Lawyers who handle Chapter 11 Bankruptcy cases for small to medium size businesses usually address these questions in the initial conversation with potential clients. "How much is a Chapter 11 case?" "Why is it so expensive?" "I just want to stop the foreclosure/lawsuit/collection, then we can dismiss." "Can’t I pay a little over time?" While these questions are very reasonable, the answers are often not what prospective clients like to hear.
Initially, unlike other types of cases, lawyers representing Chapter 11 debtors have several restrictions in getting paid:
- After a case is filed, lawyers cannot get paid for fees or expenses without notice to the parties in the case, and Court approval. This includes drawing on any initial retainer provided by the client. Detailed fees and expenses are reviewed by the U.S. Trustee and Court prior to approval.
- Lawyers typically must wait a minimum of 4 months to even request approval of fees, but more often, it is six months or more. If the fees and expenses incurred during this time are more than the initial retainer held by the lawyer, the lawyer is at risk if the client does not have the funds to pay the additional amount.
- The lawyer’s fees and expenses are have the same priority as other expenses of the business during the Chapter 11. If the client runs up other bills during the Chapter 11 case that it ultimately cannot pay (landlord, vendors, utilities, etc.), a lawyer may have to give back some of the initial retainer to pay these other company expenses.
- If the case is converted to a Chapter 7 case, the expenses of the Chapter 7 have priority over Chapter 11 expenses. More often than not, there are no funds available after the payment of Chapter 7 expenses and the Chapter 11 fees and expenses are not paid.
- If a lender has a security interest in cash and accounts of the company, there may be no unencumbered funds for fees and expenses, and the lawyer must seek approval from the creditor.
- Lawyers for businesses in Chapter 11 cannot discontinue representing the debtor without Court approval.
These rules mean that lawyers representing Chapter 11 debtors must request an initial retainer that will provide some protection that they will be paid for their services. Typically, lawyers will consider the nature of the business and the issues leading to the Chapter 11 filing, and request a retainer that will cover them for the first few months of the case.
Let’s look at a small manufacturing or retail business that has been hit hard by the economy and is facing. In the first few weeks of the Chapter 11 case:
- Detailed schedules must be completed, including historical financial information, all debts and creditor contact information, a list of all assets, and information about prior payments to creditors and insiders.
- Documents must be gathered and provided to the United States Trustee, including bank account statements, a budget, tax returns, balance sheets, profit & loss statements, and other documents. A meeting is held with the U.S. Trustee within two to three weeks of filing.
- The first meeting of creditors is scheduled about a month after filing.
- If a secured creditor has a security interest in cash and accounts, a motion is filed and a hearing scheduled to get approval to use funds of the business.
- Other emergency motions may be necessary, including the continuation of utility service, the payment of salaries, authority to maintain bank accounts, etc.
- The first monthly reports are due, and the first U.S. Trustee fees will be billed.
The items listed above are required in every Chapter 11 case, whether it is a single asset real estate entity or a large manufacturing company. Even if a company decides to seek dismissal of the case soon after filing, the Court and U.S. Trustee normally require that most or all of these requirements are satisfied as a condition of dismissal.
Hopefully this post answers the question of why experienced business bankruptcy lawyers request retainers that may seem large to owners and managers of companies already experiencing financial difficulties. If the company has a chance of success, it is imperative that an experienced lawyer is retained even if the owners wish to get out of Chapter 11 as soon as possible.
Scott Riddle’s practice focuses on bankruptcy and litigation. Scott has represented Chapter 7 and 11 debtors, creditors, trustees and other interested parties in bankruptcy cases and bankruptcy litigation. For more information, click here.