Sua Sponte

Steve Ungerman
Bankruptcy Section Chair
saungerman@aol.com

In the last two weeks we have seen the government take over Fannie Mae and Freddie Mac and loan AIG $85 billion with an eighty percent ownership interest.  In addition, Lehman Brothers filed bankruptcy and Bank of America bought Merrill Lynch.  Also stock values have declined.  In the twelve months, ending June 30, nearly one million individuals and businesses filed bankruptcy.  There were 967,831 cases filed, up from 751,056, for the previous twelve months, which is a twenty-nine percent increase.  Non-business cases made up over ninety-six percent of the increase.  Business cases totaled 33,822, of which 23,372 were Chapter 7’s. 

It appears the mortgage meltdown was a major cause of all of the above.  Part of the Bankruptcy Section’s program at the National Conference of Bankruptcy Judges in Scottsdale on September 25th is From a Ripple to a Tsunami: The Impact of the Subprime Meltdown.  Our NCBJ committee has placed the CLLA and our Section in the forefront of the financial crisis facing our country and our economy.

I am looking forward to seeing our members who are attending the NCBJ conference.  I also hope you are planning to attend the CLLA meeting in New York in November.

Case Analysis

Jessica Kontul, Esq.
Buchanan Ingersoll & Rooney
One Oxford Centre
Pittsburgh, PA 15219

Two courts recently ruled on the constitutionality of sections in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA").  In Milavetz,Gallop & Milavetz, P.A. v. United States, the Eighth Circuit ruled on the constitutionality of sections 526(a)(4) and 528(a)(4) and (b)(2) which impact lawyers representing certain consumers in connection with bankruptcy.  In Connecticut Bar Ass'n v. United States, the District Court for the District of Connecticut filed its judgment regarding the constitutionality of sections 526(a)(4), 527, and 528(a)(1), (a)(2), (a)(3), (a)(4) and (b)(2).  The Commercial Law League of America filed an amicus brief in support of the appellees in Milavetz and in support of the plaintiffs in Connecticut Bar Ass'n supporting their arguments that all of the challenged sections of the BAPCPA are unconstitutional.

Attorneys as Debt Relief Agencies
The Eighth Circuit and the District Court of Connecticut held that attorneys are "debt relief agencies."  Both of the courts reasoned that because attorneys were not specifically excluded from the definitions of "bankruptcy assistance" and "assisted persons", and both definitions are broad and cover legal services provided by attorneys, they must be included under the definition of "debt relief agencies." 

The District Court of Connecticut went one step further and held that the BAPCPA applies to even those attorneys who represent non-debtor assisted persons.  The Eighth Circuit also recognized in a footnote that the broad definitions of debt relief agency, bankruptcy assistance, and assisted person, might result in certain attorneys meeting the definition of debt relief agencies even though they do not represent debtors in bankruptcy nor help people file for bankruptcy relief under the Code.

Section 526(a)(4) - Prohibition on Advice to Incur More Debt
Both of the courts held that section 526(a)(4) of the BAPCPA is unconstitutional as it applies to attorneys.  This section prohibits debt relief agencies from advising clients "to incur more debt in contemplation" of filing for bankruptcy or "to pay an attorney or bankruptcy petition preparer fee."  Neither court ruled on whether strict scrutiny or the balancing test is the proper standard for review, but both held that the section was unconstitutional as it applied to attorneys because the section is overbroad.  The court reasoned that, as written, the section prohibits attorneys from advising their clients to incur any kind of debt prior to filing for bankruptcy, including debts that are legal and desirable in certain instances.

Section 528(a)(4) and (b)(2) - Advertising Requirements
These disputed sections of 528 require debt relief agencies to disclose: "We are a debt relief agency.  We help people file for bankruptcy relief under the Bankruptcy Code.' or a substantially similar statement," in all of their bankruptcy-related advertising materials directed to the general public.  Both of the courts categorized this section as requiring a factual disclosure and applied the reasonably related, or rational basis, standard.  In Milavetz, the Eighth Circuit held that the section was constitutional as it was reasonably related to the government's interest in protecting consumer debtors from deceptive advertising. 

