Restructuring

Contributed by Debra McElligott
When the Bankruptcy Code clashes with state or local law regarding procedures for attorneys to collect unpaid bills from clients, which law should the courts apply?  In a recent decision, the United States Bankruptcy Court for the District of New Jersey held that the Bankruptcy Code’s automatic stay preempted a conflicting state rule regarding notice to clients in professional fee disputes.  The opinion, however, suggests that courts should not blindly apply the Bankruptcy Code whenever another law appears to pose a conflict in this arena.  Rather, courts should consider two factors to determine the outcome: the nature of the attorneys’ claims (secured versus unsecured) and the possibility that both laws can be enforced together.
In In re Microbilt Corporation, a law firm, Maselli & Warren, filed a proof of claim for a prepetition claim of over $50,000 in unpaid legal fees for representation prior to the bankruptcy.  Microbilt did not file a timely objection to the firm’s claim, thus deeming it allowed under section 502(a) of the Bankruptcy Code.
After Microbilt filed a certification stating that it had made all payments to prepetition unsecured creditors under its confirmed plan, Maselli & Warren sought an order directing Microbilt to pay out the allowed claim.  In response, Microbilt claimed that the firm’s proof of claim was defective because it failed to give proper pre-action notice under a New Jersey court rule of procedure prohibiting attorneys from filing suits to recover fees before giving thirty days’ notice to the client, as well as notice of the right to request fee arbitration.  The firm, on the other hand, argued in part that it could not serve notice under the New Jersey rule without violating the automatic stay provided by the Bankruptcy Code.
Relying on the Third Circuit’s decision in Simon v. FIA Card Services, N.A., the bankruptcy court in Microbilt held that the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure trumped the New Jersey state court practice rule.  In Simon, the debtor filed a lawsuit pursuing claims for violations of the Fair Debt Collection Practices Act (FDCPA).  The District Court dismissed, ruling that the Bankruptcy Code precluded the FDCPA claims.  The Third Circuit modified the ruling, holding that blanket preclusion was inappropriate; rather, the Bankruptcy Code prevails only where there is a direct conflict between the Code and the FDCPA.  In Simon, due to the “Hobson’s choice” facing a party that would violate the automatic stay if it sent a notice required by the FDCPA but would violate the FDCPA by not sending a notice, there was an actual conflict and the Bankruptcy Code prevailed.  Applying the Third Circuit’s rationale to the Microbilt case, the bankruptcy court similarly found a direct conflict, as the firm’s choice was not really a choice at all: no matter what action it took, it would either be violating the state rule or violating the automatic stay.
The bankruptcy court factually distinguished the conflict in Rapid Freight Systems, Inc., which Microbilt relied on in its argument.  In that case, the court examined whether an attorney’s lien securing prepetition fees was unperfected due to the attorney’s failure to serve the pre-action notice.  The bankruptcy court in that case, relying on the United States Supreme Court’s decision in Butner v. United States, found that the state rule applied because a lien represents a property interest, and applicable state law determines property rights in bankruptcy.  The Microbilt court stated that this decision reflected a correct application of Butner, but that the decision was inapplicable to the case before it because the firm was seeking treatment as a general unsecured creditor.
The bankruptcy court’s analysis in Microbilt suggests that courts should consider two factors in determining whether the Bankruptcy Code prevails over state law in a fee dispute: first, what type of prepetition claim the attorney is seeking, and second, whether there is a way to enforce both apparently conflicting laws.  If the claim is a general unsecured claim, the Bankruptcy Code will probably prevail, because no property rights are at issue.  On the other hand, if the attorney holds a security interest, which the court considers a property interest, applying Butner will necessarily place the matter in the realm of state law.  To the extent that the Bankruptcy Code and a seemingly conflicting law can actually be applied together, there is no true conflict and both laws govern the dispute.