Legislative Update Bankruptcy Cases on the Supreme Courts October Term

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Sep 2003

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The U.S. Supreme Court has agreed to hear five bankruptcy cases in its upcoming term. Till v. SCS Credit Corp.,
on interest rates for chapter 13 cramdown, was discussed in the July/August issue.<a href="#1" name="1a">1</a> This month's column covers
whether chapter 7 debtor's counsel may be paid from the estate. Next month, we will address whether the filing
deadline for objection to discharge may be waived by the debtor.<a href="#2" name="2a">2</a> We will also look at Yates v. Hendon, on a sole
shareholder as participant in a corporate employee benefit plan, and United States v. Galetti, on enforcing partners'
derivative liability for partnership taxes.<a href="#3" name="3a">3</a>

<h3>Lamie: That Chapter 7 Retainer: Going, Going, Gone?</h3>

A 1994 amendment deleted counsel for chapter 7 debtors from Code §330(a)'s list of persons who may be awarded
compensation from the estate. Controversy has raged ever since and divided the circuits as to whether the omission
was an inadvertent error or an intentional change from prior practice. Some chapter 7 counsel rely on retainers to
avoid the problem, but that tactic did not work in a recent Fourth Circuit case. The Supreme Court's grant of
certiorari in the case, Lamie v.United States (In re Equipment Services Inc.),<a href="#4" name="4a">4</a> should settle the matter.

Petitioner John Lamie, an attorney, was hired to represent debtor Equipment Services Inc. in its chapter 11 case.
Before the case was filed, the debtor gave Lamie a $6000 retainer, which he could draw upon as he performed
services, with any unearned balance to be returned. Lamie prepared and filed the petition, earning $1000
pre-petition, and then represented the debtor in the 11.

Soon, however, the case was converted to chapter 7 on
motion by the U.S. Trustee. Lamie continued work on the case, work which for purposes of appeal is assumed
necessary and beneficial to the estate. Lamie eventually asked the court to approve $1,325 for post-petition chapter
11 work and $1,000 for chapter 7 services. The U.S. Trustee opposed any award for post-conversion work on the
ground that §330(a) "makes no provision for counsel of the debtor to be compensated by the estate." The trustee
took the position that the retainer, to the extent not earned pre-petition, was all property of the estate.

Judge William Stone of the U.S. Bankruptcy Court for the Western District of Virginia agreed that §330 does not
allow awards from the estate to chapter 7 debtor's counsel. However, he went on to approve all the requested fees
and expenses, since the retainer was sufficient to cover them. In Judge Stone's view, the retainer was property of the
attorney, with the estate's interest limited to any balance after the attorney had been paid for all services and
expenses under §329. On appeal, District Judge James Jones affirmed.

On appeal to the Fourth Circuit, Judges Niemeyer and Williams affirmed the holding that §330(a) does not allow
compensation for chapter 7 debtor's counsel from estate property. They overruled the lower courts on the retainer,
however, holding that once the case was filed, this retainer became estate property. On that ground, they reversed the
allowance of compensation for Lamie's chapter 7 services. Circuit Judge Michael concurred that the retainer was
property of the estate, but dissented from the majority's reading of §330(a). Judge Michael said 1994 statutory
change was a drafting error that should not prevent payment of chapter 7 debtor's counsel from the estate.

The Fourth Circuit's majority opinion recognizes that the Second, Third and Ninth Circuits all hold the omission
of chapter 7 debtor's counsel from §330(a) to be an inadvertent drafting error.<a href="#5" name="5a">5</a> However, that was insufficient to
overcome the plain language of the statute, Congress's failure to amend the section and arguments that in chapter 7,
unlike chapters 11, 12 and 13, "debtors and creditors do not act like a team," and that Congress had good reason to
refuse to compensate chapter 7 debtor's counsel from the estate. The Fourth Circuit, then, lines up with the Fifth
and Eleventh Circuits on this question.<a href="#6" name="6a">6</a>

The Fourth Circuit's views on the retainer are interesting. The whole panel agreed the retainer in question was
property of the estate. However, that outcome depended on state law of contracts and the agreement creating the
retainer. If a retainer is paid simply to ensure counsel's availability, whether or not services are performed, or is
pre-payment of a flat fee for all future services, then the panel said the attorney takes title to it as soon as it is paid.
In such a case, counsel's entitlement to the retainer in bankruptcy would be determined under §329, not §330 If, as
in Lamie's case, the retainer is instead held in trust as security for future fees, it remains property of the client until
a bankruptcy petition makes it estate property, and counsel's claims to payment from it are subject to §330
standards. The court noted that Virginia's attorney disciplinary rules required a trust type retainer. Characterization
of the retainer is not at issue in the Supreme Court.

