New to the Barrister's Club Board of Directors

We are pleased to announce that Reno Fernandez has been appointed for a two-year term to the Board of Directors for the Barrister's Club of San Francisco.  You can read the press release here. - Reno Fernandez

Payments to Creditors Ahead of Schedule May Constitute Avoidable Preferences

A recent decision by Judge Stuart M. Bertnstein of the Bankruptcy Court for the Southern District of New York in the case of M. Fabrikant & Sons, a jewelry retailer, could make it more difficult for a creditor to defend against an action to avoid pre-petition payments as preferences in the case where the payments were made early or on time.

Under Bankruptcy CodeSection 547, payments to creditors made by the debtor within the 90 days preceeding bankruptcy that are deemed to favor one creditor over another can be reversed.  A common defense to a preference action is the “ordinary course of business” defense under Section 547(c)(2).  In order to prevail, the creditor must show that the debt was incurred in the ordinary course of business and either:  (1) the payment was made in the ordinary course of business between the debtor and the creditor; or (2) the payment was made according to ordinary business terms.

In the typical case, a debtor rushes to pay several old invoices, sometimes in order to curry favor with a trade creditor or satisfy the demands of an insider, and the payments are subject to avoidance in order to place the recipient on equal footing with other creditors.  In M. Fabrikant & Sons' case, although the debtor made payments for jewelry purchased from Gramercy on average 65 days after the invoice, the debtor made a certain payment 30 days after the invoice (and another payment 95 days after the invoice).  Significantly, the 30-day payment was consistent with the payment terms provided in the invoice.  Nevertheless, the court found that the payment constituted an avoidable preference because it was inconsistent with the debtor's practice of paying the invoices late.

Creditors and their attorneys should keep this case in mind when defending a preference suit.  If a creditor paid some invoices late and others on time or early, it will be necessary to carefully present the facts to harmonize the payments with the debtor's practices.

By Reno F.R. Fernandez III

Holiday Reading

The holidays are approaching, so why not treat yourself to an education in the history of American bankruptcy law?  Last Christmas, my wife Laura gave me a copy of David A. Skeel, Jr.'s Debt's Dominion:  A History of Bankruptcy Law in America (Princeton University Press, 2001).  Skeel's book explores the development of bankruptcy law from the 1800's to the reforms proposed in the early 2000's, some of which were incorporated in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  Debt's Domion gives a particularly enlightening treatment of railroad receiverships, which ultimately developed into modern Chapter 11 practice, and William Douglas' mid-century crack-down on the Wall Street reorganization bar.  We had the honor of hearing the author give a lecture as the keynote speaker at the California Bankruptcy Forum last May, and his insights into contemporary bankruptcy law and his preductions for the future were fascinating. - Reno Fernandez

Upcoming Event: Alternative Strategies in Assisting Distressed Companies

UPDATE:  This program was moved to January 13, 2010, at 12:00 pm, due to the Giants' victory parade!

Check out this upcoming lunch program, "Alternative Strategies in Assisting Distressed Companies," on November 3, 2010.   John Seeley, managing directors of Acrius Capital, will give the inside scoop on turnaround financing and other issues to the Barrister's Club of San Francisco Business, Commercial and Bankruptcy Section.  For more information and to sign up, click here.  - Reno Fernandez

Serving Two Masters: Representing the Chapter 11 Debtor and the Estate

On September 19, 2010, Judge Alan Jaroslovsky entered a short memorandum opinion denying $8,000 in attorney's fees for defending an individual chapter 11 debtor's claim of exemption for $1 million in retirement funds.  The Judge ruled that it was a conflict of interest for a law firm to represent both the estate and the debtor where their interests were opposed.  The court noted that it had the power to order the firm to disgorge all of its unpaid fees, but declined to do so in order to avoid a financial disaster for the firm.  In the end, the firm's fees were reduced by $8,000 and it was barred from collecting this amount from the estate, the debtor or anyone else.  This opinion underscores the fact that handling an individual chapter 11 bankruptcy case requires a high degree of care and skill.  To learn more, check out our in-depth article on individual chapter 11 cases. - Reno Fernandez

Just Married!

