How Attorney Fees Work in Business Bankruptcy: Chapter 11 vs. Chapter 7 in Georgia

Background:

  When a business is in severe financial trouble, the business owner starts to consider filing for bankruptcy in the U.S. Bankruptcy Court for the Northern District of Georgia, either to close the company through Chapter 7 or to restructure the debts and continue to operate through Chapter 11. Here, the Atlanta business owner faces a dilemma: If a business does not have enough money to pay creditors, how can it even afford an Atlanta law firm?

The Bankruptcy Code deals with this issue by dividing lawyer fees into two camps: pre and post petition fees. Understanding how and when attorney fees are paid under Georgia law can help business owners plan realistically and ATL attorneys from losing out on paid work.

What are pre-petition and post-petition fees in Georgia Law?

To explain simply, pre-petition fees are fees for the work the Atlanta bankruptcy attorney has done for the case before the bankruptcy petition is filed with the court. This often includes reviewing the business’ financial situation, identifying the business’ goals and the most appropriate bankruptcy chapter to file under (if needed), and preparing the bankruptcy filings for the Northern District of Georgia.

Vice versa, post-petition fees are fees for the work the attorney will have to do after the petition is filed. This can include attorney fees for attending court hearings at the Richard B. Russell Federal Building in Atlanta, meeting and working with creditors, trustees, and the U.S. Trustee, litigating and resolving disputes, developing a plan and getting the plan confirmed in a Chapter 11.

How does the Bankruptcy Code treat pre-petition?

Pre-petition fees are generally treated as unsecured claims in both Chapter 7 and 11 because they are considered debts incurred prior to the filing of the bankruptcy petition. In both chapters, general unsecured creditors—whether in Alpharetta or downtown ATL—are at the bottom of the priority list and often receive just pennies on the dollar. To avoid becoming the debtor’s unsecured creditor, Atlanta law professionals often and should request a retainer upfront to cover the legal work performed before the bankruptcy petition is filed.

How does the Bankruptcy Code treat post-petition?

Legal fees for post-petition are both treated as administrative expenses under Chapter 7 or 11.

Once a Chapter 7 petition is filed, a Chapter 7 trustee is appointed to administer the estate. The debtor and its attorney essentially step away from the case. The trustee may employ attorneys to assist the trustee in carrying out the trustee’s duties, provided that they do not hold or represent an adverse interest to the estate.1 The employment of such attorneys must be approved by the Georgia bankruptcy court,2 and they are allowed reasonable compensation for actual, necessary services rendered to the estate.3 Sometimes the trustee may decide to hire the debtor’s attorney to continue with the case. From this point on, the attorney’s legal fees are treated as administrative expenses and are paid before the general unsecured creditors but after secured creditors.4

In Chapter 11 cases, the Atlanta debtor typically remains in possession of the estate and continues to operate its business as a “Debtor in possession” (DIP) unless a trustee is appointed. The DIP has the authority to hire Georgia law firms to assist with the reorganization process, with the approval of the court.5 Thus, the pre-petition attorney tends to stay with the case. Legal fee incurred post-petition is treated as administrative expenses and is paid before the general unsecured creditor similar to how it is treated in a Chapter 7 case as mentioned above. However, if a Chapter 11 case is converted into a Chapter 7, the administrative expenses, including the legal fee, of the Chapter 7 estate will take priority over the Chapter 11 estate.6 Once the conversion is made, it is not guaranteed that the pre-petition attorney is retained by the Chapter 7 trustee.

What should the post-petition attorney do to ensure (s)he is paid?

In either Chapter, if the bankruptcy estate does not have enough unencumbered assets—in other words, it is administratively insolvent—the Atlanta attorney may receive only a pro rata portion of the fees owed. In this case, the attorney should evaluate the estate’s asset and liabilities carefully and should consider a “carve-out” to protect themselves from not being paid. A carve-out is essentially an agreement between the trustee or DIP and secured creditors to set aside a portion of the asset sale proceeds to satisfy administrative expenses, including attorney’s fee. This carve-out agreement requires court approval to be enforceable. Georgia courts typically apply heightened scrutiny to these carve-out agreements to prevent abuse and to ensure that they do not interfere with a meaningful distribution to the creditors.7

At the same time, the Atlanta attorney should regularly apply for the interim compensation as allowed under Section 331.8 Interim compensation permits the attorney to request compensation and reimbursement of expenses every 120 days, or more frequently if the court allows. The purpose of this provision is to reduce the financial strain on attorneys and professionals hired by the DIP and trustee, especially in lengthy and complicated Georgia law cases. The requested compensation must be reasonable and for actual, necessary services in the best interest of the estate, and is subject to the approval of the court.9 It is important to note that interim compensation awards are always subject to a court’s re-examination and adjustment during the course of a case.10 Thus, if the interim compensation exceeds the final award, the court may order the attorney to disgorge the excess back to the estate.