640 B.R. 104
Bankr. W.D. Ky.2021Background
- Attorney Michael Harris used bifurcated pre‑petition and post‑petition fee agreements for Chapter 7 clients; post‑petition payments were financed through a Fresh Start Funding (FSF) Line of Credit and Accounts Receivable Management Agreement (LOCARMA).
- Harris often advanced the $335 filing fee at filing, with clients signing post‑petition contracts to repay fees (flat fee quoted $2,100–$2,500) in installments; Harris’s Form 2030 disclosures often stated $0 due or otherwise misstated amounts.
- Under the LOCARMA, FSF advanced ~60% of the quoted fee to Harris, retained 15% as a pooled holdback and kept ~25% as its compensation; LOCARMA conditioned advances on use of bifurcated post‑petition contracts.
- The U.S. Trustee investigated, concluded the arrangements were problematic (advancing filing fees, factoring, inadequate disclosures, potential fee‑splitting and conflicts), and submitted a memorandum to the court.
- The Bankruptcy Court held hearings, reviewed the LOCARMA and contracts, and concluded the bifurcated agreements and FSF factoring violated the Bankruptcy Code, Federal Rules of Bankruptcy Procedure, the Court’s Local Rules, and Kentucky Rules of Professional Conduct; the Court ordered such agreements prohibited in the Western District of Kentucky.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| May an attorney advance a debtor's filing fee and be repaid post‑petition? | U.S. Trustee: No; advancing with expectation of post‑petition repayment creates a pre‑petition dischargeable obligation and violates §526 and ethical rules. | Harris: Disclosure (Form 2030 ¶7) and client consent make the arrangement permissible; cited access‑to‑justice concerns. | Court: Attorney may not advance filing fee with expectation of repayment; practice violates Rule 1006, §526(a)(4) and Kentucky ethics rules. |
| Does factoring/LOCARMA that advances and collects post‑petition fees violate bankruptcy and ethical rules? | U.S. Trustee: Yes; factoring creates nondischargeable obligations, conflicts of interest, improper shifting of fees, and inadequate disclosure to debtors and court. | Harris/FSF: Financing enables access and convenience; FSF performs collection/processing and protects attorney cash flow. | Court: Factoring arrangement violates the Code, Local Rules and Kentucky professional rules; creates inherent conflicts and is impermissible. |
| Were disclosures to debtors and the court adequate under §528 and §329 and Kentucky professional rules? | U.S. Trustee: Disclosures were misleading/insufficient—failed to explain defaults, LOCARMA terms, FSF role, and true fee allocation. | Harris: Form 2030 narrative and contracts provided required information and client consent. | Court: Disclosures were inadequate and misleading; Form 2030 filings did not comply with §329 and required candor. |
| Did Harris improperly split fees with FSF or fail to disclose fee‑sharing? | U.S. Trustee: Yes; FSF kept a portion of the fee and LOCARMA functioned as fee‑splitting/cost shifting without disclosure, implicating fee‑sharing prohibitions. | Harris: Characterized FSF receipts as financing costs, not fee‑splitting; relied on contracts and consent. | Court: The arrangement raised fee‑splitting and disclosure concerns; Harris’s disclosures were misleading and violated rules. |
| Were the bifurcated/post‑petition fees reasonable compared to standard Chapter 7 fees? | U.S. Trustee: No; bifurcated fee (often $2,500) far exceeded customary fees (~$900–$1,600) for substantially similar services and worsened debtors’ finances. | Harris: Higher fee justified by payment flexibility and services; relied on client choice. | Court: Fee increase was unreasonable given similar services; arrangement not in clients’ best interests. |
Key Cases Cited
- Lamie v. United States Tr., 540 U.S. 526 (2004) (§330(a)(1) does not authorize compensation to debtors’ attorneys from estate funds absent proper employment under §327)
- Rittenhouse v. Eisen, 404 F.3d 395 (6th Cir. 2005) (unpaid pre‑petition attorney fees are dischargeable in bankruptcy)
- In re Carr, 613 B.R. 427 (Bankr. E.D. Ky. 2020) (under facts presented, limited fee advancement was permissible but did not address factoring)
- In re Prophet, 628 B.R. 796 (Bankr. D.S.C. 2021) (disapproved bifurcated Fresh Start arrangements; local rule requires full scope representation by counsel who files petition)
- In re Wright, 591 B.R. 68 (Bankr. N.D. Okla. 2018) (criticized Fresh Start‑style factoring and misleading §329 disclosures)
- In re Allen, 628 B.R. 641 (B.A.P. 8th Cir. 2021) (reduced enhanced post‑petition fee under bifurcated option where services were the same; did not rule on factoring validity)
- In re Whaley, 282 B.R. 38 (Bankr. M.D. Fla. 2002) (§329 and Rule 2016 disclosures are mandatory and must be accurate)