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Attorney fees get discharged in bankruptcy

Easterbrook

“Judges are not entitled to override the legislative approach with a lawyercentric public policy that puts members of their own social class higher in the priority list at the expense of other creditors, or of the debtors themselves.”

Hon. Frank Easterbrook, 7th Circuit Court of Appeals

The discharge of a debtor in bankruptcy relieves him of the obligation to make payment on unpaid installments to his attorney, the Seventh Circuit held on Dec. 17.

Three debtors in bankruptcy hired lawyers before filing their petitions. Each agreed to a retainer that would cover the legal services entailed in preparing and prosecuting the proceedings.

Under the retainers, payments were to be made over time, with some installments before the petition was filed, and others thereafter. The lawyers performed as promised, all three debtors received their discharges, and the cases were closed.

When the lawyers continued to collect the unpaid installments, the three debtors, with the assistance of new counsel, commenced adversary proceedings, asking the bankruptcy court to hold their former lawyers in contempt for violating the injunctions implementing the discharges.

The bankruptcy judge concluded that “reasonable” attorneys’ fees are not discharged in bankruptcy, and dismissed the proceedings. The district court affirmed, and the debtors appealed.

The Seventh Circuit reversed in a decision written Judge Frank Easterbrook and joined by Judge Kenneth F. Ripple. Judge Richard D. Cudahy wrote separately, concurring in part, and dissenting in part.

The Statutes

At issue was the relationship between 11 U.S.C. 329(b) and 11 U.S.C. 727(b).

Section 727(b) provides: “Except as provided in section 523 of this title, a discharge under subsection (a) of this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter, and any liability on a claim that is determined under section 502 of this title as if such claim had arisen before the commencement of the case, whether or not a proof of claim based on any such debt or liability is filed under section 501 of this title, and whether or not a claim based on any such debt or liability is allowed under section 502 of this title.”

Attorneys’ fees are not included in the debts excepted from discharge by sec. 523. Thus, the court concluded, unless sec. 329 creates an implicit exception to sec. 727(b), the debts to the attorneys are discharged.

Section 329(a) requires every attorney representing a debtor in bankruptcy to file with the court a statement of all compensation received, or to be received, in connection with the bankruptcy. Subsection (b) then requires the court to determine whether the fees are reasonable.

Pre-Petition Debts

The lower courts determined that this provision creates an exception to discharge for pre-petition debts, lest it be a superfluous provision, but the Seventh Circuit rejected that conclusion, for several reasons.

The court concluded, “Section 329 has plenty to do in Chapter 7 cases, even if debts for legal fees are subject to discharge. First, prepaid fees exceeding the ‘reasonable’ value of the legal services must be recouped for the benefit of other creditors. Second, the judge must ensure the reasonableness of any fees incurred during the proceeding itself, once more to protect other creditors. Third, if the debt is reaffirmed during the proceeding, yet again the judge must ensure reasonableness.

Finally, if the debtor repudiates the executory portion of the agreement with counsel, and the estate rehires the same lawyer (an approach that gives administrative priority to ongoing legal fees), once again sec. 329(b) requires the judge to review the fee agreement for reasonableness. Because grouping legal fees with other debts subject to discharge does not gut sec. 329(b) for Chapter 7 cases, the structure of the Bankruptcy Code does not support treating sec. 329 as an implicit exception to sec. 727.”

Accordingly, the court held that pre-petition debts for legal fees are dischargeable, agreeing with the Ninth Circuit holdings in In re Biggar, 110 F.3d 685 (9th Cir. 1997).

The court acknowledged that its holding has the potential to force the most destitute of debtors to forego legal assistance, because counsel neither could be paid in advance, nor collect after the case ends.

What the court held

Case: Albert Bethea, et al., v. Robert J. Adams & Associates, No. 03-1303

Issue: Are unpaid attorney’s fees, incurred in a bankruptcy proceeding, discharged at the
conclusion of the bankruptcy proceedings?

Holding: Yes. Because attorney’s fees are not enumerated as exempt from discharge in sec. 523, they are discharged.

However, the court concluded, “That argument about what makes for good public policy should be directed to Congress; the judiciary’s job is to enforce the law Congress enacted, not write a different one that judges think superior.”

