This article was written forThe Alabama Lawyerand was published Jan. 30, 2023.
Ignorance of the law is no excuse. We all learned that in law school. Still, you don't know what you don't know. And when it comes to bankruptcy law, too many of us just don't know some basics, like how to protect your fee. Non-bankruptcy lawyers routinely represent debtors or their litigation opponents in non-bankruptcy disputes, such as personal injury claims. To comply with your duty to competently represent clients who are in bankruptcy or litigating against a debtor, and to protect your fee, know these fundamentals.
Filing a voluntary petition creates an estate consisting of "all legal or equitable interests of the debtor in property."1Claims of the debtor arising prepetition are property of the estate [hereinafter "POTE"].2In a case under Chapter 12 or 13, or an individual case under Chapter 11, claims arising after the petition date, but before the case is closed, dismissed, or converted are also estate property.3Proceeds of estate claims (i.e. settlement funds) are, similarly, estate property.4
In a Chapter 7 case, the Chapter 7 trustee, as the real party in interest, has authority and responsibility for prosecuting and resolving prepetition claims.5
In Chapters 11 and 12, the debtor-in-possession has all rights and powers of a trustee, including the right and power to prosecute and resolve estate claims.6
In Chapter 13, the debtor has authority and responsibility for prosecuting and resolving estate claims.7When working on a matter involving an estate claim or a potential estate claim, do the following.
Before Representing an Estate Fiduciary, Have Your Employment Approved by the Bankruptcy Court
Before an attorney may represent an estate fiduciary, such as a trustee or debtor-in-possession, the fiduciary must obtain court approval of the terms of the professional's engagement. The Bankruptcy Code [the Code] provides that only attorneys "that do not hold or represent an interest adverse to the estate, and that are disinterested persons" may be employed to assist the estate fiduciary in carrying out his duties under the code.8A "disinterested person" is a person who (A)is not a creditor, an equity security holder, or an insider; (B)is not and was not, within two years before the date of the filing of the petition, a director, officer, or employee of the debtor; and (C)does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.9
With court approval, under section 327(e), an estate fiduciary may employ an attorney that has represented the debtor, for a specified special purpose, if the attorney "does not represent or hold any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed."10Rule 2014 of the Federal Rules of Bankruptcy Procedure sets out the information that must be included in an employment application. It provides that such application must set forth specific facts showing the necessity for the employment, the name of the person to be employed, the reasons for the selection, the professional services to be rendered, any proposed arrangement for compensation, and, to the best of the applicant's knowledge, all of the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee11or any person employed in the office of the United States trustee.
The application must be accompanied by a verified statement of the person to be employed setting forth "the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee or any person employed in the office of the United States trustee."12
Special counsel should communicate with bankruptcy counsel or the trustee at the beginning of the representation or commencement of the bankruptcy about having his employment and terms of engagement approved by the court. Too often, special counsel waits until settlement has been reached and then seeks to have his employment, compensation and the settlement all approved in one go, with the employment approved nunc pro tunc to the date of engagement. This practice is frowned upon and, considering a recent United States Supreme Court ruling, arguably impermissible.13
Before Settling an Estate Claim, Have the Settlement Approved by the Bankruptcy Court
To be enforceable, any settlement of estate claims must be approved by the bankruptcy court after notice and a hearing under Rule 9019.14In other words, the compromise of estate claims has no effect until approved by the bankruptcy court. Rule 9019 provides that "[o]n motion by the trustee and after notice and a hearing, the court may approve a compromise or settlement. Notice shall be given to creditors, the United States trustee, the debtor and indenture trustees as provided in Rule 2002 and to any other entity as the court may direct." Rule 9019 gives bankruptcy courts broad discretion in approving compromises.15In the 11thCircuit, courts consider the following factors in determining whether to approve a settlement of estate claims: (a) The probability of success in the litigation; (b) the difficulties, if any, to be encountered in the matter of collection; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; and (d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises.16Like other courts, bankruptcy courts typically favor the consensual resolution of claims. It is not the Court's intent to unjustly deny a settlement agreement, but it does require a record upon which to base findings of fact and conclusions of law approving your settlement. Be sure to provide this.
Before Taking Your Fee, Have Your Fees and Expenses Approved by the Bankruptcy Court
For professionals employed pursuant to section 327, section 330 governs the award of compensation and reimbursement.17Compensation awarded under section 330 is entitled to administrative expense priority,18which is paid ahead of general unsecured creditors.
As the statute makes plain, the bankruptcy court has discretion to determine reasonable attorney fees and expenses and an independent duty to satisfy itself that the fees and expenses requested are reasonable and necessary.19To enable the bankruptcy court to award the fees and expenses requested, the applicant must provide the court with evidence of the time spent, fees charged, substance of the work performed, complexity of work performed, attorney's skills and expertise and market rates for comparable work.
