Per Se Bad Faith? an Empirical Analysis of Good Faith in Chapter 13 Fee-only Plans

• Publication year: 2014

Per Se Bad Faith? An Empirical Analysis of Good Faith in Chapter 13 Fee-Only Plans

Alexander F. Clamon

PER SE BAD FAITH? AN EMPIRICAL ANALYSIS OF GOOD FAITH IN CHAPTER 13 FEE-ONLY PLANS

Abstract

Section 1325(a)(3) of the Bankruptcy Code requires chapter 13 plans to be "proposed in good faith and not by any means prevented bylaw." Section 1325(a)(7) requires that "the action of the debtor in filing the petition was in good faith." Courts evaluate both good faith provisions through a subjective inquiry into the totality of the circumstances in each case, typically using similar factors in the analysis. Many jurisdictions provide a list of factors for this assessment. Courts caution that any list is non-exhaustive and should not limit the subjective nature of the good faith inquiry. Some chapter 13 plans propose to pay little more than the trustee and attorney fees, and leave nothing or a nominal repayment to general unsecured creditors. These so-called "fee-only" plans challenge one of the underlying goals of chapter 13: a fair distribution of the debtor's future income to repay creditors. While courts find most fee-only plans fail to satisfy the good faith requirements, three circuit courts have ruled that fee-only plans are not per se bad faith.

This Comment provides insight into how courts are actually dealing with fee-only cases through an empirical study of good faith litigation over plans proposing zero or a nominal repayment to general unsecured creditors. This study compiles data and conducts a broad analysis of the factors that courts have listed and discussed in the totality of the circumstances test for good faith. This Comment hypothesizes that two particular variables are significant predictors of a court's ruling on good faith: (1) the repayment to general unsecured creditors and (2) the number of factors discussed in the case. Analysis of the data does not support the first hypothesis but does support the second. This Comment concludes that, in the absence of a strong correlation between the number of factors and good faith rulings, courts should not overhaul the traditional good faith analysis when dealing with fee-only plans. This Comment suggests, however, one of the circuit court rulings may provide a modified approach that balances the benefits of a subjective, discretionary standard against the wide-ranging concern over plans that propose little or no repayment to general unsecured creditors.

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Introduction

"I am not going to allow these folks to come in here and pay lawyers," proclaimed the bankruptcy judge.¹ The judge had been curious why, other than an inability to pay the attorney fee up front, the debtor wished to file for chapter 13 relief instead of chapter 7.² The attorney replied, "Well, the reason he wants to is because he wants some relief and he can't get it with a [c]hapter 7 because he has no money."³ But the judge replied, "And he has no money to, you have to finish the sentence, pay his lawyer."⁴

The judge suggested that the debtor need only save his proposed chapter 13 payment for a few months, and then pay the attorney for a chapter 7 filing.⁵ But for ethical reasons, the judge would not allow debtors to file for chapter 13 relief merely to finance their attorney fees.⁶ If debtors cannot afford the fee up front, the judge explained, "I don't see how in the world you expect that they are going to be able to pay a five or three-year plan and not default and then, once they do, they are back in the soup again and they have made no headway."⁷

This exchange highlights the problems in chapter 13 bankruptcy with so-called "fee-only" plans, which propose to pay the debtor's attorney fees through plan payments while leaving nothing or a nominal amount to general unsecured creditors.⁸ In this case, as with many fee-only plans, the judge denied confirmation of the plan because it violated chapter 13's good faith provisions under 11 U.S.C. §§ 1325(a)(3) and 1325(a)(7).⁹

When it enacted the modern Bankruptcy Code (Code),¹⁰ Congress included § 1325(a)(3), an ambiguous confirmation requirement that "the plan has been proposed in good faith and not by any means forbidden by law."¹¹

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Unsurprisingly, the good faith standard spurred litigation.¹² In 2005, Congress added § 1325(a)(7),¹³ another confirmation requirement that "the action of the debtor in filing the petition was in good faith."¹⁴ In assessing good faith under both provisions, courts typically apply a totality of the circumstances test, which requires a fact-intensive inquiry in each case.¹⁵ Various lists of factors have emerged as a result, though courts acknowledge that these lists are not exhaustive.¹⁶

