Bench & Bar of Minnesota is the official publication of the Minnesota State Bar Association.

Counseling Clients in Financial Distress

Individuals suffering personal financial failure or the failure of their business often need more than legal advice from their lawyer.  Counsel who can identify and address the psychological, ethical, and spiritual aspects of the situation will not only facilitate the restructuring of the client’s financial affairs and have a positive effect on the individual’s personal well-being, but may recycle the occasional soul.

The global financial crisis has introduced the bitter taste of financial failure to some who considered themselves immune. Cyclical market forces and a number of acute events, such as the proliferation ofPonzi schemes, have afflicted naïve and “conservative” investors alike, wiping out fortunes without notice. Even Warren Buffet has seen his portfolio decrease over 55 percent. While Mr. Buffet can afford this type of hit, most cannot maintain equanimity—and many may risk insolvency—when the value of their business or net worth drops by 50 percent.

In these circumstances, while much emphasis is placed on the legal aspects of restructuring a business or a personal bankruptcy, the personal issues for the individuals involved are often neglected. This is particularly true of commercial lawyers who generally represent sophisticated clients they believe do not need psychological or business assistance. While personal injury and family law attorneys have institutional mechanisms to address their client’s personal needs, commercial lawyers, by definition, assume their clients’ needs are merely financial.

My mentor, an attorney named Bill Kampf, would often describe his job as a bankruptcy attorney as “recycling souls.” While this may have been hyperbolical, it was to a great extent how he practiced his craft. His concern for the psychological impact that chronic and acute financial hardship had on the individuals involved made him an extremely effective attorney.

Understanding the psychology of failure, particularly when the failure of a business involves individuals who have a history of spectacular success, is equally or more important than addressing their financial circumstances. Counseling your clients through the psychological, ethical and spiritual implications of failure is imperative to a successful restructuring. Understanding your limits as a lawyer and when a referral is appropriate is also important. In sum, a holistic approach to representation will not only serve your client’s legal needs but will lead to a feeling of accomplishment and value-added service.

Psychology of Financial Failure 
The psychological aspects of a financial failure are important to identify as they affect your ability to work through the ethical and spiritual aspects as explained below. Donald Trump, who used bankruptcy as a financial tool like some people use credit cards, ironically opined that “‘success breeds success’ has something to it. It’s that feeling of confidence that can banish negativity and procrastination and get you going the right way.”  However, it is equally important to emphasize that the only predicate to success is failure, and as Sumner Redstone observed, “success is not built on success. It’s built on failure. It’s built on frustration. Sometimes it’s built on catastrophe.” In other words, it’s imperative to address that failure is the flip side of success—with a very different emotional impact.

A financial failure will damage a client’s reputation and their perception of their self-worth. As Karl Speak writes in his best-selling book, Be Your Own Brand, a personal brand—a fancy way of defining reputation—is an accumulation of impressions from relationships.1 When the sum total of those relationships are based on success, a strong brand ensues. While going through a financial crisis, a person’s brand will no doubt be damaged.

An important psychological aspect which the commercial bankruptcy attorney must also identify and address is the “deal mentality” of your client. For the most part, business clients charge from deal to deal and are constantly moving toward a closing. Clients accustomed to making money on a transactional basis view time as the enemy, and every day that elapses without a deal is a concern. This transaction-based “deal mentality” is antithetical to a successful workout where the elapse of time is a positive. I cannot tell you how many times I have heard such clients ask, “What is the plan?” and “When is this deal going to be done?” Since patience is often the key to resolving these financial problems, it is imperative not to allow your clients to push an unnecessary and poor solution.

Treating Psychological Aspects 
Once the psychological aspects of failure are identified, you must counsel your clients in a way that “treats” the psychological effects of their financial failure. I use the term “treat” generally, as my psychological training consists of an undergraduate degree, which in no way qualifies me to diagnose or treat serious emotional or mental issues. That being said, lawyers have intimate and ongoing contact with clients in various stages of distress, and should be cognizant of how their counseling relates to their clients’ emotional health. Likewise, it is important to understand your educational limitations and engage experts in the process if necessary.

