2008 Was a Busy Bankruptcy Year for the Fifth Circuit

The Fifth Circuit has busy this year. They have been turning out bankruptcy opinions at a rate where they might consider changing the name of the court to the Fifth Circuit Court of Bankruptcy Appeals. So far I have written a dozen articles about their decisions this year. However, there are still a lot of interesting cases that I didn’t get around to. Here is a quick rundown of the best of 2008 (and one from 2007). Where I have already written about a case, I have provided the reference to the prior article. Some cases can be summed up in a sentence while others are more complicated and some are just plain baffling.

Appellate Practice
_______________________________________________________________________

Matter of Gadzooks, Inc., 2008 U.S. App. LEXIS 19339 (5th Cir. 2008). “Fifth Circuit Dismisses Gadzooks Appeal.” (10/2/08).
_______________________________________________________________________

Matter of Hilal, 534 F.3d 498 (5th Cir. 2008).

Substantial consummation of plan did not result in dismissal of appeal based on equitable mootness where debtor framed his appeal narrowly.
_______________________________________________________________________

Matter of S.I. Restructuring, Inc., 542 F.3d 131 (5th Cir. 2008).
“Equitable Mootness Fails to Prevent Disgorgement” (10/2/08).
_______________________________________________________________________

Attorney Fees

Matter of Babcock & Wilcox Company, 526 F.3d 824 (5th Cir. 2008).

Bankruptcy court did not abuse its discretion in reducing amounts billed for travel time in half.
_______________________________________________________________________

Automatic Stay/Discharge
_______________________________________________________________________

Matter of Bayhi, 528 F.3d 393 (5th Cir. 2008).

This case is not easy to follow, but is worth reading, for no reason other than the fact that Chief Judge Edith Jones dissented to vindicate the debtor’s discharge. The case begins with a husband and wife who consolidated their student loan debts into a single obligation. Under Louisiana law, liability was in solido meaning that the creditor could seek recovery of the entire debt from either party or both. The couple divorced and agreed that each would pay half of the debt. The wife continued to pay until she filed bankruptcy. Although the husband was listed as a creditor, he did not file an action to determine dischargeability under Sec. 523(a)(15).

Post-discharge, the husband filed a declaratory judgment action seeking a determination that the debt was a community obligation and thus solidary. This was agreed to. Subsequently, he filed a complaint for specific performance seeking to compel the wife to pay her share of the student loan directly to Sallie Mae. The state court granted a judgment in the husband’s favor.

The wife then re-opened her bankruptcy and sought to have the husband held in contempt for violation of the discharge. The bankruptcy court agreed, finding the pro se husband in contempt, but did not award any damages. Instead, it enjoined the husband from seeking to collect the wife’s share of the debt and vacated the state court judgment.

On appeal, Judge Wiener, writing for himself and Judge Barksdale, voted to reverse and remand, while Chief Judge Jones dissented in part. Section 524(a)(1) states that the discharge “voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged . . .” The judges disagreed among themselves as to what was a debt.

The majority judges concluded that the wife’s obligation to pay one-half of the student loan debt pursuant to the divorce decree was not a “debt.” Therefore, it could not be discharged. Since the student loan debt was not discharged, the husband’s attempt to compel the wife to pay a non-discharged debt did not violate the discharge.

Chief Judge Jones agreed that the husband should not be held in contempt because “in asserting that novel claim, (the husband) did not intentionally violate his ex-wife’s discharge order and should not be subject to civil contempt for violation of the 11 U.S.C. §524(a) discharge injunction.” However, the Chief Judge held that vacating the state court judgment was nothing more than an end run around the discharge. Judge Jones viewed the wife’s obligation vis-à-vis the husband to pay one-half of the student loan debt as a separate debt from the student loan itself. While the husband could have sought a determination that his contribution right was not discharged pursuant to 11 U.S.C. §523(a)(15), he did not and his rights were discharged.

This is a case where the dissent has the better side of the argument. While the wife’s obligation to Sally Mae was clearly not discharged, the husband’s right to compel the wife to pay her share of the debt is “an equitable remedy for breach of performance” which can be reduced to judgment and thus falls within the definition of a claim under 11 U.S.C. §101(5)(B).

