U.S. Bankruptcy Court Opinions

IN RE HILL, (Or. 11-30-2006) In re JOHN ANDREW HILL,
Debtor. Case No. 305-47061-tmb7. United States Bankruptcy
Court, D. Oregon. November 30, 2006

MEMORANDUM OPINION

TRISH BROWN, Bankruptcy Judge

This matter came before the court on the Trustee’s Motion
to compel turnover of funds held by Debtor John A. Hill’s
bankruptcy counsel, Shawn P. Ryan (hereinafter “Mr. Ryan”).
Both Mr. Ryan and the Trustee, Rodolfo Camacho, appeared
pro se.

Following an initial hearing on this matter I set a
briefing schedule and took the matter under advisement. At
my request, the parties thereafter submitted additional
materials, including copies of the billing statements, the
fee agreement, and briefs. I have reviewed my notes, and
the pleadings and other submissions in the file. I also
have read applicable legal authorities, both as cited to me
and as located through my own research. I have considered
carefully the oral arguments presented and have read
counsels’ submissions in detail. The following findings of
fact and legal conclusions constitute the court’s findings
under Federal Rule of Civil Procedure 52(a), applicable in
this proceeding under Federal Rule of Bankruptcy Procedure
9014.

FACTS

The facts are undisputed. Debtor paid Mr. Ryan a retainer
of $5,000 and signed a written fee Page 2 agreement. Mr.
Ryan deposited that sum into his client trust account. Mr.
Ryan paid himself $2,115.15 for prepetition bankruptcy
services provided to the Debtor and paid the Chapter 7
filing fee of $209.00 from the funds in his client trust
account.

The case was filed on October 13, 2005. The Statement
Pursuant to Rule 2016(B) reflects that “[t]he unpaid
balance due and payable” to Mr. Ryan was “0.00.” The Rule
2016 statement also stated:

“6. The source of payments to be made by debtor(s) to the
undersigned for the unpaid balance remaining, if any, will
be from earnings, wages and compensation for services
performed, and

Gifts, loans, tax refunds, and cash retainer of
$2,675.85.”

Debtor scheduled the $2,676.00 balance of the retainer on
Schedule B. On May 4, 2006, the Trustee filed a motion
seeking turn over of the funds held in Mr. Ryan’s trust
account at the time of the filing of the petition. Mr. Ryan
objected to the motion.

At the time of the Turnover Order, Mr. Ryan had incurred
post petition fees of $688.50 and expenses of $19.57 for a
total of $708.07. The remainder of his fees appear to be
related to the issue of whether the Turnover Order is
valid.

ISSUE

Whether the United States Supreme Court’s decision in Lamie
v. United States Trustee, 540 U.S. 526 (2004) overruled the
result reached in In re Century Cleaning Services, Inc.,
202 B.R. 149 (Bankr. Or. 1996) (“Century I”), which allowed
the attorney for the Chapter 7 debtor to assert a lien
against a prepetition retainer held by him in his trust
account for potential postpetition services.

DISCUSSION

The Trustee contends that the funds held by Mr. Ryan are
property of the estate and must be turned over to him. Mr.
Ryan disagrees. He contends that the “interest retained by
Mr. Hill, and, thus, the Trustee, is the contingent right
to any refund of the unearned retainer, it is a
reversionary interest.” (Mem. in Opp’n. to Tr’s. Mot. for
Turnover of Retainer at 4). Therefore, he argues the
balance of the retainer remaining at time of filing did not
become property of the estate and is available for payment
of his postpetition fees and expenses. Page 3

A. The Retainer is Property of the Estate.

Funds paid to an attorney by a client for services “become
property of the estate only if, under applicable state law,
the debtor has an interest in the [funds] at the time of
filing the bankruptcy case.” In re GOCO Realty Fund I, 151
B.R. 241, 250 (Bank. N.D. Cal, 1993) (emphasis added).