“Anyone who says that winning isn’t everything, hasn’t won anything,” and anyone who has built a business or personal fortune will attest to this. It follows that failure is, and to an extent should be, devastating. While your client will be depressed at the change in their circumstances, that depression should be motivating, and not debilitating. It is acceptable to allow your client to grieve for their loss, but do not allow them to dwell on their misfortune at the expense of their future. To mitigate damage to your client’s brand, counsel your client to continue to present to the public the positive traits which make up their brand. Accepting responsibility is one thing, but there is no room for despair in a sinking ship. The excellent book by the Chinese American, Chin Ning-Chu, Think Face, Black Heart,discusses the importance of a rigid outer facade when facing difficult times. This strategy is essential for your clients to embrace in facing partners, investors, and other interested parties.

Implore your client to focus on two things: first, what is necessary to get them through the financial crisis; second, their future, and their next “success.” The first of these is a short-term issue, and it helps to frame it with timelines. Your client can’t simply ignore the situation and hope it will go away. Their knowledge and skill set are essential to salvage whatever is left, and their employees, families, and others require their focus. Looking over the longer term to the future, they must realize that the same skill set they utilized to build their prior fortune is the one that will bring them future success.

While managing expectations on the upside is often the goal in deal work, managing the downside expectations is equally important when dealing with financial failure. Talk specifically about the challenges your client will face as well as the issues they will not face. Describing the worst-case scenario eliminates irrational tears. The misconceptions that people have regarding a financial collapse are truly amazing. Once your client understands their exemptions and the assets they are most likely to keep, they often feel much better about their condition.

Moreover, shifting the focus from wealth to work will provide a psychological lift for your client. Wealth may have defined their lives for the immediate past; however, at some point, in order to amass their wealth, they were driven by work. Recapturing that spirt is an important aspect of rehabilitating your client’s financial fortunes. It is also important to understand and explain that the lack of stressful circumstances does not diminish anxiety, overcoming stressful circumstances does—a theory proven by the University of California Berkeley.2

Diet and exercise are also essential factors to address in counseling an individual in financial distress. Ironically, during times of stress, people often neglect these aspects of their lives. Further exacerbating the situation, individuals tend to rely on less-productive coping mechanisms, such as alcohol. Encourage your client to seek out new forms of exercise. This has real practical benefits, as Duke University scientists who researched the subject determined that exercising four days a week has more benefits than being on antidepressants.3 Recommending a change in diet and exercise and going so far as to accompany a client to a gym can have more positive benefits than anything you do for them legally. Personally, I am a fan of Yoga, which not only assists in physical conditioning, but also deals with spiritual issues discuss below.

Whatever approaches you employ to address your client’s psychological state, be sure you recognize the limits of your knowledge and expertise. Giving your client a “pep talk,” creating realistic expectations, and refocusing your client is one thing—as is recommending physical exercise to your clients.  However, if your client exhibits symptoms of withdrawal or hints that they may be contemplating suicide, you should refer them to a professional immediately.

Ethical Aspects of Business Failure
It is a truism that financial distress leads to distressed decisions. As a drowning individual will unconsciously grasp onto someone trying to save them, an individual drowning in financial debt will grab onto anything and anyone that may assist them. While the grasping of the drowning person risks death for both the victim and the lifesaver, that of the financially distressed person can lead to civil and criminal exposure for client and counsel alike.

Working with entrepreneurial clients poses special risks since entrepreneurs tend to be risk takers, and their natural instinct when faced with financial difficulty will be to “double down,” taking greater risks. Further, such clients likely have been accustomed, during good times, to having the last word, and may have embraced decisions where the “ends justified the means.” While excess profits in good times will cover up numerous missteps, an empty bank account exposes even the most minor malfeasance. This is particularly true if your client seeks bankruptcy court protection, a process which is entirely transparent. Thus it is essential to draw strict ethical boundaries and explain that while you will do anything legal to get the client through this process, you will not do anything that crosses legal or ethical boundaries.

There is a growing line of cases on the concept of “deepening insolvency.”4 Deepening insolvency is a developing theory of law that addresses the wrongful prolongation of a corporation’s life beyond insolvency, whereby increased debt, dissipation of assets, and/or decreased reputation result in damage to the corporation.5 As a company moves toward insolvency and the operators have legal duties to creditors, there may well be pressure from principals to restructure or operate in ways that salvage company assets for them, rather than the creditors. Minnesota law has been particularly forceful in identifying the entity, rather than the principals, as the client in such matters. Where the lawyer’s personal loyalties run to the principals, there can be a mismatch and tension.

