The Journal of The DuPage County Bar Association

Back Issues > Vol. 10 (1997-98)

Bankruptcy and Personal Injury Cases
By Brenda Porter Helms

The interaction between Federal bankruptcy statutes and State Court litigation is not always smooth. This is especially true in the case of personal injury litigation.

For the purposes of this article, the following assumptions are made: You are an attorney in DuPage County practicing primarily in the area of personal injury, medical malpractice and tort. You have a client who has been injured in an automobile accident, suffering injuries which required medical attention. The client incurred medical bills in excess of $50,000, lost months of time from work and continues to require medical treatment. You have filed a complaint in the Circuit Court of DuPage County, alleging negligence on behalf of several defendants and demanding damages in excess of $50,000. You have taken a substantial amount of discovery and have responded to discovery served upon you by the defendants. The case is scheduled for trial in two months.

Due to the press of the medical bills, a job loss and other personal factors, the client has been forced to file a chapter 7 bankruptcy proceeding pursuant to Title 11 United States Code. A Trustee has been appointed by the Office of the United States Trustee and your client has attended a first meeting of creditors with her bankruptcy lawyer, the Trustee and any creditors who chose to appear.

At the first meeting of creditors, the Trustee questioned the debtor about the personal injury lawsuit that was pending. Your client is sure that she will receive more than $7,500 from the settlement or trial of the lawsuit. She responded that she was grievously injured and she found a wonderful personal injury attorney who has assured her she will be getting either a big settlement or a large verdict at trial. Your client’s bankruptcy lawyer has claimed $7,500 of the proceeds of the settlement exempt pursuant to 735 ILCS 5/12-1001(h)(4). The Trustee has asked your client for your name and telephone number and you have just received a letter from the Trustee asking you to turn over the file and your assessment of the case..

The Lawsuit Becomes Property of The Bankruptcy Estate

The filing of a bankruptcy petition by your client creates a bankruptcy estate which the Trustee is appointed to administer. Pursuant to 11 U.S.C. section 541(a), property of the estate consists of all legal or equitable interests of the debtor in property as of the commencement of the case.

The right to the proceeds of the personal injury lawsuit become property of the estate and, upon the filing of the bankruptcy, the Trustee succeeds to any right of the debtor in the lawsuit.

The Trustee may pursue or abandon the personal injury lawsuit depending on the Trustee’s judgment of its value and benefit to the estate.

If the lawsuit is likely to bring into the estate more than $7,500, plus payment of any bona fide liens, and any attorneys fees, the Trustee may decide to pursue the lawsuit. In deciding whether to pursue or abandon the personal injury lawsuit, the Trustee will also take into account the amount of debt your client has incurred and the burden to the estate in pursuing the lawsuit.

Bear in mind, the Trustee’s goal is to make a substantial distribution to the creditors.

The first thing the personal injury attorney should do is contact the Trustee and give her a short assessment of the likelihood of success on the merits.

You should also be prepared to give or send the Trustee a short synopsis of your credentials as a personal injury attorney.

Some trustees know an attorney to whom they refer most of their personal injury cases. Other Trustees prefer to allow the case to continue to be handled by the debtor’s initial attorney, assuming the personal injury attorney is competent to do so.

If the Trustee decides to hire her own personal injury attorney, you must turn over your file to the new attorney. 11 U.S.C. section 542(e).

Obtaining Employment as Special Counsel

If the Trustee decides that you should continue to handle the case, court approval must be obtained for your continued employment.

Your client is now the Trustee. The Trustee will prepare the necessary documents to obtain court approval.

You should review the list of creditors of the debtor and see if you have any conflicts of interest. Generally, an attorney who has represented the debtor pre-petition is not a "disinterested person" pursuant to 11 U.S.C. section 327(a). However, pursuant to 11 U.S.C. section 327(e), the Trustee, with the court’s approval, may employ for a specified special purpose, other than to represent the trustee in conducting the case, an attorney that has represented the debtor, if it is in the best interest of the estate and if such attorney does not represent or hold any interest adverse to the debtor or to the estate.

