Bankruptcy Court Not In Love With Attorney Loophole Debt Settlement. It’s a Duck.

A recent memorandum opinion from Kansas in the United States Bankruptcy Court against Persels and Associates and attorney Stan Goodwin didn’t probably wind up how Persels would have wanted it to.

The summary of the opinion is intriguing and clear. The United States Chief Bankruptcy Judge, Robert Nugent, says:

If it walks like a duck and swims like a duck and quacks like a duck, it is a duck. Persels and Goodwin may hold themselves out as lawyers providing unbundled, limited legal representation, but there is plenty of evidence in the summary judgment record to suggest that they “walk, swim, and quack” like a credit services organization that supplies debt settlement services while posing as a law firm.

Here are excerpts from the opinion that will be of interest to readers.

Kansas consumer protection law prohibits both deception and unconscionable conduct in offering consumers debt settlement services. While it also prohibits firms that are not registered with the State Bank Commissioner from supplying those services, Kansas law establishes a safe harbor that exempts Kansas lawyers who supply debt settlement services in the course of practicing law from registration and regulation by the Commissioner. Persels and Associates, L.L.C. (“Persels”), a law firm owned and controlled by Neil J. Ruther, Esq., enters into independent contractor agreements with Kansas attorneys as part of a calculated effort to slip into this safe harbor. None of the lawyers who work directly for Persels is admitted to the Kansas bar or practices in Kansas. Persels is an unregistered credit services organization that represents to Kansas consumers that it will “represent” them as attorneys in the negotiation and settlement of their debts. It made these (and more) representations to Levi Kinderknecht, the debtor in this chapter 7 case, and received over $1,000 from Kinderknecht for its purported services.

His chapter 7 trustee, Linda S. Parks, sued both Persels and Stan Goodwin, one of Persels field attorneys in Kansas, in connection with their “representation” of Kinderknecht. Parks asserted a variety of state law tort claims, state law consumer violations, and a 11 U.S.C. § 548 fraudulent conveyance claim, all arising from Kinderknecht’s enrollment and participation in a debt settlement plan with Persels.

Among the defendants’ assertions was their claim that they are exempt from the provisions of the Kansas Credit Services Organization Act (KCSOA), KAN. STAT. ANN. § 50-1116(b)(2005). The Persels law firm is a limited liability company that is neither owned by or employs Kansas lawyers. Because none of its individual lawyers are “licensed to practice law in this state,” and because entities are not “licensed” to practice law, Persels is not exempt from the provisions of the KCSOA, including the requirement that it register with the State Bank Commissioner, § 50-1118. Further, Persels’ failure to register with the State Bank Commissioner is a per se deceptive act or practice in violation of the Kansas Consumer Protection Act (KCPA) under § 50-1132. Finally, neither the KCSOA nor the KCPA is unconstitutional as applied to Persels and Goodwin.

Understanding Persels workflow requires a description of the cast of characters who participate in it. CareOne Services, Inc., not a party to this proceeding, is a national company registered with the Kansas Bank Commissioner under the Kansas Credit Services Organization Act (KCSOA), KAN. STAT. ANN. § 50-1116 et seq. to provide debt management services to Kansas consumers. A debt management plan is a plan in which a debtor’s creditors agree to stay attempts to collect a debt while the debtor makes payments under a plan that pays all debts in full. CareOne refers those debtors who do not have the income or assets to participate in debt management to Persels & Associates, LLC for debt settlement. In that debt settlement process that Persels advertises, Persels negotiates with debtor’s creditors for a reduction in the amount of the debt. The debtor makes payments to Persels to fund the payment of its attorneys fees and the compromised debts. In this case, CareOne referred debtor Levi Kinderknecht to Persels for debt settlement. Persels is not registered with the Kansas Bank Commissioner under the KCSOA.