However, the dissent evenhandedly provides a benefit to the creditor as well. Because the husband was asserting a novel claim, he did not intentionally seek to violate the discharge. Before a creditor can be held in contempt, he must intentionally violate a court order. Where the scope of the order is unclear, contempt is not available. The dissent pairs nicely with the Gervin opinion, in which the creditor was held not to violate the discharge by trying to collect from property it believed was subject to its judgment lien, but was actually owned by the co-debtor.
_______________________________________________________________________

Campbell v. Countrywide Home Loans, Inc., 545 F.3d 348 (5th Cir. 2008).

At the time that Debtors filed chapter 13, they owed 15 delinquent mortgage payments, owed for taxes and insurance advanced for a prior year and had not made any escrow payments in the current year. Rather than including the current year’s escrow shortage in the proof of claim, the creditor stated that the amount of the post-petition payment would be increased to recoup these amounts. The Bankruptcy Court found that Countrywide had violated the automatic stay, but allowed for an interlocutory appeal prior to assessing damages.

Under RESPA, Countrywide had the right to increase the debtors’ payment by the amount of any insufficiency in the escrow account. The Fifth Circuit held that the pre-petition escrow arrearage was a “claim” within the meaning of the Bankruptcy Code and that the automatic stay applied to efforts to collect that claim. However, where the creditor did not actually collect the increased amount stated in the proof of claim and did not take any affirmative steps to collect the increased amount other than including the statement in the proof of claim, the creditor had not taken an action which violated the stay.
_______________________________________________________________________

Matter of Gervin, No. 07-50099 (5th Cir. 11/21/08)(unpub).

The Bankruptcy Court affirmed the District Court finding that the creditor did not violate the discharge when it attempted to collect a debt from property that it believed to be subject to its judgment lien. The District Court opinion is discussed at “District Court Reverses Discharge Violation; Finds Some Violations Too Technical to Punish.” (7/23/07).
_______________________________________________________________________

In re Repine, 536 F.3d 512 (5th Cir. 2008).
“Fifth Circuit Answers Three Questions of First Impression on Automatic Stay.” (7/25/08).
_______________________________________________________________________

Avoidance Actions
_______________________________________________________________________

Matter of Bossart, 2008 U.S. App. LEXIS 21807 (5th Cir. 2008)(unpub).

This unpublished opinion affirmed a bankruptcy court opinion allowing a trustee to sue a company which issued an annuity to recover the annuity payment as a fraudulent transfer. The case was essentially an end run around the debtor's claim of the annuity as exempt.
_______________________________________________________________________

In re Entringer Bakeries, 2008 U.S. App. LEXIS 23313 (5th Cir. 2008).
“Fifth Circuit Explains Earmarking” (11/6/08)
_______________________________________________________________________

Matter of N A Flash Foundation, Inc., 541 F.3d 385 (5th Cir. 2008).

Where creditor was paid out of debtor’s general operating account, but debtor would have received funds subject to a construction trust fund claim subsequently, creditor did not receive more than it would have in a hypothetical chapter 7 liquidation. In a hypothetical liquidation case, the court presumes that the debtor would have preserved the trust funds and the creditor would have been paid in full.
_______________________________________________________________________

Constitutionality

Hersh v. United States, No. 07-10226 (5th Cir. 12/18/08)
“Fifth Circuit Relies on Constitutional Avoidance to Uphold Sec. 526(a)(4)(12/19/08)
_______________________________________________________________________

Dischargeability

Matter of Shaffer, 515 F.3d 424 (5th Cir. 2008).

Dentist had license revoked and was required to pay costs incurred in investigation in amount of $217,852.13. Fifth Circuit held that costs were in compensation of actual pecuniary loss and therefore did not fall within exception to discharge for fines and penalties under 11 U.S.C. §523(a)(7).
_______________________________________________________________________

Due Process

Matter of Waterford Energy, 2008 U.S. App. LEXIS 20972 (5th Cir. 2008)(unpub).

