Jeff’s On Call!: Fee Collection and Client Bankruptcy

Nov 10, 2010

This week’s inquiry comes from Joseph H. Davidson:


I am a big fan of Jeff’s On Call! and also an owner of your Fee Collection Guide. I work at a boutique size firm, primarily with hospitals, and place senior and executive leadership at those facilities. Last year, I was retained to find a CFO for a new client. Here is the series of events, timetable, and my question(s):

  • Client signs contract and pays 20K retainer, with remaining 2/3’s  to be paid upon completion of search.
  • 45 days later, CFO successfully placed.
  • We invoice our fee, 25% of 250K = $62,500 – 20K retainer = balance of $42,500.
  • Client doesn’t pay and makes me chase them for months.
  • Client, after substantial delay, asks that balance be paid in two installments and cuts check for $21,250.
  • Within 90 days of writing check, client declares Chapter 7 bankruptcy. The last third of the fee is not paid to my firm.
  • Meanwhile, the CFO collects 24 Million in active accounts receivable management over the 4 months he is employed. What a success!
  • Six months later, a bankruptcy trustee writes to us and demands the 2nd third of our fee back because it was a “preferential” payment.
  • We negotiate the trustee from $21,500. down to $7500. and “settle.”

Since the candidate was successfully placed, stayed well through the guarantee period, and made our client a lot of money, how do you explain how a $62,500 fee turns into a $34,000 fee? I’m told that this is a typical issue of “preference,” and that the “ordinary course of business” argument is not applicable here. What steps could we have taken to ensure payment of our entire fee?

Thanks for your reply.


Joseph H. Davidson

Hi Joseph,

I’m so glad that you’re benefiting from the JOC’s! You and the rest of the placers on the placement planet. It’s my pleasure to help.

As the number of Q&A’s increases, we’re building an ongoing reference resource for our industry. The hippest recruiters are printing out the postings, sometimes distributing them to staff and associates, but always retaining them for the future. I hereby consent to all of it. Please use them well, folks!

Now – back down to business:

I really appreciate you asking this fee-keeper that needs to be answered for so many shocked recruiters these days.

Your question about the bankruptcy clawback is so important because in the vast majority of cases there is no legal reason to give back any portion of the placement fee! Yet in the vast majority of cases, that’s exactly what happens. As Fordyce founding father Paul Hawkinson would say, “Hooboy!”

We’re deep in the depth of Section 547 of the U.S. Bankruptcy Code [11 USC 547(c)]. Anyone who has downloaded 779 pages from Westlaw with the case citations and reads the thousands of cases cited will conclude that they are inconsistent, inscrutable, and incomprehensible. You won’t find a single one concerning a contingency-fee recruiter. That’s really good news!

But look closer. There are tons of big words in the Section 547 annotations that you can use to defend against the clawback (attempted return of your well-earned placement fee). You can save a lot in legal fees by just studying the cases yourself and highlighting those you like for use in responding to the trustee’s lawyer. Life’s so much happier when you know the law.

The clawback rationale is that creditor preferences (where a business contemplating bankruptcy pays favored “sweetheart creditors” and ignores others) are unfair. So the trustee in bankruptcy responsible for administration of the estate (finances of the business) automatically threatens a federal lawsuit against all of them if they don’t return the money. That’s why you received that demand letter from the trustee’s lawyer. Along with every other non-employee paid within 90 days from the filing – whether preferred or not.

You might wonder why these threatening letters are sent out so indiscriminately to those like you who provided such valuable services in good faith, then had to chase cash-clutching clients to get paid, never dreaming they’d have to refund their fees. The answer is that the trustee is under no obligation to figure out if any of the creditors are preferred! So the threat of a federal lawsuit gets a lot of money returned for distribution to all of the creditors because so few resist. It’s an unintended consequence Congress overlooked and debtor lawyers exploit. Recruiters aren’t the only ones who get paid on “cash-in”.

In your case, negotiating that clawback of $21,500 down to $7,500 was a business decision, not a legal one. The initial argument should have been simply that the contract was formed much earlier when the original (uncontested) $20,000 retainer was paid. Therefore, the subsequent payments were merely installments.

Then there are the two basic ways all of our contingency-fee readers can defend against the claim of voidable transfers (preferential payments) of placement fees. They are by treating the fees as:

  1. Contemporaneous exchanges. A placement fee paid to a recruiter contemporaneously (immediately) due in exchange for hiring a referred candidate. [11 USC 547(c)(1)(A) and (B)], and
  2. Payments in the ordinary course of business on ordinary terms. An ordinary course of business (customary) placement fee paid on ordinary terms (customary) to a recruiter for hiring a referred candidate. [11 USC 547(c)(2)(A) and (B)].

The burden of proof (requirement) shifts to the recruiter to establish that despite the prima facie (apparent) preference (simply because it was paid within 90 days of the bankruptcy filing), it was a protected payment (legitimate business expense). How could it be otherwise? There’s a specific candidate placed for every fee paid.

Note the italicized Legalese in this reply, since those words and the citations I’ve given you will help you knock out unfounded preference claims. If your lawyer reads only one case (among the reported thousands), it should be In re Tennessee Valley Steel Corp. (203 BR 949).

You can and should resist these claims. Quote the ruling in Tennessee Valley in a letter that includes this paragraph verbatim:

Recruiters should not be punished for helping troubled companies by making it possible for them to acquire the best management possible immediately. As the court stated in In re Tennessee Valley Steel Corp. (203 BR 949, 952), “Creditors should not be punished for dealing with troubled companies; thus, preferences should ‘leave undisturbed normal financial relations, because they do not detract from the general policy of the preference section to discourage unusual activity by either the debtor or creditors during the debtor’s slide into bankruptcy’.” (citing cases)

Again, we appreciate you asking this one – and helping so many recruiters keep their well-earned fees if that shocking letter arrives!

Best to you too – if it’s not too late.


If you have a legal question you’d like to have Jeff answer here on The Fordyce Letter, check out Jeff’s On Call! and submit your question.

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