In the Matter of Richard C. Browy et al., Bankrupts.james S. Brannon, As Trustee in Bankruptcy, Plaintiff-appellee, v. Stephen D. Gay, Attorney, Defendant-appellant, 527 F.2d 799 (7th Cir. 1976)

Attorney Stephen D. Gay appeals from the decision of the district court confirming a bankruptcy judge's order to produce certain corporate records in Gay's possession. Gay had been the pre-bankruptcy attorney for Richard C. Browy and three companies in which Browy owned a controlling interest. On September 30, 1974, Receiver James S. Brannon filed a complaint for the turnover of corporate records of the three companies; in the alternative, the complaint prayed for an order permitting examination of the corporate records. In response Gay filed a motion to dismiss the complaint supported by an affidavit claiming an attorney's retaining lien upon the corporate books and records. The lien, Gay asserts, permits him to retain possession of the records until he is fully paid for the legal services he had rendered to Browy and the three corporations.

On November 21, 1974, the bankruptcy judge entered an order dismissing the complaint. On the following day, Brannon, who in the meantime had become Trustee in bankruptcy for Browy and the three bankrupt corporations, applied for an order under Bankruptcy Rule 205 requiring Gay to be examined in Bankruptcy Court regarding 'acts, conduct, and property of the bankrupts.' As a result, the bankruptcy judge ordered Gay to appear to testify on January 7, 1975. An accompanying subpoena duces tecum required him to bring with him the aforesaid corporate minutes. The bankruptcy judge denied the ensuing motion to quash the subpoena on January 31, 1975, stating:

'It is necessary for the proper administration of the bankruptcy estates that the Trustee examine the said books, papers, and records of the bankrupt(s) and that this need of the Trustee has priority over the claimed retaining lien of Stephen D. Gay.'

The bankruptcy judge therefore ordered Gay to permit the bankruptcy trustee to examine the corporate books and records within 20 days. On appeal to the district court, the order was affirmed.

The sole question before us is whether the bankruptcy trustee, without paying Gay's fee, may examine the books and records of the bankrupts where there is an attorney's retaining lien on them. This Court must balance Gay's rights to payment of his fee, evidenced by the lien, against the needs of the judicially supervised bankruptcy proceeding to inquire into the transactions of the bankrupt. We believe these two interests can be accommodated by requiring Gay to surrender the records subject to an order of the bankruptcy court preserving the attorney's priority afforded by his lien.

It is well settled that an attorney's retaining lien survives bankruptcy. In re San Juan Gold, Inc., 96 F.2d 60 (2d Cir. 1938); 4A Collier on Bankruptcy (14th ed.) P70.87(2) and cases cited at 1003--1004. Gay's retaining lien, cognizable under Illinois law,¹  is a passive or possessory one and may not be foreclosed.²  The attorney simply has the right to hold the client's papers until the legal fees are paid. This right is enforceable against the client (McCracken v. City of Joliet, 271 Ill. 270, 111 N.E. 131 (1915)), third parties (In re Professional Hockey Antitrust Litigation (Multidist, Lit.), 371 F. Supp. 742 (E.D. Pa. 1974); Beardsley v. Cockerell,240 F. Supp. 845 (D.D.C. 1965)), and the trustee in bankruptcy. In re San Juan Gold, Inc., supra. It makes no difference that San Juan Gold was a reorganization proceeding under Chapter X rather than a straight bankruptcy case; the rule is the same. In re Allied Owners' Corporation, 72 F.2d 255 (2d Cir. 1934); In re Stronge & Warner Millinery Co., 33 F.2d 1001 (D. Minn. 1929); In re Luber, 261 F. 221 (E.D. Pa. 1919).³ 

In this case, the trustee has conceded that the lien is valid under Illinois law. He has asserted no grounds which would permit the court to upset the lien as a fraudulent or preferential transfer. Rather, the trustee contends that the bankruptcy laws automatically void the lien because of the nature of the retained property. We disagree.

The trustee also relies on the second sentence of Section 70(c) of the Bankruptcy Act⁴  as supporting the district court's order. However, that sentence, called the 'strong-arm clause,' is designed to permit a trustee to prevail over prior liens where 'under the applicable law such a creditor might prevail over prior * * * liens * * *.' 4A Collier Bankruptcy P70.46 at 559--560. No such showing has been made here. The trustee also cites Section 70(e) (1) of the Bankruptcy Act⁵  which permits the bankruptcy trustee to avoid fraudulent or voidable transfers. This record does not reflect any such transfer, so that Section 70(e) (1) also lends no support to the district court's order. These Sections would be appropriate were the trustee attacking the validity of the lien--similar to an attempt to set aside a lien on any other property--under either state or federal law. Nothing in those provisions of the Bankruptcy Act states or implies that this particular lien is automatically voided.

Although the lien is valid and consequently must be recognized by the bankruptcy court, this objective can be attained by less drastic means than withholding access to the papers. One of the purposes of the Bankruptcy Act is to provide for an equitable distribution of the bankrupt's assets among his creditors. The trustee's ability to comb the bankrupt's records for fraudulent or otherwise invalid transactions is a necessary concomitant of that statutory goal. Therefore, we agree with the affirming district court that this documentary examination is 'necessary for the proper administration of the bankruptcy estates.' Justice will best be served by permitting such an examination subject to an order of the bankruptcy court preserving the priority afforded by Gay's lien.⁶ 

This result adequately protects Gay's interest in receiving his fees. Valid liens must be paid before the assets of the bankrupt can be distributed to the creditors. City of Richmond v. Bird, 249 U.S. 174, 39 S. Ct. 186, 63 L. Ed. 543; Durand v. National Labor Relations Board, 296 F. Supp. 1049, 1057 (W.D. Ark. 1969); 3A Collier on Bankruptcy P64.02(2). If there is any money in the estate, Gay will have a superior claim to the funds; if there is no money, he would not be paid in any event.⁷ 

Vacated and remanded for further proceedings consistent herewith.