CHAPTER 9 GETTING PAID & ETHICS OF REPRESENTATION

• Jurisdiction: United States

CHAPTER 9: GETTING PAID & ETHICS OF REPRESENTATION

With case filings down, consumer attorneys may be struggling with the bankruptcy portion of their practice. Creative solutions to finding new clients may be helpful, but there are ethical implications we should all be aware of.

Very often we hear potential clients tell us that they are "too broke for bankruptcy." The prospect of coming up with the funds needed for an attorney fee can be daunting and discouraging to a consumer, but as we all know, any unpaid chapter 7 pre-petition legal fees are covered by the stay and discharge. Some attorneys have been attempting to find creative ways to get paid. One idea is bifurcation, or separating the fee into two separate representations, one to cover the pre-petition work and a second to cover the post-petition work. Courts have considered the viability of such agreements. Where the client is fully informed, and there are two separate, legitimate agreements covering the pre-petition and post-petition work, courts have found there may be nothing prohibiting the arrangement. Another method of getting paid is by filing a debtor who could be adequately served in a chapter 7 in a chapter 13 case instead, with most if not all of the attorney's fee being paid through the plan. Both bifurcation and chapter 13 fee solutions may be legitimate ways of achieving the debtor's goals and getting paid, but there are ethical issues and negative consequences to the debtor to consider.

Internet law firms such as UpRight Law, LLC offer a new way to reach clients. Consumers are relying on the internet more and more for services, and legal representation is no different. Under UpRight's business model, consumers can search online for bankruptcy assistance and be provided with an attorney in their state. Ethical issues regarding fee arrangements, disclosures and case preparation have arisen, with courts providing guidance on how to ethically participate in internet-dependent firms.

Many consumer attorneys struggle with the balance of running a business and providing the legal services of bankruptcy representation. To alleviate the stress of an overburdened calendar, an attorney may choose to rely on appearance counsel, when another attorney represents the debtor at the § 341 meeting of creditors. These arrangements are problematic when the appearance counsel is not fully informed, or when the clients were unaware that a different person would be with them at the meeting. Courts have disgorged fees and issued sanctions in cases where issues arose.

A. Problematic Consumer Debtor Attorneys' Fee Arrangements and the Illusion of "Access to Justice"

ABI Journal

October 2018

Written by:

Adam D. Herring

Executive Office for U.S. Trustees

Washington, D.C.

The U.S. Supreme Court has recognized that under the Bankruptcy Code, the traditional payment model for attorneys representing individual consumer debtors in chapter 7 cases is straightforward: An attorney receives payment for the case in full, generally as a flat fee, prior to filing the case.¹ However, attorneys, law firms and third parties have recently sought to creatively reimagine the terms and methods of payment for representation of consumer chapter 7 debtors. Some of these alternative arrangements could run afoul of bankruptcy law and ethical obligations. As the statutory watchdog of the bankruptcy system,² the U.S. Trustee Program (USTP) is acutely familiar with identifying these issues and, where appropriate, taking action to enforce the Code and redress the harms resulting from unethical and substandard practices.³

This article will first examine the legal and factual background for the creation of alternative consumer debtor attorneys' fee arrangements. Next, the terms and potentially problematic features of some of the more common alternative arrangements the USTP has observed — including illegitimate schemes, fee-only chapter 13 cases, bifurcated fee agreements and factored fees — will be discussed. Finally, the article will discuss the flawed "access to justice" arguments sometimes raised cynically by practitioners in defense of harmful and noncompliant fee structures.

Background

In contrast to chapters 11 and 13, the Bankruptcy Code is relatively silent as to payment of debtor attorneys' fees in chapter 7 cases. Because chapter 7 debtor attorneys do not represent the estate, they are not employed under § 327 of the Code, nor can they receive compensation from the estate under § 330.⁴ Nevertheless, bankruptcy courts retain the ability to review and reduce unreasonable or undisclosed compensation in chapter 7 cases under § 329 of the Code, and chapter 7 debtor attorneys' transactions with their clients are governed where applicable by §§ 526, 527 and 528 of the Code.⁵