Oregon law distinguishes between non refundable retainers
known as an “earned on receipt” retainers and true
retainers. See In re Complaint as to the Conduct of John M.
Biggs, 318 Or. 281, 864 P.2d 1310 (1994). In Biggs, the
Oregon Supreme Court held that absent “a clear written
agreement between a lawyer and a client that fees paid in
advance constitute a non-refundable retainer earned on
receipt, such funds must be considered client property. . .
.” Biggs at 293. (emphasis in original). Section 541 of the
Bankruptcy Code provides that filing of a bankruptcy
petition creates an estate consisting of “all legal or
equitable interests of the debtor in property as of the
commencement of the case.” Since no “earned on receipt
retainer” exists, the Trustee’s position is that funds held
in the client trust account are the Debtor’s property which
the Trustee has a duty to collect.

Mr. Ryan relies upon Redmond v. Lentz & Clark (In re
Wagers), 340 B.R. 391 (Bankr. D. Kan. 2006) for the
proposition that the Trustee only has a reversionary
interest in the retained funds. In Lentz and Clark, the
debtors gave their attorneys a prepetition retainer of
$5,000.00. In addition, they gave the firm an assignment of
any tax refunds they might be entitled to receive “as
deposits for payment of fees to be incurred in representing
them in dealing with financial difficulties and,
ultimately, filing a Chapter 7 bankruptcy.” Id. at 394. At
the time of the bankruptcy filing, the attorneys held
$2,134 from the initial $5,000 retainer in their client
trust account. Post petition the firm received tax refunds
totaling $51,660.00. The trustee filed an adversary
proceeding to compel turnover of the unused retainer in
existence at the time of filing and the funds received from
the tax refund arguing that both were property of the
debtors’ bankruptcy estate. Id. at 394-95.

The debtors’ attorneys opposed the motion contending that
“because the Debtors assigned the refunds to the Firm before
they filed for bankruptcy, the bankruptcy estate’s interest
in the refunds is limited to a contingent right to receive
any balance remaining after the Firm’s fees and expenses
for representing the Page 4 Debtors in their bankruptcy
case are paid from the refunds.” Id. at 396-97. The court
agreed. It recognized that, generally, “all the tax refunds
attributable to money the Debtors had paid to the IRS for
tax years ending before their bankruptcy filing and for the
tax year in which they filed would constitute property of
the estate. . . .” Id. at 401. However, it found that the
prepetition assignment of the tax refunds divested the
debtors of title to the funds. As a result, it found the
debtors retained only “a reversionary interest in the
portion, if any, of the tax refunds not needed for their
representation.” Id. at 402. The court further found that
“because the cash was transferred for the same purpose as
the tax refunds were assigned and counsel for the Debtor
reported to the Court that both the cash and tax refunds
constitute the retainer in this case, . . . the cash was
likewise an assignment transferring all of Debtors’ right,
title and interest.” Id. at 402.

I am unpersuaded by the reasoning of the Lentz and Clark
decision. Under Oregon law, a standard retainer, such as
that given to Mr. Ryan, remains the client’s until earned
by the attorney. Biggs, 318 Or. at 293. At the time of the
filing, the Debtor owed no fees to Mr. Ryan. Thus, the
Debtor had an absolute right to a refund of those fees. As
such, the funds became property of the estate within the
meaning of 11 U.S.C. § 541(a)(1) upon the filing of
the bankruptcy petition.

B. The Effect of Bankruptcy on the Retainer.

Mr. Ryan contends that if the funds are property of the
estate, he holds a valid prepetition security interest in
those funds. He further contends that because he holds a
security interest in the retained funds he may be paid from
those funds consistent with the Supreme Court’s Lamie
decision.

In Lamie, the Supreme Court held that the Bankruptcy Code
contains no authority allowing compensation of a chapter 7
debtor’s attorney from estate assets unless the attorney has
been appointed in accordance with § 327 of the Code.
The Trustee, relying on Lamie, contends that since the
funds held by Mr. Ryan constitute estate property, Mr. Ryan
may not look to those funds for payment of his postpetition
fees and expenses. Again, Mr. Ryan disagrees. Under Oregon
law he asserts he holds a valid prepetition security
interest in the retainer.

