Court Rejects Proposed Order for Payment of Attorney Fees in Event of Dismissal

Language in a proposed order for attorney fees that, in the event of dismissal or conversion, the fees were to be paid out of undistributed funds held by the trustee was rejected by the bankruptcy court as unsupported by the Code. In re Weatherspoon, No. 11-46755 (Bankr. W.D. Wash. Jan. 3, 2014). Over the course of the debtor’s chapter 13 plan, the debtor’s attorney sought and obtained several orders for fees. In his final proposed order the debtor’s attorney included the following language: “The fees and costs awarded are administrative expenses under 11 USC §503(b) and shall be paid through the plan as directed herein. If the case is later dismissed or converted, approved attorney fees shall be paid to Debtor’s counsel pursuant to 11 USC §1326(a)(2) prior to funds being refunded to the Debtor. Any refund to the Debtor following dismissal or conversion shall be made payable to the Debtor and forwarded to the Debtor through the office of Debtor’s counsel.” The court declined to approve the order finding that post-petition funds in the trustee’s hands revest in the debtor upon dismissal or conversion.

The case involved the interplay between sections 1326(a)(2) and 349(b)(3). Section 1326(a)(2) provides that if a plan is not confirmed, the trustee must return all funds collected under the proposed plan to the debtor “after deducting any unpaid claim allowed under section 503(b).” Section 503(b)(4) refers to payment of administrative expenses including “reasonable compensation for professional services rendered by an attorney” for specified expenses. In contrast, upon dismissal, section 349(b)(3) revests all property of the estate in the “entity in which such property was vested immediately before the commencement of the case.”

In finding that the proposed language in the fee order was unsupported, the court rejected counsel’s argument that because the debtor’s post-petition earnings did not exist when the bankruptcy was filed, those funds would not revest in the debtor upon conversion or dismissal and may, therefore, be used to pay attorney fees. Rather, the court agreed with the holding in In re Hamilton, 493 B.R. 31 (Bankr. M.D. Tenn. 2013), that under section 1306 post-petition earnings become part of the chapter 13 bankruptcy estate and, therefore, revest in the debtor upon dismissal or conversion (though the Weatherspoon court disagreed with Hamilton’s dictum that the plan could specify a different treatment).

Debtor’s counsel next argued that he was entitled to payment of fees out of funds still held by the trustee because the fees were administrative and therefore treated differently than creditor claims. In rejecting this argument, the court made a distinction between pre-confirmation and post-confirmation fees. Under section 1326(a)(2), when a plan is not confirmed the trustee is required to return any funds to the debtor but may deduct administrative claims allowed under section 503(b). But that section does not make any provision for post-confirmation dismissals. Rather, under section 349(b)(3), dismissal of a case revests all outstanding funds in the debtor.

The court found that section 349(a)’s “unless the court, for cause, orders otherwise,” could not be used to support counsel’s position. While courts have found that bad faith or inequity could constitute “cause” for not revesting funds in the debtor upon dismissal, there was no motion for dismissal before the court and it could not determine that, in the event of dismissal or conversion, there would be just cause for permitting funds to be applied to debtor’s attorney fees.

In comparing the case with cases involving conversion under section 348(f), the court cited In re Michael, 699 F.3d 305 (3d Cir. 2012), as standing for the rule that undistributed funds at the time of conversion from chapter 13 to chapter 7 belong to the debtor. This harmonizes with NACBA’s position in Michael and other cases dealing with proper use of undistributed funds at the time of conversion. NACBA took part as amicus in Michael arguing that, based on the plain language and legislative history of section 348(f), the funds must be returned to the debtor rather than paid out to creditors. NCBRC has also filed an amicus brief on behalf of the NACBA membership in the case of Viegelahn v. Harris (In re Harris), No. 13-50374 (5th Cir. August 20, 2013), dealing with the same issue. Although in the current case, the debtor’s attorney was unsuccessful in selling his proposed order, as the court pointed out, the “for cause” language in section 349 may be the better avenue for relief without the risk of undermining the general rule of revesting undistributed funds in the debtor.

Weatherspoon opinion