Monday, October 31, 2011

Prepetition Attorney Fees Collected Post Petition Violate Automatic Stay

       There is a common practice that has long taken place in the Chapter 7 bankruptcy realm which attorneys and debtors need to be aware of has some problems.  The practice is the acceptance of attorney fees after the debtor's bankruptcy petition has been filed and case commenced.  A majority of courts, including the 6th Circuit, have held that the requiring payment of attorney fees post petition is a violation of the automatic stay in section 362 of the Code.  Despite the 2009 Tennessee decision, I still see this practice continuing.  Maybe its because more young attorneys are entering the bankruptcy field and are unaware of this 2009 case, or local attorneys just did hear of it (The Nevin Law Firm is based in the Middle District of Tennessee in Nashville while the decision was in the Eastern District of Tennessee of Knoxville.)  No matter the reason, this practice openly continues despite the Bankruptcy Court's obvious using one law group as an example.

       The far reaching consequences of this decision, and the rich analysis of the Bankruptcy Code, make the case worthy of a law review article; however, tempted as I am to write a full-blown review of this decision, I will keep this article brief.

       The United States Bankruptcy Court of the Eastern District of Tennessee held that an agreement to pay attorney fees for the bankruptcy case, entered into prepetition, is a prepetition debt and is therefore dischargeable.  They also held that where an attorney makes the arrangement not to be paid in full upfront before filing the case creates a conflict of interest because the attorney then becomes a creditor of their own debtor-client once the case has been filed.  Moreover, any attempt to collect the unpaid balance from the debtor, the court held, would violate the automatic stay of section 362 and be cause for the debtor's own attorney to be issued sanctions by the court which would include a disgorgement of the fees already paid prepetition. 

       The court had multiple problems with the law group in this specific case including:  (1) the fact that the attorneys did not disclose to the client that such an agreement could at least potentially be dischargeable (since this was a case of first impression);  (2) the attorneys' disclosure to the court was that they had been paid in full prepetition, when in fact that was not true;  (3) after post-dated checks from the debtors had been returned, they made collection phone calls and sent collection letters. 

       However, the court did note that there are acceptable ways to receive proper compensation for attorney fees, for both post and prepetition payments.  The following are such options, which have been employed by other courts, and appear to fall within the scope of potential and allowable solutions: “(1) requiring Chapter 7 debtors to pay flat attorney’s fees in full prior to filing; (2) revising retainer agreements and expressly designating pre-petition services, which are paid pre-petition, and post-petition services, which shall be paid post-petition; or (3) accepting payment by third parties.”

       Therefore, if you are a debtor and your attorney is asking for post-petition payment, you might have found a way to have free legal service.  Attorneys! Make sure you get paid up front in full before filing the case! If, however, a debtor is in a bind and needs a case filed ASAP, then take either of the two following actions.  First either have a family member or friend of the debtor sign the fee agreement as a surety, since they would not fall under the protection of the Bankruptcy Code for your debtor's case.   

       Or, second, write two separate contracts.  The first contract should specifically delineate prepetition services, duties, and disclosures with fees scheduled next to each.  State specifically that any prepetition payments are for only the delineated services and that this contract does not bind the attorney to perform any post petition work on the case.  After filing the case, sign a second contract with the debtor which is for postpetition services.  Specifically delineate what those services are and how much you charge.  Also make full disclosure to the bankruptcy court of your fee arrangement on Form 7 Statement of Financial Affairs and the Compensation Statement of Attorney for Debtor. You must also disclose to your client the reason for the separate contracts, explaining to your client the automatic stay implications and the attorney fees. 

To read the case in full please see In re Waldo, 417 B.R. 854.

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