Exactly what does PI Counsel need to know to keep out of trouble? The first thing is to recognize that upon filing of the bankruptcy the cause of action becomes property of the bankruptcy estate, which will be administered by a Chapter 7 Trustee under the supervision of the bankruptcy court. Upon the filing of the petition, the debtor/client no longer has control of the cause of action. PI Counsel must confirm if the cause of action has been disclosed in the bankruptcy schedules filed by the debtor with the bankruptcy court. If the action has not been disclosed, debtor’s bankruptcy counsel must be notified so the debtor’s Schedules can be amended to reflect the asset. PI Counsel must cease prosecuting the cause of action on behalf of the debtor and decide if it wants to accept an invitation by the bankruptcy trustee to be retained by the bankruptcy estate to prosecute the matter. Ordinarily, the Trustee will seek to retain PI Counsel because of counsel’s familiarity with the action, the relationship developed with the debtor and the attorneys’ lien that can be asserted against any future recovery.
For practical and monetary reasons, PI Counsel readily welcomes the opportunity to represent the Trustee and not the original client. This is so because the debtor’s interest in the litigation is generally reduced to asserting entitlement to a limited bankruptcy exemption from a potential recovery, not the entire recovery. PI Counsel usually knows little about bankruptcy exemptions and is rightfully more comfortable with debtor’s bankruptcy counsel addressing those issues. Additionally, PI Counsel will not earn a contingency fee if they do not represent the estate that owns the action. So, while PI Counsel may want to finish the action it started and continue to represent the client, the debtor simply does not own or control the action. For these reasons, PI Counsel are consistently motivated to represent the party with the greater financial interest – here the trustee, so a contingency fee can be earned on the entire recovery, which is property of the estate.
It is unwise for PI Counsel to ignore the bankruptcy. First, the automatic stay prohibits any action against or with regard to assets of the bankruptcy estate. Ignoring the bankruptcy will result in a violation of the stay. Violation of the automatic stay can result in the imposition of monetary or other sanctions. Additionally, if PI Counsel is not properly retained, it will not be entitled to a fee. If a fee was paid, the court could order that it be disgorged. Worse yet, if the matter is settled and the proceeds disbursed to the debtor, PI Counsel may be held liable for return of all the money.
Because the debtor lacks standing to prosecute an action that belongs to the estate, the action can be dismissed by motion of the defendant. Insurance carriers often check bankruptcy records to see if the plaintiff filed bankruptcy. If the statute of limitations has run, the debtor and the Trustee may be time barred from commencing a new action. Counsel should ask every client if they previously filed bankruptcy, are in a bankruptcy or contemplate filing bankruptcy.
Here is a checklist of what the PI Counsel should do if their client files bankruptcy:
1. Contact the Trustee and provide him or her with all the details of the case, including the existence of any pre-petition liens asserted against the cause of action and provide the basis for the enforceability of same as against the trustee, and communicate that you have interest in continuing to prosecute the cause of action.
2. If the Trustee wants to retain PI Counsel, ask the Trustee for the form of affidavit to complete and return so that an application can be presented to the bankruptcy court for PI Counsel to be officially retained by court order as Special Counsel to the estate.
3. Explain to the client that by virtue of the bankruptcy, PI Counsel no longer represents their interests in the litigation, and the now “former” client will need to obtain information with regard to their rights from their bankruptcy counsel, not PI Counsel.
4. Look at the form of order of retention of Special Counsel, which the Trustee should provide. The order may provide that the Special Counsel must inter alia (i) provide regular status reports to the Trustee (at least quarterly) and otherwise cooperate with the Trustee; (ii) change the caption of the action to list the Trustee as the plaintiff; (iii) keep detailed time records (to protect the attorney as the Office of the United States Trustee, which oversees these cases, has asked for such records in the past); (iv) not settle the case without the Trustee’s permission and authorization of the bankruptcy court by entry of an appropriate order; (vi) turn over the gross proceeds of the recovery without deduction of the attorneys’ contingency fee and reimbursable expenses; (vii) not turn over the proceeds of the litigation to the debtor, notwithstanding that the debtor may have received his discharge (which has nothing to do with the cause of action that remains an asset of the bankruptcy estate for payment of creditor claims.
If the attorney accepts the responsibility of representing the Trustee as Special Counsel it cannot be an advocate for the debtor. That includes not trying to have the bankruptcy case dismissed, structuring settlements to benefit the amount of money the debtor can “exempt” from the reach of creditors, and the like. Special Counsel is an advocate for the Trustee and the bankruptcy estate - not the debtor. This is something that personal injury attorneys sometime have difficulty understanding or accepting. The debtor’s bankruptcy or other counsel, not the Trustee’s Special Counsel, is the one to address these issues.
Personal injury attorneys who do not understand the rules have been called into bankruptcy court to explain inter alia (i) why they settled the case without the consent of the Trustee and the bankruptcy court; (ii) why they participated in and permitted the debtor to assign a portion of the anticipated recovery to a company that provides money to the debtor in need of an “advance” payment or living expenses or to pay litigation expenses; (iii) why they took their fees or paid money to the debtor. This has resulted in bankruptcy courts directing PI Counsel to disgorge fees and being sanctioned.
In most cases, the process can proceed without incident if PI Counsel follows the rules. That means being properly retained, reporting to the Trustee regularly, prosecuting the action, obtaining advance approval of any settlement and turning over the gross proceeds to the Trustee, who will obtain an order authorizing the Trustee to pay Special Counsel’s fees and expenses.
There are numerous other issues that can arise during the course of a personal injury case that intersect with bankruptcy law. These include the scope and form of releases, noticing requirements, and the structuring of settlements, all of which are beyond the scope of this blog.
The bottom line is that protection of the personal injury attorney’s financial stake in the underlying litigation as well as his reputation and good standing before the courts is paramount. The attorney should not hesitate to confer with a knowledgeable bankruptcy practitioner to avoid any missteps that could result in unintended and costly adverse consequences.