By: Donald L Swanson
Many people live the American Dream. They’ve started a business and are succeeding. They’re what makes the U.S. economy work.
But bad things can—and do—happen to them: things like product obsolescence, economic downturn, health problems, a costly mistake, bad luck. Such things can destroy their Dream and can destroy the entrepreneurs themselves.
No Safety-Net for Entrepreneurs
We have a safety net in these United States and do a reasonably good job of helping the poor among us.
But there’s no such thing as a safety net for entrepreneurs on the bad side of the American Dream. The primary aid for them is bankruptcy. Yet our bankruptcy laws often treat them as rascals and cheats, deserving of punishment: as if they are no different from spendthrifts, ne’er do wells and swindlers.
The reality is quite different. People on the bad side of the American Dream are often good citizens who employ others, pay taxes, create value, and contribute to their communities in countless ways. But when bad times hit, there is often nothing they can do: the tides of adversity sweep their business away, despite best efforts and most-prudent practices.
–Example of Anti-Entrepreneurial Bias in Bankruptcy
Here’s an example of an anti-entrepreneurial bias in our bankruptcy laws. Legislative history leading to the enactment of today’s Bankruptcy Code (the “Bankruptcy Reform Act of 1978”) contains this gem:
“The bill places dollar limitations on . . . who may use chapter 13.” The purpose of such limitations is “to prevent sole proprietors with large businesses from abusing creditors by avoiding chapter 11.” Such limits “create an irrebuttable presumption that chapter 13 is inappropriate for businesses with more than $100,000 in unsecured debt or more than $500,000 in secured debt.”
Yikes! The anti-entrepreneurial bias in this political statement is astounding. The politicians are saying:
A business owner on hard financial times is worse than any spendthrift consumer;
Any use by an entrepreneur of chapter 13 would be “abusing creditors”; and
Entrepreneurs needing bankruptcy must either, (i) file chapter 11, where creditors have a veto power over debtor’s reorganization and discharge, or (ii) file chapter 7, where debtors can only keep assets that are exempt or retained through reaffirmation.
This is a terrible way to treat our entrepreneurs. Bankruptcy should provide a safety-net for them—not try to punish them!
–A Chapter 7 Problem for Entrepreneurs
Not only are entrepreneurs with sizable debts explicitly excluded from reorganizing under Chapter 13, and not only is Chapter 11 often ineffective for them, but they can be shut-out of Chapter 7 as well.
Provisions like §§ 706 & 707 of the Bankruptcy Code are often cited in efforts to keep entrepreneurs out of Chapter 7. When such efforts are successful, entrepreneurs in financial stress can be prohibited from obtaining a bankruptcy discharge under any bankruptcy chapter, even when they have conducted themselves properly!
A Favorable Ruling for Entrepreneurs
But we have a favorable development, this year, on the § 707(a) front. The development is in Janvey v. Romero (In re Romero), Case No. 17-1197 (4th Cir., Feb. 21, 2018).
The question in Romero is whether Peter Romero’s Chapter 7 bankruptcy should be dismissed “for cause” because of a “bad faith” bankruptcy filing. The concern is that the exempt assets he could keep are too valuable.
–Peter Romero’s Story [Fn. 1]
Peter Romero “had a storied career” of 24 years in the U.S. Foreign Service. He served, “most prominently” as Ambassador and as Assistant Secretary of State for Western Hemisphere Affairs. Upon retirement from there, he began advising companies that do business overseas.
As an advisor, he earned fees of $700,000, over seven years, from Stanford Financial Group. But Romero “cut ties” with Stanford upon learning that it was, in reality, “a multibillion-dollar Ponzi scheme.”
The SEC sued Stanford entities and leadership in Federal Court. The court-appointed Receiver in that case, Ralph Janvey, also sued Romero to recover the money he received from Standford. After an unsuccessful mediation, the Receiver obtained a $1.275 million judgment against Romero that includes $320,000 of Janvey’s attorney fees. Romero appealed, but he lost the appeal.
When the Receiver moved to collect on the judgment, Peter Romero filed Chapter 7 bankruptcy. Here is his financial condition at bankruptcy filing:
Assets: Romero had more than $5.348 million in assets, the bulk of which is exempt: i.e., three real properties (a homestead and two rentals owned with his wife “as tenants by the entirety”) and “pension, retirement, and benefit plans.” Romero surrendered a car and two boats to the Chapter 7 trustee.
Unsecured Debts: The Receiver’s $1.275 million judgment “accounted for roughly 90% of Romero’s unsecured debt,” with the remaining debt consisting of $150,000 to “two law firms for unpaid legal fees” from the unsuccessful lawsuit defense.
Expenses: Romero’s wife (a lawyer) “contracted a bacterial brain infection in 2013” while serving with a nonprofit in Colombia, leaving her 100% incapacitated and “in need of extensive care.” Three disability policies were covering her medical expenses ($12,000 per month), but two of those policies terminated after Romero’s bankruptcy filing. Meanwhile, her condition improved “slightly” so that care could be scaled back.
