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.
Homestead Cap May Not Apply To Recently-Established Residence On Previously Owned Property
Except as provided in paragraph (2) of this subsection and sections 544 and 548, as a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $136,875 [the amount was raised in 2007] in value in —
(A) real or personal property that the debtor or a dependent of the debtor uses as a residence;
(B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;
(C) a burial plot for the debtor or a dependent of the debtor; or
(D) real or personal property that the debtor or dependent of the debtor claims as a homestead.
Section 522(p) was enacted by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) , and the court held that its purpose is to close the so-called “mansion loophole” in which a wealthy debtor may shield assets by purchasing a lavish home in a state with an unlimited homestead exemption such as Texas or Florida shortly before filing bankruptcy.
By Reno F.R. Fernandez III
"Ride Through" Option Did Not Survive BAPCA
In Dumont v. Ford Motor Credit Company (In re Dumont), C.D.O.S. 11793, 08-60002 (9th Cir. September 15, 2009), the Ninth Circuit held that the "Ride Through" option, which allowed debtors to retain collateral and continue to make payments, did not survive the Bankruptcy Abuse and Prevention Act of 2005 ("BAPCPA").
In 2003, Antoinette Dumont purchased a car from Ford Motor Credit Company. The loan documents contained an "ipso facto" clause, which provided that the loan would be in default if Dumont filed bankruptcy. In 2006, Dumont filed a voluntary chapter 7 petition, and she listed the car as an asset with a value of $5,800. At the time, Dumont owed $8,288 for the car, and she was making payments of $335.78 per month. Dumont filed a Statement of Intention with the bankruptcy court, stating that she would retain the car and continue making payments (Bankruptcy Section 521(a)(2)(A) requires a debtor to file a Statement of Intention with respect to collateral). A discharge was entered in Dumont's case, and three months later Ford repossessed the car even though the payments were current.
Under Ninth Circuit law, a debtor was entitled to retain collateral and continue making payments. See McClellan Fed. Credit Union v. Parker (In re Parker), 139 F.3d 668, 673 (9th Cir. 1998). A creditor holding a lien against the collateral was barred from taking possession of the collateral. Dumont successfully moved to reopen her bankruptcy case and alleged that Ford violated the discharge injunction. The bankruptcy court disagreed, and the Bankruptcy Appellate Panel ("BAP") affirmed.
The Ninth Circuit ruled that BAPCPA added a requirement to Bankruptcy Code Section 362(a)(1)(A), requiring debtors to elect one of three options with respect to collateral: redeem (essentially, to "buy back" the property); reaffirmation (to reaffirm the debt with approval from the bankruptcy court); or assumption (to assume the debt). Because Dumont did not elect one of these options in her Statement of Intention, Ford's rights under the loan agreement were revived, including the "ipso facto" clause, and Dumont was in default of the loan.
Judge Graber entered a strong dissent. Noting that BAPCPA has been criticized for its lack of clarity, Judge Graber explained that the text of Bakruptcy Code Section 521(2), which BAPCPA redesignated as 521(a)(2), was left unchanged. Furthermore, Congress made no comment to suggest that it intended to impose a new requirement under Bankruptcy Code Section 362(h)(1)(A) despite the vigorous public debate surrounding the "ride through" issue. In other words, Judge Graber argued that BAPCPA perpetuated the status quo, and he concluded that he would not have overrulled Parker.
By Reno F.R. Fernandez III
In 2003, Antoinette Dumont purchased a car from Ford Motor Credit Company. The loan documents contained an "ipso facto" clause, which provided that the loan would be in default if Dumont filed bankruptcy. In 2006, Dumont filed a voluntary chapter 7 petition, and she listed the car as an asset with a value of $5,800. At the time, Dumont owed $8,288 for the car, and she was making payments of $335.78 per month. Dumont filed a Statement of Intention with the bankruptcy court, stating that she would retain the car and continue making payments (Bankruptcy Section 521(a)(2)(A) requires a debtor to file a Statement of Intention with respect to collateral). A discharge was entered in Dumont's case, and three months later Ford repossessed the car even though the payments were current.
Under Ninth Circuit law, a debtor was entitled to retain collateral and continue making payments. See McClellan Fed. Credit Union v. Parker (In re Parker), 139 F.3d 668, 673 (9th Cir. 1998). A creditor holding a lien against the collateral was barred from taking possession of the collateral. Dumont successfully moved to reopen her bankruptcy case and alleged that Ford violated the discharge injunction. The bankruptcy court disagreed, and the Bankruptcy Appellate Panel ("BAP") affirmed.
