The Prohibition on Fee Sharing Words of Caution to Professionals

The Prohibition on Fee Sharing Words of Caution to Professionals

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Your practice as a financial professional is booming to the extent that you can no longer keep your head above water. You've been retained by the bankruptcy court in four different matters—each of which will require extensive attention over the next few months. You worry because you and your staff cannot possibly devote sufficient time to properly handle each matter. Meanwhile, your friend, a financial professional at another firm in town, is experiencing a lull in his practice. You know he's highly competent and trustworthy. You consider contracting to him some of the work that you know you can't properly staff. Seems like a great idea—everybody wins. Your clients' matters get the attention they require. You and your staff avoid working to the point of exhaustion. Your friend generates some much needed revenue.

Alternatively, another colleague in town has asked if he could work for you part-time rather than full-time so that he can spend more time with his family and improve the quality of his life outside the office. He is highly skilled and would like remuneration based on hours worked or billings collected. Your workload varies greatly. One month, you barely have enough work to keep yourself busy, yet the next month you are scrambling to attend to each of your matters. Accordingly, your neighbor's proposal seems appealing. You can increase your manpower capacity and your flexibility to take on new matters without adding fixed overhead to your organization. A perfect fit for both parties.

Don't act so fast. While §504 of the Bankruptcy Code was drafted to protect the integrity of the bankruptcy process and to ensure that adequate attention is paid to bankruptcy matters, the section strictly prohibits your "contracting out" of work and classifies that practice as unauthorized "fee sharing" that can result in the denial of your compensation. While the practicalities of today's service industry practice may call into question §504's strict prohibition of obtaining assistance on a contractual basis, professionals of all types must be cognizant of the dangers they face if they choose to staff matters in that manner.

There is no real guidance from the bankruptcy courts as to where the boundary between "employee" and "contract employee " lies.

Section 504 of the Bankruptcy Code provides:

504. Sharing of compensation.

(a) Except as provided in subsection (b) of this section, a person receiving compensation or reimbursement under §§503(b)(2) or 503(b)(4) of this title may not share or agree to share—

(1) any such compensation or reimbursement with another person; or

(2) any compensation or reimbursement received by another person under such sections.

(b)(1) A member, partner, or regular associate in a professional association, corporation, or partnership may share compensation or reimbursement received under §§503(b)(2) or 503(b)(4) of this title with another member, partner, or regular associate in such association, corporation, or partnership, and may share in any compensation or reimbursement received under such sections by another member, partner, or regular associate in such association, corporation, or partnership.

(2) An attorney for a creditor that files a petition under §303 of this title may share compensation and reimbursement received under §503(b)(4) of this title with any other attorney contributing to the services rendered or expenses incurred by such creditor's attorney.

Essentially, §504 prohibits all fee sharing with individuals from outside a professional's firm. The section seeks to extend to all professional persons who seek compensation in bankruptcy cases the general ethical duty of loyalty that lawyers are subject to under various ethical rules. See, e.g., Model Code of Professional Responsibility Rule 1.5(e)(1983); Model Code of Professional Responsibility DR 2-107 (1980). One treatise notes that "the legislative history of §504 is sparse" and that "[t]he section illustrates a Congressional intent to preserve the integrity of the bankruptcy process so that professionals engaged in bankruptcy cases attend to their duty as officers of the bankruptcy court, rather than treat their interest in bankruptcy cases as ‘matters of traffic.'" 4 Collier on Bankruptcy, ¶504.02[1] at p. 504-4 (Lawrence P. King ed. 1997). Accordingly, to prevent professionals from, in effect, buying and selling matters, §504 strictly prohibits fee sharing in all but a few limited situations concerning involuntary bankruptcy cases.

Thus, the proposed use of a contract professional to help you adequately staff your temporary abundance of work would violate the strict language of the statute. Similarly, a debtor's attorney is prohibited from "contracting out" work to attorneys who are not associated with the attorney's firm. Rather, a court may hold that payments made to those contract attorneys not only violate §504's clear language but also constitute a sharing of compensation which violates the disclosure requirements of Rule 2016. Moreover, an attorney's sharing of compensation with a non-attorney also constitutes unauthorized "fee sharing" that is prohibited by §504. SeeIn re Knights Groceries Inc., 190 B.R. 966, 968 (Bankr. M.D. Fla. 1996).

Section 504's prohibition of fee sharing is strict and absolute. Unless and until Congress amends the section to provide specifically for the use of contract professionals, you and other professionals who have been retained by the bankruptcy court must consider the risk inherent in engaging in activities that potentially could be considered fee sharing.

There is no real guidance from the bankruptcy courts as to where the boundary between "employee" and "contract employee" lies. Accordingly, caution should be exercised. For instance, it remains to be determined whether the fee sharing analysis will differ if an employee is issued a 1099 rather than a W-2. Moreover, it is unclear whether the analysis will differ if a part-time employee is compensated on the basis of billings collected rather than on an hourly basis.

While no reported decisions exist regarding these issues, questions of this nature have been raised and fees have been objected to in numerous bankruptcy cases. The nature of today's economy promotes the utilization of contract employees of one sort or another by professional service firms, especially smaller firms. The conventional wisdom regarding conflicts of interest and professional fee issues, in general, suggests that disclosure often can mitigate potential problems. However, it is unlikely that disclosure alone will be sufficient to overcome many of the problems encountered by professionals attempting to conform their standard practices with the prohibitions contained in §504. Any solution to the problem will have to come from Congress. In the meantime, professionals utilizing contract employees should proceed with caution, consult counsel, adequately disclose all relationships and, at the time of retention, seek court approval of any relationship that could be considered in conflict with §504.


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Monday, September 1, 1997
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