Appendix A – The Bankruptcy Brief

In re Onken, SC S57801

The Bankruptcy Issue

In spring of 1990, Mr. Onken filed bankruptcy listing as creditors commercial lenders, holders of student loans, the Oregon State Bar, an ex-employer, and three potential malpractice claimants.  After contested case proceedings with the Bar, the ex-employer and the holders of student loans all the listed debts were discharged.  He had no employment income that year and would not again earn a paycheck until the summer of 1992.  When he was readmitted to the Bar in 1993 no questions were raised about the bankruptcy, the discharge, or repayment of any of the debts.  As of the filing of this application for reinstatement, none of the discharged debts have been repaid. 

One of the issues raised by the Bar in its statement of objections is to what extent Mr. Onken has paid restitution to those injured by his misconduct as a lawyer.  In doing so they raise the issue of whether there are issues of morality and character surrounding the decade-old bankruptcy that preclude him from being readmitted.  To a certain extent this comes down to whether some or all of the discharged debts can be labeled “moral obligations” or “restitution” and thus be exempt from the nondiscrimination provisions of the bankruptcy code.

Perez and Non-Discrimination

 

In Perez v. Campbell, 402 U.S. 637, 91 S.Ct 1704, 1971 U.S. Lexis 127 (1971) the court held unconstitutional an Arizona statute denying driving privileges to a party with an unpaid judgment arising out of a traffic accident even if the judgment had been discharged in bankruptcy.  In that case the Arizona law, like Oregon’s attorney discipline scheme, had been definitively construed as existing solely for the protection of the public and not for the punishment of judgment debtors.  The question was whether the statute conflicted with the Bankruptcy Act that is similarly clear in providing debtors a new opportunity in life and a clear field for future effort.  The court proceeded to examine the effect of the act -- not the stated purpose.  The court stated, ”We can no longer adhere to the aberrational doctrine of Kessler and Reitz that state law may frustrate the operation of federal law as long as the state legislature in passing its law had some purpose in mind other than one of frustration.”

In 1978 the Perez decision was ratified by congress and codified at 11 USC § 525

(a) ... a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to, condition such a grant to, discriminate with respect to such a grant against, deny employment to, terminate the employment of, or discriminate with respect to employment against, a person that is or has been a debtor under this title [11 USCS §§ 101 et seq.] or a bankrupt or a debtor under the Bankruptcy Act or another person with whom such bankrupt or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title [11 USCS §§ 101 et seq.] or a bankrupt or debtor under the Bankruptcy Act, has been insolvent before the commencement of the case under this title [11 USCS §§ 101 et seq.], or during the case but before the debtor is granted or denied a discharge, or has not paid a debt that is dischargeable in the case under this title [11 USCS §§ 101 et seq.] or that was discharged under the Bankruptcy Act.

 

Section 525(a) essentially prohibits the type of discrimination referred to in the subsection if the discriminatory act is taken because of one of three triggering events. These three events can be (1) use of the bankruptcy process, (2) the debtor's insolvency, or (3) failure to pay a dischargeable obligation.  In the instant case we face those issues surrounding failure to pay dischargeable obligations.

            Perez reflects conventional morality and an ancient social sensibility that the obligations of creditors and debtors are intimately related.  Thus, Deuteronomy (15:1) provides that debts be forgiven every seven years and provides sanctions for those who would try and evade the debt relief provisions (15:9). Mathew entreats God to forgive us our debts, as we also have forgiven our debtors (6:12).  The Koran advises creditors to forgive debtors who cannot pay and prohibits the charging of interest. A basic assumption in Judeo-Christian morality is that we all fall short -- thus forgiveness is both our need and our obligation.  No person may claim morality solely due to paying his debts, but must also be willing to forgive the debts owed him.  In the modern world of commerce, government and large financial institutions forgiveness of the personal Biblical kind is impractical.  Instead our legislative bodies provide the rules for the collection and forgiveness of debt. Individual Bar members are entitled to advocate a moral system that contrasts with the legislative scheme:  one in which creditors have the higher moral ground and debtors are not forgiven.  They cannot, however, according to federal law impose that moral vision upon the admission process for the practice of law nor can they build a separate morality for lawyers that eliminates the right to seek debt relief.  

