Bifurcated Fees for Destitute Chapter 7 Debtors Approved in Utah

To make chapter 7 accessible for those who can’t pay fees before filing, Bankruptcy Judge Kevin R. Anderson of Salt Lake City laid down extensive guidelines and disclosure requirements enabling lawyers to use so-called bifurcated fee arrangements, where the debtor pays all costs and fees in installments after filing.

Blame the Supreme Court for the Problem

In Lamie v. U.S. Trustee, 540 U.S. 526 (2004), the Supreme Court held that a chapter 7 debtor’s counsel fees cannot be paid from estate property, and any prepetition obligation for unpaid attorneys’ fees is dischargeable. In his April 10 opinion, Judge Anderson said that the “predicament” created by the high court “precipitated the concept of bifurcated fee agreements in consumer cases.”

Often, Judge Anderson said, individuals needing immediate chapter 7 relief lack the cash to pay an attorney up front. Those consumers have “three ineffectual options,” he said. They can file pro se, but 30% never receive a discharge. Second, “and more problematic,” they can use a petition preparer.

Third, destitute debtors can file chapter 13 petitions to pay counsel fees through the plan, but they are bound to the bankruptcy process for three to five years when they would be eligible for an immediate chapter 7 discharge had they the resources to pay a prepetition retainer.

For a fourth and effective option, an enterprising attorney in Salt Lake City developed elaborate disclosures and procedures allowing a chapter 7 debtor to pay all costs and attorneys’ fees after filing.

The Solution

The lawyer gave the client three options. The client could pay a $2,400 prepetition retainer to cover services throughout the subsequent chapter 7 case. Second, the lawyer could take $500 to prepare and file a bare-bones petition, allowing the client proceed pro se or hire another lawyer after filing.

Third, the lawyer offered a bifurcated fee arrangement, also known as a “zero-down option.” The client would pay nothing up front, but the lawyer would file a bare-bones petition. After filing, the debtor would sign a retainer agreement calling for 10 monthly payments of $240, to be deducted automatically from a bank account.

Judge Anderson explained how the lawyer gave the client “a multitude of disclosures, explanations and warnings regarding the fee arrangement, the bankruptcy process and the “possible use of . . . a third party [factor] to collect the payments.” In addition, the judge said the lawyer gave the client written information and instructions, including 50 paragraphs of disclosures and explanations that the client was required to read and initial.

The client agreed to the bifurcated arrangement and paid nothing before filing. The lawyer filed the petition, and the client received a discharge 115 days later in the course of an uneventful chapter 7 case.

More than one year after the entry of discharge, the U.S. Trustee filed a motion asking the court to cancel the fee arrangement, require the attorney to disgorge all fees, and impose sanctions. At oral argument, Judge Anderson said the U.S. Trustee was more interested in “obtaining guidance from the court” than in sanctioning the lawyer.

Copious Disclosure Is the Key

In a 27-page opinion worthy of reading in full text, Judge Anderson exonerated the debtor’s lawyer.

Judge Anderson ruled that bifurcated fee arrangements “to effectuate affordable legal services” in consumer chapter 7 cases are not prohibited per se by the Bankruptcy Code, nor do they “per se implicate ethical issues and they are not per se unfair.”

“With appropriate disclosures,” Judge Anderson held, “debtors can make informed decisions as to the risks and benefits of incurring a post-petition obligation in order to retain an attorney’s services.” He said the lawyer “had a reasonable basis to employ bifurcated fee arrangements when clients were unable to pay a full retainer prior to the bankruptcy filing.”

Judge Anderson found that “this process did not harm the Debtor. Indeed, it facilitated the Debtor’s ability to afford legal counsel to expeditiously receive a discharge.”

According to Judge Anderson, the “propriety of using bifurcated fee arrangements” is “directly proportional to the level of disclosure and information” provided to the client. In the case at bar, he said the documents given to the client “satisfy the requirements of full disclosure and informed consent.”

Judge Anderson laid down what he called “essential practices” when using a bifurcated fee arrangement.

Naturally, the fee must be reasonable but not necessarily the same that a client would pay up front. Still, the “pricing differential must be based on reasonable and quantifiable factors, and it must not include the cost of pre-petition services,” Judge Anderson said.

Judge Anderson found that the fee was reasonable, because the client was paying about $2,000 after deducting the filing fee. The lawyer kept time records, showing that the lodestar fee would have been $2,240.

Finally, Judge Anderson dealt with the factoring arrangement where the collection agency paid the law firm $1,800 for the right to collect $2,400. The lawyer disclosed the discount to the client, but the factoring arrangement was not revealed in the lawyer’s disclosure of compensation filed with the court.

Judge Anderson quoted from a state bar association ethics opinion saying, among other things, that the client must consent to the sale of the receivable and be offered the same discount. The judge said he would “discourage” the use of a factoring arrangement “unless it strictly complies with the guidance from” the bar association’s ethics opinion.

Judge Anderson granted summary judgment in favor of the lawyer dismissing the U.S. Trustee’s motion for sanctions and disgorgement.