INADEQUATE COMPENSATION OF
DEBTORS' ATTORNEYS
IS IMPAIRING THE CHAPTER 13 SYSTEM

Morgan D. King, Esq.

NACTT Quarterly - National Association of Chapter 13 Trustees
Vol. 8, No. 4, July 1996)

There is a certain natural tension between debtors' attorneys and chapter 13 trustees, and it sometimes seems the attorney is viewed with suspicion, perhaps even as an obstacle to the smooth running of the machine instead of as a vital leg in the debt adjustment system. There should be no doubt, however, that debtors' lawyers in chapter 13 play a crucial part in the system, and that without quality representation by lawyers the system would, quite simply, fail.

When the system operates as intended the result provides debt recovery for creditors on the one hand, and debt relief to consumers on the other. This happens when each entity in the system (judge, trustee and private attorney) understands and appreciates the objectives and roles, as well as the duties and burdens of the others, resulting in a unity of professional goals.

A dialogue in which information, problems and solutions may be shared among the professionals in the system facilitates this unity of goals. In this spirit the remarks that follow are intended to apprise chapter 13 trustees of some of the concerns of private attorneys who practice in the chapter 13 system.

There is evidence that recent budget cutbacks for funding the chapter 13 offices is beginning to impair the trustees' ability to provide the level of services necessary to make their leg of the system function as well as it should. Accordingly, chapter 13 trustees may be so preoccupied with their own problems that they are not noticing problems developing in another leg ... the debtors' bar. However, these problems bear directly on the success or failure of the trustees' endeavors.

 

DEBTORS' LAWYERS OPERATE ON A SHOESTRING

Public policy is that debtors' lawyers are entitled to earn the same level of compensation as lawyers practicing in other, comparable areas of consumer law.

However, despite this explicit public policy, the evidence is clear that this is not happening, and in fact too many consumer debtor attorneys are not being adequately compensated for their services. This evidence comes from anecdotal information, studies, surveys and reported cases. The documentation is too abundant to cite at length in this article.

Problems with compensation are not uniformly felt in all jurisdictions, and there are some jurisdictions which satisfaction with compensation. However, the evidence indicates that the problem is widespread throughout the country, and in some areas is quite critical.

 

CONSEQUENCES TO THE SYSTEM

Consumer debtor attorneys are not being adequately compensated. The consequences of this go far beyond the mere pecuniary interest of lawyers in private practice, and in fact impact on the rights of debtors to quality legal representation, impair the recovery of debt by creditors, and interfere with the smooth administration of the chapter 13 system. Accordingly, the financial health of consumer bankruptcy lawyers should be deemed an important concern not only of the private bar but of the trustees and courts charged with oversight of the system.

Some of the negative consequences of inadequate compensation of debtors' attorneys are discussed below.

 

Channeling debtors away from chapter 13

Public policy encourages chapter 13 as the preferred bankruptcy remedy, and in fact chapter 13 filings have increased slightly in recent years.

However, the numbers of chapter 13 filings may be substantially below their potential because a great many lawyers appear to be channeling their clients away from chapter 13 and into chapter 7 instead. The reason is that many private attorneys believe they cannot be adequately compensated for their services in chapter 13. "Chapter 7 cases present less obstacles for consumer bankruptcy practitioners to set and receive their fees."

The evidence of this channeling is appearing from numerous sources. For example, the New Mexico law firm of Behles-Giddens conducted a survey of compensation issues in 1995. This survey was presented as a report by Jennie Behles, Esq. to the ABI Symposium on Professional Compensation in Montana. Among its findings was that 32% of the responding lawyers believe that fee caps in chapter 13 cases cause lawyers to steer their clients into chapter 7, instead. This evidence has been corroborated by the recent survey of debtor attorneys conducted by the National Association of Consumer Bankruptcy Attorneys (NACBA, 1996) in 1996. It is further supported by anecdotal evidence coming into the NACBA Committee on Compensation from across the country; for example, one report disclosed that two high-volume firms in Chicago, Illinois recently filed approximately 700 bankruptcy cases in one month; of these, only one was a chapter 13. The reason given for this was that the firms involved believe they cannot be adequately compensated representing debtors in chapter 13 cases.

There are a few areas where the opposite is happening; that is, some lawyers channel their clients away from chapter 7 and into chapter 13 because of artificial fee caps imposed by local rules pertaining to compensation in chapter 7. However, the extent of this channeling is apparently substantially less than the channeling away from chapter 13.

In either event, it must be viewed as wholly unsatisfactory from a public policy standpoint that debtors are being funneled into either chapter 7 or chapter 13 not because of the merits of their respective financial affairs, but rather because of economic pressures on their attorneys respecting compensation for legal services.