Income: Both Romero and his wife are unemployed: “she because of her illness,” and Romero couldn’t find work “after the Stanford scheme was discovered.” Their combined monthly income “came entirely from” his “State Department pension plan,” the two rental properties, social security, and disability payments.
–Receiver’s Motion to Dismiss Romero’s Chapter 7
The Receiver moved to dismiss Romero’s Chapter 7 bankruptcy under 11 U.S.C. § 707(a) [Fn. 2], arguing that Romero is guilty of “bad faith” because he “abused the bankruptcy process to avoid” the Receiver’s judgment. The bankruptcy court denied the motion, and the District Court affirmed.
The Fourth Circuit Court of Appeals also affirmed. Here is their rationale on the “bad faith” issue:
The Receiver’s claims “boil down to an accusation that Romero has abused the bankruptcy process and should therefore be ineligible for its protections”;
While “bad faith may constitute ‘cause’” under § 707(a), the dismissal remedy must be reserved for “cases of real misconduct”;
The “bar for finding bad faith is a high one,” applying only in “egregious cases” that include “concealments or misrepresentations” of assets or income, “excessive and continued expenditures” supporting a “lavish life-style,” and attempts “to avoid a large single debt” by “conduct akin to fraud, misconduct, or gross negligence”;
There is no “strict formula” for finding ”bad faith”; instead, judges “must consider the totality of the circumstances”; courts have developed “multifactor tests” as “guides only,” under which judges are given broad discretion to evaluate and determine whether “bad faith” exists; and
The Bankruptcy Court in Romero evaluated all relevant evidence and reached a no-bad-faith conclusion, in which appellate courts could find no error.
Here’s how the Bankruptcy Court applied the multifactor test [Fn. 3]. Romero:
–did not conceal or misrepresent any assets or sources of income, made no fraudulent transfers while being sued, and fully “disclosed” pertinent information to the Receiver at various times;
–completed and filed his bankruptcy schedules as accurately and completely as possible and in a timely manner;
–has “substantial resources” that are mostly exempt—real estate assets (having $2 million equity) are exempt from Romero’s creditors because of their tenancy-by-entireties status, and pension assets are exempt;
–“cooperated with the trustee and turned over all nonexempt assets,” which have been sold by the Trustee for benefit of creditors, and Romero did not spend or diminish nonexempt assets;
–“lives a comfortable, but not exorbitant, lifestyle”;
–was in dire financial straits at bankruptcy filing—could not find employment “because of the judgment“ and had to address his wife’s illness and care needs with disability policies coming to an end;
–did not demonstrate any type of “deliberate” or “persistent pattern” of “evading the Receiver’s judgment” beyond disputing the Receiver’s claims at trial and exhausting his appeals;
–is not “over-utilizing the protection” of the Bankruptcy Code;
–“did not reduce his creditors to a single creditor” before filing bankruptcy—beyond the judgment, he owes “more than $150,000 to two law firms”;
–“made good faith” efforts, though unsuccessful, to reach a settlement with the Receiver “at least twice” before filing bankruptcy;
–“made no payments or transfers to insiders” nor took any other action that might “render himself judgment-proof” or “place assets outside the reach of his creditors”; and
–“has not engaged in any ‘procedural gymnastics’” to defeat creditors.
The Bankruptcy Court acknowledged that Romero is retaining a large amount of exempt assets, while receiving a bankruptcy discharge, but it held that such a result is neither unfair nor evidence of bad faith. Notably, the Bankruptcy Judge declares, there is no such thing as a “judicially-created cap on exempt assets.”
Conclusion
The Romero opinion is encouraging. It treats an entrepreneur with respect in a Chapter 7 bankruptcy case, rather than as a rascal or cheat. And the reason for such treatment is this: the evidence shows him to be an upright fellow caught in a problem of someone else’s making.
This is a good result. Granted, the case deals with a single and narrow issue and unusual circumstances. But it reflects a trend toward treating entrepreneurs in distress with respect, rather than as people to be punished.
Footnote 1: Information and quotations about facts of the Romero case are from the Fourth Circuit Court’s opinion: Janvey v. Romero (In re Romero), Case No. 17-1197 (4th Cir., Feb. 21, 2018).
Footnote 2: 11 U.S.C. § 707(a) provides: (a) The court may dismiss a case under this chapter only after notice and a hearing and only for cause, including—(1) unreasonable delay by the debtor that is prejudicial to creditors; (2) nonpayment of any fees or charges required under chapter 123 of title 28; and (3) failure of the debtor in a voluntary case to file . . . the information required by paragraph (1) of section 521(a), but only on a motion by the United States trustee.
Footnote 3: The Bankruptcy Court ruling is at Doc. 132 (dated Sept. 19, 2016) and denies the Receiver’s Motion to Dismiss Peter Romero’s Chapter 7 bankruptcy case. The bankruptcy case is, In re Romero, Case No. 15-23570 in the U.S. Bankruptcy Court for the District of Maryland, and the Bankruptcy Court’s opinion is published at In re Romero, 557 B.R. 875 (Bankr. D. Md. 2016).
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