Another Partial Blow to Constitutionality of BAPCPA "Debt Relief Agency" Rules

Another court has joined the fray in addressing the constitutionality of the BAPCPA provisions regulating "debt relief agencies." In Olsen v. Gonzales, Case No. 05-6365-HO (D. Or. 8/11/06), an Oregon District Court has held unconstitutional the provisions prohibiting certain advice, but otherwise upheld several other provisions. This follows two other recent decisions, Hersh v. U.S., 2006 WL 2088270 (N.D. Tex. 7/26/06) which held the same provision unconstitutional (as discussed in here in "Portion of BAPCPA "Debt Relief Agency" Provisions Held Unconstitutional"), and Geisenberger v. Gonzales, 2006 WL 1737405 (E.D. Pa. 6/19/06) which declined to address the constitutional issues on standing grounds (as discussed in "Pennsylvania Constitutional Challenge to BAPCPA Rejected on Standing Grounds").

In Olsen, three attorneys (two of whom represented consumers debtors in bankruptcies, and one of whom advised clients regarding bankruptcies but did not file bankruptcy petitions or represent clients in bankruptcy cases) challenged the constitutionality of BAPCPA provisions prohibiting "debt relief agencies" from providing advice to clients to incur debt [11 U.S.C. 526(a)(4)], prohibiting "debt relief agencies" from failing to provide services which they advised that they would provide [11 U.S.C. 526(a)(1)], requiring "debt relief agencies" to make certain disclosures [11 U.S.C. 527], and requiring "debt relief agencies" to make certain statements in advertisements [11 U.S.C. 528], all as violating the First Amendment protection of free speech. The attorneys also challenged the BAPCPA provisions as being unconstitutionally vague in violation of the Due Process Clause.

The court initially tackled the question of whether attorneys are "debt relief agencies" covered by the provision. Notwithstanding the sua sponte opinion in In re Attorneys At Law and Debt Relief Agencies, 332 B.R. 66 (Bankr. S.D. Ga. 2005) the Olsen court found that the plain language of the definition included attorneys. It also noted that a proposed amendment that would have excluded attorneys from the definition was not adopted, giving further support to the plain language interpretation.

Having crossed that initial threshold, it considered whether the attorneys had standing to challenge the statute's constitutionality. It noted that there had been no threatened enforcement of BAPCPA against the plaintiffs. In considering the "chilling effect" on speech, the court referred to one case which permitted such a challenge despite an attorney general's acknowledgment that it would not likely enforce the statute, as compared to another where the court denied standing when the attorney general had unequivocally acknowledged the statute's unconstitutionality and communicating her intention and direction not to enforce it. Here, the attorney general had somewhat equivocally taken the position that 526(a)(1) "does not require attorneys to perform services that become unnecessary or unethical because to do so would be contrary to the purpose of the statute" (a remarkable bit of double-speak, it would seem), which the court apparently concluded was not sufficient to preclude a possible "chilling effect" challenge. As a result, the court addressed the challenged statutes for their "chilling effect," but otherwise found the plaintiffs lacked standing.

On the merits, the Olsen court agreed with the Hersh court that the restrictions on advising clients to incur debt in contemplation of bankruptcy were unconstitutionally overbroad. As in Hersh, the court noted that there may be legitimate reasons for providing such advice to a client, such as taking out a loan to obtain the services of a bankruptcy attorney or to pay the filing fee, legitimately converting a non-exempt asset to an exempt asset, or refinancing a mortgage in order to pay off other debts. However, that was the only provision which the court rejected on constitutional grounds.

On 526(a)(1) (which directs that a debt relief agency "shall not fail to perform any service that such agency informed an assisted person ... it would provide"), the court rejected the challenge that the statute might compel attorneys to provide services which it turned out the client did not need, or which might turn out to be unethical. Instead, the court held that "courts should interpret this section to not require attorneys to provide ill-advised or unethical services," on the theory that this was the purpose of the statute and an interpretation "is based on purpose." (Whoa, what happened to plain language? The case cited by the court, Clark v. Martinez, 543 U.S. 371 (2005), involved an ambiguous statute; where is the ambiguity in 526(a)(1)?) Alternatively, the court suggested that speech would not be chilled, as attorneys would simply be required to couch their promises in conditional language and not abstain from speech.

The court also rejected the attorney's challenge that the disclosure requirements of 527 -- for instance, that attorneys must advise assisted persons that they have a right to hire a bankruptcy petition preparer who is not an attorney -- unconstitutionally compel speech. Like Hersh, the Olsen court held that these provisions do not compel disclosure of an "opposing viewpoint," but only require "notice of another option," and as such pass constitutional muster, particularly since attorneys are also free to provide additional information including the benefits of hiring an attorney.