The Debtor owned oil and gas well in Oklahoma and was required to pay royalties to the State of Oklahoma. When it filed bankruptcy, it did not give notice to the State, but it did file a copy of its bankruptcy petition and draft plan in the real estate records. Under Oklahoma law, a certified copy of a bankruptcy petition filed in the real estate records constitutes constructive notice. However, the Fifth Circuit held that federal law rather than state law controlled on question of whether constructive notice to unknown creditors was adequate. Notice by filing in the real estate records was inadequate. Notice to unknown creditors should have been given by publication. As a result, the State did not receive notice complying with due process and its claims were not discharged.
_______________________________________________________________________

Equitable Subordination

Matter of S.I. Restructuring, Inc., 532 F.3d 355 (5th Cir. 2008).
“Fifth Circuit Rejects Equitable Subordination Claim With Deepening Insolvency Aspect; Insiders Not Liable for Stoking Fires of Sinking Ship.” (7/1/08).
_______________________________________________________________________

Exempt Property
_______________________________________________________________________

Matter of McClain, 516 F.3d 301 (5th Cir. 2008).

Debtor purchased an insurance policy with funds which were not disclosed on his schedules. When the insured died, the trustee claimed the policy proceeds under a constructive trust theory. The Fifth Circuit held that the trustee could have an interest in the policy if it could trace the undisclosed funds to the policy premiums and remanded the case for a trial to determine tracing and to determine what portion of the proceeds, if any, should go to the trustee.
_______________________________________________________________________

Matter of Peres, 530 F.3d 375 (5th Cir. 2008).

Where creditors’ meeting was continued but a new date was not announced at the meeting, time to object to exemptions did not start to run until creditors’ meeting was concluded eleven months later.
_______________________________________________________________________

Matter of Rogers, 513 F.3d 212 (5th Cir. 2008).
“Fifth Circuit Rules on Homestead Cap” (1/30/08).
_______________________________________________________________________

Matter of Soza, 542 F.3d 1060 (5th Cir. 2008).

Debtor bought an annuity the day before filing bankruptcy. Based on timing of purchase, fact that debtors retained control of funds and fact that annuity payment would have been sufficient to pay all creditors in full among other things, the Fifth Circuit found that the annuity was purchased “in fraud of a creditor” and denied the exemption based on Texas law.
_______________________________________________________________________

Interest Rate

Drive Financial Services, LP v. Jordan, 521 F.3d 343 (5th Cir. 2008).
“Fifth Circuit Releases Interest-Ing Opinion on Chapter 13 Interest Rates” (3/30/08).
_______________________________________________________________________

Judicial Estoppel

Kane v. National Union Fire Insurance Company, 535 F.3d 380 (5th Cir. 2008). “Trustee Avoids Judicial Estoppel Finding As Fifth Circuit Comes Full Circle” (7/25/08).
_______________________________________________________________________

Jurisdiction

Matter of Maples, 529 F.3d 670 (5th Cir. 2008)

This is a case where the published opinion sheds very little light on what happened. The opinion was published at the request of the dissenting judge and the majority goes to great lengths to say very little other than that there was no reversible error. It is necessary to read the unpublished District Court opinion to get some understanding of the case.

The Debtors owned Global Limo, Inc. Partain obtained a judgment against the Debtors and obtained a turnover order for the Debtors’ stock in the company. Partain then took possession of the assets of Global Limo. The Debtors filed bankruptcy and brought suit to set aside the turnover order as a preference. Partain, acting on behalf of Global Limo, brought a third party action against Texas State Bank alleging that it had harmed Global Limo. Somewhere there was also a claim that the Debtors and Texas State Bank had conspired to deprive Partain of his choice of counsel.

The Bankruptcy Court avoided the turnover order as a preference and denied Partain’s claims for lack of standing, since he did not have authority to act on behalf of Global Limo.

On appeal to the Fifth Circuit, the majority stated: “This case is poorly briefed, and the record is incomplete. The majority is therefore unwilling to say anything other than that the district court committed no reversible error in affirming the bankruptcy court.”

