Retainer Agreement
In the post-judgment world, a creditor may levy execution upon the debtor’s non-exempt assets wherever they are found within the court’s jurisdiction. This includes the debtor’s cash, whether in physical form or in a bank account. If a creditor finds the debtor’s bank account, the creditor can have the sheriff serve a notice of levy on the bank and thereby levy upon (read: collect against) any and all accounts that are owned by the debtor. The bank must freeze the account funds immediately and then respond to the levy within a few days by turning over all the debtor’s cash to the sheriff. Usually a couple of weeks later, the sheriff then turns the funds over to the creditor.
But what if the debtor’s funds are held in the name of somebody else who has an account at the bank? In that event, the creditor has the sheriff serve the notice of levy upon the person holding the funds for the benefit of the debtor, and that person must then freeze the debtor’s funds and turn them over to the sheriff. If that person claims that they are the real owners of the funds, they can request that the court have a hearing wherein they can make a third-party claim against the funds by asserting that their right to the funds is superior to that of the creditor.
What happens with the debtor’s deposit for legal fees that are held in an attorney’s client trust fund? You see, creditors absolutely love to levy upon the debtor’s attorneys for any money they are holding for the benefit of the debtor. Not only can hitting this money provide the creditor with immediate cash to be applied against the judgment, but also taking those fees can deprive the debtor of legal representation thus making the creditor’s job that much easier.
Can the creditor really do this? The answer was given by the California Court of Appeals in its opinion in Dickson v. Mann, 2024 WL 3421751 (Cal.App.Distr. 4, July 16, 2024), which we shall now consider.
Nicholas Dickson sued Jack Mann for alleged misconduct relating to Dickson’s living trust. Mann ultimately stipulated to a $12 million judgment in favor of Dickson which was entered on August 8, 2022. To enforce the judgment, two weeks later, on August 22, 2022, Dickson had the sheriff levy upon Mann’s law firm, being Higgs, Fletcher & Mack LLP (“HFM”), for any funds which HFM was holding for Mann. In response, HFM gave the sheriff a notice of third-party claim. In this third-party claim, HFM held an ownership or at least security interest to protect its fees in $585,000 that it had received from Mann. This resulted in a hearing before the Superior Court of San Diego County on the third-party claim.
Now we have to dive into the nitty-gritty of HFM’s agreement with Mann as it related to the $585,000. The HFM engagement agreement with Mann provided that HFM would provide him with a legal defense, including defending against Dickson’s efforts to enforce the judgment, and that Mann agreed “to pay a flat fee in the amount of $585,000, inclusive of costs.” In other words, were one to look at that clause in isolation, Mann paid HFM $585,000 to handle the matter from start to finish and Mann would not be getting any money back at the end.
But that clause would not be looked at in isolation. HFM’s engagement agreement then went on to state:
“Both [HFM] and [Mann] understand and acknowledge that (1) [Mann] has the right to have [HFM] deposit the Flat Fee in a trust account until the fee is earned; and that in such case, (2) [Mann] is entitled to a refund of any amount of the Flat Fee that is unearned because the services were not completed. Despite being fully informed of the rights described in the preceding sentence, [Mann] consents to [HFM] depositing the Flat Fee into [HFM]’s operating account upon payment and consents to such fee being deemed earned by [HFM] when received.”
HFM claimed that Mann already owed HFM $948,260 and that ― had the levy not occurred first on August 22 ― by the end of August HFM would have applied the entire $585,000 against Mann’s outstanding bill of $948,260 thus leaving nothing of Mann’s money remaining. However, ” HFM presented no evidence during the litigation of its third party claim that it had begun providing any of the legal services covered by the $585,000 flat fee at the time the notice of levy was served on August 22, 2022.”
Dickson opposed HFM’s third-party claim by pointing out that HFM held the $585,000 in its client trust account. This is an account that is meant to only and exclusively hold client funds in trust for the client’s benefit. The $585,000 was held in HFM client trust account this, Dickson argued, meant that the entirety of the $585,000 still belonged to Mann and was dispositive of the whole matter.
After the third-party hearing, the Superior Court ruled in favor of Dickson, denied HFM’s third-party claim, and awarded Dickson the $585,000. The Superior Court had two grounds for its ruling:
First, under the California Rules of Professional Conduct (the state bar ethical rules), where a law firm such as HFM has charged a flat fee, that flat fee is not considered to be earned until the matter has been concluded. In the meantime, until the fee is earned the funds remain the property of the client, being Mann. Since HFM was still obligated to represent Mann on the enforcement of the judgment (and some other matters), the Superior Court held that HFM had not yet earned its fee and so the funds in the account remained Mann’s funds.
Second, and although neither Dickson nor HFM raised this matter, the Superior Court concluded that Mann had transferred the $585,000 to HFM for purposes of defrauding Dickson, and thus the California Uniform Voidable Transactions Act (“CUVTA”) would apply to void Mann’s attempted transfer of the funds to HFM.
On the basis of all this, the Superior Court ordered HFM to turn over $585,000 by December 13, 2022. HFM filed a motion for reconsideration asking that the Superior Court allow HFM to keep $53,458 for certain services that it had provided previously to Mann, but the Superior Court denied this request as well because, essentially, HFM did not timely raise the issue prior to or at the third-party hearing. HFM then appealed, which resulted in the opinion next to be discussed.
After a lengthy explanation of the third-party hearing process, the California Court of Appeals agreed with HFM that the location of the funds in HFM’s trust account was not dispositive. Instead, the Court noted that there may be exceptional circumstances where a law firm’s own funds may be held in a client trust account, such as where the law firm has billed against the funds but has not yet removed them from the account to pay the law firm’s invoice.