The Bankruptcy Reform Act of 2005 now imposes additional certification requirements on bankruptcy attorneys. Section 704(b)(4) of the Bankruptcy Code requires attorneys to certify after “reasonable inquiry” the accuracy of the bankruptcy schedules.6 As such, absolute candor is essential in representing individuals going through difficult financial issues. If a client intends to seek the benefits of bankruptcy, it is imperative that they understand the implications of attempting to hide assets or perpetuating any fallacy by omission.

If a bankruptcy trustee is appointed, there is a transfer of attorney-client privilege and client file rights, and the trustee may well look on the lawyer as a potential defendant. The Lawyers Board recently published for comment a proposed new Board Opinion 21, which would impose on lawyers heavy obligations to disclose their own possible malpractice. A bankruptcy trustee might well allege that failure to make disclosure was a breach of fiduciary duty warranting disgorgement of all fees. This type of claim was ultimately rejected in Leonard v. Dorsey & Whitney, 553 F.3d 609 (8th Cir. 2009), but the Board Opinion, if issued, could have the effect of reviving this kind of claim.

Finally, these ethical issues have significant practical impact on a lawyer’s representation in a bankruptcy matter. A lawyer cannot withdraw from representation in a bankruptcy proceeding without court approval.7 The Minnesota Bankruptcy Court has specifically held that a retainer agreement to represent a debtor was improper because it provided for a right to withdraw if fees were not paid, without conditioning withdrawal on court approval.8 The court rejected as “disingenuous” the attorney’s argument that court approval was an implicit term of the agreement and ordered the disgorgement of all fees.

Spirituality & Rehabilitation
It’s said there are “no atheists in foxholes.” A final issue in counseling an individual in financial distress is addressing their spiritual needs. All individuals have faith. Some express their faith in terms of formal religion, some in the form of a narcissistic belief in themselves. The evangelical community often preaches that the most devout will receive the greatest material gain. When material abundance is taken from someone, it is not unusual for them to blame the failure on the “god” that allowed it to happen. That being said, it is imperative not to allow your client to abandon their spiritual base at a time they need it the most. Moreover, encourage them to seek out additional spiritual and/or religious counseling to assist them through the financial challenges that exist.

In sum, the actual legal work of a financial restructuring or bankruptcy is often the easiest part of the process. When dealing with individuals in distress, it is essential to deal with the psychological, ethical and spiritual issues that permeate the process. In doing so, you will not only facilitate the legal restructuring and have a positive affect on your client’s personal well-being, but will also recycle the occasional soul.

1 McNally, David and Karl Speak. Be Your Own Brand: A Breakthrough Formula For Standing Out From The Crowd.  San Francisco: Berrett-Koehler Publishers, Inc., 2002.
2 Editors of The Wellness Letter. The New Wellness Encyclopedia. New York: Mariner Books, 1995.
3 Babyak Michael, Blumenthal, James, Doraiswamy, Murali, et al., “Exercise and Pharmacotherapy in the Treatment of Major Depressive Disorder,” Psychosomatic Medicine 69:587-596 (2007).
4 Rohrbacher, Blake, “Deepening Insolvency: Developments for Directors,” Corporate Governance Advisor (2007).
5 “What is Deepening Insolvency?” 15 Journal of Bankruptcy Law and Practice No. 6 (December 2006).
In re Bailey (Bankr. E.D. Pa. 2005) citing In re Weaver, 307 B.R. 834 (Bankr. S.D. Miss 2002).
7 In re Bulen, 375 B.R. 858 (Bankr. D.Minn. 2007).
Id. At 865.

STEVE SILTON is a partner with the law firm of Hinshaw & Culbertson LLP, practicing with the Minneapolis office.  He represents small to mid-sized corporations, banks, credit unions and financial groups in commercial and complex bankruptcy matters and has been instrumental in the reorganization of a number of businesses. He often consults and/or associates with lawyers regarding their financially distressed business clients.

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