The court then addressed the 528 advertising requirements - i.e., that any "debt relief agency" (that is, any person who provides "bankruptcy assistance" to an "assisted person") clearly and conspicuously state in advertisements, "We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code" or a substantially similar statement. Although one of the plaintiff attorneys did not in fact file bankruptcy petitions or represent people in bankruptcies, the court nonetheless found the statute did not compel him to make an untrue statement, since it permitted a "substantially similar statement" (such as, "We advise people about filing for bankruptcy assistance under the code"). It evaluated the provision under an "intermediate scrutiny" standard for commercial speech as applied to professional service advertising as in In re R.M.J., 455 U.S. 191 (1982). Under this four-prong test, described in Central Hudson Gas & Elec. Corp. v. Public Serv. Comm'n of New York, 447 U.S. 557 (1980), the expression must be protected speech; the government must have a substantial interest; the regulation must directly advance that interest; and it must be narrowly drawn. The Court found that "narrowly drawn" does not mean the "least restrictive means" but rather "something short of a least-restrictive-standard," citing Board of Trustees of State Univ. of New York v. Fox, 492 U.S. 469, 477 (1989) (How's that for guidance?) .

Applying this standard, the Olsen court found: (1) the advertisement was protected speech; (2) Congress' intent to prevent deceptive and fraudulent advertisement is a substantial interest; (3) on its face, at least, the regulation advances that interest, notwithstanding arguments of possible overinclusion; and (4) the statute is adequately narrowly drawn, requiring only the insertion of a "two-line admonition into certain advertisements". Even if "there may be better ways to prevent deceptive advertising", Section 528 generally applies to most consumer bankruptcy attorneys while generally not applying to non-consumer bankruptcy attorneys. Accordingly the provision was upheld.

Finally, the court rejected the attorneys' vagueness challenge to sections 526-528, finding that the provisions were not subject to a facial challenge on that basis but would only be subject to an "as applied" challenge. Although the plaintiffs could come up with "abstract challenge[s]" to the language of certain provisions, they were not ripe for review and did not demonstrate facial unconstitutionality.

Pennsylvania Constitutional Challenge to BAPCPA Rejected on Standing Grounds

The Constitution may have been signed there, but it won't be interpreted there. At least that's the decision of a Philadelphia District Court Judge on a challenge to the constitutionality of the BAPCPA "debt relief agency" provisions in Geisenberger v. Gonzales, __ B.R. __, 2006 WL 1737405 (E.D. Pa. 6/19/06). In contrast to the decision in Hersh v. U.S., __ B.R. __, 2006 WL 2088270 (N.D. Tex. 7/26/06) (discussed recently here), Judge Sanchez has held that a bankruptcy attorney lacks standing to challenge provisions imposing certain obligations and restrictions on attorneys who fall within the definition of a "debt relief agency".

The BAPCPA provisions challenged by attorney Geisenberger were the ones: (1) requiring attorneys to certify that a debtor's decision to reaffirm a debt represents a "fully informed and voluntary" agreement that "does not impose an undue hardship" (11 U.S.C. 524); (2) prohibiting attorneys from advising potential debtors to incur more debt in contemplation of a filing (11 U.S.C. 526); (3) requiring attorneys to inform debtors how to value certain assets at "replacement value" (11 U.S.C. 527); and (4) requiring attorneys to state in advertisements: "We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code" (11 U.S.C. 528).

The Geisenberger court held that the complaint failed to adequately establish sufficient injury to present a "case or controversy." Specifically, the complaint failed to allege that any governmental entity had threatened to enforce the "debt relief agency" provisions of BAPCPA against the attorney. Holding that the plaintiff must present a "real and immediate" threat of enforcement, the court found that the mere possibility of future enforcement was not enough to confer standing. Nor had the plaintiff established an imminent danger of economic loss which would establish standing. Rather, the court found that Geisenberger was merely seeking an "advisory opinion", and dismissed the complaint.

The holding in Geisenberger stands in contrast to that in Hersh, which found that BAPCPA's potential chilling effect on protected First Amendment speech was sufficient to confer standing on the attorney (and then went on to find that portions, specifically the 526 restrictions, are in fact unconstitutional). In finding standing, the Hersh court cited to cases recognizing that when First Amendment issues are at stake, the threshold for standing may be relaxed and does not necessarily require an imminent threat of enforcement. See Center for Individual Freedom v. Carmouche, 449 F.3d 655 (5th Cir. 2006), citing Virginia v. Am. Booksellers Ass'n, 484 U.S. 383 (1988). Rather, the potential chilling effect of the statute on protected speech is sufficient to confer standing (even when the effect may be on the First Amendment rights of others, as in the Am. Booksellers case).

