OPINION RE: TURNOVER OF RETAINERS

RANDOLPH J. HAINES, Bankruptcy Judge.

The threshold issue here, and perhaps the only issue, is when does a retainer become the attorney's money instead of the client's. This matter comes before the Court on the Chapter 71 Trustee's Motion to Compel Turnover, and the response filed by Jennings, Strouss, & Salmon, P.L.C. ("JSS"). The Trustee has requested an order from the Court compelling turnover of the pre-petition retainers paid to both JSS and also the pre-petition retainer paid to Wright Tax Solutions ("Wright" or "Wright Tax Solutions").

Based on the following analysis, the Court finds and concludes that the pre-petition retainers paid to JSS and Wright were paid from pre-petition property of the Debtor, and to the extent that such property had not been applied pre-petition for services rendered pre-petition, the retainers became property of the bankruptcy estate once the voluntary petition was filed. Both JSS and Wright remained employed as professionals of the post-petition Chapter 7 Debtor, but neither was ever employed by the Chapter 7 bankruptcy estate. The retainers retained their character as property of the estate, and neither JSS nor Wright had any authority to apply these pre-petition funds to pay for post-petition professional services rendered to the individual Debtor, and not to the bankruptcy estate. Accordingly, the Court finds that the Motion to Compel Turnover must be granted.

Factual Background

Pre-petition, Debtor, David Glimcher, employed the professional services of JSS to represent and advise him, and to possibly act as Debtor's counsel if a bankruptcy petition might eventually need to be filed. In connection with this representation, Glimcher signed a retention letter and paid a pre-petition retainer of $40,000.00.2 The $40,000.00 was paid via a check from the David J. Glimcher Company.3 According to the retention letter's terms, "In the event it becomes necessary to proceed with a bankruptcy filing, it will be necessary [for Glimcher] to provide an additional $110,000." Further, the agreement indicated, "We will have the right to request additional advances from time to time based on our estimates of future work to be undertaken." The retainer was to be held in the JSS client trust account, and the agreement also provided: "We require that you pay our periodic invoices in full, although we may apply any of the retainer to your statements in our discretion at any time, all subject to Bankruptcy Court requirements." According to the declarations of Debtor's counsel, and of the Debtor himself, at the time JSS was engaged and the initial retainer was paid, it was not known if a bankruptcy petition would actually need to be filed, and a decision had not been made at the time of the engagement, if such a petition was eventually filed, whether it would be a Chapter 7 or a Chapter 11 petition.

Prior to the bankruptcy petition being filed, JSS received an additional $119,000.00. On May 25, 2011, JSS received a wire transfer from Wiz Holdings, LLC4 directly into the JSS account in the amount of $60,000.00. On May 26, 2011, prior to the filing of the bankruptcy petition later that same day, JSS received a wire transfer from Wright Tax Solutions directly into the JSS account in the amount of $59,000.00. In total, JSS received $159,000.00 pre-petition based on these three deposits. The money was held in the JSS client trust account.

Wright Tax Solutions apparently received $89,000 in cash (actual dollar bills) from David Glimcher on May 20, 2011.5 Wright allegedly kept $30,000 of the cash paid for pre-petition work completed by Wright and wired $59,000.00 to Debtor's counsel, JSS on May 26, 2011.6 Wright received an additional $25,000 from Glimcher. According to Ms. Johnsen's March 16, 2012 email, see footnote 5, supra, the $25,000 paid to Wright was paid on May 25, 2011 from Wiz Holdings, LLC and was paid as a retainer for services for Wiz Holdings, LLC, and not on behalf of David Glimcher.7

Trustee filed a Motion to Compel Turnover seeking return of the pre-petition retainers paid by the Debtor to JSS and to Wright Tax Solutions.

