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A Buffalo woman who used a divorce settlement to buy a condominium from her son-in-law— then filed bankruptcy allegedly to avoid paying her divorce lawyer—can use a homestead exemption to shield her assets, a Buffalo bankruptcy judge has held in a case of first impression.

Western District Judge Michael Kaplan rebuffed HoganWillig’s allegations that its former client tried concealing assets to skirt a nearly $93,000 legal bill, noting that as the client’s former divorce counsel, the firm “knew every penny of her financial affairs.”

The ruling potentially puts law firms on different, and less stable, footing than other creditors.

“She hid nothing from anyone, HoganWillig least of all,” Kaplan wrote in In re Wrobel, 12-13001. “The firm’s effort to argue that it should be treated as, or represents, some other unsecured creditor of the debtor—a creditor who actually might argue surprise and deception—is rejected.”

However, while Kaplan allowed Krystyna Wrobel to claim a homestead exemption, he expressed concern about the possible “insider” transaction and left a lien on the property in place. If Wrobel sells the condominium in the next three years, or her son-in-law returns the money she gave him for the property, HoganWillig may be able to assert a claim.

The case turned on an analysis of 11 U.S.C. §522 (o) of the Bankruptcy Code, which was enacted in 2005. Under that provision, if a debtor disposes property “with the intent to hinder, delay or defraud” a creditor, the homestead exemption is reduced accordingly.

Here, Wrobel was living in an apartment owned by her estranged husband and had retained HoganWillig to represent her in what became a lengthy divorce proceeding. At some point, Wrobel fired HoganWillig and hired a different lawyer, who settled the divorce. Wrobel became the apartment building’s owner in the settlement.

When HoganWillig learned that its former client was about to sell the building, and would net about $100,000, the firm went to state court in an unsuccessful attempt to prevent her from using the funds to buy a homestead. Wrobel in turn bought a condominium from her son-in-law; a year later, she filed for bankruptcy and claimed a homestead exemption.

HoganWillig, which is holding a $92,377 judgment against Wrobel, accused its former client and her current lawyer of scheming to convert non-exempt assets into exempt assets in an attempt “to hinder, delay or defraud” the firm, as that phrase is contemplated in §522(o). While acknowledging the law tolerates bankruptcy exemption planning as a financial device, the firm asked the court to determine “when it is that a pig becomes a hog.”

But Wrobel’s current attorneys with the firm Dennis Gaughan in Hamburg said HoganWillig is trying to “bully” a “relatively unsophisticated Polish immigrant” to extract an exorbitant fee from a client in her 60s who works part time as a $20,000-a-year hospital housekeeper. The attorney, Christopher Tyrpak, said Wrobel made no attempt to conceal assets and argued she should not be denied the homestead exemption.

Kaplan said the dispute centers largely on how §522(o) impacts bankruptcy planning, but with several “twists and turns,” agreed with Tyrpak.

The judge said it “once was clear” that a debtor could convert non-exempt property to exempt property before filing bankruptcy. But Kaplan said that changed in the wake of a few notorious cases where wealthy debtors moved to states with unlimited homestead exemptions to keep their money away from creditors, and Congress responded with the “hinder, delay or defraud” provision.

Kaplan said there is no Second Circuit authority on applying that provision in the framework of a bankruptcy planning, and no state law that addresses the situation that arose in the Wrobel matter. He said courts have adopted a “smell test” to determine if a debtor had engaged in an inappropriate transaction.

Here, Kaplan said, HoganWillig’s assertion that the debtor concealed assets “borders on sanctionable conduct.” He said Wrobel “openly and notoriously acquired the homestead” and rejected HoganWillig’s claim that her actions constituted “badges of fraud” and established that the transaction was a sham.

“The badges of fraud bespeak ‘hiding,’ ‘absconding,’ ‘avoiding, ‘sharp dealing,’ etc.,” Kaplan wrote. “The natural question is ‘Who exactly is it who was victimized by such evil actions?’ Certainly not HoganWillig, and no one else is complaining.”

Tyrpak said the ruling clarifies the law in the Second Circuit.

“I think it is significant because it provides a basis for interpreting §522(o), at least in the Second Circuit, and it adopts a significant portion of the holdings of other circuits that have already answered this question,” Tyrpak said.

Cheryl-Lane Bechakas of HoganWillig represented her firm. Steven Cohen, who runs the firm’s litigation department, said HoganWillig will seek leave to appeal to the district court.

“Judge Kaplan’s decision is very, very dangerous,” Cohen said. “He is making new law here. What he is saying is that a law firm is not a creditor in the same category of other creditors.”

Cohen said that if the ruling stands, law firms will be understandably reluctant to represent some clients because there would be an almost sure-fire way to cheat lawyers out of their earned fees.

“Certainly, we went into this with our eyes open and the understanding that there were non-exempt assets we could use for our fees, and [that] encourage[d] us to sink the amount of time and effort into this case that we did,” Cohen said. “What his honor has said is, ‘I don’t care what you and your client talked about. I don’t care whether these assets are exempt. I don’t care if §522(o) prohibits a debtor from hiding this money in a transaction with a son-in-law. You’re a law firm so you don’t get paid.’ That is troubling.”