In Century I, 202 B.R. 149 (Bankr. D. Or. 1996), the court
addressed the issue of whether a Chapter 7 debtor’s
attorney could seek payment from a prepetition retainer for
services rendered postpetition. In that Page 5 case the
debtor retained the firm of Garvey, Schubert & Barer
(“Garvey”) to represent it in a Chapter 11 bankruptcy filing
and paid Garvey a $28,301.84 retainer for “postpetition
services and expenses.” The debtor subsequently converted
to a Chapter 7. Thereafter, Garvey filed an application for
compensation for fees and expenses incurred after the
conversion in which it sought payment from the prepetition
retainer. The United States Trustee (“UST”) objected to the
application, arguing that the Bankruptcy Code contained no
authority authorizing payment of a chapter 7 debtor’s
attorney’s fees from estate assets.

The bankruptcy court, relying on In re Fassinger, 191 B.R.
864 (Bankr. D. Or. 1996) held that § 330 of the
Bankruptcy Code “does not authorize an award of a Chapter 7
debtor’s postpetition attorney fees from property of the
estate” unless the attorney has been appointed in
accordance with § 327. Century I at 150. However, it
concluded that Garvey could nonetheless look to the
retainer for payment of its post conversion fees and
expenses because it held a valid lien against that
retainer. In doing so it rejected the UST’s argument that
“there can be no lien for postpetition services until the
postpetition services are provided.” Id. at 152.

The Century I court began its analysis by noting that the
“validity of an attorney’s lien in bankruptcy is determined
by state law.” Id. The court went on to note that “Oregon
law recognizes two types of attorney’s liens for services,
a retaining lien and a charging lien. A retaining lien
attaches to papers, money and other personal property of a
client that comes into the attorney’s hands in the course
of employment, and gives the attorney the right to retain
that property until the attorney’s fees are paid.” Id.
(citations omitted). Unlike a charging lien, which is
effective only upon the filing of a notice of claim of
lien, “[t]he retaining lien statute . . . requires only
that the attorney be in possession of the property.” Id.
Because no notice of lien is required to perfect a
retaining lien, the court found that such a lien “is
effective upon the attorney’s possession of the client’s
money or other property. Because a lien can secure an
obligation consisting of a contract for performance of an
obligation in the future, it is not necessary that the
services have been actually performed before the lien
becomes effective.” Id. at 152-53 (citations omitted). In
conclusion the court held:

“Although section 330 [of the Bankruptcy Code] does not
authorize an award of Page 6 compensation to counsel for
Chapter 7 debtors, if counsel has a valid attorney’s lien
on a retainer for payment of postpetition attorney fees,
counsel’s reasonable postpetition fees and expenses are
secured by that retainer. Section 330 does not preclude
counsel from looking to its collateral for payment of the
debt secured by its lien.” Id. at 153.

The UST appealed the bankruptcy court decision to the
Ninth Circuit Bankruptcy Appellate Panel which “affirmed
the award under the state law lien theory, after
concluding, like the bankruptcy court, that Garvey could
not be compensated under § 330.” United States
Trustee v. Garvey, Schubert & Barer, (In re Century
Cleaning Servs), 195 F.3d 1053, 1055 (9th Cir. 1999)
abrogated by Lamie v. United States Trustee, 540 U.S. 526
(2004) (“Century II”). The UST then appealed to the Ninth
Circuit contending that “the Bankruptcy Appellate Panel
correctly determined that § 330 precludes
compensation to a Chapter 7 debtor’s attorney, but that it
erred in allowing Garvey compensation pursuant to an
attorney’s lien under Oregon law.” Id. at 1055. In support
of its contention the UST argued that “Oregon law does not
allow a lien for post-petition services, and that in any
event, § 330 preempts Oregon law to the extent that
it allows for such a lien in Chapter 7 proceedings.” Id. at
1055. The Ninth Circuit concluded that Garvey was “eligible
under § 330 for compensation of Chapter 7
post-petition services” and reversed the contrary
determination of the Bankruptcy Appellate Panel. Id. at
1061. However, because the Ninth Circuit granted Garvey
compensation under § 330, it “need not decide . . .
whether he would also be entitled to those fees under
Oregon’s attorney retaining lien statute. . . .” Id. at
1061.