JSS filed a response to the motion, and argues that the retainer it received was not property of the bankruptcy estate because what JSS received was an "advance payment retainer." Further, JSS argues that even if the retainer were property of the bankruptcy estate, it should nevertheless be entitled to offset its fees against the retainer because JSS performed services at the Trustee's request that benefitted the bankruptcy estate. JSS argues that the pre-petition retainers received by JSS were from three different sources and the funds were all commingled in JSS's client trust account. The retainers were commingled and the funds are not susceptible to tracing; as such, the Trustee cannot identify if the "balance" remaining constitutes funds from the Debtor or the non-Debtor entities.8 Finally, JSS argues that the retainer received was reasonable because at the time of the retention agreement, it was not known if a bankruptcy petition would be filed, and the agreement provided for additional funds if a bankruptcy were indeed filed, and the determination of whether to file a Chapter 7 or Chapter 11 case was not decided until the end of May, 2011. The amount of the retainer paid to JSS was reasonable due to the size and complexity of this case.

Wright Tax Solutions did not file a response to the motion and did not appear at the hearing held on April 23, 2012. At that hearing, Ms. Johnsen specifically stated that she did not officially represent Wright at that time, but Ms. Johnsen stated the issues are intertwined so she wanted to make some comments on Mr. Wright's behalf. Ms. Johnsen commented that the Trustee raised in his reply for the first time the issue of possible preferential payments for both JSS and Wright concerning payments received on the petition date and applied to pre-petition services rendered. Further, Mr. Wright had not had time to obtain counsel as of the time of the hearing.

Analysis

A. Types of Retainers

First, there are basically two types of retainers: retainers that are earned upon receipt, and retainers that are held to secure payment of future legal fees. Of the retainers that are earned upon receipt, there is the classic non-refundable retainer and there is the advance payment, which is sometimes called a "flat fee retainer." Provided the overall fee is reasonable, it is ethically permissible under the Arizona Rules of Professional Conduct9 to charge a flat fee retainer or a classic non-refundable retainer.10 The common element of both of these retainers is that they are actually earned upon receipt because once the client pays the retainers, the client no longer has an interest in the retainer and all interest immediately transfers to the attorney.11

The retainer that is held by the attorney to secure payment of future legal fees, sometimes called a "security retainer," is different from an earned-upon-receipt retainer because the money remains property of the client, even if it is held by the attorney.12 Such retainers must be placed in the attorney's client trust account according to the Arizona ethical rules.13 In contrast, an earned-upon-receipt retainer may not be placed in the attorney's client trust account because those funds are the property of the attorney, and it is unethical for an attorney to commingle the attorney's money with client trust funds.14

B. The Type of Retainers in This Case

Jennings Strouss contends that its retainer was an "advance payment retainer," a rather ambiguous and uninformative label because all retainers are advance payments of some kind. The Jennings Strouss' position is clarified by the declaration of attorney Carolyn Johnsen, who declared under penalty of perjury that "It was my intention that the Retainer would be an advance payment retainer for fees and that the Debtor would not retain an interest in it." If the Debtor was to have no interest in the retainer immediately on its payment, this would necessarily imply the retainer was fully earned upon receipt and immediately became the law firm's money.

But the firm's position is belied by the terms of the retainer agreement itself, which does not describe an earned-upon-receipt retainer. To the contrary, the retainer states: "Our fees will be based primarily on the [hourly] billing rate for each attorney and legal assistant devoting time to this matter." That unmistakably implies that the fees were neither determined nor earned immediately upon payment of the retainer, but to the contrary would be determined and earned only as the hours are worked. This is confirmed by the provision that additional retainers could be required in the event more hours needed to be worked: "In the event it becomes necessary to proceed with a bankruptcy filing, it will be necessary to provide an additional $110,000. We will have the right to request additional advances from time to time based on our estimates of future work to be undertaken."

The retainer agreement also makes clear that the funds remained the client's trust funds until the hours were worked, the fees were billed and the retainer applied to such invoices:

Those provisions are dispositive and determinative that the retainer remained the client's money until future work was performed and billed, and the retainer applied. Moreover, there would be serious ethical problems with Ms. Johnsen's position that the retainer was earned upon receipt and the client retained no interest in the funds.

