Are Bifurcated Chapter 7s Actually Legal? [Part 2 of 2]
This is the second part of a 2-part episode that answers a simple question:
Are bifurcated Chapter 7s actually legal?
In the first part, I went over 5 specific mistakes that you need to avoid in order to “bulletproof” your bifurcated Chapter 7s from a US Trustee.
In this second part, I update these 5 mistakes with lessons that I’ve learned over the last 2 and a half years, as well as some new case law. In fact, I even added a new mistake based on a recent case out of Missouri (see In re Allen).
Plus, to help you make up your own mind about what the legal precedents here are, I’ve written a case law summary of the 20 cases that cover issues relevant to zero down bifurcated Chapter 7 bankruptcies. So if you’re interested in learning more on this topic, you can download my case law summary for free, which includes:
- A writeup of each of the 20+ cases relevant to bifurcated bankruptcies
- A review of every seminal case, including Utah’s In re Hazlett, and Florida’s In re Brown, that has blessed bifurcation
- A detailed analysis of opinions written by judges who clearly hate bifurcation, including an opinion in South Carolina that was reversed on appeal
- Precise guidelines lifted directly from these opinions that show you how to comply with legal guidelines whatever district you’re in
- The full text of every opinion
You can listen to the episode by clicking the “play” button in the audio player above, or read a full transcript below.
You can also sign up to get an email when we release new episodes of the Bankruptcy Law Success podcast at the top of that page.
Hi, this is Bob Hiler of the Bankruptcy Law Success podcast, where we introduce you to successful bankruptcy lawyers, as well as powerful ideas that can transform your bankruptcy practice. Today, I’m recording another solo episode, and it’s a follow-up to my last episode about the legal underpinnings of bifurcated Chapter 7s.
Today, I’d like to give an update on these legal underpinnings, because I published my book, The Zero Down Bankruptcy Revolution, in August 2019. And that was actually before the pandemic even started.
Now as I record this new podcast episode, it’s May 2022. So it’s been a whole two and a half years since the book.
In that time, I’ve seen a handful of attorneys get into hot water with a US Trustee. And there’s also been a few new opinions about bifurcated Chapter 7s.
In chapter two of my book, I went over the five deadly bifurcation mistakes to avoid in order to bulletproof your zero down bifurcated chapter 7s from zealous US Trustees.
So in today’s episode, I’m going to review these deadly bifurcation mistakes, mostly by relating some stories about attorneys who I’ve seen commit one of these mistakes. And I’m also going to define a new deadly bifurcation mistake, and we’ll discuss that one too.
But before we get into all these mistakes to avoid, I want to start with the good news, which is that most USTs and judges have come to accept bifurcated chapter 7 bankruptcies, as long as they’re done properly. There’s even been some great new opinions blessing bifurcation.
The most positive opinion was In re Brown in June 2021 from the Southern District of Florida in the 11th Circuit. And there, the court concluded that “The Court holds that so long as attorneys offering a bifurcated fee arrangement comply with the terms of this Order, those arrangements do not violate the Bankruptcy Code or Bankruptcy Rules, this Court’s Local Rules or the Florida Bar Rules.”
In other words, bifurcated chapter 7s are okay, as long as they’re done properly.
To be fair, not every decision has been positive. For instance, in the Western District of Kentucky in the Sixth Circuit, there was an interlocutory opinion in the In re Baldwin case that basically said that bifurcated 7s are wrong and that we should just put poor people in chapter 13s instead.
But In re Baldwin is only an interlocutory opinion, it’s not even a final opinion. And once it becomes a final opinion, it can also be appealed, so I’m really not worried about that opinion.
There’s also been some state-specific cases where bifurcation conflicted with certain Local Rules. For instance in March of 2021, South Carolina banned bifurcation because it violated a Local Rule on unbundling, or that’s what the opinion said anyways. The good news is that that opinion was successfully overturned in an appellate decision recently. So things are looking up in South Carolina.
Another Local Rule issue came in that Brown case in the Southern District of Florida, where the court blessed bifurcation, but also held that a Local Rule prevented filing fees form being advanced by the attorney. But it’s fair to say that bifurcation in general is now broadly accepted. And as long as we avoid some common bifurcation mistakes, we should be able to confidently attend any Section 329 hearing on attorney’s compensation. Or even better, we should be able to avoid any Section 329 hearings from being scheduled in the first place.
So without further ado, let’s get into the first deadly bifurcation mistake to avoid.
