U.S. Tr. v. Cialella (In re Cialella)

643 B.R. 789

IN RE: In the Matter of Attorney Paula J. CIALELLA Concerning Fee Agreements Entered on Various Chapter 7 Proceedings

United States Trustee, Movant

v.Paula J. Cialella, Respondent

Brenda J. Anthony, Debtor

Robert E. White and Mary J. White, Debtors

Misc. No. 21-210-TPA

Case No. 21-20705-TPA

Case No. 21-20755-TPA

United States Bankruptcy Court, W.D. Pennsylvania.

Signed September 26, 2022

Larry Wahlquist, Esq., for the Movant.

Ryan Cooney, Esq., Pittsburgh, for the Respondent.

MEMORANDUM OPINION AND ORDER

Thomas P. Agresti, Judge

INTRODUCTION

These proceedings present closely intertwined issues involving Attorney Paula Cialella ("Cialella") and her use in a number of Chapter 7 bankruptcy cases of a bifurcated fee arrangement with her clients that is a novel one in this District. The Anthony and White matters are individual bankruptcy cases in which Cialella employed the fee arrangement in question and in which the Court sua sponte raised the issue of whether it should be permitted, and if so under what conditions. A separate Miscellaneous Proceeding, In the Matter of Attorney Paula J. Cialella , Misc. No. 21-210-TPA ("Misc. Case"), was subsequently initiated by the United States Trustee ("UST") and it raises the issue of whether Cialella should be sanctioned for her admitted failure to properly disclose the bifurcated fee arrangement in many of the cases in which she used it, in violation of 11 U.S.C. § 329(a) and Fed.R.Bankr.P. 2016(b) . Because the matters involve many common legal and factual questions the Court has combined its conclusions as to both in this single Memorandum Opinion and Order .¹

BACKGROUND

The means of paying for consumer Chapter 7 cases presents something of a conundrum to would-be debtors and the attorneys who represent them. Individuals who are contemplating a Chapter 7 filing are obviously already under considerable financial stress, yet to gain the protection of bankruptcy they are faced with the additional burden of coming up with the filing fee. If they wish to be represented by an attorney, as most in this District do, there is also the question of paying the attorney fee. The current Chapter 7 filing fee in this District is $338 and the average fee charged in 2022 by local attorneys for a routine Chapter 7 case is approximately $1,500.² Thus, an already financially-strapped individual may need to come up with at least $1,800, and most likely more, in order to file a Chapter 7 bankruptcy.

There are options available to assist debtors with respect to the filing fee component of this necessary fund. If the debtor is unable to pay the filing fee immediately in full it is possible to seek permission to pay the fee in up to four installments, a request that is routinely granted. See 28 U.S.C. § 1930(a) and Fed.R Bankr.P. 1006(b) . If the debtor has a sufficiently low income and cannot even afford to pay the filing fee in installments it is possible to obtain a waiver of the filing fee altogether. 28 U.S.C. § 1930(f) and Fed.R.Bankr.P. 1006(c) . Thus, a debtor's inability to pay the full filing fee immediately is generally not an insurmountable impediment to a Chapter 7 bankruptcy filing. How to deal with the much larger attorney fee component has proven to be a more intractable problem, especially since the decision in Lamie v. U.S. Trustee , 540 U.S. 526, 124 S.Ct. 1023, 157 L.Ed.2d 1024 (2004).

The Court in Lamie found that an attorney who is acting as the debtor's attorney in a Chapter 7 case is not eligible to obtain compensation from property of the bankruptcy estate unless the attorney has actually been employed by the Chapter 7 Trustee and approved by the court – a rare occurrence. Attorneys obviously want to be paid for the good work they do in representing the debtor, and in the Chapter 7 context payment is usually structured as a flat fee agreement rather than on an hourly, ongoing basis. However, if the debtor does not pay the agreed upon fee in full in advance of the filing, under Lamie the attorney cannot expect to be paid the balance of the fee from estate funds. In such circumstances the attorney will technically also be a prepetition creditor of the debtor for the portion of the fee that is still owed when the case is filed. That can put the attorney in a conflict position unless the claim for the unpaid fee is waived by the attorney. Even if the case is able to move forward without a waiver of the fee ever arising as an issue, the attorney would then face the additional prospect that the claim against the debtor for the unpaid fee will be discharged in the bankruptcy, thus making any attempt by the attorney to subsequently collect it after the case has closed a violation of the discharge injunction. See e.g., In re Mansfield , 394 B.R. 783, 787-88 (Bankr. E.D. Pa. 2008) (citing cases holding that unpaid portion of flat fee due under prepetition attorney fee contracts are prepetition debts dischargeable in bankruptcy).