The Ninth Circuit ruled that BAPCPA added a requirement to Bankruptcy Code Section 362(a)(1)(A), requiring debtors to elect one of three options with respect to collateral: redeem (essentially, to "buy back" the property); reaffirmation (to reaffirm the debt with approval from the bankruptcy court); or assumption (to assume the debt). Because Dumont did not elect one of these options in her Statement of Intention, Ford's rights under the loan agreement were revived, including the "ipso facto" clause, and Dumont was in default of the loan.
Judge Graber entered a strong dissent. Noting that BAPCPA has been criticized for its lack of clarity, Judge Graber explained that the text of Bakruptcy Code Section 521(2), which BAPCPA redesignated as 521(a)(2), was left unchanged. Furthermore, Congress made no comment to suggest that it intended to impose a new requirement under Bankruptcy Code Section 362(h)(1)(A) despite the vigorous public debate surrounding the "ride through" issue. In other words, Judge Graber argued that BAPCPA perpetuated the status quo, and he concluded that he would not have overrulled Parker.
By Reno F.R. Fernandez III
Judge Sotomayor's Bankruptcy Record Gets Passing Grade
Bankruptcy bloggers approve of Judge Sonya Sotomayor's bankruptcy record. Judge Sotomayor, whose colleagues on the Second Circuit decided the Chrysler appeals, was not asked whether she believes major assets can be sold free and clear of personal injury claims. Nevertheless, bankruptcy bloggers who canvassed her opinions found "nothing to complaint about." - Reno
Sale of General Motors Assets Approved
On Monday, July 6, 2009, just over one month after filing for chapter 11 bankruptcy protection, Judge Gerber approved a sale of substantially all of General Motors' valuable assets to a new company known as "New GM." In a 95 page Decision approving the sale, Judge Gerber wrote that there is a "need for speed" in selling GM's assets and the alternative, liquidation, would be a “disastrous” result.
Government Influence Apparent
The U.S. Government and the Treasury played an active role in GM's case. Judge Gerber set the tone of the Decision by citing a speech by President Barack Obama early on, as follows:
GM is developing a new small-car plant in Orion, MI, and the chief factors in choosing its location were the plant's carbon footprint and the local unemployment rate. GM assures that there was no "political meddling" in its choice, according to the Wall Street Journal.
Sale to be Funded by Government Loans; Saturn Likely to be Liquidated
The sale will be funded by loans from the governments of the United States, Canada and the City of Ontario (Decision, 14). The U.S. loan was contingent upon the approval of the sale on or before July 10, 2009. (Decision, 35-36). Following the sale, the US Treasure will own 60.8%, the Canadian governments will own 11.7%, a new GM employee benefits association will own 17.5%, and, assuming a reorganization plan is confirmed, “Old GM” will own 10% of the new company (Decision, 19-20). Old GM is set to receive approximately $45 billion in assets, plus the value of equity interests that it will receive in New GM. (Decision, 18). Saturn and certain other entities will be left with Old GM and liquidated. (Id.)
Lack of National Health Care Played Role
Judge Gerber noted that lack of a national health care system made GM less competitive than it could have been. One of the U.S. Treasury's conditions for providing funding was negotiation of a new agreement with the United Auto Worker's Union, which was accomplished (Decision, 20). A concession by the employees was agreement to a new health care structure. Judge Gerber opined that the lack of a public health care system and GM's attempts to provide health care benefits directly kept the company from being competitive, as follows:
As part of the new deal, rather than provide health care benefits directly, New GM will make contributions to the new employee benefits association (Decision, 22).
Sale Approved Over Objection of Creditors
The sale was approved over the objection of certain bondholders. The sale to New GM was a so-called “Section 363” sale, free and clear of liens and other interests, including certain personal injury claims. Section 363 of the Bankruptcy Code provides that a debtor's assets may be sold free and clear of the interests of third parties under certain circumstances, and the sale may be accomplished quickly, prior to confirmation of a reorganization plan.