I believe the Ninth Circuit’s Century II opinion as well as
the bankruptcy court’s initial ruling were abrogated, in
part, by the Supreme Court in Lamie v. United States
Trustee, 540 U.S. 526 (2004). The Lamie facts are very
similar to the case at bar. John Lamie (“Lamie”) was
retained by Equipment Services, Inc., to represent it in a
chapter 11 bankruptcy proceeding. The debtor paid Lamie a
$6,000 prepetition retainer. Lamie used $1,000 of the
retainer to pay the fees and costs of filing the Chapter 11
petition. He deposited the remaining $5,000 in his trust
account “to be drawn upon as [he] earned fees.” In re
Equipment Services, Inc., 290 F.3d 739, 742 (4th Cir.
2002). Although the retainer agreement was not documented,
Lamie advised the court that under his agreement with the
debtor any unused fees remaining at the end of the case
were to be refunded to the debtor. Id. at 742. Page 7

Equipment Services, Inc’s chapter 11 case was subsequently
converted to a Chapter 7 on the U.S. Trustee’s motion. At
the time of conversion the $5,000 retainer was subject to
charges of $1,328.85 for post petition fees and expenses,
leaving a balance of $3,671.15. Following conversion, Lamie
filed an application for fees in the amount of $2,325.00.
Of this amount, $1,000 had been earned postconversion. The
UST objected to the fees to the extent they included fees
for services rendered postconversion, arguing that —
330 of the Code “`makes no provision for counsel of the
debtor to be compensated by the estate’ in a Chapter 7
proceeding.” Id. at 743. The bankruptcy court agreed that
“under 11 U.S.C. § 330(a), a debtor’s attorney is
not authorized to be paid funds from the bankruptcy estate
for services rendered after the case is converted to a
Chapter 7 proceeding. The court nonetheless awarded Lamie
all of his requested fees, in the amount of $2,325, plus
$3.85 in costs. Id. The court did so based on its
conclusion that the prepetition retainer held by Lamie was
property of the bankruptcy estate only to the extent that
it exceeded the total fees allowed to the debtor’s counsel
for all services rendered in the case, including services
rendered after the Chapter 7 conversion.” Id.

The UST appealed to the district court and Lamie cross
appealed. The district court affirmed the bankruptcy court
on both the issue of whether § 330 authorizes
compensation of a chapter 7 attorney from estate property
and the ability of the debtor’s attorney to be paid for
post petition services from a prepetition retainer stating:

“In the present case, however, the fee paid to the
attorney was not unearned simply because the case was
converted to chapter 7. While a chapter 7 debtor’s
attorney may not be entitled under the Bankruptcy Code to
compensation from the estate, the debtor is not prohibited
from being represented and until such representation is
ended, the debtor — and hence, the debtor’s
bankruptcy estate — is not entitled to a refund.

Section 329 of the Bankruptcy Code clearly anticipates
that pre-petition legal fees will be paid by debtors, and
because of the potential for overreaching in such
circumstances, gives the bankruptcy court broad power to
cancel the agreement or order the return of any excessive
payment. This provision, together with the trustee’s power
to avoid fraudulent transactions, helps insure that
debtor’s attorneys will only receive proper payments for
pre-petition retainers.

For these reasons, I find that the bankruptcy court was
correct in allowing the debtor’s attorney to receive fees
from the pre-petition retainer.” Page 8

United States Trustee v. Equip. Servs. (In re Equipment
Servs,), 260 B.R. 273, 280 (W.D. Va. 2001) (citations
omitted).

