Morris v. King (In re Rosales), Case No. 17-10729

Decision Date26 October 2020
Docket NumberAdv. No. 19-5126,Case No. 17-10729
Citation621 B.R. 903
Parties IN RE: Isidro ROSALES, Jr., Reyna S. Lopez, Debtors. J. Michael Morris, Trustee, Plaintiff, v. Timothy J. King, and Law Office of Paul Hogan, LLC, Defendants.
CourtU.S. Bankruptcy Court — District of Kansas

J. Michael Morris, Wichita, KS, pro se.

Timothy J. King, Wichita, KS, pro se.

Paul D. Hogan, Hogan & Keil, P.A., Wichita, KS, for Defendants.

MEMORANDUM OPINION

Mitchell L. Herren, United States Bankruptcy Judge

In this Chapter 7 to Chapter 13 and back to Chapter 7 bankruptcy case, settlement proceeds from a co-debtor's personal injury lawsuit during Chapter 13 proceedings were improperly used by the debtors. After failing to collect the net proceeds of the settlement from the debtors, the Chapter 7 trustee filed this adversary proceeding against debtors' personal injury attorneys for turnover of the settlement proceeds and disgorgement of the fees and expenses paid to them from the settlement.

Attorneys employed by Chapter 13 debtors are subject to turnover under 11 U.S.C. § 542(a) if the settlement proceeds are property of the estate, the attorneys knew of the bankruptcy, and were in possession, custody, or control of the settlement proceeds during the case. In addition, attorneys employed by Chapter 13 debtors in connection with a bankruptcy case are required to disclose the terms and source of compensation and any fee-sharing arrangements under 11 U.S.C. § 329 and Fed. R. Bankr. P. 2016. Upon conclusion of the matter, by way of settlement or otherwise, attorneys must also file a fee application for review by the bankruptcy court and obtain allowance and court approval of their fees and expenses under § 329, § 330(a)(4)(B), and Rule 2016. Failure of counsel to do so can have severe consequences that include disgorgement of their fees and expense reimbursements, even when the attorneys provided value to the bankruptcy estate.

As discussed below, the trustee's turnover complaint and request for disgorgement of attorney fees and expenses is granted for the reasons stated in this opinion.1

I. Jurisdiction

An action for turnover of property of the estate under § 542(a) is a core proceeding over which the Court has subject matter jurisdiction.2 Whether an attorney must disgorge fees for failure to comply with §§ 329 and 330 and Rule 2016 is a matter concerning administration of the bankruptcy estate, and is also a core proceeding.3 The parties have stipulated to the Court's jurisdiction and consent to the Court's entry of a final order.4

II. Findings of Fact 5

Debtor Lopez was injured in a car accident on December 4, 2015. She retained the services of Law Office of Paul Hogan, LLC (Hogan) on June 15, 2016 to pursue her claim for injuries on a contingency basis.6 Lopez's fee agreement provided that if a lawsuit was necessary to obtain recovery, Hogan could refer the matter to another attorney whom would share in the fee.

On April 26, 2017, debtors filed a voluntary Chapter 7 bankruptcy. J. Michael Morris was appointed Chapter 7 trustee (Morris or Trustee). Debtors did not initially disclose the existence of the prepetition car accident or any claims against third parties arising therefrom on their bankruptcy schedules.7

Chapter 7 Trustee's Employment of Attorneys as Special Counsel to Prosecute Debtor's Prepetition Personal Injury Claim

On August 29, 2017, Morris filed an application to employ Hogan under § 327(e) for the special purpose of representing the estate in Lopez's personal injury claim on a proposed one-third contingency fee basis.8 Morris filed an identical § 327(e) application on October 6, 2017 to employ Timothy J. King (King) to represent the estate in the same matter.9 King's affidavit stated that he would share a combined one-third contingency fee with Hogan.10 The Court approved both employment applications; the orders approving King's and Hogan's employment as special counsel provided that their compensation would be subject to the Court's review upon the attorneys' final application for allowance of fees.11

On November 10, 2017, King filed a petition in state court against KW, the individual who allegedly caused Lopez's injury.12 That suit was brought in the name of Morris, as Trustee of the bankruptcy estate of Lopez. In the petition, King alleged that Lopez's cause of action is property of the bankruptcy estate being administered by Morris.

