Blog Topic

Free Speech rights of bankruptcy attorneys
Posted by: Peter Scribner
December 04, 2009

Free Speech rights of bankruptcy attorneys

Milavetz, Gallop & Milavetz v. United States
United States Supreme Court docket 08-1119 and 08-1225
Oral arguments December 1, 2009

When the Bankruptcy Code was amended in 2005, “debt relief agencies” were forbidden to advise clients “to incur more debt in contemplation of” filing bankruptcy (11 USC Sect. 526(a)(4). Did this prohibition applies to lawyers, and did it limited the freedom-of-speech rights of attorneys to advise their clients? The United States Supreme Court heard oral arguments on this question December 1, 2009.

The term “debt relief agency” was used in the 2005 amendments to apply to people who advise people concerning their debts. The concern was that many shady operations were ripping people off or were encouraging people to defraud their creditors.  The new statute implied that attorneys would be considered debt relief agencies, and most attorneys in western New York have acted under the assumption that the provisions apply to them.

Shortly after the 2005 amendments went into effect, a law firm in Minnesota, Milavetz, Gallop & Milavetz, filed a lawsuit in District Court (not bankruptcy court) seeking a declaratory judgment that attorneys were not debt relief agencies and that the prohibition against advising clients regarding debts was unconstitutional.

In retrospect, I am not so sure this was a great idea. The petitioners were not arguing that these provisions were being applied to them specifically, or that they had been caused harm in a specific case. Rather, they were complaining that they could be harmed in the future. Hypothetical cases are problematic; they may encourage courts to make rulings on issues that are not actually being contested. The ruling may create problems where no real world problem existed before.  The extensive hypotheticals thrown at the parties at oral arguments (see articles below) my reflect the inability to argue the actual facts of this case, as there were none.

In any case, the District Court ruled that the prohibition against advising clients concerning debts was an impermissible violation of the attorney’s constitutional rights.The district court also ruled that attorneys are not debt relief agencies.  Milavetz v. U.S. 355 B.R. 758 (Minn. 2006).  The United States Court of Appeals for the Eighth Circuit upheld that the District Court on the free speech issue, but ruled that attorneys clearly are debt relief agencies, as that term is defined in the statute.  Milavetz v. U.S., 541 F.3d 785 (8th Cir. 2008).  The Fifth Circuit had reached a contrary result, upholding the statute. Hersh v. U.S., 553 F.3d 743 (5th Cir. 2008).

In oral argument, the Supreme Court justices appear to agree that attorneys are debt relief agencies, but the prohibition against advising clients was sharply criticized. It would appear that the court will limit or eliminate that provision, at least in relation to attorneys, but how narrow that limitation will be remains to be seen.

For legal analysis and links to briefs: SCOTUS WIKI

New York Times article

Washington Post article

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Partial Discharge of Student Loans in an erroneous Chapter 13 plan? The Supreme Court to decide.
Posted by: Peter Scribner
December 04, 2009

United Student Aid Funds Inc. V. Francisco Espinoza
United States Supreme Court case #08-1134
Oral arguments December 1, 2009

Can a student loan be discharged, even in part, in a Chapter 13 plan without a finding of “undue hardship”? More broadly, how final is a confirmed chapter 13 plan? The United States Supreme Court will be answering these questions in a rare bankruptcy case appeal.

The facts of the case are simple. In 1988, Francisco Espinoza borrowed $13,050 in a student loan. In 1992, he filed a Chapter 13 case in Arizona, listing that loan as his only debt. His Chapter 13 plan called for paying off the student loan in full, without interest. The plan specifically stated that the student loan would be fully satisfied at the completion of the plan, and a copy of the plan was mailed to the student loan bank at their payment address. The student loan creditor did not object plan, and the bankruptcy court confirmed it.  The creditor filed a claim for $17,832.15, and the Chapter 13 trustee filed an objection to the claim, beyond the principal amount of $13,250. Apparently, the creditor did not oppose the objection to claim. The plan was completed, and the bankruptcy court issued a bankruptcy discharge. The creditor did not oppose the discharge, or appeal any of these bankruptcy decisions.

Two years after he received his bankruptcy discharge, the student loan creditor sgtarted collecting on the unpaid interest. The debtor moved in bankruptcy court to have the creditor found in contempt of court for violating the discharge order. He argued that the interest on his student loans was fully discharged:  the Chapter 13 plan specifically said so, the creditor received copy the plan, the creditor did not object to the plan or appeal the plan confirmation order, and the creditor did not object to the discharge or appeal the discharge order. The bankruptcy court agreed with the debtor that the student loan, including interest, was fully discharged.

The creditor appealed to District Court, which reversed the bankruptcy court decision. The debtor then appealed to the United States Court of Appeals for the Ninth Circuit, which upheld in the Bankruptcy Court and reversed the District Court. The United States Supreme Court agreed to hear the case, and oral arguments took place December 1, 2009.

The position of the parties is fairly simple. The student loan creditor argues that student loans are never discharged no matter what the plan says and no matter what the bankruptcy court says. The Bankruptcy Code is self-executing on the point and an order to the contrary is void. The bankruptcy court has no power to discharge a student loan absent a finding of “undue hardship” following a bankruptcy adversary proceeding. The debtor’s position is that by failing to object to the plan, the confirmation order, or the discharge order, the creditor has waived its rights to object to the discharge of the student loan.

