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This Just In – Supreme Court to Provide Clarity on Whether Collection of Time-Barred Debts in Bankruptcy Violates the Fair Debt Collection Practices Act.

jabez-stoneWe all remember The Devil and Daniel Webster – the Devil comes to collect a seven year old debt (secured by Jabez Stone’s soul), only to be foiled by the great trial lawyer Daniel Webster – thanks to a skilled litigator, the old debt is forgiven!

But that isn’t the only example of years’ old debt becoming a real matter of contention.  Earlier today, the Supreme Court granted certiorari on an issue that (a) is pretty important in the world of consumer debt collection, and (b) makes some folks pretty darn furious. The issue is this:  if you file a proof of claim in a bankruptcy case, and you know such claim is barred by the applicable statute of limitations, are you committing a “misleading” or “unfair” practice under the Fair Debt Collection Practices Act (FDCPA)?  (Coverage of the case and copies of the briefs can be found here, on the SCOTUSBlog.)

Who does this?  There are lots of funds out there that purchase charged-off consumer debt.  Some of that debt is quite old.  John Oliver has spoken extensively about this industry on his show – here’s a link to the hilarious (or infuriating, it is actually both) episode where he bought, and forgave, $15 million in old, uncollectible medical debt.

Why do people do this?  Those old and cold claims can lead to a nice little recovery when the party owing the funds files a Chapter 13 case that pays creditors 5, or 10, or even a penny on the dollar.  In Chapter 13 cases, no one really has an incentive to scrub all the claims that are filed, and so a great many of these claims – completely invalid, mind you – slip by unnoticed and get a distribution.  If the charged-off debt is sold for pennies on the dollar – or fractions of a penny – the returns are spectacular, even though the old debt is in every way invalid.

How Can These Invalid Claims Get Paid?  It is because no one raises an objection to them during the bankruptcy case.  The Debtor doesn’t have any interest or incentive to scrub the claims – he or she is paying the same amount over the course of the Chapter 13 plan no matter how large or small the creditor pool is.  The Debtor doesn’t have the money to scrub the claims, or any incentive to do so.  The Chapter 13 trustee has no practical ability to scrub the claims – there are thousands, or tens of thousands, of Chapter 13s pending in every single bankruptcy court across this country – no Chapter 13 trustee has the time or ability to review each claim.  The other creditors won’t do it – why would a creditor owed, say, $2,000, scheduled to get a distribution of $100 in the case (over 3-5 years, to boot), spend a few thousand dollars reviewing each and every proof of claim field in the bankruptcy case (there are often a few dozen claims, or more)?  And without any party to note the time-barred claim to the Bankruptcy Court, the Bankruptcy Court never knows to disallow the claim.

So What will The Supreme Court Do?  The Supreme Court will decide if this practice is “misleading” or “unfair” as those terms are used in the FDCPA.  If the Supreme Court rules against the debt collectors, they will be liable for attorneys’ fees and additional damages for each invalid claim that is filed.  The practice will end in an instant, as now there would be penalties for seeking recovery of time-barred debt.  But if this practice does not violate the FDCPA, then the bankruptcy system will continue to be used to collect time-barred debt.  A great post going into the competing considerations in detail can be found here.

This is a tough one for The Bankruptcy Cave.  Legitimacy of the system requires that invalid claims receive no distribution.  Holders of valid claims should not be taxed due to an inability of any other party to practically review the claims.  On the other hand, an expired claim is subject to a defense – and it is not a creditor’s job to raise defenses to its own claims.  We think this will be a great ruling, either way.  Stay tuned!

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Improper Use of Contract Attorneys, Failure to Disclose Terms – This Case Has It All.

business concept/dropping coins

Estate professionals are under continued scrutiny. Unlike other professionals, getting paid is not simply a matter of sending a bill.  The bankruptcy court, appropriately so, closely oversees the amount and timing of payment of estate professional fees.  And proper disclosure under the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure (the “Bankruptcy Rules”) is critical for all estate professionals.

Recently, in In re Wilkerson, Case No. 14-00582, Docket Entry No. 127 (Bankr. D.D.C. Jun. 13, 2016), the Bankruptcy Court declined to award a significant portion of attorneys’ fees and expenses to counsel for a chapter 13 debtor due to counsel’s failure to disclose the work being done by a contract attorney under Bankruptcy Rule 2016(b).  This lack of disclosure infected other portions of counsel’s fee application as well.  The court bound counsel to his initial Rule 2016 statement wherein he designated the representation as a “flat fee” arrangement.  Thus, bankruptcy counsel was partially precluding from amending the representation to charge by the hour except with respect to one “extraordinary” matter, as a sanction for his failure to adequately disclose the use of the contract attorney, and failure to disclose a separate retainer agreement with the debtor.