Several bondholders objected to the sale, arguing that a debtor cannot circumvent the protections of chapter 11 and short circuit the plan confirmation process by selling substantially all of its assets through a Section 363 sale (Decision, 26). It is important to note that creditors, such as bondholders, are entitled to vote upon a reorganization plan, but there is no vote prior to a Section 363 sale. Nevertheless, the Second Circuit Court of Appeal does not limit Section 363 sales to emergency situations, and substantially all of a debtor's assets may be sold if there is some articulated business rationale for the sale, such as the need to preserve a company's going concern value (Decision, 30-31). In support of his Decision, Judge Gerber cited from the Chrysler cases, as follows:
Judge Gerber also quoted from the U.S. Supreme Court's recent Piccadilly Cafeterias case. Although the propriety of a 363 sale was not the main issue, the Justices wrote:
Chapter 11 bankruptcy proceedings ordinarily culminate in the confirmation of a reorganization plan. But in some cases, as here, a debtor sells all or substantially all its assets under § 363(b)(1) before seeking or receiving plan confirmation. In this scenario, the debtor typically submits for confirmation a plan of liquidation (rather than a traditional plan of reorganization) providing for the distribution of the proceeds resulting from the sale. Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc.,128 S.Ct. 2326, 2331 n.2 (2008).
The Judge found that a quick 363 sale was necessary to avoid liquidation, and he noted that: “As the Court’s Findings of Fact set forth at length, GM, with no liquidity of its own and the need to quickly address consumer and fleet owner doubt, does not have the luxury of selling its business under a plan.... And if that is not by itself enough, the U.S. Treasury’s willingness to fund GM is contingent upon the approval of the 363 Transaction by July 10.” (Decision, 35-36). The bondholders argued that the Judge should delay the sale of GM's assets in hopes that the U.S. Treasury would offer a better deal, but he declined to play “Russian Roulette” with the U.S. Government. (Decision, 38).
Sale to be Free and Clear of Personal Injury Claims
Judge Gerber clarified that the sale will be free and clear of personal injury claims, including accident- and asbestos-related claims (Decision, 57-61). The Judge cited to the Chrysler cases, where Justice Ginsburg briefly stayed the sale of the debtor's assets. One blogger suggests that the Justice might have misgivings about the sale cutting off personal injury tort claimants from recovery (see ”What's Bothering Ruthie?”). While the law of the Second Circuit clearly holds that Section 363 permits sale free and clear of personal injury claims, there are conflicting authorities from other circuits. Did the Supreme Court miss an opportunity to clarify Section 363?
Shakeup Expected
One thing is clear: It is no longer business as usual at GM. Frederick "Fritz" Henderson, GM's CEO, says “Business as usual is over at GM,” and he expects hundreds of middle managers to be let go in the coming weeks, reports the Wall Street Journal.
By Reno F.R. Fernandez III
Government Influence Apparent
The U.S. Government and the Treasury played an active role in GM's case. Judge Gerber set the tone of the Decision by citing a speech by President Barack Obama early on, as follows:
What I'm talking about is using our existing legal structure as a tool that, with the backing of the U.S. Government, can make it easier for General Motors . . . to quickly clear away old debts that are weighing [it] down so that [it] can get back on [its] feet and onto a path to success; a tool that we can use, even as workers stay on the job building cars that are being sold. What I’m not talking about is a process where a company is simply broken up, sold off, and no longer exists. We’re not talking about that. And what I’m not talking about is a company that’s stuck in court for years, unable to get out. (Decision, 12).
Sale to be Funded by Government Loans; Saturn Likely to be Liquidated
The sale will be funded by loans from the governments of the United States, Canada and the City of Ontario (Decision, 14). The U.S. loan was contingent upon the approval of the sale on or before July 10, 2009. (Decision, 35-36). Following the sale, the US Treasure will own 60.8%, the Canadian governments will own 11.7%, a new GM employee benefits association will own 17.5%, and, assuming a reorganization plan is confirmed, “Old GM” will own 10% of the new company (Decision, 19-20). Old GM is set to receive approximately $45 billion in assets, plus the value of equity interests that it will receive in New GM. (Decision, 18). Saturn and certain other entities will be left with Old GM and liquidated. (Id.)
