One situation that comes up more often than you might think in bankruptcy practice involves a client who is struggling financially and may also have a potential personal injury claim, wrongful termination claim, employment discrimination claim, or some other legal cause of action.

Sometimes, during an initial bankruptcy consultation, I discover that the person sitting across from me may have a valuable legal claim that has nothing to do with bankruptcy. For example, the client may have been injured in an automobile accident, suffered a serious injury at work, or been terminated under circumstances that may give rise to a wrongful termination or employment discrimination lawsuit.

I will often recommend that the client speak with an attorney who specializes in that particular area of law. After all, bankruptcy attorneys are not personal injury attorneys, and personal injury attorneys are not bankruptcy attorneys. The client deserves advice from someone who regularly handles those types of cases.

But this raises an interesting question: Can the bankruptcy attorney who refers the client to a personal injury attorney receive a referral fee if the personal injury case eventually settles or results in an award?

The answer depends largely on one important consideration: When did the injury or legal claim arise in relation to the bankruptcy filing?

The distinction is particularly important because of the bankruptcy estate and the restrictions imposed by the Bankruptcy Code on sharing professional compensation.

1. What happens when a personal injury claim existed before the bankruptcy filing?

This is where bankruptcy law creates a significant problem for a bankruptcy attorney who might otherwise expect to receive a referral fee.

Under Section 541 of the Bankruptcy Code, when a bankruptcy case is filed, a bankruptcy estate is created. The bankruptcy estate generally consists of all of the debtor’s legal and equitable interests in property as of the date the bankruptcy petition is filed.

Importantly, property includes more than the things we ordinarily think of as assets. It can include:

• A personal injury claim arising from an automobile accident.
• A claim for wrongful termination.
• An employment discrimination claim.
• A claim for unpaid wages or other damages.
• Other legal causes of action that existed when the bankruptcy case was filed.

A person does not necessarily have to have filed a lawsuit before filing bankruptcy for the claim to become property of the bankruptcy estate. The underlying legal right to pursue the claim may itself be an asset.

For example, suppose someone is injured in an automobile accident in January. The individual subsequently experiences financial difficulties and files Chapter 7 bankruptcy in June. The personal injury lawsuit is not filed until August.

Even though the lawsuit was filed after the bankruptcy petition, the underlying personal injury claim arose before the bankruptcy filing. Consequently, it may be property of the bankruptcy estate.

This is an important distinction. The date the lawsuit is filed is not necessarily the date that determines whether the claim belongs to the bankruptcy estate. What matters is when the debtor acquired the underlying legal interest.

2. What is the bankruptcy estate, and who controls the personal injury claim?

When an individual files Chapter 7 bankruptcy, a Chapter 7 trustee is appointed to administer the bankruptcy estate.

The trustee is not simply someone who reviews paperwork and conducts the debtor’s 341 meeting of creditors. The trustee has an important responsibility: identifying assets that may be available to pay creditors.

If the debtor has a personal injury claim that arose before bankruptcy, the trustee may take control of that claim and determine whether pursuing it would benefit the bankruptcy estate.

For example, suppose a Chapter 7 debtor has a personal injury claim arising from a car accident that occurred six months before filing bankruptcy. The debtor may have already hired a personal injury attorney, or the debtor may have never even consulted one.

If the trustee determines that the claim has sufficient value, the trustee may employ a personal injury attorney to pursue the claim on behalf of the bankruptcy estate.

This is where another important distinction comes into play.

The personal injury attorney is no longer simply representing the individual debtor. The attorney is employed to represent the bankruptcy estate.

Under Section 327 of the Bankruptcy Code, a trustee may, with bankruptcy court approval, employ attorneys and other professionals to represent or assist the trustee in carrying out the trustee’s responsibilities.

The personal injury attorney’s job is to pursue the claim for the benefit of the estate. Any recovery, after payment of approved expenses and attorney compensation, may be used to pay creditors, subject to applicable exemptions and other bankruptcy law.U.S. Code+1

3. Why can’t the bankruptcy attorney accept a referral fee in this situation?

The reason is Section 504 of the Bankruptcy Code, which addresses the sharing of compensation.

Section 504 generally prohibits a person receiving compensation under certain bankruptcy compensation provisions from sharing that compensation with another person. There are limited statutory exceptions, including certain fee sharing among members, partners, or regular associates of the same professional association, corporation, or partnership.