The parties cross appealed to the Fourth Circuit which
affirmed on the issue of whether the a chapter 7 debtor’s
counsel can be compensated from estate assets. Equipment
Services, 290 F.3d. at 745. However, the Fourth Circuit
reversed on the issue of whether Lamie could nonetheless
look to his prepetition retainer for payment of his
attorney fees. In doing so, the court distinguished between
retainers which were held solely as security for payment of
future services and those which are paid as a flat fee for
future services or to ensure an attorney’s availability to
represent a client. In the latter cases, the court noted,
the “attorney acquires title to the retainer fee at the
time he receives it, regardless of whether he thereafter
performs legal services for the client.” Id. at 746. By
contrast, where the retainer is given to ensure payment for
future services, then “the retainer so held, less any fees
charged against it, constitutes the property of the
client.” Id. Lamie admitted that the fees at issue were
held for the client to ensure payment of his fees.
Accordingly, the Fourth Circuit held since Lamie was not
authorized to receive payment from the bankruptcy estate
for his services as counsel to the chapter 7 debtor, he
could not look to his retainer for payment of those fees.
Lamie appealed from that decision. Id.

In his appeal to the Supreme Court, “Lamie presented a
single question, `Does 11 U.S.C. § 330(a)(1)
authorize a court to award fees to a debtor’s attorney.’
Notably, Lamie did not challenge the court of appeal’s
state-law determination that the particular retainer in
[his] case was property of the estate rather than the
petitioner.” Morse v. Ropes & Gray, LLP (In re CK
Liquidators), 343 B.R. 376 (D. Mass. 2006). (citations
omitted)

The Supreme Court upheld the Fourth Circuit’s Equipment
Services, Inc. decision. In its opinion the Supreme Court
rejected Lamie’s argument that precluding compensation of
Chapter 7 attorney’s fees from estate assets would adversely
effect the administration of chapter 7 cases. The Supreme
Court found that “[c]ompensation for debtors’ attorneys
working on Chapter 7 bankruptcies, moreover, is not
altogether prohibited.” Lamie at 537. It noted, “[i]t
appears to be routine for debtors to pay reasonable fees
for legal services before filing for bankruptcy to ensure
compliance with statutory requirements.” Id. It also noted
Page 9 that “[i]n the majority of cases, the debtor’s
counsel will accept an individual or a joint consumer
chapter 7 case only after being paid a retainer that covers
the `standard fee’ and the cost of filing the petition.”
Id.

In this case, it is undisputed that at the time the
bankruptcy petition was filed, there was no underlying debt
to Mr. Ryan as all the prepetition fees had been deducted
from the retainer. Therefore, the retainer became estate
funds upon the filing of the petition.

Several courts have addressed the effect of the Lamie
court’s recognition of the fact that an attorney
representing a debtor in a Chapter 7 may have received a
prepetition retainer from his client. In In re Channel
Master Holdings, Inc., 309 B.R. 855 (Bankr. D. Del. 2004)
the court allowed an attorney to apply a prepetition
retainer to payment of his postconversion attorney fees
noting that “[a]lthough the Supreme Court has held that,
after conversion to chapter 7, debtor’s counsel’s fees may
not be paid from the estate, it did acknowledge that those
fees may be paid from a retainer received prior to
conversion.” Id. at 859. By contrast, the Bankruptcy
Appellate Panel for the Eighth Circuit refused to allow
debtor’s attorney to apply a prepetition retainer to
attorney fees incurred after conversion to chapter 7 noting
“[i]n Lamie v. United States Trustee, the United States
Supreme Court held that section 330(a)(1) of the Code does
not authorize compensation awards to debtors’ attorneys
from estate funds, unless such attorneys have been employed
by the trustee with approval of the court. [Debtor’s
attorney] was not so employed by the trustee. The
bankruptcy court, thus, did not err when it found that
[debtor’s attorney] was not entitled to payment of its
postpetition fees and expenses from the unapplied portion
of the security retainer, or from other assets of the
estate.” Fiegen Law Firm, P.C. v. Fokkena (In re On-Line
Servs. Ltd.), 324 B.R. 342, 347 (8th Cir. BAP 2005).