In dissent, Judge Emilio Garza argued that the Bankruptcy Court lacked subject matter jurisdiction over the claims between Partain and Texas State Bank and that the bankruptcy court had exceeded its authority in ordering the corporate assets of Global Limo brought into the bankruptcy estate of the debtors. The dissent took the majority to task for failing to consider the jurisdictional issue on the ground that the underlying claim was patently meritless. The dissent stated: “Nothing in the record suggests that TSB’s potential exposure would impact the Mapelses’ bankruptcy estate. Because this claim between third parties has no conceivable effect on the bankruptcy estate, the bankruptcy court improperly resolved this claim over which it lacked subject matter jurisdiction.” The dissent also faulted the bankruptcy court for ordering the corporate assets transferred to the estate. Although the corporate charter had been forfeited, the corporation and not its debtor shareholders still owned its assets.
_______________________________________________________________________

Newby v. Enron Corporation, 535 F.3d 325 (5th Cir. 2008).
“Fifth Circuit Clarifies Post-Confirmation Jurisdiction” (7/11/08).
_______________________________________________________________________

Property of the Estate

Matter of Seven Seas Petroleum, Inc., 522 F.3d 575 (5th Cir. 2008).

This case is the latest in a line of cases including In re MortgageAmerica Corp., 714 F.2d 1266 (5th Cir. 1983) and In re Educators Group Health Trust, 25 F.3d 1281 (5th Cir. 1994) which construe whether a cause of action belongs to the bankruptcy estate or may be asserted by individual creditors.

The Debtor owed money to unsecured bondholders. The bonds provided a formula which limited the amount of secured debt which the debtor could incur. This formula was based in part on the value of the debtor’s reserves. A consultant (Ryder Scott) calculated the reserves in an amount which proved to be highly overstated. The debtor sold $45 million in secured notes, half of which were purchased by Chesapeake. The other half were purchased by a group of investors led by the Debtor’s chairman (Hefner).

An involuntary bankruptcy was filed against the Debtor. The trustee brought various claims against Chesapeake, but dropped all claims except one seeking to re-characterize the debt as equity. All claims against Chesapeake were settled pursuant to the Debtor’s plan, which was supported by the unsecured bondholders.

The bondholders then brought a state court action against Chesapeake, Hefner and Ryder Scott alleging Conspiracy to Defraud and Aiding and Abetting Fraud. Chesapeake removed the case to the bankruptcy court. The bankruptcy court found that the claims against Chesapeake were property of the estate and had been released under the plan.

The bondholders appealed claiming that the claims belonged to them individually and were not property of the estate. The Fifth Circuit reversed and remanded. It held that the bankruptcy estate may bring claims which are typically brought by creditors outside of bankruptcy if the claims seek to recover assets which rightfully belong to the bankruptcy estate but are held by others. Thus, fraudulent conveyance claims and claims to pierce the corporate veil belong to the estate. However, claims to recover damages incurred by creditors will continue to belong to the creditors. In this case, the court found that the creditors were not seeking to recover assets belonging to the estate. As a result, the claims belonged to them and the bankruptcy court erred in dismissing the claims based on the plan.
_______________________________________________________________________

Sanctions and Misconduct
_______________________________________________________________________

Baum v. Blue Moon Ventures, LLC, 513 F.3d 181 (5th Cir. 2008).

U.S. District Judge had authority to enter pre-filing injunction preventing vexatious parties from filing litigation in any federal court, but lacked jurisdiction to enjoin state court filings.
_______________________________________________________________________

Cochener v. Barry, 2008 U.S. App. LEXIS 22339 (5th Cir. 2008).
“Fifth Circuit Reinstates Sanctions Award” (11/14/08).
_______________________________________________________________________

Matter of Pratt, 524 F.3d 580 (5th Cir. 2008).
“Fifth Circuit Clarifies Requirements of Rule 9011.” (4/8/08).
_______________________________________________________________________

Matter of Yorkshire, LLC, 540 F.3d 328 (5th Cir. 2008)

This is a case which is not designated for publication, but which is included in the West Reporter. Thus, it seems to be a published unpublished opinion. This case involved a business dispute between owners/managers of a business. When Knight, who was one of the managers, received notice that the other owners planned to remove him, he hired an attorney to file bankruptcy for two related entities. The bankruptcy attorney “conducted little diligence on the financial status of the entities an no diligence on their ownership and management so as to reach an informed decision as to whether a bankruptcy was warranted, and if so, who had authority to file it.” Shortly thereafter, Knight was removed from management and the new management voted to fire the attorney who had filed the bankruptcy case. After being fired by the debtor, the attorney represented Knight against the debtor. The Bankruptcy Court dismissed the cases after finding that the debtors were solvent and not in default upon their debts, but retained authority to consider sanctions. The Bankruptcy Court sanctioned both Knight and the attorney. The Fifth Circuit affirmed the Bankruptcy Court, finding that its conclusion of bad faith conduct was supported.
_______________________________________________________________________

Single Asset Real Estate

Matter of Scotia Pacific Company, 508 F.3d 214 (5th Cir. 2007).

