Monday, July 31, 2006

BAPCPA Found to Unconstitutionally Limit Attorney Speech

In one of the first decisions construing the Debt Relief Agency provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the U.S. District Court for the Northern District of Texas has held that one specific provision of the statute is unconstitutional but denied relief on several other claims. No. 3:05-CV-2330-N, Susan B. Hersch vs. United States of America, et al (N.D. Tex. 7/26/06).

Attorney Susan B. Hersch of Dallas filed suit seeking a determination that attorneys did not fall within the definition of Debt Relief Agencies and that several provisions of BAPCPA were facially unconstitutional. On July 26, 2006, District Judge David C. Godbey released a 15 page Memorandum Opinion and Order. The Court’s ruling was a mixed bag for debtor’s attorneys. On the one hand, the Court found that Sec. 526(a)(4), which prohibits attorneys from advising clients to incur debt in contemplation of bankruptcy, was unconstitutional. However, the court rejected a challenge to the compelled disclosures required by Sec. 527 and held that attorneys were clearly within the scope of Debt Relief Agencies.

Attorneys Are Debt Relief Agencies

The Court found that the plain meaning of Sec. 101(4A) and 101(12A) provided that attorneys were included within the meaning of debt relief agencies. Debt relief agencies were defined as persons providing “bankruptcy assistance” in return for money, while bankruptcy assistance was defined as including “providing legal representation with respect to a case or proceeding under this title.” The court stated:

“A reading of the text for plain meaning indicates that the term ‘debt relief agency’ includes bankruptcy attorneys such as Hersch. Plain meaning is the preferred method for interpreting statutory language (citation omitted). Here, as only attorneys are authorized to provide legal advice and ‘providing legal advice’ is part of the definition of bankruptcy assistance, it seems clear that bankruptcy attorneys such as Hersch fit within the definition of ‘persons providing bankruptcy assistance.’ Attorneys also provide most of the other functions defined as ‘bankruptcy assistance.’”

It is hard to argue with the judge’s plain meaning analysis. While some courts have tortured the language into a conclusion that attorneys are not covered, In re Attorneys at Law and Debt Relief Agencies, 332 B.R. 66 (Bankr. S.D. Ga. 2005), this argument is probably a dead letter.

Section 526(a)(4) Impermissibly Limits Free Speech

Section 526(a)(4) was found unconstitutional under the First Amendment. However, this part of the opinion was a little procedurally confused. The plaintiff apparently did not plead that Sec. 526(a)(4) was unconstitutional. However, both parties briefed this issue extensively. As a result, the court ruled on the substantive issue subject to the plaintiff amending her pleadings to raise the issue which had already been decided.

Section 526(a)(4) states that a debt relief agency shall not “advise an assisted person . . . to incur 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.” The plaintiff argued that the statute should be subject to strict scrutiny, which is the standard generally applied to content based restrictions on speech. The government, on the other hand, argued that Sec. 526(a)(4) was an ethical restriction and should be reviewed under the more lenient standard contained in Gentile v. State Bar of Nevada, 501 U.S. 1030 (1991). The District Court noted that there was nothing in Sec. 526(a)(4) which would indicate that it was an ethical prohibition. However, it noted that even under the more lenient standard, that the statute was not constitutional.

Under the Gentile standard, the statute must (1) serve “the State’s legitimate interest in regulating the activity in question” and (2) “impose only narrow and necessary limitations on lawyer’s speech.” The Court noted that both the strict and lenient standards require that the restriction be narrowly tailored. Here, the court found that Sec. 526(a)(4) was not “narrow and necessary.” In this respect, the government was hoist on its own petard. The government argued that taking on additional debt “may” harm a debtor in some cases. As a result, the Court concluded that in other cases, it may not. The Court stated: “Section 526(a)(4), therefore, is overinclusive in at least two respects: (1) it prevents lawyers from advising clients to take lawful actions; and (2) it extends beyond abuse to prevent advice to take prudent actions.”

Section 527 Is Constitutional

Section 527 requires attorneys to give mandatory discloses to clients. The Plaintiff argued that this section unconstitutionally compelled speech. The court dismissed this argument finding that it was permissible to require the disclosure of accurate information. In this case, the court noted that even though the disclosures could be misleading in certain specific circumstances, the attorney was allowed to tailor the disclosure so long as it contained the required substance.

