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11th Cir. Holds Debtors’ Counsel Violates BK Code by Advising Debtor to Pay Legal Fees by Credit Card

In an action against a Florida consumer plaintiffs’ firm that also functions as consumer bankruptcy debtors’ counsel, the U.S. Court of Appeals for the Eleventh Circuit recently held that a bankruptcy attorney violates section 526(a)(4) of the Bankruptcy Code if he instructs a client to pay his legal fees using a credit card.

In so ruling, the Court held that there is no requirement under the statute that the advice be given for an invalid purpose designed to manipulate the bankruptcy process.

A copy of the opinion in Loyd P. Cadwell v. Kaufman, Englett & Lynd, PLLC is available at:  Link to Opinion.

A debtor retained a bankruptcy law firm, agreeing to pay $1,700 in legal fees in installments. The debtor paid the installments using two credit cards.

The debtor terminated his relationship with the law firm and sued it, alleging that it violated 11 U.S.C. § 526(a)(4), which provides that a “’debt relief agency’”— including a law firm that provides bankruptcy-related services —‘shall not … advise’ a client ‘to incur more debt in contemplation of such person filing a case under this title or to pay an attorney’ for bankruptcy-related legal services.”

The law firm moved to dismiss for failure to state a claim.  The trial court granted the motion, holding that “the mere advice to use credit cards to pay for legal fees does not violate” § 526(a)(4). The trial court reasoned, based on the Supreme Court’s decision 2010 in Milavetz, Gallop & Milavetz, P.A. v. United States, that “Section 526(a)(4) only ‘prohibits a debt relief agency from advising a debtor to incur additional debt for an invalid purpose.’”

Because the debtor alleged no facts from which the trial court could infer an improper purpose or intent to manipulate the bankruptcy system, the trial court concluded the debtor failed to state a claim upon which relief could be granted under the statute.

On appeal, the debtor argued that the statute does not contain any improper purpose requirement when a lawyer advises a client to incur debt to pay bankruptcy-related legal fees. The law firm argued that the trial court “correctly interpreted the statute to impose an invalid-purpose element, but that even if [debtor] had stated a claim, the statute violates the First Amendment.”

The Eleventh Circuit began by analyzing the text of § 526(a)(4), explaining that “the parties agree that the statute contains two distinct prohibitions — one about incurring debt in anticipation of bankruptcy filings generally, and the other about incurring debt to pay for bankruptcy-related legal services more specifically.”

The Court reasoned that there were three different ways to interpret the statute’s “two prohibitions.” Under the first, “suggested (obliquely) by the Supreme Court’s opinion in Milavetz[,] … in which the hinge — the word ‘either’ in the Court’s paraphrase — comes before the words ‘to incur more debt,’ the statute would separately prohibit advice (a) ‘to incur more debt in contemplation of’ filing for bankruptcy and (2) ‘to pay an attorney’ for bankruptcy-related representation.” The Court rejected this reading of the statute because it would prohibit any advice about paying an attorney for bankruptcy representation, which didn’t make sense since Bankruptcy Code contains other provisions “that clearly contemplate that attorneys will get paid for bankruptcy-related services.”

Under the second interpretation, argued by the law firm, “the statute prohibits a lawyer from advising his client to incur debt to pay for bankruptcy-related legal services only if that advice was given for an ‘invalid purpose.’” The Court disagreed, distinguishing Milavetz because it “addressed only Section 526(a)(4)’s first prohibition; it said nothing about the second.” It also reasoned that the Supreme Court’s reasoning in Milavetz did not “sensibly apply to the statute’s second prohibition.”

First, the Eleventh Circuit reasoned that this second interpretation did not make syntactical sense because it would read as follows: “A lawyer shall not advise his client ‘to incur more debt in contemplation of … to pay an attorney.” Second, “reading the phrase ‘in contemplation of’ to apply to both prohibitions renders the second prohibition essentially meaningless.”

The Court found that the third possible interpretation was the correct one, reasoning that “[u]nder this reading, the hinge comes after the phrase ‘to incur more debt,’ such that the statute prohibits advice ‘to incur more debt’ either (1) ‘in contemplation of’ a bankruptcy filing or (2) ‘to pay an attorney’ for bankruptcy-related services. Unlike the first two interpretations, this one doesn’t produce goofy results, defy the usual rules of syntax, or render a phrase meaningless.”

The Eleventh Circuit explained that “[i]mportantly, this second prohibition — unlike the first, which is modified by the ‘in contemplation of’ phrase of art that drove the result in Milavetz — entails no invalid-purpose requirement. In contrast to the first prohibition, under which the “‘in contemplation of’ clause acts as a divining rod of sorts to separate the abusive advice from the salutary[,]” the second prohibition … is aimed at one specific kind of misconduct — in essence, a bankruptcy lawyer saying to his client, ‘You should take on additional debt to pay me!’ That sort of advice is inherently abusive … [because first,] it puts the attorney’s financial interest — getting paid in full — ahead of the debtor-client’s. … Second, it puts the lawyer’s own interests ahead of the creditors’ in that, while ensuring the lawyer’s full payment, it leaves a diminished estate on which creditors can draw. .. Section 526(a)(4)’s second prohibition, then, has no need for any further invalid-purpose gloss, because the advice it targets is, in effect, suspect per se.”

Accordingly, the Eleventh Circuit held that the trial court erred in concluding that the debtor “was required to allege that [the law firm’s] advice was given for some additional, invalid purpose. Rather, the statute required only that he allege that he was ‘advise[d] … to incur more debt … to pay an attorney’ for bankruptcy-related legal services.”

The Court then turned to address whether the debtor’s allegations state a claim “under the statute’s second prohibition[,]” concluding that they were sufficient because the debtor alleged that the law firm “instructed [him] to pay the initial retainer and all subsequent payments by credit card.” This satisfied both the statute’s requirement of “advice” and “incur more debt.”

Finally, the Eleventh Circuit rejected the law firm’s argument that even if the debtor stated a claim under section 526(a)(4), “that provision is unconstitutional because it improperly restricts [the law firm’s] attorney-client communications.” The Court reasoned that first, the debtor never claimed, and the Court didn’t hold, “that the statute flatly prevents a lawyer from advising a client to pay legal fees.” Second, “[s]ection 526(a)(4) doesn’t prevent [law firms] … from discussing with debtors potential options and their legal consequences. It merely prohibits them from giving their clients ‘affirmative advice’ to incur more debt in order to pay for bankruptcy-related representation.”

Accordingly, the Court held that:

“(1) a debt-relief agency (including a law firm) violates 11 U.S.C. § 526(a)(4) if it advises a client to incur additional debt to pay for bankruptcy-related legal representation, without respect to whether the advice was given for some independently ‘invalid purpose’’; and

(2) that [the debtor’s] … allegation that [the law firm] instructed him to pay his bankruptcy-related legal bills by credit card states a viable claim under Section 526(a)(4); and

(3) that none of the constitutional arguments [the law firm] presented to us warrants invalidating the statute on First Amendment grounds.”

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