Fifth Circuit considered whether debtor was a Single Asset Real Estate debtor. Test is: (1) debtor must own real property constituting a single property or project; (2) which generates substantially all of the gross income of the debtor; and (3) on which no substantial business is conducted other than the business of operating the real property and activities incidental thereto. Fifth Circuit affirmed finding that debtor conducted a substantial business on the property. Debtor employed over 60 employees and engaged in sophisticated activities such as soil conservation, road planning, design and engineering. In order to be a SARE, revenues received by the debtor must be passive rather than active.
_______________________________________________________________________

Standing

Matter of United Operating Company, LLC, 540 F.3d 351 (5th Cir. 2008).

Reorganized debtor lacked standing to pursue claims arising during bankruptcy, where (i) assets of estate did not revest in debtor upon confirmation and (ii) plan provided for retention of claims created under Bankruptcy Code but not common law claims.

Bankruptcy Court Limbers Up to Tackle Mental Gymnastics of Lien Avoidance

A Texas bankruptcy judge had to engage in some mental gymnastics to decide whether to avoid a lien on property exempted under the federal wildcard in In re Melissa Catherine Powell, No. 08-60204 (Bankr. W.D. Tex. 11/6/08). Powell presented some interesting facts. The debtor owned four tracts of real property. However, those properties were encumbered with a $1.1 million judgment lien. Ms. Powell had apparently been up to no good, since the judgment creditor subsequently obtained a non-dischargeable judgment against her. In the absence of bankruptcy, the debtor would have lost the three non-homestead properties. However, the debtor filed bankruptcy, claimed the property as exempt under Sec. 522(d)(1) and (5) and then sought to avoid the judgment lien as a lien impairing an exemption. While the result may raise a few eyebrows, the court faithfully followed the code sections.

The debtor was able to claim four properties as exempt because Texas allows use of the federal exemptions and each property had minimal equity. The debtor claimed total exempt equity of $7,406.43 between the four properties. The exempt values were determined based on the difference between the scheduled values and the non-judgment liens. No party objected to the exemptions, so that they became final. The debtor then moved to avoid the judgment lien as a non-purchase money lien impairing an exemption under Sec. 522(f). The creditor tried to hold the debtor to its scheduled exemption, arguing that the debtor had claimed $7,406.43 in exempt property and could not avoid the judgment lien to the extent that the equity in the properties exceeded this amount.

The Bankruptcy Court framed two issues for decision:

1. Exactly what was claimed and allowed as exempt?

2. Are the creditors, in defense of a lien avoidance motion under Sec. 522(f), foreclosed from challenging the exempt nature of the properties in question due to their failure to timely object to the Debtor's exemption claims?

The creditor's defense to the lien avoidance motion raised the question of what the debtor had claimed as exempt. Was it the property or was it a specific dollar value in equity? The court dryly noted, "Remarkably, this is an issue about which there has been some controversy."

The court pointed out that when a debtor claims an unknown amount as exempt or lists the exempt value at $1, she is putting creditors on notice that the entire value of the asset is claimed as exempt. On the other hand, when the debtor listed a specific dollar amount calculated as the difference between the scheduled value and the scheduled liens, creditors were not on notice that the debtor might claim a greater value. The court noted that there was a difference between "in kind" exemptions which apply to the entire asset and "not to exceed" exemptions which are limited to a dollar value.

The Court stated:

Section 522(d)(1) and (5) allow the Debtor to exempt her aggregate interest in the real property in question. There are not "in kind" statutes. However, when the Debtor places a value on her exemption under (d)(1) and (5) which is less than the monetary amount allowable under the statute and such value was reached by deducting the amount of debt from the value of each such listed property as set forth on Schedule A; it is clear, at least to this Court, that the Debtor's intention was to exempt the maximum allowable under the federal exemption statute. There is no intent to exempt the Properties in their entirety. Even so, this is not determinative of the issue at had as discussed below.

