Part of New Bankruptcy Law Ruled Unconstitutional

One of the provisions of the new bankruptcy law (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”)) places limits and requirements on what an attorney may and may not say to clients considering bankruptcy. Some of these requirements are quite onerous. For example, 11 U.S.C. Sec. 526(a)(4) states as follows:

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.

There are many legitimate instances where an attorney might advise a client to incur additional debt before filing bankruptcy. For example, courts have held that it is okay for a debtor to take steps to maximize his exemptions before filing bankruptcy. That might involve borrowing against a car to maximize the available homestead exemption. It does not hurt the lender on the car, because the borrower will have to reaffirm the debt and it allows the debtor to maximize the value of the exemption.

In Zelotes v. Martini, Case No. 3:05cv1591 in the United States District Court for the District of Connecticut, the Court recently ruled that these limitations on attorney speech are facially unconstitutional. The Court stated as follows:

Rather than changing the bankruptcy system by closing the loopholes, eliminating the incentives for opportunistic action or enacting penalties for those who take on such debt prior to filing for bankruptcy, Congress enacted § 526(a)(4), a prophylactic rule which prohibits attorneys from advising their clients to take on any additional debt in contemplation of bankruptcy, even when doing so would be lawful. As Plaintiff argues, and as both the Hersh and Olsen courts found, there are instances whereby taking on more debt in contemplation of bankruptcy would not constitute abuse of the bankruptcy system. Without delving too deep into the complexities of bankruptcy law, it is clear that the prohibition in § 526(a)(4), while addressing opportunistic abuses, could also ensnare lawful, financially prudent actions. The Hersh and Olsen courts noted examples where the prohibition could reach lawful and beneficial actions, including (1) "refinancing at a lower rate to reduce payments and forestall or even prevent entering bankruptcy," (2) "taking on secured debt such as [a] loan on an automobile that would survive bankruptcy and also enable the debtor to continue to get to work and make payments," (3) "taking out a loan to obtain the services of bankruptcy attorney, to pay the filing fee in a bankruptcy case or the conversion of a non-exempt asset to an exempt asset which is still allowed under the Bankruptcy code," and (4) "refinanc[ing] a mortgage that allows a debtor to pay off the mortgage and other debts, such as credit card debt, in a chapter 13 where failure to refinance may only allow the debtor sufficient funds to pay off one or the other but not both." Hersh, 347 B.R. at 24; Olsen, 2006 U.S. Dist. LEXIS 56197, at *20. Plaintiff cited these and other examples of lawful, financially prudent actions, including: (1) borrowing money from friends and family or taking out a secured loan to obtain the services of a bankruptcy attorney or to pay a filing fee, in order to (a) prevent a wage garnishment or attachment, (b) prevent a home foreclosure, repossession or associated costs or (c) avoid a preferential payment or fraudulent transfer to insiders; and (2) borrowing from friends and family or taking out a secured loan to finance the purchase of a new vehicle in order to (a) purchase a less expensive vehicle with lower monthly payments in order to maintain transportation, (b) obtain transportation and secure employment, (c) avoid the higher rate of interest-and therefore, potentially higher likelihood of default-which the debtor would face after filing for bankruptcy, (d) obtain a more economical and/or reliable vehicle in order to reduce average monthly expenses.

By prohibiting lawyers from advising clients to take a course of action that is lawful and in the client's best financial interest, albeit a counterintuitive one, § 526(a)(4) prevents lawyers from giving clients the best and most complete advice. As Plaintiff argues, "[s]ection 526 chills the attorney's very exercise of the advice and counsel function that is the defining feature of our profession." (Pl.'s Opp. 11.) By prohibiting lawyers from advising clients to take lawful, prudent actions as well as abusive ones, § 526(a)(4) is overbroad and restricts attorney speech beyond what is "narrow and necessary" to further the governmental interest. Gentile, 501 U.S. at 1075; Hersh, 347 B.R. at 25 (citing In re R. M. J., 455 U.S. 191, 203, 102 S. Ct. 929, 71 L. Ed. 2d 64 (1982) (Even under intermediate scrutiny, "[s]tates may not place an absolute prohibition on certain types of potentially misleading information . . . if the information also may be presented in a way that is not deceptive."); Conant v. Walters, 309 F.3d 629, 638-39 (9th Cir. 2002) (finding that government could not justify policy that threatened to punish a physician for recommending to a patient the medical use of marijuana on ground that such a recommendation might encourage illegal conduct by the patient)); Olsen, 2006 U.S. Dist. LEXIS 56197, at *21. Accordingly, the Court finds 11 U.S.C. § 526(a)(4) facially unconstitutional.