Chapter III. Facilitating Effective Access to Bankruptcy

• Jurisdiction: United States

III. Facilitating Effective Access to Bankruptcy

A. Paying for Bankruptcy

§ 3.01 Chapter 7 Attorney’s Fees

(a) The dischargeability of prepetition attorney’s fees in chapter 7 hinders access to the bankruptcy system and access to justice. Congress and all stakeholders to the bankruptcy system should take steps to lower barriers to access, including:

(1) consistent with the Commission recommendation at § 5.06 Bankruptcy Forms, creating easy-to-understand online data input forms that would generate asset and liability compilations that could be reviewed by a bankruptcy professional to make preparation of schedules less time-consuming;

(2) increasing provision of pro bono bankruptcy representation for low-income debtors;

(3) reducing filing fees for low-income debtors, even if represented by paid counsel;

(4) allowing video attendance at § 341 meetings and scheduling these meetings outside of regular working hours, with safeguards ensuring that the named debtor is the one appearing; and

(5) providing low-income debtors legal representation through a governmental office, akin to public defenders’ offices.

(b) Congress should amend the Bankruptcy Code to allow postpetition payment for attorney services rendered prepetition. Different mechanisms have different costs and benefits. The Commission believes two mechanisms merit consideration:

(1) Excepting fee agreements from the automatic stay and delaying the discharge of fees for a period of time, such as six months, with other coordinating amendments to the Bankruptcy Code to ensure no change to other creditors’ access to their collateral during the delay.

(2) Making prepetition attorney’s fees nondischargeable in a chapter 7 with judicial review of the fee agreement.

Background. How consumers pay for legal representation in bankruptcy is one of the most important issues facing the bankruptcy system. Consumers who cannot pay either cannot access the bankruptcy system or must file pro se, and studies show pro se filers get inferior outcomes.²⁸⁰ Another study suggests consumers are increasingly using “no money down” chapter 13 cases that allow payments of their attorney’s fees through the chapter 13 plan, although such filers end up paying more and are less likely to receive a bankruptcy discharge.²⁸¹ A bankruptcy system that works only for those who can pay for legal representation does not further the American ideal of equal justice under law.

The current situation is the result of legal rules that begin with the U.S. Supreme Court’s decision in Lamie v. United States Trustee,²⁸² which held that attorney’s fees for work done on behalf of chapter 7 debtors during the bankruptcy case cannot be treated as an administrative expense and therefore cannot be paid from estate assets. Next, almost every published decision has held that any agreement to pay attorney’s fees is a prepetition fee agreement subject to the automatic stay and the bankruptcy discharge.²⁸³ Putting this case law together, an attorney who is owed money for work done before filing the bankruptcy petition is no different than any other unsecured creditor. Additionally, the Eleventh Circuit has held that an attorney cannot advise a client to incur debt from another person to pay the attorney fee for bankruptcy representation.²⁸⁴

Under this state of the law, an attorney offering representation to potential chapter 7 debtors has four fee options, each of which produces undesirable results:

Option 1 : The attorney can delay filing a chapter 7 case until the debtor has paid up front all of the anticipated fees in the case. There are three problems with this common approach. First, it deprives the debtor of immediate relief, which might especially frustrate the debtor’s goal in filing bankruptcy if there is ongoing or imminent collection activity, such as wage garnishment or seizure of collateral. Second, if the debtor is unable to complete the prepetition payments, no case will be filed, and the debtor will likely lose at least some portion of the funds deposited with the lawyer as payment for whatever services — legal or administrative — were provided. Third, if the debtor does complete the required prepetition payment, and the case requires unanticipated services after filing, the attorney will have the same difficulties in collecting additional fees as in cases filed without prepayment.

Option 2: The attorney can file a chapter 7 case without receiving full payment of the anticipated fees, hoping that the debtor will voluntarily pay the fees from non-estate assets postpetition. This option presents a low likelihood that the attorney will be paid. The debtor has no financial incentive to pay the fees because the bankruptcy is accomplishing the debtor’s goals without payment, and the attorney has no ability to take any collection action — even suggesting voluntary repayment — because the claim for fees is subject to the automatic stay and the discharge injunction.