Final Thoughts

This appears to be a cogent and well-reasoned opinion. The court rejected weak arguments from both parties and cut to the heart of the issues. Judge Godbey was appointed by the current President Bush so that he cannot easily be dismissed as a liberal activist. This opinion is merely persuasive authority rather than binding precedent. However, until the circuit courts weigh in, Hersch is likely to be very persuasive.

Tuesday, July 18, 2006

Opinions Regarding Failure to Obtain Credit Counseling Underscore Dissatisfaction With Law

Mandatory pre-bankruptcy credit counseling was one of the reforms enacted by BAPCPA. Its drafters intended for credit counseling to be a prophylactic step which would prevent avoidable bankruptcies. In practice, it has become a formality for some and a stumbling block for others. Several recent opinions from the Western District of Texas highlight differing approaches to this issue.

Approach One: This Is Stupid, I’m Going to Say It’s Stupid, But I Am Going to Enforce This Stupid Law

On December 22, 2005, Judge Frank Monroe from the Austin Division of the Western District of Texas released his opinion in In re Sosa, 336 B.R. 115 (Bankr. W.D. Tex. 2005). Judge Monroe did not mince words about the wisdom of the credit counseling requirement.

"One of the more absurd provisions of the new Act makes an individual ineligible for relief unless such individual, 'has during the 180-day period preceding the date of filing of the petition by such individual, received from an approved nonprofit budget and credit counseling agency described in §111(a) an individual or group briefing (including a briefing conducted by telephone or on the Internet) that outlined the opportunities for available credit counseling and assisted such individual in performing a related budget analysis.' See 11 U.S.C. § 109(h)(1). No doubt this is a truly exhaustive budget analysis."

Judge Monroe goes on to describe the circumstances in which a certificate of exigent circumstances can be filed and approving, concluding:

"Simply stated, if a debtor does not request the required credit counseling services from an approved nonprofit budget and credit counseling service before the petition is filed, that person is ineligible to be a debtor no matter how dire the circumstances the person finds themselves in at that moment.

"This Court views this requirement as inane. However, it is a clear and unambiguous provision obviously designed by Congress to protect consumers."

Approach Two: This Is Foolish But Congress Gave Me Room to Avoid a Foolish Result

Judge Monroe seemed pretty definitive, but things were not so clear in San Antonio. On June 27, 2006, Judge Leif Clark released his Order on Motion for Exigent Circumstances in In re Navarro, No. 06-51007 (available at www.txwb.uscourts.gov/opinions). Judge Clark was faced with a pro se debtor who “was unable to obtain counseling within the five day window because she did not know that she needed to obtain counseling as a prerequisite to filing for bankruptcy.”

Judge Clark, like Judge Monroe, did not view the credit counseling requirement as particularly helpful Judge Clark stated:

"The credit counseling briefing is superficially designed to discourage people from filing for bankruptcy on the theory that, if they but knew of the alternatives, they might pursue those instead. In practice, however, the briefing has little or no effect on the actual decision to file because, by that time, the person’s financial condition has deteriorated too far for any alternative other than bankruptcy to be effective. The 'briefing' called for by section 109(h)(1) does little more than make the debtor aware of credit counseling as an alternative. But credit counselors attempt to negotiate a payment plan with the consent of the debtor’s creditors, for a fee, and their success will depend on whether they can get all creditors to cooperate…The actual negotiation of an alternative thus requires a voluntary “standstill” by the creditors while an arrangement is worked out. In practice, that will not happen. (citation omitted). What is more, the debtor may well be actually discouraged from filing when filing might be the right thing to do—by a credit counselor who is not lawyer effectively giving the debtor legal advice. (citation omitted). The result is that the credit counseling briefing ends up being a useless formality.

"It also operates as a trap for the unwary, potentially causing the dismissal of so-called 'ineligible' debtors from bankruptcy. (citation omitted). While certain private financial interests may be rewarded as a result, (citation omitted), no genuine public interest appears to be served."

