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Protecting the Integrity of the Bankruptcy System
in Chapter 7 No-Asset Cases
By W. Clarkson McDow, Jr.
United States Trustee, Region 4 (1)
If we are to protect the integrity of the bankruptcy system, it is
imperative that we give increased scrutiny to chapter 7
no-asset cases and debtors filing no-asset cases. Of the approximately
950,000 chapter 7 cases that will be filed this year, approximately 96% will
turn out to be no-asset cases, meaning that no assets will be administered and
no money returned to creditors. Not only are the vast majority of the chapter 7
cases no-asset cases, but that is where the public sees a problem with the
bankruptcy system. Many people have neighbors or co-workers with bigger houses
and nicer cars who file for bankruptcy and keep the same house and car. Because
there has traditionally been a belief that one loses everything in bankruptcy,
many people have trouble understanding concepts such as fresh start and
exemptions. They expect to see men walking around wearing barrels as I saw in
the funny papers when I was a child.
Those of us who have devoted great parts of our careers to bankruptcy,
and particularly those who deal with consumer debtors, know the good that comes
from our system of bankruptcy relief for the needy debtor. That, however, is
only one side of the coin. There is a need to rid the system of the taint of
bankruptcy fraud and to reduce the mystery of bankruptcy, so that even the
casual observer will have confidence in the system. To do this, additional
scrutiny must be given to the no-asset case and the no-asset debtor.
In choosing this topic and this forum for presenting it, I do not mean
to be critical of trustees or to join the "they are all crooks" chorus. I was
touched by Robert Furr's recent column reminding us of the ability of bankruptcy
to restore dignity. It is not the honest unfortunate debtor who needs our focus,
but the small percentage of debtors who for whatever reason do not play by the
rules, creating the perception that the entire system is flawed. Similarly, a
few underperforming attorneys lower the image of all attorneys, and lessen
confidence in the schedules and other disclosures.
Several obstacles hinder the prevention of fraud and abuse in no-asset
cases. Identifying these obstacles is the first step toward overcoming them.
Consider the following:
- The trustee is in the best position to take action, but at $60 per case
the economic realities discourage such action.
- The trustees' dockets are crowded and there is only a short time
allocated for the meeting of creditors. This may not allow parties
sufficient time to thoroughly examine the debtors.
- The schedules are often inaccurate, but economically the trustee cannot
always justify following up to make them more accurate. In addition, courts
are crowded, and bringing each case before the court would be time-consuming
and would clog the courts.
- Some debtors are truly fraudulent; it is too easy for them to avoid
detection and even when caught they are not always held accountable.
- Debtors sometimes hide assets with the plan of converting to chapter 13
if caught. The diligent trustee who discovered the assets has to watch as
the debtor converts to chapter 13. (2)
- Debtors' attorneys often have to compete for business with petition
preparers and cut-rate lawyers who deliver shoddy work at rock bottom rates.
The choice for attorneys is to deliver high quality work at lower rates or
to allow the quality of their work to sink along with the fees.
- Debtors continue to make poor choices and attorneys often fail to
protect them or to advise them fully.
In viewing these problems and seeking to find solutions, it becomes
apparent that the business as usual approach will not work; similarly,
legislation alone will not provide a cure. The problem with no-asset cases is
one of both perception and reality. The erroneous perception is that all debtors
are crooks and bankruptcies are bad. The dangerous reality is that large numbers
of schedules are filed inaccurately, in part because of an economic structure
that discourages attorney diligence, and that the mechanism for preventing fraud
and abuse by the small minority of abusers is not effective enough.
An effective system of bankruptcy administration must offset both the
perception and the reality. The United States Trustees must work cooperatively
with trustees to increase accountability; improve the standards of practice; and
protect consumer debtors, creditors, and others from fraud and abuse. Just as 10
years ago we focused on slow case administration, today we need to focus on
civil enforcement to ensure that accurate schedules are the standard and not the
exception, that the rules are followed by all who file petitions on behalf of
debtors, and that the deserving debtor-- and only the deserving debtor--
receives a discharges
in chapter 7 cases.
Some of the ways we may wish to address the problems are set forth
below. These are solely my opinions, and more definitive answers will require a
dialogue between panel trustees and United States Trustees. Martha Davis, Acting
Director of the Executive Office for United States Trustees, has announced a
civil enforcement initiative that will be one of the Program's major priorities
as of Oct. 1, 2001. Certain elements of this initiative address problems with
no-asset cases. While United States Trustees can focus on what we want to
accomplish, our best results come when we work with others toward a common goal.