The fact that you have handled the litigation and are the most familiar with the facts and circumstances may make your continued employment as special counsel in the best interest of the estate. Your failure to be properly employed puts your compensation at risk.

In addition, you must also reach an agreement with the Bankruptcy Trustee regarding how you will be compensated for your services.

In most cases, a contingent fee agreement is reached and that arrangement should be fully disclosed in the motion seeking approval of your employment.

However, the simple fact that you have entered into a contingent fee agreement and that agreement is disclosed to the Court in the motion requesting authority to employ you, does not mean that you will necessarily be compensated on that basis when the case is resolved.

Nor is the Trustee bound by the same agreement that you had with the debtor.

Further discussion of compensation appears later in this article.

The Trustee will draft an affidavit for your signature disclosing any contacts between you and creditors of the debtor and setting forth your experience in personal injury matters.

You should not proceed with the litigation until you receive a copy of the court order approving your employment. Those lawyers who render services without court approval are deemed to be mere volunteers and volunteers do not get paid.

If for some reason the Trustee decides to have another lawyer handle the case, you should monitor the bankruptcy case and be prepared to file a proof of claim. You may be entitled to fee compensation on a quantum meruit basis.

If the Trustee does hire you as special counsel, you must immediately start doing one additional task: RECORD YOUR TIME SPENT ON THE FILE ON A DAILY BASIS. While this may not be second nature to you, it is required in bankruptcy cases when fees are requested.

Authority To Settle

There is no need to obtain an order from the bankruptcy court modifying the automatic stay contained in 11 U.S.C. section 362 if the debtor is the plaintiff in the lawsuit. The automatic stay applies only to actions pending against the debtor, not to actions that the debtor is pursuing. However, if the defendants have a counterclaim or affirmative defenses against the debtor, they will need to obtain relief before proceeding on those issues.

Let us now assume the defendants make a generous settlement offer prior to trial of $80,000. You must communicate that offer directly to the Trustee. It is the Trustee who has the right to accept or reject any offers, presumably after consulting with you on the likelihood of success at trial.

If the Trustee decides to accept the offer, she must obtain court approval. Do not let the circuit court dismiss the case prior to obtaining bankruptcy court approval.

The Trustee will file with the bankruptcy court a Motion for Authority to Compromise ("Motion") pursuant to Bankruptcy Rule 9019. The Motion will set forth the status of the case and the reasons for accepting the settlement. Until the bankruptcy court approves the settlement, the case is not settled. This presents a delicate situation.

If your personal injury case has some weak areas or some facts which might not support such a favorable verdict at trial, the Trustee would not want to admit those facts in her Motion as they might later be held against her by your opponent.

The Trustee and litigation attorney need to carefully consider how the grounds for settlement are set forth in the Motion.

The Trustee must provide adequate grounds so that the Court and the creditors will agree with the Trustee’s decision to settle; on the other hand, the Trustee does not want to irreparably damage your case if the settlement is not approved and you ultimately proceed to trial.

Notice of the proposed settlement must be sent by the Trustee to all creditors of the debtor, the debtor and other parties in interest pursuant to Bankruptcy Rule 2002(a), which requires a twenty day notice. The notice will provide an opportunity for any creditor to object to the proposed settlement if it thinks the Trustee can obtain a better settlement or would be more successful at trial.

The Court can also object to the settlement, as can the debtor. In some situations, the debtor may not be pleased with the settlement the Trustee wishes to accept. If the debtor had hoped for a larger settlement and thinks that the Trustee should be receiving enough money to pay off all her creditors and return a dividend back to the debtor, the debtor may object.

In accepting a settlement, the Trustee and the Court will consider the terms of the settlement compared with the probable complexity, expense, duration and outcome of the litigation at trial. In re Bond, 16 F.3d 408, 30 C.B.C.2d 784 (4th Cir. 1994), In re Energy Cooperative, Inc., 886 F.2d 921, 22 C.B.C.2d 1224 (7th Cir. 1989).

The Trustee will also consider the amount of debt listed on the debtor’s bankruptcy schedules.

If the Court, a creditor or the debtor objects to the proposed settlement, the bankruptcy court will require a briefing of the Motion and, since there are usually factual issues involved, a hearing on the proposed settlement.