Judge Clark then turns his thoughtful mind to the court’s role in policing eligibility. Judge Clark notes that eligibility is not jurisdictional. Thus, an ineligible debtor may proceed in bankruptcy unless someone timely objects. In this case, the court is appointed as gatekeeper. The clerk may not refuse to accept a petition which is not accompanied by a certificate of credit counseling. The clerk may bring any deficiency to the attention of the court, which, under Rule 1007(e) “may” dismiss the case, but is not required to. If the debtor files a certificate of exigent circumstances, the court “may” conduct a hearing, but is not required to. Further, “If the court finds the certificate of exigent circumstances to be satisfactory, then the issue of eligibility under section 109(h) is deemed resolved for all purposes, and the debtor is henceforth eligible for relief as a debtor under title 11, no further questions asked.”

Judge Clark seems to be saying that he has the discretion to ignore a failure to obtain credit counseling as well as the discretion to accept any explanation of exigent circumstances. In a footnote, he states:

"Section 707(a) permits (but does not require) the court to dismiss a case for failure to file the information required by section 521(a)(1), but the certificate of credit counseling briefing is not one of the documents required to be filed by section 521(a)(1). …Thus, while some courts have elected to dismiss cases that do not comply with Interim Rule 1007(b)(3)(including my colleague in this division), they apparently do so as a matter of judicial housekeeping, but not as a matter of statutory or rule construction."

Judge Clark concludes that not knowing about credit counseling was an exigent circumstance in the case before him.

"The court finds that this debtor, a non-lawyer, was justified in not knowing about the credit counseling briefing requirement as a pre-condition to eligibility for bankruptcy. That justifiable lack of knowledge, in turn, satisfies the court as an exigent circumstance."

While Judge Clark’s logic is elegant and his heart is clearly in the right place, the result seems to be a bit off. The exigent circumstances provision is part of a clause which has three parts connected by an “and.” Judge Clark’s ruling appears to state that a person may be a debtor if they submit a certificate describing exigent circumstances which is satisfactory to the court. While this satisfies the first and third requirements, it appears to read out the second one. The middle provision requires that the “debtor requested credit counseling services from an approved non-profit budget and credit counseling agency, but was unable to obtain the services … during the five-day period beginning on the date on which the debtor made that request.” If the debtor did not request credit counseling at all, the debtor would not be able to establish that credit counseling was not available within five days. Therefore, the debtor would not be able to establish exigent circumstances. However, in the Navarro case, that is exactly what happened.

Approach Three: The Law Seems Clear to Me

The final salvo in this round of cases comes from Judge Ronald King from San Antonio, who weighed in with an opinion on July 7, 2006. Like Judge Clark, Judge King was faced with a pro se debtor. In In re Gallardo, No. 06-50724 (available at www.txwb.uscourts.gov/opinions), the debtor sought to reconsider dismissal of his case. The debtor contended that he had looked on the internet for requirements to file bankruptcy but did not discover the credit counseling provision. Judge King was not impressed. He said:

"This Court cannot control publication of the United States Code on internet websites. The fact that the Debtor could not locate section 109(h) of the Bankruptcy Code on a particular website does not make the amendments made by BAPCPA inapplicable to this Debtor. Section 109(h) of the United States Bankruptcy Code, as amended by BAPCPA effective October 17, 2005, requires that credit counseling must be taken prior to the filing of a new bankruptcy case by an individual debtor and certification of such credit counseling must be filed with the petition. There are certain exceptions for exigent circumstances, incapacity, disability or active military duty which are not applicable in this case. This Court must follow the law as enacted by Congress and signed by the President."

It seems obvious that Judge King considers dismissal of a non-complying case to be mandatory rather than a matter of judicial housekeeping. The fact that Judge King would publish this scant 1 ½ page opinion just ten days after Judge Clark’s opinion in Navarro could be read as an attempt to stake out his own position on this issue.