The Oregon Court has only obliquely referred to Perez and 11 USC § 525(a) but has recognized the policies on which it is based.  Thus, in In re Taylor, 293 Or 285, 647 P2d 462 (1982) the court noted that the filing of bankruptcy standing alone is not a factor to be considered in determining moral fitness.  Similarly in In re Scallon,  327 Or 32, 956 P2d 982n (1997) the court declined to hold that a bankruptcy in the history of an applicant for admission to the bar is disqualifying even when it appears the financial difficulties that led to the bankruptcy were the fault of the applicant.

Surrounding Circumstances

While the filing of bankruptcy and failing to pay discharged debts cannot be ground for denying one a license to practice law, nothing in federal law prohibits a disciplinary tribunal or court from examining the circumstances surrounding a bankruptcy filing in an evaluation of an applicants general moral fitness. In re Taylor, 293 Or at 294 n.4.  Thus, when applicants have manipulated the bankruptcy law in highly technical ways to avoid payment of debts that might have been easily paid, courts have been willing to find the applicant sufficiently lacking in character to be denied admission to the Bar.

In Taylor, the Oregon court quoted with approval In re Gahan, 279 NW2d 826, 831 (Minn 1979) to the effect that applicants who default on serious financial obligations such as student loans are lacking in good moral character if the default is neglectful, irresponsible and cannot be excused by compelling hardship.  In Gahan, as in several other cases, the applicant filed for bankruptcy and discharged student loans within a few months of graduating from law school and at a time when the applicant’s future actually looked financially promising. The Gahan court was careful to point out, however, that it was the default rather than the discharge or failure to repay that formed the basis for their decisions.  The court wrote wrote,

Consistent with Gahan's Federal bankruptcy rights, we expressly state that our decision is in no way influenced by any assessment of Gahan's motivation in seeking bankruptcy. Nor are we interested in whether Gahan has any present willingness or ability to reaffirm the debts. We have based our decision solely on the circumstances surrounding Gahan's default on the student loans and the resulting failure to satisfy this important obligation. Gahan's subsequent conduct of obtaining discharge in bankruptcy and release from the default is of no concern to us.

 

Similarly, in Florida Bd of Bar Examiners re GWL, 364 So2d 454 (Fla 1978) the court faced an applicant who filed for bankruptcy to discharge student loans three days before he graduated from law school and long before any significant debts became due.  Over dissents that worried about constitutionality, the court held that the applicant’s calculated avoidance of debt during a brief period in which he was technically bankrupt demonstrated sufficient lack of moral character to deny him admittance.  In Florida Bd of Bar Examiners re Groot, 365 So2d 164 (Fla 1978) the same court, however, allowed the admission of an applicant who had discharged loans in bankruptcy soon after graduation from law school and just a week before he accepted a job as legislative assistant.  In Groot the court held that “the mere fact that debts are incurred beyond a debtor's present capacity to repay them is not, without more, an indication of immorality,” and explained that the expenses incident to being the single father of two children were sufficient justification for bankruptcy relief.  And in Florida Bd of Bar Examiners re SMD, 609 So. 2d 1309 (Fla. 1992) the court allowed admission of an applicant who filed bankruptcy in her last semester of law school to discharge about $25,000 in credit card debt noting that the vast majority of the credit card charges were to maintain herself while going to school.

             What is consistent throughout these cases is that the analysis goes to the circumstances surrounding the default, not the discharge.  Defaults when there is no need to do so or default and discharge immediately before a predictable financial upturn suggest and immoral manipulation of legal process.  However, defaults occurring in circumstances traditionally associated with financial hardship have not been held to be indicators of immorality even if the financial hardship was brought about by the foolishness of the debtor.

Timeliness

 

In order for default and discharge to be indicators of immorality the immoral acts should be reasonably related in time to the application for bar admission.  Two important cases involving the same applicant in different states address this issue.

