US Trustee’s “Guidelines” For Bifurcated Fee Agreements In Chapter 7

When an enforcement authority issues guidelines to its personnel for making enforcement decisions and makes those guidelines public, all who are subject to that authority should sit-up and take notice.

On June 10, 2022, the U.S. Trustee’s Office, Department of Justice, issues “Guidelines” to its personnel for enforcing rules on “Bifurcated Chapter 7 Fee Agreements.”[Fn. 1]

Here is an internal description on the nature of the guidelines (at 6):

they are an internal directive to US Trustee personnel for carrying out duties;
they have no force or effect of law or impose any obligations beyond those set forth in the Bankruptcy Code and Rules; and
the final determination of whether a bifurcated fee agreement complies with the Bankruptcy Code and Rules resides solely with the court.

What follows is an attempt to summarize information in the “Guidelines” document.

Introduction

The U.S. Trustee’s role as “watchdog” of the bankruptcy process includes ensuring that, (i) debtors are properly and adequately represented by their attorneys, and (ii) their attorneys are negotiating the terms of fee arrangements and representation in good faith.

–Traditional model

The Bankruptcy Code’s statutory framework generally prohibits post-petition payment of attorney fees arising from prepetition retention agreements in chapter 7 cases. That’s because the U.S. Supreme Court held in Lamie v. United States Trustee that a chapter 7 debtor’s attorney fees may not be paid by the bankruptcy estate, since:

§ 330(a) only authorizes compensation to professionals employed under § 327; and
§ 327 does not include the debtor’s attorney in a chapter 7 case, unless employed by the trustee under § 327(e).

Other courts hold that debtor’s attorney fees owing under a prepetition retainer agreement are a dischargeable debt.

As a result, the traditional model for representation in chapter 7 cases is payment of the entire attorney fee for the case in full before the case is filed.

–“Bifurcated” Chapter 7 fee agreements

“Bifurcated” fee agreements split an attorney fee between work performed prepetition and work performed postpetition. Such agreements have become increasingly prevalent in chapter 7 consumer bankruptcy cases.

Bifurcated agreements are generally structured so that:

minimal services (those essential to commencing the case) are performed under a prepetition agreement for a modest (or no) fee; and
all other services are performed post-petition, under a separate post-petition retention agreement, arguably rendering those fees non-dischargeable.

Some courts hold that bifurcation, by its nature, violates local rules on professional responsibilities of counsel to their debtor clients. Other courts hold that nothing is inherently improper about bifurcation, provided certain limits are obeyed.

US Trustee’s view

Absent contrary local authority, the US Trustee views bifurcated fee agreements as permissible, so long as:

fees charged under the agreements are fair and reasonable;
the agreements are entered into with the debtor’s fully informed consent; and
the agreements are adequately disclosed.

–Balancing concerns

Bifurcated fee agreements increase bankruptcy access and relief to those in need, but there is a corresponding risk that such fee arrangements, if not properly structured, could harm debtors and deprive them of the fresh start afforded under the Bankruptcy Code.

The US Trustee’s enforcement approach to bifurcated fee agreements attempts to balance these concerns.

–Enforcing

The US Trustee will review bifurcated fee agreements to ensure that they do not harm either, (i) the debtors who rely on the bankruptcy system for relief, or (ii) the integrity of the system.

When appropriate, the US Trustee will bring enforcement actions to address the harms.

U.S. Trustees and their staff will use these guidelines to determine whether enforcement action is needed on bifurcated fee agreements.

Three common issues

The three most common issues in bifurcated fee agreements, discussed below, relate to:

allocation of fees and services between pre-petition and post-petition services;
reasonableness of the fees; and
third-party financing.

One. Allocation

The allocation issue commonly arises in no- or low-money down cases. Fees for prepetition services must be either paid prepetition or waived, because a debtor’s obligation to pay those fees is dischargeable.

