Contingency and Hybrid Fee Arrangements in Bankruptcy
This article was written for and published in the January 2025 issue of ABI Journal's Straight & Narrow.
Contingency fee arrangements, where attorneys are paid a percentage of the recovery only if the case is successful, and hybrid fee agreements, where the attorney is paid a reduced hourly rate or fixed rate, but accepts an “upside” on contingency, are not new to the legal industry. However, such alternative fee arrangements are not common in bankruptcy, possibly due to the limitations imposed by the Bankruptcy Code and the ethical fee implications of such fee structures. Combine the current high cost of litigation for financially strapped litigants such as debtors and bankruptcy trustees, add material monetary benefits if the case is won, and contingency or hybrid fee arrangements in bankruptcy deserve a closer look.
Debtors and trustees seeking to balance the high risks of litigation by engaging bankruptcy professionals who are willing to accept the risk in light of the prospect of a high economic reward are no different from other clients seeking access to justice. Congress agreed and enacted § 328 of the Bankruptcy Code, which permits the use of alternative fee arrangements in bankruptcy. Common cases in which alternative fee arrangements have been used are stay-violation cases and adversary proceedings. Practitioners willing to take the risk of an alternative fee arrangement must do so within the ethics rules and recognize that despite approval under § 328, bankruptcy courts will continue to review approval of alternative fee awards using a reasonableness standard.
Court Approval and Oversight of Alternative Fee Arrangements
Professionals have the option to be employed and compensated under either § 328 (a) or 330 (a) of the Bankruptcy Code.1Section 328 (a) provides: (a) The trustee, or a committee appointed under section 1102 of this title, with the court’s approval, may employ or authorize the employment of a professional person under section 327 or 1103 of this title, as the case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed- or percentage-fee basis, or on a contingent-fee basis. Notwithstanding such terms and conditions, the court may allow compensation different from the compensation provided under such terms and conditions after the conclusion of such employment, if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.
Several courts have noted that the purpose of § 328 (a) is to allow counsel the option to avoid the uncertainty of what constitutes reasonable compensation under § 330 after the fact, and receive an advance approval of the reasonableness of the fee sought that will only be reconsidered later (i.e., when the final fee application has been filed), if the compensation sought warrants a second look by the court. The U.S. Court of Appeals for the Fifth Circuit has described the difference between fees awarded under § 328 and fees awarded under § 330, noting that the award of a contingency fee “pre-approved” by a court will only be reversed if the fee arrangement was improvident,2while fees sought under § 330 are subject to review for reasonableness under factors illustrated by those set forth in § 330.3
Section 328 expressly indicates that a professional may be employed “on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed- or percentage-fee basis, or on a contingent-fee basis.”4Section 328 provides a useful mechanism by which alternative fee arrangements will be approved, but the section does not deprive the court of assessing the reasonableness of the earned fee at the fee-application stage.
While the improvidence standard cited by the Fifth Circuit may be a lower bar, bankruptcy courts continue to require professionals to substantiate the awarded fees, even assuming that employment is approved under § 328.5Bankruptcy courts inherently impose a reasonableness standard from the beginning of the fee-application process and retain the ability to review alternative fee awards for reasonableness under § 329.6Professionals employed under an alternative fee arrangement should be mindful of the court’s subsequent review of an awarded fee and endeavor to maintain consistent time records should reasonableness of the fees become an issue.7
Ethical Framework Governing Alternative Fee Arrangements
Alternative Fee Arrangements The American Bar Association’s Model Rules of Professional Conduct or similar adaptations of the model rules that each jurisdiction may have governing attorney conduct and fee arrangements provide a framework for ensuring that legal fees are fair and reasonable. In addition, “it is within the court’s inherent power of supervision over the bar to examine the attorney’s fee for conformance with the reasonable standard of the Code of Ethics.”8
Model Rule 1.5 (Fees) requires that fees be reasonable.9The factors to determine reasonableness under the Model Rules are similar to the Johnson factors, including the time and labor required, the skill needed, the fee customarily charged in the locality, and the amount involved and results obtained. In stay-violation cases, this means ensuring that the contingency fee is proportionate to the damages recovered and the effort expended by the attorney. Courts reviewing contingency fee awards in stay-violation cases routinely reduce the contingency fee rate, finding a reduction to be reasonable, normally because the financial risk was not sufficient to justify the rate.10
Courts evaluating hybrid rates also have granted the contingency fee award but required further review of the fixed fee rate using the lodestar method.11
Model Rules 1.7 (Conflict of Interest: Current Clients) and 1.8 (Conflict of Interest: Current Clients: Specific Rules) address conflicts of interest that may arise when attorneys agree to alternative fee arrangements. Under these rules, an attorney should not be motivated by their own self-interest in obtaining a fee and pursue unnecessary litigation.12
The use of hybrid fee agreements might well be viewed as a factor in analyzing whether such litigation was necessary or improvident, or motivated more by the attorney’s self-interest than by the debtor’s needs. Logically, a hybrid arrangement should involve a lower hourly rate coupled with a lower contingency rate.13On the flip side, a hybrid rate might protect an attorney against the client eliminating the benefit of the upside contingency for the client’s own business reasons.
Under Model Rules 1.7 and 1.8, attorneys must also ensure that their financial interests in a contingency fee arrangement do not compromise their duty to act in the client’s best interests. For example, an attorney might be tempted to settle a case quickly to secure a fee, even if pursuing further litigation could yield a better outcome for the client.