In Florida Board of Bar Examiners re Kwasnik, 508 So2d 338 (Fla 1987) the applicant had killed a man in a drunk driving incident.  A civil judgment in a wrongful death action in the sum of $200,000 was entered against him in 1974.  He declared bankruptcy and discharged the debt in 1980.  In 1987 his application to join the Florida bar reached that state’s highest court.  The examining board found that although Kwasnik and his wife had a combined income of $90,000 and equity in a home of over $225,000, he had made no voluntary efforts to pay the judgment.  The Florida court wrote,

 The question here is whether following bankruptcy he should be refused admission for not having made any effort to provide assistance to the family of the decedent, even though he was not legally obligated to do so. Given the fact that our bankruptcy laws are designed to provide a fresh start for those who are overburdened with debt, we cannot say that the subsequent failure to make payments on the discharged debts may be considered as a basis to deny admission to the practice of law. We recognize that Kwasnik may have continuing moral obligations to the family of the man he negligently killed, but to permit such considerations in a petition for admission to the Bar would require the making of such subtle distinctions that no satisfactory rule could be devised.

 

 Mr Kwasnik subsequently applied for membership in the California Bar and faced the same problem.  In Kwasnik v. State Bar of California, 791 P2d 319 (Cal 1990) the California court faced the issue whether failure to pay “moral” obligations, as opposed to legal debts, could be the basis for denying an applicant admission to the bar.  The court acknowledged that the Bar would violate the 11 USC § 525 if its sole reason for denying admission were the “moral” obligation to the family of the man he killed.  Turning to the circumstances surrounding the debt and discharge the court wrote,

That the review department considered the circumstances surrounding the bankruptcy proceedings as well as petitioner's discharge of the judgment, therefore, does not mean it can refuse to certify him for admission without violating section 525(a). The circumstances surrounding the 1981 bankruptcy proceedings are so remote in time that they cannot reasonably be said to reflect on petitioner's moral fitness to practice law. The evidence relied on by the State Bar rebuts neither petitioner's prima facie case of good moral character nor his showing of rehabilitation. As a result, the State Bar cannot refuse to certify petitioner for admission without relying solely on the discharged judgment and, thus, violating section 525(a).

 

In the case before this disciplinary board the Bankruptcy took place in the winter of 1990 and the defaults somewhat earlier.  That winter was also the beginning of more than two years of unemployment and alcoholism.  There was no financial upturn just around the corner nor were there significant income or assets that might have been used to pay the discharged debts. Whatever state of mind or moral condition existed at the time of the defaults and discharge is now far in the past. 

Restitution

An exception to the non-discrimination provisions of 11 USC § 525 is for the payment of restitution.  Restitution, however, is more than an unpaid debt.  It is an obligation imposed by a governmental entity as part of a rehabilitative program. Although nonpayment of restitution can be grounds for denial of a license to practice law, only certain kinds of debts qualify for the exemption from 525(a). 

The Bankruptcy Code, 11 USC § 523(a) preserves from discharge restitution obligations that are for the benefit of a governmental unit and are not compensation for actual pecuniary loss.  The Court held in Kelly v. Robinson, 479 U.S. 36, 107 S.Ct. 353 (1986) that restitution obligations in state criminal proceedings are not discharged because they serve the state’s interest in rehabilitation and punishment rather than the victim’s desires for compensation.  Failure to pay restitution has been held by various courts to be grounds for denying a bar application. 

The basic law of attorneys, restitution and bankruptcy comes from the disciplinary process.  In Brookman v. State Bar of California, 46 Cal3d 1004; 760 P2d 1023 (1988) the plaintiff disputed a condition of discipline requiring that he repay the Client Security Fund close to $50,000 to cover an amount paid by the fund to a former client.  The attorney objected on the grounds that the underlying debt to the client had been discharged in bankruptcy.  The court held that restitution was proper, especially since payments to the Client Security Fund were clearly for the benefit of the public at large and not for the underlying victim in the case. 