Curiously, the Geisenberger court did not address this line of authority on First Amendment issues, even though it seems to have been followed within the Third Circuit in other cases. See, e.g., Ruocchio v. United Transp. Union, Local 60, 181 F.3d 376, 385 (3d. Cir. 1999); Amato v. Wilentz, 952 F.2d 742, 749 (3d Cir. 1991); Rode v. Dellarciprete, 845 F.2d 1195, 1199-1200 (3d Cir. 1988). Why not? It seems we will never know, as no appeal of the dismissal order was taken.

BAPCPA Preference Amendments Are Creditor-Friendly, But Not Always Enough

In what may be the first published decision interpreting the BAPCPA amendments to bankruptcy preference provisions for an "ordinary course of business" defense, a North Carolina court has held that the new provisions substantially lighten a creditor/defendant's load, but not enough to provide a defense to the creditor in this particular case. In re National Gas Distributors, LLC, __ B.R. __, 2006 WL 2135557 (Bankr. E.D.N.C. 7/31/06).

In bankruptcy a trustee has the authority to recover "preferential" payments made by an insolvent debtor within 90 days before the filing on debts owed to creditors. The Bankruptcy Code also provides several defenses to preference actions, including what is known as the "ordinary course of business defense." Under pre-BAPCPA law, this defense, codified in 11 U.S.C. 547(c)(2), required a creditor to demonstrate that the payment was:

(1) in payment of a debt incurred by the debtor in the "ordinary
course of business" or financial affairs of the debtor and creditor;
(2) made in the "ordinary course of business" or financial
affairs of the debtor and creditor;
and
(3) made "according to ordinary business terms."

As generally interpreted, the pre-BAPCPA provision required creditors to demonstrate both that the transfer was ordinary with respect to the debtor and creditor's dealings (the "subjective" test), and that such dealings were ordinary for the industry (the "objective" test - sometimes applied to the debtor's industry, sometimes the creditor's, and sometimes both). The objective test in particular often required creditors to find industry experts who could testify as to industry practices, a complicated and expensive burden in most preference cases. BAPCPA amended 547(c)(2), however, so that it now provides protection for transfers:

(1) in payment of a debt incurred by the debtor in the "ordinary course of
business" or financial affairs of the debtor and creditor;
(2) made in the ordinary course of business or financial affairs of the
debtor and creditor;
or
(3) made "according to ordinary business terms".

In National Gas, the corporate debtor had made two payments within 90 days of the filing totaling about $3.25 million to its bank lender to pay off a line of credit and working capital loan owed by the corporation (and also guaranteed by the principals). The line of credit and loan had both matured prior to the payments but had been extended by the bank several times before the payoff. In defense, the bank creditor/defendant contended that the payments were made "according to ordinary business terms" (but not necessarily in the ordinary course of business of the debtor and creditor. In support, the bank submitted an affidavit from one of its loan officers (who had 15 years of experience with the bank and 30 in the banking industry) that: (1) the terms of the line of credit and working capital note were customary for the bank and the banking industry; (2) it was a customary practice at the bank and in the industry to extend maturity dates on loans, and that the extensions were done on standard and ordinary terms; (3) when a loan becomes due, it is typical for the bank and in the industry for borrowers to pay the loans in full on or shortly before the maturity date; and (4) the payment of the line and loan were made within the terms of the notes, as modified. The trustee submitted an affidavit in opposition to summary judgment, but according to Judge Small, the affidavit did not address the bank's "ordinary business terms" defense.

To evaluate whether the bank's evidence established an "ordinary business terms" defense, the court was required to evaluate the effect of the BAPCPA amendments. It started by noting while 547(c) previously included one "ordinary course of business" defense with three separate elements, as amended it now provides both an "ordinary course of business" defense and a "separate, independent" "ordinary business terms" defense. Since the context of the phrase "ordinary business terms" has changed, the court had to look at whether it acquired a different meaning in this new context.

The court looked first to the plain language, but found that the phrase "ordinary business terms" is so inclusive that a plain meaning analysis is not helpful. It also found the legislative history unhelpful. Although the history makes clear that the "or" is to be read in the disjunctive, it provides no further insight into how the reconstructed statute should be interpreted.