Arguments for and Against the Use of Alternative Fee Arrangements
Alternative fee arrangements make it possible for debtors with limited financial resources to obtain legal representation, most notably in circumstances where they seek to enforce their rights under the automatic stay. Since attorneys are paid based on the outcome, their motivation should be aligned with the client to achieve the best possible result, which can lead to more vigorous advocacy. Because the attorney assumes the financial risk of the litigation, a contingency agreement might be more appealing to the client where the outcome is uncertain. The goal should be to agree to a mutually beneficial arrangement.
There are risks on both sides. An alternative fee arrangement could result in a fee that is disproportionate to the damages awarded, particularly if the recovery is small or the case is resolved quickly. As previously discussed, this risk should be low in bankruptcy given the courts’ authority to review fee awards. As such, a downside for the attorney is potentially negotiating an agreement with the client and receiving approval of the agreement under § 328, only to have the fee reduced by the bankruptcy court.
The best practice for attorneys is to review their fee arrangements for compliance with ethical standards and court requirements. An attorney should prepare an agreement that is mutually beneficial and ensures that clients fully understand the terms and implications of the fee arrangement. In addition, the agreement must be clear on the detailed documentation that the attorney will provide the client (and the court) regarding calculation of the fee and the handling of potential costs.
Conclusion
Alternative fee arrangements are a valuable tool for expanding access to justice for debtors facing financial constraints. However, they also present unique ethical challenges that must be carefully managed. By adhering to ethical guidelines and engaging in transparent practices, attorneys can ensure that their contingency fee arrangements serve the best interests of their clients while maintaining the integrity of the bankruptcy process.
1 In re Barron, 325 F.3d 690, 693 (5th Cir. 2003).
2 Some bankruptcy courts have used a list of nonexhaustive factors to assess reasonableness at the employment approval stage, none of which speak directly to the use of an alternative fee arrangement but rather to whether the fee arrangement is normal and the result of arm’s-length negotiation. See, e.g., In re Energy Partners Ltd., 409 B.R. 211, 226 (Bankr. S.D. Tex. 2009). For example, there are cases where a court can find a proposed contingency fee to be per se unreasonable and altogether deny or cancel the fee arrangement. See In re Jones, 356 B.R. 39 (Bankr. D. Idaho 2005) (canceling 75 percent contingency fee arrangement in automatic stay litigation as promoting litigation and putting counsel’s economic interest ahead of client’s interests).
3 In re ASARCO LLC, 702 F.3d 250 (5th Cir. 2012).
4 Several courts have approved contingency fee agreements or “hybrid” agreements. See In re RFS Ecusta Inc., 422 B.R. 53, 56-57 (W.D.N.C. 2009); In re Midway Motor Sales Inc., 355 B.R. 26, 34-36 (Bankr. N.D. Ohio 2006); see also In re Commercial Fin. Servs. Inc., 298 B.R. 733, 750 (B.A.P. 10th Cir. 2003).
5 See In re MMA Law Firm, 661 B.R. 548 (Bankr. S.D. Tex. 2024) (approving employment of debtor’s counsel with hybrid fee arrangement but noting that while subsequent review of such fee arrangement was limited under § 328, reasonableness of fee could be considered).
6 Pursuant to § 329, a bankruptcy court may cancel a fee agreement if the compensation sought exceeds the reasonable value of services.
7 Bankruptcy courts play a primary role in overseeing attorney compensation to ensure that such compensation is reasonable and necessary. The lodestar approach, whereby the court multiplies a reasonable number of hours expended by a reasonable hourly rate, is customarily employed to measure the value of legal services rendered in a case. Courts also routinely rely on the so-called Johnson factors. Johnson v. Ga. Highway Express Inc., 488 F.2d 714, 717-19 (5th Cir. 1974). These factors are largely incorporated into § 330 (a) (3). Regardless, the possibility of a contingency fee is one of the Johnson factors and remains permissible under § 328.
8 In re A.H. Robins Co. Inc., 182 B.R. 128, 136 (Bankr. E.D. Va. 1995).
9 Some jurisdictions’ professional rules, such as California and Texas, reference an unconscionable standard rather than an unreasonable standard. The distinction could be that while a properly negotiated fee may be reasonable, the fee awarded may be considered unconscionable if it is excessive or otherwise “shocks the conscience.”
10 See In re Ferguson, No. 17-41615-JJR, 2019 WL 1270451 (Bankr. N.D. Ala. March 15, 2019) (reducing 45 percent contingency fee as excessive for simple stay violation); Jones, 365 B.R. at 39 (disallowing 75 percent contingency fee and reducing hourly rate by 25 percent in multi-case litigation related to automatic stay violations); In re Buckner, 350 B.R. 874 (Bankr. D. Idaho 2005) (rejecting 50 percent contingency fee for pursuit of alleged violation of automatic stay).
11 See, e.g., In re Adam Aircraft Indus. Inc., No. 08-11751, 2013 WL 414213 (Bankr. D. Colo. Feb. 1, 2013).
12 See Eskanos & Adler PC v. Roman (In re Roman), 283 B.R. 1, 11-12 (B.A.P. 9th Cir. 2002); In re Robinson, 228 B.R. 75, 85-86 (Bankr. E.D.N.Y. 1998) (expressing dismay at notion of § 362 being used to generate legal fees for debtor’s attorney).
13 See, e.g., Marquis Aurbach Coffing PC v. Dofrman, No. 2:15-CV-701, 2016 WL 3395462 (D. Nev. June 13, 2016) (hybrid fee agreement specified that client agreed to pay reduced hourly rate in exchange for reduced contingency rate of 20 percent); In re Adam Aircraft Indus. Inc., No. 08-11751, 2013 WL 414213 (Bankr. D. Colo. Feb. 1, 2013) (firm agreed to 15 percent contingency rate and to charge 75 percent of its normal hourly rate).
