30 percent (1,004,342 filings) from last year.

The Year Ahead
Experts in the field are predicting even more filings for 2009. “The crest of the problem is still ahead of us,” observes David Weinstein, Los Angeles, CA, cochair of the ABA Section of Litigation Bankruptcy and Insolvency Litigation Committee, whose bankruptcy practice spans almost three decades.

While past surges in bankruptcy filings “may be attributed to mismanagement or product obsolescence,” Weinstein believes that the latest trend of increased bankruptcy filings is driven by “macroeconomics.” That is, the pervasive economic crisis rather than specific and discrete financial problems faced by particular companies or individuals. 

Transitions for Lawyers
As a result, John R. Burns III, Fort Wayne, IN, cochair of the Section’s Bankruptcy and Insolvency Litigation Committee, sees more attorneys transitioning into the bankruptcy field. “Lawyers who previously devoted their time to transactional and real estate work are now finding their skills useful in bankruptcy courts,” Burns observes.

“The same lawyers who in the good times work on the mergers of two solid businesses also have the same skills required in bankruptcy to sell or acquire the bankruptcy estate,” notes Burns. From a firm’s perspective, “it is simply a matter of good planning to have lawyers that are versatile enough to be able to step into the bankruptcy side when that is necessary and then step back into [their transactional or real estate practice] when the economy picks up,” he explains.

Pitfalls and Protections
Given the trend of bankruptcy filings and the likelihood of more filings in the immediate future, litigators should be aware of potential traps and consequences of bankruptcy for a pending case. From a strategic standpoint, Weinstein says that a bankruptcy filing by the plaintiff may provide the opportunity to remove pending litigation to federal court and may lead to evaluation of whether the case should proceed.

When a defendant seeks bankruptcy protection, trickier questions come to light. Stressing that each case presents unique concerns, Weinstein notes that, in general, the defendant-debtor will be protected by the automatic stay—the provision of the bankruptcy code (Section 362(a) of the Bankruptcy Code) that essentially imposes a temporary injunction against creditor activity aimed against the debtor’s assets. In a case with multiple defendants, where only one has filed for bankruptcy, counsel and the judge may question whether it is practical to continue with proceedings, discovery, or trial—even though the stay applies to only one of the defendants, explains Weinstein.

“Other concerns arise when your client commences bankruptcy,” Weinstein notes. From a practical perspective, a litigator will be concerned with collection of fees from an insolvent client. However, the litigator’s fees will likely be considered one more unsecured debt, in line with other vendors or judgment creditors, he says.

Effects on Attorney Fees
A litigator may try to “finesse” a claim for attorney fees in an attempt to recoup for services rendered, but “there’s not a lot of finessing that can be done, due to the very high scrutiny of attorneys fees” by the bankruptcy court, says Weinstein. From an ethical perspective, a litigator may question whether he or she may withdraw (or seek permission to withdraw) from a case in which he or she represents a financially strapped client.

Burns advises that a savvy litigator should be aware of a defendant’s financial situation before and during a case so that a bankruptcy filing would not present a surprise. While there’s not much a litigator can do should a party become insolvent, being able to gauge the likelihood of financial problems for your client or a target party may effect a litigator’s decisions about settlement or prosecution. “That’s where bankruptcy counsel can help,” says Burns.

He notes that bankruptcy attorneys may be able to inform litigators about a client or target’s business, the industry, business cycles, and provide financial due diligence on the relevant company. In short, the bankruptcy of a plaintiff, defendant, or client presents significant practical, strategic, and even ethical concerns for the litigator—issues that may be best decided by consulting a bankruptcy practitioner.

Keywords: Bankruptcy, attorney fees


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