Attorneys Fees When a Client Files for Bankruptcy
by Steven R. Neuner, Esq.
It should not surprise any of us that people we represent who have suffered either bodily or financial injuries need bankruptcy protection as a result of the resulting loss of income, loss of a business, or other financial distress. The filing of that bankruptcy, however, creates serious potential problems for the unwary. (This article is a synopsis of a more complete article originally published in the New Jersey Law Journal in February 1998. A complete copy of the article is available on request. The article is addressed to attorneys handling personal injury matters.)
The Impact of a Client’s Filing for Bankruptcy
When your client files for bankruptcy protection, you and she lose control and ownership of all causes of action, and rights to collect on them, including the one you are handling. Instead, these and most of your client’s property rights, become part of a Bankruptcy Estate, under the jurisdiction and control of the Bankruptcy Court. That Estate, and the property in it, is administered in the bankruptcy proceedings for the benefit of creditors, subject to your client’s rights to exempt and keep for herself specific types and amounts of property. A Bankruptcy Trustee, where one is appointed, takes control of the Estate and your client’s causes of action. In essence, a new “client” has been substituted for the person who signed your Retainer Agreement, and that Agreement may no longer have the same legal effect.
Further, your original client no longer has authority, without Bankruptcy Court approval on notice to creditors, to settle the case or sign a valid Release. The procedures and requirements for obtaining such approval from the Court are discussed in greater detail below.
This situation continues until the cause of action is “abandoned” in compliance with the procedure set forth in Bankruptcy Code §554. Your cause of action may properly be abandoned if it is “burdensome or of inconsequential value to” the Estate. (In other words, if keeping it in the bankruptcy will not likely result in additional money, after payment of exemptions, fees, and costs, to pay creditors, or if the risks and costs of keeping it in the Estate for that purpose outweighs the likely benefits). Abandonment, in this context, is a term of art. It does not occur by inaction, but requires some action or filing in the Bankruptcy Court. If your client’s cause of action is abandoned, it reverts to your client’s control, free of bankruptcy court control. Abandonment, and use of available exemptions to achieve that result, are discussed in more detail below.
If you have not yet completed your representation of the Debtor, your client, you must obtain an Order of the Bankruptcy Court approving your continued representation. This Order is a pre-condition to your getting paid for anything you do, or did, after the bankruptcy started. As soon as you become aware of your client’s bankruptcy, you must begin acting immediately to obtain this approval. Here, ignorance of the bankruptcy filing may be an excuse, but ignorance of the law is not.
Attorneys owed money for costs advanced or services rendered before the bankruptcy have additional protection as holders of statutory charging liens, or common law retaining liens. Having such a lien does not, however, substitute for or remove the requirement for the Bankruptcy Court to approve the attorneys continued retention, as described above. Finally, notwithstanding such a lien, the attorney may still be ordered to turn over his file or its contents to the Trustee, the Debtor, or successor counsel selected by either of them. Such liens and how to handle these situations are described in more detail below.
Critical First Steps when you learn your client is in bankruptcy
First, find out more about the bankruptcy from your client or your client’s bankruptcy attorney. Identify which Chapter the case was filed in, whether it has been converted, who is the trustee, and in Chapter 11 or Chapter 13, whether a plan has been filed and if so, what it says.
By now it should be clear, at least as to still-pending matters, that getting yourself retained is of critical importance. If you knew about the bankruptcy filing beforehand, you will want to take steps as soon as possible after the filing to get yourself retained as Special Counsel for the Bankruptcy Estate, or to get the claim abandoned. However, you may not learn about the bankruptcy until some time after the filing. In this situation, you should contact your client’s bankruptcy counsel as soon as you become aware your client is in bankruptcy. Ask for the bankruptcy case number, the date the case was filed, the bankruptcy chapter under which the case is currently pending, the name of the Judge assigned, and most importantly, the name, address and telephone number of the Trustee, if one has been appointed. You should also request a filed copy of the bankruptcy Petition and a complete copy of the Schedules and Statement of Affairs. Find out if the claim or cause of action you are handling was listed there among the debtor’s assets, and if so, what exemptions were claimed for it.
In a Chapter 7 case, you should call the Trustee next as he/she is the person with power to get you the necessary retention approval order. In a Chapter 13, the debtor files this application, but it does not hurt to let the Chapter 13 trustee know who you are and your position and involvement. In
Chapter 11, a trustee may have been appointed but this is the exception, not the rule. In your initial contacts with either the debtor’s bankruptcy attorney or the trustee, you should make a specific request to be appointed as special counsel, and confirm your request in writing.