Normally, malpractice claims are not misconduct and do not raise restitution issues.  In In re Borowski, 216 B.R. 922 (1998) the debtor attorney discharged in bankruptcy a mediation award arising from a malpractice claim.  In a related disciplinary hearing the malpractice creditor objected to a proposed settlement on the grounds that it did not include payment of the discharged dept as a condition of Borowski’s continued practice of law.  Borowski filed a motion asserting that the creditor’s efforts to have the debt revived as a restitution order was an effort to collect a debt and thereby violated the permanent injunction created by discharge in bankruptcy. The Bankruptcy court noted that not only would an order by the disciplinary board to pay the discharged malpractice debt violate 525(a) but that efforts by a creditor to make repayment a condition of practicing law violated the permanent injunction.

In Colorado v. Huntzinger, 967 P2d 160 (Colo 1998) a malpractice creditor once again attempted to have a discharged malpractice judgment revived as a restitution order.  The Colorado court found that while an associated contempt order was connected to both misconduct and rehabilitation the malpractice claim was not.  Thus, it could not be imposed upon the bankrupt as restitution.  And in In re Schwenke 849 P2d 573 (Utah 1993) the court refused to find that a pre-existing restitution order could survive bankruptcy where it arose from malpractice rather than misappropriation.

In readmission cases there is no formal restitution order because during the period of disbarment the applicant was not subject to the jurisdiction of the bar.  The rule in such cases seems to be that an applicant must show that he or she paid restitution in instances where the bar might have ordered restitution.  Thus, even for an applicant seeking readmission, restitution is not an obligation owed to all creditors, but instead only to those creditors who were victims of the applicants intentional misconduct or dishonesty.

`           In Hippard v. State Bar of California, 49 Cal3d 1084, 782 P2d 1140 (1989) an applicant for readmission had discharged in bankruptcy a wide variety of debts to clients and the Client Security Fund.  His misconduct included several instances of borrowing money from clients without sufficient disclosure and two instances of misappropriation.  The hearings panel found that the applicant had made no effort to repay funds he had received from clients.  Citing Brookman, the court held that in evaluating an applicant for readmission the court may consider efforts towards restitution as an indicator of rehabilitation.  The court stated that “The weight that should be attached to whether restitution has been undertaken in whole or in part is dependent upon the applicant's ability to restore the misappropriated funds as well as the attitude expressed regarding the matter.”  The focus of Hippard, however, is solely on funds obtained from clients through misconduct.  It is not authority for the idea that all debts become the subject of restitution merely because they were incurred by an applicant to the bar.

The Washington Court faced the issue of restitution and disbarred lawyers in In re Batali, 657 P2d 775 (Wash 1983).  In Batali the applicant had been disbarred in 1975 for misappropriating client funds, acts which resulted in five counts of grand larceny and one count of forgery.  He entered guilty pleas to all six counts and was sentenced to prison.  In 1982, Mr. And Mrs. Batali filed for bankruptcy and, because no creditors objected, many of the debts attributable to misappropriation were discharged. Shortly, thereafter Mr. Batali reaffirmed those debts and made arrangements for repayment.  The Board of Governors recommended Mr. Batali for reinstatement subject to his completing the plan for restitution and his ultimate repayment of the IRS some $40,000 in unpaid taxes. The Court disagreed, holding that requiring the applicant to pay the IRS would violate 525(a).  Restitution was appropriate where the debts were attributable to misappropriation of client funds, but it is not a vehicle whereby general creditors such as the IRS can circumvent the non-discrimination provisions of the Bankruptcy Code.  Mr. Batali was readmitted without a requirement that he pay back taxes.