Across the board, the most serious problem is lawyers steering their clients away from chapter 13. This must be a concern to creditors, in particular. It should be noted that leaders in the creditor side of the system commenting at the 1995 ABI National Symposium on Professional Compensation in Montana made it clear they view reorganization as a plus for the credit industry, and remarked favorably on the clear relationship between professional compensation and the quality of lawyering on the one hand, and the success of reorganization efforts on the other.

 

Impairment of quality of legal representation

It may be assumed as a given that only an adequately compensated lawyer is able to provide excellent legal services.

The problem is that quality lawyering is expensive, and the reason it is expensive is because of the kinds of resources that are necessary to support the lawyer doing bankruptcy work. A law firm that undertakes to represent debtors in chapter 13 requires a well-trained, highly motivated and well-compensated staff, usually including paralegals; expensive legal research resources, and a high level of investment in law office technology such as computers, photocopy equipment, etc.

The hidden costs of bankruptcy practice must also be considered. These include high phone-answering requirements, enormous demands on paper supplies, unusually high wear and tear on photocopy equipment, higher than average malpractice insurance premiums, and a higher than average investment in advertising. In fact, many lawyers have concluded that the overhead costs of handling consumer bankruptcy cases are considerably higher than for most other areas of consumer law.

When a lawyer is unable to obtain timely and adequate compensation for his work, the quality of the work suffers. A large number of lawyers responding to the NACBA 1996 survey indicated that problems with compensation impair their ability to deliver quality legal services, and the 1995 Behles-Giddens survey revealed that 54% of attorneys believe that fee caps result in a decrease in the quality of legal services provided for the debtor. This is corroborated by the NACBA 1996 survey, which found that 40% of responding lawyers believe that problems with compensation impair their ability to deliver quality legal services. And, a startling fact is that the malpractice rate among bankruptcy lawyers is the third highest of all fields of consumer law, indicating a problem with the quality of legal services being provided in the field of consumer bankruptcy law.

 

Inability to provide post-petition counseling or services

Across the nation only 32.89% of filed chapter 13 cases are successfully completed. Why so many fail to complete their plans is a subject of concern that has caught the attention of the National Bankruptcy Review Commission. To date, there appears to have been few, if any, empirical studies attempting to identify the causes of the high failure rate.

Intuitively, however, we may presume that one reason is the debtor's need for postpetition financial and budget counseling.

Debtor's attorneys could do more to meet this need. However, without adequate financial resources, they are unable to do so. In the present financial shoestring environment, the typical debtor's lawyer reaches his limit of ability to provide services the moment the plan is confirmed.

 

Encouraging "form-filers" operating on high volume

Because the profit margin is so thin on each case (and this presumes there is any profit at all in handling chapter 13 cases ... a dubious presumption) the economic pressure on chapter 13 practitioners is to do a high-volume business which minimizes the level of professional resources that may be devoted to each case. In other words, in order to make a profit any individual representing debtors in chapter 13 is virtually forced to take as many cases as possible and keep the level of professional services invested in each case to an absolute minimum. The result is that each individual case is given a superficial level of lawyering, at best.

This is contrary to the tradition of quality in delivery of legal services that is expected in this country. The message that one receives in one's legal education is to give each case one's best; the message given by the chapter 13 system is just the opposite ... to give each case one's least.

This pressure toward high-volume, cheap lawyering has two unfortunate consequences.

First, it discourages quality lawyers from representing debtors in chapter 13, and impairs the ability of those quality lawyers who do stay in the system to provide quality services in each case.

Second, it encourages an unprofessional culture which fosters high-volume "form-filer" entities to spring up and exploit the market. Thus, in some areas there are lawyers who file massive quantities of cases without adequate attention to each case. And worse, in many areas so-called independent paralegals and other legal service schemes spring up which generate massive volumes of cases using aggressive advertising methods. These entities typically provide virtually no legal services at all, and in too many cases damage the debtor's right to a fair chance at debt adjustment through chapter 13, while disrupting the orderly processing of cases through the trustee's offices and the courts. The empirical evidence is clear that in all too many cases such entities routinely fail to provide competent services to the debtor.

 

WHAT TRUSTEES CAN DO

If we accept the premise that adequate compensation for doing chapter 13 work improves the quality of lawyering on behalf of the debtor, then it would seem that more chapter 13 cases will succeed, and more money will be recovered by creditors. And, of course, more debtors will receive the quality of representation to which they are entitled under the law.

