The Supreme Court created a problem for cash-starved debtors when the Court held in Lamie that a discharge prevents a lawyer from requiring a chapter 7 debtor to pay for post-petition services after filing because the obligation arose before filing. Lamie v. U.S. Trustee, 540 U.S. 526 (2004).
Bankruptcy Judge Laurel M. Isicoff of Miami described Lamie as giving rise to an “access to justice” problem. In re Brown, 631 B.R. 77, 85 (Bankr. S.D. Fla. June 16, 2021). To read ABI’s report, click here.
Debtors’ counsel and courts have struggled to find a workaround. Sometimes they work, and sometimes they don’t.
The Solutions
One solution to the problem created by Lamie is for cash-strapped debtors to file chapter 13 petitions, where the lawyer can be paid after filing. However, chapter 13 doesn’t confer an immediate discharge and is more expensive for debtors eligible for chapter 7.
Another solution is the use of so-called bifurcated fee arrangements, where the chapter 7 debtor pays the lawyer little or nothing before filing and agrees after filing to pay most or all of the fee. Some courts have banned bifurcated fees outright. Others permit the arrangements, but inadequate disclosures and other details often trip up lawyers.
In a January 24 opinion dealing with bifurcated chapter 7 fees, Bankruptcy Judge Jeffery A. Deller of Pittsburgh ended up paying the lawyer $425 in each of six cases, even though the debtors received their discharges with no problems. His opinion highlights the importance of having Congress enact legislation to lower the cost of bankruptcy for debtors eligible for chapter 7.
The Six Routine Cases
At the behest of the U.S. Trustee, Judge Deller undertook a review of fees being charged in six chapter 7 cases where the debtors were represented by the same lawyer. He said that the “garden variety” cases were “not complex.”
For routine chapter 7 cases, Judge Deller said that the average fee in the district was $1,500.
For chapter 7 clients who paid in full before filing, the lawyer in question charged $1,425. For clients who couldn’t pay up front, the lawyer offered to carry the case to completion for about $1,700 under a bifurcated arrangement.
The bifurcated clients signed two retention agreements, one before filing and one after. The agreements explained the services that the lawyer would perform under each. The client was not required to sign the postpetition agreement, and the lawyer said he would continue to represent the client unless and until the court permitted him to withdraw.
The agreements explained that the $1,700 bifurcated fee was higher because the client would be paying a factoring fee of some $275 in return for making the payments over a year after filing.
Judge Deller calculated that the lawyer spent almost seven hours on each case after filing. At the lawyer’s normal rate, he said that a $1,425 fee was within the “range of reasonableness.” The U.S. Trustee did not even object to a $1,700 fee on the basis of time spent.
So What’s Wrong?
Judge Deller decided that the $275 factoring fee “cannot be foisted upon the debtors.”
Finding deficiencies in the disclosures to the clients, Judge Deller characterized the description of the factoring fee in the retention agreements as a “word salad.” Of more significance, he said that the factoring fee was “nothing but a coy device by which [the lawyer] forces his clients to pay financing fees to [the lawyer’s] lender.”
Judge Deller saw the factoring fee as “payment of overhead incident to the overall operation of the law practice, and is not a necessary component to direct attorney work that [the lawyer] does for the affected clients.” He disallowed the factoring fee in all cases as “unreasonable.”
Next, Judge Deller decided that the $1,425 fee was reasonable compared to the services actually rendered, but there was more.
Judge Deller said that the lawyer’s disclosures were “a mess” and “lacked the substance section 329 and Bankruptcy Rule 2016 require.” As a “meaningful sanction,” he reduced the lawyer’s compensation by an additional $1,000 in each case.
Judge Deller said he did “not impose a greater sanction because, as set forth above, [the lawyer] did successfully obtain a discharge on behalf of all of his clients in the Cases.”
On the bottom line, Judge Deller concluded that a fee of $425 in each case was “reasonable.” To the extent that a client had paid more to the lawyer or to the factor, he required the lawyer or the factor to disgorge.
Observations
After Lamie, chapter 7 is the only segment of bankruptcy law where debtors cannot pay their lawyers after filing. The effect of Lamie is peculiar because low-income chapter 7 debtors are the least likely to have perhaps $1,700 in cash to pay a lawyer up front.
Congress needs to act. Attorneys’ fees in chapter 7 could become nondischargeable debts, with bankruptcy courts ensuring that debtors knew what they were doing and that debtors’ counsel earned the fees. Accompanied by official forms making required disclosures to the debtors and the courts, a legislative fix would be nationwide.
Bankruptcy judges in some districts have done their best fix the Lamie problem. The Brown decision by Judge Isicoff in June 2021 was the functional equivalent of a local rule permitting bifurcated arrangements as long as the lawyer makes proper disclosures to the client and to the court. This writer understands that bifurcated agreements have been used since then without incident in the Southern District of Florida.
Local arrangements are good so far as they go. However, they are cumbersome and aren’t uniform throughout the country. There is always the danger than an appellate court might even decide that a local rule violates the Bankruptcy Code.
If there ever was a nonpartisan fix that deserves immediate congressional action by unanimous consent, this is it.
The opinions are those of the writer, not ABI.
The Supreme Court created a problem for cash-starved debtors when the Court held in Lamie that a discharge prevents a lawyer from requiring a chapter 7 debtor to pay for post-petition services after filing because the obligation arose before filing. Lamie v. U.S. Trustee, 540 U.S. 526 (2004).
Bankruptcy Judge Laurel M. Isicoff of Miami described Lamie as giving rise to an “access to justice” problem. In re Brown, 631 B.R. 77, 85 (Bankr. S.D. Fla. June 16, 2021).
Debtors’ counsel and courts have struggled to find a workaround. Sometimes they work, and sometimes they don’t.