Three bankruptcy judges in St. Louis sat en banc and wrote an opinion that effectively bars bifurcated fee arrangements in the Eastern District of Missouri.

Recognizing “the difficulty that many [chapter 7] debtors experience in hiring competent counsel during times of financial distress,” the judges’ March 29 opinion is a plea for Congress to “remedy this situation.” The judges said that Congress “could except bankruptcy attorneys’ fees and expenses, whether incurred pre- or post-petition, from discharge, or it could reverse its 1994 modification of Section 330 of the Bankruptcy Code to permit counsel to be paid from the bankruptcy estate.”

The Bifurcated Fee Agreements

A consumer bankruptcy lawyer put five individuals through what the judges called “straightforward, no-asset Chapter 7” cases. “Each of the Debtors received a timely discharge,” the judges said.

The debtors paid the lawyers nothing before filing. For fees, the debtors signed two engagement agreements, one before filing and one after. The agreements were a total of 15 pages, single-spaced.

Electing to pay nothing before filing, the post-petition agreement called for the debtors to pay about $1,500 in installments after filing.

The U.S. Trustee filed a motion asking the judges to void the pre- and post-petition agreements and order a refund of anything the debtors had paid. The U.S. Trustee also wanted the judges to impose a civil penalty under Sections 329, 526 and 528 and Bankruptcy Rule 2017.

The opinion describes the two engagement agreements in exacting detail. Among other things, the agreements said that the lawyer would continue representing the debtors throughout their cases even if they didn’t agree to pay, unless the court were to allow the lawyer to withdraw.

The Problem and the Potential Solution

The judges explained the problem created by Lamie v. United States Trustee, 540 U.S. 526, 538-39 (2004), where they said the Supreme Court “concluded that [the] plain language [in Section 330(a)(1)] prohibits a debtor’s attorney from receiving payment from a bankruptcy estate post-petition unless the attorney is also employed by the trustee.”

The problem is further compounded since, as the judges said, a “debtor’s attorney also cannot collect from a debtor post-petition under a pre-petition engagement agreement because that agreement creates a debt that is subject first to the automatic stay and later to the debtor’s bankruptcy discharge.”

“As a practical matter,” the judges said that “a debtor must pay their attorney in full prior to the commencement of a Chapter 7 case, including for services that the attorney may provide postpetition. This is not possible for some prospective debtors, who simply cannot save enough money in advance to retain counsel.”

“Bifurcation represents a potential solution to the problem of payment for a Chapter 7 debtor’s attorney,” the judges said. However, they went on to observe that “[b]ifurcated agreements have met with mixed results.” Citing decisions on both sides of the fence, they said that “some courts” have found “bifurcation acceptable if counsel complies with certain requirements.”

“Others disagree,” the judges said, by ruling “that bifurcated agreements are illusory, duplicitous, or otherwise impermissible.” A third groups of courts didn’t decide whether bifurcation is permissible, because they found violations of other federal or local rules.

The Cases at Hand

The judges examined the pre- and post-petition agreement to determine whether they comported with the statute, the Bankruptcy Rules and local rules. For instance, they said that the post-filing agreement “lacks clarity.” They asked, “[H]ow can a client lacking legal training possibly understand them?”

The judges decided that the agreements “do not comply with Section 528(a)(1)” because the “Pre- and Post-Filing Agreements do not clearly describe the services to be provided by the Firm.” They went on to say that “the Firm has not shown that all of its fees in these cases were reasonable.”

On the other hand, the judges found that the “U.S. Trustee has not shown that the Firm misrepresented the services it would provide for purposes of Section 526(a)(3)(A).”

In terms of monetary relief, the debtors had paid nothing before filing, so there was nothing to disgorge regarding pre-filing services. With regard to post-filing services, the judges said that the violation of Section 528(a)(1) required a refund of all post-petition services. As a result, the judges were not required to decide what portion of the services was reasonable.

Because the judges found no violation of Section 526(a)(3), they saw “no basis . . . to award a civil penalty under Section 526(c)(5).”

Concluding the opinion, the judges saw “bifurcated fee agreements as an effort to address this substantial problem of access to justice,” because “debtors who do not have the benefit of legal assistance find the bankruptcy process daunting, frequently do not obtain discharges, and suffer other hardships during their cases.” They urged Congress to fix the mess, saying that “the judicial branch . . . cannot alter the Bankruptcy Code or choose to ignore existing precedent controlling these matters.”

The judges were Chief Bankruptcy Judge Bonnie L. Clair and Bankruptcy Judges Kathy A. Surratt-States and Brian C. Walsh.