Most debtors that are contemplating chapter 7 are on the brink of economic disaster. They have creditors harassing them, calling them nonstop, garnishing wages and income tax returns, and seizing their vehicles to satisfy judgments. These hardworking individuals simply do not have the extra funds to pay a bankruptcy attorney up front in full to file a bankruptcy case to stop the creditors. Alternatively, the options for the unfortunate debtor are to proceed file their bankruptcy pro se, hire a bankruptcy petition preparer or find an attorney that accepts alternative fee agreements. The debtor who attempts to go it alone or with a petition preparer faces a substantially greater risk of the bankruptcy case getting dismissed without a receiving a chapter 7 discharge. In the U.S. Bankruptcy Court for the Eastern District of Michigan, during 2010-11, approximately 98 percent of individual chapter 7 cases filed by an attorney received a discharge, while only approximately 69 percent of chapter 7 cases filed without an attorney received a discharge.[1]
Attorneys’ fees in a chapter 7 have long been a disputed and a contentious portion of the Bankruptcy Code and the Rules of Professional Responsibility because bankruptcy attorneys must be zealous advocates for their clients while attempting to keep their lights on in their own offices. Attorneys’ attempts to creatively structure getting paid has been address by the U.S. Supreme Court, which has held in Lamie v. United States that “§ 330(a)(1) does not authorize compensation awards to debtors’ attorneys from estate funds, unless they are employed as authorized by 11 U.S.C. § 327.”[2] Further, 11 U.S.C. § 523 states that attorneys’ fees are not except from discharge, and pre-petition debts for legal fees are subject to discharge pursuant to 11 U.S.C. § 727.[3] Consequently, pursuant to 11 U.S.C. § 362, attorneys are unable to proceed with any active collection activity for pre-petition debt.
It is apparent that an attorney will lead to a successful chapter 7, ensuring that the debtor receives a discharge and obtains a fresh start. Unfortunately, if the debtor seeks counsel but is unable to pay the entire attorneys’ fees, filling fees and credit counseling fees up front, they may have run into a roadblock to their fresh start. Creative attorneys have attempted to craft alternative fee agreements that ensure that the debtor is protected from creditors and that the attorneys are able to receive their fees. An attorney might agree to either one fee agreement with payments to be made pre- and post-petition or a bifurcated fee agreement where services and fees are split pre- and post-petition. However, these alternative fee agreements are challenged on many fronts in bankruptcy court as violating the Bankruptcy Code and, in Michigan, the Michigan Rules of Professional Conduct (MRPC).
In 2004, a challenge of an alternative fee payment in the U.S. Bankruptcy Court for Eastern District of Michigan in In re Michel held that a pre-petition fee agreement that draws no distinction between pre- and post-petition services and fees creates a debt that is entirely a pre-petition debt, which is subject to the automatic stay pursuant to 11 U.S.C. § 362(a) and is dischargeable in the chapter 7 case pursuant to 11 U.S.C. § 727(b).[4] The court reasoned that the fee agreement did not condition the post-petition installment payments of the flat fee on the debtor’s attorney’s actual performance of post-petition services. Recently, in another challenge regarding attorney fees in the same district, the court held that the there is no exception to discharge for a pre-petition agreement to pay attorneys’ fees and the pre-petition agreement between the debtor and attorney was cancelled under § 329(b) of the Bankruptcy Code.[5]
Attorneys are eternally creative and there seems to be a remedy that might reach a solution to the problem of ensuring that debtors are able to receive the protection of bankruptcy and permitting the attorneys to receive their fees. The debtor’s attorney and debtor in In re Slabbinck agreed to a limited scope of representation fee agreement, whereby two separate fee agreements were entered into (one pre-petition and one post-petition) and both agreements stated specifically that the fee was to be paid and the services were to be rendered.[6] The court held that if the attorney’s legal services are unbundled between pre- and post-petition services in strict conformance with the MRPC, such unbundling of legal services does not by itself warrant any relief under 11 U.S.C. § 329. MRPC requires that (1) the attorney competently represents the individual debtor despite any limitation on the scope; (2) the attorney provides adequate consultation to the individual debtor concerning the limitation on the scope of attorney’s representation and legal matter in question; and (3) the individual debtor makes a fully informed and voluntary decision consent to such limitation. Therefore, the post-petition fee agreement survives the bankruptcy, thereby obligating the debtor to pay for post-petition attorneys’ fees.
The Slabbinck holding does create an opportunity for the debtor to retain an attorney and file their bankruptcy at a reduced upfront fee, thereby receiving protection from their creditors within chapter 7 and permitting the attorney to receive payment on attorneys’ fees post-petition. However, additional issues arise once the bankruptcy is filed and there is outstanding attorneys’ fees because the relationship between counsel and the debtor changes. The debtor’s attorney duties and obligations now seem to be in conflict: (1) protecting the debtor and get as much debt discharged as the Bankruptcy Code permits, and (2) ensuring that their fees paid. The debtor who is desperately seeking a fresh start now has a new obligation to their attorney that will survive the bankruptcy discharge. Further, it appears that the attorney is permitted to proceed with collection matters if the debtor does not pay his/her attorneys’ fees, thereby putting the debtor back in their original conundrum that brought them to seek the attorney’s counsel.
Obligating the debtor with new nondischargeable debt from their attorney does not seem be what Supreme Court had in mind when it held more than 80 years ago that the “purpose of the act has been … emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor … a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt.”[7]
A possible solution might be a specific and uniform pre-petition fee agreement that is monitored by the bankruptcy court that counsels and informs the debtor that unpaid attorneys' fees will be discharged in the chapter 7. However, a debtor has the option to continue payments to the attorney, which will allow the debtor that does not have the funds to pay the attorney pre-petition protection under the Bankruptcy Code, and the expertise of a skillful and knowledgeable attorney, thereby increasing the debtor’s chance of a successful discharge.
[1] You Have Bills to Pay? Ethics in Getting Paid in Chapter 7, 11 and 13 Cases. Hon. Phillip J. Shefferly. ABI Central States Bankruptcy 2013 Workshop written materials, p. 426.
[2] Lamie v. Unitied States Trustee, 540 U.S. 526, 538 (2004).
[3] Rittenhouse v. Eisen, 404 F. 3d 395, 396 (6th Cir. 2005).
[4] In re Michel, 2014 WL 1647009 (Bankr. E.D. Mich. 2004).
[5] In re Gourlay, 483 B.R. 496 (Bankr. E.D. Mich. 2012); aff’d, 496 B.R. 857 (E.D. Mich. 2013).
[6] In re Slabbink, 482 B.R. 576 (Bankr. E.D. Mich. 2012).
[7] Local Loan Co. v Hunt, 292 U.S. 234 (1934).