A number of different strategies have been employed to address the Chapter 7 attorney fee "problem" as discussed above. One is for the attorney to just insist that the entire attorney fee must be paid in advance before the attorney will prepare and file the bankruptcy petition. If the debtor does not have the ability to make such a payment then he or she must save up until the full fee can be paid, thereby delaying the filing. This approach often works if the debtor is not facing any immediate threat from creditors, but if there is an imminent foreclosure or repossession in the picture such a delay can be quite problematic.

Another approach that some attorneys take when the debtor cannot afford to pay the entire attorney fee in advance is to file the case under Chapter 13, which allows for the postpetition payment of attorney fees as part of the plan, instead of under Chapter 7. While this can work, it ends up being much more expensive and burdensome for the debtor because Chapter 13 attorney fees are typically far larger than those in Chapter 7 and the debtor will be in bankruptcy for a longer period of time. Furthermore, using Chapter 13 primarily as a means to fund the payment of attorney fees when a Chapter 7 filing would actually be more appropriate for the debtor can be problematic as well and viewed as an undesirable distortion or abuse of the bankruptcy process. See e.g. , In Re Brown, 742 F.3d 1309 (11th Cir. 2014) (affirming finding by bankruptcy court that a Chapter 13 filing motivated not by a desire to adjust debts or preserve assets, but rather as a means to pay attorney fees, was not made in good faith; debtor would have been better off in Chapter 7); Foohey, et al., "No Money Down" Bankruptcy , 90 S. Cal. L. Rev. 1055 (2017) (discussing the empirical study showing that debtors who use Chapter 13 rather than Chapter 7 as a way to pay attorney fees pay $2,000 more and have their cases dismissed at a rate of eighteen times higher than if they had filed under Chapter 7).

A third strategy is for the attorney to proceed with a Chapter 7 filing even though the debtor has only partially paid the agreed upon fee in the expectation, or perhaps only hope, that the debtor will voluntarily pay the remainder of the fee at some future time though not legally required to do so once a discharge has been entered. This is obviously no sure thing and presents a risk many attorneys will avoid. A fourth approach that some attorneys have attempted is to require a check from the debtor post-dated until after the filing date in the hope that the unpaid fee will then be treated as a post-petition obligation that is not discharged in the bankruptcy. This practice, however, has in general not fared well when brought to the attention of a court. See e.g., In re Davis , 2014 WL 3497587 (Bankr. N.D. Ala., July 11, 2014.) A fifth approach that has been taken, and the one which is the subject of the present cases, is a so-called "bifurcated" fee arrangement under which the attorney and the debtor enter into two separate fee agreements, one a "prefiling," or "prepetition" agreement signed before the petition is filed, and the other a "postfiling" or "postpetition" agreement signed thereafter.

In it's most basic form, the bifurcated fee approach entails the use of the prefiling agreement to provide solely for the minimum amount of legal services needed to have a skeletal petition prepared and filed, thus initiating the bankruptcy, following which the parties enter into a postfiling agreement under which the bulk of the legal work is to be done. The overall fee for the bankruptcy filing is split between the two agreements, generally weighted heavily (or even entirely) to the postfiling agreement. The theory behind this approach is that the debtor's obligation under the postfiling agreement will not be discharged in the bankruptcy and will thus remains a binding obligation of the debtor, providing some assurance to the attorney that the fee will be paid, even if over time. In some instances, including the one presented here, the attorney also enters into a factoring or financing agreement with a third-party as part of the bifurcated fee arrangement, with the third party paying the attorney a discounted amount on the postfiling agreement fee "up front" in exchange for a security interest in the attorney's account receivable and a role in collecting subsequent installment fee payments due from the debtor under the postfiling agreement.

A number of bankruptcy courts from around the country have considered whether the bifurcated fee approach is allowable under the relevant provisions of the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, and in some instances even Local Rules and applicable rules of professional conduct. The results have been mixed, though a majority of the courts to have considered the matter have recognized that bifurcated fee arrangements are not inherently proscribed and thus may be used if certain conditions are met. This is a question of...