Bankruptcy Abuse Rarely Works . . . Because Of Gatekeepers—APPELLATE COURTS (Part 5)

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 fifth of a multi-part series of articles on how gatekeepers prevent abuse. This article focuses on the appellate courts that oversee cases in the bankruptcy system. 

Appellate Courts

Unlike bankruptcy courts, appellate courts are not in the trenches. 

They do not receive evidence in real time.  Instead:

• what they get is a set of documents to review, including the pertinent bankruptcy court filings, a written copy of oral testimony at trial, documentary evidence received at trial, and briefs; and
• then, they identify the applicable law, apply it to the evidence received, and decide whether the bankruptcy judge made any error of fact or law or both.

What the appellate courts do, regarding allegations of abuse, is this: 

• decide upon and identify what the elements of a particular type of abuse might be; and
• determine whether and how the evidence establishes an abuse of the Bankruptcy Code or the bankruptcy system.

Evolving Views

Views of what constitutes “abuse” can evolve over time. 

That’s true in the bankruptcy appellate courts at all levels (i.e., district courts, bankruptcy appellate panels, U.S. circuit courts of appeals, and the U.S. Supreme Court). 

Here’s an example of that evolution:

• in my early decades of practicing bankruptcy law, I heard many times (at seminars and elsewhere) that Chapter 11 of the Bankruptcy Code has no eligibility requirement—specifically, there is no requirement of insolvency, or even financial stress, for Chapter 11 eligibility; but
• in current times—with mass tort bankruptcies—appellate courts are finding bankruptcy abuse when the debtor is in no immediate financial peril.

In the words of Bob Dylan, “Times they are a-changin’.”

Creativity v. Abuse

And then there’s the issue of attorney creativity.

Consider this:

• every debtor and every creditor tries to get the best-possible deal out of a bankruptcy case—by utilizing the details of the Bankruptcy Code and Bankruptcy Rules in the most-advantageous way possible; and
• occasionally, a debtor attorney or a creditor attorney does an attorney-like thing—i.e., finds a new and creative way to apply bankruptcy law details to a set of facts, to achieve an even-better result.

Some people describe such creativity as a good thing—as effective lawyering, by applying the law in a new and favorable way. 

But others insist that such a thing is inappropriate—that creativity is an “abuse” of the bankruptcy system. 

It is the appellate courts who, ultimately, decide which of these two views prevails in any particular circumstance. 

Alex Jones Cases

The Alex Jones cases in Texas are creating an “abuse” stir these days. 

That’s because, for example, one of the Alex Jones debtors files its bankruptcy petition under Subchapter V.  It does so:

• shortly before a trial is set to begin on tort claims;
• while the amounts of the tort claims are still unliquidated; and
• to assure Subchapter V eligibility under § 1182(1)(A). 

Trial of the tort claims, when it finally occurs shortly thereafter, produces judgments against the Subchapter V debtor in amounts far, far beyond Subchapter V’s $7.5 million debt limit.

Had the same bankruptcy been filed as a regular Chapter 11, an “abuse” controversy would still have existed—but the controversy would have been materially different.  That’s because of these two points:

• filing shortly before trial to assure Subchapter V eligibility looks like abuse; and
• Subchapter V’s plan confirmation standards are less stringent than those for a debtor in regular Chapter 11.

Regarding those two points:

• if the bankruptcy court finds such facts to be an abuse, the court can dismiss the case—which hasn’t happened yet; and
• the same judgment is also against Alex Jones, personally—Alex Jones is in a regular Chapter 11 proceeding, and the Subchapter V case for one of his companies won’t protect him, personally.

Ultimately, it is the appellate courts who must determine whether such circumstances qualify as an abuse or not.

–Outlier

The Alex Jones cases are a bankruptcy outlier—with unusual facts in a Subchapter V proceeding.  The unusual facts produce both, (i) allegations of abuse that need to be addressed by the court, and (ii) calls for adjusting Subchapter V rules to prevent similar things from happening hereafter.

Here’s hoping the unusual facts in the Alex Jones outlier cases don’t have an outlier effect—by messing up Subchapter V laws for everyone else . . . especially at the appellate levels.

–Hard Cases

In the words of Oliver Wendell Holmes, “Hard cases make bad law.” 

The Alex Jones cases fall within the “hard cases” category—and they raise both a fear and well-founded hope.

The Fear. Alex Jones cases will mess up Subchapter V laws through a stray and ill-advised court ruling or through ill-advised Congressional reaction—and harm the debtors for whom Subchapter V is designed.

The Well-Founded Hope.  The appellate courts, collectively, are more-than-capable of preventing abuse throughout the bankruptcy system, on a case-by-case basis and in an even-handed and ever-evolving way.

Conclusion

It is the appellate overseers of the bankruptcy system who are the ultimate guardians of what is abuse and what is proper.

And their collective history of addressing creative approaches and ferreting out what is abuse and what is not provides assurance that we are in good hands.

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