Fifth Circuit Upholds Sec. 526(a)(4):

The Fifth Circuit has just handed down an opinion in Hersh v. United States, upholding sec. 526(a)(4) of the Code (added by BAPCPA).

Section 526(a)(4) provides:

“(a) A debt relief agency shall not – . . . (4) 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.”

The purpose of the provision was to prevent attorneys from advising their clients to incur additional debt right before filing bankruptcy (and discharging the debt). Or, as the statute indicates, to deal with the situation where lawyers would tell clients to use their credit cards to pay for the lawyers' filing fees and then discharge it.

The Eight Circuit previously had ruled that the statute constituted a facial violation of the First Amendment as a violation on free speech of the attorneys. Hersh summarizes that case as follows:

where the panel majority held “that § 526(a)(4) is substantially overbroad, and unconstitutional as applied to attorneys who provide bankruptcy assistance to assisted persons, as those terms are defined in the Code.” 541 F.3d at 794 (footnote omitted). The panel majority there reasoned that “§ 526(a)(4) prohibits attorneys . . . from advising any assisted person to incur any additional debt in contemplation of bankruptcy; this prohibition would include advice constituting prudent bankruptcy planning that is not an attempt to circumvent, abuse, or undermine the bankruptcy laws,” and that thus “[s]ection 526(a)(4), as written, prevents attorneys from fulfilling their duty to clients to give them appropriate and beneficial advice not otherwise prohibited . . . .” Id. at 793.8 Judge Colloton dissented, on the ground that the court, under authorities such as Boos v. Barry, 108 S.Ct. 1157 (1988), should have adopted a narrowing construction of “in contemplation of” bankruptcy in section 526(a)(4) to mean “with the intent to abuse the protections of the bankruptcy system,” and that as so construed section 526(a)(4) was not overbroad. Milavetz, 541 F.3d at 798-99 (Colloton, J., dissenting).

The Fifth Circuit rejected that reasoning, invoking the canon of avoiding constitutional conflicts to hold that the statute survived a facial challenge, even if there were situations where it might be unconstitutional as applied:

If interpreted literally and broadly, section 526(a)(4) would raise serious constitutional 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.10 Thus, if interpreted literally, section 526(a)(4) may apply to speech that is protected by the First Amendment.

However, Hersh does not dispute that section 526(a)(4), even when read literally, does prohibit some speech that Congress can regulate without violating the First Amendment. The “principal purpose of the Bankruptcy Code is to grant a fresh start to the honest but unfortunate debtor.” Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105, 1107 (2007) (internal citation omitted). By incurring debt before bankruptcy without intending to repay the debt, a debtor can cost creditors significant amounts of money. A debtor may also disqualify himself from obtaining bankruptcy relief. See id. at 1112 (holding that a debtor cannot automatically convert his bankruptcy from Chapter 7 to Chapter 13 under section 706(a) if he acts in bad faith). Thus, Congress has an interest in preventing abuse of the bankruptcy system by both the debtors who incur debts just before filing for bankruptcy and by the people who advise them to do so. A debtor who incurs debt before bankruptcy in order to abuse the system is not one of the “honest but unfortunate” debtors that the bankruptcy system is designed to protect. Id. at 1107.

Furthermore, when a debtor incurs debt in contemplation of bankruptcy with no intention of repaying his debts or with the intention to otherwise manipulate the bankruptcy system, he may well be committing a fraudulent act that may violate federal law. See 11 U.S.C. § 523(a)(2);11 18 U.S.C. § 152(2) (“A person who . . . knowingly and fraudulently makes a false oath or account in or in relation to any case under title 11 . . . shall be fined under this title, imprisoned not more than 5 years, or both.”); Id. at § 157.12 See also Attorney Grievance Comm’n of Maryland v. Culver, 849 A.2d 423, 434 (Md. 2004) (“[b]y advising his client to obtain loans with the intention of having the debts discharged in bankruptcy, [the defendant] counseled [his client] to commit a fraudulent act,” which violated the Maryland Rules of Professional Conduct). Taking out loans without intending to repay them may also be considered theft under state law. See Henke v. State, 730 S.W.2d 117, 118-19 (Tex. App.—Corpus Christi 1987) (affirming a grain hauler’s conviction of felony theft because he took grain under a contract knowing that he would not be able to pay for it). The government may regulate or ban speech in which a person proposes an illegal transaction. Village of Hoffman Estates v. Flipside, Hoffman Estates, Inc., 102 S.Ct. 1186, 1192 (1982).

At the time of the Eighth Circuit's opinion I expressed the view that I thought that it had misapplied the canon of constitutional avoidance.

Eventually the Supreme Court will take up the issue and I expect that it will agree with the holding of the Fifth Circuit.