In re Shatusky and its novel financing arrangement for bifurcated Chapter 7 bankruptcies
I recently learned about the In re Shatusky case in the Middle District of Florida. It’s a great case with lots of implications for bifurcated Chapter 7 bankruptcies, but I’ve read very little about it online…
In this Chapter 7, the debtor was Shatusky and the debtor’s bankruptcy attorney was Alan Borden of Debt Relief Law Group. After filing a bifurcated 7, the debtor (jointly with a third-party financing company) asked a bankruptcy judge in the MDFL to approve the novel financing arrangement used for this bifurcated Chapter 7 bankruptcy. Erik Johanson was the counsel for movant in this matter.
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This case is interesting because it received the blessing of Judge Roberta A. Colton in the MDFL for its novel financing arrangement. Also, Judge Colton applies the ethical and statutory requirements laid out in the Walton v. Clark and Washington and In re Brown decisions, creating a binding precedent for bifurcated 7s in the MDFL and a persuasive authority elsewhere.
Before I explain how Shatusky‘s financing approach was novel, let’s outline how most law firms deal with postpetition payments in a bifurcated Chapter 7 bankruptcy. In a “modern bifurcated Chapter 7,” the attorney will use a two-contract approach, where the client can sign a pre-petition agreement and then, after the bankruptcy petition is filed, the client has the option to sign a post-petition agreement. And because that post-petition agreement is signed after the petition is filed, the debtor can make payments to the attorney on a post-petition basis, without that debt being subject to the automatic stay or the discharge injunction.
To turn that post-petition contract into cash, the bankruptcy attorney now has two options.
The first option is often called “self-financing,” because attorneys finance the bankruptcy themselves as the debtor makes monthly payments directly to the attorney. Assuming that the attorney’s fee is $2,000 and that 10% of the time debtors don’t make their payments, here’s what the cash flow for a self-financed case might look like:
|Amount in %
|Amount in $
|Amount attorney earns over time
|Amount never received because
the average debtor defaults
The second option is usually called “third party financing,” because bankruptcy attorneys that want their money now (instead of waiting for debtors to slowly pay them) will work with a third-party financing company. In this option, the debtor pays the third-party financing company directly. Typically, this involves the financing company fronting the attorney 65% of the attorney’s fee today, putting 10% of that fee into a reserve against defaults by debtors, and keeping 25% as their own fee.
|Amount in %
|Amount in $
|Advance to attorney
|Financing company fee
|Reserve against defaults
OK, so those two options are the only way that I’ve seen a “modern bifurcated Chapter 7” past the muster of a bankruptcy court.
However, in the Shatusky case, the bankruptcy attorney involved a third-party financing company, but there were three major differences.
The first major difference is that in previous cases involving a third-party financing company, the debtor borrows the attorney’s fee from the attorney without cash changing hands with a promise to pay him or her back over time. This means that if debtors default on their future payments, they owe the money to their attorney. This creates a possible conflict of interest between attorneys’ role as a postpetition creditor to the debtor, and their role as a debt relief agency seeking to discharge the debtor’s prepetition debts.
However, in the Shatusky case, that the debtor borrows money to pay the attorney’s fee directly from the third-party financing company. That means that if debtors default on their future payments, they will have defaulted on a loan from the third-party financing company and not the attorney. This mitigates the possible conflict of interest described above. For instance, if debtors default, the third-party financing company can sue and garnish the debtor, without the attorney being a direct party to any collections activity.
The second major difference is that in previous cases involving a third-party financing company, the debtor typically pays a 0% interest rate to the attorney for the amount financed. However, the attorney typically receives 65% of the amount financed when they “factor1” their legal accounts receivable . This means that if the attorney always charges the same amount in attorney’s fees, the amount they receive for a bifurcated-and-financed case will always be 35% less than the amount they receive for a paid-in-full cash case.
This creates an incentive for the attorney to charge more for a bifurcated-and-financed case, so that the attorney ends up netting the same amount for both types of cases.
However, in the Shatusky case, the debtor pays a ~18% APR2 to the third-party financing company. This means debtors end up paying more if they choose the bifurcated-and-financed option versus the paid-in-full cash option. These extra payments mean that there is no longer a huge difference in fees received by the attorney depending on the financing option, which lessens the incentive for attorneys to charge a higher amount in attorney’s fees when debtors choose the bifurcated-and-financed option.
The third major difference is that in previous cases involving a third-party financing company, attorneys are the only ones compensating the third-party financing company by giving them that 35% factoring discount. However, as described above, in the Shatusky case, debtors compensate the third-party financing company by paying an APR. To be fair, in addition to the debtor’s interest rate, in the Shatusky case, the attorney also agreed to pay $120 to the third-party financing company as a processing fee. So the attorney still compensates the third-party financing company. But at least the attorney isn’t the only entity paying the financing company.
Motion to Approve Post-Petition Attorney Fee Financing Arrangement,
in re shatusky, Case No. 8:22-bk-00131-RCT, Doc. No. 36 (Bankr. M.D. Fla. Mar. 18, 2022
- I am using the word “factoring” loosely here. To be precise, “factoring” is when a business (including an attorney) sells an accounts receivable worth a certain nominal amount to a third party in exchange for receiving an amount of money today that is a discount to that face value. In a modern bifurcation, rather than sell an accounts receivable, the attorney will collaterally assign the accounts receivable to the third party in exchange for money today. ↩︎
- This APR is clearly designed to be a tick below the amount allowed by Florida’s usury laws: “The maximum permissible interest rates in Florida are 18% per annum simple interest for loans up to $500,000.00” ↩︎