As noted in a recent article in this column, in the case of Lamie v. U.S. Trustee, ___ U.S. ___ 124 S.Ct. 1023 (2004),² the U.S. Supreme Court held that a chapter 7 debtor's attorney who was not employed by the chapter 7 estate under 11 U.S.C. §327³ cannot be paid by the estate, stating:

Adhering to conventional doctrines of statutory interpretation, we hold that §330(a)(1) does not authorize compensation awards to debtors' attorneys from estate funds, unless they are employed as authorized by §327. If the attorney is to be paid from estate funds under §330(a)(1) in a chapter 7 case, he must be employed by the trustee and approved by the court.

An interesting question not directly or clearly answered in Lamie was whether this decision requires a debtor's chapter 13 counsel to be hired under 11 U.S.C. §327(a) in order to be paid in a debtor's chapter 13 estate.

The Problems Facing the Chapter 13 Debtor's Attorney

The initial issue facing a debtor's chapter 13 debtor's attorneys is whether they need to be retained as counsel for the debtor chapter 13 estate under 11 U.S.C. §327. Although by its terms 11 U.S.C. §327 does not apply to the retention of professionals in chapter 13 cases,⁴ this issue arose in the recent case of In re Gutierrez, 309 B.R. 488 (Bankr. W.D. Tex. 2004), when a chapter 13 trustee used 11 U.S.C. §327 to attack a pre-petition claim of a chapter 13 debtor's attorney.

The second question arising about chapter 13 debtor's attorneys is this: Even if 11 U.S.C. §327 does not directly require them to be retained under its provisions, must a chapter 13 debtor's counsel be still retained under 11 U.S.C. §327 in order to be paid from a chapter 13 debtor's estate? That issue was recently addressed in the case of In re Moore, ___ B.R. ___ 2004 WL 1801192 (Bankr. N.D. Ala. 2004).

In re Gutierrez: 11 U.S.C. §327 Means What It Says

Chapter 13 debtor's counsels do not need to be retained under 11 U.S.C. §327. The Gutierrez decision arises in a rather unusual context. In 2001, the debtor filed a chapter 13 (original 13) that was ultimately dismissed. At the time of the dismissal, the debtor's counsel was owed $1,195 by the debtor in unpaid fees for the original chapter 13. In June 2003, the debtor, with the same attorney, filed a new chapter 13 (new 13). One of the claims in the new 13 was an unsecured nonpriority claim of the chapter 13 debtor's attorney for his unpaid $1,195 in fees from the original 13.

After the case was filed, the chapter 13 trustee in Gutierrez objected to the unsecured claim of the chapter 13 debtor's attorney, arguing that (1) the claim should be disallowed as the chapter 13 debtor's attorney received a reasonable fee in the original 13,⁵ (2) the claim should be disallowed because the chapter 13 debtor's attorney could not have been retained under 11 U.S.C. §327 because that attorney held a pre-petition claim against the debtor and was therefore not a disinterested person,⁶ and (3) the debtor's chapter 13 attorney had an actual conflict of interest with the debtor by virtue of a pre-petition claim under applicable state law.

The Gutierrez court, after finding that the fees from the original 13 were reasonable, rejected the chapter 13 trustee's other two arguments. The court held that 11 U.S.C. §327 does not apply to the retention of chapter 13 debtor's attorneys either by its terms or as a condition for payment of professional fees from the chapter 13 estate, stating:

The rules change, however, in chapters 12 and 13. Under those chapters, the debtor's lawyer, even though clearly not retained by "the trustee" (and so clearly not bound by §327(a)), nonetheless gets paid out of property of the estate. See 11 U.S.C. §330(a)(4)(B); see, also, 11 U.S.C. §1307 (property of the estate in chapter 13 includes the debtor's post-petition earnings). The trustee suggests that the debtor's attorney in a chapter 13 case should be subject to the same standard of disinterestedness in the interest of preserving the integrity of the process and to avoid unseemly conflicts. The court declines the invitation to extend the reach of §327(a) beyond its plain language. Congress was no doubt aware of the anomaly of paying the debtor's attorney with property of the estate, yet not binding that attorney by the strictures of §327(a). The unique language of §330(a)(4)(B) confirms that much. Finding no ambiguity in the statute to justify judicial intervention, the court declines to invent a limitation not present in the statute itself.

