Nine days apart, bankruptcy judges in Colorado and Minnesota disallowed so-called bifurcated fee arrangements where chapter 7 debtors paid nothing before filing. The two judges found multiple misrepresentations in the pre- and post-filing fee agreements, rendering them void and unenforceable under Section 526(c)(1).
It is doubtful whether any artfully drafted fee agreements could pass muster in Colorado and Minnesota, because the lawyer who files the petition is obliged to complete the representation whether or not the debtor pays or agrees to pay the fee after filing.
The impetus for bifurcated fee arrangements arose because the Supreme Court in Lamie v. U.S. Trustee, 540 U.S. 526, 538 (2004), ruled that an agreement signed before bankruptcy cannot compel a chapter 7 debtor to pay for services rendered before or after filing. In essence, Lamie compels chapter 7 debtors to pay the lawyer’s fee in full before filing.
As Bankruptcy Judge Thomas B. McNamara of Denver said in his May 10 opinion, “there may well be sound policy reasons for changing the Bankruptcy Code to allow attorneys to be paid postpetition for performing even pre-petition services. But, that is not the Court’s role . . . . Because the Pre-Filing Agreement and Post-Filing Agreement contain misrepresentations and are misleading, they are void.”
Scholarly Commentary
Prof. Nancy Rapoport told ABI, “It’s past time for Congress to fix this problem.”
Elaborating, Prof. Rapoport said:
There wouldn’t be such machinations, with some jurisdictions allowing bifurcations and some not, if Congress would act.
On the other hand, sometimes when Congress messes with the bankruptcy laws, the law gets worse, not better.
Also, there’s a lot to be said for making contracts that non-law-trained people understand that actually give them the correct options.
An expert on ethics in bankruptcy cases, Prof. Rapoport is the Garman Turner Gordon Professor of Law at the Univ. of Nevada at Las Vegas William S. Boyd School of Law.
The Pre- and Post-Filing Agreements
The pre- and post-filing retention agreements in both cases were lengthy and complex. It is questionable whether the debtors ever read them, understood them, or were told what they meant. Basically, the agreements in both Colorado and Minnesota told the clients that the lawyers would prepare and file bare-bones chapter 7 petitions, with no fees paid by the clients before filing.
The clients could elect after filing to sign post-filing retention agreements obliging the lawyers to provide all necessary services apart from adversary proceedings. The clients were also given the option to proceed pro se or hire another attorney.
The agreements did not disclose to the clients that both courts had local rules requiring the lawyers who filed the petitions to provide all required services (apart from adversary proceedings) until the court allows the lawyer to withdraw on motion, regardless of whether the client pays the fee after filing. Given the short deadlines for filing all required papers, a motion to withdraw would not be heard before the lawyer would have drafted and filed the remaining chapter 7 papers.
The Minnesota Opinion
In her May 19 opinion, Kesha L. Tanabe of St. Paul, Minn., found numerous “untrue and misleading statements” about the legal services in the retention agreements. For example, the agreements said that the lawyer’s services would terminate on filing, absent the client’s agreement to pay the fee after filing.
Referring to the court’s local rule, Judge Tanabe said,
Upon filing a petition, counsel agrees to represent the debtor and provide all reasonably necessary bankruptcy services throughout the case, until and unless permitted to withdraw through substitution or court approval, and authorization to withdraw is neither automatic nor presumed. An agreement that purports to withhold such services, or to condition such services upon execution of an additional fee agreement, is fundamentally untrue and misleading, in violation of § 526(a)(2) and (3).
Judge Tanabe said the agreement violated Section 526(a)(2)-(3) because it “affirmatively misrepresent[ed] well-settled law about withdrawal and the scope of services in bankruptcy cases.” She found another violation of Section 526(a)(3), because “the Agreements omit any explanation that counsel would not be permitted to withdraw from representation after filing a partial petition, absent truly extraordinary circumstances.”
Judge Tanabe went on to say that the “Agreements obscure the reality that execution of the Post-Petition Agreement was not necessary to ensure the provision of legal services in Debtor’s main case after filing the partial petition. In fact, the real purpose of the Post-Petition Agreement is to ensure the collectability of Applicant’s unpaid legal fees.”
