“Fee-Only Plan” in a Chapter 13; Gray area now even grayer with the decision pursuant Berliner v. Pappalardo, No. 11-1831 (1st Cir. March 22, 2012)

The Supreme Court case Lamie v. U.S. Tr., was a landmark case that essentially required bankruptcy attorneys to collect all their payments upfront from their clients in a Chapter 7 proceeding. More specifically, except in limited circumstances, attorney’s fee are not payable from the debtor’s estate once a Chapter 7 proceeding has commenced. This may or may not have  benefitted both attorneys and/or debtors, but regardless, became an additional obstacle that needed to be addressed by bankruptcy attorneys representing debtors who are faced with the difficulty of making the payment on their Chapter 7 bankruptcy.

In order to avoid the issue of making all the payments upfront for a Chapter 7 bankruptcy, a debtor who would have qualified for a Chapter 7 bankruptcy would be placed in a Chapter 13 bankruptcy for the purpose of making payments on his attorney’s fees. Once in the Chapter 13 bankruptcy, the debtor’s Plan would essentially only reflect his payments for his attorney fees. The debtor would still only pay his unsecured creditors what they would have received in a Chapter 7 bankruptcy, which generally ends up being zero to none. As a result, the debtor would end up filing a Chapter 13 in disguise of a Chapter 7 for the sole purpose of paying his attorneys fee for his bankruptcy.

In addressing this sole issue, the 1st Circuit Court of Appeals in the case Berliner v. Pappalardo held that while a “Fee-Only” Chapter 13 Plan is not “pre se” bad faith filing, the Court must apply the totality of the circumstances test, as construed under Section 1325(a)(3) of the Bankruptcy Code, to determine whether the “Fee-Only” Chapter 13 Plan was filed in “good faith”.

The facts in Berliner are very simple. The debtor retained the services of an attorney who quoted the debtor a fee of $2,300 for a Chapter 7 bankruptcy. The attorney informed the debtor that the attorney fees must be paid up front prior to his case being filed. Alternatively, if the debtor chose to be in a Chapter 13, the debtor did not have to pay the whole amount up front, but could pay the amount over a period of time. The attorney anticipated the attorney’s fee for a Chapter 13 to be $4,100. Due to his financial restraint, the debtor choose to file a Chapter 13 and made a $500 upfront payment. The debtor’s Chapter 13 Plan proposed to pay $100.00 per month for the next 36 months for a total of $3,600.00. Specifically, the Plan proposed to pay 2% or $300 of the roughly $15,000 owed to the debtor’s unsecured creditors while paying $2,900, the remainder of his attorney’s fee, to his bankruptcy attorney.

The bankruptcy court rejected the debtor’s chapter 13 Plan on precedent rulings that held that such “fee-only” Chp 13 Plans were “per-se” bad faith filings. The bankruptcy court allowed the debtor to either, convert to a Chp 7, amend his Chp 13 Plan or simply dismiss his case entirely. The debtor decided to convert to a Chp 7. Meanwhile, the debtor’s attorney sought under Section 330, the fees and expenses that he expended while representing debtor in the Chp 13, a total amount of $2,872.00. The bankruptcy court awarded the bankruptcy attorney in the amount of $299.00, the amount that cost the debtor to file his Conversion. Essentially, the bankruptcy attorney was disgorged an amount of $200 of the $500.00 that the debtor paid the attorney prior to the filing of the case. The bankruptcy court reasoned that where an attorney who prepared the bankruptcy case knows or has reasons to know that the case is filed in bad faith, such attorney will not be entitled to professional fees incurred.

On appeal filed by the bankruptcy attorney, the District Court affirmed the bankruptcy court’s ruling. The appellant appealed subsequently before the 1st Circuit Court.

The Circuit Court reversed and remanded to the lower court on the ground that the “per se” bad faith rule did not apply to “fee-only” chapter 13 bankruptcy cases. Rather, the Court, in consistency with its Sister Courts precedent decisions, adhered to the “good faith” totality of the circumstances test provided under Section 1325(a)(3) of the bankruptcy code. Although the Court does not specify any specific elements that may differ from the already existing analysis of “good faith” under precedent case law, the Court does caution    the susceptibility of a “fee-only” Chp 13 Plan. Specifically, the Court states

“The fundamental purpose undergirding Chapter 13 is to allow a debtor to pay his creditors over time…and a fee-only plans, by definition, leave the vast majority of debts unsatisfied. Moreover, fee-only arrangements may be vulnerable to abuse by attorneys seeking to advance their own interests without due regard for the interest of debtors; and such plans, by their very nature, create that appearance.”

“While fee-only plans should not be used as a matter of course, there may be special circumstances, albeit relatively rare, in which this type of odd arrangement is justified.”

“The dangers of such plans are manifest, and a debtor who submits such a plan carries a heavy burden of demonstrating special circumstances that justify its submission.”

In particular to this case and without rendering a decision on the matter, the Court analyzed the fact patterns of the debtor's Chp 13 Plan and excluded such situations from being a “special circumstance” allowing the “fee only” Chp 13 Plan. Although the debtor claimed that filing a Chp 13 was the only way of securing that bankruptcy attorney’s assistance, there was no showing as to whether the debtor had a pressing need for that specific bankruptcy attorney. There was no showing that debtor couldn’t have retained another attorney without the fee-only Plan or filing the case Pro-Se. Moreover, debtor claimed that he could of have filed the Chp 7 if he had 3 more months to gather the payments. Similarly, there was no record to show any compelling reasons why the debtor couldn’t have waited those 3 months to get the payments.

In Conclusion, the Circuit reversed and remanded the case to the bankruptcy court to reconsider the issue under the good faith totality of the circumstances test in analyzing the debtor’s fee-only Chp 13 bankruptcy.

Link: http://docs.justia.com/cases/federal/appellate-courts/ca1/11-1831/11-1831-2012-03-22.pdf

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