Seventh Circuit Holds Fees Due Under Pre-petition Agreement Subject to Discharge
By the Hon. Dennis R. Dow

In Bethea v. Robert J. Adams and Associates, 352 F.3d 1125 (7^th Cir. 2003), the Seventh Circuit has ruled that in a chapter 7 case a pre-petition agreement for payment of legal fees creates a debt subject to discharge like any other. The court rejected arguments that §329 evinces an intent to except such fees from the scope of the discharge and that public policy, including the need to facilitate the employment of counsel for chapter 7 debtors, mandated an exception for pre-petition fees.

Three different debtors had retained lawyers to file chapter 7 cases for them and entered into retainer agreements under which the agreed fee was to be paid in installments over time, some before the filing of the petitions, others after. The cases were filed and the debtors received their discharges. Post-closing, counsel sought to collect the balances due on the retainers. Proving the maxim that no good deed goes unpunished, the debtors then hired new lawyers and commenced adversary proceedings to hold their former counsel in contempt for violation of the discharge injunction. The bankruptcy court dismissed the complaints, holding that §329(b) of the Code implicitly carves out an exception to the scope of the discharge provided under §727 for attorney’s fees. The court reasoned that any other holding would render §329(b), which authorizes the court to assess the reasonable value of counsel’s fees, superfluous. The district court affirmed and the debtors appealed.

The Court of Appeals reversed, holding that §727 provides that all debts, except those specified in §523, are discharged and the latter section contains no provision for pre-petition counsel fees. The court further held that the retainer agreements each gave rise to a pre-petition claim for fees, the unpaid balance of which was discharged.
Responding to an argument that formed the basis of the holding below, the Seventh Circuit denied that finding the fees subject to discharge would render §329(b) without effect. If nothing else, the court said, it would still allow the court to examine the reasonableness of any fees paid to debtor’s counsel in the one-year period prior to the filing of the petition or during the proceeding and order any necessary disgorgement.

Defendants argued that subjecting fees due under pre-petition agreements to discharge would deprive debtors of lawyer representation. Lawyers, they contended, would be reluctant to take cases for some debtors if they could not collect fees after the conclusion of the case and many debtors would be unable to afford to pay the required fees in advance. The court responded to this public policy argument by stating that if the statute required an interpretation that had that effect, it was up to Congress, not the court to change it. In the realm of practical suggestions, the court noted that debtors could represent themselves or pay a small retainer to counsel for pre-petition work, with counsel seeking the balance from the estate after filing.

A compromise position, adopted by the Ninth Circuit in In re Hines, 147 F.3d 1185 (9th Cir. 1998), had been considered (but rejected) by the bankruptcy court under which the retainer is parsed, with only that part attributable to pre-petition work being subject to discharge. Interestingly, although the plaintiffs would have found that result acceptable, the court held it could not sanction that approach. The court viewed that position as being inconsistent both with the Bankruptcy Code and the terms of the retainer agreements entered into in the cases. The court in Hines viewed the retainer agreement as giving rise to multiple claims, each one arising only as the services were performed. The Bethea court, however, held that any claim for compensation arises out of the one contract creating a right to payment arising pre-petition and thus subject to discharge.

When considered in conjunction with the Supreme Court’s holding in January 2004 in Lamie v. United States Trustee that debtor’s counsel may not be compensated from the estate in chapter 7 cases unless hired by the trustee, the holding in Bethea, decided one month earlier, proposes some interesting challenges for debtor’s counsel. One of the suggestions offered by the Seventh Circuit, that counsel take a small retainer pre-petition and apply for the balance of the fee as an administrative expense, obviously no longer works. Other suggestions have been offered, including using an agreement that provides for a retainer for pre-petition services with an agreement to pay hourly rates for post-petition work or a fixed-fee retainer agreement that the debtor would reaffirm post-petition. Consumer Bankruptcy News, Vol. 14, No. 3, p. 4. The latter approach has obvious shortcomings. The former may or may not pass muster in a court adhering to the Bethea holding. One likely outcome of the decision is that bankruptcy courts will see more cases in which debtors have opted for another of the court’s offered solutions to the problem created by its holding – representing themselves.

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