Attorneys must assure, and clearly document, that debtors receive appropriate prepetition service, including adequate work on exemptions and chapter selection. An attorney’s signature on a bankruptcy petition or other filing, for example, certifies that the attorney has reasonably investigated into the facts and circumstances involved.

Bifurcation must not foster cutting corners. For example:

attorneys must properly prepare the bankruptcy case for filing and not eliminate or postpone tasks that should be performed pre-petition—just to get paid;
fees for postpetition services must be rationally related to the services actually rendered postpetition—a flat postpetition fee must not be a disguised method to collect fees for prepetition services; and
attorneys should not advance filing fees and then seek reimbursement postpetition—such advancements are dischargeable prepetition obligations.

Two. Reasonableness

Attorney fees charged to debtors in bifurcated cases must be reasonable.

Bifurcated fee agreements must not, for example, be a way to collect higher fees than those collected from clients who pay in full, before filing.

To illustrate, it is inappropriate for an attorney to offer the debtor a fee of (i) $1,500, if paid up front, but (ii) $2,000 if paid over time postpetition. That’s because fees for prepetition work are to be paid prepetition or waived.

Three. Third party financing

Outside financing of bifurcated fee agreements (e.g., factoring, assignment of attorney accounts receivable, and direct lending to clients) warrant higher scrutiny.

Details of such arrangements must be fully disclosed, because:

the costs of such arrangements must be borne by the attorney and cannot be passed along to the client—which can provide an over-charge incentive; and
such arrangements can create unwaivable conflicts of interest between the attorney and client—and may also violate state ethics rules.

Ensuring adequate disclosure to and consent from debtor

Courts who permit bifurcated fee agreements emphasize the importance of adequate disclosure and fully informed consent.

One such court notes, “the propriety of using bifurcated fee agreements” is directly proportional to “the existence of documentary evidence that the client” made a voluntarily and informed election to enter into a postpetition fee agreement.

The Bankruptcy Code requires that attorneys for consumer debtors:

deal forthrightly and honestly with their clients;
avoid misrepresentations about (i) services they will provide, or (ii) benefits and risks of filing bankruptcy; and
make adequate, clear and conspicuous disclosures about the services to be rendered and fee terms involved.

Here is a list of non-exhaustive factors the U.S. Trustee will consider in evaluating bifurcated fee agreements:

whether clear disclosures exist on services to be rendered prepetition and postpetition, and the corresponding fees for each;
whether disclosure exists on the attorney’s obligation to continue the representation (even if debtor fails or refuses to execute a postpetition fee agreement), unless the bankruptcy court permits the attorney’s withdrawal;
whether the attorney has clearly disclosed, (i) client’s option to choose a bifurcated fee agreement, (ii) any difference in total attorney fees between the bifurcated fee agreement and a traditional fee agreement, and (iii) client’s options regarding the postpetition portion of the fee agreement; and
whether the agreement includes (i) clear and conspicuous explanations on options, costs, and consequences of entering into a bifurcated fee agreement, and (ii) an option for debtor to rescind the bifurcated agreement.

Such considerations, (i) are not to be mechanically applied, but (ii) instead, must be qualitatively assessed to determine whether adequate disclosures and informed consent exist. Local rules and jurisprudence on disclosure and formed consent (whether more or less stringent) must also be considered.

Ensuring adequate disclosure to the public

The Bankruptcy Code and Rules also require public transparency on professional fee arrangements and on fees already paid.

The U.S. Trustee enforces such requirements. In deciding whether to take action, the emphasis is to be on cases where the debtor is harmed or the integrity of the bankruptcy process is jeopardized.

Conclusion

Here’s a “thank you” to the US Trustee for both, (i) issuing these guidelines, and (ii) making the guidelines available to the public.

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Footnote 1. The complete title of the “Guidelines” and a link thereto are: “Guidelines for United States Trustee Program (USTP) Enforcement Related to Bifurcated Chapter 7 Fee Agreements.”

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