So mistake number one is not respecting the bifurcation.
What do I mean by respecting the bifurcation?
Well ,to review, when we bifurcate a case, we’re splitting a Chapter 7 bankruptcy into two pieces. So by respect, I mean there’s work that you’re only supposed to be doing after you file the petition. So you’re not respecting the bifurcation when you do that work before you file the petition.
That’s the main high-level concept here.
Okay, so let’s drill down a little on what you’re supposed to do in each of the two pieces.
The first piece is the prepetition portion. Now in this piece, you should be doing your due diligence and then you’ll file a skeletal petition with the court. But at this point, you shouldn’t have actually filled out the statements and schedules. Now, if you’re doing a true zero down Chapter 7 bankruptcy, you’ll be waiving fees for any work that you do prepetition. Of course, you can charge for the prepetition portion if you want to, I’m just talking about what a true zero down Chapter 7 bankruptcy looks like.
The second piece in a bifurcated Chapter 7 is the postpetition portion. In this piece, you’ll be doing all the work to fill out the statement and schedules. attend the 341, stop garnishments and all that.
Now it’s important to note that if you’re bifurcating the case and you’re waving your fees for prepetition work, you’re only charging for your postpetition work. And that means that if there isn’t any postpetition work, you don’t have anything to charge for.
Okay, so I know two attorneys that got into hot water for not respecting the bifurcation.
So the first example is that a bankruptcy attorney committed the cardinal bifurcation sin of continuing to do all the work prepetition.
Instead of just doing basic due diligence prepetition, and then filling out the statements and schedules postpetition, he did all the work prepetition. Then he would file a skeletal petition, wait a bit, and then he’d file the statements and schedules.
I suppose that if you’re an experienced bankruptcy attorney who’s set in your ways, this could be an easy mistake to make.
Now to be clear, there’s nothing wrong with opening your bankruptcy software and starting a petition during that first consultation.
But if you continue to work on the petition before you file the bankruptcy petition, you’re doing all or at least most of the work prepetition. Of course, the problem then is that you don’t have enough work to do postpetition to justify the reasonableness of your fee.
In this particular case, the UST picked up the phone and called the bankruptcy attorney and straight out asked him whether he was doing most of the work prepetition on his bifurcated Chapter 7s.
Now here’s where the story gets crazy to me.
The bankruptcy attorney told me that he admitted to the UST that he was doing all the work prepetition. In other words, he admitted that he wasn’t respecting the bifurcation at all. Okay, so taking a step back, two things in this story caught my attention. The first thing that surprised me is that this guy is a bankruptcy attorney. He’s not a clueless creditor trying to collect a discharge that.
So he had to know all about the dischargeability of prepetition debt. Plus he had to know that in a bifurcated zero down Chapter 7, the attorney can’t charge postpetition for work done prepetition. In other words, he had to know that he should have respected the bifurcation.
But because of habit or for whatever reason, he never changed his workflow accordingly.
The second thing that surprised me here is that he immediately told the UST that he was essentially violating the automatic stay and the discharge injunction. I mean, I guess he was just throwing himself at the mercy of the UST.
Amazingly, this attorney got off lightly in this case. In fact, that’s the part of the story that surprised me the most. The UST could have easily filed a motion to do an examination of attorney compensation with a section 329 hearing and forced them to at least disgorge attorney’s fees.
I mean, the UST could have even added civil penalties or referred them to the state bar for sanctions. But instead the UST just told them that they’d forgive and forget as long as he signed a consent decree to never do a bifurcated Chapter 7 again. They said he could still do traditional Chapter 7s, just not bifurcated 7s.
To be honest, if I was that bankruptcy attorney, I would thank my lucky stars that I’d run into the kindest US Trustee in the universe, and I would have signed the consent decree as fast as my hand could produce a signature. And that’s exactly what he did.
Okay, so the facts of this second story actually come from an opinion issued in the Eastern District of Missouri in June of 2021. And like the first story, I was surprised about the facts of the case.
The opinion was from the In re Allen case, and we’ll go over this opinion more completely later on.
But for now, let me read you the first bit of this case that’s relevant: “On May 21, 2020, the attorney filed a Chapter 7 petition and creditor matrix on behalf of Mr. Allen. The schedules, statement of financial affairs, and disclosure of attorney’s fees were filed 44 minutes later.”
And here’s the second relevant bit about the price that the debtor paid. $2,000 or $1,665 of attorney’s fees and $335 for the filing fee.”