Lamie's Supreme Court brief begins by pointing out that a chapter 7 debtor has an array of duties under the Code
that require competent counsel, but the debtor lacks money to pay because its assets are property of the estate.<a href="#7" name="7a">7</a>
Congress recognizes that counsel will seldom serve if they cannot be paid. Since 1898, Congress permitted paying
debtor's counsel from the estate for services that benefit the estate, and the 1994 amendments, he argues, were not
intended to change that practice. Instead, a scrivener's error inadvertently omitted key language, making §330(a)
ambiguous and internally inconsistent in that it lists "attorneys" as providers of potentially compensable services,
but omits them from a conjoined list of persons in fact entitled to an award from the estate.

These defects, Lamie argues, justify looking beyond §330(a)'s not-so-plain language to seek Congressional intent in
related Code provisions, legislative history, prior practice and sound bankruptcy policy. He points to §§330(a)(5)
and 331, authorizing interim compensation for debtor's counsel, as being in conflict with the Fourth Circuit's
reading of §330(a). In the legislative history, he finds no clear evidence that Congress intended to depart from the
long-standing prior practice of paying debtor's counsel from the chapter 7 estate. Further, he ascribes Congress'
failure to enact any of several bills that would have corrected this technical error to likely objections to other
provisions bundled into those bills. He points out that a restrictive reading of §330(a) may discourage debtor
representation not only in chapter 7 but also in chapter 11s for fear of conversion or appointment of a trustee in the
11.

Respondent United States argues that §330(a)'s plain language is not ambiguous and could be disregarded only if
Lamie proved not only an unquestionable scrivener's error but also that enforcing the text as written would produce
absurd results. The United States quotes Justice Kennedy's concurrence in United States. v. Granderson, "It is
beyond our province to rescue Congress from its drafting errors, and to provide for what we might think...is the
preferred result."<a href="#8" name="8a">8</a> The brief urges extra caution because Congress has enacted several bankruptcy bills since 1994
without correcting the alleged scrivener's error.

Next, the United States argues that Congress had sound reasons for deleting debtor's counsel from §330(a)'s list.
First, in 96 percent of chapter 7 cases, there are no estate dollars from which to pay counsel. Second, chapter 7
debtors "play very little role in the administration of the estate, and their counsel should not be paid from it."
Chapter 7 debtors can pay for representation as they usually do, via "a pre-petition flat fee or...post-petition income,
or both." This distinguishes chapter 7 from chapters 11, 12 and 13, where post-petition income is property of the
estate. Debtor's counsel in chapters 12 and 13 are expressly entitled to compensation under §330(a)(4)(B). Further,
the brief cites legislative history indicating that the 1994 changes were intended to influence debtors and their
counsel to choose chapter 13. Lamie's fears for chapter 11 counsel are unfounded, it argues, as they may protect
themselves from working for free post-conversion by limiting in advance "the scope of the representation
to...services for the chapter 11 debtor-in-possession" with court approval under §327(a).

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Till, 301 F.3d 583 (7th Cir. 2002)</a>,
cert. granted sub nom, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. SCS Credit Corp., 123 S.Ct. 2572 (June 16, 2003)</a>; Culhane, Marianne, "Supreme Court to Rule on Chapter 13 Cramdown Interest," ABI Journal 6 (July/August 2003). <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Ryan, 295 F.3d 724 (7th Cir. 2002), cert. granted, 123 S.Ct. 1899 (2003)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Yates, 287 F.3d 521 (6th Cir. 2002)</a>, cert. granted sub nom, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… v. Hendon, 123 S.Ct. 2637(2003)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3… States v. Galletti, 314 F.3d 336(9th Cir. 2002),</a> cert. granted, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
S.Ct 2606 (2003)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
States v. Equipment Services Inc., 290 F.3d 739 (4th Cir. 739),</a> cert. granted sub nom, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. U.S. Trustee, 123 S.Ct. 2664 (2003)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a><a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Top Grade Sausage, 227 F.3d 123 (3d Cir. 2000)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Century Cleaning Servs. Inc., 195 F.3d 1053 (9th Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
re Ames Dep't. Stores Inc., 76 F.3d 66 (2d Cir. 1996)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Am.Steel Product Inc., 197 F.3d 1354 (11th Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Pro-Snax Dist. Inc., 157 F.3d 414 (5th Cir. 1998)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> Lamie's petition for certiorari was supported by an amicus brief from the National Association of Consumer Bankruptcy Attorneys
(NACBA). NACBA's brief argues that efficient administration of chapter 7
cases requires the debtors and their counsel to assist and cooperate with the
trustee; for example, in a small business liquidation involving receivables and
other causes of action, counsel for debtor's knowledge of the business
could aid the trustee in pursuing those assets. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
U.S. 39, 68 (1994)</a>. <a href="#8a">Return to article</a>

Journal Authors

Marianne B. Culhane

Journal Date

Monday, September 1, 2003 - 12:00

Bankruptcy Rule

2003