The Oregon court faced questions of bankruptcy, restitution and readmission in In re Graham, 299 Or 511, 703 P2d 970 (1985).  Graham had been disbarred after writing bad checks, borrowing money from clients, transferring property to frustrate judgment creditors, overreaching with an elderly client, and several instances of misappropriation of client funds.  Litigation against him by clients resulted in his confessing judgment at least three times. In 1977, Graham filed bankruptcy and discharged some or all of the obligations owed to his former clients.  Responding to his application for readmission several years later, the court stated that

[W]e agree with the Trial Panel that applicant has not demonstrated his appreciation of the magnitude of misuse of client's funds and property.  In order to demonstrate that, and as a prerequisite to rehabilitation, it is necessary that applicant take steps to learn exactly what is owed, if anything, to each of his former clients and to develop a plan to commence to repay those obligations.  

 

The court in Graham does not explicitly address the extent to which the expectation of restitution can be extended without violating 525(a), but it’s holding is consistent with other states in that it connects restitution to instances arising from the misuse of client property.  The case implicitly recognizes that the concept of restitution is not a freeway around the anti-discrimination prohibitions in the bankruptcy code but a narrow path to be used only in cases where the discharged debt is a direct result of lawyer dishonesty.

 

The Moral Issues in Mr. Onken’s Bankruptcy

 

Discovery and preliminary negotiations suggest that there are only two conceivable claims of immoral activity connected to Mr. Onken’s decade-old bankruptcy.  One involves Mr. Melkonian, the Bar’s chief witness in this matter, and the second involves Mr. Onken’s ex-wife.  Mr. Melkonian maintained in the original bankruptcy proceeding that Mr. Onken committed a fraud on the bankruptcy court by stating that he owned his 1984 Toyota pick-up truck jointly with his wife when in fact he was the sole registered owner.  Mr. Melkonian, after losing at the trial level in his efforts to collect just over $500, appealed this and other issues to the Ninth Circuit Court of Appeals.  Although Mr. Onken did not appear in the appellate proceeding, Mr. Melkonian lost on appeal as well.  He had a full and fair opportunity to litigate all issues connected to the debt. Mr. Onken ought not have to visit the issue once again over a decade later.

The second issue involves a debt to Mr. Onken’s previous wife.  As part of Mr. Onken’s 1988 divorce a stipulated judgement was entered against him for the sum of $6,000.  In 1989 his ex-wife executed a satisfaction of the judgement in exchange for an unsecured note for the same amount.  The Bar suggests that Mr. Onken exercised undue influence to effectuate this exchange.  However, the entire debt was discharged a few months later in the bankruptcy court, a forum in which non-lien judgements and unsecured notes are treated exactly the same.  In fact, the one judgement creditor in the case was treated neither better or nor differently from any of the others and had his state court lien satisfied without payment pursuant to ORS 18.420.  Mr. Onken received no financial advantage from the transaction with his ex-wife.  She suffered no detriment and has never made a complaint.  Considering the age of the transaction and the fact that it had no ascertainable effect on anybody, it is insufficient to support re-examination of the 1990 bankruptcy.

Conclusion

Every established moral or ethical system at some point concerns itself with the treatment of debtors.  In law, the moral precepts accepted by Americans on that issue are contained in the federal bankruptcy code and the cases that arise from it.   That body of law provides that a state may not deny a citizen a license to practice law based upon either the filing of bankruptcy or the failure to repay debts discharged in bankruptcy.  Therefore a bankruptcy by an applicant to the bar is relevant in only two circumstances:  (1) when it reveals unpaid obligations that can legally be treated as restitution and are therefore exempt from normal discharge; and (2) when the bankruptcy was recent and circumstances reveal that the defaults on the loans themselves were unwarranted and manipulative of the legal system.  In the instant case, Mr. Onken’s bankruptcy was filed well over ten years ago in the midst of a two-year period of alcoholism and unemployment.  It was a straightforward bankruptcy under circumstances common in the bankruptcy courts.  He is fully entitled to the benefit of the moral prohibitions against the abuse of debtors and the legal prohibitions against discrimination provided by federal law.  This panel finds it in the same position as the Minnesota Supreme Court in  In re Gahan, 279 NW2d 826, 831 (Minn 1979)(discussed above) in which it admitted forthrightly, “we cannot declare bankruptcy a wrong when Federal law has declared it a right.”