Accordingly, it seems fitting that chapter 13 trustees should be sympathetic to the needs of the debtors' bar for timely and adequate compensation. Although there are limitations to what chapter 13 trustees can do to help improve the situation, some suggestions are made here.

 

1. Treat fees as priority administrative expenses - pay off first

One of the causes of inadequate compensation is the delay in payment of fees built into the typical chapter 13 plan. The delay costs the lawyer in terms of risk of loss, and in loss of value of money over time. The risk of loss arises to some extent from dismissal or conversion of cases in which substantial portions of the attorney's fees remain to be paid. Collection of such fees following a dismissal or conversion is typically not feasible.

As a consequence, many lawyers report that they collect much less of their billable time in chapter 13 than in any other kind of work, and Judge Keith Lundin in 1992 testified before the Senate Judiciary Committee's Courts and Administrative Practices subcommittee that attorneys in his district typically collect only 62% of awarded fees.

Jennie Behles, in her report to the ABI Symposium in Montana remarked:

[A] factor that has not been considered in setting these fees is collectability. Collectability is a real problem in consumer cases. If you think that $1,500 is a reasonable fee, that's fine. But what this survey shows is that out of that $1,500 somebody's probably collecting a thousand. That has an effect on keeping good attorneys in the system.

Trustees can help ameliorate this problem by, among other things, developing payment formulas that expedite and shorten the time required to pay off the balance of the attorney's fees in the plan.

Another helpful policy is to send refund checks for dismissed cases to the attorney, and encourage the attorney to seek priority administrative expense status for his fees. This was suggested by Hon. Keith Lundin in his treatise on handling chapter 13 cases. If the fee is declared an administrative expense pursuant to 11 U.S.C. § 503(a), then if the case is dismissed the trustee must deduct these fees from any refund check due to the debtor and send the fees directly to counsel pursuant to § 1326.

 

2. Oppose fee guidelines and fee caps that limit recovery of fees.

Jennie Behles reported to the ABI at the 1995 Symposium that her firm's survey indicated "... we found out from the survey that effective lawyering increases distribution to creditors. So, we need to make sure that any guidelines that we use in these cases don't get good lawyers out of the system." And, a substantial number of responses from the 1996 NACBA survey revealed that many consumer lawyers are convinced that unfair fee guidelines have discouraged them from handling chapter 13 cases, and the 1991 ABI National Report On Professional Compensation discovered evidence that inadequate compensation was causing lawyers to decline bankruptcy work or leave the system entirely.

Other evidence generated by these and other reports and studies indicates that such guidelines are actually unnecessary, and that across the board ordinary market mechanisms, such as competition, market rates, advertising and state bar ethical guidelines are just as effective at keeping fees within reasonable boundaries. Furthermore, such guidelines may indirectly violate the Lodestar formula, which is the formula adopted by majority rule in the bankruptcy courts for awarding compensation based on reasonable hourly rates and the actual amount of time reasonably necessary to handle the case.

Accordingly, trustees can help improve compensation of debtors' attorneys by opposing restrictive fee caps on prepetition retainer fees and on total amounts of fees being paid through the plan.

 

3. Support efforts to provide for interest on deferred fees.

The almost universal practice among nonbankruptcy attorneys is to charge interest for delayed payment of compensation. And, it is not uncommon in chapter 11 cases for debtor's counsel to receive a Lodestar enhancement to compensate for the loss of the value of such compensation due to deferred payment.

Delays in payment of the fees provided for in the plan cause a substantial loss of the value of the money eventually received by the attorney. But typically attorneys fees scheduled for payment through the plan are not coupled with interest to compensate for this delay.

It may of course be argued that general unsecured creditors are not entitled to interest, so why should the debtors' lawyers be entitled to it? But this misses the point ... if public policy is to assure that debtors' attorneys are paid commensurate with their nonbankruptcy colleagues doing comparable work, then as a matter of public policy they are entitled to interest on their deferred compensation.

One of the recommendations of the 1991 ABI Report on Professional Compensation is that;

The Bankruptcy Code should be amended to expressly provide that reasonable compensation for delay in payment may be awarded to trustees and professionals where the court finds, after notice and hearing, that the delay and amount of compensation involved are material. The survey reveals that the courts are expeditiously hearing and ruling on fee applications, but that delays engendered by lack of available estate funds and other causes not the fault of the professional are common.

 

4. Encourage simplified fee application procedures.

Another significant cause of inadequacy of compensation in chapter 13 is the time and effort necessary to apply for additional fees when additional services are required. In fact, a substantial number of consumer bankruptcy attorneys indicate that they simply cannot invest the time and resources necessary to make fee applications. In other words, it costs more in the value of time than the lawyers can recover by making the effort.