Circuit Courts of Appeal are divided on this issue, or, more specifically, the Ninth Circuit's 2008 decision, Espinosa v. United Student Aid Fund, Inc., 530 F.3d 895 differs significantly from two other circuits. The 10th Circuit in In re Mersmann, 505 F.3d 1033 (2007) and the Second Circuit in Whelton v. Educ. Credit Mgmt. Corp., 432 F.3d 150 (2005) both came out the other way.

Oral Arguments: The Supreme Court heard the case on December 1, 2009.  The justices appeared to believe the bankruptcy court erred in allowing a partial discharge of student loans absent a finding of undohardship.  The question was what should be done with bankruptcy court orders entered in error.  The student loan creditor emphasized in its brief that other claims, such as child support or recent income taxes, might be discharged erroneously in a similar chapter 13 plan, absent objection.  The debtor’s attorney admitted as much to Justice Ginsburg. On the other hand, the creditor’s attorney faced skepticism from Justices Ginsburg, Kennedy and Stevens in claiming that the student loan creditor could never waive its rights to an undo hardship hearing. Justices Sotomayor and Breyer questioned whether a court order could be considered void unless the court lacked jurisdiction.  Justice Alito raised the prospect that the debtor’s attorney might be sanctioned for including a provision like this in a Chapter 13 plan, and Justices Bryer and Scalia were sympatically to this argument.

Student loan dischargeability: One thing just about everyone seems to know about bankruptcy is that student loans are not dischargeable. Starting in the 1970's, Congress has increasingly restricted the dischargeability of student loans. In 1976, student loans were made dischargeable in bankruptcy only after five years had passed from when the first payment was due. That period was extended to seven years in 1990 (and applied to Chapter 13 as well), and the time limit was eliminated altogether in 1998. The original purpose of making government-backed student loans nondischargeable was to protect the taxpayer from huge student loan losses. In 2005, the definition of student loans was expanded to include private for-profit loans, so even those loans not guaranteed or subsidized by the public are now protected from bankruptcy discharge.

Student loans may be discharged in bankruptcy if they are an “undue hardship”. The primary case as to what constitutes an undue hardship is In re Brunner, 831 F.2d 395, 396 (2d Cir. 1987).  Under a Brunner analysis, the debtor must pass a very difficult three-part test. The debtor must show that he or she cannot maintain a “minimal” standard of living for his or her family based on current income and expenses, that the situation is likely to persist for a significant period of time, and that the debtor has made a “good faith” effort to repay the loan. It is the second prong of this test, showing that the situation is unlikely to change in the future, that is extremely difficult to prove, absent some permanent disability preventing employment.

When Brunner was decided in 1987, student loans could be discharged after five years from when they were first due and payable, so perhaps the decision was not considered all that significant. However, since then the time limit has been eliminated, so the Brunner test has become the only way to discharge these loans.

Student loans in the Western District of New York: Burnner, as a Second Circuit case, must be followed by the Western District of New York, a Second Circuit court.  Local decisions show how difficult Brunner is when implemented.  

The debtor in In Re Martin, Bk #93-20701, AP #93-2163 (Judge Ninfo; Bankr. W.D.N.Y. 1994) was granted a hardship discharge after showing serious long-term physical disabilities.  But the debtor in In Re Kraft, 161 B.R. 82 (Judge Kaplan, Bankr. W.D.N.Y. 1993), a poorly-paid bus driver with some physical infirmities was not allowed to discharge her student loan, as she had not waited long enough to see whether her future employment would be more lucrative.

The debtor in In Re Maulin,190 B.R. 153 (Judge Bucki; Bankr. W.D.N.Y. 1995) attempted a discharge one year after the loan became payable, having not made any attempt to repay it; she was unsuccessful.  

The mental stress of repaying student is not sufficient to justify discharge, if the betor has the financial ability to do so. In re N.M. 325 B.R. 507 (Judge Bucki; Bankr. W.D.N.Y. 2005).  On the other hand, a debtor suffering from agoraphobia, which prevented her from earning more than a very modest income working at home, was found to pass the Brunner test. In re Armesto, Bk #02-10445, AP 02-1087 (Judge Bucki, Bankr. W.D.N.Y. 2003).  A debtor suffering from bi-polar illness was similarly discharged. In re Douerty, 219 B.R. 665 (Judge Kaplan, bankr. W.D.N.Y. 1998)

One line of Wester District of New York student loan partial-discharge cases may be re-examined following the Espinoza ruling .  In In Re Raimondo, 183 B.R. 677 (Bankr. W.D.N.Y. 1995), Judge Bucki ruled that the bankruptcy court could partially discharge a student loan, that it did not have to be an all-or-nothing result.  This decision does not appear to have been appealed, and it continues to be followed by Judge Bucki (In re Davis, 336 B.R. 604 (Bankr. W.D.N.Y. 2006)) and others (In Re Barron, 264 B.R. 833 (Bankr. E.D.Tex. 2001), The partial-discharge approach has also been criticized (see In Re Pincus, 280 B.R. 303 (S.D.N.Y. 2002).


For more information:

Legal analysis of the case and issues by Cornell University Law School

NPR analysis of case and December 1 oral arguments

SCOTUS blog Analysis of oral arguments December 1, 2009

Courthouse News Service analysis of oral arguments December 1, 2009

Petitioner’s brief

Respondent’s brief

Transcript of Supreme Court oral arguments

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