Slip op. at 8.

The issue is thornier because Sec. 522(f) allows the debtor to avoid a lien "to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section . . ." Thus, for purposes of lien avoidance, the issue is not what amount was exempted by the debtor, but what amount the debtor would have been entitled to. "For purposes of Sec. 522(f), the issue starts with the inquiry of whether we are dealing with property the debtor would have bene entitled to exempt not whether the debtor has scheduled them as such." Slip op. at 11.

Based on the "would have been entitled" language of Sec. 522(f), a debtor who under-exempts his property would be entitled to avoid the lien based on the full amount he was entitled to, while a debtor who over-exempted or claimed property which should not have been exempt at all could not resort to use of Sec. 522(f).

In the specific case, the amount actually claimed as exempt by the Debtor was $7,406.43. However, the Debtor was entitled to claim exemptions of $21,275.00 based on Sec. 522(d)(1) and (5). The lien would impair the exemption to the extent that it prevented the Debtor from realizing the value of $21,275 that she "would have been entitled" to. If there was less equity in the property than the maximum which could be claimed as exempt, then the lien "should be avoided in its entirety as the Debtor's claimed exemption is totally impaired." On the other hand, if the properties were worth more than the value of the unavoidable liens plus the Debtor's maximum exemption, then the "judicial lien would be preserved to the extent of such excess value." Although the Debtor's schedules indicated that there would not be any excess value for the lien to attach to, the court gamely offered that, "if the (creditors) would like to offer such proof, the court is amenable to holding a hearing for such purpose."

There are a number of important points to take away from this opinion.

1. Just because the Debtor is a bad person does not prevent them from using the tools available under the Code. While we frequently say that the Bankruptcy Court is a court of equity and that litigants must do equity to receive equity, that will not overcome a statutory command. In this case, the court, in discussing the creditors' claim, dropped a footnote stating, "There is no indication in the Complaint as to whether the Debtor was prosecuted for her alleged misdeeds; but, if they are true, prosecution would seem most appropriate." Where else but Bankruptcy Court would a party for whom "prosecution would seem most appropriate" prevail against the wronged party?

2. There are two types of exemptions: in-kind and not to exceed. An in-kind exemption exempts the entire property, while a not to exceed exemption just protects a dollar amount. As a result, failure to object to a "not to exceed" exemption does not make the entire property exempt unless the debtor clearly stated an intent to claim the entire asset or the asset was worth less than the allowable exemption. Therefore, if the debtor claims a $5,000 wildcard exemption on a million dollar asset, the debtor gets to keep $5,000 rather than $1,000,000.

3. Lien avoidance under Sec. 522(f) is based on what the debtor should have been entitled to exempt rather than what she actually claimed as exempt. Therefore, every lien avoidance hearing is also a hearing to determine what the exemption should have been.

Fifth Circuit Relies on Constitutional Avoidance to Uphold Sec. 526(a)(4)

In a departure from rulings by the Eighth Circuit and several lower courts, the Fifth Circuit has held that Sec. 526(a)(4), which limits the advice debt relief agencies can give potential debtors "in contemplation of" bankruptcy, passes constitutional scrutiny. Susan B. Hersh v. United States of America, No. 07-10226 (5th Cir. 12/18/08). The Fifth Circuit also found that attorneys were "debt relief agencies" and upheld the constitutionality of Sec. 527.

Section 526(a)(4) is found amongst three sections regulating the activities of "debt relief agencies." It states that a debt relief agency shall not "advise an assisted person or prospective 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." Several courts, including the Eighth Circuit, have held that this statute is an overly broad restriction on protected speech because it prohibits beneficial speech as well as abusive advice. Milavetz, Gallop & Milavetz, P.A. v. United States, 541 F.3d 785 (8th Cir. 2008).

The Fifth Circuit acknowledged that if the statute were interpreted literally, it could be problematic.

If interpreted literally and broadly, section 526(a)(4) would raise serious consitutional problems because, as Hersh suggests, it would restrict some speech that is protected by the First Amendment. The statute does not expressly qualify its restriction on advice to situations in which incurring more debt would be an abuse of the bankruptcy system. Thus, if interpreted literally, section 526(a)(4) creates a blanket restriction on attorneys advising clients to incur any debt when intending, or contemplating whether to, file for bankruptcy under any circumstances. It would prohibit some attorney advice that would not be abusive to the bankruptcy system, harmful to creditors, or harmful to debtors. Thus, interpreted literally, section 526(a)(4) may apply to speech that is protected by the First Amendment.

