Secret No More: Filing For Bankruptcy Can Destroy The Attorney-Client Privilege

Secret No More: Filing Fo…

Filing for bankruptcy is a big decision, and many factors should be considered: the cost versus the potential benefit, the possibility of objections from creditors to a discharge, the long-term effect on one’s credit rating, among many others. Here’s one more: Entering bankruptcy may force the disclosure of conversations a debtor has had with his or her attorneys before filing for bankruptcy. Under certain circumstances, control over the attorney-client privilege can pass from the debtor to the bankruptcy trustee.

The attorney-client privilege is the oldest privilege for confidential communications under the common law. Generally, the privilege protects communications between lawyers and their clients and presumes that full and frank communications promote the public interests of law and justice. However, because the privilege results in the exclusion of relevant evidence, thus hampering judicial fact-finding, the party claiming the privilege must establish its applicability, and, when the privilege applies, courts construe it narrowly. The privilege is held by the client and can be waived only by the client – normally. Once that client becomes a debtor in bankruptcy, however, the bankruptcy trustee steps into the shoes of the debtor. Thus, the trustee can pursue claims that belonged to the debtor pre-petition and now belong to the bankruptcy estate.

In some cases, those claims arise out of pre-bankruptcy litigation involving the debtor. For example, assume the debtor has been involved in an accident and been sued. Claims can arise when the debtor’s liability insurer defended the debtor and a judgment was entered against the debtor that exceeded available insurance coverage. Such “bad faith” claims often accuse the insurer of providing its insured a deficient defense or conducting settlement negotiations without the insured’s best interest in mind. In some cases, malpractice claims against the attorney the insurer retained to defend its insured may also exist. In such cases, the attorney’s files, including communications with the client (now debtor) and the insurer, can be a gold mine for the trustee. The question then becomes: Can the trustee, standing in the shoes of the debtor, waive the attorney-client privilege and gain access to the attorney’s files?

Corporate Debtors Lose Control over the Privilege to the Bankruptcy Trustee

First, in cases of corporate debtors, control over the privilege passes to the trustee as a matter of law. In Commodity Futures Trading Com. v. Weintraub, the U.S. Supreme Court explained that the privilege for a corporation is held by its management, and that a bankruptcy trustee most closely resembles a solvent corporation’s management. Therefore, this is an issue only in a chapter 7 bankruptcy or if a trustee is appointed in a chapter 11 bankruptcy, and even then, only if the trustee pursues claim for the benefit of the bankruptcy estate that require the disclosure of pre-bankruptcy communications between the corporation and its attorneys.

Individual Debtors May Lose Control over the Privilege

But the Weintraub decision left open the question of whether control over the attorney-client privilege passes to the trustee in an individual bankruptcy. To date, neither the Supreme Court nor any Circuit Court has taken up this question, and the bankruptcy courts, without guidance from above, have covered the spectrum of possible answers.

At least one court – here in Florida – held in 1982 that the privilege passes to the bankruptcy trustee as a matter of law even in an individual bankruptcy, although few other courts have agreed. Most bankruptcy courts apply a balancing test that weighs the trustee’s duty to maximize the value of the debtor’s estate and the benefit of waiving the privilege against the harm that disclosure would cause to the debtor and to the privilege itself. However, a court in California held in 2014 that Supreme Court precedent did not allow such a balancing test, but the court’s reasoning has not gotten much attention from other courts.

Here, in the Middle District of Florida, bankruptcy judges have applied the balancing test in the past, but recent decisions have rejected it. Therefore, it is not clear whether the court will apply the balancing test, and if it does, the outcome is uncertain.

The bottom line is, if you are considering filing for bankruptcy, put the potential disclosure of confidential conversations you have had with your attorney on your list of issues to consider. Is there a potential claim a bankruptcy trustee might pursue on behalf of the estate, and would it make sense for the trustee to pursue otherwise privileged communications? At Iurillo Law Group, we will be glad to guide you through your analysis and help you obtain the maximum benefit from a bankruptcy filing.

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