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The New Supreme Court: a Discussion of Recent Bankruptcy Decisions

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The New Supreme Court: a Discussion of Recent Bankruptcy Decisions The New Supreme Court: A Discussion of Recent Bankruptcy Decisions Article contributed by: George Klidonas of Baker Hostetler LLP With the advent of the Bankruptcy Abuse prevent bankruptcy abuse, Justice Sotomayor held Prevention and Consumer Protection Act of 2005 that such debt relief agencies cannot advise clients (“BAPCPA”), Congress intended to deter debtors to incur more debt in contemplation of bankruptcy.7 from abusing the bankruptcy system when they had Additionally, attorneys who advertise must state the actual ability to repay their creditors the that they are a “debt relief agency” and that they maximum that they could afford.1 Obeying the spirit “help people file for bankruptcy relief under the of congressional intent, the Supreme Court has Bankruptcy Code.” 8 added its own patina through various decisions this past year. Specifically, the Supreme Court has A case involving a Minnesota-based law firm, addressed debtors’ methodology in calculating their Milavetz, Gallop & Milavetz (“Milavetz”), illustrates projected disposable income and reasonably the point. Milavetz sought a declaratory judgment necessary expenses for the purpose of funding their that it was not bound by the provisions of BAPCPA plans2 and in scheduling their exempt property.3 because attorneys are not “debt relief agencies.”9 Recognizing that bankruptcy abuse may harm Milavetz also did not want to be bound by the debtors as well, the Supreme Court has placed statutory restrictions on advising debtors with more stringent requirements on consumer respect to debts incurred in contemplation of filing bankruptcy attorneys4 and has required creditors to for bankruptcy10 and attorney advertisements.11 pay more attention to non-dischargeable debt in The Supreme Court accepted the case to resolve a chapter 13 plans.5 The following will explore the conflict between the Fifth and the Eighth Circuits.12 effects of these rulings on debtors and creditors alike. As a preliminary matter, Justice Sotomayor concluded that attorneys who provide bankruptcy Regulation of Attorney Speech under BAPCPA assistance are debt relief agencies.13 A debt relief agency is defined as “any person who provides any In order to correct certain perceived abuses in the bankruptcy assistance to an assisted person.”14 The bankruptcy system, part of the reform term “bankruptcy assistance” includes several accomplished by BAPCPA included regulating the services provided by attorneys, including “legal conduct of debt relief agencies, defined as representation with respect to a case or professionals who provide bankruptcy assistance to proceeding.”15 Congress also delineated exceptions consumer debtors.6 Because attorneys who provide to the definition of “debt relief agency” and bankruptcy assistance to consumers constitute debt attorneys were not specifically listed.16 Finally, the relief agencies, in order to protect debtors and legislative record indicates that attorneys were ________________ © 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 5, No. 22 edition of the Bloomberg Law Reports—Bankruptcy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. meant to be included in the definition of “debt Maintaining the concept of finality in bankruptcy relief agency” to address misconduct by attorneys.17 court orders, Justice Thomas decided that non- dischargeable student loan debt can be discharged The next question before the Supreme Court was under a plan where a creditor fails to object. In whether attorneys, as debt relief agencies, could doing so, the Court concluded that a finding of advise clients to incur more debt immediately undue hardship was not necessary and that the before filing for bankruptcy.18 Rejecting the Eighth undue hardship requirement can be waived where a Circuit's view, Justice Sotomayor concluded that a creditor sleeps on its rights. debt relief agency violates 11 U.S.C. § 526(a)(4) only when the impetus of the advice is to incur more Francisco Espinosa ("Espinosa") was the recipient of debt in contemplation of bankruptcy.19 There must student loans who later filed for chapter 13 relief be a valid purpose to the advice.20 For example, and listed his student debt as his only specific attorneys may discuss with their debtor-clients the indebtedness.28 He proposed to pay only the consequences of incurring debt in contemplation of principal on the student loan debt and to discharge filing for bankruptcy.21 The Court’s conclusion is the interest.29 The clerk of the bankruptcy court consistent with Model Rule of Professional Conduct mailed a copy of Espinosa’s plan to the student loan 1.2(d), which states that a lawyer cannot counsel a creditor, United Student Aids Fund, Inc. (“United”). client to engage in conduct that the lawyer knows is The plan clearly stated underneath the caption: criminal or fraudulent and that a lawyer may, “WARNING IF YOU ARE A CREDITOR YOUR RIGHTS however, discuss the legal consequences of any MAY BE IMPAIRED BY THIS PLAN.”30 Even though proposed conduct.22 United filed a proof of claim at the beginning of the bankruptcy case, it did not object to the plan and Finally, the Supreme Court concluded that the the court subsequently confirmed the plan.31 advertising requirements under 11 U.S.C. § 528 are constitutional,23 holding that the government can Five years later, Espinosa completed the principal regulate commercial speech to “directly payments under his plan and received a discharge advance*e+” a substantial governmental interest for the unpaid interest from the bankruptcy court.32 and be “n*o+ more extensive than is necessary to Almost a decade after Espinosa filed the petition serve that interest.”24 Section 528 requires debt and years after he received a discharge, United relief agencies to state in their advertisements that attempted to collect on the unpaid interest.33 The their services relate to bankruptcy relief and that debtor then reopened the case and filed a motion they “are a debt relief agency” helping “people file with the bankruptcy court seeking to enforce the for bankruptcy relief.”25 Milavetz’s advertisements discharge. United cross-moved under Federal Rule were not found to be misleading. At the same time, of Civil Procedure 60(b)(4) to set aside the however, “*w+hen the possibility of deception is confirmation order as void.34 self-evident . we need not require the State to ‘conduct a survey of . the public before it *may+ The Supreme Court granted certiorari to determine determine that the [advertisement] had a tendency whether a confirmation order, which discharges to mislead.’”26 Because the congressional record student loan debt in the absence of undue hardship reflected a “pattern of advertisements that hold out or an adversary proceeding (or both), is a “void” the promise of debt relief without alerting judgment under Rule 60(b)(4).35 The Supreme Court customers to its potential cost,” the likelihood of held that such an order was not void, reasoning that deception was not speculative.27 Accordingly, § 528 a judgment will not be deemed void “simply was upheld as constitutional. because it is or may have been erroneous.”36 Instead, orders are considered void if the court Dischargeability of Student Loans lacked jurisdiction to enter the order or if there was a lack of due process that deprived the party of notice or the opportunity to be heard.37 In sum, the © 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 5, No. 22 edition of the Bloomberg Law Reports—Bankruptcy. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. bankruptcy court did not lack jurisdiction to enter plans. In cases where a creditor has slept on its an order approving confirmation despite the rights and a debtor seeks to discharge non- discharge of the student loan debt. dischargeable debts such as student loans, domestic support obligations, and specified tax debts, courts The Court also examined Federal Rule of Bankruptcy may, in the future, place the burden on creditors to Procedure 7001(6) and the dischargeability object.45 provision of 11 U.S.C. § 523(a)(8), and held that those provisions are non-jurisdictional in nature.38 Calculating “Income” Portion of Disposable Income The student loan discharge provision merely requires a bankruptcy court to make a finding of Consideration of economic realities motivated the undue hardship as a precondition to discharge; it is Court to adopt a “forward looking approach” rather not a limitation on the court’s jurisdiction.39 than a “mechanical approach” to determining a Furthermore, the requirement under Bankruptcy debtor’s “projected disposable income” for chapter Rule 7001(6) that the undue hardship finding must 13 plan purposes.
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