8th Circuit Rules Section 526(a)(4) Unconstitutional as Applied to Attorneys

The United States Court of Appeals for the Eighth Circuit just ruled on a matter of first impression among circuit courts--the constitutionality of the treating attorneys as "debt relief agencies" under provisions of the 2005 Bankruptcy Abuse Prevention and Creditors' Consumers' Protection Act. (Freudian slip...) In so doing, the 8th Circuit struck down a major BAPCPA provision that inartfully restricts attorneys' ability to give clients advice about how to prepare their finances in contemplation of filing for bankruptcy.

For those readers not familiar with the intricacies of BAPCPA, the Act contains a provision, codified at 11 U.S.C. Sec. 526(a)(4), that provides that a "debt relief agency" may not advise a client (whether or not in bankruptcy) to incur more debt more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for services performed as part of preparing
for or representing a debtor in a case under this title." A "debt relief agency" is defined as "any person who provides any bankruptcy assistance to an assisted person in return for the payment of
money or other valuable consideration..." 11 U.S.C. 101(12A). The question before the 8th Circuit was whether an attorney is a "debt relief agency," and if so, whether 526(a)(4) is an unconstitutional abridgment of First Amendment free speech rights of attorneys.

The 526(a)(4) issue is important because levels and types of consumer debt determine a consumer's eligibility for Chapter 7 (liquidation) bankruptcy instead of Chapter 13 (repayment plan) bankruptcy. The centerpiece of BAPCPA was "means testing"--looking at a consumer's income relative to other consumers in the state under a complicated formula, with above-average consumers required to file in Chapter 13. A well-informed consumer might be able to structure his or her finances so as to avoid Chapter 13, which requires living on a court-supervised repayment plan for 3-5 years, but in which creditors' might have larger recoveries.

The Eighth Circuit held that attorneys are "debt relief agencies" within the meaning of the statute, but that restrictions on their ability to advise clients are unconstitutional. The Eighth Circuit, however, upheld the requirement that attorneys, as debt relief agencies, advertise using specific precatory language.

The arguments about section 526(a)(4) are reasonably straightforward. The government, defending the statute, argued that section 526(a)(4) is designed to prevent consumers from "gaming" the system. The court, however, noted that it interferes with advice that has nothing to do with gaming the system: it might be financially better for all creditors for the debtor to refinance a mortgage into one with lower monthly payments (not least because of 1322(b)(2)'s mortgage anti-modification provision) or to purchase a reliable automobile, as that might not be possible once in Chapter 13. More generally, one can think of other cases, in which a consumer might expect to end up in Chapter 13, but might not want to gamble with the local Chapter 13 trustee's personal sense of what are reasonably necessary expenses (orthodontia? replacing a furnace with a cracked heat exchanger? Probably no monoxide poisoning, but do you want to gamble?)

Here's the thing about 526(a)(4)--it really doesn't prevent gaming of the system. First, a well-informed consumer can game the system without advice from an attorney. Second, at least on its face, section 526(a)(4) doesn't prevent an attorney from suggesting that a consumer cease or reduce working in order to lower monthly income. Third, section 526(a)(4) doesn't prevent an attorney from explaining--very clearly--the state of the law, including how the means test works and how a person with more debt of certain types would be able to qualify for Chapter 7. 526(a)(4) doesn't prevent gaming of the system, it just places a very artificial constraint on attorney advice and thereby reduces attorneys' ability to give clients the best advice that might have nothing to do with gaming the system and thereby undermines the attorney-client relationship. (I know not to romanticize the attorney-client relationship in volume-based consumer bankruptcy practice, but still, we give homage to that sacred theoretical bond).

So what does the 8th Circuit's ruling mean for consumer bankruptcy law? I'm going to be a contrarian and argue that it really doesn't change much. All it does is show that the emperor has no clothes, but everyone who deals with consumer bankruptcy knew that already. The 8th Circuit's decision results in the worst of all worlds jurisprudentially--poorly constructed means testing and the ability to game it with competent counsel. But this sorry state of affairs is no different than what exists outside the 8th Circuit--poorly constructed means testing and the ability to game it by sophisticated debtors or slightly more competent counsel. The 8th Circuit's decision just illustrates what a Through the Looking Glass world BAPCPA has made.

We could, of course, fix this nonsensical situation by leveling up or leveling down--getting rid of means testing or making it a sensible system. The current situation, however, makes little sense. That's not to say it was wrongly decided--the problem was a means testing system that relied on muzzling attorneys to have any shot at being effective, and that's not a system we should have. The BAPCPA's problems are, unfortunately, too big for courts to clean up piecemeal. Courts can try to make sense out of a poorly conceived and drafted statute, but fixing it into a sensible, cohesive system remains a legislative task.

[Hat tip to my student Robert for the ruling!]

Comments

[AMC]

So, our choice is between a Vice President cadidate who championed BAPCPA's garbage laddened and harmful provision to his fellow democrats, or John McCain, who also supported BAPCPA and is a charter member of the Keating 5.

God help us.

[Patches]

There has always been a lot of rumbling that the provision was unconstitutional and nobody liked being labeled as a “debt relief agency” either. Can anyone think of another law or proposed law that attempted that kind of restriction on an Attorneys' speech or advice? I though Republicans were for the concept of “Free Speech” and “Attorney Client Privilege” "Smaller Government"? I know Bush used “executive” privilege and "Attorney Client" privilege several times in recent memory. Oh, but he wasn’t trying to “game the system”. My bad! I don’t think Valerie Plame thought so especially after Bush let ole’ Scooter off the hook. I see, they mean smaller government for the rich (deregulation) but bigger more restrictive government for the poor and middle class, the ones most likely to “game the system” a.k.a. (Bankruptcy Abuse Prevention and Creditor Protection Act) They should just “come out with it” and say that instead of saying they are for the concept of smaller government and then going around and pass “Anti-Robinhood” legislation.

I agree AMC, rock and a freggin hard place with those two! Hey, the bright spot is that because the housing market is all screwed up, I am now able to purchase a good home (REO of course) for a decent price; in a decent neighborhood (no more being out bid by ARMs anymore). The icing on the cake is that we are so busy in the Consumer Bankruptcy Business that I got a raise, bonuses and soon an IRA. "Movin on up!". So I am kind of torn between presidential candidates for those reasons. I think I am starting to like things all screwed up. Job security! Like that guy on the movie “The 5th Element”. Someone has to clean up the mess when the glass breaks.

[AMC]

I think the "mess" is going to continue regardless of who gets elected.

Bill Gross is a smart guy, and if anything, he understates the problems going forward:

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/IO+July+2008.htm