Bankruptcy Abuse Rarely Works . . . Because Of Gatekeepers—BANKRUPTCY COURTS (Part 4)

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 fourth of a multi-part series of articles on how gatekeepers prevent abuse. This article focuses on bankruptcy courts and the judges that animate them.

Bankruptcy Courts

Bankruptcy courts are the decision-making gatekeepers against fraud and abuse within the bankruptcy system.  They are the enforcers.

When suspicions arise about the possibility of abuse, bankruptcy courts enable discovery efforts by:

• authorizing fishing-expedition discovery under Rule 2004;
• appointing an examiner in regular Chapter 11 under § 1104(c);
• authorizing an investigation by the trustee in Subchapter V or Chapter 12, under §§ 1183(b)(2) & 1202(b)(2);
• enforcing motions to compel under Rules 7037 & 9014(c); and
• etc.

Bankruptcy courts deal with evidence in real-time.  They make determinations on whether abuse exists and mete out remedies when they find that abuse has occurred.  Such remedies include:

• granting relief to creditors from the automatic bankruptcy stay under § 362(d);
• dismissing a case or converting it to Chapter 7 (except that an ineligible, middle-class consumer cannot be converted to Chapter 7);
• denying a discharge under § 523 and/or § 727;
• appointing a trustee in regular Chapter 11 under § 1104(a);
• removing a debtor from possession in Subchapter V or Chapter 12, under §§ 1185(a) & 1204(a); and
• etc.

Bankruptcy courts take their abuse-prevention role seriously.  And they are not bashful about meting out remedies when abuse is established by the evidence.

And my observation, from decades of experience, is this: bankruptcy judges are highly effective in their abuse-prevention role.

Disagreements on Abuse

But here’s the thing: bankruptcy courts don’t always agree on what constitutes abuse—and what doesn’t. 

Consider, for example, the problem of student loans in bankruptcy.  Here is some history:

• our student loan system arises out of many different circumstances, but it takes off in the 1970s—during the Vietnam war, when young men might get a draft deferment by going to college;
• there is a concern, back then, that students will abuse both the student loan system and the bankruptcy system by:
  • using student loans to go to college for the sole purpose of avoiding the draft; and
  • using bankruptcy to get out of paying those loans;
• so, bankruptcy laws on student loan topics have always had an abuse-prevention component;
• in 1987, the Second Circuit Court of Appeals issues its Brunner opinion (831 F.2d 395), taking Congress’s “undue hardship” standard for discharging student loans and giving it a harsh twist;
• thereafter, many bankruptcy courts adopt the Brunner test as their own—but many one-up the Second Circuit by applying Brunner in a excessively-harsh manner, creating what’s been described as a “certainty of hopelessness” standard for discharging student loans; but
• other bankruptcy courts disagree and, where allowed by their court of appeals to do so, take a more-flexible approach to discharging student loans.

So, the reality is this:

• “abuse” is in the eye of the beholder; and
• the many bankruptcy judges across the land can see things differently—the very same facts one judge might see as “abuse” can be declared by another as proper and acceptable.  

Conclusion

Bankruptcy courts and the judges that animate them are highly-effective gatekeepers against fraud and abuse within the bankruptcy system.

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