Furthermore, the court concluded that debtors should still be able to obtain counsel, stating, “Those who cannot prepay in full can tender a smaller retainer for prepetition work and later hire and pay counsel once the proceeding begins … Legal fees incurred after filing in such situations receive administrative priority; that prospect (plus some prefiling retainer) should be enough to summon legal assistance.”

Post-Petition Debts

The court rejected the position adopted by the Ninth Circuit, however, that discharged only attorney fees incurred pre-petition attorney fees, but not post-petition fees, in In re Hines, 147 F.3d 1185 (9th Cir. 1998).

The Hines court wrote that the Code as written is unsatisfactory as a matter of public policy, and the “doctrine of necessity” required that post-petition fees be nondischargeable. Hines, 147 F.3d at 119091.

Rejecting this approach, Easterbrook wrote, “We do not conceive revision of the Code as a proper part of the judicial job. The Bankruptcy Code is a complex compromise among debtors and different kinds of creditors; tilting it to help one of these interests is unwarranted. Attorneys compete with other creditors, such as banks, credit card issuers, supermarkets, auto dealers, colleges, spouses, and children; some of these have obtained protection under sec. 523 and others have not.

Judges are not entitled to override the legislative approach with a lawyercentric public policy that puts members of their own social class higher in the priority list at the expense of other creditors, or of the debtors themselves.”

The court also rejected the legal arguments that the Hines court used to support its holding, stating, “Hines shattered each retained (sic) agreement into multiple claims by holding that a ‘claim’ does not accrue until the legal services are performed. Each month (potentially each day or hour) that the lawyer performs services for the estate then becomes a separate claim. That contradicts both the Code and the retainer agreement, which says that the fee is due whether or not the client uses the services.”

The court concluded, “The most a court could do is give administrative priority to postpetition fees for work in the action’s prosecution. Yet if the debtor’s estate is insufficient to pay administrative claims, even those are discharged. Nothing in the Code permits a categorical exception for any kind of debt other than one listed in sec. 523 — and legal fees are not on that list.”

Accordingly, the court vacated the district court opinion, and ordered that the attorneys must repay the debtors any sums collected after the discharges were entered, and any sums collected pursuant to the retainers during the pendency of the bankruptcies in violation of the automatic stay.

The Concurrence

Judge Cudahy wrote separately, concurring in part, and dissenting in part.

Cudahy agreed that there is no conflict between secs. 329 and 727 sufficient to defeat discharge, but pointed out other incongruities in the Bankruptcy Rules.

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7th
Circuit Court of Appeals

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Case Analysis

Cudahy noted “For example, Bankruptcy Rule 1006, implementing 28 U.S.C. sec. 1930, provides for payment of bankruptcy filing fees in installments within 120 days after the filing of a bankruptcy petition, but Rule 1006(b)(3) prohibits any payment to the debtor’s attorney before the filing fee is paid in full. Rule 1006 codifies the longstanding practice under the former Bankruptcy Act and rules. Thus, the rules at least implicitly recognize that attorneys representing debtors in connection with their bankruptcies may be paid, and may agree to be paid, postpetition. Although the Bankruptcy Rules may not contradict substantive provisions of the Code, rules propounded by the Supreme Court are presumed not to do so (cites omitted).”

Cudahy added, “There is also evidence in the history of sec. 60(d) of the Bankruptcy Act of 1898, as amended (the predecessor of sec. 329 of the Code), that Congress did not intend that prepetition attorneys’ fees be discharged. The Supreme Court characterized sec. 60(d) as ‘recogniz[ing] the right of … a debtor to have the aid and advice of counsel, and, in contemplation of bankruptcy proceedings which shall strip him of his property, to make provisions for reasonable compensation to his counsel.’… I do not see this, as the majority suggests, as a species of ‘social class preference.’ It seems to me an arrangement that might enable debtors to obtain counsel in bankruptcy when counsel might be sorely needed. The elementary demands of fairness are offended when a necessitous debtor retains a lawyer to help him unburden himself of his debts and then hoists the unsuspecting attorney on his own petard by not only refusing to pay what is due under the retainer but asking that the lawyer be held in contempt.”

Cudahy agreed that Congress has failed to include pre-petition fees as an exception to discharge, and concurred in that portion of the court’s holding. However, Cudahy concluded that, since pre-petition fees were the only ones the parties disputed in the case, there was no reason for the court to consider post-petition fees, and create a conflict with the Ninth Circuit over the issue. Accordingly, he dissented from that portion of the lead opinion.

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David Ziemer can be reached by email.

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