Sometimes I am called a dreamer and an idealist, but I would like panel trustees
to join in the dream of improving the integrity of the no-asset cases. For too
long the panel trustees have carried much of the burden alone. United States
Trustees recently have become more focused on these issues, and in the future
should shoulder more responsibility in this area.
The Trustee's Economic Dilemma
In the typical no-asset case the trustee does not always have an
obvious economic incentive to litigate objections to discharge or to spend many
hours ferreting out assets only to see the debtor convert to chapter 13.
Trustees should consider that their primary revenuescomes
from asset cases. In 2000, the trustees in the 48 states served by United States
Trustees received more than 75% of their revenues from asset cases, even though
asset cases comprised only about 4% of all chapter 7 cases. Additionally, in
recent years the fees for no-asset cases have remained fairly constant, rising
from $47.5 million in 1996 to $50.1 million in 2000 while revenues from asset
cases increased from $105.3 million to $161.7 million. (3)
These numbers demonstrate that trustees should be seeking greater
recovery from asset cases rather than relying upon no-asset fees for future
growth. Making debtors honest by objecting to discharge and finding assets where
none appear to exist is in the trustee's economic interest. Once compliance is
improved, the trustees will be able to administer more assets with less effort.
Section 727 Actions
While improving integrity is in the trustee's economic interest, it
should not be a burden borne by trustees alone. The United States Trustee has an
interest and a right to bring objections to discharge pursuant to 11 U.S.C. §
727, and trustees and the United States Trustee should cooperate to share the
burden of this litigation in no-asset cases.
With a cooperative effort, the trustee can be a source of referrals
and information and the United States Trustee can litigate the objection to
discharge or seek revocation of discharge in appropriate cases. This has not
traditionally been a role of the United States Trustee, but it is supported by
the Bankruptcy Code and protects the integrity of the system. Criminal cases
should continue to be referred to the U.S. Attorney, but together the United
States Trustees and the private trustees should also aggressively pursue
objections to discharge and revocations of discharge.
The Section 341 Meetings
In some instances the Section 341 meeting docket is so crowded that
the trustee has only a few minutes to question the debtor. The trustee must ask
the questions required by the Handbook for Chapter 7 Trustees, and must
orally examine the debtor pursuant to 11 U.S.C. § 341. This leaves little room
for the creditors to ask questions as provided by 11 U.S.C. § 343; if creditors
have more than a few questions, a 2004 examination is usually required.
The 341 meeting is the primary opportunity to screen for misstatements
in the schedules and to help begin the process of locating undisclosed assets.
Some discussion between United States Trustees and chapter 7 trustees is
warranted, to determine how best to utilize the 341 meeting to elicit meaningful
information from the debtors and allow real creditor participation.
More Accurate Schedules
All debtors should be required to prepare reasonably accurate
schedules and should be held accountable for material deviations. The casual
observer who has never helped a debtor complete a set of schedules cannot
understand how difficult this process is, and I understood the process better
seven years ago when I was fresh out of private practice. When a debtor brings
records in a plastic bag and makes a complete mess of the attorney's
well-thought-out questionnaire, the attorney may be tempted to either send the
debtor away or prepare "bare bones" schedules. In turn, a trustee faced with
these schedules is tempted to ask a few questions at the 341(a) meeting and let
the schedules slide--after all, 96% of the cases are no-asset cases anyway.
It is worth noting that statistics indicate the percentages of asset
cases are dropping. In 1986 asset cases were 10.8% of filings, but by 1999 this
percentage had fallen to an estimated 3.5% of filings. My guess is that accurate
schedules and increased scrutiny would increase the number of asset cases. The
state-by-state variation in the number of cases administered as asset cases
cannot be explained by the wealth of the state or the variation in allowable
In many cases, assets located by trustees and administered to the
benefit of creditors were not originally scheduled by the debtor, but were found
through the skill and diligence of the trustee. Often these debtors are allowed
to receive a discharge because the trustee would be forced to use the creditors'
assets to litigate the discharge issue. This may create a situation where an
objection or a revocation under 11 U.S.C. § 727 by the United States Trustee
would be justified and desirable. As long as there is no price to be paid for
inaccurate schedules, there will be little incentive for more accurate ones.
Conversions to Chapter 13
Not all courts hold that debtors have an absolute right under 11 U.S.C.