In addition to CareOne personnel and Persels staff attorneys, Persels has field attorneys in virtually every state, including Kansas. After Persels signs a debtor up for debt settlement and the debtor pays an initial legal fee, Persels assigns the client to a field attorney in the state in which the field attorney is licensed to practice. The field attorney makes an introductory call to the client. Thereafter, the field attorney monitors or reviews the client file monthly and enters notes in the Persels software and may communicate with CareOne personnel, credit negotiators, or Persels employees. If the Persels client is sued by a creditor, the field attorney is available to provide advice to the client but the field attorney does not enter an appearance in the case or otherwise represent the client in court. They may draft answers and other pleadings for the client to sign and file pro se. The pleadings disclose that they were prepared by a Persels attorney.

Stan Goodwin was the Kansas field attorney for Persels assigned to Kinderknecht. Goodwin’s relationship with Persels is defined by an Independent Contractor Agreement under which Goodwin agreed to provide legal services to Persels’ clients, including: “ . . . providing legal advice in the general practice of law, Debt Settlement, Bankruptcy, . . .”.7 Goodwin does not practice law apart from his arrangement with Persels and has no clients other than those assigned to him by Persels; these number approximately 500 clients. Goodwin does not file bankruptcy cases or practice in this court. His only experience representing debtors is dealing with Persels clients enrolled in a debt settlement plan. He does not have access to the escrow account set up for the debtor’s payments. He is paid a flat fee of approximately $10-12 per client per month and is issued a 1099 from Persels for his work. Goodwin does not record or keep time records for his services, but did enter notes on Kinderknecht’s plan in the computer software upon his monthly review of the client file.

The success rate of Persels clients is dubious at best. During the one year period from October 2008 to October 2009, Persels enrolled 681 Kansas residents in a debt settlement program. 320 participants terminated within six months and 465 participants dropped out of the program within one year.

According to her file notes, the Persels representative, reading from a script, advised Kinderknecht about several points: (1) Persels fees would total 15% of his debts, (2) Persels would collect the fee over the initial 18 months of the plan; (3) the initial $100 legal fee was due on March 2; (4) Kinderknecht’s monthly payments were $162.90 which included a legal fee of $140.13 for the first five months, then $100.10 a month for months 6 through 18; (5) the monthly payments began March 13 and would be held in trust; (6) no payments would be made to creditors until they agreed to a settlement offer; (7) any creditors might pursue legal action to collect their debt before they accepted a settlement offer; (8) Kinderknecht should notify Persels when he received communication from his creditors; (9) Persels would send cease and desist letters to creditors upon receipt of Kinderknecht’s initial payment; and (10) Persels would notify Kinderknecht of all settlement activity but he should not expect any activity until the escrow account had accumulated enough money over an unspecified period of time.

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He had monthly disposable income of $22.90 to pay toward these unsecured debts. Notwithstanding his meager disposable income, the payment schedule attached to the retainer agreement called him to make 60 monthly payments of $162.90, for a total of $9,774.00.19.

Kinderknecht electronically signed the retainer agreement on February 19, 2009. When he signed on with Persels, he believed he had hired a lawyer, that he was not going to get sued by his creditors, and that by hiring a lawyer, he would be able to resolve his debt in 60 months. Prior to retaining Persels, he had never hired a lawyer before. He would not have signed on if he had understood that this relationship offered him no protection from suit by his creditors and that he would have to represent himself in court. Nor would he have enrolled in debt settlement had he been informed that most people who sign up for debt settlement do not complete the plan.

According to the log, a Persels attorney named “Swyngaard” conducted an “Attorney Record Review” on February 20, 2009. Goodwin identified this individual as Sara Wyngaard, a Persels attorney living in Mexico. This notes log entry apparently references the “underwriting” conducted by a Persels staff attorney to determine that the debtor is an appropriate candidate for debt settlement before assigning the debtor to a field attorney.