Although the Code only requires general unsecured creditors in chapter 13 to receive at least as much as they would in a hypothetical chapter 7 liquidation,¹⁷ fee-only plans nevertheless challenge one of chapter 13's primary goals: to distribute a debtor's future income to repay creditors in lieu of liquidating the debtor's assets.¹⁸ As one court explained, "[c]hapter 13 is titled 'Adjustment of Debts of an Individual with Regular Income.' [With fee-only plans, debtors] are not adjusting anything, much less debt; they are canceling and eliminating the claims of creditors while simply paying their attorneys."¹⁹

"Fee-only" and other court-coined terms for these plans do not have a concrete definition.²⁰ Regardless of the terminology, fee-only plans uniformly allow debtors the benefits of retaining their assets and financing their legal fees through a chapter 13 bankruptcy plan while offering little or nothing in return to general unsecured creditors.²¹ Three federal circuit courts have rejected the view that fee-only plans are bad faith per se.²² Though in one of the opinions, Berliner v. Pappalardo (In re Puffer), the First Circuit seems to narrow their

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treatment of fee-only plans within the totality of the circumstances test.²³ No other circuits have definitively addressed the issue, and lower courts have taken various approaches.²⁴

Regardless of the approach, and despite the appellate courts' unwillingness to adopt a per se rule so far, courts invariably view fee-only plans with a great deal of suspicion; as one court explained, "a heavy burden of proof is required to rule that fee-only plans comply with chapter 13's good faith requirements.²⁵

Although the Code doesn't necessarily require any repayment to unsecured creditors in chapter 13,²⁶ courts seem to acknowledge that something is inherently wrong with a chapter 13 plan that only exists to finance attorney (and court) fees.²⁷ Where chapter 13 exists to allow debtors to repay debts through future income when they are able to do so,²⁸ fee-only plans appear to be "little more than disguised [c]hapter 7 proceedings."²⁹ Perhaps this is the perfect place to examine the line between good faith and bad. When a chapter 13 plan offers no more repayment to general unsecured creditors than a chapter 7 liquidation, should courts adopt a per se rule against fee-only plans, or at least modify the totality of the circumstances test for good faith? Are any particular factors within the totality of the circumstances test more significant than others?

This Comment addresses these questions by conducting an empirical analysis of chapter 13 fee-only plans, specifically the factors courts list and discuss in the totality of the circumstances test for good faith. This analysis provides insight on the actual application of those factors within the specific context of fee-only plans, and determines whether courts are indeed trending toward common considerations in ruling on good faith. To the author's knowledge, the factors have not been studied empirically, and certainly not

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with a focus on fee-only plans. Empirical research can provide valuable insight in consumer bankruptcy.³⁰ This Comment only provides a rough sketch of how courts are actually applying the good faith standard within the specific context of fee-only plans. While the totality of the circumstances test is subjective, the factors courts list offer a hook for which an empirical study can examine the test.

In light of three recent circuit court decisions, this study offers insight on whether courts are focusing their good faith analysis in fee-only cases with any statistical significance. Conducting this analysis will help inform courts whether the traditional good faith test should be modified in the context of fee-only plans.

Part I provides relevant background discussion of chapter 13 and the evolution of its good faith standard. Part II dissects the concept of "fee-only," defines its scope for purposes of this study, and discusses the three circuit court decisions that have definitively ruled on the validity of fee-only plans.

Part III first discusses the empirical study's method, assumptions and limitations, and the list of good faith factors. It then presents the results of the analysis. The study found no statistically significant relationship between the percentage of repayment to general unsecured creditors and a good faith finding. The findings, however, did reveal a few statistically significant relationships: (1) within the totality of the circumstances test, as the difference between the number of factors a court discusses and the number of factors a court lists increases, the likelihood that a court finds the plan to be in good faith decreases; (2) one factor's listing and one other factor's discussion are statistically significant predictors of a good faith finding; and (3) four pairs of factors are discussed in the same case at statistically significant rates.

Part IV discusses the overall implications of the study's results and offers options moving forward, including a discussion of a modified approach to fee-only plans, which would require special circumstances to justify the plan under 11 U.S.C. §§ 1325(a)(3) and 1325(a)(7). This approach is derived from one...