Counsel occasionally seek post-petition retainers. In a Kentucky case, In re A Top New Casting, Inc., counsel unsuccessfully sought a payment arrangement in the nature of an escrow, which is more lawyer-friendly than a security retainer. Less frequently, a post-petition retainer is paid with bankruptcy court approval, with payments from the retainer subject to court approval.
If an attorney is not entitled to charge the client, and thus be paid from the security retainer, the unused balance must be refunded. A line of cases in Chapter 15 matters hold that the presence of such an unused retainer is property of the debtor located in the United States to establish eligibility for bankruptcy relief.
In the context of payment from estate property, no payment to counsel may be authorized absent compliance with Bankruptcy Code §§ 329, 330, 331 and applicable Bankruptcy Rules. Among other requirements, the court must approve employment of counsel, disclosure of compensation terms, and ultimately the fees and expenses sought. Failure to comply with the requirements of the Code and Rules can result in denial of compensation and disgorgement of a retainer.Where counsel has received a retainer that is property of the estate, any refund of the retainer is refunded to the estate.
Even a properly disclosed retainer may be at risk if the Chapter 11 case is converted. After conversion, the debtor may not hire counsel at estate expense, so the lawyer may no longer use estate property to pay for legal services. And because chapter 11 administrative expenses, like fees of debtor in possession counsel, are subordinated in chapter 7 to chapter 7 bankruptcy expenses of administration, like fees of a trustee and counsel, if the trustee seeks subordination of Chapter 11 claims for legal services to Chapter 7 administrative expenses under § 726(b), the trustee may seek disgorgement of the retainer for reallocation under bankruptcy priorities.
A South Carolina case, In re Parast, addressed the scenario where a debtor sought post-petition authority to retain counsel, and the attorneys required a retainer as a condition of the representation. Absent authority to make an out of the ordinary course of business transfer under § 363(b)(1), the debtor may not use estate property to pay the retainer, nor is counsel protected against the risk of disgorgement if retention of counsel is not approved. And counsel is not protected with respect to fees incurred before court approval of retention of counsel. However, the rules are less clear when the retainer is paid by a third party.
In Parast, proposed counsel received and disclosed a $25,000 retainer paid by the debtor’s brother as part of the firm’s employment application. The retainer was fashioned as a conditional gift from the brother to the debtor, conditioned upon court approval of counsel’s retention. Due to objections, the firm eventually withdrew the employment application (after incurring over $40,000 in charges). The court held that the payment from the third party (brother) was not property of the estate, because the condition to the gift was not satisfied, and so the estate was not entitled to a refund. Therefore, the dispute between the law firm and the brother over the retainer would have to be resolved in a non-bankruptcy forum.
Obtaining a retainer as a condition of representing a debtor in bankruptcy court litigation without understanding the legal environment for payment, including from a retainer, may create grave risks for the lawyer. Those risks include potential denial of compensation, refund of the retainer balance, and even disgorgement of sums paid from the retainer.