Finally, the court held that while 11 U.S.C. §327 did not govern whether an attorney could be employed as a chapter 13 debtor's attorney, traditional state court ethical standards did govern the ability of an attorney to represent a chapter 13 debtor where the attorney had a pre-petition claim against the debtor.⁸

The Gutierrez court, reviewing this issue under the applicable Texas Disciplinary Rules of Professional Conduct, held that there were no conflicts of interest in a chapter 13 attorney being owed pre-petition fees by a chapter 13 debtor that prohibited the counsel's representation of the chapter 13 debtor, absent unusual circumstances. The court also found that to the extent a technical conflict could be found to exist, it could be waived by the debtor after full disclosure.⁹ The court found there was no conflict in this case and overruled the trustee's objection.

In re Moore: Lamie Means What It Says

Estate professionals cannot be paid from estate funds unless retained under 11 U.S.C. §327. While Gutierrez forcefully states that a chapter 13 debtor's attorney need not comply with 11 U.S.C. §327 in order to represent a chapter 13 debtor and be paid their professional fees, this analysis of the applicable law is not universally followed as noted by the holding in In re Moore, ___B.R.___ 2004 WL 1801192 (Bankr. N.D. Ala. July 29, 2004).

Like Gutierrez, the facts of Moore are somewhat unusual. In 1994, the debtor filed suit against Indies House Inc. and Southern Housing Inc. (defendants) for damages related to the purchase of a mobile home. The debtor employed counsel in this state court action to prosecute the suit. The state court counsel was also never retained as a professional under 11 U.S.C. §327 in the debtor's chapter 13 case and apparently had no knowledge of the debtor's chapter 13 filing. In 1996, the debtor filed a chapter 13 petition but did not list the state court action as an asset. The debtor won its case at trial, but the defendant appealed¹⁰ and ultimately lost in the Alabama Supreme Court in 2000. On Oct. 31, 2001, the debtor made his final payment under his chapter 13 plan to the trustee. On Nov. 14, 2001, the state court counsel negotiated a settlement of the state court lawsuit for $25,000 and received that sum from the defendants. The state court counsel retained $10,000 as his professional fee and paid the remaining $15,000 to the debtor.

On Oct. 16, 2002, after not making payments to the chapter 13 trustee for nearly a year, the debtor's chapter 13 was converted to a chapter 7. The chapter 7 trustee then filed suit against the state court counsel to recover the $25,000 payment.¹¹ As part of this action, the state court counsel attempted to retain the $10,000 in legal fees he was owed by the debtor.

The Moore court, relying heavily on Lamie, held that the state court counsel had no right to be compensated from the debtor's bankruptcy estate, stating:

Under 11 U.S.C. §327(a), "the trustee, with the court's approval, may employ one or more attorneys...or other professional persons that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee's duties under this title." With respect to attorneys hired by a debtor, the Supreme Court recently held that "the statute authorizes an award of compensation to one of three types of persons: trustees, examiners and §327 professional persons. A debtor's attorney not engaged as provided by §327 is simply not included within the class of persons eligible for compensation." Lamie v. U.S. Trustee, __U.S.__, 124 S.Ct. 1023, 1030, 157 L.Ed.2d 1024 (2004).

Additionally, this court has held that "the Code sets out specific rules for professionals to comply with in order to be compensated. Absent compliance with the Code and rules, an attorney has no 'absolute right' to an award of compensation." In re Federal Roofing Co. Inc., 205 B.R. 638, 644 (Bankr. N.D. Ala. 1996) (citation omitted). Thus, from the plain language of the statute and from the cases interpreting the applicability of that statute, only those attorneys who are employed pursuant to §327 may receive compensation from the estate.

In this case, the defendant received $25,000 from Southern Housing, which was property of the estate. The defendant retained $10,000 as compensation and gave the remainder to the debtor. This was an improper disposal of property of the estate, paying an unapproved attorney. "In the absence of compliance with the Code and rules, the court believes that where fees have been paid to an unapproved attorney, the return of the compensation is the most appropriate remedy." In re Federal Roofing Co. Inc., 205 B.R. 638, 644 (Bankr. N.D. Ala. 1996). Therefore, the court finds that the defendant received improper compensation from the estate, being an unapproved attorney, and that the amount of $10,000 must be returned to the estate."¹²

This decision, although made in a very unusual context, seems to require that the state court counsel had to be retained under 11 U.S.C. §327 in order to be paid from a chapter 13 estate. This decision stands in stark contrast to the Gutierrez decision. While Moore can possibly be distinguished from the typical chapter 13 case, as the turnover action was brought after the case was converted to a chapter 7 proceeding, such a distinction ignores the fact that the only time the state court counsel could have been retained was during the chapter 13, as he had completed his representation of the debtor nearly a year before the case converted.