§ 706(a) to convert a case under chapter 7 to chapter 13. A growing number
appear to require "good faith" as a requirement for such conversion. A good
example of such a case is In re Thornton, 203 B.R. 648 (Bkrtcy S. D.
Ohio 1996), where the court held that a debtor who failed to report significant
assets on the petition and lied to the trustee about jewelry did not have the
right to convert to chapter 13 because no proposed plan could meet the good
faith requirement of § 1325(a)(3). The court in Thornton said:
The Thorntons became honest in this case only after the trustee
diligently pursued the truth and their present attorney insisted on accurate
schedules. * * * To allow conversion of this case would condone debtors'
attempts to conceal assets and mislead a trustee to avoid administration of
In many instances the United States Trustees and the panel trustees
are working together to prevent abusive conversions. More cooperative efforts in
this regard can be made. In addition, case law is developing to allow the
trustee to recover some amount for the efforts, but it appears that denial of
the conversion or reconversion back to chapter 7 is often the best solution.
Debtors' Attorneys and Petition Preparers
If the system is to have integrity, the vast majority of debtors must
have competent representation. In my view most consumer debtor attorneys are
honest and competent, and encourage debtors to be open and honest. They do a
good job and perform a public service, including more than their share of
pro bono service for the bar. Before becoming a United States Trustee, I
represented a number of consumer debtors. They were generally honest and
appreciative, and they did not enjoy finding themselves in bankruptcy.
If, however, debtors choose a petition preparer or an attorney who
competes for business with "low ball" pricing, the result is usually a petition
that reflects the standards of the preparer or attorney. Sometimes the debtor is
harmed by petition preparers or attorneys when exemptions are not claimed and
exempt property is not identified. Creditors may be left out because petition
preparers or attorneys do not insist that all creditors be listed on the
schedules. Honest debtors are sometimes misled into omitting creditors or
property by the belief that "everybody does it."
Bankruptcy relief is too important to be left to the petition
preparers and the cut-rate attorneys who cut corners as readily as they cut
rates. As bankruptcy professionals we should seek to ensure that every debtor
and creditor is represented professionally. We should seek to change the culture
and ensure excellence. This will not be easy, but we should work together to
improve the quality of service even if it comes at a higher price. Trustees
should not condone schedules that do not meet minimum standards. The United
States Trustee should seek to disgorge fees when attorneys do not fully
represent their clients and do not meet the minimum standards. Section 329
should be used to ensure that attorneys are not charging for services that are
not delivered, such as attendance at the 341 meeting. Shoddy, unethical legal
representation is not a bargain at any price.
We should also continue our efforts to require petition preparers to
comply with § 110. These efforts are generally successful, in part because of
assistance from trustees.
The image of the bankruptcy system is greatly diminished each time an
undeserving debtor slides through the system. One protection against abuse is 11
U.S.C. § 707(b). The case law is developing ways that better define abuse, and
with or without the proposed legislation § 707(b) will remain a priority for
United States Trustees.
In most districts the United States Trustee's office and the panel
trustees have established cooperative efforts whereby the trustees use their
unique knowledge and instincts to assist the United States Trustee in making
decisions on § 707(b) motions. In those districts where this has been less of a
priority, there should be increased emphasis upon § 707(b) motions. In all
districts our review for abuse under § 707(b) is enhanced by the savvy and
skills of the panel trustees, who are in an excellent position to spot abuse.
As we think about protecting the integrity of the system in no-asset
cases, it becomes apparent the first step is to make sure that the cases are
truly no-asset cases by insisting upon accuracy of schedules. Beyond that first
step, however, as United States Trustees we need to make sure our policies
encourage administration of asset cases. Panel trustees and United States
Trustees must work together to encourage the good lawyers and to discourage any
tendency to cut corners. We must be aggressive but also exercise discretion in
bringing good cases that send the right message. The bankruptcy system does too
much good to allow the worst elements to lower the standards and taint the
honest debtor or the diligent lawyer.
1. The views expressed in this article are those of the
author and are not intended to represent the views of the Department of Justice,
the Executive Office for United States Trustees, or any other United States
2. Interestingly, the number one wish among trustees is
that the code be amended to remove the automatic right of conversion to Chapter
13 and to allow the trustee to be heard on the issue. See "A Trustees Wish
List," NABTalk, Vol. 17, No.2, pg 39.
3. NABTalk, "The Questions Behind the Numbers" by
Christopher Marshall, Chart # 4, Vol. 17, No. 2.
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