Option 3 : The attorney can bifurcate the legal services to be provided, first entering into an agreement with a nominal fee covering only prepetition services and then entering into a postpetition agreement for the bulk of the fees to cover postpetition services. Because it occurs postfiling and creates postfiling obligations, the automatic stay and the bankruptcy discharge do not apply to the postpetition agreement. Thus, the attorney theoretically can demand payment and engage in collection activity after discharge. This option, however, has at least five drawbacks. First, local rules or practice may not allow the unbundling of postpetition services. ²⁸⁵ Second, even if unbundling is allowed, the court may find that the fees allocated to prepetition services are unreasonably low and the fees for postpetition services are unreasonably high. Third, the client may decline to enter into the second fee agreement, requiring the attorney to withdraw from the representation, leaving the debtor unrepresented and leaving the attorney with no ability to obtain additional payment for the services already rendered. Fourth, where the client enters into a postpetition contract, there is no incentive for the client to pay for the postpetition services other than a threat of collection action, which the attorney may be reluctant to engage in, both because of its expense and because it may generate unfavorable reviews of the attorney, online and otherwise. Fifth, the attorney may assign the right to be paid under the postpetition agreement to a third-party collector, incurring significant charges and increasing the fee charged to the client to offset these charges. As illustrated by later discussion of options that merit congressional consideration, the Commission expressly disapproves of attorney fee factoring agreements between debtors’ attorneys and third-party collectors. ²⁸⁶

Option 4 : The debtor can file the case under chapter 13 instead of chapter 7. If the debtor makes any payments required by the chapter 13 plan, at least a portion of the attorney fees will be paid. Also, the debtor has an incentive to make payments because, absent the uncommon occurrence of a “hardship” discharge, the court will grant a discharge only if the debtor makes all plan payments. But this option also has drawbacks. First, chapter 13 imposes additional costs on the debtor, both in higher fees and in the requirement that the debtor devote all disposable income to paying claims under the plan. Second, if the court does dismiss the case, the debtor will not only fail to receive a discharge but also will lose any fees paid to the attorney and chapter 13 trustee, as well as other costs the debtor has incurred in filing. Third, it may be unethical for an attorney to file a chapter 13 case for a client when chapter 7 provides the relief that the client needs, simply because the attorney prefers the more secure fee payment in chapter 13.

Table 1 summarizes the effects of these four options on debtors and their attorneys, setting out for each option (a) how much the option increases the likelihood of debtor payments, (b) how much it increases the attorney’s costs, and (c) how much it diminishes the debtor’s relief.

Comparisons of Existing Options to Pay Chapter 7 Attorney Fees Table 1
Effectiveness in encouraging; fee payment	Cost to the attorney	Negative effect on the debtor
Option 1: Delay filing until anticipated fees are paid	High Debtor has high incentive to pay the fees, because otherwise there will be no filing.	Low Any administrative cost in holding funds before filing can be covered by a higher fee.	High The delay in filing may cause harm to the client, and the attorney may deduct expenses from any refund if the case is not filed.
Option 2: Chapter 7 filing without prepayment	Low The debtor is under no legal obligation to pay the fees; the automatic stay and discharge prevent the attorney from asking for fee payment.	High Failure of the debtor to make completely voluntary payments results in no possibility of payment for the services provided.	Low There is no negative effect. Unless the debtor chooses to pay the fee, without prompting, the debtor obtains the legal services without charge.
Option 3: Bifurcated representation	Moderate Although excepted from discharge, fees under the post-filing contract may be difficult to collect.	Moderate The attorney incurs costs of collection if the debtor fails to complete payments and may have to defend the bifurcation if it is challenged as unethical.	Moderate The debtor is subject to collection of unpaid fees and may incur liability for costs of collection. The unpaid fees may be assigned for collection, increasing costs to the debtor.
Option 4: File chapter 13	High The debtor is encouraged to complete plan payments to obtain a discharge and avoid the need for refiling after dismissal.	Moderate The court may dismiss the case for...