The statute is designed to prevent the improper sharing of compensation paid for professional services performed for the bankruptcy estate.

This is important because the personal injury attorney employed by the Chapter 7 trustee is being compensated for services performed on behalf of the bankruptcy estate. The attorney’s compensation is subject to bankruptcy court supervision and the applicable provisions governing professional compensation.

A bankruptcy attorney who originally referred the debtor to that personal injury attorney cannot simply enter into an agreement to receive a percentage of the personal injury attorney’s court-approved compensation.

In other words, the fact that the bankruptcy attorney made the original introduction does not create an exception to the Bankruptcy Code’s fee-sharing prohibition.

The bankruptcy attorney cannot avoid this restriction by calling the payment a referral fee, consulting fee, or some other type of compensation. The substance of the arrangement matters.

There are limited statutory exceptions, but an ordinary lawyer-to-lawyer referral arrangement is not one of them.U.S. Code+1

4. What if the accident occurs after the bankruptcy case is filed?

Now let’s consider a different situation.

Suppose someone files Chapter 7 bankruptcy in January. The bankruptcy case is proceeding normally, and the debtor is preparing for the 341 meeting of creditors.

In March, the debtor is involved in an automobile accident caused by another driver’s negligence.

The debtor suffers injuries and subsequently consults with a personal injury attorney.

Generally, this is a different situation because the accident and resulting personal injury claim arose after the bankruptcy case commenced.

Under the usual Chapter 7 rules, a personal injury claim arising from a genuinely postpetition accident is not property of the bankruptcy estate simply because the debtor previously filed bankruptcy.

The claim belongs to the debtor, not the bankruptcy estate.

Consequently, if the bankruptcy attorney refers the debtor to a personal injury attorney in this situation, the attorney may generally enter into a referral fee arrangement with the personal injury attorney.

Section 504’s prohibition on sharing bankruptcy estate compensation does not ordinarily apply to compensation earned by an attorney representing the debtor in a separate, postpetition personal injury matter that is not property of the estate.

There is, however, an important qualification: Chapter 13 bankruptcy is different. Section 1306 generally expands the bankruptcy estate to include certain property acquired by the debtor after the bankruptcy filing. Therefore, a postpetition personal injury claim in a Chapter 13 case requires a separate analysis.

Also, the date of the accident is not always the only relevant date. A claim may arise from conduct or injuries that began before the bankruptcy filing, even if some consequences or damages occur afterward.

The attorney needs to examine the underlying facts rather than simply look at the date a lawsuit was filed or a settlement was received.U.S. Code+1

5. What if the bankruptcy attorney refers the client to a personal injury attorney before bankruptcy is ever filed?

This is another common scenario in my practice, and it is an important one.

Over the years, I have had numerous people come into my office seeking bankruptcy advice while simultaneously dealing with another legal problem.

Sometimes the person has been injured in an automobile accident. Other times, the person has been terminated from employment under circumstances that may give rise to a wrongful termination or employment discrimination claim.

The individual may be overwhelmed financially. Creditors may be calling, wages may be garnished, and the person may be considering Chapter 7 bankruptcy as a way to get a fresh start.

During the initial consultation, I may discover that the person has a potential legal claim that should be evaluated by another attorney before making a decision about bankruptcy.

In those circumstances, I will often recommend that the person first consult with a personal injury attorney or employment attorney who specializes in that particular area of law.

There is a good reason for doing this.

Consider a person who has a substantial personal injury claim from an automobile accident but is also struggling with $75,000 in credit card debt.

If that person files Chapter 7 bankruptcy, the personal injury claim may become property of the bankruptcy estate. The Chapter 7 trustee may then have the right to pursue the claim for the benefit of creditors.

Depending on the value of the claim and the exemptions available to the debtor, a substantial portion, or potentially all, of the nonexempt recovery could be used to pay creditors.

That is something the individual needs to understand before filing bankruptcy.

I would much rather have the client understand the potential consequences of filing bankruptcy before the petition is submitted than discover afterward that a valuable legal claim has become an asset of the bankruptcy estate.

Sometimes, after consulting with the personal injury attorney and understanding the potential value of the claim, the individual decides not to file bankruptcy at all.

And that brings us to the referral fee question.

If the bankruptcy case is never filed, there is no bankruptcy estate.