Looking further back, Judge Small provides an interesting review of the development of this particular amendment, including a 1995 American Bankruptcy Institute task force recommendation that the defense be clarified, which was adopted by the National Bankruptcy Review Commission. Although the NBRC recommendation was to limit the "objective industry test" to situations where there was insufficient pre-petition conduct to establish a course of dealing between the debtor and creditor, that is not what Congress ultimately did in BAPCPA. Rather, the statute as amended "allows the 'ordinary business terms' defense to be used where a course of dealing existed and even where the transfers at issue clearly deviated from that course of conduct."

Judge Small notes that pre-BAPCPA interpretation of the "ordinary business terms" clause often tied it to the "ordinary course of business" prong -- for instance, applying a "sliding scale" whereby industry standards become more or less important depending on the length of the parties' relationship. But under the amendments, "'ordinary business terms' has been released from the controlling influence of the ordinary course of business subsection." While pre-BAPCPA cases varied in their analysis of which particular industry was relevant (the debtor's, the creditor's, or both), under BAPCPA the court found that review of both the debtor's and creditor's industry was required. It found this result mandated, notwithstanding prior Fourth Circuit law directing that only the creditor's industry need be considered, based on the generally recognized purpose of the ordinary course of business defense being to "leave undisturbed normal financial relations". "If the 'ordinary business terms' defense only requires examination of the industry standards of the creditor, there would be no review or check on the debtor's conduct."

Accordingly, the court looked to the industry standards of both the debtor and its creditors. Applying this test, it found that the bank's affidavit describing the typical and customary practices of the bank and the banking industry "too general to establish industry norms." But perhaps even more significantly, it found that "the industry standards must be applied to the factual circumstances of the transfer." Even though "From [the bank's] point of view, it did nothing out of the ordinary," the court would look at "the debtor's industry standards and the standards applicable to business in general":

"When those standards are examined, the conduct of the debtor in paying its loans was not in accordance with 'ordinary business terms.' It is clear what was going on here: [the debtor] was going out of business and was paying off those debts which [the principals] guaranteed and for which [one of the principal's] assets stood as collateral. These payments were not made 'according to ordinary business terms' and are not the type of transfers that the 'ordinary business terms' defense is designed to protect."

Accordingly, even though the BAPCPA amendment to 547(c)(2) "substantially lightens the creditor's burden of proof," the court rejected the bank's defense and entered judgment in the trustee's favor.

This result is, to me, a puzzling one. It seems that notwithstanding the clear split of 547(c)(2) into an either/or proposition of evaluating either the ordinary course of business or financial affairs of the parties, or the ordinariness of the terms of the transaction, the National Gas decision rejects an "ordinary business terms" defense not because the terms were extraordinary, but because the payment was extraordinary in relation to the rest of the debtor's financial affairs. There doesn't appear to be any evidence in the case that the terms of the loans were unusual or that the payments were not made in accordance with their terms; rather, the payments were extraordinary only when viewed in light of what else was happening in the debtor's business.

If the "ordinary business terms" defense is to be given separate, independent meaning, then it would seem that payments that are made in accordance with the terms of an ordinary loan should be protected, even if they can not be shown to be ordinary with respect to the debtor's other financial affairs.

Erratas, Mea Culpas, Credits and Previews

Just a few notes to clean up and clarify some prior postings:

In "Excuses, Excuses - Temporary Waivers of Credit Counseling" I queried how, in the Piontek case, the debtor's lawyer would have felt about the Court's suggestion that $50 of the debtor's $400 retainer -- $274 of which was used for the filing fee -- could have been used for credit counseling. What I should have pointed out is that the Court was not proposing that the $50 come out of the lawyer's hide, but rather that the debtor likely could have qualified to pay the filing fee in installments and could have used some of the funds used to pay the filing fee to instead pay for credit counseling. In the same case, Judge Deller has issued a corrected opinion reflecting the citation to Interim Bankruptcy Rule 1006(b) regarding the payment of the filing fee in installments (rather than 1007(b)).

In "Portion of BAPCPA Debt Relief Agency Provisions Held Unconstitutional" we cited the case as Hersch v. United States. Although we clarified that the decision contained a typo and the lawyer's name is actually Susan Hersh (no "c"), we've been assured that the case caption actually contains the correct spelling. It now appears (with the correct spelling) at 2006 WL 2088270. Thanks to attorney Hersh for letting us know of this significant decision.

Thanks are also due to attorney Dennis LeVine of Tampa for promptly bringing to our attention the Landahl case discussed in "Homestead Cap Gets Another Adherent" (in which he represented the successful trustee).

What's coming? We will have a little more to say about credit counseling (including a BAPCPA Blog sighting in a published opinion!) and then hope next to catch up on decisions on means testing / disposable income issues, car loans, and domestic support obligations. Seen an interesting decision? Please let us know.