In Connecticut Bar Ass'n, the court also ruled that the section was constitutional under most circumstances, however, the district court of Connecticut held that section 528(a)(3), (a)(4) and (b)(2) were unconstitutional as applied to attorneys not aiding debtors.  The district court found that the disclosure was not an accurate disclosure as applied to these attorneys and that it was not reasonably related to the government's interests in preventing consumer deception, as there was no evidence that advertisements by these attorneys were deceptive.

Section 527 - Required Disclosures
The District Court of Connecticut, in Connecticut Bar Ass'n, held that section 527 of the BAPCPA was constitutional.  This section required attorneys to provide "assisted persons" with written notice of specified information regarding bankruptcy and the bankruptcy process.  The court classified this section as requiring factual disclosures and held that the disclosures were reasonably related to the interest in ensuring that debtors are well informed about bankruptcy and the bankruptcy process.  The plaintiffs challenged that the requirements were overbroad.  The court dismissed this argument, stating that the attorney is only required to provide the information "to the extent applicable" and the statement can be modified as long as it is "substantially similar". 

Section 528(a)(1) and (a)(2) - Contract Provisions
The District Court of Connecticut, in Connecticut Bar Ass'n, also held that section 528(a)(1) and (a)(2) require that debt relief agencies execute a written contract with an "assisted person, clearly explaining the services the attorney will provide and the fees or charges for such services, within five business days of the initial date of provision of bankruptcy assistance to that person.  The plaintiffs argued that, because there is no exception for situations in which a client refuses to sign the agreement, it imposes strict liability on attorneys and violates due process.  Plaintiffs also asserted that it impermissibly restricts the lawyer's freedom of speech. 

The District Court dismissed the argument that the section restricted the attorney's freedom of speech and found that this is simply an economic requirement.  It ruled that the section was constitutional under the rational basis standard.  It dismissed the plaintiff's argument that the section imposed strict liability by reasoning that a client may only bring an action if the attorney intentionally or negligently failed to comply with the provision. 

In summary, the Eighth Circuit and the District Court of Connecticut both held that lawyers are "debt relief agencies" and section 526(a)(4) of the BAPCPA is unconstitutional.  The Eighth Circuit held that section 528(a)(4) and (b)(2) is constitutional.  However, the District Court of Connecticut held that these sections were unconstitutional as applied to attorneys not aiding debtors.  The District Court of Connecticut further ruled that sections 527 and 528(a)(1) and (a)(2) are constitutional.

Case Law Update

Mullin v. Travelers Indem. Co. of Connecticut

  • U.S. 10th Circuit Court of Appeals
  • 9/14/08

In an action against defendant-insurer seeking a declaratory judgment that plaintiffs-property owners are entitled to recover from defendant the full amount owed on their judgment against insured-bankrupt property management company, summary judgment for plaintiffs-owners is reversed and remanded where: 1) plaintiffs abandoned a claim that the policy covered a loss from discounted rents; 2) a failure to forward rental income was not a covered loss; 3) theft from plaintiffs' property was not covered because it predated the policy coverage period; and 4) although the policy covered theft from a condominium plaintiffs occupied, disputed facts preclude summary judgment on insurer's claim of inadequate notice from the management company.

In the Matter of Soza

  • U.S. 5th Circuit Court of Appeals
  • 09/12/08

In a bankruptcy case, approval of an exemption from the bankruptcy estate for an annuity purchased by debtors one day prior to filing their bankruptcy petition is reversed and remanded where: 1) the purchase of the annuity was not an intentional fraud upon creditors, but the state exemption statute would apply a standard set at something less than intent to defraud to determine whether an exemption should be allowed; and 2) several "badges of fraud" were evident in the purchase, and under the totality of circumstances, the transaction represented a payment made in fraud of a creditor.

In Re: Willet

  • U.S. 7th Circuit Court of Appeals
  • 9/12/08

In a bankruptcy case, grant of debtor's motion to avoid a lien on their residence is reversed and remanded where for the purposes of a motion to avoid a lien made pursuant to 11 U.S.C. section 522, a bankruptcy court should value a Chapter 13 debtor's interest in real property as of the date that interest becomes part of the bankruptcy estate.