Lack of National Health Care Played Role
Judge Gerber noted that lack of a national health care system made GM less competitive than it could have been. One of the U.S. Treasury's conditions for providing funding was negotiation of a new agreement with the United Auto Worker's Union, which was accomplished (Decision, 20). A concession by the employees was agreement to a new health care structure. Judge Gerber opined that the lack of a public health care system and GM's attempts to provide health care benefits directly kept the company from being competitive, as follows:
Workers in the U.S. do not have government provided healthcare benefits of the type that the employees of many of GM’s foreign competitors do. Over the years, GM and the other members of the Big Three committed themselves to offer many of those healthcare benefits, resulting in decreased competitiveness and enormous liabilities. GM tried to reduce the costs of healthcare benefits for its employees, but these costs continued to substantially escalate. Many of these costs were in the form of obligations to pay healthcare costs of union employees on retirement. (Decision, 21-22).
Sale Approved Over Objection of Creditors
The sale was approved over the objection of certain bondholders. The sale to New GM was a so-called “Section 363” sale, free and clear of liens and other interests, including certain personal injury claims. Section 363 of the Bankruptcy Code provides that a debtor's assets may be sold free and clear of the interests of third parties under certain circumstances, and the sale may be accomplished quickly, prior to confirmation of a reorganization plan.
Several bondholders objected to the sale, arguing that a debtor cannot circumvent the protections of chapter 11 and short circuit the plan confirmation process by selling substantially all of its assets through a Section 363 sale (Decision, 26). It is important to note that creditors, such as bondholders, are entitled to vote upon a reorganization plan, but there is no vote prior to a Section 363 sale. Nevertheless, the Second Circuit Court of Appeal does not limit Section 363 sales to emergency situations, and substantially all of a debtor's assets may be sold if there is some articulated business rationale for the sale, such as the need to preserve a company's going concern value (Decision, 30-31). In support of his Decision, Judge Gerber cited from the Chrysler cases, as follows:
A debtor may sell substantially all of its assets as a going concern and later submit a plan of liquidation providing for the distribution of the proceeds of the sale. This strategy is employed, for example, when there is a need to preserve the going concern value because revenues are not sufficient to support the continued operation of the business and there are no viable sources for financing.(Opinion, 34, quoting from In re Chrysler LLC, 405 B.R. 84, 96 (Bankr. S.D.N.Y. 2009).
Judge Gerber also quoted from the U.S. Supreme Court's recent Piccadilly Cafeterias case. Although the propriety of a 363 sale was not the main issue, the Justices wrote:
Chapter 11 bankruptcy proceedings ordinarily culminate in the confirmation of a reorganization plan. But in some cases, as here, a debtor sells all or substantially all its assets under § 363(b)(1) before seeking or receiving plan confirmation. In this scenario, the debtor typically submits for confirmation a plan of liquidation (rather than a traditional plan of reorganization) providing for the distribution of the proceeds resulting from the sale. Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc.,128 S.Ct. 2326, 2331 n.2 (2008).
The Judge found that a quick 363 sale was necessary to avoid liquidation, and he noted that: “As the Court’s Findings of Fact set forth at length, GM, with no liquidity of its own and the need to quickly address consumer and fleet owner doubt, does not have the luxury of selling its business under a plan.... And if that is not by itself enough, the U.S. Treasury’s willingness to fund GM is contingent upon the approval of the 363 Transaction by July 10.” (Decision, 35-36). The bondholders argued that the Judge should delay the sale of GM's assets in hopes that the U.S. Treasury would offer a better deal, but he declined to play “Russian Roulette” with the U.S. Government. (Decision, 38).
Sale to be Free and Clear of Personal Injury Claims
Judge Gerber clarified that the sale will be free and clear of personal injury claims, including accident- and asbestos-related claims (Decision, 57-61). The Judge cited to the Chrysler cases, where Justice Ginsburg briefly stayed the sale of the debtor's assets. One blogger suggests that the Justice might have misgivings about the sale cutting off personal injury tort claimants from recovery (see ”What's Bothering Ruthie?”). While the law of the Second Circuit clearly holds that Section 363 permits sale free and clear of personal injury claims, there are conflicting authorities from other circuits. Did the Supreme Court miss an opportunity to clarify Section 363?
Shakeup Expected
One thing is clear: It is no longer business as usual at GM. Frederick "Fritz" Henderson, GM's CEO, says “Business as usual is over at GM,” and he expects hundreds of middle managers to be let go in the coming weeks, reports the Wall Street Journal.
By Reno F.R. Fernandez III
Listen to Chrysler and GM Hearings Online!
The Bankruptcy Court for the Southern District of New York has made available recordings of hearings in the Chrysler and General Motors chapter 11 bankruptcies! Listen to the recordings here. Please feel free to post any comments and questions about the hearings.
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