Decided August 26, 2004 by a bankruptcy court in North Dakota in the Eighth Circuit

In this case, an attorney used a one-contract retainer agreement in which the attorney offered to redeem a vehicle for a debtor in exchange for the debtor’s promise to pay $600. The debtor signed and accepted this agreement before the petition was filed.

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After the petition was filed, the attorney completed the work needed to redeem a vehicle for the debtor. A third party financing company (722 Redemption Funding, Inc.) then made a postpetition loan to the debtor, the proceeds of which were disbursed to redeem the debtor’s vehicle, as well as to pay debtor’s counsel for the attorney’s fees associated with the vehicle redemption.

Citing Bethea v. Robert J. Adams Associates, the court held that:

the elements necessary to create a right of payment under the relevant contract law occurred pre-petition. Thus, the claim resulting from the motion to redeem [which was performed postpetition] is a pre-petition contract-based claim. Thus, … the collection of any sums during bankruptcy is a violation of the automatic stay, and as such, the sums so collected must be refunded.

The court also commented at length about Bethea’s comments in dicta about how a debtor “can tender a smaller retainer for prepetition work and later hire and pay counsel once the proceeding begins [and after the petition is filed].” The court interpreted Bethea’s comment to mean the following:

[T]he future debtor and his bankruptcy counsel would both voluntarily enter into a pre-petiton contract that requires counsel to perform legal services only to the point of filing the bankruptcy case (and perhaps a handful of post-petition services that might include the §341 meeting); then, if further post-petition services were desirable or necessary, the debtor would have to seek to re-retain the same (or possibly another) bankruptcy attorney for an additional fee that the debtor would not be contractually obligated to pay until after the case is filed.

The court notes that Bethea’s proposed solution did not explicitly address how bankruptcy attorneys could avoid creating a conflict of interest when they advise a debtor to reaffirm a prepetition retainer that entitles the client to receive postpetition legal services. This conflict of interest arises when attorneys ask a court to further the attorneys’ interests (by reaffirming a prepetition agreement that creates a new debt for a debtor in exchange for certain legal services), when that lies in opposition to debtors’ interests (as debtors can already legally obtain those legal services for free because the the debtors’ promise to pay are stayed by the filing of a bankruptcy, while the attorney still has an obligation to provide those legal services).

The court notes that to eliminate this conflict of interest, an attorney must use a two-contract bankruptcy retainer agreement that strictly segregates services into two parts:

A … potential solution to the problem posed by Bethea would be for the debtor and the bankruptcy attorney to enter into a pre-petition retention contract requiring the attorney to perform either no post-petition services or very limited ones not including redemption work; then these parties could potentially enter into a postpetition contract for post-petition services the attorney has not already agreed to perform, creating a new post-petition claim. The trick here is that the post-petition contract must really be a post-petition contract. That is, the legally operative events — the offer, acceptance, and exchange of consideration (either a promise to pay or an act of payment in exchange for a promise to render services) — must in fact occur after the date of the Chapter 7 filing to qualify as a claim arising post-petition and falling outside the scope of §362(a)(6).

As the judge observes, attorneys using this segregated two-contract approach will never have to advise debtors to reaffirm a prepetittion retainer agreement, because the only agreement needed postpetition would be a postpetition retainer agreement covering postpetition issues. This eliminates any conflict of interest associated with a reaffirmation of a prepetition retainer agreement.

This segregated two-contract approach is a pillar of the modern bifurcation.

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