Remarks of Director Cliff White at the 54th Annual Seminar of the National Association of Chapter 13 Trustees

INTRODUCTION

Thank you again for letting me share some updates on the United States Trustee Program (USTP or Program). I always enjoy my visit to the NACTT annual seminar. This year, besides these remarks, I also will participate in the two-hour panel considering the findings and recommendations of the American Bankruptcy Institute’s Consumer Bankruptcy Commission. So, by the end of the day, I am sure you will have heard more than enough from me.

There are several topics I want to touch on while we are together in this plenary session, but first, some acknowledgments. I am grateful to David Peake for his year of service as President of the NACTT. David is a “professional’s professional” who brings high integrity and knowledge to addressing the many issues in chapter 13 practice. It has been a pleasure working with him and I thank David for his outstanding service. And, just as David was a worthy successor to Joyce Babin, Byron Meredith will be a worthy successor to David. Byron has worked closely with the USTP for many years as a key member of the NACTT-USTP Liaison Committee. I know that under his leadership the NACTT can look forward to another year of accomplishment.

As you know, at this seminar each year, I am joined by some of the members of the USTP’s trustee group. I am pleased to announce that the group now includes our recently appointed Assistant Director for Oversight, Bob Gebhard. Bob has more than 30 years of bankruptcy experience in both consumer and business cases, including many years in private practice and as the Assistant United States Trustee in the Program’s San Jose field office from 1995 to 2002. I know that Bob is looking forward to meeting as many of you as possible. I hope that you will be sure to introduce yourself to him during the conference.

Bob’s transition into his new role is being facilitated by Deputy Assistant Director Suzanne Hazard, who knows pretty much everything there is to know about trustee oversight. And, of course, Tiffany Carroll also is helping to ensure a smooth transition after having covered as Assistant Director for the past year and a half. I owe a huge thank you to Tiffany, who will continue her outstanding work on the USTP’s private trustee liaison committees. She also will serve as an important resource for Bob. Thank you, Tiffany, for your service to the USTP and to the consumer bankruptcy community.

Finally, let me recognize Nancy Gargula, our local United States Trustee (UST), who also is joining us this morning. Like many senior officials in the Program, Nancy serves double-duty. She is the UST here in Region 10, where she oversees three offices in Indiana and Illinois. She also serves as UST for Region 21, where she covers eight offices in the southeast and Puerto Rico.

CHAPTER 13 TRUSTEE PRACTICE

Now, let me share a few observations with you about the state of chapter 13 practice.

Caseloads and Compensation Trends

In keeping with tradition, I will begin with a recap of some of the more salient facts about the economics of trustee operations from a system-wide perspective. There are about 1.5 million ongoing bankruptcy cases under all chapters of the Bankruptcy Code. In fiscal year (FY) 2018, the average caseload administered by a chapter 13 trustee was around 3,900, a decrease of about five percent from the previous year. Unsurprisingly, the caseload decrease has been accompanied by an increase in the average percentage fee, which rose modestly within the last year from 7.3 percent to 7.4 percent. More than 20 trustees now charge the maximum 10 percent fee on debtor payments, which is more than double the number of trustees who charged the maximum just two years ago. The caseload and percentage fee trends are not alarming, but they deserve close attention as we decide on appropriate trustee office budgets and make other economic decisions.

Lessons Learned from Defalcations

Let me move on to an important yet difficult matter relating to trustee practices. Thankfully, defalcations in trustee operations are extremely rare.

Here are some of the numbers. Over the thirty year period of 1988 to 2018, there were 94 cases of defalcations by trustees or their staffs under all chapters. Seventy of these occurred prior to 2000. Despite the rarity of defalcations, a recent case serves as an important reminder that we must always be vigilant. When dishonest behavior is suspected, the USTP will act swiftly by sending in a reconstruction team and referring the matter to law enforcement as appropriate. The USTP also will evaluate its findings from the reconstruction to identify lessons learned that can be used to help educate trustees and USTP staff on early warning signs, questionable practices, and preventative steps.

A recent reconstruction reinforced to us that there is one common feature to most defalcations. That is, trustees abdicated duties to their assistants and placed unchecked trust in their staff. In almost every case of employee defalcation, the trustee felt blindsided because the employee was viewed as always reliable and trustworthy. It is that blind trust that can lead to complacency and, in turn, present opportunities for misconduct.

A few lessons have been learned that I want to highlight for you. These lessons already are reflected in extant guidance that has been issued, and have informed the development of the employee fraud indicators that are posted on our Web site. First, trustees must establish and abide by internal controls, such as ensuring dual control over receipts, reviewing logs, securing “live” checks, and running red flag reports. Second, trustees must review bank statements and bank account reconciliations carefully—not just in a perfunctory way. Third, trustees must be conscientious in compiling and reviewing required financial and case administration reports. It is your responsibility to ensure that the information provided by staff is verified and monitored for unauthorized changes. Innocent mistakes happen, but it is important to ensure that that is exactly what they are—innocent.

