If You Can’t Say Something Non-Fraudulent, Don’t Say Anything At All: The Discoverability of Bankruptcy Planning Discussions

If you think the attorney-client and work-product privileges protect all communications between a bankruptcy attorney and his client, think again. In reality, many pre-bankruptcy planning discussions are discoverable under the crime-fraud exception.

I. The Crime-Fraud Exception

In re Grand Jury Proceedings, G.S., F.S.¹ involved the crime-fraud exception to attorney-client and work product privilege. A party seeking discovery of privileged communications based upon this exception must make a threshold showing that the legal advice was obtained in furtherance of the fraudulent activity and was closely related to it. This burden is not satisfied merely by alleging that a crime or fraud has occurred and then asserting that disclosure of privileged communications might help prove the crime or fraud. Rather, there must be a specific showing that a particular document or communication was made in furtherance of the client's alleged crime or fraud.

The Grand Jury case involved a grand jury investigation into two men for bankruptcy fraud. It all started when several businesses that the men owned together started experiencing financial trouble. Things continued to get worse, and eventually they hired an attorney and started planning for bankruptcy. When their pre-bankruptcy planning began, the men owned several nonexempt assets, including thousands of dollars worth of furniture, jewelry, various stock holdings, and a business contract worth $300,000. They also had a few ideas about how to keep creditors from getting those assets, including a plan to sell their furniture to a relative and recover it after the bankruptcy. Sniffing what they were up to, the attorney counseled the two about the dangers of bankruptcy fraud, explicitly advising them that their proposed plan for hiding the furniture would constitute bankruptcy fraud.

Against their attorney's advice, the men began selling and loaning nearly all of their nonexempt assets to close family members. In one transaction, stock holdings were pledged to a relative in exchange for a $52,000 loan. When the relative couldn't quite scrape together the money for the loan, the father of one of the men picked up the tab. The attorney assisted in the closing of that transaction. The men deposited the sale proceeds from these transactions into exempt life insurance policies and moved to Florida, where they filed for bankruptcy a little over a year later. By the time the men entered bankruptcy, they had virtually no nonexempt assets left. Then, once the bankruptcy concluded, they moved back to Iowa and reclaimed their assets from family.

Not surprisingly, the men later came under investigation for bankruptcy fraud. Investigators sought documents and testimony from the men's attorney relating to their pre-bankruptcy planning discussions. The attorney refused to testify or produce the documents, invoking the attorney-client and work product privileges. A District Court held that probable cause existed to show that the men sought their attorney's legal advice in furtherance of a crime or fraud and, therefore the crime-fraud exception applied to destroy privilege. On appeal, the men claimed that the crime-fraud exception should not apply, because they had merely engaged in legitimate pre-bankruptcy exemption planning, not fraud.

II. Attorney-Client Privilege

The mere conversion of nonexempt assets into exempt assets prior to bankruptcy is not in itself fraudulent. In fact, most bankruptcy cases involve the conversion of at least some assets prior to filing. However, sometimes when taken together, legitimate individual transactions can evince a pattern of conduct that goes beyond legitimate pre-bankruptcy exemption planning. The determination hinges on whether the debtor had fraudulent intent. The Court of Appeals in the Grand Jury case agreed with the District Court that there was such intent on the part of the debtors and that the crime-fraud exception applied.

So what was it about the men's actions in this case that crossed the line from legitimate pre-bankruptcy exemption planning to fraud? First, the men transferred almost all of their nonexempt assets to close relatives. Second, some of the transactions appeared to be specifically designed to conceal their true nature. Third, the men relocated from Iowa to Florida to file bankruptcy and returned to Iowa after the proceedings were final. Fourth, they recovered their original assets from their family members after the bankruptcy for the same prices at which they had been sold. Taken together, these facts gave rise to the inference that the men carried out a carefully planned scheme to divest themselves of all of their property through sham transactions, to discharge their debts in bankruptcy, and to immediately reacquire their original assets, and they'd used their attorney's knowledge of bankruptcy law to help carry out the plan. Accordingly, the men could not assert the privilege over the evidence of this illegal scheme.

III. Work Product Privilege

The Court applied a different analysis to the attorney's assertion of work product privilege. Attorneys have a well-recognized interest in protecting their own opinions and thought processes from disclosure. Non-opinion work product is generally discoverable upon a showing of a substantial need and an inability to secure the substantial equivalent of the materials by alternate means without undue hardship. On the other hand, opinion work product--which encompasses a lawyer's opinions, conclusions, mental impressions, and legal theories--is afforded substantially more protection. An attorney may assert the work product privilege over opinion work product even when a client has used the attorney's services to commit a crime or fraud, so long as he is not complicit in the client's wrongdoing.

With regard to the non-opinion work product in this case, the Court found that, in light of the close connection between the possible fraud and the legal advice, the government had shown a substantial need for the evidence and that it could not be obtained through any other means. With regard to the opinion work product, the Court found the attorney could not assert privilege, because there was probable cause to believe he was complicit in his clients' fraud. Specifically, there was a reasonable likelihood that the attorney either knew or was willfully blind to the fact that the clients were entering into sham transactions with relatives so that they could later retrieve their original assets after discharging their debts. Documents reviewed in camera by the District Court judge suggested that the attorney was aware that the men were contemplating strategies for reacquiring at least some of their assets at a later time (hence his warning to the men about bankruptcy fraud). Despite knowing the transactions were likely illegal,² the attorney helped facilitate at least one of those transactions (the sale of furniture which the father of one of the men had indirectly funded). Thus, there was probable cause to believe that the attorney was complicit in his client's fraudulent activity.

IV. Conclusion

All in all, this case shows how broad a view Courts can have regarding a lawyer's "complicity" with a client's illegal behavior during pre-bankruptcy planning. Unfortunately, the case does little to clarify the line between legitimate planning and bankruptcy fraud. As a result, it has some bankruptcy practitioners reevaluating their pre-bankruptcy interactions with their own clients.

¹ 609 F.3d 909 (8th Cir. 2010)
² One judge on the Court of Appeals, who concurred in part and dissented in part with the majority's opinion, pointed out that there was no evidence that the attorney even knew that the funds used in that transaction came from the father of one of the men.