There's A Storm A Brewin': The Ethics and Realities of Paying Debtors' Counsel in Consumer Chapter 7 Bankruptcy Cases and the Need for Reform.

AuthorMichael, Terrence L.

In 2020, the United States of America--indeed, the world--endured a crisis unlike anything most of us under the age of 85 ever witnessed. The Covid'19 pandemic brought the world to a standstill as resources were mobilized and behaviors modified. While there are many things to be gleaned from this experience, it is safe to say that the most important lesson learned is the critical role those on the front lines-the medical personnel, first responders, and those involved in maintaining "essential businesses"-play in winning the battle against this virus. Without these people, we did not stand a chance. When the pandemic passes, it will leave behind an economic crisis of major proportions. Many experts expect a surge in both business and consumer bankruptcies. (1) Whether we are talking about business or consumer cases, bankruptcy law is, to put it mildly, complex, and good lawyering is a must. Without it, businesses will suffer. The economy will suffer. People will suffer.

Those people will need lawyers. Attorneys are professionals earning a livelihood. They wish to be paid for their services. This is rarely a problem in chapter 11 cases, as the Bankruptcy Code contains a comprehensive structure for payments of debtors' counsel in reorganization cases. The same is true in chapter 13 cases, where a procedural vehicle exists for payment of debtors' counsel after the case is filed. Unfortunately, the same cannot be said when it comes to chapter 7 cases.

In many cases, the time individuals face financial distress and need access to the bankruptcy court is often the time they lack the funds to pay for professional services.

Paying for an attorney is simply not possible for many who need the benefits of the Bankruptcy Code. Not having $1,000 or more for an up-front fee causes many to choose the wrong chapter or seek out fraudulent services. Without adequate access for all to our nation's bankruptcy laws, our courts are, very simply, failing to meet the Constitution's promise of equal justice for all. It is an odd situation when the nation's debt-relief laws are only meaningful to the well-heeled, but cash-strapped, debtor or large corporations. (2) People who represent themselves in bankruptcy cases in general, and in chapter 7 cases in particular, tend to fare worse than those who obtain competent counsel. (3) When it comes to chapter 7, some alternative and creative methods have arisen in attempts to get debtors' counsel paid. Many create practical and ethical problems for attorneys and clients alike. This article explores the problems, and offers a solution requiring only minimal amendment to the Bankruptcy Code and Rules.

NAVIGATING THE WATERS OF BANKRUPTCY--WHAT KIND OF HELP IS OUT THERE?

When an individual debtor seeks protection under the United States Bankruptcy Code, she has three choices:

  1. Do it yourself (often referred to as proceeding pro se);

  2. Enlist the aid of a petition preparer to prepare the necessary documents, after which the debtor is on her own; or

  3. Hire an attorney.

    With bankruptcy relief, it is not a simple question of whether to file; a prospective debtor also has to decide what he or she wants to file; namely, under which chapter of the Bankruptcy Code he or she wishes to proceed. For consumer debtors, there are two basic choices: chapter 7 and chapter 13. Each has its advantages and its disadvantages. In addition, it requires a significant level of expertise to determine which chapter is right for a particular debtor. (4)

    Chapter 7 cases are often referred to as "straight liquidation" cases. They are designed to be relatively simple and straightforward and comprise the majority of bankruptcy cases filed. (5) A debtor lists all of her assets and liabilities, and a trustee is appointed to investigate her financial affairs. The debtor is entitled to claim certain property as exempt and, in the event there are any unencumbered, nonexempt assets, the trustee sells those assets and distributes the net proceeds to unsecured creditors. The vast majority of chapter 7 cases do not contain any such assets. Those cases are referred to as "no asset" cases. (6) Unless grounds exist to deny the debtor's discharge or determine that a particular debt should not be discharged, the debtor receives a discharge of all secured and unsecured debt.

    Chapter 13 cases are referred to as "individual wage earner" cases. In a chapter 13 case, a debtor is required to surrender his or her disposable income to a chapter 13 trustee for distribution to secured and unsecured creditors under the terms of a chapter 13 plan that must be approved, or "confirmed," by the bankruptcy judge. Chapter 13 plans commonly focus on saving an asset valued by the debtors, such as a house or an automobile. There are detailed requirements for confirmation of a chapter 13 plan and equally stringent definitions of "disposable income." Upon successful completion of a chapter 13 plan, a chapter 13 debtor receives a discharge. (7)

    Opening the door to the bankruptcy courts became more complex in 2005, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"). (8) Debtors now must meet certain eligibility criteria to file a chapter 7 case, and are required to undertake both pre- and post-filing credit counseling in order to be eligible to file the case (the prepetition counseling) and receive their discharge (the postpetition counseling). In order to navigate these waters successfully, most debtors need professional help. Unless the debtors qualify for free legal services from an entity such as a legal aid society, those professionals need to be paid. The questions are when and how.