The automatic stay is imposed upon filing a voluntary petition.⁶ With limited exceptions,⁷ it bars the collection of pre-petition debt during the pendency of the case. Pre-petition debtor attorneys' fees are subject to both the automatic stay and discharge.⁸ However, the Ninth Circuit Court of Appeals has held that fees owed for services rendered post-petition, even when based on a pre-petition contract, could be collected without running afoul of the stay or discharge.⁹ The only other court of appeals that has addressed this question soundly rejected this approach.¹⁰

The realities of consumer debtor practice are also relevant. Defenders of alternative fee arrangements quickly point to filing numbers that have trended downward in recent years. True enough, the number of filings doubled between fiscal years 2007-10, then dropped to current levels that approximate the number of cases filed in 2007.¹¹ However, it also bears remembering that debtor attorneys' fees rose by about 45 percent following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).¹²

Types of Arrangements

Consumer debtors in financial distress sometimes find it difficult to pay the chapter 7 attorney's fee in a lump sum prior to filing the bankruptcy case. Under the traditional model, these debtors who wish to be represented must either delay filing until the fees are paid in full (which might be infeasible in light of pending foreclosure sales or garnishments), or their attorneys must file the case without having received payment in full and with no recourse to compel payment of the balance. Alternative payment arrangements fall into three general categories: outright or potentially fraudulent schemes, fee-only chapter 13 cases, and bifurcated fee agreements (including "factoring" arrangements). In addition to the USTP, all stakeholders in the bankruptcy system should be committed to addressing the first category and vigilant in avoiding potentially problematic issues with the others.

Courts have found that some lawyers have engaged in schemes to obtain payment of their fees in illegitimate ways and in violation of the Bankruptcy Code and Rules. A high-profile example was discussed in a recent article in the ABI Journal summarizing a case regarding a national law firm's conduct decided in the Western District of Virginia.¹³ In this case, which the USTP brought and which is on appeal, the bankruptcy court imposed sanctions after finding that the law firm engaged in a practice of referring clients to a towing company, which paid the clients' bankruptcy attorneys' fees in exchange for taking possession of and, in some cases, selling the clients' vehicles by priming the lenders' secured claims.

Fortunately, these sorts of attorneys' fee payment arrangements are not typical, but extreme misconduct presents substantial risks to both participating attorneys and other stakeholders. In the aforementioned example, the court found that lenders holding valid liens could have been harmed by the loss of their collateral or by the payment of exorbitant fees to recover the collateral. Moreover, the court found that the debtors could have been exposed to legal risk, including breaches of contract and possible violations of state law. Fee arrangements that are based on potentially fraudulent conduct have and will continue to draw the USTP's scrutiny and, where appropriate, enforcement action.

Another method of circumventing the Code's limitations on the post-petition payment of chapter 7 attorneys' fees that deserves further examination is the practice of placing debtors who are otherwise better served by chapter 7 in chapter 13 cases. In chapter 13, a significant portion (or even all) of the attorneys' fees can be paid over time under the debtor's plan.¹⁴ This practice has a number of possible disadvantages.

Fees in chapter 13, even for "no money down" chapter 13 cases, could be substantially higher than in chapter 7, meaning that these debtors pay more for the same relief that they could more easily (and quickly) obtain in chapter 7.¹⁵ Chapter 13 imposes greater obligations on debtors, including requirements to propose, obtain confirmation of and fund a plan that under the Bankruptcy Code must run for a minimum term of 36 months. Even if the goal is to convert the case to chapter 7 once the attorney's fees have been paid, the debtor could also run the risk of having the case dismissed for bad faith without obtaining the ultimate benefit for which bankruptcy relief was sought: a discharge. Finally, filing chapter 13 cases in which the prospect for confirmation of — and successful compliance with — a plan is doubtful imposes additional burdens on bankruptcy courts and chapter 13 trustees.

Another article in the ABI Journal recently focused on the virtues of "bifurcation," the practice by which an attorney representing a consumer debtor in a chapter 7 case charges for their services under the color of two fee agreements.¹⁶ This practice also merits scrutiny.

Under the first "pre-petition" agreement, the debtor pays a nominal or no fee for work performed on the case prior to filing, such as consultation and the completion and...