The Chapter 13 Proceedings

On February 8, 2018 debtors moved to convert their Chapter 7 case to Chapter 13 under § 706(a).13 Morris objected14 but the Court granted the motion to convert on April 13, 2018 on the condition that:

(a) any and all net recovery from the personal injury action be [sic] shall be turned over to the Chapter 13 Trustee; and (b) the case shall be re-converted to Chapter 7, rather than dismissed, in the event a Plan is not confirmed or the Debtors default on any confirmed Plan.15

Upon conversion of the bankruptcy case to Chapter 13, King substituted Lopez for Morris as plaintiff in the state court action.16 Lopez executed an addendum to the Hogan fee agreement on April 17, signifying her retention of King for the personal injury claim under the same terms and conditions as Hogan.17 Debtors amended their bankruptcy Schedule A/B on May 18, 2018, disclosing the personal injury claim.18

Debtors' Employment of Attorney King to Prosecute Lopez's Personal Injury Claim on behalf of the Chapter 13 Estate

After conversion to Chapter 13, debtors filed an application to employ King as special counsel for the estate and to represent debtor Lopez on the personal injury claim.19 The application stated that King would be paid fees on a contingency fee basis "pursuant to the attached employment agreement."20 However, the employment agreement was not in fact attached to the application.21 Nor did the application reference the pending state court lawsuit.

King's affidavit under D. Kan. L.B.R. 2014.1 was attached to the application. In it, King averred he was disinterested and that he was qualified to represent Lopez "as special counsel for the estate."22 King also stated that he "underst[ood] that the Court's approval of the Application for employment is not approval of any proposed terms or [sic] compensation ..."23 On June 14, 2018, the Court signed an "Order Granting Debtors' Application Pursuant to § 327(e) to Employ Timothy J. King as Special Counsel for the Estate," on the terms set forth in the application.24 The Standing Chapter 13 Trustee Carl Davis approved the Order.

Neither debtors' employment application nor King's affidavit mentioned a fee sharing agreement with Hogan or its terms. Hogan was not similarly employed by debtors during the Chapter 13 case. Neither King nor Hogan filed a Rule 2016 disclosure of compensation.25

The Chapter 13 Plan

Debtors filed their Chapter 13 plan on April 18, 2018.26 In it, they proposed to make plan payments of $150 per month for thirty-six months. In addition to the monthly payments, Debtors proposed to "pay to the [Chapter 13] Trustee all amounts necessary to pay all timely filed and allowed claims in full out of any net recovery from a pending personal injury claim being prosecuted by attorney Tim King."27 Under Section 16 of the plan, all property of the estate would vest in debtor "at discharge or dismissal of the case," not at confirmation. Debtors' plan included the following non-standard provision: "Debtors will file an application to approve the employment of attorney Tim King to prosecute a personal injury claim on behalf of the bankruptcy estate , with all timely filed and allowed creditor claims paid from the net recovery."28

On July 31, 2018, the Court confirmed debtors' Chapter 13 plan as modified.29 Specifically, the confirmation order provided that "in the event of post-confirmation default, the [Chapter 13] Trustee will seek re-conversion of the case pursuant to the Order Granting Debtors' Motion to Convert to Chapter 13 entered April 13, 2018."30 The debtors were obligated to report to Trustee Davis any proceeds received from the personal injury lawsuit, by settlement or otherwise, during the pendency of the case, and were prohibited from disposing of the proceeds without prior court order.31 With respect to vesting, the confirmation order provided that "all property of the bankruptcy estate that is not proposed or reasonably contemplated to be distributable under the Plan, shall re-vest in Debtor as Debtor's property following dismissal or discharge , unless the property earlier vested by terms of the confirmed plan."32

The Personal Injury Settlement and Re-Conversion to Chapter 7

By a January 9, 2019 e-mail, King advised Trustee Davis that the insurer had made a "final and best" settlement offer of $22,500 on Lopez's personal injury lawsuit.33 Apparently weighing whether to accept the offer, Lopez inquired how much of that amount Trustee Davis would receive if she settled the lawsuit. Davis's office responded six days later that $18,163 was needed to complete her case. In other words, the settlement offer was insufficient to pay both King's fee and all creditors' claims in full. At the time the Chapter 13 Trustee's office responded, King held the $22,500 settlement check from Progressive Insurance dated January 11, 201934 made payable to his trust account and O/B/O Reyna Lopez. King did not request Trustee Davis's approval of the settlement.

Notwithstanding the shortfall, on January 28 Lopez directed and authorized King to settle the lawsuit for $22,500.35 She also executed a settlement statement that set forth the deductions for expenses ($681.56) and a one-third contingency fee ($7,272.81), yielding a net recovery of $14,545.63 to Lopez. King delivered to Lopez that same day a check drawn on his trust account and made payable to Lopez in the amount of $14,545.63.36 He reminded Lopez that "these funds are subject to your Chapter 13 bankruptcy," and advised her to contact her bankruptcy attorney before spending the money in any...

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