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May A Bankruptcy Attorney Advise A Client to Incur Debt Prior to Filing Bankruptcy?

May 20, 2014 by  
Filed under Blog

Under Section 526 of the Bankruptcy Code, a debt relief agency cannot advise a client to incur more debt “in contemplation of bankruptcy.” The Supreme Court, in Milavetz, Gallop & Milavetz, P.A. v. U.S., ruled that a bankruptcy attorney is a debt relief agency, and therefore cannot advise clients to incur more debt in contemplation of bankruptcy. However, the Supreme Court applied a narrow interpretation of “in contemplation of bankruptcy,” because a broad interpretation of Section 526 would render the code section unconstitutional as a violation of the First Amendment.
The District Court of Minnesota found section 526 unconstitutional as applied to attorneys. The Eighth Circuit also found Section 526(a)(4) unconstitutional because it is unconstitutionally overbroad and is not narrowly tailored to restrict speech that the government has an interest in restricting. The Eighth Circuit explained that Section 526(a)(4) broadly prohibits debt relief agencies from advising assisted persons to incur any additional debt in contemplation of bankruptcy even when the advice constitutes prudent pre-bankruptcy planning. This would include actions not motivated by an attempt to abuse the bankruptcy system.

The Supreme Court rejected the Eight Circuit’s conclusion, and held that Section 526 is constitutional, but it “only prohibits a [bankruptcy attorney] only from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose.” Milavetz, Gallop & milavetz, P.A. v. U.S., 559 U.S. 229, 243 (2010). The Supreme Court explained that “in contemplation . . . of filing” means “the portended bankruptcy “‘induce[d]’ the transfer at issue, understanding inducement to engender suspicion of abuse.” The purpose of Section 526 is to prevent abuse. The Supreme Court explained the advice “prohibited by 526(a)(4) will generally consist of advice to ‘load up’ on debt with the expectation of obtaining its discharge—i.e., conduct that is abusive per se.” Id. at 244. The Supreme Court concluded that Section 526(a)(4) prohibits a bankruptcy attorney “only from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose.” Id. at 243. Therefore, the controlling question is “whether the impelling reason for ‘advising an assisted person . . . to incur more debt’ was the prospect of filing for bankruptcy.” Id. Importantly, a more broad interpretation of 526 would be unconstitutional as explained by the Supreme Court and the Eighth Circuit.

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