The Power of Bifurcated Fees in Chapter 7 Bankruptcy

Debt relief should be accessible for consumers who need it

For many debtors, Chapter 7 bankruptcy has historically presented a Catch-22. They need the debt relief bankruptcy provides, but because of their financial situation, they can’t pay an attorney out of pocket, and the nature of bankruptcy makes payment plans tricky to set up. It sounds ridiculous, but it’s true: some people are too broke to afford bankruptcy.

Bankruptcy attorneys, judges, and trustees have been aware of this problem for many years, but solutions have been difficult to come by. However, a new development in the bankruptcy courts has the potential to reshape the entire system: bifurcated fee agreements.

Understanding the problem with fees in Chapter 7 bankruptcy

Bankruptcy, of course, is hardly the only area of law where fees are an issue for clients. However, in some other types of matters, attorneys can use contingency fees, payment plans, and additional “file now, pay later” agreements to provide legal representation to people who cannot pay up front. The unique problem with Chapter 7 bankruptcy is that once the bankruptcy is complete, debts are discharged (wiped out) – and in particular, if the client still owes money to their attorney, that debt is wiped out too.

Traditionally, this has meant that debtors must pay the entire attorney’s fee, usually between $1,500 and $2,500, up front, which is challenging for someone struggling with medical debt, credit card debt, or other overwhelming debts. The only other option would be representation on the honor system: any payments after the bankruptcy would be voluntary, and the attorney would have to explicitly advise their client “you aren’t legally obligated to pay me” before accepting those voluntary payments. Of course, most lawyers can’t afford to take that risk, so they have to ask for payment up front.

Faced with this challenge, some debtors file Chapter 7 bankruptcy petitions pro se, meaning they represent themselves. This is legal, but it creates practical issues because bankruptcy is a complex process, and non-lawyers are not well-equipped to correctly fill out all the paperwork and financial disclosures. Studies have shown that nearly a third of debtors who represent themselves have their bankruptcy petitions denied, whereas virtually all who hire an attorney have their petitions granted. Pro se debtors also use more of the courts’ time and slow down the system for everyone. While debtors should have the right to represent themselves if they so choose, it’s a huge problem when so many feel obligated to do so because they can’t afford to pay an attorney up front.

Another unfortunate consequence is that many debtors file for Chapter 13 bankruptcy even though Chapter 7 would be in their financial interest. Because Chapter 13 creates a repayment plan and it’s fairly easy to roll the attorney’s fee into that payment plan, it doesn’t have the same issues regarding up-front payment.

To be clear, Chapter 13 is a good option in some circumstances. Still, it shouldn’t be the default option for cash-strapped debtors just because they can’t afford to pay up front for Chapter 7 – particularly since attorney’s fees for Chapter 13 are ultimately higher than Chapter 7.

Bifurcated fees provide a way out of this problem

The whole point of bankruptcy is to provide debt relief for people in difficult financial situations, and it’s a truly perverse outcome that debtors have to pay for Chapter 7 up front. Bifurcated fee agreements provide an escape hatch from this problem. In a bifurcated engagement, the attorney and the client agree to split the attorney’s fee into pre-petition and post-petition portions. Only the pre-petition portion, which includes the fee to file the case with the bankruptcy court and other expenses, must be paid up front. The post-petition portion can be paid in installments after the bankruptcy is filed.

The bifurcating model aims to make the process as financially feasible for the debtor as possible. Therefore, only expenses that must be paid up front are billed up front. The remainder of the attorney’s fee is only charged after the bankruptcy is filed and the debtor is under the protection of the automatic stay, which means their creditors must stop calling, and any garnishment, repossession, eviction, or foreclosure proceedings are halted.

Disclosure and informed consent are critical in bifurcated fee agreements

The practice of fee bifurcation is not without controversy, especially from well-meaning detractors who argue that the post-petition payment plan undermines the whole purpose of bankruptcy. Certainly, fully informed consent is critical in bifurcated cases. However, if a debtor is facing wage garnishment and repossession, the prospect of paying their lawyer in installments in exchange for stopping those collection actions may be better than the alternative.

Attorneys who offer bifurcation need to thoroughly document their work to ensure that the fee accurately reflects the work done on the case and commit to at least one additional meeting with the client post-petition. Ultimately, the court needs to approve these fee agreements, which means they need to determine that the lawyer has a reasonable, legal basis to employ the agreement and the debtor has made an informed business decision to enter the payment agreement.

The rise of fee bifurcation makes Chapter 7 bankruptcy much more accessible, but debtors need to do their research and make sure they know what they’re signing up for. An attorney with experience and a strong track record in bankruptcy cases is well-positioned to help people who need debt relief exercise their options under the law. If you are considering Chapter 7 bankruptcy, contact Benjamin R. Matthews & Associates today. We can explain our bifurcated fee agreement in a free consultation.