Reno F.R. Fernandez III is proud to announce that, on August 14, 2010, he was happily wedded to Laura H.W. Fernandez (nee Wineland)!  The wedding was held in Madison, Wisconsin, near Laura's home town, and the newlyweds have just returned from their honeymoon in Playa del Carmen, Mexico!  Laura and Reno would like to thank everyone who offered their support in bringing joy to their wedding day, including their parents, Laura's grandmother Ms. Ann Sphar, and Reno's boss Mr. Iain A. Macdonald, who gave a moving toast!

We're Making News!

Check out my article in The Recorder on a recent Supreme Court decision, Hamilton v. Lanning, which is likely to significantly impact chapter 13 plan payments. - Reno

Supreme Court Rules Section 526(a)(4)’s Limitation on Advice to Debtors is Constitutional

        On Monday, March 8, 2010, the Supreme Court in Milavetz, Gallop & Milavetz, P.A. v. United States, 10 C.D.O.S. 2797 (2010), an opinion authored by Justice Sotomayor, ruled that attorneys fall within the definition of “debt relief agencies” provided in Bankruptcy Code Section 101(12A) and that the advertising rules provided in Bankruptcy Code Section 528(a)(4) and the limitations on advice to debtors provided in Bankruptcy Code Section 526(a)(4) are constitutional.  However, the Justices narrowly construed Section 526(a)(4) to prohibit an attorney “only from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose.”



        Milavetz, Gallop & Milavetz, a Minnesota law firm that represents both consumer debtors and creditors in bankruptcy matters, along with two of its clients, brought an action for declaratory relief to determine that attorneys are excluded from the definition of “debt relief agency” provided in Section 101(12A) and that Sections 526(a)(4) and 528(a)(4) are unconstitutional under the First Amendment.  The District Court agreed with Milavetz, and the Eighth Circuit affirmed in part, finding that Section 526(a)(4) is overbroad because it prohibits counseling debtors to incur any debt in contemplation of bankruptcy even when the advice is for valid reasons.  However, the Eighth Circuit overruled the District Court’s ruling that attorneys are not “debt relief agencies” and that Section 528(a)(4)’s mandatory disclosures in advertisements violate the First Amendment.



        Sections 101(12A), 526(a)(4) and 528 were added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”).  Section 101(12A) defines a “debt relief agency” as “any person who provides any bankruptcy assistance to an assisted person in return for the payment of money of other valuable consideration, or who is a bankruptcy petition preparer under section 110,” but does not include certain specifically persons exempted from the statute.  Section 101(3) defined an “assisted person” as “any person whose debts consist primarily of consumer debts and the value of whose nonexempt property is less than $164,250.”  Section 526(a)(4) provides that a “debt relief agency” cannot “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.”  Section 528(a)(4) provides that, in any advertisement regarding bankruptcy services as provided in Section 528(a)(3), a “debt relief agency” shall use the following statement:  “’We are a debt relief agency.  We help people file for bankruptcy relief under the Bankruptcy Code.’ or a substantially similar statement.”



        The Supreme Court considered, as a threshold issue, whether attorneys who provide bankruptcy assistance to “assisted persons” are “debt relief agencies” pursuant to Section 101(12A).  Milavetz argued that:  (1) the inclusion of “bankruptcy petition preparers” and the fact that attorneys are not specifically included in Section (12A) indicates that Congress did not intend to include attorneys; (2) the imposition of the definition of “debt relief agency” upon attorneys would infringe upon a State’s power to regulate attorney practice; (3) Section (12A)’s omission of partners from the persons excluded from the definition would obligate entire law firms to comply with Sections 526, 527 and 528 based on the practice of a single partner while other types of business entity are shielded from the requirements; and (4) the Court should read Section (12A) narrowly to avoid ruling on further constitutional issues.  The Court was not persuaded that these issues prevailed over the text of the statute, and the Court held that “the text and statutory context of §101(12A) foreclose a reading of ‘debt relief agency’ that excludes attorneys.”  The Court noted that, “[b]y definition, ‘bankruptcy assistance’ includes several services commonly performed by attorneys”, including providing legal advice, which can only be provided by attorneys.  Moreover, “bankruptcy petition preparers” are specified in the disjunctive along with other persons who provide bankruptcy assistance, and Congress did not include attorneys in the exemptions provided in Section 101(12A).