And the Answer Is?

From the statements made by the Supreme Court in Lamie to the effect that 11 U.S.C. §330 does not greatly impact chapter 13 practice,¹³ along with the wording of §§327 and 330(a)(4)(B), it appears that the holding of Gutierrez is correct and that chapter 13 debtor's counsels do not need to apply for retention under §327 in order to be paid from the chapter 13 estate or comply with its provisions in order to be hired. However, in light of the extremely poor wording of §330 and decisions such as Moore, chapter 13 debtor's attorneys should carefully review this issue and take steps through their local courts to clarify this issue, as it does not appear litigation over this question will end in the foreseeable future.

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Footnotes

¹ Board Certified in Business Bankruptcy Law by the American Board of Certification. Return to article

² Bowles, "Watching Sausage Being Made—The Supreme Court, Not the FDA: Lamie v. U.S. Trustee," 23 ABI Journal 30 (May 2004). Return to article

³ ____ U.S. ____, 124 S.Ct. 1023, 1032 (2004). Return to article

⁴ 11 U.S.C. §327 provides:

(a) Except as otherwise provided in this section, the trustee, with the court's approval, may employ one or more attorneys, accountants, appraisers, auctioneers or other professional persons that do not hold or represent an interest adverse to the estate and that are disinterested persons to represent or assist the trustee in carrying out the trustee's duties under this title.
(b) If the trustee is authorized to operate the business of the debtor under §721, §1202 or §1108 of this title, and if the debtor has regularly employed attorneys, accountants or other professional persons on salary, the trustee may retain or replace such professional persons if necessary in the operation of such business.
(c) In a case under chapter 7, 12 or 11 of this title, a person is not disqualified for employment under this section solely because of such person's employment by or representation of a creditor, unless there is objection by another creditor or the U.S. Trustee, in which case the court shall disapprove such employment if there is an actual conflict of interests.
(d) The court may authorize the trustee to act as attorney or accountant for the estate if such authorization is in the best interest of the estate.
(e) The trustee, with the court's approval, may employ, for a specified, special purpose, other than to represent the trustee in conducting the case, an attorney that has represented the debtor, if in the best interest of the estate and if such 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.
(f) The trustee may not employ a person that has served as an examiner in the case. Return to article

⁵ The court overruled this ground, finding that the fees charged in the original 13 were reasonable under 11 U.S.C. §502(b)(4). Return to article

⁶ 11 U.S.C. §101(14) states:

(14) "disinterested person" means a person that—

(A) is not a creditor, an equity security holder, or an insider;
(B) is not and was not an investment banker for any outstanding security of the debtor;
(C) has not been, within three years before the date of the filing of the petition, an investment banker for a security of the debtor, or an attorney for such an investment banker in connection with the offer, sale, or issuance of a security of the debtor;
(D) 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 or of an investment banker specified in subparagraph (B) or (C) of this paragraph; and
(E) 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 an investment banker specified in subparagraph (B) or (C) of this paragraph, or for any other reason.... Return to article

⁷ 309 B.R. at 500-501; see, also, In re Busetta-Silvia, 300 B.R. 543, 549-550 (Bankr. D. N.M. 2003). Return to article

⁸ 309 B.R. at 496-97. Return to article

⁹ Id. at 498-99. Return to article

¹⁰ Not surprisingly, one of the grounds for the defendant's appeal was that the debtor was judicially estopped from prosecuting the lawsuit due to his failure to schedule the lawsuit. This defense was ultimately rejected by the Alabama Supreme Court. 2004 WL 1801192, *1. Return to article

¹¹ The Moore court quickly ruled that the $25,000 was property of the estate, the state court counsel was liable for turnover of the $25,000 and the chapter 7 trustee could pursue the action. This left the state court counsel's legal fees as the final issue in Moore. Return to article

¹² 2004 WL 1801192 at *6. Return to article

¹³ "Compensation for debtor's attorneys in chapter 12 and 13 bankruptcies for example, is not much disturbed by §330 as a whole. See, e.g., 11 U.S.C. §330(a)(4)(B) ('In a chapter 12 or chapter 13 case in which the debtor is an individual, the court may allow reasonable compensation to the debtor's attorney.')...." 124 S.Ct. at 1031. Return to article