March 26 (Consumer Bankruptcy News) - Good faith in filing a Chapter 13 petition and in proposing a plan must be determined based on the totality of the circumstances.  It cannot be based on a single, make-or-break requirement such as whether the Chapter 13 was filed for no reason other than to allow the debtor to pay the attorney’s fee over time, the 1st U.S. Circuit Court of Appeals ruled in Berliner v. Pappalardo, Trustee (In re Wayne E. Puffer), 2012 WL 954860 (1st Cir. 3/22/12).  However, the panel was divided as to how open bankruptcy courts should be to “fee only” plans. 

For the majority, the door isn’t open at all.  It is merely unlocked. 

“Let us be perfectly clear.  This opinion should by no means be read as a paean to fee-only Chapter 13 plans," stated retired Supreme Court Justice David H. Souter, who was sitting by designation, and Judge Bruce M. Selya.   "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 a concurring opinion, Judge Kermit Lipez left if for bankruptcy courts to decide how open the door is, saying:  

I would leave application of the test entirely to bankruptcy judges instead of prescribing a rule requiring ‘special circumstances’ limited to ‘relatively rare’ instances.  As the majority notes, the bankruptcy courts have expressed mixed views on fee-only plans as their experience accumulates in the wake of Lamie and BAPCPA's enactment.  We should allow that process to continue so that we have an adequate basis for deciding whether there is a need to construct an appellate rule disfavoring such plans in every case. Presently, I do not think we have that basis. 

WHAT THEY AGREED ON 

The Chapter 13 debtor proposed a 36-month plan paying $100 per month to the trustee.  Out of this money, $2,900 was to go to the debtor’s attorney.  The bankruptcy court denied confirmation citing In re Buck , 432 B.R. 13 (Bankr. D. Mass. 2010), which held that “fee only” Chapter 13 plans are per se submitted in bad faith. 

After the debtor accepted the court’s offer to have his case converted to Chapter 7, the debtor’s attorney asked the court to award him $2,872 in fees and expenses for his representation of the debtor in the Chapter 13 proceedings.  The bankruptcy court allowed the fee application for $299, which was the cost to file the Chapter 7 petition, and ordered the attorney to return to the debtor the balance of any fee he received.  The court found that attorneys are not entitled to fees for time spent preparing a Chapter 13 plan that they knew or had reason to believe was submitted in bad faith. 

The district court affirmed.  The 1st Circuit vacated and remanded. 

The panel agreed that good faith under Section 1325 needs to be determined based on the totality of the circumstances.  Good faith cannot be determined by the mechanical application of a checklist, and it certainly cannot be determined by the rigid application of a single make-or-break factor. 

The majority said: 

 In all events, good faith is a concept, not a construct.  Importantly, it is a concept that derives from equity.  In the case at hand, the bankruptcy court did not consider the totality of the circumstances when measuring whether the debtor's Chapter 13 plan was presented in good faith.  Instead, it mistakenly concluded that fee-only Chapter 13 plans are per se filed in bad faith and fashioned the fee award on that premise.  Thus, the fee award rested on a legal error and must be vacated. 

CONCERN OVER ‘FEE ONLY’ PLANS 

The only thing the majority rejected was the bankruptcy court’s reliance on a per se rule that “fee only” plans are proposed in bad faith.  The majority did not reject the bankruptcy court’s concern that “fee only” plans are abusive. 

The majority said the fundamental purpose of Chapter 13 is the repayment of debts.  “Fee only” plans run counter to that purpose because they leave the majority of debts unpaid.  “Moreover, fee-only arrangements may be vulnerable to abuse by attorneys seeking to advance their own interests without due regard for the interests of debtors; and such plans, by their very nature, create that appearance,” the majority said.  It added: 

Notwithstanding these shortcomings, endorsing a blanket rule that fee-only Chapter 13 plans are per se submitted in bad faith would be to throw out the baby with the bathwater.  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.  Given this possibility, prudence dictates that we hew to the overarching principle that the presence or absence of good faith should be ascertained case by case. 

LET THE COURTS DECIDE 

In his concurring opinion, Judge Lipez pointed out that “fee only” plans benefit debtors who need Chapter 7 relief but can’t afford to pay the attorney’s fee up front.  In 2004, the U.S. Supreme Court ruled that fees charged by debtors’ attorneys in Chapter 7 cases generally may not be paid from estate funds.  Lamie v. U.S. Trustee, 540 U.S. 526 (2004).  Rather than risk not getting paid for their work, debtors’ attorneys demand payment up front.  The amount of that payment increased substantially following enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  The combination of Lamie and BAPCPA has made the Chapter 7 option all but unavailable to low-income debtors. 

“As I understand it, the fee-only Chapter 13 petition can be a creative solution for the ‘Lamie problem,’” Judge Lipez said.  “At least some debtors who cannot afford an attorney-assisted Chapter 7 filing – because the attorney, understandably, would expect to be paid up front – can afford to pay for an attorney to assist with a Chapter 13 filing because the fee will be paid in post-petition installments.” 

Judge Lipez agreed with his colleagues that good faith requires application of the “totality of the circumstances” test, and that “fee only” plans require close scrutiny.  However, he was reluctant to restrict the good faith analysis as the majority did.  Judge Lipez expressed concern that “circumscribing the totality of the circumstances assessment with the requirement of special circumstances will in practical effect impose on debtors the more daunting task of disproving bad faith rather than proving good faith.” 

Judge Lipez urged courts to keep in mind that debtors who are unable to pay an attorney’s fee up front have limited options.  Theoretically, they can proceed pro se, but is having them attempt to navigate the complexities of bankruptcy on their own better than allowing them to pay the attorney’s fee through Chapter 13?  They could also attempt to find cheaper or free legal services, but Judge Lipez doubted that there was a range of fees charged for competent legal services. 

Judge Lipez concluded: 

We should have a better understanding of critical facts like these before we fashion a rule that may, in practical effect, make fee-only Chapter 13 plans unavailable,”.  “The majority notes that the debtor in this case stated that he could have saved enough money in three months to pay Chapter 7 fees, and they suggest that he should simply have waited to file for relief.  The debtor's assertion of future ability to pay is certainly a factor to consider.  For some debtors, however, the press of creditors, and the resulting stress, would likely make waiting intolerable. 

(Reporting by David J. Light, Esq., Principal Attorney Editor, Consumer Bankruptcy News)