Use Of A Contract Attorney Requires Additional Disclosures – And You May Be Limited To What You Pay The Contract Attorney, Without Upcharge.

Debtor’s counsel employed a contract attorney to assist with a bankruptcy appeal. Counsel hired the contract attorney at a rate of $65 per hour, but charged the estate $300 per hour for the work she completed.  The chapter 13 trustee objected to the fees for the contract attorney because (i) it constituted an impermissible fee sharing arrangement under 11 U.S.C. § 504(a); (ii) debtor’s counsel failed to disclose in its Bankruptcy Rule 2016 statement that the contract attorney would be representing the Debtor; and (iii) charging the estate $300 per hour for her work was impermissible “up-billing.”

The court rejected the first argument, finding that the contract attorney arrangement was not a fee sharing arrangement under Section 504(a) because debtor’s counsel was obligated to pay $65 per hour to the contract attorney regardless of whether he was able to recover such compensation from the bankruptcy court.

As to the second issue, the court ruled that debtor’s counsel violated Bankruptcy Rule 2016(b) by failing to disclose the contract attorney’s involvement. This rule does not require the disclosure of the use of a “regular associate” as defined by Bankruptcy Rule 9001(10); however, the court found that the contract attorney did not meet the definition of a “regular associate.”  While the court left open the possibility that a contract attorney could possibly be considered a regular associate of a firm under Bankruptcy Rule 9001(10), this contract attorney did not meet the definition because her employment with the firm was “sporadic” and “not on a regular basis,” despite that this attorney worked with debtor’s counsel “fairly often,” including in 4-5 cases over the past year.  Also, the contract attorney had her own single-shingle firm that the court considered her to be “regularly” involved with, and she only assisted debtor’s counsel from time to time.  As such, the failure to disclose the engagement of the contract attorney was a violation of Bankruptcy Rule 2016(b).  (We note that compliance with the US Trustee’s form fee application for large cases requires disclosure of hours by contract attorneys and staff attorneys, see pages 22 and 28 of this document, so you may as well disclose the existence of any contract attorneys or staff attorneys up front for that reason as well.)

As a corollary, the court limited the recovery of attorneys’ fees associated with the contract attorney’s work to the $65 per hour that she was actually compensated by debtor’s counsel. Counsel’s argument that $300 was the prevailing rate for her services was rejected.  The court found that such rationale would only hold if the contract attorney were an attorney within debtor’s counsel’s firm.  However, because counsel “dealt with her as an independent contractor, [and] incurred none of the expenses that would be associated with an attorney employed in his firm,” he ultimately “failed to carry his burden of proving that he incurred any meaningful extra cost beyond the $65 per hour” paid to the contract attorney.

Parties May Be Precluded From Changing A Representation From Flat Fee To Hourly Depending.

Lastly, the court in part held counsel to the flat fee arrangement disclosed in his initial Bankruptcy Rule 2016(b) statement, which designated the representation of the debtor as a “flat fee” arrangement. Counsel filed an amended Rule 2016 statement setting forth a changed agreement with the debtor to an hourly representation on the grounds that the work completed in the case far exceeded the original amount of work anticipated when the flat fee arrangement was first established, largely resulting from the appeal for which the contract attorney was engaged.

While generally a court may permit an attorney to amend its Rule 2016 statement to reflect a change in the agreement as to the payment of attorneys’ fees, the court stated that holding counsel to its original fee arrangement in this case would be an appropriate sanction for his failure to adequately disclose his compensation arrangement with the debtor. In particular, not only did counsel suffer from the failure of disclosures as set forth above, but he also failed to disclose a retainer arrangement with the debtor.  That said, the court did allow additional compensation for elements of the fee application relating to the appeal, as they derived from an “unsettled” area of law, and those fees could not have been reasonably anticipated in a typical chapter 13 representation.  (We note as well that under ASARCO, discussed in The Bankruptcy Cave at length here and here and here, counsel would also not be entitled to be paid for its fees in litigating all these fee issues – that is another strong incentive to get the disclosures right the first time!)

Conclusion.

The Bankruptcy Code and Bankruptcy Rules set forth myriad important requirements of which attorneys and parties-in-interest must be mindful when pursuing their rights in a bankruptcy court. This case is an important reminder for any estate professional to think very hard about anything unusual about the engagement, and how to tailor and expand the required disclosures up front, or promptly upon any change in circumstances, in order to avoid a loss of fees (and face).

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