First, Arizona Ethics Opinion 99-0215 clearly requires that the fee agreement explicitly state that a prepaid fee is nonrefundable or earned upon receipt, and must do so clearly, "in terms intelligible to the client." This Ethics Opinion cites a number of authorities holding that in the absence of such specific language, the retainer is not earned upon receipt and must instead be treated as a client's property and must be held in the client trust account. Here, there is no such explicit and clear language defining how or why the retainer was non-refundable or earned upon receipt. "In order to comply with the ethical rules, the attorney must explicitly describe what justifies treating all or a portion of the flat fee as non-refundable or `earned on receipt.'"16

Second, if the retainer were earned upon receipt, then both Arizona Ethical Rule 1.5(b) and Arizona Ethics Opinion 99-02 require that the basis or rate of that fee must be communicated in writing to the client. Nothing in the Glimcher retainer agreement explains how Jennings Strouss could have been deemed to have earned a flat-fee in the amount of the retainer even before the work was done. It does not, for example, explain that the retainer is nonrefundable because the representation would require the firm to decline other work due to conflicts or time commitments.

Third, the retainer agreement expressly provided that the funds would be placed in the Jennings Strouss client trust account, as in fact they were. This would be an ethical violation if the funds in fact belonged to Jennings Strouss, because that would mean that the firm's own money was being commingled with clients' trust funds. This is made clear by both Arizona Ethical Rule 1.15(a)17 and Arizona Ethics Opinion 99-02.18

As Arizona Ethics Opinion 99-02 provides, "[T]he client's agreement with the lawyer determines whether prepaid funds are earned on receipt—and therefore the property of the lawyer—as opposed to an advance against future fees that must be held in trust." Here, the client's agreement with the lawyer unmistakably determined that the prepaid funds were not earned on receipt, and were therefore an advance against future fees that remained the client's property.

C. Security Retainers for Chapter 7 Debtors May Not be Retained or Drawn On.

As suggested above, this threshold determination that the retainer was a security retainer rather than an earned upon receipt fee is also effectively the dispositive determination, at least when that conclusion is considered in the context of governing Supreme Court precedents such as Whiting Pools19 and Lamie.20 Whiting Pools leaves no room for debate that when the IRS or a law firm holds only a security interest and physical possession, the property securing it remains property of the estate and therefore subject to turnover. And Lamie leaves no room for debate that a Chapter 7 debtor's attorneys cannot be paid from the estate unless they are employed by the Trustee and such employment is approved by the court.

This case is on all fours with the holding and analysis in Blackburn:21

Most of Jennings Strouss' response consists of arguments and facts to the effect that Jennings Strouss rendered substantial services post-petition, that the services benefitted the estate and were often specifically requested by the Trustee, and that its fees for these services were reasonable, especially in light of the complexity of the estate. While the Trustee does not dispute the reasonableness of the fees for the work performed, he responds that he never employed Jennings Strouss, and that requests for the Debtor to provide information were made to Debtor's counsel only because that was ethically required when the request came from Trustee's counsel, Mr. Dake.23 But the arguments that the fees were reasonable and the services benefitted the estate are essentially irrelevant because nothing in Bankruptcy Code §§ 327, 329 or 330 permits a Chapter 7 debtor's attorney to be compensated by the estate unless also employed by the estate.

Lamie does not recognize an uncodified quantum meruit exception. Nor does it recognize a so-called "retainer exception" that is applicable to security retainers. The language of the Lamie opinion that is the alleged source of the "retainer exception"—"Section 330(a)(1) does not prevent a debtor from engaging counsel before a Chapter 7 conversion and paying reasonable compensation in advance to ensure that the filing is in order."—clearly refers to an earned-upon-receipt flat fee payment, rather than a security retainer. This was the clear analysis and holding in Blackburn and the numerous authorities cited therein.24 This Court agrees with that analysis and holding.

Conclusion

For these reasons, the Trustee's motion for turnover must be granted. Because the Wright retainer was no different in form from the Jennings Strouss retainer and no different argument or defense was raised on its behalf, the Trustee's motion must be granted as to both Jennings Strouss and Wright. Trustee's counsel is requested to upload a form of order requiring turnover of all funds held in the respective retainer accounts as of the petition date, less any amounts subsequently invoiced for pre-petition work25 that had not been drawn or paid by the petition date.