Citibank sued Kinderknecht to collect his debt, serving him with summons and a petition on August 7, 2009. He contacted Persels that day and forwarded the papers to Persels on August 11. When Kinderknecht spoke to Goodwin about the summons on August 9, 2009, he realized for the first time that Persels’ representation of him did not include court appearances. Goodwin explained to Kinderknecht that he could represent himself. Goodwin received the lawsuit papers on August 13 and on August 17, prepared form pleadings in response to the Citibank suit, and e-mailed them to Kinderknecht. Goodwin told Kinderknecht that he would try to work with Citibank’s attorneys to get them to not pursue him, but Goodwin never contacted Citibank’s counsel regarding the suit. On September 26, Goodwin conducted a file review and called Kinderknecht for the status of the Citibank litigation, leaving a voice message. Goodwin sent another request for the lawsuit status when he reviewed the file October 30. Because Kinderknecht did not want to defend himself pro se against Citibank, he hired a local bankruptcy attorney and filed a chapter 7 petition on October 20, 2009. On November 2, 2009, Kinderknecht canceled the debt settlement plan. Persels refunded $200.80, the balance in his trust account, to Kinderknecht on November 10, 2009.34

Kinderknecht’s bankruptcy case trustee commenced the current adversary proceeding on October 1, 2010. As listed in the final pretrial order,35 she asserted a variety of claims against Persels and/or Goodwin.36 They include (1) avoiding a fraudulent transfer under 11 U.S.C. § 548(a)(1)(B) because Kinderknecht did not receive reasonably equivalent value in exchange for the fees he paid; (2) claims for the commission of deceptive practices and unconscionable acts in the services provided Kinderknecht in violation of the Kansas Consumer Protection Act (KCPA), KAN. STAT. ANN. §§ 50-626 and 627 (2005 and 2010 Supp.); (3) common law legal malpractice; (4) breach of fiduciary duty; (5) disgorgement of unreasonable attorneys’ fees; and (6) claims that Persels and Goodwin violated the Kansas Credit Services Organization Act (KCSOA), KAN. STAT. ANN. § 50-1118 (2005) by providing credit services without registering with the state bank commissioner and without complying with the other provisions of that act.

In their summary judgment memoranda, the defendants also challenged the constitutionality of the KCSOA and the KCPA as sought to be applied to them under the circumstances here. The Court certified the constitutional challenge and the Kansas Attorney General intervened to defend the constitutionality of the state statutes as sought to be applied here.

Analysis and Conclusions of Law

The Kansas Credit Services Organization Act requires that credit services organizations providing debt management services to Kansas residents first register with the Kansas bank commissioner under KAN. STAT. ANN. § 50-1118 (2005). Persels and Goodwin are credit services organizations that engage in debt management services. Kinderknecht is a Kansas resident. Neither Persels nor Goodwin is registered with the state bank commissioner. They contend that they are exempt from the Act’s registration and other requirements because they are attorneys.

The attorney exemption is found in § 50-1116(b) of the Act and states:

Any person licensed to practice law in this state acting within the course and scope of such person’s practice as an attorney shall be exempt from the provisions of this act. To qualify for the attorney exemption, two requirements must be satisfied under the plain language of the statute: (1) that the “person” is licensed to practice law in Kansas; and (2) that the “person” is acting within the course and scope of such person’s practice as an attorney.

To the extent that Goodwin was practicing law, he may qualify for the attorney exemption and not be subject to the registration requirement or other provisions of the KCSOA. He is an individual licensed to practice law in Kansas and arguably represented Kinderknecht in the course of his “practice,” which consists exclusively of acting as a field attorney for Persels in Kansas and representing only clients assigned to him by Persels. He had no engagement or fee agreement with Kinderknecht and did not directly charge Kinderknecht fees. Goodwin received fees from Persels, not Kinderknecht.

Goodwin gave Kinderknecht no specific legal advice about entering into the debt settlement plan. Kinderknecht had already retained Persels and enrolled in the plan before he was assigned to Goodwin. Goodwin did no negotiating with any creditors. Indeed, he testified that he would not have advised Kinderknecht to proceed with debt settlement with respect to Bank of America or Citi. Only when Kinderknecht was sued did Goodwin confer with him about how to proceed and Goodwin’s only contribution then was to “ghost” some pleadings and forward them to Kinderknecht for Kinderknecht to sign. Despite his telling Kinderknecht that he would try to dissaude Citi’s counsel from pursuing the action, he never did so. If this is the extent of what Goodwin does for his “clients,” whether he is “practicing law” as that term is commonly understood is questionable. Therefore, enough dispute remains in the record to deny Goodwin summary judgment on the issue of his being exempt from the KCSOA under § 50-1116(b).