Defying Congress

Both Judge Monroe and Judge Clark seem intent on lecturing Congress. By referring to the credit counseling requirements as absurd, inane and a useless formality, the judges have made it clear what they think. They have also expressed what a sizeable contingent of the practicing bar (including this author) thinks. By lending the prestige of their office to the critiques voiced by many, the judges may spur corrective action by Congress (although this is probably wishful thinking). However, Judge Clark’s ruling is a bit more troubling. By claiming that he is the gatekeeper who may admit whom he finds worthy and by stating that he can make a debtor eligible “no further questions asked,” Judge Clark appears to take a very aggressive position. No party filed a timely appeal from Navarro, so that the debtor in that case will likely be able to complete her case without pre-petition credit counseling. It remains to be seen whether a creditor or the U.S. Trustee will take up the gauntlet in a future case.

Monday, July 17, 2006

The Empire Strikes Back: The Government Files Its Reply Brief in the Suit Over BAPCPA's Debt Relief Agency Provisions

I have previously written about the suit filed by the Connecticut Bar Assocation and the National Association of Consumer Bankruptcy Attorneys seeking to overturn the debt relief agency provisions of BAPCPA.

Blaming Attorneys

The United States has now responded to that suit and its defense of BAPCPA focuses largely upon the perceived ethical shortcomings of consumer debtors’ attorneys.

“In enacting the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), Congress found that there was ‘abuse by attorneys and other professionals.’ (citation omitted). To correct this abuse, Congress included in BAPCPA ‘provisions strengthening professionalism standards for attorneys and others who assist consumer debtors with their bankruptcy cases.’”

Memorandum in Support of Motion to Dismiss and in Opposition to Plaintiff’s Motion for Preliminary Injunction, p.1, filed on June 30, 2006 in Case No. 3:06CV729 (U.S. District Court for the District of Connecticut).

The USA goes on to quote from the legislative history to BAPCPA:

“Looking for the source of this meteoric increase in bankruptcy filings, Congress determined that the bankruptcy system “ha[d] loopholes and incentives that allow[ed] and—sometimes-- even encourage[d] opportunistic personal filings and abuse (citation omitted) and that attorneys sometimes played a role in exploiting these “opportunities.”

Memorandum, pp. 8-9.

The U.S. Trustee program is quoted for the proposition that “[a]buse of the system is more widespread than many would have estimated.” Another witness testified that some debtors are told that they are consolidating their debts and do not know that they have filed bankruptcy, while the Fifth Circuit’s own Judge Edith Jones is cited for the statement that “many” bankruptcy lawyers never talk to their clients; another witness testified that bankruptcy practices are run like mills and that clients do not receive adequate disclosures. Finally, Bankruptcy Judge Carol Kenner is cited for the proposition that many debtors sign reaffirmation agreements without adequate disclosure.

The picture painted here is one of out of control lawyers causing a national bankruptcy crisis. It is disheartening that a Congress full of lawyers found it necessary to blame lawyers for the level of bankruptcy filings. Of course, neither the Justice Department nor the legislative history discuss the studies finding a direct correlation between the amount of consumer debt in the economy and the number of consumer bankruptcies filed.

Tempering the Language of BAPCPA

However, the news is not all bad. In several instances, the lawyers for the Justice Department argue that the provisions applicable to attorneys are not really as bad as they appear.

BAPCPA prevents attorneys from advising prospective to incur debt “in contemplation of” bankruptcy. The plaintiffs (the Connecticut Bar Association, the National Association of Consumer Bankruptcy Attorneys and others) argued that this gagged attorneys from advising their clients about how to beneficially structure their debts, such as refinancing a high interest loan. The USA contends that “in contemplation of” bankruptcy means because of filing bankruptcy. Under this construction, the only advice which would be prohibited would be to incur debt for the sole purpose of having it discharged in bankruptcy.

In another instance, BAPCPA requires attorneys to state, “We are a debt relief agency. We help people file for bankruptcy under the Bankruptcy Code” in certain advertisements directed to the general public. While this requirement is patently offensive in any circumstance, the attorneys for the government try to minimize its effect, claiming that it only applies to advertisements directed to prospective consumer debtors. If the government is correct, then attorneys who represent debtors, creditors and trustees would not be required to place this disclaimer on their websites or other material generally promoting the firm. However, this is still a silly requirement. When an attorney says “We are a debt relief agency,” it suggests that he is affiliated with a government or non-profit agency.