Because the engagement agreements violated Sections 526(a)(2)-(3) and 528(a)(1)(A), Judge Tanabe held that they were “statutorily” void and unenforceable under Section 572(c)(1).
The Colorado Case
The case before Judge McNamara in Denver was similar, but the lawyer was factoring the receivables to be paid by the client in installments after filing.
Were the fee to be paid entirely after filing, the agreements required the client to pay almost $3,000, including the filing fee. If the fee were to be paid in full before filing, the fee would be about $2,000, not including the $335 filing fee.
Judge McNamara’s skepticism about the cost of the factoring agreement suggests that he might have nixed the fee arrangement on that basis alone. However, he found defects like those identified by Judge Tanabe, leading him to invalidate the fee arrangements without alluding to factoring.
The agreements in Denver contained a provision intended to skirt conflicts of interest. If the client decided not to pay the fee after filing, the agreements purported to say that the client waived the resulting conflict of interest when the lawyer would move to withdraw.
Judge McNamara found “numerous ways” in which the fee agreements were “false” or “misleading.” For example, the agreements didn’t mention the “numerous additional filings” that the lawyer would be required to prepare after filing under the local rule, even if the client did not agree to pay the fee.
Similarly, Judge McNamara said that the agreements failed to mention the client’s fourth option of having the lawyer “continue to represent her in all aspects of her Chapter 7 case without entering into a new Post-Filing Agreement.” [Emphasis in original.]
In Judge McNamara’s case, the lawyer advanced the $335 filing fee. He said that the retention agreement “misled [the client] into committing to repay the filing fee advanced by [the lawyer],” although the obligation to repay the filing fee had been discharged.
Having found that the agreements contained “misrepresentations” in violation of Sections 524, 526 and 528, Judge McNamara held that the agreements were “void” under Section 526(c)(1).
Judge McNamara said “there may be sound policy reasons supporting a bifurcated payment structure.” However, he said that the court “cannot legislate and cannot just make up a new policy framework for Chapter 7 debtor’s counsel fees.”
As remedy, Judge McNamara voided the retention agreements. Because the client had paid about $1,000 after filing, he required the lawyer to disgorge the payments to the chapter 7 trustee, who would turn over the disgorged fees to the debtor less whatever pre-filing tax refunds the debtor was entitled to receive.
Of in terrorem significance, Judge McNamara enjoined the lawyer “from making any of the misrepresentations or misleading statements identified in this Opinion in future Pre-Petition Agreements and Post-Petition Agreements in the District of Colorado.” Consequently, the lawyer would run the risk of being found in contempt were he to use a bifurcated fee agreement in the future that didn’t clearly tell the client there was no obligation to pay the fee after filing, among other things.
Observations
If there be a fault in either opinion, it may lie in the question of whether the local rules delve into substantive law beyond the courts’ rulemaking powers. In South Carolina, a district judge read a similar local rule as not raising a per se bar to bifurcated fee arrangements. Benjamin R. Matthews & Assoc. v. Fitzgerald (In re Prophet), 21-01082, 2022 BL 84916, 2022 WL 766390 (D.S.C. Mar. 14, 2022).
However, the court in Prophet made no ruling about the reasonableness of the fees, the adequacy of disclosures or informed consent by the debtors regarding the fee structure. To read ABI’s report on Prophet, click here.
The opinions are In re Siegle, 21-42321 (D. Minn. May 19, 2022); and In re Suazo, 20-17836 (D. Colo. May 10, 2022).
Nine days apart, bankruptcy judges in Colorado and Minnesota disallowed so-called bifurcated fee arrangements where chapter 7 debtors paid nothing before filing. The two judges found multiple misrepresentations in the pre- and post-filing fee agreements, rendering them void and unenforceable under Section 526(c)(1).
It is doubtful whether any artfully drafted fee agreements could pass muster in Colorado and Minnesota, because the lawyer who files the petition is obliged to complete the representation whether or not the debtor pays or agrees to pay the fee after filing.