Business Bankruptcy Attorney: 7 Things to Establish Before Signing the Engagement

The engagement letter decides whose lawyer this is, and it does so weeks before anyone at the courthouse reads a schedule. Owners tend to sign it the way they signed the merchant cash advance agreement that brought them here, at a kitchen table, with the pages they did not read folded under the ones they did.

A business bankruptcy attorney is hired by an entity that cannot speak for itself, paid with money that may belong to creditors, and approved (in Chapter 11) by a judge who never saw the letter. Seven points in that document deserve settling before the signature, because each one becomes harder to change after the petition is filed.

1. The Company Is the Client, and the Owner Is a Constituent

The American Bar Association's model rule on the organization as client states the premise plainly: a lawyer retained by an organization "represents the organization acting through its duly authorized constituents." The owner who signs the letter, pays the retainer, and answers the lawyer's calls is, in that sentence, a constituent.

The same rule permits a lawyer to represent a director or shareholder as well, subject to the conflict rules, and where consent is required it must come from an official other than the person being represented. In a company with one member, that last requirement produces an odd little ceremony. The letter should say, in words, whether the owner personally is a client.

2. The Personal Guaranty Needs Its Own Paragraph

When the debt carries a personal guaranty, the automatic stay offers the guarantor very little. The Second Circuit said as much in Queenie, Ltd. v. Nygard International (2003):

A suit against a codefendant is not automatically stayed by the debtor's bankruptcy filing.

So the company can be in Chapter 11 on a Monday while a funder pursues the owner on the guaranty that same week. Courts can extend protection to a non-debtor in limited circumstances, on motion, and that is a motion someone must decide to file. If company counsel will not advise the owner on the guaranty, the letter should say so, and the owner should retain separate counsel before the petition rather than after the first personal summons.

3. Disinterestedness Is Measured Against a Statute, Not a Feeling

In Chapter 11, debtor's counsel is employed under Section 327(a) of the Code, which permits only professionals who "do not hold or represent an interest adverse to the estate" and who are "disinterested persons." The Code then defines the phrase with some precision in § 101(14): a disinterested person is not a creditor, an equity security holder, or an insider, and is not and was not, within two years before the petition, a director, officer, or employee of the debtor.

Several ordinary arrangements fail that test. A lawyer who sits on the company's board fails it. A lawyer who holds a membership interest fails it. A lawyer who performed restructuring work last spring and was not paid for all of it may now be a creditor of the company, which is how a trusted adviser can learn that trust is not a qualification. (Subchapter V softens this in one respect: under § 1195 a professional is not disqualified solely for holding a prepetition claim of less than $10,000.)

Prior work for the company is a different matter. Section 1107(b) says a person is not disqualified "solely because of such person's employment by or representation of the debtor before the commencement of the case." The lawyer who drafted the company's operating agreement can still become its Chapter 11 counsel, provided nothing else on the list applies.

The harder cases involve the other side of the table. A firm that has represented a funder of merchant cash advances in unrelated matters is not automatically barred, because § 327(c) disqualifies creditor representation only where another creditor or the United States Trustee objects and the court finds an actual conflict of interest. Whether that is comfortable for the owner is a separate question, and the letter is the place to answer it, since the lawyer's verified statement of connections under Bankruptcy Rule 2014 will disclose the relationship to everyone else anyway. It is better to read that list in the office than on the docket.

4. The Retainer Has a Source, and the Court Will Ask About It

Section 329(a) requires any attorney representing a debtor to file a statement of compensation paid or agreed to be paid within one year before the petition, "and the source of such compensation." Bankruptcy Rule 2016(b) sets the deadline: two weeks from a voluntary petition (which is itself the order for relief), whether or not the lawyer ever applies for fees.

The source matters more than owners expect. A retainer wired from the owner's personal account (which can happen when the company's operating account has already been restrained, and which quietly returns the engagement to the question of whose lawyer this is) will appear on that statement with the owner's name beside it. Nothing about that is improper. It should be anticipated in writing, with a sentence about whether the payment makes the owner a client or merely a benefactor.

5. Name What the Fee Does Not Buy

Bankruptcy Rule 7001 lists the disputes that become adversary proceedings, which are lawsuits within the case, with their own complaints, answers, and discovery. The list includes proceedings to determine "the validity, priority, or extent of a lien," proceedings to recover money or property, and proceedings to determine whether a debt is dischargeable.

Each of those has an obvious merchant cash advance version. A funder's UCC filing may be contested. A trustee or debtor in possession may pursue payments made shortly before filing. An owner in a personal case may face a dischargeability complaint. An engagement letter can exclude every one of them from the quoted fee, and a letter that is silent on adversary proceedings has, if we are being exact, left the price of the case's most expensive parts unwritten.

6. Later Litigation May Belong to Special Counsel

Section 327(e) allows the estate to employ, for a "specified special purpose," an attorney who previously represented the debtor, if the attorney holds no adverse interest on that matter. The company's existing litigation counsel in a state court collection suit is the obvious candidate.

The engagement letter should say who handles that work after filing, and whose application brings that lawyer before the court.

7. The Chapter Named in the Letter Can Change

A debtor in possession may convert its Chapter 11 case to Chapter 7, and under § 1112(b) the court may convert it for cause on a creditor's request. The filing fees alone show the difference in scale: $1,738 at filing for Chapter 11 and $338 for Chapter 7, under the current federal fee schedules, with a debtor who converts from Chapter 7 to Chapter 11 paying the difference. The lawyer's role changes more than the fee does. In a converted Chapter 7 a trustee takes control of the estate and the company's lawyer is no longer estate counsel under § 327.

The letter should state what happens to the engagement, and to any unapplied retainer, if the case changes chapter. The question costs one sentence.

Where Delancey Street Sits Relative to This Letter

Delancey Street has no part in this letter. A debt settlement company and not a law firm, it signs no bankruptcy engagements, prepares no petitions, and has no place at counsel table. Its work sits on the other road: a free and confidential first look at whether merchant cash advance balances and related obligations can be resolved by negotiation, with independently licensed attorneys brought in by coordination whenever a legal question surfaces.

Some businesses need the letter described above more than they need a negotiation. A company whose accounts are already frozen, whose landlord is days from a lockout, or whose owner faces guaranty suits in several states may need the stay and the court's supervision that only a filing supplies. Others reach bankruptcy counsel with a debt problem that a written settlement would have resolved at lower cost. Knowing which one a business is comes before either signature, and it is the kind of knowledge that makes every later document easier to read.