Who Is the Client: Bankruptcy

By Marc S. Stern

Knowing who the client is in the bankruptcy context is important, particularly with small businesses or key employees. If you represent the corporation, the privilege belongs to the corporation. Consequently, if you represent both Jo and Jo’s Bar and Grill, Inc., and have been doing pre-bankruptcy planning or have been representing both when a dram shop action is filed (e.g., by the victim of an accident caused by one of the corporation’s customers who was served too much liquor by an employee), the trustee in bankruptcy for the corporation can waive any privilege.

This means that the trustee is free to get all of the information that you have obtained in your investigation of the accident. The trustee can delve into all the transactions between the owner and the corporation. Your individual client may be out of luck. It may be possible to forestall this with a joint defense agreement that specifies that the privilege is to be maintained and that information may only be disclosed with the consent of all of the parties to the agreement. However, this is uncharted territory, and there is no definitive case law.

In bankruptcy, you must also remember that there is a test of “disinterestedness” that may apply. This is a far stricter standard than a conflict (which can be waived). Representation of both the owner and the corporation, even with a conflict waiver, may result in a denial of fees or other action by the court.

In the insolvency setting it is extremely important, at the very beginning of the representation, to make sure that the individual owner knows that his or her interest is legally different from the interest of the corporation. The legal advice you should give one is or can be radically different from the advice you would give the other.

For example, if the individual has scrupulously maintained a separate economic status, a banker may want a personal guarantee to continue financing the business, or the banker might want a mortgage on the individual’s residence. If you are representing the corporation, this is wonderful news. More capital is available, and the business can continue. The owner should guarantee the obligation and pledge his house.

On the other hand, if you are representing the individual, your advice may be extremely different. Why would the client risk her assets or those of her family on a failing business? Is there any realistic hope that the business can be saved? Can we prefer the creditors that the debtor has personally guaranteed over the general creditors to avoid having to pay for the failure personally?

Clearly the interests are diverse and clearly you need to know whom you represent. You have a fiduciary duty to represent your client, and the advice you give must be very different even though the client thinks that his or her interest and the corporation’s interest coincide.

 


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