Prohibited and Allowed Fee-Sharing Under 11 U.S.C. § 504
Rubin & Levin, P.C.; Indianapolis
At times, it is necessary to hire special or co-counsel in a bankruptcy case when the case involves matters that are beyond the expertise of debtor’s counsel, such as tax law or personal-injury litigation. These employments can run afoul of the Bankruptcy Code if the applications to hire and payment of attorney fees are not handled in an appropriate manner. Section 504 of the Code prohibits fee-sharing among persons who are not employed by the same firm. The prohibition applies to any “person receiving compensation or reimbursement under section 503(b)(2) or 503(b)(4) and includes trustees, ombudsmen, examiners, attorneys, accountants, appraisers, auctioneers and other professional persons employed under section 327 or 1103 of the Bankruptcy Code.” In addition, the Bankruptcy Code and Federal Rules of Bankruptcy Procedure require full disclosure of any fee-sharing or agreement to share fees. Courts narrowly review any application where fee-sharing is suggested.
In re Ihe: Fee-Sharing Employment Application Denied by Texas Bankruptcy Court
Earlier this year, the U.S. Bankruptcy Court for the Southern District of Texas decided In re Ihe in which the court denied an application by a chapter 13 debtor attempting to hire Ryan B. Bormaster of RB Bormaster & Associates, PC and Jason Itkin of Arnold & Itkin, LLP as special litigation co-counsel for his personal-injury case. In Ihe, the application to employ was filed by Bormaster on behalf of both attorneys and the debtor. The proposed engagement agreement provided that Bormaster and Itkin would share any recovered fees after Bormaster received the first $80,000 from any fees recovered. In addition, Bormaster also proposed to split his share of the fees with a previous employer, D. Miller & Associates, PLLC, pursuant to the fee arrangement that had been in place with Miller prior to Bormaster’s departure. In denying the application, the court held that the fee-sharing provisions of the engagement agreement violated § 504(a) and that exceptions under § 504(b)(1) did not apply.
The application failed for two reasons. First, neither Bormaster nor Itkin practiced in the same firm, and as the court noted, this was a violation of § 504(b)(1). Second, Bormaster’s splitting of his fee with his prior employer also violated § 504 because that prior employer had no relationship with the debtor and was not filing a separate application for employment.
If one of Ihe’s proposed special counsel had been “of counsel” with the other’s firm, or if Bormaster had been retained via an “of counsel” relationship with his former firm, the court’s decision in Ihe may have gone the other way. Section 504(b) provides that it is permissible to share fees with a “member, partner, or regular associate” of the firm, which includes a “professional association, corporation, or partnership,” as long as it is timely disclosed. Members of the same firm can share fees without a concern that this violates § 504, and if a lawyer can be found to be an associate or “of counsel” to a law firm, the exception to § 504 applies and fee-sharing is not prohibited. However, the Bankruptcy Code does not define the phrase “regular associate.” Bankruptcy Rule 9001(10) defines a “regular associate” as “an attorney regularly employed by, associated with, or counsel to an individual or firm.” However, this definition lacks clear guidance.
Factors that Evidence “Regular Associate” or “Of Counsel” Status
So what constitutes a “regular associate”? What proof is necessary to demonstrate that an attorney falls within the exception of § 504(b)? Some cases have cited to the some of the following factors as evidence of “regular associate” status:
1.The attorney is on the payroll as an employee and client fees do not affect compensation;
2.The associated attorney is listed as “of counsel” on the law firm letterhead and is listed as an attorney on pleadings with the court;
3.The attorney is supervised by the firm;
4.The attorney is on the firm’s malpractice policy;
5.The attorney is provided a desk, computer and supplies; and
6.The attorney is paid on an hourly basis and not as a share of the client’s fees.
Direct Retention by Debtor or Trustee
A direct hire by the debtor or trustee is the cleanest method to avoid a problem with fee-splitting. If special counsel, an accountant or other professional and debtor’s counsel are separately retained, then it is difficult to see how any professional could be found to be in violation of the § 504. Thus, in Ihe, each proposed special counsel could have been engaged separately by the debtor whereby the fee would be calculated on the gross recovery to the debtor, the fee would be separately calculated, and neither attorney would be expected to receive a percentage of the other’s recovery.
