A chapter 7 debtor seeking to retain personal property secured by a lien has several options available, one of which is redeeming the property from the lien pursuant to §722 of the Bankruptcy Code. Although there remains a split of authority on the question, the prevailing view is that the appropriate measure of value for a contested redemption is the liquidation value of the property. This favorable valuation standard has made redemption motions increasingly popular. Another development making the option more accessible to chapter 7 debtors is the emergence of companies willing to finance the redemption payment. The financing package often includes a provision for payment of fees to debtors’ counsel in connection with the redemption. This fee for preparation of the redemption motion is included in the amount that the debtor finances, which is therefore paid over time with interest. This arrangement raises several ethical questions for debtor’s counsel, including whether acceptance of the fee poses a conflict of interest. Several recent cases address these issues.
In In re Miller, 312 B.R. 626 (Bankr. S.D. Ohio 2004), Judge Vincent Aug, ruling on objections filed by the U.S. Trustee, held that the structure of the fee arrangement created a conflict of interest requiring disgorgement of the fees received. In Miller, the initial fee disclosure filed by debtors’ counsel said nothing about whether the services counsel agreed to provide to the debtors included redemption motions. The motion to redeem did not disclose that the financing obtained to make the redemption payment included a fee of $600 to debtors’ counsel. A supplemental disclosure, filed subsequent to the U.S. Trustee’s objection, revealed that counsel was paid $400 for work related to the redemption. The U.S. Trustee contended the fee was excessive and asked the court, pursuant to its authority under §329(b), to order its return to the debtors. Counsel had already taken a $750 fee for the other services related to the case.
The court held that the fee was excessive, observing that the motion was a “boilerplate” one, involved no novel issues of law and was unopposed. The court did not, however, determine what amount might be reasonable in light of its alternative holding that debtors’ counsel had a conflict of interest requiring disgorgement of the fee. The court cited as a general principle that debtors’ counsel should not accept a fee from a third party if that third party is benefitting from the transaction. The problem, according to the court, is that the arrangement creates concerns about whose interest is being served. The court was particularly concerned about the lack of disclosure to the court and the debtors’ apparent unawareness that the amount financed was increased by the amount of counsel’s fee for the redemption.
A similar fate befell debtors’ counsel in In re Griffin, 313 B.R. 757 (Bankr. N.D. Ill. 2004), in which counsel was required to disgorge a $600 fee received for work relating to a redemption. In Griffin, counsel disclosed an initial fee of $1,150, $100 of which was paid before filing, with the balance to be paid in installments thereafter. Counsel filed a motion to redeem a vehicle, but did not file anything indicating any additional fee had been received for the redemption. The court raised this question on its own motion and requested additional information on the issue. Counsel then filed a supplemental application, which revealed that counsel had received a fee of $600 for work on the redemption from the proceeds of a loan made by the redemption financer.
After holding that counsel could not collect this additional fee from the estate after Lamie v. U.S. Trustee, 540 U.S. 526 (2004), and could not collect it from the debtors because the claim would be discharged and therefore unenforceable, following Bethea v. Robert J. Adams and Associates, 352 F.2d 1125 (7th Cir. 2003), the court held that counsel’s failure to file a supplemental disclosure was an independent ground for ordering disgorgement of the fee. The court began by observing that §329(b) requires the filing of a statement of compensation paid or promised in connection with the case (regardless of whether an application for such compensation is filed with the court) and the source of the compensation. That provision is implemented by Rule 2016, which requires the filing of a supplement within 15 days of any payment or agreement not previously disclosed.
Turning to another issue, the court agreed with the holding in Miller that the funding arrangement created a conflict of interest for debtors’ counsel. The court observed that demanding an additional fee for post-petition work performed on a redemption might be inconsistent with the pre-petition retention agreement between the parties. Even if it were not, the court shared the concern expressed in Miller (based on the Illinois version of Rule 1.7(b) of the Model Rules of Professional Responsibility) that this arrangement may place the lawyer’s interest in the fee offered in conflict with the client’s and impair the lawyer’s independent judgment. Since the court felt that the agreement to take a fee for the redemption was a prepetition one and subject to discharge under Bethea, it opined that it may not be in the client’s best interest to agree to fund it in the redemption loan. Under Rule 1.7(b), a lawyer may not continue to represent a client if that representation may be limited by the lawyer’s own interest unless the lawyer reasonably believes the representation will not be adversely affected and the client consents after disclosure. The irony of the court’s holding in Griffin is that the law firm representing the debtors in that case was the same one that represented the debtors who prevailed in Bethea.
A different view is reflected in the court’s opinion in In re Ray, 314 B.R. 643 (Bankr. M.D. Tenn. 2004). In that case, the court consolidated for hearing similar disgorgement motions filed by the U.S. Trustee in three otherwise unrelated cases. All involved a redemption fee taken by debtors’ counsel and funded by the lender financing the redemptions. The U.S. Trustee argued that disgorgement was required because debtors’ counsel had a conflict of interest under both the applicable ethical rules and the Bankruptcy Code and that the amount of the fee in each case was unreasonable.
The U.S. Trustee first argued that a conflict existed based on the principle espoused in Miller that counsel should not accept a fee from a third party if that third party will also benefit from the transaction. Citing Rule 1.7(b), the U.S. Trustee contended the conflict was between counsel’s loyalty to his clients and his loyalty to the redemption lender to use its services to obtain his fee. After an extensive review of the evidence in each case, the court rejected this position, finding that each client was fully aware of and understood the arrangement (as well as his or her other options), benefitted substantially from the transaction and was fully satisfied with counsel’s services.
The court rejected the U.S. Trustee’s alternative conflict argument, based on the Bankruptcy Code, by observing that counsel for a chapter 7 debtor, unlike chapter 11 debtor’s counsel, need not be “disinterested.” Section 327(c), the court observed, tolerates some kinds of conflicts, providing that counsel is not disqualified solely by reason of representation of a creditor unless on objection the court finds there is an actual conflict of interest. Here, the court held, even this section was not truly applicable because counsel for the debtors did not represent and had no contractual relationship with the redemption lender.
Finally, the court also rejected the U.S. Trustee’s contention that counsel’s $300 fee for the redemption was not reasonable. The court reviewed the circumstances of each case and held that based on counsel’s estimate of the actual attorney and staff time expended in each matter and the applicable hourly rates, the fee was reasonable. Further supporting the fee were debtor’s counsel’s experience, the unique circumstances of each case, the results produced and the client’s satisfaction with those results.
Several lessons can be learned from these cases, some of which are suggested in guidelines offered by Judge Aug in Miller. See Miller, 312 B.R. at 629. First, debtor’s counsel is not entitled to an additional fee for the redemption if the fee agreed to when the case was taken includes such work. If the fee agreement and the initial disclosure clearly specifies that such post-petition work is extra, counsel may be entitled to an additional fee. Second, any additional fee to be taken must be described in a supplemental disclosure filed with the court. Third, counsel must be satisfied that the fee is reasonable given the work required and the time expended. Finally, and perhaps most important, the client must be fully advised of all options for dealing with the property subject to the redemption and fully aware of all the details of the financing, including the additional fee to debtor’s counsel.