Bankruptcy Abuse Rarely Works . . . Because Of Gatekeepers—U.S. TRUSTEES (Part 3)

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 third of a multi-part series of articles on how gatekeepers prevent abuse. This article focuses on U.S. Trustees.

U.S. Trustee

The Office of the U.S. Trustee is the administrator of the bankruptcy system.  Its job is to make the bankruptcy system work.  

As part of the job, the U.S. Trustee is directly and explicitly charged with preventing bankruptcy abuse, like this:

• “Specific responsibilities of the United States Trustees” include,
• “Taking legal action to enforce the requirements of the Bankruptcy Code and to prevent fraud and abuse” (emphasis added).
  • from this linked U.S. Department of Justice document (emphasis added).

U.S. Trustees take this “prevent fraud and abuse” responsibility very seriously.  And they monitor bankruptcy cases closely to fulfill this responsibility. 

Chapter 11 Illustration

U.S. Trustees are active in all bankruptcy cases.

To illustrate, here are common U.S. Trustee actions in Chapter 11 cases—all of which are designed to assure compliance with the Bankruptcy Code and Rules and to identify fraud or abuse:

• conducting an initial interview with debtor and debtor’s attorney to assure that debtor (i) understands and abides by rules for a debtor in possession, (ii) is honoring cash collateral requirements, (iii) is setting up DIP accounts at an approved bank, (iv) is eligible for Subchapter V, if that status is selected, (v) has insurance coverage, (vi) etc.
• reviews debtor’s schedules, statement of financial affairs and related filings;
• conducts debtor’s first meeting of creditors and interrogates debtor in such meeting about information debtor has provided;  
• assures that debtor files monthly operating reports—and files a motion to dismiss or convert the bankruptcy, if compliance does not occur;
• monitors information in debtor’s monthly operating reports to assess continuing compliance with bankruptcy requirements and absence of fraud and abuse;
• evaluates fee applications filed by court-approved professionals and provides input to the court on the merits of each application;
• monitors the progression of each case to continually assess the conduct of all constituencies and to identify any noncompliance or fraud or abuse by anyone; and
• in the event concerns arise about compliance or fraud or abuse, brings such concerns before the bankruptcy court and litigates over those concerns.

Such efforts by the U.S. Trustees are highly effective in ferreting out and addressing any effort at fraud or abuse.

An Unfortunate Twist

But there’s an unfortunate semantic twist imposed by Congress upon the U.S. Trustees.  Here’s what I mean:

• in enacting a 2005 amendment to the Bankruptcy Code, Congress uses the word “abuse,” when talking about eligibility for Chapter 7 relief;
• in that 2005 enactment, Congress decides that too many middle-class consumers are filing Chapter 7—so, Congress excludes middle-class consumers from Chapter 7 eligibility by establishing a poverty-level cap; and 
• Congress does so by creating an irrebuttable presumption of bankruptcy “abuse,” using this language:
  • “the court . . . may dismiss a case filed by an individual debtor under [Chapter 7] whose debts are primarily consumer debts, . . . if it finds that the granting of relief would be an abuse of the provisions of this chapter”; and
  • “In considering . . . whether the granting of [Chapter 7] relief would be an abuse . . . , the court shall presume abuse exists if the debtor’s current monthly income” is higher than a specified level of poverty.  § 707(b), emphasis added.

Similar provisions in other chapters of the Bankruptcy Code are characterized as eligibility standards for the type of bankruptcy relief being pursued (see, e.g., § 109(c) for Chapter 9, § 1182(1) for Subchapter V, §§ 109(f) & 101(18) for Chapter 12, and § 109(e) for Chapter 13).

It is only in Chapter 7 that the § 109(b) criteria for eligibility are supplemented by another criterion that Congress pejoratively declares to be preventing “abuse.”

Moreover, to emphasize its abuse-prevention point, Congress entitles the 2005 Bankruptcy Code amendments as the “Bankruptcy Abuse Prevention . . . Act.” 

So, when U.S. Trustees go about fulfilling their duty to contest an individual debtor’s Chapter 7 eligibility, they commonly do so by using the “abuse” language that Congress provided:

• i.e., by declaring that the allegedly ineligible debtor is engaged in bankruptcy “abuse”!

The unfortunate result is a magnification of the false sense that bankruptcy abuse is rampant.

Conclusion

U.S. Trustees have a duty to prevent abuse—it’s part of their broader job of making the bankruptcy system work well.

They take this duty seriously and work hard at fulfilling it.

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