Jeffrey N. Schatzman
Schatzman & Schatzman, P.A.
If you represent individual debtors and take credit cards for payment of your fees, you might want to re-think that policy. On March 30, 2018, the Eleventh Circuit Court of Appeals in Cadwell v. Kaufman, Englett & Lynd, PLLC, Case No. 17-10810, reinstated a suit against Kaufman, Englett & Lynd (“KEL”) for violation of 11 U.S.C. Sec. 526(a)(4). You can find the opinion here.
Requiring Credit Cards Concerns Client
Loyd Cadwell had sought the services of KEL to file a chapter 7 bankruptcy case. Following the initial meeting, Cadwell entered into a retainer agreement with KEL that provided for KEL to be paid a fee of $1,700.00 to represent Cadwell in the chapter 7 case. The agreement provided for payments to be made in installments over several months. Cadwell alleged in his complaint that he was instructed by KEL to make the installment payments by credit card. Cadwell made the initial payment and three additional installments with two different credit cards. Thereafter, Cadwell terminated the engagement with KEL and sought the services of another firm to assist him with his bankruptcy.
Cadwell’s new attorneys noticed the credit card payments and filed suit on behalf of Cadwell for violation of 11 U.S.C. § 526(a)(4), seeking return of fees paid to KEL and punitive damages of $1 million. The lawsuit is also proposed as a class action.
BAPCPA Provision Proves Relevant
Section 526(a)(4) prohibits debt relief agencies (which includes law firms that provide bankruptcy related services) from advising clients or prospective clients to incur debt in contemplation of filing bankruptcy or to pay fees associated with the preparation of filing or representation of a debtor in a bankruptcy case. Section 526 provides in pertinent part:
(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 a fee or charge for services performed as part of preparing for or representing a debtor in a case under this title.
How to Read the Statute
KEL filed a motion to dismiss Cadwell’s lawsuit on two grounds – (1) based on the U.S. Supreme Court’s opinion in Milavetz, Gallop & Milavetz, P.A. v. United States, 559 U.S. 229 (2010), that Cadwell’s complaint failed to state a claim for which relief could be granted because it contained no allegations of incurring debt for an improper purpose and (2) that § 526 imposes an unconstitutional prohibition of attorney-client communications. The District Court, following its understanding of Milavetz, determined that Cadwell’s complaint failed to state a claim because there were no allegations to support an inference that KEL acted with an improper purpose or an intent to manipulate the bankruptcy system. The District Court did not address the First Amendment argument.
On appeal, Cadwell contended that when properly read, § 526(a)(4) does not impose a requirement to prove an improper purpose for a debt incurred to pay legal fees. In its opinion, the Eleventh Circuit breaks down § 526(a)(4) into three possible views of statutory interpretation. The Court recognizes that there are two distinct provisions of the statute – that a debt relief agency may not advise someone (1) to incur debt in contemplation of filing bankruptcy or (2) to incur debt to pay legal fees for a bankruptcy. In the first view, it analyzes that Supreme Court’s holding in Milavetz. There, the Supreme Court suggested that the statute should be read as prohibiting advice “either” to incur debt in contemplation of filing bankruptcy or to pay bankruptcy related fees. As explained in more detail below, the Supreme Court found that a violation of § 526(a)(4) requires that the advice to incur debt be given for an improper purpose. Since that case did not concern payment of fees, that portion of the statute was not addressed. In analyzing Milavetz in light of its application to the payment of attorney’s fees, the Eleventh Circuit determined that the Supreme Court’s use of the “either” separator would result in a prohibition to the payment of any bankruptcy related fees and therefore, concluded that such a view would not be rational or applicable in this case.
The second interpretation was proposed by KEL, who suggested that advising a bankruptcy client to incur debt to pay attorney’s fees should only be prohibited if the advice was given for an improper purpose. Again, the Eleventh Circuit applied Milavetz to its analysis. The question in Milavetz was whether First Amendment attorney-client communications, whether for affirmative advice or for discussion of various options, were restricted by the first provision of § 526(a)(4). The Supreme Court in determining that there was no constitutional violation, found that the phase “in contemplation of” was a term of art associated with abusive conduct such as loading up on debt with the expectation to discharge it. Therefore, it held that only advice to incur debt for an improper purpose would fall under the statute. The Eleventh Circuit explained that under KEL’s argument, § 526(a)(4) would be broken down as follows:
the statute would prohibit advice “to incur more debt in contemplation of  such person filing a case under this title or  to pay an attorney” for bankruptcy-related legal representation.
The Court rationalized that such a reading was not syntactically correct and otherwise, rendered the second portion meaningless since incurring debt for an improper purpose is a qualifier for both provisions and payment of attorney’s fees be a mere subset of the first provision. Therefore, this argument was rejected.
Finally, the third view, was adopted by the Eleventh Circuit as being the correct view, breaks down the statute as follows:
Under 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 legal services.
The Court explained that under this interpretation, there is no requirement that the payment of attorney’s fees be premised on improper advice, only that there was advice to incur debt to pay the fees. Therefore, even though Cadwell’s complaint may not have included allegations of advice given for an improper purpose, this was not necessary under the Eleventh Circuit’s ruling.
Ed. Note: The Commercial Law League of America submitted an amicus brief in Milavetz. The League contended that if Sec. 526(a)(4) was read literally, it would prohibit attorneys from advising clients to incur debt for proper purposes. The result reached by the Supreme Court--that only advice to incur debt for an improper purpose--was covered by the statute was consistent with CLLA's position. You can read CLLA's brief here.