The irony with the mandatory debt relief agency statement is that Congress identified a legitimate problem and then failed to fix it. There are some persons who advertise credit repair or debt consolidation when they mean bankruptcy. I would suspect that many of the people doing this are not lawyers and will not be affected by the statute. Congress could have fixed a legitimate problem by simply prohibiting deceptive advertisements. Instead, it mandated a silly slogan which does little to fix the problem while dissuading legitimate attorneys from representing consumer debtors.

Post-Script

The District Court heard oral argument on July 13 and has taken the matter under advisement.

Sunday, July 16, 2006

The Sad Case of John Gellene or What It Feels Like to Get Hit By Lightning

One of the interesting features of this year’s State Bar of Texas Bankruptcy Section Meeting was a lunch time presentation by Milton C. Regan, Jr., author of Eat What You Kill: The Fall of a Wall Street Lawyer (The University of Michigan Press 2006). This is the story of John Gellene, the only attorney ever to go to jail for submitting an incomplete Rule 2014 disclosure. Although the book is a bit of a difficult read (you can read more about that in my review on Amazon.com), it is an interesting case study in the dangers of cutting corners. (The book does a really good job of documenting the pressure to cut corners, so I won’t discuss that in any detail here).

A Lawyer Walks Into A Minefield

For those who don’t remember the story from the newspaper, here is what happened. Milbank, Tweed was hired to represent Bucyrus –Erie Corporation in its bankruptcy proceeding. The bankruptcy was very contentious because the largest unsecured creditor, Jackson National Life, had accused the company’s investment banker, Goldman Sachs, with manipulating the company’s financial affairs to their own benefit. Things got worse when a Goldman Sachs partner, Mikael Salovaara, started his own firm, South Street Fund, and that firm made a deal with Bucyrus-Erie which put them ahead of all the other creditors. In order to avoid limits on debt which the company could incur, South Street engineered a sale-leaseback of the company’s principal assets. The sale-leaseback left South Street in control of the company’s principal assets and subjected the company to outrageous payments.

All this happened before bankruptcy lawyer John Gellene entered the picture. However, it created an adversarial situation between the company and the different factions. The debtor’s attorney would be caught in the middle of this conflict and would have to navigate it in order to successfully reorganize the company. One example of these pressures was Jackson National Life’s demand that every major creditor but itself should have its debt written off or subordinated.

Connections vs. Conflicts

John Gellene began representing Bucyrus-Erie a year before its bankruptcy at a time when his law firm was not representing either Salovaara or South Street. However, before the case was filed, Milbank, Tweed began representing South Street in another bankruptcy and also represented Salovaara in a dispute with his partner. Both of these were “connections” with creditors. However, Gellene failed to disclose these relationships in either of two affidavits filed with the court.

Disclosing these “connections” should have been a no-brainer. However, there were probably a lot of reasons why he could rationalize not doing it (as brought out in his subsequent criminal trial). First, Salovaara was not a creditor himself. He was just a partner of a creditor. Therefore, his representation should not be disclosed. Second, Milbank, Tweed represented South Street as a small player in a completely unrelated matter. This was not a conflict.

If this was Gellene’s thought process, he made the mistake of focusing on the purpose of the Rule 2014 disclosure rather than its language. Rule 2014 requires disclosure of “connections” with the debtor, creditors, attorneys and accountants for the debtor and creditors and employees of the U.S. Trustee. This is a requirement honored more in the breach. The requirement to disclose connections could be taken to absurd levels. For example, in a case with IRS debt, the attorneys should disclose the “connection” that they pay taxes to the IRS. In a case with credit card debt, the attorneys should disclose which attorneys hold credit cards issued by creditors in the case. However, the connections in this case were a bit more obvious. They involved major players who were at odds with Jackson National Life, the company’s main antagonist. However, if Gellene focused on conflicts, then there was an argument that they did not have to be disclosed.

Gellene may have also reasoned that disclosing the connection to South Street and Salovaara would merely provide leverage to Jackson National Life. If the case was to be concluded successfully, it would need to be confirmed quickly. Having a lengthy delay over employment of counsel would endanger the case’s prospects. If that were Gellene’s thinking, he made the mistake of (to use Joe Martinec’s phrase) pledging his loyalty to the deal rather than any other obligation.