In trustee work, small things matter. The most important duties often seem to be the most mundane. Trustees cannot delegate their fiduciary responsibilities. I know that you know this, but recent experience commends these reminders.

341 MEETING ROOM SECURITY

Next, allow me to update you on another important topic that we have discussed before. That is security at meetings of creditors. As you know, the USTP maintains about 400 section 341 meeting rooms. Many of these are in federal courthouses and federal buildings, but many are in less secure, private buildings.

Over the past three years, we have committed significant funding to provide paid security guards at about 30 of these less secure locations, eventually moving six of them into secure space. In addition, five other locations were moved to secure space and two more moves are planned for this summer. Beginning August 1st, we also will further expand the security guard program to an additional ten sites.

While these more permanent solutions are pursued, it is important to remind you that we also can assist with providing security for those thankfully rare instances when there is an advance indication of a security threat that warrants special assistance. Since 2016, there have been about 20 instances where we have arranged to have guard service available to address a specific threat.

Beyond the importance of security at these statutorily mandated meetings, trustees, practitioners, and others continue to tell us that the security presence also adds a proper solemnity to the meetings, which often are the only formal appearance most debtors ever make during their bankruptcy proceeding. Bankruptcy is serious business and the stakes are high. That puts a premium on decorum and honesty in all proceedings. Added security enhances those important goals.

FRAUD AND ABUSE BY CONSUMER BANKRUPTCY LAWYERS

If I had to describe the biggest problem in consumer bankruptcy practice as I see it, it would be the small number of consumer debtor lawyers who put their interests ahead of the interests of their clients. Some of these attorneys run multi-district bankruptcy mills soliciting a large volume of clients. They fail to carry out their duties to debtors and to the court, and sometimes even engage in outright fraud or intentional misconduct.

As I discussed with you last year, some justify their violations by saying they provide access to justice. I disagree that there is any justice in the kinds of behavior we have challenged in court. Client interests are forgotten by a small number of consumer lawyers who ignore their ethical duties and professional responsibilities in the pursuit of fees. USTP enforcement activities are triggered when lawyers operate in their own self-interest at the expense of their clients and in contravention of numerous provisions of the Code. Cloaking such behavior in terms of access to justice does not justify cutting corners.

I recently read published remarks by consumer legal services lawyer and Collier’s editor Henry Sommer. In accepting an award for service to the consumer bankruptcy community, Mr. Sommer told the story of his first involvement with the National Association of Consumer Bankruptcy Attorneys. He said he was initially skeptical because “if you’re just fighting for the rights of bankruptcy attorneys, I’m really not that interested.” But after being assured that the focus would be on clients, not on lawyer self-interests, he signed up. Let me associate myself with his advocacy for clients ahead of lawyers. The essence of professional responsibility is to be client-focused.

Abusive Conduct by Consumer Debtor Lawyers

As you know, in addition to our own efforts, we have partnered with trustees to identify instances of poor consumer lawyering. We appreciate your referrals of bad consumer lawyers, and our field offices work hard to investigate allegations and seek civil remedies as appropriate. Last year, we brought nearly 600 actions in court and took more than 2,100 additional out-of-court actions.

A few critics—which generally means those against whom we have taken action—have suggested that the USTP is too rigid in its reading of the bankruptcy laws and requirements. I gladly plead guilty to pursuing an institutional goal of strictly reading the Code and Rules in both consumer and chapter 11 cases. We are textualists and must demand that all parties follow the laws as Congress has written them.

But I ask you: is it overly rigid enforcement to insist that lawyers obtain their clients’ signatures before filing a bankruptcy petition? Is it rigid to expect attorneys to file cases in a timely manner once paid? And is it rigid to expect honest disclosures about the scope of the representation, fees charged and collected, and tie-ins with third parties?

I would suggest that all of these violations are prohibited by the Bankruptcy Code, harm debtors, and ill-serve creditors, the courts, and other stakeholders who depend on honesty in bankruptcy filings.

Examples of Cases Pursued by the USTP

Since we last spoke, the USTP has taken a variety of actions. Beyond the violations I just alluded to, our actions led to serious sanctions against a bankruptcy mill that made a mockery of credit counseling by directing its paralegals to take credit counseling courses for its clients and then filing false certificates with the court.