This problem was identified at the 1995 Symposium on Compensation, and has been documented by the 1996 NACBA Survey on Compensation.

The problem of unnecessarily burdensome fee application requirements has been identified by some courts. For example, the court in In re Zwern, a chapter 13 case out of Colorado, discussed the tension arising out of the "... economics and difficulties of the fee allowance process for a chapter 13 practitioner." Said the court;

Regrettably, this tension is exacerbated by Congress' mixed message in the Bankruptcy Code. Congress encourages Chapter 13 filings but fails to relieve chapter 13 practitioners of the administrative burden associated with fee allowance under § 330. However, in the absence of further amendments in the Bankruptcy Code, both counsel and this Court are left with their respective obligations.

Any efforts that trustees can make to simplify the fee application process may be a substantial help in solving this problem.

 

5. Encourage efforts to reduce the need for a lawyer's participation in non-legal aspects of the system.

For example, the vast majority of motions for relief from stay are merely questions of money ... did the debtor pay his postpetition mortgage payments, or not? If not, how much time does he or she need to catch up? There is utterly no need at all for a lawyer to invest time or resources in representing the debtor in those cases ... there are no legal questions involved, and the level of "negotiation" that may be required in such cases can typically be done quite efficiently between the debtor and the creditor.

Yet too often the lawyer is expected to invest substantial time and resources in sorting out these problems and attending court hearings ... doing essentially nothing more than financial baby-sitting ... and all too often not being compensated for his time and effort. Does this really need to be happening?

 

6. Be more sensitive to the costs of comparable services standard.

Congressional intent is clear that bankruptcy attorneys should be paid on a level commensurate with their nonbankruptcy colleagues performing comparable legal services. This standard has been incorporated into the standards of review provided for in 11 U.S.C. § 330(a)(3)(E).

Yet how many trustees are familiar with market rates and billing practices outside the field of bankruptcy? If the level of knowledge among trustees is comparable to that of bankruptcy judges, it is pretty dismal; the 1991 ABI Report on Compensation found that a large number of judges have no knowledge whatever of nonbankruptcy compensation, and the majority have only a smattering of familiarity.

Trustees should encourage local lawyers to provide evidence of nonbankruptcy billing rates and billing practices in order to facilitate fair and realistic appraisals of their compensation and billing needs.

 

CONCLUSION

A fundamental problem with chapter 13 from the lawyer's point of view is the split personality of the system ... because of its relatively recent statutory origins it is in some respects akin to a governmental or bureaucratic public service, and yet at the same time is set up to function like a traditional legal remedy with judges, an adversary system, and official published legal opinions.

Thus, on the one hand the system would like to shuffle the public through a quick clerical process designed to conform all cases to a predetermined profile, minimizing the distinctive features of each debtor's situation; on the other hand, it invites lawyers to step in and represent a debtor in the traditional manner of lawyering ... that is, to assure that the debtor is not run over by the system ... in fact to assure that the distinctive features of his or her client's situation are emphasized, not minimized, and that decisions are not made in a cookie-cutter fashion, but just the opposite ... are made in an adversary manner designed to advance the interests of the individual client. The system is motivated to force the debtor to bend to the needs of the system; but on the contrary, the lawyer's duty is to force the system to bend to the client's needs.

This split personalty may be seen by looking at whose compensation is actually at risk in the chapter 13 process. When a case requires attention, the courts and the trustees and their respective employees get paid the same, regardless of whether that attention is actually given. When a chapter 13 case fails, the judge and the trustees and their respective employees still get paid and still collect their benefits ... it is only the debtor's lawyer who loses a portion of his compensation. And this risk of loss by the debtor's lawyer is accepted by the system as altogether fitting and appropriate (not, however, by the debtor's lawyer).

This split personality creates an environment in which the lawyer is felt to be almost more of an impediment than a necessary and esteemed part of the system. And this, in turn, creates a culture in which the lawyer's expectations of being paid adequately for his services are deemed unseemly, unnecessary, even unethical. A lawyer who actually presumes to be properly compensated all too often is forced to "rock the boat," and before long is viewed in a manner akin to the leper at the courthouse.

Lawyers representing debtors in chapter 13 do not like the feeling of being treated like lepers when it comes to being compensated. But far more serious than the lawyer's mere feelings is the effect of inadequate compensation on the system itself. The system will never achieve its full potential, as originally envisioned, until the debtors' bar is able to perform its proper function in a tradition of excellence in the delivery of legal services. And this can only happen with appropriate reform in the philosophy, culture and procedure of compensation of debtors' lawyers.


© Morgan D. King 1996