It is also possible that Gellene made a quick cost-benefit analysis. In the recent Leslie Fay case, Weil Gotshal had made a very big failure to disclose. They were allowed to continue to represent the debtor and had to forfeit a “mere” $1 million out of their fees. They certainly did not go to jail. If Gellene had weighed the likely consequence of being caught against the possibility of being disqualified on the front end, he likely would have chosen to take the risk.

It is also possible that the failure to disclose was inadvertent. Gellene began working on the Bucyrus-Erie case in February 1993. However, the case was not filed until February 2004. The representations of Salovaara and South Street did not come up until December 2003. Therefore, it is possible that disclosures were drafted before the connection arose and were never updated during the hustle and bustle to prepare the case for filing.

From Triumph to Tragedy

Gellene successfully guided Bucyrus-Erie through its reorganization and his firm was paid nearly $2 million in fees for doing so. Unfortunately, his successful plan put the company’s old adversary, Jackson National Life, in control of the company. Years later, Jackson found out about the failure to disclose and sued Milbank, Tweed to return its fees and for malpractice. This proved to be very costly for Milbank, Tweed but it was worse for John Gellene. The publicity spawned by the fee litigation prompted the U.S. Attorney to file criminal charges against Gellene. A deal to plead to a misdemeanor fell through and the case went to trial. The prosecution sought to portray the failure to disclose as black and white, the while the defense attempted to put the statement in context. The jury sided with the U.S. Attorney and Gellene was convicted and sentenced to 15 months in prison. Gellene went from being a highly respected bankruptcy attorney to a convicted felon in a relatively short period of time.

Why John Gellene?

So, what happened? In some respects, Gellene was the victim of extremely bad luck. The Asst. U.S. Trustee in the case had previously been the U.S. Attorney (not an Asst. U.S. Attorney, but the U.S. Attorney). Therefore, he was more likely to look at the case from a criminal viewpoint than with bankruptcy eyes. He was also likely to have the informal clout needed to get a criminal referral taken seriously. Additionally, the Bucyrus-Erie case was filed in Wisconsin rather than New York or Delaware. Here, a big firm came swooping into Wisconsin, took a respected company into bankruptcy and walked away with nearly $2 million in fees. There had to be a little bit of jealousy of and distrust toward the outsiders. (Let’s face it, no one likes it when big firms poach all the good cases). Finally, Gellene’s own work product was part of his undoing. The confirmed plan left Jackson National Life in control of the company and allowed it to prosecute claims on behalf of the estate. Jackson National Life was still plenty upset toward Goldman, Sachs, Salovaara, South Street and Milbank, Tweed. Being left in a position to investigate the claims while having control of the company’s attorney-client privilege, made it likely that they would discover the non-disclosure and would be unhappy. This case proves that just because lightning may only strike one in a million times, doesn’t mean that it won’t hurt the person who gets hit.

Lessons to Be Learned

The lessons to be learned may be fairly simple. As Jay Westbrook is quoted as saying in the book, “Disclosure should be like voting in Chicago—early and often. Disclose, disclose, disclose. It’s hard to get in trouble when you follow that rule.” Eat What You Kill, p. 228. Attorneys rarely have to make statements under penalty of perjury. Since Rule 2014 is one of the few cases, it should be treated seriously. However, there is a significant temptation not to. The Rule 2104 disclosure is filed toward the beginning of the case. As a result, there is a temptation to get it on file quickly and to copy the disclosure from the previous case with a few modifications. This would be a mistake. As I have read 2014 again recently, I was surprised to learn not only that it required disclosure of connections rather than conflicts, but that it required disclosure of connections to other attorneys and accountants in the case. Sometimes it is easy to get so familiar with something that you respect for it. That would be a mistake.

Another lesson would be that it is better to tattle on yourself than to get caught. John Gellene could have submitted an amended disclosure at any point during the case, but did not. Even if he had brought it up at the hearing on his own fees, he probably would have received little more than a slap on the wrist. Instead, the issue didn’t come up until Jackson National Life brought it up and by that time, they were plenty mad so that the time for a slap on the wrist was gone.