Summary:

One of the persistent realities of consumer bankruptcy practice is that Chapter 13 debtor's counsel routinely undertake thousands of dollars of work with only a modest payment up front, relying on future plan payments to be compensated. When a case is dismissed or converted before confirmation, however, that expectation can disappear overnight.

A thoughtful recent ABI Journal article by John Slack and David Treacy examines the unsettled law that has developed following the Supreme Court's 2015 decision in Harris v. Viegelahn, focusing on a deceptively simple question:

If a Chapter 13 trustee is holding undistributed plan payments derived from the debtor's post-petition wages, may those funds be used to pay debtor's counsel after dismissal or conversion?

The Problem Created by Harris

In Harris v. Viegelahn, the Supreme Court held that when a Chapter 13 case is converted to Chapter 7 in good faith, post-petition wages do not become property of the Chapter 7 estate. Once conversion occurs, the Chapter 13 trustee's authority ends, and undistributed post-petition wages generally must be returned to the debtor—not distributed to creditors.

The Court, however, never decided whether debtor's counsel should be treated differently from ordinary creditors. Because the debtor in Harris did not challenge the fees already paid to his attorney, that issue simply was not before the Court.

That omission has produced a significant split among bankruptcy courts.

Two Competing Approaches

The article identifies two primary lines of authority.

The Broad Reading

Courts following In re Beauregard conclude that Harris leaves no room for any post-conversion disbursement of post-petition wages—including payment of debtor's attorney's fees.

Under this view, once the Chapter 13 trustee's authority terminates, the trustee cannot pay anyone except by returning the funds directly to the debtor. Administrative expenses receive no special treatment.

The Narrow Reading

Other courts, beginning with In re Brandon, distinguish pre-confirmation cases from the facts presented in Harris.

These courts focus on § 1326(a)(2), which specifically directs trustees, if a plan is not confirmed, to return payments to the debtor after deducting unpaid administrative expenses allowed under § 503(b).

Accordingly, these courts conclude that Congress expressly authorized payment of debtor's counsel before refunding the remaining funds to the debtor, and that Harris did not silently repeal this statutory directive.

The Suggested Solution: Fee Assignments

Slack and Treacy note that one area of growing consensus involves carefully drafted assignments contained within attorney-client engagement agreements.

Rather than relying solely on the trustee's statutory authority, counsel can obtain an assignment of the debtor's right to receive refunded plan payments to the extent necessary to satisfy approved attorney's fees.

Several courts have upheld these assignments as contractual rights that do not conflict with Harris because they merely direct payment to the party who now owns the debtor's right to receive those funds.

The authors recommend that engagement agreements clearly disclose such assignments, comply with applicable state law and ethics rules, and fully satisfy bankruptcy disclosure requirements.

Commentary:

This is an excellent article describing an issue that has enormous practical importance but receives surprisingly little attention outside the consumer bankruptcy bar.

After all, Chapter 13 depends upon competent attorneys willing to represent financially distressed families, often with minimal retainers and substantial deferred compensation. If the law routinely prevents those attorneys from being paid after performing months of work, fewer lawyers will be willing—or financially able—to represent Chapter 13 debtors. Access to bankruptcy relief suffers.

The article also illustrates a recurring problem in bankruptcy jurisprudence. The Supreme Court decides one relatively narrow issue—in Harris, whether post-petition wages belong to the Chapter 7 estate after conversion—and lower courts spend the next decade debating questions the Court never actually answered.

I do wonder, however, whether there is another possible analytical path that deserves greater exploration.

If the attorney-client agreement expressly grants counsel an assignment or security interest in future plan refunds, perhaps those funds never truly become "the debtor's" upon dismissal or conversion. Instead, they become property subject to an existing contractual transfer. That analysis may ultimately prove more durable than attempting to reconcile the competing statutory interpretations of §§ 348, 349, and 1326(a)(2).

There is also a broader policy concern. Congress has repeatedly recognized that debtor's counsel perform an essential function in the bankruptcy system. Numerous provisions of the Bankruptcy Code—from administrative expense treatment to compensation review under §§ 329 and 330—reflect an expectation that attorneys representing consumer debtors will, in appropriate circumstances, actually be paid. Reading Harris so broadly that it effectively discourages Chapter 13 representation seems difficult to reconcile with that overall statutory structure.

Finally, practitioners in jurisdictions that have not yet addressed this issue should probably not wait for an appellate court to resolve the split. As the article persuasively argues, carefully drafted engagement agreements containing assignment provisions may provide the best protection available in an uncertain post-Harris landscape. That is a relatively simple drafting change that could prevent substantial uncompensated work—and one that consumer bankruptcy attorneys would be wise to consider before the next Chapter 13 case unexpectedly converts or is dismissed.