If the bankruptcy court does not approve the settlement, the case must proceed to trial in circuit court.

Liens, Liens and More Liens

By the time the settlement has been approved and the insurance company or defendant is ready to issue its draft, the debtor has usually received her discharge.

Barring any objection, a discharge is usually entered approximately four or five months after the case is filed and is not contingent upon anything going on in the personal injury lawsuit.

A discharge means that the debtor is no longer legally obligated to pay any of the debts owed pre-petition.

However, those creditors, usually hospitals and doctors, who file liens against the proceeds of the litigation pre-petition are entitled to be paid from the proceeds of the settlement.

The Trustee should request from the personal injury attorney, a copy of all liens on file. All liens that are valid, perfected security interests under the Illinois Compiled Statutes are entitled to payment from the proceeds.

The Trustee should disclose in the notice that is sent to all creditors of the proposed settlement, a listing of the liens she deems to be valid and perfected and the fact that she proposes to pay them from the settlement proceeds.

It is probably a good idea to include the settling party’s attorney on the list of persons who received notice so their insurance company can object if there are additional liens they deem to be secured.

When the Motion is approved, the insurance company should be provided a court order directing them to issue a settlement draft payable to the Trustee in bankruptcy only and also setting forth the liens the Trustee proposes to pay from those proceeds. This Court order should provide adequate assurance to the insurance party that the proper parties are receiving the settlement proceeds.

Authority To Pay Special Counsel

The Trustee must obtain bankruptcy court approval to compensate her special counsel from the settlement proceeds. Pursuant to 11 U.S.C. section 330, after notice and a hearing, if requested, the Court may award to a professional person employed under section 327, actual, necessary, reasonable compensation and reimbursement of actual, necessary expenses.

The only method the bankruptcy court has to determine whether the compensation requested by special counsel is reasonable, actual and necessary is to review time records. Therefore, the records must be submitted to the Trustee and attached to an Application for Compensation ("Application") which the Trustee must file with the bankruptcy court.

All creditors of the debtor and other parties in interest must receive twenty days notice of the Application and an opportunity to object.

The issue of compensation of attorneys in bankruptcy cases has received a lot of attention from the Courts. Generally, the bankruptcy court will award compensation to a professional if: the services that are the subject of the application are properly compensable; 2) the services rendered were actual and necessary; and 3) the services are properly valued. In re Lifschultz Fast Freight, Inc. 140 B.R. 482 (Bankr. N.D. Ill. 1992).

Specifically, to aid in determining factors one through three, above, the Court will require are: 1) billing set forth in tenths, not quarters, of an hour; 2) a full description of each telephone call, court appearance, deposition, letter drafted or reviewed and conference, including the date, the attorney rendering the service and the nature of the service (i.e. telecon w/ J. Doe re: court hearing on 2/9); 3) a description, broken down into appropriate categories, of the legal services provided; 4) the credentials and hourly rate of the attorney providing the services; and 5) any special circumstances involved in the case requiring extra work In re Wildman, 72 B.R. 700 (Bankr. N.D. Ill. 1987).

Expenses incurred must be actual and necessary and enough detail must be given so the Court can make that determination. For example, the amount charged for each photocopy must be included in the application for compensation. In re Convent Guardian Corp., 103 B.R. 937 (Bankr. N.D. Ill. 1989)

The personal injury attorney must keep in mind, that all fees awarded in bankruptcy cases are subject to court approval. It is the responsibility of the personal injury attorney to convince the bankruptcy Court that the fee compensation sought is fair and equitable given the circumstances. Factors the Court may take into account include the novelty or complexity of the issues and the percentage distribution the Trustee will make to unsecured creditors. If the settlement proceeds will be sufficient to pay the one-third attorneys fee, all costs of bankruptcy administration and the creditors in full, it is likely that the bankruptcy court will approve the entire fee requested.

Brenda Porter Helms
is a Principal of Raleigh, Helms & Finke, Wheaton. She represents creditors, debtors and trustees in bankruptcy cases. She received her Undergraduate Degree in 1975 from the University of Wisconsin and her Law Degree in 1982 from Loyola University-Chicago.

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