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Suspended, Bankrupt Lawyer Can Discharge Debt Owed to Client

By Casey C. Sullivan, Esq. | Last updated on

Consider it a silver lining: even if your law license is suspended and you're so broke former clients are now your creditors, you can still discharge that client debt in bankruptcy.

That's the conclusion of the Ninth Circuit, which ruled last Thursday that a suspended California lawyer could discharge in bankruptcy the $6,000 she owed a former client for unearned legal fees.

Unlawful Advanced Payment

In 2010, Marilyn Scheer agreed to help a client, referred to by the court only as Clark, modify his home mortgage loan. She took $5,500 payment up front. Clark later fired Scheer and, through California's mandatory attorney fee arbitration program, tried to get his $5,500 back.

In August 2011, the arbitrator ordered Scheer to fully refund Clark's payment. It found that she had violated California mortgage law, which prohibits advanced fees for residential mortgage modification services.

Scheer claimed lack of funds, but the state bar court found her able to pay back the award, suspending her license until she does so.

Escape Client Fees in Bankruptcy

Just a few months later, Scheer filed for bankruptcy. Scheer named both Clark and the State Bar as creditors and neither objected to the discharge of her debt. She then demanded her law license back, citing 11 U.S.C. § 525(a), which, as the Ninth Circuit explains, "prohibits the government from revoking or refusing to renew a license 'solely because' an individual has not paid a debt that was dischargeable" in bankruptcy.

When the California bar ignored her demand, she sued in bankruptcy court. The bankruptcy court, however, ruled that her debt to Clark was nondischargeable under § 523(a)(7), which makes debt nondischargeable "to the extent such debt is for a fine, penalty, nor forfeiture payable to and for the benefit of a government unit, and is not compensation for actual pecuniary loss."

Working Around the Supreme Court

That seems a strange basis for denying discharge of Scheer's debt, however. As the Ninth Circuit noted, the debt to Clark was neither a fine, penalty, or forfeiture, nor was it owed to a governmental unit.

But, under the Supreme Court's 1986 ruling in Kelly v. Robinson, restitution obligations, imposed as conditions of criminal probation, are nondischargeable, despite the language of 523(a)(7).

The Ninth Circuit, in an opinion written by Judge John B. Owens, was not impressed by this Supreme Court precedent:

The Court's approach in Kelly -- to untether statutory interpretation from the statutory language -- has gone the way of NutraSweet and other relics of the 1980s and led to considerable confusion among federal courts and practitioners about section 523(a)(7)'s scope.

Thankfully, the Ninth Circuit had an alternative in In re Findley, its 2010 ruling on fees imposed by the state bar against a suspended attorney. In Findley, the Ninth Circuit ruled that an attorney's state bar imposed $14,054 fee was nondischargeable. But those fees were explicitly intended to "promote rehabilitation and to protect the public," the Ninth found. Here, Scheer's fees were simply compensatory, meaning that the fall outside the scope of 523(a)(7), Kelly, and Findley.

As the court explained:

"Scheer's performance as an attorney leaves much to be desired, and it is unsettling that she can use bankruptcy to avoid refunding her client's improperly collected fee. But our moral take on Scheer's conduct does not control-the statutory language and policies underlying Section 523(a)(7) do. And under the current state of the law, the debt to her client does not fall within the Section 523(a)(7) nondischargeability exception."

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