Most recently the issue was addressed in Morse v. Ropes &
Gray, LLP, (In re CK Liquidation Corp.), 343 B.R. 376 (D.
Mass. 2006). In Morse, the debtor paid its attorneys a
$100,000 retainer for services relating to the debtor’s
obligations to creditors, including preparation for a
possible chapter 11 filing and sale of assets. Id. at 377.
During the pendency of the Chapter 11 proceedings the court
approved a sale of substantially all of the debtor’s
assets. Thereafter, the debtor converted to a chapter 7.
Id. at 378.

Following conversion, the debtor’s counsel filed a final
fee application which included approximately Page 10
$7,820 for services performed after the conversion of the
case. The UST objected to those fees. The firm responded,
arguing that the fees at issue could be paid from the
retainer “consistent with the Supreme Court’s statement in
Lamie that Section 330(a)(1) does not prevent a debtor from
engaging counsel before a chapter 7 conversion and paying
reasonable compensation in advance to ensure that the
filing is in order.” Id. at 379. The bankruptcy court
allowed the requested compensation and the UST moved for
reconsideration. Id.

The bankruptcy court denied the motion for reconsideration
holding that:

“while Lamie precludes compensation from unencumbered
assets for post-conversion services by a debtor’s counsel
who has not been re-employed by the Chapter 7 trustee,
Massachusetts state law provides a lien for such counsel
to the extent of an undisbursed pre-petition retainer and
subject to the validity of the underlying claim.

In essence, the bankruptcy judge determined that, even if
the Retainer became estate property upon the Conversion
Date, payment could be made from it on account of its
encumbrance by a lien under state law. Apparently
bolstering the court’s decision was the fact that R & G
sought payment for `required’, `transition’ services. The
Bankruptcy Court asserted that its conclusion was not
inconsistent with Lamie because the Supreme Court had not
specifically ruled upon whether a pre-conversion retainer
could be used for payment of post-conversion services,
that issue `never [having been] presented to the Supreme
Court.'” Id. at 380 (emphasis in original) (citations
omitted).

The United States Trustee appealed the order denying its
motion for reconsideration.

On appeal, the District Court held that because the
prepetition retainer was property of the estate, the
debtor’s attorney could not be compensated for
postconversion services from that retainer. In doing so it
accepted the UST’s argument that “the Supreme Court must
have intended the exception to apply only to flat fee
retainers.” Id. at 383. It also accepted the UST’s argument
that “application of state lien law in such a manner
seriously undermines, if not circumvents, federal bankruptcy
law and the Lamie decision.” Id. at 384 (emphasis in
original). The Court concluded that “[w]here the Supreme
Court has interpreted § 330(a)(1) as preventing
payment from the debtor’s estate to counsel not appointed
under § 327, authorization of such payment on the
basis of state law is forbidden by the Supremacy Clause.”
Id. at 384.

I agree with the reasoning and holding of Morse. The
“retainer exception” set forth in Lamie is limited to flat
fee retainers and does not extend to retainers intended
solely to secure payment of post filing attorney fees.
Interpreting state lien law to allow payments that are
specifically prohibited by the Page 11 Bankruptcy Code
violates the Supremacy Clause. Thus, Lamie overruled the
bankruptcy court’s holding in Century I which allowed the
attorney to assert a lien on property of the estate for
post petition services.

The funds in Mr. Ryan’s trust account as of the date of
filing are property of the bankruptcy estate. Under Lamie
those funds cannot be used to pay the Debtor’s post filing
attorney fees regardless of whether Mr. Ryan holds a
security interest in the funds. The funds must, therefore,
be turned over to the Chapter 7 trustee for distribution to
creditors. Mr. Camacho should prepare an order consistent
with this opinion.