Slip op. at 15.

However, at this point, the Fifth Circuit took a cue from the dissent in Milavetz and noted that the constitional problem could be avoided through a narrow construction. While section 526(a)(4) could prohibit some permissible speech, it also restricts malignant speech as well. Under the doctrine of constitutional avoidance, courts will decline to hold an act unconstitutional when another legitimate construction is available. The court concluded that this was possible in the case of speech in contemplation of bankruptcy.

To avoid potential constitutional questions regarding section 526(a)(4)'s restrictions on speech, this court construes the statute to prevent only a debt relief agency's advice to a debtor to incur debt in contemplation of bankruptcy when doing so would be an abuse of the bankruptcy system. In so interpreting the statute, we avoid the constitutionality questions raised by Hersh (and those relied on by the Milavetz majority) and conclude that the statute only affects unprotected speech.

Slip op. at 19.

Having decided to avoid the constitutional issue, the Fifth Circuit took some pains to explain why its construction was plausible, noting that constitutional avoidance "is not a license for the judiciary to rewrite language enacted by the legislature." The court pointed out that the "in contemplation" phrase is frequently used to connote bad intent. The court also stated that the civil remedies for violation of the section, which include recovering damages for the benefit of the debtor and enjoining bad conduct, indicate a purpose to protect debtors from abusive advice rather than to shield them from good counsel. Finally, the court found that curbing abusive attorney practices was a major concern of BAPCPA, so that such an intent could be used to inform the statute's construction.

Milavetz and Hersh represent two different approaches to the issue of regulating attorney speech. The Milavetz decision focuses primarily on not chilling protected speech. On the other hand, the Hersh opinion seeks to protect regulation of abusive speech. With a split within the Eighth Circuit and between the Fifth and Eighth Circuits, this issue may be heading for the Supreme Court.

Republic Windows & Doors Case Illustrates Gaps in Employee Protection

Republic Windows & Doors, the Chicago company which recently closed its doors, is not a debtor in bankruptcy, at least not yet. However, it illustrates the point that when laws designed to protect employees meet secured financing, the workers can come up short.

Republic was a company which had operated since 1965. It began losing money in 2002. It tried various strategies, including raising new capital and selling assets. However, by October 2008, management knew that they were nearing the end of the road. As a last ditch effort, they presented an offer to Bank of America, their lender, to sell their note for $3.0 million on a balance of $4.5 million. Bank of America denied the request and demanded a plan for an orderly wind down. The company presented its first plan on October 16, 2008, which was turned down a few days later. The company submitted another proposal which was also rejected. Then it asked for permission to pay its employees for their vacation pay. Finally, on December 2, 2008, the company gave its employees three days notice that it would be closing.

Under the WARN Act, companies are required to give employees 60 days notice of a plant closing in many circumstances. Additionally, the employees would be entitled to a priority claim in bankruptcy for their wages up to $10,950. However, those rights are not worth much without money to pay them. The news articles don't go into detail about the lending relationship with Bank of America. However, in an asset-based lending transaction, all receivables are paid into a lockbox controlled by the bank. If the bank does not advance the money back under the loan, there is no money to operate with. In this situation, if management is not willing to divert receivables in violation of the credit agreement, the bank has the final control over whether employees are paid or not.

The fact that employees rights can be frustrated so easily has led to some creative methods to get workers paid. Some plaintiffs lawyers have sued banks under the WARN Act under the theory that they have become the employer. In the Republic Windows & Doors case, the employees have staged a sit-in at the factory to bring attention to their cause. They have managed to get prominent politicians from Rep. Luis Gutierrez to President-elect Barack Obama to plead their cause. Some have criticised Bank of America for accepting $25 billion in federal bailout money, but turning a cold shoulder toward the unpaid workers. Illinois Gov. Rod Blagojevich has ordered all state agencies to stop doing business with Bank of America until the workers are paid. However, the fact that Gov. Blagojevich was indicted on federal corruption charges today may give him less influence than he might have had otherwise.