Consequently, the Bankruptcy Code’s prohibition on sharing compensation paid for services to the bankruptcy estate does not apply to that referral arrangement.

Assuming the requirements of the Michigan Rules of Professional Conduct are satisfied, the attorney who initially consulted with the individual may receive a referral fee from the personal injury attorney if the case eventually settles or results in an award.

The important distinction is that the referral was made before a bankruptcy case was commenced, and the personal injury attorney is representing the individual rather than being employed by a bankruptcy trustee to represent the bankruptcy estate.

Of course, a lawyer should never encourage someone to delay an otherwise necessary bankruptcy filing simply to preserve a potential referral fee. The client’s interests must come first. The client needs appropriate advice about the consequences of filing and the potential value of the legal claim.

6. What do the Michigan Rules of Professional Conduct require for a referral fee?

Even when the Bankruptcy Code does not prohibit a referral fee, the attorney must still comply with the applicable rules of professional responsibility.

In Michigan, Rule 1.5(e) of the Michigan Rules of Professional Conduct governs the division of fees between lawyers who are not in the same law firm.

The rule provides two basic requirements:

1. The client must be advised of and must not object to the participation of all lawyers involved.
2. The total fee charged must be reasonable.

Michigan’s rule is particularly interesting because it does not expressly require the referring attorney to perform a proportionate amount of the legal services or assume joint responsibility for the case.

The rule also does not require disclosure to the client of the exact percentage each attorney will receive, although obtaining the client’s written acknowledgment is a very good practice.

In other words, a lawyer cannot simply refer a client to another attorney, privately arrange to receive a portion of the fee, and assume that the arrangement is automatically permissible.

The client must be informed, must have an opportunity to object, and the overall fee must remain reasonable.

7. The timing of the injury and the bankruptcy filing makes all the difference

When evaluating whether a bankruptcy attorney may accept a referral fee from a personal injury attorney, I would start by asking when the underlying claim arose and whether a bankruptcy case was ever commenced.

Here is a simplified comparison:

Situation	Referral fee
Personal injury occurred before bankruptcy; trustee employs PI attorney to represent estate	Generally prohibited
Personal injury occurred after a Chapter 7 filing and claim is not estate property	Generally permissible
Client consults bankruptcy attorney, is referred to PI attorney, and never files bankruptcy	Generally permissible
Client files bankruptcy after a prepetition personal injury claim arose	Estate property issue; generally prohibited if PI attorney is employed by trustee and sharing involves estate compensation
Client is in Chapter 13 and suffers a postpetition injury	Requires separate analysis under Chapter 13

These conclusions assume the referral fee otherwise complies with applicable professional responsibility requirements and that the payment is not compensation belonging to the bankruptcy estate.

Conclusion: Always evaluate the personal injury claim before filing bankruptcy

One of the things I have learned over more than 35 years of practicing bankruptcy law is that people rarely come into my office with just one financial or legal problem.

Someone may be struggling with credit card debt, medical bills, wage garnishments, or a foreclosure while simultaneously having a potentially valuable personal injury or employment-related claim.

That is why I believe it is important to look at the entire financial picture before filing bankruptcy.

A personal injury claim can be a significant asset. The fact that the individual has not yet hired an attorney, filed a lawsuit, or received a settlement does not mean the claim can be ignored when evaluating a bankruptcy filing.

The distinction between a claim that arose before bankruptcy and one that arose afterward can make a substantial difference, not only to the debtor but also to the attorneys involved.

For bankruptcy attorneys who regularly refer clients to personal injury attorneys, understanding Section 504 of the Bankruptcy Code is particularly important. A referral fee that would ordinarily be permissible under Michigan’s professional responsibility rules may nevertheless be prohibited when the personal injury attorney is employed by the bankruptcy trustee and is being compensated for services to the bankruptcy estate.

If you are considering bankruptcy and believe you may have a personal injury, wrongful termination, or employment discrimination claim, make sure you discuss that claim with your bankruptcy attorney before filing. The timing can have important consequences for your financial future.

Legal note: This article discusses general principles under the Bankruptcy Code and Michigan’s Rules of Professional Conduct. Whether a particular claim belongs to the bankruptcy estate, and whether a particular fee arrangement is permissible, depends on the facts, the applicable bankruptcy chapter, and the source of the compensation.