The case of In re Lombardo, 2007 WL 1893206 (Bkrtcy.E.D.N.Y. 2007) involved a debtor who filed a Chapter 7 bankruptcy petition listing as her major creditor her divorce lawyer. The debtor had executed a retainer agreement with the divorce lawyer that gave the lawyer a security interest in any equitable distribution to which the debtor became entitled to in the divorce, including a 401(k) plan. The Debtor agreed to pay her lawyer in monthly installments of $400 per month or from the Debtor’s share of the equitable distribution that she would receive in the divorce proceeding, including her husband’s 401(k) plan, whichever came first. Moreover, the Debtor agreed that upon receipt of any settlement from her husband, the amount due and owing to her lawyer would be paid at once, rather than upon the Debtor’s attaining age 59 and one-half regardless of any tax consequences she may incur.

So the debtor takes on this lawyer and strings her along for a good long time - the divorce got nasty, and there was a ton of litigation. Then the debtor up and becomes . . . well, a debtor. Files a Chapter 7 bankruptcy case.

The lawyer, meanwhile, doesn’t file a nondischargeability complaint on the basis that the debtor incurred the debt without the intent or ability to repay (which may or may not have been the case). There’s no objection to the debtor’s claimed exemption of the 401(k) proceeds that she got as part of the divorce, with a claim that it was encumbered by the legal fees as an unperfected security interest. Nope, none of that happens.

What does the lawyer do? Files a motion for dismissal of the case under 11 U.S.C. § 707(a), citing bad faith as the grounds for a dismissal “for cause.”

Judge Eisenberg finds for the lawyer in this case, noting the split in authority among the circuits in allowing dismissal for bad faith. She notes that while the Second Circuit had yet to rule on the issue of whether bad faith constitutes cause for dismissal under § 707(a), courts in this Circuit have followed In re Zick, 931 F.2d 1124, 1127 (6th Cir.1991) in dismissing cases where there is an absence of good faith. In re O’Brien, 328 B.R. 669 (Bankr.W.D.N.Y.2005); In re Blumenberg, 263 B.R. 704, 713-714 (Bankr.E.D.N.Y.2001); In re Griffieth, 209 B.R. 823, 827-828 (Bankr.N.D.N.Y.1996). Judge Eisenberg also looks to the recent case of Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007) to note that “routinely treat dismissal for prepetition bad-faith conduct as implicitly authorized by the words ‘for cause’.” Marrama at 1111 (2007) (stating that the practical effect of a dismissal of an individual’s Chapter 13 case due to prepetition bad-faith conduct is tantamount to a ruling that the individual is not a ‘honest but unfortunate debtor’ that the bankruptcy laws were enacted to protect.)

Courts have considered the following factors to be relevant to such an inquiry of bad faith:

(1) The debtor’s manipulations having the effect of frustrating one particular creditor;

(2) The absence of an attempt to pay creditors;

(3) The debtor’s failure to make significant lifestyle changes;

(4) The debtor has sufficient resources to pay substantial portion of debts;

(5) The debtor inflates expenses to disguise financial well-being, and

(6) The debtor is overutilizing protections of the Bankruptcy Code to the conscious detriment of creditors.

Blumenberg, 263 B.R. at 715 (citing, In re Griffieth, 209 B.R. at 827). Some courts also considered whether the following additional factors exist in determining bad faith:

(1) The debtor reduced his creditors to a single creditor in the months prior to The filing of the petition;

(2) The debtor filed in response to a judgment, pending litigation or collection action; there is an intent to avoid a large single debt;

(3) The unfairness of the use of Chapter 7;

(4) The debtor transferred assets;

(5) The debtor is paying debts to insiders;

(6) The debtor failed to make candid and full disclosure;

(7) The debts are modest in relation to assets and income; and

(8) There are multiple bankruptcy filings or other procedural “gymnastics”.

In re O’Brien, 328 B.R. at 675; In re Eddy, 288 B.R. at 505 (citing, In re Spagnolia, 199 B.R. 362, 365 (Bankr.W.D.Ky.1995). While the presence of one of these factors alone will not be sufficient to support a dismissal for cause, a finding of a combination of factors may suffice. In re Eddy, 288 B.R. at 505; In re Spagnolia, 199 B.R. at 365.

The court notes that the debtor filed Chapter 7 specifically to avoid payment of the legal fee. The court also realizes that the lawyer could have backed out and cut her own losses but decided to stay in the game for whatever reason. And for that, the court finds that the debtor engaged in trickery and bad faith.

Let’s look at it from the debtor’s position. She did what she was permitted to do under the law. She owed money that she couldn’t pay back. She got into a business deal with someone else and that person took a chance on repayment. The lawyer did all of the work and rolled the dice - isn’t that was commerce is all about? A divorce lawyer presumably knows the financial position of his or her own client by virtue of the financial discovery that is a part of every divorce case, and can more readily assess the ability to repay than can anyone else.

Rather than holding the lawyer responsible for a dumb business move, the court allows the lawyer to not only recover her own fees but also effectively leaves the debtor with no recourse in the bankruptcy court for ANY of her other (admittedly small, but still valid) debts.

So what Judge Eisenberg is telling us is that a debtor with one major debt should not file for Chapter 7 bankruptcy because it’s bad faith. You’ve got to have a bunch of debts to make a go of it, apparently. Had this debtor owed a ton of money to MBNA, Chase and Citibank then the end result would have presumably been different.

And as to the divorce lawyer I can only wonder why she sat on the sidelines during the rest of the case? Why wreck the whole bankruptcy rather than knock her own claim out through a non-dischargeability complaint? Why not attempt to enforce a security interest in the 401(k) plan?

I’d love to hear your comments on this, folks.