Be Careful Representing Debtors in the Gap Period of an Involuntary Bankruptcy Filing

Attorneys representing debtors faced with an involuntary petition may have a difficult time getting paid for their fees incurred in the "gap" period from the bankruptcy estate. Further, even if counsel is paid by the debtor and need not seek payment from the bankruptcy estate, the court will examine the fees paid under Section 329 of the Bankruptcy Code for reasonableness.

If the attorney must seek payment from the bankruptcy estate as an administrative expense, Section 507(a)(2) gives a second priority status to administrative expenses allowed under Section 503(b). Section 503(b) allows an administrative expense for, "other than claims allowed under section 502(f) ... the actual, necessary costs and expenses of preserving the estate." As such, Section 503(b) "expressly excludes from administrative expenses 'gap' claims 'allowed under section 502(f)" which would include attorneys' fees incurred by the debtor during the gap period. In re Baab Steel, Inc., 495 B.R. 530, 533 (Bankr. D. Co. 2013).

Section 507(a)(3) gives a third priority status to claims allowed under Section 502(f). Section 502(f) allows claims in an involuntary case arising "in the ordinary course of the debtor's business or financial affairs after the commencement of the case but before the earlier of the appointment of a trustee and the order for relief."

But fees incurred opposing and defending an involuntary petition, however, are not in the ordinary course of the debtor's business. The bankruptcy estate is prohibited from "paying debtor's counsel for 'gap' attorney's fees incurred in opposing an involuntary petition" as it is not in the debtor's ordinary course of business. Baab Steel, 495 B.R. at 534. In Baab, the Court held that legal fees incurred during the gap period relating to opposing or defending the involuntary did not qualify as administrative expenses of the estate and that only "routine or ongoing legal services" might qualify under Section 502(f) and be entitled to administrative priority under Section 507(a)(3). Id.

Similarly, in In re May Lumber Co., 135 B.R. 368, 371 (Bankr. W.D. Mo. 1992), the Court disallowed "gap" period fees and noted: "Debtor engaged skilled counsel. As such, skilled counsel should have recognized immediately that avoidance of Title 11 and its inevitable consequences was impossible. Counsel had an obligation to advise debtor of these facts. Actions taken thereafter to avoid or delay adjudication had to be either unreasonable or solely at the whim of the debtor, with counsel knowing the inevitable result and willingly participating in delaying the process. This is not intended as a unilateral condemnation of counsel. The debtor may have decided to 'go to the wall' despite the advice of counsel. If so, that is the debtor's option, but not at the expense of the estate. Where what counsel does in the gap period is not reasonable and/or benefits only the debtor, it is only the debtor who should pay - not the estate."

Debtor's counsel should be careful about the actions it takes and the fees it incurs during the "gap" period as it runs the risk of non-payment or possibly disgorgement.

If you have any questions, please contact Melissa Lowe or any of the other attorneys at Shulman Bastian Friedman & Bui LLP at 949-340-3400.

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