The following is a case update written by the Hon. Meredith A. Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), analyzing a recent decision of interest:

In a recent case which addressed the dilemma faced by many potential chapter 7 debtors who cannot afford to pay up front a flat sum for attorney’s fees for a chapter 7 case, a bankruptcy court in Kentucky approved a “dual contract” arrangement, whereby the attorney and debtor entered into separate prepetition and postpetition contracts which bifurcated the services and the debtor’s obligation to pay for those services. Recognizing the controversy surrounding this type of fee arrangement, the Kentucky court painstakingly explained why the circumstances of this case made the fee arrangement reasonable for the debtor, compliant with the duties imposed on debtor’s counsel by the Bankruptcy Code, and ethical. In re Carr, 2020 WL 373507 (Bankr. E.D. Ky. Jan. 22, 2020).

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FACTS

Attorney Christian A. Dennery and his firm, Dennery, PLLC (collectively Dennery), entered into a “dual contract” arrangement with Debtor Chanda Carr whereby he had two separate contracts for services to be provided to Debtor. The prepetition contract was for $300 to cover the preparation and filing of a skeletal chapter 7 case and an application to pay filing fee in installments. After the case was filed, the parties executed a second contract under which Dennery agreed to provide the balance of the routine services for a chapter 7 case for a $1185 postpetition fee payable in twelve equal installments at 7.5% interest, which he would collect by direct withdrawal from Debtor’s bank account.

Utilizing this arrangement, the Debtor filed a successful chapter 7 and received her discharge in the ordinary course. However, because of the explanation regarding the Dennery fee arrangement in the Disclosure of Compensation filed with the court, the court sought additional information from the attorney, which Dennery filed. The court also asked the United States Trustee (UST) to file a response to these documents, set a hearing, and allowed post hearing briefing. At the conclusion of this court-initiated investigation, the court allowed the fees, concluding “the Attorneys proceeded reasonably and after having obtained Debtor’s informed consent in writing. They accepted reasonable fees for prepetition work under their prepetition contract and agreed to a reasonable payment arrangement for their fees for post-petition work under their post-petition contract.”

REASONING

Per the court, the key to Dennery’s success in using this method, which allowed Debtor to use the services of competent counsel throughout her chapter 7 case while paying only $300 upfront, was the extensive disclosures both to the client and to the court. Dennery’s system required two separate engagement meetings with Debtor. At the first meeting, after obtaining sufficient information to determine Debtor was a viable candidate for a chapter 7 case, Dennery orally and in writing gave Debtor two options to pay for his services: one was to pay a flat fee of $800 plus the filing fee up front, after which he would provide all pre and post-filing services routinely included by that district’s debtors’ counsel for a chapter 7 case; the second was for her to enter into the dual contract arrangement as described above.

The disclosures about how the two contracts would work were extensive, including that Debtor was not required to use Dennery’s firm to provide the postpetition services. When she chose the second option, he then obtained her written consent to the limited services he would provide under the first contract before they entered into the prepetition contract. A few days after the petition was filed, Dennery met a second time with Debtor, again going over the dual nature of the representation, making it clear she was not obligated to retain him further, and explaining in detail how the installment payments would be made. After Debtor again gave her written consent, they executed the second contract and the case proceeded.

At the conclusion of the post hearing briefing (without any discussion of the UST’s response), the court made a series of detailed findings on why the arrangement was fair, reasonable, and ethical and ruled that it would take no action under § 329(b) to “disrupt the fee arrangement.”

AUTHOR’S COMMENTS

In 1998, the Ninth Circuit Court of Appeals in Gordon v Hines (In re Hines), 147 F. 3d 1185 (9th Cir. 1998) held that chapter 7 debtor’s counsel could not collect postpetition attorney’s fees under a contract for chapter 7 services which was executed prepetition because such collection violated the automatic stay and the fees were discharged. However, the circuit court left the door open for some kind of different fee arrangement to cover those services which routinely were provided after the petition date. The Seventh Circuit in Bethea v Robert J. Adams & Associates (In re Bethea), 352 F.3d 1125 (7^th Cir. 2003) took issue with Hines, making it clear that in that circuit a creative fee arrangement would not pass muster to pay any chapter 7 fees after the case was filed. But the Seventh Circuit’s reasoning partly relied on its belief that those fees would be an administrative priority expense, to be paid by the estate. The possibility of debtors’ counsel collecting fees from the bankruptcy estate was squelched by the Supreme Court a year later in Lamie v. United States Trustee, 540 U.S. 537 (2004). Each of these opinions criticized Congress for not providing a framework by which chapter 7 debtors’ counsel could be assured of payment.

Alas, despite extensive revisions to the Bankruptcy Code in 2005, none addressed this circumstance, which is a manifest dilemma for potential chapter 7 debtors. Many of them in desperate need of professional services are broke, often under garnishment, and totally unable to quickly come up with the flat fee counsel require be paid in advance. They have a couple of choices, neither ideal: file pro se and struggle through the system on their own (well-sourced studies suggest between 30-40% of all pro se filers never receive a discharge) or delay the filing until they can save up the necessary fees. For many, the second choice—called by some writers “Life in the Sweatbox”—is really no option at all because of wage garnishments, foreclosures, or repossessions, so they must file without counsel.

Motivated more by a desire to have paying clients than by public policy or access to justice issues, attorneys have developed some responses to this situation, including “fee only” chapter 13’s; severely restricted limited scope representation such as document preparation only with no appearances, advice, or guidance; bifurcated fee arrangements such as the one in this case; and most recently factoring in conjunction with a postpetition installment contract. These alternatives are all controversial, with a few journal articles criticizing them (for example, Adam D. Herring, “Problematic Consumer Debtor Attorneys’ Fee Arrangements and the Illusion of ‘Access to Justice’” AM. BANKR. INST. J. Oct. 2018 at 32) or supporting them (Daniel Garrison, “Liberating Debtors from ‘Sweatbox’ and Getting Attorneys Paid” AM. BANKR. INST. J. June 2018 at 16.)

Cases are similarly split, with a some favoring bifurcated fee arrangements, such as In re Hazlett, 2019 WL 1567751 (Bankr. D. Utah Apr. 10, 2019), Walton v. Clark & Washington, PC,454 B.R. 383 (M.D. Fla. 2012), and In re Slabbinck, 482 B.R. 576 (Bankr. E.D. Mich. 2012), and others adamantly opposed, In re Wright, Case No. 17-11936 (Bankr. N.D. Okla. Sep. 4, 2018) and In re Grimmett, 2017 WL 2437231 (Bankr. D. Idaho Jun. 5, 2017). Attorneys who have used factoring arrangements (BK Billing is best known example) or charged an unreasonable interest rate that resulted in a much higher fee for those paying in installments have not fared well with either the UST nor the courts.

Dennery succeeded in Kentucky for reasons that could be a role model for debtors’ counsel who wish to try bifurcated representation or dual contracts. First, his disclosures to both Debtor and the court were transparent, hiding nothing about what was going on. Second, the engagements were legitimately separate, prepetition and postpetition. Third, the court found the fees for each part of the work performed were reasonable for that portion of the routine work. Fourth, Dennery obtained informed written consent from Debtor, twice. And, finally, the overall fee charged was reasonable and rationally related to the upfront flat fee, increased only by a reasonable interest rate on the balance.

These materials were authored by the Hon. Meredith A. Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), a member of the ad hoc group, with editorial contributions by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, a member of the ad hoc group and the 2018-19 Chair of the CLA Business Law Section. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.