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Pre-petition Debts for Legal Fees Are Subject to Discharge

The Seventh Circuit has ruled that Section 727 of the Bankruptcy Code authorizes the discharge of a debt for attorneys' fees pursuant to a pre-petition retainer agreement that called for pre and post-petition payments. Bethea v. Robert J. Adams & Associates, No. 03-1303 (Dec. 17, 2003).

Three debtors hired counsel to file bankruptcy petitions. Each agreed to a retainer covering the preparation and prosecution of the proceedings. These retainers, however, were to be paid over time, both pre- and post-petition. After the debtors received their discharges and the cases were closed, the lawyers continued to collect the unpaid installments pursuant to the agreement. The debtors (with the assistance of new counsel) commenced adversary proceedings seeking to hold their former lawyers in contempt for violating the injunctions implementing the discharges. The bankruptcy court found that “reasonable” attorneys' fees under ' 329(b) are not discharged. Further, that ' 329 supersedes the more general reach of the discharge provision, ' 727, “reasoning that any other conclusion would leave no work for ' 329(b) to do.” The district court affirmed.

The Seventh Circuit reversed. The court held that unless an unenumerated exception to ' 727(b) is created by ' 329, then the debts to the attorneys were discharged. Under ' 329(a), every attorney representing a debtor in bankruptcy is required to file a statement outlining the compensation received during the preceding year, or to be received, in connection with the bankruptcy. This enables the court to determine if there has been a preferential transfer to counsel. If the compensation is not “reasonable,” the court may cancel the agreement, or order the return of any excessive payment. Here, the lower courts stated that “this power is exclusive of discharge under ' 727; otherwise, they stated, 329(b) would play no role in Chapter 7 cases.”

The appeals court however, found that “' 329 has plenty to do in Chapter 7 cases, even if debts for legal fees are subject to discharge. First, prepaid fees exceeding the 'reasonable' value of the legal services must be recouped for the benefit of other creditors. Second, the judge must ensure the reasonableness of any fees incurred during the proceeding itself, once more to protect other creditors. Third, if the debt is reaffirmed during the proceeding, yet again the judge must ensure reasonableness. Finally, if the debtor repudiates the executory portion of the agreement with counsel, and the estate rehires the same lawyer (an approach that gives administrative priority to ongoing legal fees), once again ' 329(b) requires the judge to review the fee agreement for reasonableness.” The court reasoned that since collectively applying legal fees with other dischargeable debts does not “gut ' 329(b) for Chapter 7 cases, the structure of the Bankruptcy Code does not support treating ' 329 as an implicit exception to ' 727.” In so ruling, the court agreed with the Ninth Circuit's similar ruling in In re Biggar, 110 F.3d 685 (9th Cir.1997). The court here noted that nearly every bankruptcy judge and district court to have considered this issue has come to the same conclusion, that pre-petition debts for legal fees are subject to discharge under ' 727.

Pre-petition Debts for Legal Fees Are Subject to Discharge

The Seventh Circuit has ruled that Section 727 of the Bankruptcy Code authorizes the discharge of a debt for attorneys' fees pursuant to a pre-petition retainer agreement that called for pre and post-petition payments. Bethea v. Robert J. Adams & Associates, No. 03-1303 (Dec. 17, 2003).

Three debtors hired counsel to file bankruptcy petitions. Each agreed to a retainer covering the preparation and prosecution of the proceedings. These retainers, however, were to be paid over time, both pre- and post-petition. After the debtors received their discharges and the cases were closed, the lawyers continued to collect the unpaid installments pursuant to the agreement. The debtors (with the assistance of new counsel) commenced adversary proceedings seeking to hold their former lawyers in contempt for violating the injunctions implementing the discharges. The bankruptcy court found that “reasonable” attorneys' fees under ' 329(b) are not discharged. Further, that ' 329 supersedes the more general reach of the discharge provision, ' 727, “reasoning that any other conclusion would leave no work for ' 329(b) to do.” The district court affirmed.

The Seventh Circuit reversed. The court held that unless an unenumerated exception to ' 727(b) is created by ' 329, then the debts to the attorneys were discharged. Under ' 329(a), every attorney representing a debtor in bankruptcy is required to file a statement outlining the compensation received during the preceding year, or to be received, in connection with the bankruptcy. This enables the court to determine if there has been a preferential transfer to counsel. If the compensation is not “reasonable,” the court may cancel the agreement, or order the return of any excessive payment. Here, the lower courts stated that “this power is exclusive of discharge under ' 727; otherwise, they stated, 329(b) would play no role in Chapter 7 cases.”

The appeals court however, found that “' 329 has plenty to do in Chapter 7 cases, even if debts for legal fees are subject to discharge. First, prepaid fees exceeding the 'reasonable' value of the legal services must be recouped for the benefit of other creditors. Second, the judge must ensure the reasonableness of any fees incurred during the proceeding itself, once more to protect other creditors. Third, if the debt is reaffirmed during the proceeding, yet again the judge must ensure reasonableness. Finally, if the debtor repudiates the executory portion of the agreement with counsel, and the estate rehires the same lawyer (an approach that gives administrative priority to ongoing legal fees), once again ' 329(b) requires the judge to review the fee agreement for reasonableness.” The court reasoned that since collectively applying legal fees with other dischargeable debts does not “gut ' 329(b) for Chapter 7 cases, the structure of the Bankruptcy Code does not support treating ' 329 as an implicit exception to ' 727.” In so ruling, the court agreed with the Ninth Circuit's similar ruling in In re Biggar, 110 F.3d 685 (9th Cir.1997). The court here noted that nearly every bankruptcy judge and district court to have considered this issue has come to the same conclusion, that pre-petition debts for legal fees are subject to discharge under ' 727.