A similar type of fee-sharing arrangement was approved by the bankruptcy court in In re Age Refining Inc. In Age, the trustee sought to hire his counsel as well as counsel for the creditors’ committee as special litigation co-counsel specifically for the pursuit of avoidance actions. The two firms were to be retained under a payment arrangement whereby hourly rate payments were charged at 85 percent of normal rates, plus a 6 percent contingency to be shared by the two firms on a 50/50 basis. In approving the employment applications, the court raised the § 504 fee-splitting issue on its own, holding that the “split” of the 6 percent contingency fee was “more like a separate agreement to pay each firm a contingency fee of 3% of any award” and that “[n]either firm is expected to look to the other firm for ‘its cut’ of the fee.” Bormaster and Itkin’s fee arrangement could have been so structured.
Regarding Bormaster’s “fee split” with his former firm, the parties could have executed a separate agreement whereby Bormaster’s firm would have assumed a general obligation rather than a split-fee arrangement. In this way, the Ihe decision could possibly have been avoided, and Mr. Ihe’s proposed special counsel retained pursuant to court authority.
 11 U.S.C. § 504(a) and (b). Section 504 provides:
a.Except as provided in subsection (b) of this section, a person receiving compensation or reimbursement under section 503(b)(2) or 503(b)(4) of this title may not share or agree to share —
(1) any such compensation or reimbursement with another person; or
(2) any compensation or reimbursement received by another person under such sections.
a.(1) A member, partner, or regular associate in a professional association, corporation, or partnership may share compensation or reimbursement received under section 503(b)(2) or 503(b)(4) of this title with another member, partner, or regular associate in such association, corporation, or partnership, and may share in any compensation or reimbursement received under such sections by another member, partner, or regular associate in such association, corporation, or partnership.
(2) An attorney for a creditor that files a petition under section 303 of this title may share compensation and reimbursement received under section 503(b)(4) of this title with any other attorney contributing to the services rendered or expenses incurred by such creditor's attorney.
b.This section shall not apply with respect to sharing, or agreeing to share, compensation with a bona fide public service attorney referral program that operates in accordance with non-Federal law regulating attorney referral services and with rules of professional responsibility applicable to attorney acceptance of referrals.
 Robert C. Yan and Louis A. Scarcella, “Fee Sharing under the Model Rules of Professional Conduct and the Bankruptcy Code,” ABI Ethics and Professional Compensation Committee Newsletter, November 2013, available at www.abiworld.org/committees/newsletters/ethics-and-professional-compensa... (Changes to Model Rules by ABA allowing fee sharing does not change result under § 504).
 Fed. R Bankr. P. 2016(a) and (b); 11 U.S.C. § 329(a).
 In re Bradley, 495 B.R. 747, 767 (Bankr. S.D. Tex. 2013).
 No. 14-33382-H3-13, 2014 Bankr. LEXIS 3486 (Bankr. S.D. Tex. 2014).
 Id. at 3-4.
 Id. at 4.
 Id. at 3.
 In re Laberge, 380 B.R. 277 (Bankr. D. Mass. 2008) (failure of debtor’s attorney to disclose agreement with the contract attorney precluded him from receiving any compensation from the chapter 7 representation).
 Fed. R. Bankr. P. 9001(10).
 See Morgan D. King, “Fee Splitting; Between the Devil and a Boulder,” 7 Norton Bankr. L. Adviser 1, 10 (2012) (Mr. King’s cited cases listed in footnotes 13-18 below).
 In re Brown, 2011 Bankr. LEXIS 433 at 24-25 (Bankr. W.D. Mo. 2011); McDonald V. Southern Farm Bureau Life Ins., 291 F.3d 718 (11th Cir. 2002).
 In re Sheehan Memorial Hospital, 380 B.R. 299 (Bankr. W.D.N.Y. 2007).
 In re Worldwide Direct Inc., 316 B.R. 637, 648 (Bankr. D. Del. 2004).
 In re Greer, 271 B.R. 426 (Bankr. D. Mass. 2002).
 In re Worldwide, supra note 15, at 648.
 Quesada v. U.S. Trustee, 222 B.R. 193 (D.P.R. 1998).
 447 B.R. 786 (Bankr. W.D. Tex. 2011).
 Id. at 793.
 Id. A party to be sued objected to the Trustee’s application because it (1) improperly permitted the committee to pursue avoidance actions, (2) improperly changed the role of the trustee’s counsel, (3) duplicated efforts, and therefore disclosure of the firms’ respective roles should be revealed, and (4) improperly required consultation with JPMorgan (secured creditor) regarding any settlement proposal. Id. at 794-795.
 Id. at 799.