With certain limitations, being cooperative with everyone involved is, at this point, in your best interest and that of your client. Debtor’s bankruptcy attorney should be brought up to speed as soon as possible. If the cause of action was not listed in the Schedules, insist that these be amended to include it, with all available exemptions. Where a Trustee is involved, you should freely provide (without violating any attorney-client privilege. See below) the information he or she will need to evaluate whether the cause action should be pursued or abandoned. Provide a brief history of the causes of action, including a description of the current status of the case, any upcoming Pre-Trial or Status Conferences, the amounts and status of any settlement demands or offers, any information you have on coverage or policy limits of defendants, and an anticipated date of trial, arbitration hearings, or other resolution, if possible. Attach a copy of any pleadings and pending motions or orders. Summarize any information relevant to the value of the case which has already been disclosed in discovery.
The Trustee will be interested in your evaluation of the claim, including any liability problems, and an estimate of damages, if these are available. The purpose of providing this information is to assist the Trustee in deciding whether your client’s claim is large enough to be worth administering, or whether it should be abandoned. To avoid potential claims that you violated or waived your client’s attorney-client privilege, request a commitment, in writing, that the Trustee will maintain the confidentiality as to third parties of any communications of your mental impressions, assessments, strategy, work product, or other matters which might otherwise be privileged . This is necessary because, at this stage, no attorney-client relationship exists, and, if the Trustee abandons the claim, none might ever be formed.
Providing this information voluntarily could create a potential waiver of your possessory lien on your file. Generally, since you want to be retained by the trustee, this is a risk worth taking. However, if suit has not yet been filed, before you turn over any work product of value that is not in the public record, you should consider conditioning any turnover of documents in your file on the Trustee agreeing in writing that by your doing so, you will will not be waiving any possessory lien rights you might have, if for some reason the Trustee does not retain you. You should also indicate that without this commitment, unless you are retained, and your retention approved by the Court, you will require a court order (even if by consent) before turning over your files, so as to preserve any retaining lien you may have. The downside with this approach is that it may antagonize the trustee.
Any bankruptcy court application for your retention must fully disclose all prior dealings or relationships with the debtor, or any of the debtor’s relatives, officers, or business associates, as well as any previous representation of the debtor. You must also disclose any fees, debts or expenses the debtor owes you. In order to be retained, you will probably have to provide the Trustee a copy of your Retainer Agreement and a listing of any costs or disbursements you have incurred to date. Request that the Trustee discuss with you any concerns he may have about your “disinterestedness” or other qualifications to be appointed.
Can the Cause of Action be removed from the Bankruptcy through Abandonment?
The threshold issue for you, the Trustee, and the Debtor, is whether the cause of action ought properly to be abandoned. Individual debtors with personal injury actions have fairly liberal exemptions available to them. These exemptions, once claimed and allowed, define what part of any recovery the Debtor becomes entitled to keep, free of discharged claims of creditors or the rights and interests of a Trustee. Put another way, the amount of the Debtor’s allowed exemptions must be paid to her, normally without deduction of any fees or expenses incurred by the Trustee.
Thus, if you can establish that, after deducting your counsel fees, the Debtor’s exemptions, and other “costs of administration”, little or nothing will remain to help pay creditors out of any likely settlement or verdict, abandonment of the cause of action you are handling will become appropriate. Abandonment becomes effective only upon completion of specified procedures in the Bankruptcy Court.
The Retention Application
If the Trustee determines not to abandon the cause of action, an application for your retention as “Special Counsel” will be necessary. 11 U.S.C. 327(a) mandates that all professionals being compensated out of the Estate (including you, and any expert witnesses you hire) must have their retention approved by the Bankruptcy Court. Professionals to be retained must show that they do not hold or represent an interest adverse to the Estate. The mere fact that you may be owed monies for costs advanced or for services rendered is not by itself disqualifying. For this application, you will have to sign a Certification showing that you do not hold or represent any interest adverse to the Trustee or the Estate. Full disclosure of all past or present dealings with the Debtor, any family member or business associate of the Debtor, or any creditor of the Debtor is absolutely critical.
Prior approval of a professional’s retention is strictly enforced. Applications for Retention can be granted on a nunc pro tunc basis, only where extraordinary circumstances, beyond mere inadvertence or neglect, exist. However, it is the applicant’s burden to establish this. You will want to document when you first became aware of the bankruptcy, and that you diligently sought and pursued approval of your retention as soon as practicable.
Once you are retained, and up to the point of a settlement or recovery, your duties and responsibilities are little different that what would exist absent a bankruptcy. Most Trustees want to be kept apprised of significant developments, and settlement offers. However, you need to stay neutral and not get involved in disputes between the Debtor (your original client) and the Trustee (your new client). Just pursue the claim and give everyone (both the Trustee and the Debtor) your best advice as to the matter you were retained for. You must leave advising the debtor about his or her rights in the bankruptcy (such as what exemptions to claim or how any settlement or recovery is to be divided up) to others. For this reason, you should not also be representing the debtor as bankruptcy counsel.
However, if a settlement offer is made and accepted, it must be submitted to the Bankruptcy Court for approval before the Trustee (or Debtor if no Trustee exists) can sign a valid release.
In bankruptcies, as elsewhere, settlements are favored. In deciding whether or not to approve the settlement, the court must determine “whether the proposed settlement is in the best interest of the est