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Persels’ status under the KCSOA stands on a different footing from Goodwin and compels a different conclusion. Persels is a Maryland limited liability company that holds itself out as a national law firm dedicated to consumer rights. Although a law firm, might fall within the KCSOA’s definition of “person,” law firms are not licensed to practice law in Kansas. Nor does Persels suggest or point to facts in this record that would support a finding that the Persels firm (as opposed to its member lawyers) has been granted a license to practice law anywhere. On March 23, 2012 while this motion was pending, the Kansas Court of Appeals handed down its decision in Consumer Law Associates, LLC, et al v. Stork, Acting Com’r of the Office of the Kansas State Bank Com’r, and affirmed the state trial court’s determination that the attorney exemption in the KCSOA does not apply to a limited liability company or any other entity that is not licensed to practice law by the Kansas Supreme Court.

Only individual members or attorneys of a law firm may be licensed to practice law. A law firm can only act through the individuals that comprise the firm, just as a corporation can only act by and through individuals. The Persels law firm is comprised of both attorney and non-attorney employees. Obviously, the non-attorney staff of Persels are not licensed to practice law in Kansas or any other state. Persels admits that none of its “staff attorneys” or members is licensed to practice law in Kansas. Nor has Persels identified a Kansas licensed attorney in the Persels firm who represented Kinderknecht and provided legal services to him. Indeed, the fact that Persels has no attorneys licensed in this State is the very reason it needed Goodwin, who is licensed in the state of Kansas, to “represent” the Kansas debtor. But Goodwin’s relationship with Persels is that of an independent contractor, not a member of the Persels law firm acting as an agent of Persels. Thus, Persels can neither rely on the fact that Goodwin is a Kansas-licensed attorney, nor claim that it “practices” law in Kansas through the instrumentality of a Kansas-licensed independent contractor. Holding otherwise would allow Persels to insulate itself from any liability resulting from Goodwin’s conduct because he is an independent contractor while availing itself of the KCSOA safe harbor on the strength of Goodwin’s Kansas license. Persels can’t have it both ways.

Because no member or associate of the Persels law firm is licensed to practice law in Kansas, the Court need look no further to determine that Persels is not protected by the safe harbor of § 50-1116(b). There is no need to determine whether Persels was acting within the course and scope of such person’s practice as an attorney. The Persels law firm is not protected by the attorney exemption in § 50-1116(b) and was required to register with the Kansas bank commissioner and comply with the provisions of the KCSOA.

The Persels’ workflow model as established by the uncontroverted facts demonstrates that non lawyers performed the vast majority of services provided to Kinderknecht and that so-called “credit negotiators” – non-lawyer members of Persels’ administrative staff – were tasked with negotiating debtor’s debts with creditors. Neither Persels staff attorneys nor Kansas attorney Goodwin negotiated any of Kinderknecht’s debts. Other than the “cease and desist” letters, no attorney communicated with any of the creditors Kinderknecht enrolled in his plan, despite Persels’ representation that he would “be represented for purposes of negotiation of your debts by a Persels . . . attorney licensed in your state of residence.” What Kinderknecht was sold were debt settlement services that Persels’ dressed up as “legal services” in a bald-faced effort to evade complying with the KCSOA. What could be more deceptive?

Neither Persels nor Goodwin disclosed to Kinderknecht that because he had so little disposable income, his debts were simply too high for successful debt settlement to be likely. Persels and Goodwin knew that certain creditors were more aggressive and likely to sue debt settlement clients rather than negotiate the debts. And they knew that Kinderknecht owed two of them money. This would have been particularly relevant information for Kinderknecht. He considered debt settlement because he feared getting sued by his creditors and sought the assistance of attorneys to help him deal with his creditors. Had Persels or Goodwin told him that, Kinderknecht might not have enrolled in debt settlement or retained Persels to represent him. Yet neither Persels nor Goodwin ever discussed with Kinderknecht the advantages and disadvantages of debt settlement versus bankruptcy or explained why he was a suitable candidate for debt settlement.

You can read the full Order Designated as Opinion here.


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