Did you catch the surprising part? This attorney filed a skeletal petition and then 44 minutes later, he followed the complete statement and schedules.
This filing involved a bifurcated zero down Chapter 7. So he had waived fees on the prepetition part of his work and only charged for his postpetition work. Now, normally there’s nothing wrong with that, but he charged $1,665 in postpetition attorney’s fees, and the timestamps made it look like they were only 44 minutes of postpetition work.
If we do the math and divide $1,665 by 44 minutes, that makes his effective hourly rate $2,270 an hour. That’s a very high hourly rate to justify to a court for a consumer no-asset Chapter 7 bankruptcy case.
Now to be fair, I looked at the transcript of the hearing on this case and the attorney did testify that in fact, he had filled out the statement and schedules after the petition was filed. And that it just so happened that this took 44 minutes in this particular no-asset case.
He also testified that there was additional work done in this case, even after filing the SoFA and schedules, including stopping an existing wage garnishment. So the facts weren’t as bad as they looked initially.
So did the court throw the book at him? Amazingly in both the lower court opinion and then eventually the Eighth Circuit BAP opinion, both judges confined their response to observing that the statements and schedules were filed 44 minutes after the petition was filed.
We’ll discuss this opinion in detail later in this episode. But for now, I’ll just note that this attorney was lucky that the court was mainly reviewing conclusions of law de novo. This looks like one of those cases where the judges kind of glossed over some facts so they could focus on the joy of new law instead.
Now this attorney did end up having to disgorge a small amount of attorney’s fees. But there were no civil penalties, no sanctions, and the judges didn’t even use any strong words in their opinions. So it was a great result for this attorney. But unless you want to throw yourself at the mercy of a zealous UST, or an unforgiving judge, you might want to consider waiting to file the final statements and schedules until a certain amount of time has passed. You have 14 days to file them after you file the petition. So it’s up to you to decide whether you want to wait at least a day, a few days, whatever.
I know an attorney that usually waits 10 days.
I have another attorney client who usually waits a day. The idea here is that we just don’t want the UST to be able to assume incorrectly that you must be doing all your work prepetition. Or that the work that you did postpetition couldn’t have been enough to justify reasonableness for your fees.
Okay, so next I’m going to cover mistakes number two and three, and that’s not disclosing to the client, and not disclosing to the court.
To illustrate these mistakes. I’ll tell you about an attorney who’s currently facing a section 329 hearing.
To be fair, this attorney made some mistakes. His first mistake was that after starting to offer zero down bifurcated Chapter 7s, he didn’t change the way he disclosed attorney’s fees to the court with his Form 2030.
Instead, he continued to use the original unmodified Form 2030.
Unfortunately, if you’re bifurcating Chapter 7s and still filling out an unmodified Form 2030, you’re putting a square peg into a round hole.
For instance, the unmodified Form 2030 doesn’t have an obvious place for you to disclose that you’re bifurcating the case and receiving post-petition payments for post-petition work. Likewise, there’s no natural place for you to mention that you’re using a financing company or maybe that you’re financing the filing fee. So if you’re using an unmodified Form 2030, it’s easy to neglect to mention these things, which is a critical disclosure omission.
Luckily, Form 2030 is a Director’s form, so you can tweak your Form 2030 to make the disclosures work for a bifurcated Chapter 7.
This same attorney also made another common mistake with this court disclosures, which is that he didn’t list the post-petition payments on schedule J of the petition.
To be fair, the case law that says that you need to add these payments to Schedule J is mixed. Two opinions have held that you do need to do this. The first was in 2018 where the judge in In re Wright in the Northern District of Oklahoma lambasted an attorney for not doing this.
Conversely in 2019, the judge in In re Hazlett in Utah praised an attorney for adding the postpetition payments to his Schedule J.
But the case law isn’t all one sided on this issue. In fact, the Brown decision in the Southern District of Florida says that schedule J “reflects information as of the petition date. As of the petition date, a Chapter 7 debtor does not have an obligation to pay an attorney a fee post-petition.” So the Brown opinion outright says that you don’t even need to list the postpetition payments on Schedule J, because that obligation doesn’t exist as of the moment that the petition is filed.
But this raises a larger point that I want to stress, which is that our goal here isn’t to be able to take a certain action, like justifying not listing postpetition payments on Schedule J of the petition, and then pointing to a single opinion like Brown and saying that what we’re doing is okay.