If the location of the fund is not dispositive, then what is dispositive? The answer is that the law firm’s engagement agreement with the client that describes how the law firm’s fee is earned and how the client’s funds are to be held is dispositive.
The Court of Appeals turned its attention to HFM’s agreement with Mann that HFM would charge a flat fee for its services. Under the California Rules of Professional Conduct, a flat fee cannot be earned on receipt or be nonrefundable. Instead, the fees deposited by the client can only be paid to the attorney either as certain tasks are completed (as the law firm and the client have agreed) or upon the conclusion of the matter.
Here, the Court of Appeals distinguished a flat fee where the client has paid in advance against something known as a true retainer. A true retainer is an amount of money which a client pays to an attorney to make sure that the attorney will be available to handle the client’s matter if it arises, but does not compensate the attorney for the attorney’s work. One could think of a pure retainer as basically an availability deposit. Unlike a flat fee, a true retainer can be earned upon receipt or made nonrefundable to the client.
Returning to the concept of a flat fee, the Court of Appeals reiterated that a flat fee cannot be deemed to have been earned until certain specified tasks have been completed or the matter is finally concluded. With a flat fee, until the attorney completes the tasks or concludes the matter fully, the client has a right to a refund of the fee, but only if the client chooses to have the fee held in the attorney’s client trust account instead of in the attorney’s operating account (which is permissible with flat fees only).
Applying all this to the facts of the case before it, the Court of Appeals noted that HFM had utterly failed to present any evidence that it had performed any legal services at all to earn the $585,000 flat fee. Thus, HFM failed to prove that it was the owner of the $585,000 at the time of the levy, which meant that Mann was still the owner of those funds at that time. The Superior Court’s finding that HFM had not established its ownership of the $585,000 was thus affirmed.
Having decided that Dickson was entitled to the $585,000 on his levy, the Court of Appeals felt that it did not need to address the Superior Court’s second grounds for ruling in Dickson’s favor, which was the CUVTA theory, i.e., that Mann had fraudulent transferred the $585,000 to HFM. The Court of Appeals also denied HFM’s claim for the $53,458 that it claimed had been earned by its representation of Mann because, as the Superior Court had found, HFM’s claim was untimely.
ANALYSIS
Both the Superior Court and the Court of Appeals found that HFM had failed to prove that it was owed any attorney fees. But let’s assume hypothetically that HFM was owed fees by Mann: What would happen then?
The answer is that Dickson’s successful levy on Mann’s funds held by HFM would not somehow make those fees disappear. Instead, HFM would become an unsecured creditor for those fees, but would be in line to recover only after Dickson’s judicial liens were satisfied. In other words, the law firm then goes to the back of the line behind other creditors. Good luck recovering anything when you are behind a $12 million judgment.
How could HFM have protected itself against not being paid for work performed? The answer to that question is easy. HFM should have billed Mann by the hour, and not flat fee, and taken a security interest in Mann’s funds that were deposited in HFM’s client trust account. This would not have protected the entire $585,000 but at the end of the day it would have assured that HFM would be compensated for the work that it did perform.
The underlying problem here is that the the $585,000 transfer by Mann reeked of the smell of Mann transferring those funds to HFM precisely so that Dickson could not recover against them, i.e., a fraudulent transfer under the CUVTA. Indeed, that was the finding which underpinned the Superior Court’s second ground for ruling against HFM. To this end, HFM was probably lucky to have lost the $585,000 by the levy as opposed to a finding under the CUVTA. As I have related in numerous past articles, a transferee to a fraudulent transfer in California can not only lose and have the transfer avoided, but there can be tacked on conspiracy damages, attorneys fees, and even trebled damages under Civil RICO and similar theories.
If not obvious from this article, attorneys who represent debtors can be at extreme risk of not being paid for representing the debtor and, if they are not careful, they can also find themselves on the wrong end of a fraudulent transfer lawsuit. This is why attorneys who sometimes represent debtors (my own practice is about 60% creditor-side and 40% debtor-side) must give a lot of thought to how they are going to be paid. Most debtor attorneys will either require that the client come up with their deposit from exempt funds, such as exempt retirement accounts, or that they be paid from some third-party source such as family or friends. Taking non-exempt money from a debtor is quite hazardous, as illustrated by this case, unless you want to be working for the debtor for free.
The hard truth is that many attorneys do not regularly engage in post-judgment representation and thus are blissfully unaware of these pitfalls. It is a common creditor tactic to smother the debtor’s attorney with a lot of work up-front, knowing that the debtor attorney will get a large deposit from the debtor to perform that work, and then hit the debtor’s attorney with a levy exactly as Dickson did here. Easy money.
But what about the fact that taking this money may leave a debtor such as Mann without counsel, or at least quality counsel? The reality is that a debtor does not have a right to spend their non-exempt funds for their legal defense. Instead, the net effect of the law is that debtor should instead spend that money paying down the judgment instead of paying for somebody to defend him in post-judgment proceeding. Cruel, possibly, but the law offers very little protection for those who don’t pay their judgments other than the statutory exemptions allowed to debtors, and the ability to pay legal defense fees is not one of those.
This is a flaw of many asset protection plans: They protect the assets, but do not provide a means for a debtor to properly fund a post-judgment defense. Too many asset protection plans are concocted with the idea that a creditor will see the plan and simply go away, which does not often happen in real life. To the contrary, defending a debtor’s asset protection plan can be very expensive, last a long time, and that contingency must be considered well in advance.
Simply transferring a bunch of non-exempt money to one’s attorney (even if the attorney is so foolish to accept it) is not a plan, but little more than a temporary stopover of those funds on the way to the creditor.
As here.