Rule 2016 of the Federal Rules of Bankruptcy Procedure sets forth the procedure for applying to the court for approval of compensation for services rendered and reimbursement of expenses incurred. The application for compensation must include a detailed statement of "(1) the services rendered, time expended and expenses incurred and (2) the amounts requested." CITE. It must also disclose any payments made or promised to the applicant in connection with the case, including details about the source of any such payments. Crucially, the application must also state whether any payments previously received by the attorney have been shared and whether any agreement exists for the sharing of compensation received in connection with the case.
Do Not Share Fees
Disclosure of the particulars of any agreement to share fees approved in connection with the case is crucial because the Code strictly prohibits fee sharing in bankruptcy cases.20 It provides, "a person receiving compensation or reimbursement under section 503(b)(2) or 503(b)(4) of this title may not share or agree to share (1) any such compensation or reimbursement with another person; or (2) any compensation or reimbursement received by another person under such sections." This prohibition encompasses typical referral fee agreements common among the plaintiffs' bar but is much broader than that. It also prohibits an attorney from contracting out legal work to a professional who is not a regular member of the court-approved attorney's firm.
What You Don't Know Absolutely Can Hurt You
Determining whether an individual or entity is the subject of a pending bankruptcy is free, quick, and easy. The bankruptcy courts in Alabama expect you, a competent attorney, to (1) know how to determine whether an entity or individual is in bankruptcy, (2) know when to make such a determination, and (3) promptly inquire as the circumstances require.
How to Determine Whether a Party Is in Bankruptcy
The federal court electronic filing and records database, PACER, has a Case Locator function that allows you to locate bankruptcy cases nationwide by social security number [SSN] or employer identification number [EIN]. If you do not have this information and cannot obtain it, the advanced bankruptcy search option allows you to search by party name, narrow by date and sort by jurisdiction, among other features. You can train your staff to do this.
Relying on your client or another party's representations about whether he or she is subject to a pending bankruptcy is not sufficient to fulfill your obligation to diligently inquire. InIn re Fisher,a Chapter 13 debtor listed a claim arising from a prepetition car wreck, which was the subject of a pending lawsuit, on her schedules.21 Over a year after the bankruptcy filing, while the bankruptcy case was pending, the debtor's state court attorney settled her car wreck claim and took his fee from the settlement proceeds. The attorney's employment, his fee, and the settlement itself had not been approved by the court. After receiving an order from the bankruptcy court to turnover his fee, an order that threatened sanctions and a report to the Alabama State Bar if he failed to comply, and then an order to show cause why he should not be sanctioned for failure to comply with the turnover order, the attorney pled ignorance of the whole bankruptcy situation. He showed the court a settlement memorandum, signed by the debtor-plaintiff, which said in numerous places "I am not a party to any bankruptcy proceedings and no trustees (sic) in bankruptcy or creditor is entitled to or even claims to be entitled to any of the funds paid out of this settlement."22
The court found the attorney's reliance on this statement wholly inadequate, stating: Every trial attorney has or should have a PACER account with which to check federal court pleadings, including bankruptcy court pleadings. It takes only a few moments to check a client's name on PACER before distributing settlement proceeds to determine whether that client is in bankruptcy. To rely on a client's representation that he or she is not in bankruptcy is not enough. The client may not notice or understand thenot in bankruptcylanguage; the client may be confused as to whether he or she is in bankruptcy; and (not surprisingly) sometimes clients will lie, particularly if they think that answering correctly may cause them to get less money. In this court's view, if a lawyer fails to check PACER to confirm that a client is not in bankruptcy immediately before distributing settlement proceeds, the lawyer runs the risk of being held liable for the settlement funds that would have otherwise gone into the bankruptcy estate. Of course, a prudent lawyer should also check PACER upon initial retention as well so that her employment can be approved by the bankruptcy court on a timely basis.23
When to Determine Whether a Party Is in Bankruptcy
Plaintiff's counsel should determine whether his client is in a pending bankruptcy at the outset of the representation, as part of the file opening process and before any referral is made or accepted with an expectation of compensation. Plaintiff's counsel should run a new bankruptcy search on his client immediately before finalizing any settlement terms. He should run yet another search before disbursing settlement proceeds to his client.
Diligent defense counsel should determine whether a plaintiff is in a pending bankruptcy, or has had prior bankruptcies, at the outset of her representation, as part of her initial investigation of the plaintiff. Defense counsel should update her bankruptcy search before finalizing settlement terms, to confirm plaintiff's authority to settle and release claims. Finally, defense counsel should run a search immediately prior to disbursing settlement proceeds to a pro se plaintiff or to plaintiff's counsel to confirm the settlement (and release) was properly approved by the court and will be enforceable.