I mean, I actually agree with Brown. That actually makes sense about how schedule J is only supposed to reflect a payment as the petition date. But I also believe that our larger goal here is that we want to be able to bulletproof our bifurcated Chapter 7s against zealous US Trustees that may be looking for an excuse to drag us into a Section 329 hearing on attorney compensation. So with that in mind, unless you’re in the Southern District of Florida, where In re Brown controls, I would just go ahead and always list the postpetition payments on the schedule J.
Finally, the attorney also made a third mistake with his disclosures, which is that the UST complained that some of the attorney’s numbers on the various disclosures weren’t consistent. And that’s a new problem that only arises in bifurcated Chapter 7s.
Let me explain.
In a traditional bankruptcy, you have a single legal services agreement, which is often the only document where you have your client disclosures. You also have your Form 2030 disclosures to the court. So you just have to make sure that the numbers on those two documents match.
However, in a bifurcated bankruptcy, you’re going to have five different places where you’re disclosing your fees.
First there’s your prepetition legal services agreement.
Second, there’s your postpetition legal services agreement.
Third, there’s the payment authorization form, which the client is going to sign to authorize you to charge them postpetition payments on a periodic basis.
And the final two places are the two disclosures to the court, namely the Form 2030 and the Schedule J.
So all five places need to match up or at least be consistent. For instance, and these numbers are made up to keep the math easy, but if your payment authorization form says that your client is paying a hundred dollars a month in attorney’s fees for the next year, that needs to match up with the amount that you’re putting on Schedule J. And if your client’s making 12 monthly payments of a hundred dollars, that’s $1,200 in total attorney’s fees. So you need to make sure that you have $1,200 on your prepetition and postpetition agreements, as well as your Form 2030.
On a related note, if you’re advancing the filing fee to clients, you also need to make sure that you both disclose this to the courts, and also that you don’t include this as an attorney’s fees since it’s not.
At the very least you need to break it out on your Form 2030 and say, “I am advancing the filing fee of $338.”
Now if all your numbers don’t match up, you’re open to a complaint from a UST that you haven’t disclosed the actual attorney’s fees properly to the court.
So in this case that we’re talking about, the judge has scheduled a Section 329 hearing next month. So I can’t tell you how this story ends. I can report that the attorney has already improved his client and court disclosures, and he isn’t making any of these mistakes anymore. I can also tell you that he wishes that he had made these client and court disclosures properly from day one.
All right, there’s actually another element of this case though, that I haven’t mentioned, and it has to do with reasonableness.
So now let’s discuss the last two mistakes, which are mistakes number 4 and 5.
Number 4 is “not passing the reasonableness test” and 5 is “charging different fees for financed cases.”
At the end of the day, both of these mistakes have to do with reasonableness, so they’re tightly linked. In the case of this attorney facing the Section 329 hearing, he only charges $1,200 in attorney’s fees for a cash case. Now that sounds extremely reasonable to me, so he hasn’t violated the basic reasonableness standard that is mistake number 4.
But he did make a mistake related to reasonableness, which is a new mistake number 5 that I didn’t have in my old book.
Basically, this attorney charged $500 more for financed cases than he did for cash cases. And that’s what got him in trouble.
This all stems from that In re Allen case that I mentioned earlier from the Eastern District of Missouri. In that case, the attorney also charged $500 extra for financed cases. The UST used this logic: clients receive similar legal services, whether they’re paying cash or finance their payments postpetition. Thus, if the attorney charges more in attorney’s fees for a finance case, the extra amount in attorney’s fees is automatically excessive and should be disgorged.
Now the bankruptcy attorney attempted to counter the USTs logic, using the same “lodestar method” I mentioned in my book to justify reasonableness. That method says that the attorney’s fees are reasonable when the amount charged is less than the value of a lawyer’s work, which can be calculated as “reasonable hours times a reasonable hourly rate.”
Unfortunately, the attorney in that case lost not once, but twice. And when this case got appealed to the Eighth Circuit BAP, they held that “courts are not bound to apply the lodestar calculation in every case where attorney’s fees are challenged.”
Now that decision is not a national precedent and it only applies to bankruptcies in the Eighth Circuit. But that hasn’t stopped zealous USTs from using this logic outside of the Eighth Circuit to claim that attorneys should charge the same in attorney’s fees, whether it’s a cash case or a financed case.
Part of me thinks that this decision makes no sense because the lodestar method has been approved by the Supreme Court and it’s worth fighting for this on principle.
