Bankruptcy Abuse Rarely Works . . . Because Of Gatekeepers—CREDITORS AND THEIR ATTORNEYS (Part 2)

By: Donald L Swanson

Over the years, I’ve heard lots of people say, “Bankruptcy abuse is a huge problem,” as a self-evident and undeniable proposition. 

But here’s the thing.  Debtors who try to abuse the bankruptcy system rarely get away with it.  That’s because there are too many gatekeepers—and no debtor can fool them all! 

The gatekeepers are debtor’s counsel, creditors and their attorneys, U.S. Trustees, bankruptcy courts, and appellate courts.    

This is the second of a multi-part series of articles on how gatekeepers prevent abuse. This article focuses on creditors and their attorneys.

Creditors and Their Attorneys

Creditors and their attorneys serve a gatekeeping function to prevent debtors from cheating—and they do so with high degrees of effectiveness.

Their effectiveness comes from a combination of these two realities:

• creditors have real dollars at stake in every bankruptcy—so, they are energized and inspired to assure that debtors play by the rules . . . or pay a price for cheating; and
• creditors tend to have, either singly or collectively, an understanding of debtor’s business and financial affairs—so, they have an intuitive sense of something amiss when debtor tries to cheat.  

Toolshed of Mechanisms

Creditors have an entire toolshed of bankruptcy mechanisms to discover debtor rule-breaking, insist upon debtor rule-following, and pursue remedies for debtor rule-breaking. 

Such mechanisms include:

• scouring debtor’s disclosures (in schedules, statements of financial affairs, monthly operating reports, declarations, etc.) for damning information or deceptive omissions;
• examining debtor at the § 341 meeting;
• conducting fishing-expedition discovery under Fed.R.Bank.P. 2004;
• objecting to exemptions claimed by individual debtors;
• filing dispositive motions, like motions for relief from automatic stay, to dismiss, or to convert the case from a reorganization chapter to Chapter 7;
• objecting to debtor’s plan of reorganization;
• filing a creditor plan of reorganization in regular Chapter 11;
• moving for appointment of a trustee or examiner in regular Chapter 11;
• seeking removal of debtor from possession in Subchapter V or Chapter 12;
• filing a complaint to deny debtor’s discharge of the creditor’s own claims, under § 523; and
• filing a complaint to deny debtor’s discharge in its entirety, under § 727.

An Illustration

Here’s a personal illustration of how a creditor serves the gatekeeping function—with great effectiveness—in a case I filed . . . that failed for my client and me, spectacularly.

I’m retained by a family, many years ago, to represent them (as co-counsel with their local attorney) in a Chapter 12 case.  Clients provide information for preparing the schedules—and I’m working on a preliminary draft.

I’m troubled at this point: there are things about the information the family provides that don’t make sense.  So, I have them go back and rework the numbers—several times.

After these back-and-forth attempts, I’m very nervous about the information provided.  So, I talk with co-counsel about my concerns.  I do this a number of times.  Finally, with a tone of exasperation, co-counsel assures me: “The numbers are right!”

So, I make a huge mistake.  I say, “Ok”;  and I let them sign the schedules under oath; and I then file those schedules with the Bankruptcy Court.

Co-counsel represents the family at the § 341 meeting (I don’t do it because I don’t understand and am nervous about information on the schedules). 

Not long after that, a Bank attorney (who appeared and asked questions at the § 341 meeting) requests a Rule 2004 examination.  At this point I’m thinking, “This can’t be good.” 

The examination happens in co-counsel’s office, since it’s a short distance from debtors’ operation (and a couple hours from mine).  And co-counsel provides their representation at the examination. 

What happens next: I get a call from co-counsel saying, “We’ve got a problem.”

Things deteriorate quickly. 

Long story short: client ends up in federal prison for bankruptcy fraud.

So . . . the moral of the story (for purposes of this article) is:  

• my debtor clients attempted to cheat the bankruptcy system; but 
• it didn’t work.

Their attempt to cheat (i.e., abuse) the bankruptcy system gets past me as the initial gatekeeper.  But it does not get past the next gatekeeper—a diligent creditor and its counsel.

And the only good thing about the foregoing story is this:

• no one ever suggested that I had been complicit in my clients’ attempt at bankruptcy abuse.   

Conclusion

Creditors and their counsel are gatekeepers to prevent bankruptcy abuse.  And they are highly effective in that role.  

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