What Could Happen if You Fail to Follow These Rules: A Cautionary Tale
InIn re McLemore, a Chapter 13 debtor was involved in a car accident post-petition.24 His plan, which was confirmed in December 2020, shortly after the accident, provided that nonexempt proceeds of the claim would be paid to the Chapter 13 trustee for the benefit of unsecured creditors. In July 2021, seven months after the plan was confirmed, and apparently spurred by the Chapter 13 trustee's investigation of the status of the pending claim, the debtor notified his bankruptcy counsel that he had engaged a plaintiff's firm to represent him in the personal injury action. In August, the plaintiff's lawyer contacted the Chapter 13 trustee. He notified her that the personal injury claim had been settled in June 2021 for $40,000 and that $16,788.26 in settlement proceeds had been disbursed to the debtor. In response, the trustee filed a Motion to Examine the Debtor's Transactions with Attorneys, Motion to Examine Attorney Fees and Motion to Dismiss the bankruptcy case. The debtor amended his schedules to reflect receipt of the settlement proceeds and claim an exemption in a portion of the proceeds and filed a Motion to Modify Chapter 13 Plan Post Confirmation. In turn, the debtor filed a Motion to Employ Special Counsel, Nunc Pro Tunc, a Motion to Approve the Settlement, and an Application for Approval of Attorney Fees and Expenses.
The Court found that the settlement funds were property of the estate and that disbursement of the funds constituted conversion of estate property. Finding that plaintiff's firm had a history of disbursing settlement funds without court approval, the Court denied both the motion to employ and the fee application and ordered plaintiff's counsel not only to disgorge his fees to the trustee, but to turn over the full $40,000 in settlement proceeds to the trustee within 14 days.
In addressing violations of bankruptcy law, bankruptcy courts are not limited to ordering disgorgement of fees and return of converted property. Courts can and do refer counsel to state disciplinary boards, order sanctions and issue show cause orders, among other things. A client who is found to have converted estate assets may have her own complaints to file with the state bar.
When you run that PACER search and discover your client (or another party) is in bankruptcy, and you aren't certain how that bankruptcy affects your case, there is a whole cast of characters in the bankruptcy world who can and will help you figure it out. You can find contact information for the debtor's bankruptcy attorney, the Chapter 13 trustee, the Bankruptcy Administrator and/or the Chapter 7 trustee either at the top of the PACER docket report or on the court's website.
Don't put your engagement, your fee, or your settlement in jeopardy. When in doubt, reach out.
1 11 U.S.C. § 541(a)(1).
2 In reTarrant, 349 B.R. 870, 873 (Bankr. N.D. Ala. 2006).
3 11 U.S.C. §§ 1115(a)(1), 1207(a)(1), 1306(a)(1).
4 In reMcLemore, No. 20-32131, 2022 WL 362915 (Bankr. M.D. Ala. Feb. 7, 2022).
5 In reTarrant, 349 B.R. at 873.
6 11 U.S.C. §§ 1107,1203.
7 Crosby v. Monroe County, 394 F.3d 1328, 1331 n.2 (11thCir. 2004) (citing with approvalIn reMosley, 260 B.R. 590, 595 (Bankr. S.D. Ga. 2000)).
8 11 U.S.C. § 327.
9 11 U.S.C. § 101(14).
10 In reTarrant, 349 B.R. at 875.
11 Bankruptcy cases are administered by the United States Trustees ("UST"), a division of the U.S. Department of Justice, in all but two states: North Carolina and, you guessed it, Alabama. In Alabama, bankruptcy cases are administered by the Bankruptcy Administrator ("BA"). While UST's and BA's are not a perfect parallel, in Alabama, to construe code sections, cases, and secondary sources that reference the U.S. Trustee, substitute Bankruptcy Administrator.
12 Rule 2014 (a), FRCP.
13 SeeRoman Cath. Archdiocese of San Juan v. Feliciano, 140 S. Ct. 696, 700-701 (2020).See also In reOsprey Utah, LLC, Case No. 16-2270 (Bankr. S.D. Ala. Mar. 27, 2018) (doc. 295) (noting a circuit split on the permissibility of nunc pro tunc employment orders, adopting a more lenient approach allowing same, but requiring the nunc pro tunc applicant to demonstrate both suitability for employment and excusable neglect in failing to timely seek employment).
14 11 U.S.C. § 363(b);see alsoIn reTarrant, 349 B.R. at 893.
15 In reTarrant, 349 B.R. at 893.
16 Wallis v. Justice Oaks II, Ltd. (In re Justice Oaks II, Ltd.), 898 F.2d 1544, 1549 (11thCir. 1990).
17 In reTarrant, 349 B.R. at 893.
18 11 U.S.C. § 503(b)(2).
19 In reTarrant, 349 B.R. at 895.
20 11 U.S.C. § 504.
21 In reFisher, No. 16-1911, 2019 WL 1875366 (Bankr. S.D. Ala. Mar. 27, 2019).
22 Id.at *2.
24 In reMcLemore, No. 20-32131, 2022 WL 362915 (Bankr. M.D. Ala. Feb. 7, 2022).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.