However, the rest of me is pragmatic and just wants a UST to allow bankruptcy attorneys to offer affordable bifurcated Chapter 7s.
So that’s why I was excited when I heard that Dan Garrison, over at Fresh Start Funding, he’s the chief litigator over there, he has come up with a new pricing strategy to address this issue.
So Dan’s approach leverages the fact that the USTs position is quite narrow, because it’s focused solely on attorney’s fees. . To review the USDS logic is that if the attorney charges more in attorney’s fees for a financed case, that extra amount of attorney’s fees is automatically excessive and should be disgorged. However, it doesn’t say that the attorney can’t charge more in other fees for a financed case.
And that’s what Dan Garrison proposes bankruptcy attorneys actually do.
Specifically, he suggests that bankruptcy attorneys charge. , administrative fee of 19.9% on the amount that’s financed. So if an attorney charges say $2,000 in attorney’s fees and doesn’t finance the filing fee, Dan proposes that the attorney also charges a roughly 20% administrative fee. So that’s an extra around $400.
More precisely, their premium would be $380, if the attorney’s fees on a cash case where $2,000. And in total, the amount charged for a financed case would be $2,380.
There’s nothing in the Eighth Circuit ruling or any code of professional ethics that says that it’s unfair to charge an administrative fee to pay for the staff to help administer these payment plans. So that’s the new approach that I’m urging all my clients and podcast listeners to take.
Okay, there’s one last common bifurcation mistake from the book that I’ll just mention briefly, which is mistake number six, “not paying the court first.”
And that’s the one about how you have to pay the court first to satisfy Rule 1006 (b) (3). As it turns out, I haven’t seen any of my clients run into this as an issue over the last two and a half years since I published my book.
I only saw Rule 1006 B3 applied in that outlier Western District of Kentucky ruling which banned bifurcation altogether. That’s the In re Baldwin opinion. In that opinion, the judges seemed to claim that since the financing company didn’t advance funds to bankruptcy attorneys via dedicated IOLTA accounts, the possibility exists that the attorney would be paid before the court filing fee was paid, which would supposedly violate Rule 1006(B)(3).
Now this objection is a narrow issue and it could easily be worked around with IOLTA accounts. It can also be worked around by mandating in some of the agreements that the court filing fee be paid first before the lawyer takes any money. In any case, the In re Baldwin decision, which I’m going to talk about in a later episode, essentially banned bifurcation anyway so this workaround isn’t exactly relevant.
Also In re Baldwin is an interlocutory opinion where the final opinion hasn’t even been released, let alone appealed. So that decision isn’t exactly a binding precedent at the moment.
The upshot is that if you avoid making these six common bifurcation mistakes, you should avoid unwanted encounters with your UST, and you’ll be able to offer bifurcated Chapter 7s to your clients who are desperate for debt relief, while simultaneously growing your practice by helping people who need help and just can’t afford your attorney’s fees up front.
The last thing is that if you’re interested in learning more about the legal underpinnings of bifurcation, I’ve written a case loss summary that you can download for free. And you can just go to BK law, success.com. Slash case law. Case law is all one word. So it’s just c a s e l a w with no spaces or dashes.
So just go to bklawsuccess.com/caselaw. There you’ll be able to sign up to download my case law summary. It goes over 20 cases that feature issues relevant to bifurcated Chapter 7 bankruptcies.
So I’ve mentioned a few of these cases in this podcast episode.
There’s In re Wright in the Northern District of Oklahoma in 2018 and that goes over how even minor disclosure infractions can lead to major sanctions.
There’s the seminal In re Hazlett in 2019 in Utah which is a huge victory for bifurcation in the Tenth Circuit. There’s also the relatively new In re Brown in the Southern District of Florida.
That’s another seminal case for bifurcation. And it has a lot of complexities too that I go over in the case law summary. There’s also In re Allen in the Eastern District of Missouri, and that talks about whether attorneys can charge a premium on attorney’s fees when they finance a case, which is a topic that we went over today.
I even wrote up an analysis of that weird interlocutory opinion In re Baldwin in the Western District of Kentucky.
So in addition to my write-ups of 20 different cases, I’ve also included the full text of every opinion in the free download. So you can read my case law summary and then you can make up your own mind on how you interpret that opinion.
Again, you can download my case law summary for free. Just go to BKlawsuccess.com/caselaw, all one word. So it c-a-s-e-l-a-w with no spaces or dashes.
Okay. Great, thanks. I’ll see you in the next episode.