    PAYING DEBTORS' PROFESSIONALS IN CHAPTER 13 CASES

    While it takes a bit of statute surfing to reveal the answer, a review of the Bankruptcy Code and a bit of case law reveals that, in chapter 13 cases, counsel for the debtor can be paid postpetition for services rendered both before and after the case is filed. The elements of what may be placed in a chapter 13 plan are found in [section] 1322 of the Bankruptcy Code. Section 1322(a)(2) requires, unless the holder of a priority claim agrees otherwise, that the chapter 13 plan "provide for full payment, in deferred cash payments, of all claims entitled to priority under section 507." (9) From there, we look to [section] 507(a)(1), which affords first priority to "administrative expenses allowed under section 503(b)." (10) Section 503(b) states, in relevant part, "there shall be allowed, administrative expenses, ... including" ... (2) compensation and reimbursement awarded under section 330(a) of this title[.]" (11) Reading these statutes together, an attorney fee awarded under [section] 330(a) is given first priority under [section] 507(a)(1), and must be paid in full under the terms of the chapter 13 plan, unless the attorney agrees otherwise. Debtors' counsel in chapter 13 cases are expressly included in the list of professionals who may be compensated in chapter 13 cases under [section] 330(a)(4)(B):

    In a chapter 12 or chapter 13 case in which the debtor is an individual, the court may allow reasonable compensation to the debtor's attorney for representing the interests of the debtor in connection with the bankruptcy case based on a consideration of the benefit and necessity of such services to the debtor and the other factors set forth in this section. (12) The vast majority of courts have held counsel for debtors in chapter 13 cases may be paid for both pre' and postpetition services under the terms of a chapter 13 plan, as all of those services are performed "in connection with the bankruptcy case" as contemplated by [section] 330(a)(4). (13) But unfortunately there is no such administrative classification for payment of attorneys' fees to debt' ors' counsel in chapter 7 cases.

    Courts are split on the issue of whether a "fee only" chapter 13 plan, where the sole purpose of a chapter 13 plan is to pay the claim for unpaid attorneys' fees, with no distribution to other creditors. Many courts have held such plans are allowed by law and may be confirmed.

    At issue is whether the Code permits Debtors to file under Chapter 13 in good faith when allegedly the only reason they elected Chapter 13 is because they do not have the ability to pay up front for representation in Chapter 7. Bankruptcy courts are divided on this issue. Courts in New York, New Hampshire, and Massachusetts have rejected attorney-fee-only plans as contrary to the spirit and purpose of the Code. However, three circuit courts have found that attorney-fee-only Chapter 13 plans are not per se bad faith. Courts in North Carolina, New Mexico, Wisconsin, Illinois, and Kansas have also upheld attorney-fee-only Chapter 13 plans. (14) This means, at least in some courts, debtors who do not have the money to pay their lawyer up front can still obtain bankruptcy counsel by choosing to file chapter 13 instead of chapter 7.

    PAYING DEBTORS' PROFESSIONALS IN CHAPTER 7 CASES

    The majority rule in chapter 7 cases is simple. In order for debtors' counsel to be paid in a chapter 7 case, they must be paid in full by the debtor or someone on his or her behalf prior to the filing of the bankruptcy petition. Any balance owed to the attorney at the time the case is filed is a prepetition unsecured debt subject to discharge in the case. The rule was summarized by United States Court of Appeals for the Sixth Circuit in Rittenhouse v. Eisen:

    This appeal presents only an issue of law concerning the interpretation of 11 U.S.C. [section] 523. Therefore, we review the decision of the district court de novo. In re Surah, 163 F.3d 397, 400 (6th Cir. 1998). The issue of whether pre-petition attorney fees are dischargeable in bankruptcy is res nova in this circuit. We join three other circuits in concluding that pre-petition attorney fees are dischargeable, and we affirm the order of the district court. In re Tickling, 361 F.3d 172...

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