Ethical Implications of Recent Supreme Court Consumer Bankruptcy Opinions

In the last year, the U.S. Supreme Court issued four opinions which addressed what appear to be fairly discrete questions of some practical import to consumer bankruptcy practitioners. Three of those cases have ethical implications which the Supremes either did not comprehend or did not attach much significance to.

 The first case, United Student Aid Funds, Inc. v. Espinosa, 130 S.Ct. 1367 (2010), involved a Chapter 13 in which the debtor filed a plan which proposed to pay his student loan debt in full through the plan, but without payment of interest. No one objected and the plan was confirmed. Approximately three years later, the creditor intercepted the debtor’s tax refund, the debtor moved to enforce the confirmation order, the creditor moved to set aside the order as void under FRCP 60(b), and eventually the case ended up before the Supremes. The court held that the order was not void because the court has jurisdiction to to hear student loan hardship discharge cases. The court further held that the creditor was not denied due process although it was not served with a summons and complaint (the creditor was served with a copy of the plan and filed a proof of claim in the case) because Rule 7011 requiring an adversary be filed is procedural, not jurisdictional. Result: debtor wins. Interest on the student loan debt is discharged.

 This case places a debtor’s attorney in the unfortunate position that he/she has conflicting duties to the court and to the client. Although the Supremes make it clear that the confirmation order never should have been entered (they refer to the “bankruptcy court’s error”), they nonetheless held that the provision was effective. As a debtor’s attorney I have an obligation to represent my clients zealously within the bounds of the law. Isn’t it my duty to try to get a plan confirmed that provides my client with the most relief possible? The obvious answer is that the relief granted to the debtor in Espinosa never should have been granted. (The relief granted was not within the bounds of the law.) I concede that point, but it was granted so – Which duty is higher – the duty to the court or the duty to the client? The Supremes at least recognized this issue in Espinosa. In the final paragraph of the opinion, the court states: “We acknowledge the potential for bad-faith litigation tactics. But expanding the availability of relief under Rule 60(b)(4) is not an appropriate prophylaxis. As we stated in Taylor v. Freeland & Kronz (citation omitted), “debtors and their attorneys face penalties under various provisions for engaging in improper conduct in bankruptcy proceedings. The specter of such penalties should deter bad faith attempts to discharge student loan debt without the undue hardship finding Congress required. And to extent existing sanctions prove inadequate to the task, Congress may enact additional provisions to address the difficulties United predicts will follow our decision.”


The second case was Hamilton v. Lanning, 130 S.Ct. 2464 (2010), which involved a debtor who took a one time buyout from her previous employer. That income caused her income to be above the median for her state. She proposed a 36 month plan based upon her new job and the trustee objected contending that the Code requires mechanical application of the means test. The court rejected that position and held: “When a bankruptcy court calculates a debtor’s projected disposable income, the court may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.” This ruling should come as no surprise as the majority of the courts which have addressed this issue have reached the same result – holding that “projected” has to add something to “disposable income.” This is the one opinion of the four that does not raise any serious ethical implications. (You can’t advise your debtor to quit their job so they qualify. Right? Seems pretty straightforward to me.)

 The third case was Schwab v. Reilly. 130 S.Ct. 2652 (2010). In that case, the debtor had operated a restaurant before filing a Chapter 7. She claimed restaurant equipment as an asset and assigned a dollar value to the asset of $10,718 which fit within her allowable federal exemptions. The trustee obtained an appraisal of the equipment at $17,200 and moved to sell the equipment subject to the debtor’s claimed exemption. The debtor objected contending that because the trustee did not object to her exemptions, she was entitled to keep 100% of the value. The court disagreed holding that because the dollar value assigned to the asset by the debtor fit within the dollar range of the allowable exemption, the trustee was not required to object to the exemption to preserve the estate’s interest in any value in excess of the exempt interest. This is the case which has resulted in many debtor’s attorneys now including a provision in their Schedule C which states some version of “amount claimed is 100% of market value.”

 The problem with this is that it places the trustee in the position of having to at least consider filing an objection to exemptions where the debtor’s schedules include such a provision. This may not be an issue in the “typical consumer case” where the assets consist of basic household goods and a house and two cars. (Of course, how many of us have had clients who listed only minimal jewelry but show up in our office wearing something which was clearly not valued accurately?) It seems that the more common problem scenario for the trustee is the scenario that played out here. The debtor owns something other than basic household goods – inventory, equipment, etc – and assigns a value that fits within the allowable exemption amount (i.e., under the wildcard.) Is it just fortuitous that the value fits within the allowable amount, or did the debtor “lowball” the value to make it fit? The trustee in these cases may feel compelled to object just to preserve the estate’s interest and to get some opinion of value. (Which he is going to pay for out of the $60 he gets out of the filing fee.) I would suggest that if a judge catches a debtor’s attorney doing this on more than a few occasions, there should be serious consequences. (Both for the debtor and the attorney.)

 Finally, in Ransom v. FIA Card Services, N.A., 131 S.Ct. 716 (2011), the court was faced with the issue of whether a debtor gets a vehicle ownership expense on the means test for a vehicle which is not encumbered by any debt. The court concluded that the debtor does NOT get such an expense. For those of us in Texas, this reversed the holding of In re Tate, 571 F.3d 423 (5th Cir.2009). But if the debtor went out and got a title loan for, say, enough to pay the bankruptcy attorney’s retainer, then there would be a debt secured by the car and the debtor would get the full vehicle ownership expense for that vehicle even if the debt would be paid in only a few months. Of course, 526(a)(4) provides that a debt relief agency may not advise an assisted person to incur more debt in contemplation of filing bankruptcy or to pay an attorney for filing a bankruptcy, but the reality is that an attorney is not prohibited from telling his client “You do not qualify for Chapter 7 by a few hundred dollars and if you only had a title loan, you would qualify. I am not advising you to do that, I am just advising you of the fact that you do not currently qualify, but you would if…….” (Wink, wink.)

 The unfortunate effect of three of these four opinions is that it places the debtor’s attorney in the precarious position of balancing his duty of fully advising his client of all of their rights and responsibilities while maintaining his duty to the integrity of the system.

 Just thinking out loud. (Or is it shouting into the hurricane?)

 Michael Baumer


Law Office of Michael Baumer

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by Michael Baumer