        Next, the Court considered whether Section 526(a)(4)’s limitation on attorney advice is unconstitutionally overbroad or vague under the First Amendment.  Milavetz argued that the limitation is a content-based restriction that will chill protected speech by preventing attorney’s from advising clients to incur debt prior to filing bankruptcy for legitimate purposes, including attempts to obtain sufficient capital to avoid filing bankruptcy.  The Court considered Section 526(a)(4)’s language of “in contemplation of” bankruptcy; citing to a definition of the phrase in Black’s Law Dictionary and certain legislative reports, the Court found that the phrase is frequently associated with abusive practices, such as purchasing a sizeable quantity of goods on the eve of bankruptcy.  The Court further noted that the other provisions of Section 526 are designed to curb abusive practices.  In light of these facts, the Court held that the “the phrase refers to a specific type of misconduct designed to manipulate the protections of the bankruptcy system.”  Therefore, the Court ruled that Section 526(a)(4) “prohibits a debt relief agency only from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose”, and that attorneys remain free to talk “fully and candidly about the incurrence of debt in contemplation of filing a bankruptcy case.” (emphasis in original).



        It is important to note that the opinion does not give clear guidance as to when a pre-filing debt is incurred “for a valid purpose.”  For example, a debtor may need to purchase expensive medical supplies or a reliable automobile prior to commencing a case.  The Court held that advice to incur debt prior to filing violates Section 526(a)(4) “when the impelling reason for the advice is the anticipation of bankruptcy.”



        Finally, the Court addressed the advertizing rules provided in Section 528(a)(4).  Milavetz contended that Section 528(a)(4) is an unconstitutional restriction on speech as applied to the firm.  The parties agreed that Section 528(a)(4) regulates only commercial speech, and Milavetz argued that the Court should apply the intermediate scrutiny standard in Central Hudson Gas & Elec. Corp. v. Public Serv. Comm’n of N.Y., 447 U.S. 557 (1980).  However, the Court held that the statute is aimed at misleading commercial speech, and it applied the reasonable scrutiny standard set forth in Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio, 471 U.S. 626 (1985).  Milavetz argued that there was no evidence that its advertisements were misleading, but the Court noted that Zauderer applies where the possibility of deception is “self-evident” and the Congressional record demonstrates “a pattern of advertisements that hold out the promise of debt relief without alerting consumers to its potential cost”.  Milavetz further argued that that the phrase “debt relief agency” is itself confusing and misleading and that the mandatory disclosures are not reasonably related to any governmental interest because it applies equally to attorneys who represent creditors.  To the contrary, the Court found the language to be clear, and the Court noted that it affords attorneys flexibility in providing additional information about their services.  The Court further held that Milavetz misreads the statute, which is explicitly limited to attorneys who provide advice to consumer debtors and does not apply to attorneys representing creditors.



        Justice Scalia filed a separate concurrence and disagreed with the opinion’s citation to legislative history, which he found to be unnecessary and objectionable in that it encourages attorneys to waste their time analyzing legislative materials when the text of the statute is unambiguous.  Justice Thomas also filed a concurrence in which he stated that Zauderer is not on point because it concerned advertisements that were misleading on their face; in fact, he has never agreed with the relaxed level of scrutiny applied in Zauderer and he would have been willing to reexamine the case if the parties had asked.