Fifth Circuit Facilitates ‘No Money Down’ Chapter 13s

The Fifth Circuit opened the door a crack for so-called no-money-down chapter 13s, where debtors’ counsel are not required to “eat” the filing fee, the credit counseling fee and the cost of a credit report.

The May 13 opinion by Circuit Judge Jennifer Walker Elrod gives an expansive interpretation to expenses that courts have the discretion to reimburse in fee applications by debtors’ counsel. In that regard, the opinion should be applicable in chapter 11, not only chapter 13.

The opinion seems to chip away at Lamie v. U.S. Trustee, 540 U.S. 526 (2004), where the Supreme Court held that a chapter 7 debtor’s counsel’s fees cannot be paid from estate property, and any prepetition obligation for unpaid attorneys’ fees is dischargeable.

The Business Model

By seeming to require the payment of retainers and filing fees before bankruptcy, strict enforcement of cases like Lamie had the effect of making bankruptcy unavailable for those most in need of bankruptcy — namely, individuals who are so broke they can’t afford the cost of filing.

Last month, we reported a decision by Bankruptcy Judge Kevin R. Anderson of Salt Lake City, who laid down guidelines and disclosure requirements enabling lawyers to use so-called bifurcated fee arrangements, where chapter 7 debtors can pay all costs and fees in installments after filing. In re Hazlett, 16-30360, 2019 BL 130458 (Bankr. D. Utah April 10, 2019). To read ABI’s report on Hazlett, click here.

The appeal in the Fifth Circuit dealt with so-called no-money-down chapter 13s, where debtor’s counsel pays the filing fee, the fee for credit counseling and the cost of a credit report. Counsel would intend to recoup the fees through an allowance of compensation and reimbursement of expenses. We will refer to the fees and costs collectively as the “expenses.”

Debtors, of course, do not pay prepetition retainers to lawyers whose business plan is no money down. In the test case on appeal, the debtor’s counsel intended to take advantage of a local rule in the Western District of Louisiana permitting a so-called no-look fee. So long as the requested fee does not exceed the amount specified in the local rule, the debtor’s counsel fees will be allowed and paid under the plan without filing a detailed fee application, assuming there is no objection. The Fifth Circuit had previously permitted no-look fees.

The local rule in the district had changed. Previously, the local rule explicitly required the expenses to be included in the no-look fee. However, the local rule was modified in early 2017. The amended rule did not mention expenses, raising the question of whether debtors’ counsel could recover expenses in addition to no-look fees.

And that’s what debtor’s counsel did, by filing a chapter 13 plan where the expenses would be reimbursed to the lawyer from the debtors’ post-petition income. The chapter 13 trustee objected to the plan.

The bankruptcy court ruled that the expenses were not separately reimbursable under the local rule and were not administrative expenses reimbursable under Section 503(b)(1). Causing consternation in the debtor’s bar, the bankruptcy court also held that the expenses could never be reimbursable as part of compensation in a fee application under Section 330(a).

Debtor’s counsel appealed and lost in district court. McBride v. Riley (In re Riley), 17-1302, 2018 BL 129776 (W.D. La. April 12, 2018). To read ABI’s reports on the bankruptcy and district court opinions, click here and here.

On the second appeal, Judge Elrod affirmed in part and reversed in part, employing de novo review.

The Circuit’s Analysis

Judge Elrod began by upholding the bankruptcy court’s interpretation of the new local rule: Under the no-look rule, counsel was not entitled to reimbursement of expenses “separately from (and in addition to) the applicable no-look fee amount.”

Likewise, Judge Elrod had little difficulty upholding the bankruptcy court’s ruling that the expenses were not necessary costs of preserving the estate under Section 503(b). Had they fallen under Section 503(b), they would have been reimbursed in full as expenses of administration.

Judge Elrod said the expenses did not come under Section 503(b) because they were either the debtor’s personal expenses or did not preserve the estate. She therefore upheld the lower courts by ruling that the expenses were not reimbursable as costs of administration under Section 503(b).

Of perhaps greatest significance to debtors’ counsel, Judge Elrod concluded the opinion by holding that the fees “could” be allowed as part of attorneys’ compensation under Section 330(a)(4)(B).

In an individual’s chapter 12 or 13 case, the subsection provides that “the court may allow reasonable compensation to the debtor’s attorney for representing the interests of the debtor in connection with the bankruptcy case based on a consideration of the benefit and necessity of such services to the debtor and the other factors set forth in this section.” [Emphasis added.]

As “a matter of statutory interpretation,” Judge Elrod rejected the lower courts’ conclusions that the expenses never could be reimbursed. She said that Section 330(a)(4)(B) “vests the bankruptcy courts with discretion to determine what constitutes ‘reasonable compensation.’”

Given the discretionary language in Section 330(a)(4)(B), Judge Elrod rejected the notion that the bankruptcy court must always reimburse counsel for advancing expenses. However, she held that the subsection “permits bankruptcy courts to reimburse debtor’s counsel for the [expenses] as reasonable compensation.”

Of significance beyond chapter 13, Judge Elrod held that “the plain meaning of ‘compensation’ is broad enough that it would generally be understood to include reimbursement.” Still, she said, there is a separate question: Does the subsection permit reimbursement of the filing fee, the credit counseling fees, and the cost of a credit report?

To answer the question, Judge Elrod noted the “textual distinction” between Section 503(b)(1) and Section 330(a)(4)(B).

Section 503(b)(1) is limited to the expenses of preserving the estate, while Section 330(a)(4)(B) encompasses compensation for representing the debtor’s interests. “[B]y any ordinary understanding of the words,” the expenses are “interests” of the debtor, Judge Elrod said.

Therefore, Judge Elrod held that Section 330(a)(4)(B) “grants bankruptcy courts the discretion to authorize compensation to a Chapter 13 debtor’s counsel even when the underlying activity fulfills a personal obligation of the debtor — such as advancing the cost of a filing fee — so long as that obligation is an interest of the debtor connected with the bankruptcy case.”

Judge Elrod added, however, that the statute does not compel reimbursement. “That call remains within the discretion of each bankruptcy court.”

The appeals court upheld the lower courts’ rulings that counsel was not entitled to reimbursement of the expenses under the local rule, but the circuit vacated the rulings that the bankruptcy court could never award compensation including reimbursement of expenses.

The Takeaway

The Fifth Circuit is saying that courts can reimburse counsel for advancing prepetition costs. But will bankruptcy courts refuse reimbursement on the theory that passing debtors’ expenses to the estate will diminish creditors’ recoveries?

Maybe there should be no hard-and-fast rule. If a debtor is flush with cash, perhaps the debtor should pay the prepetition costs and not pass the expenses along to creditors. If the debtor is flat broke, and paying costs means defaulting on a mortgage or car payment, perhaps reimbursement is proper, if not almost compulsory.

Counsel nonetheless need a bright-line rule. This is another mess that Congress needs to clean up so those most in need can file bankruptcy.