In another case, we obtained a successful result against a firm for seriously mishandling a client’s simple bankruptcy case that caused a lengthy delay before filing and the dismissal of the case not once, but twice. Rather than accept the consequences of its misconduct and incompetence, the firm appealed. The USTP prevailed in the United States Court of Appeals for the Fifth Circuit, which described the firm’s conduct as “appalling.”

We also have brought cases in which lawyers improperly bifurcated their fees in chapter 7 cases into pre- and post-petition services. Typically, this allows the lawyer to obtain a competitive advantage by advertising low- or no-money down bankruptcy cases. In some cases, the lawyers sell their post-petition accounts receivable—at a discount offset by unjustifiably higher fees—to a factoring company that can sue the debtor irrespective of the discharge injunction and “fresh start.”

We focus on cases in which this bad conduct is advanced by a breach of professional responsibility, such as failing to perform due diligence prior to filing, making false or misleading disclosures to the client and court, or inflating fees to pay the cost of the factoring.

Scrutiny of Lawyers Filing in Bad Faith

Beyond the violations just described, let me address research by some scholars and the Pro Publica investigative journalism organization alleging systemic violations in certain judicial districts. Under its theory, some chapter 13 cases are being filed without any likelihood of confirming a plan or obtaining a discharge. The lawyers charge the higher chapter 13 fee for cases that likely will be dismissed, leading to additional fees for re-filed cases.

A systemic practice by lawyers to prey upon the financially distressed by filing a bankruptcy case in bad faith for the primary, if not exclusive, purpose of increasing attorney compensation would not be acceptable under any legal theory. In addition to debtors, the rights of creditors and the integrity of the bankruptcy system also would be compromised by such behavior.

Some who accept the just-described allegations as true have attributed the problem to broader social or economic issues. But let me suggest there is no excuse to engage in conduct that knowingly violates the Bankruptcy Code and Rules. The decision to file bankruptcy, and the choice of chapter, should be based on the debtor’s best interests, not the benefit to the lawyer. Distressed debtors should not pay a higher fee just so the lawyer can increase professional compensation while creditors collect nothing.

This conduct, if proved true, would represent an enforcement issue that ought to be of concern not just to the USTP, but to all constituents in the bankruptcy process—consumer advocates, trustees, creditors, and the bankruptcy courts.

Criminal Conduct

Sometimes bad consumer bankruptcy practices constitute crimes. Let me highlight one indictment that is related to the USTP’s initiative to scrutinize national bankruptcy mills. Just about two months ago, the United States Attorney right here in Indianapolis announced the indictment of two non-attorney defendants for carrying out a scheme against financially distressed individuals, some of whom were debtors in bankruptcy, as well as against their creditors. Under the scheme, borrowers who were upside down on their automobile loans were induced to turn over their cars to a towing company in return for full payment of their bankruptcy attorney’s fees. The defendants then allegedly exploited Indiana’s mechanic’s lien law to strip the vehicles of the banks’ liens and conducted phony auctions, so that the lenders were deprived of their collateral.

Of course, an indictment is only a charge and is not evidence of guilt. All defendants are presumed innocent until proven otherwise in federal court. The allegations do point, however, to the importance of scrutinizing the behavior of those who might exploit bankruptcy debtors to the detriment of debtors and creditors alike.

BANKRUPTCY CASES WITH MARIJUANA ASSETS

The final topic I would like to address with you is how to deal with chapter 13 bankruptcy cases with marijuana assets, including income. We have spoken before about this subject. Since my letter in April 2017 to all private trustees highlighting the need to refer cases involving marijuana assets to their United States Trustee, we have received scores of referrals. That is not surprising given the cooperation we receive from trustees on so many issues. It also is not surprising because state legalization of medicinal and even recreational marijuana has grown. In 2012, Colorado was the first state to legalize recreational marijuana and, since then, nine other states and the District of Columbia have followed suit. Similarly, medical marijuana legalization on the state level has accelerated. Some form of marijuana is now legal in 31 states, the District of Columbia, Puerto Rico, and Guam.

Our position is simple. As long as the possession, use, and sale of marijuana is a federal crime, then the USTP will protect the bankruptcy system from facilitating such illegal behavior. Federal courts may not be used to advance criminal enterprises.

We have prevailed in almost every consumer and business case we have brought involving marijuana. Our actions have protected trustees from having to administer marijuana assets in violation of federal law, prevented proceeds from illegal marijuana activities from entering the bankruptcy system, and denied the privilege of bankruptcy reorganization to people and companies who seek to use the federal courts to perpetuate criminal activity.

There is an exception to our success. We recently lost a marijuana bankruptcy case in the United States Court of Appeals for the Ninth Circuit. In Garvin v. Cook Investments, Garvin v. Cook Invs. NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019), the Ninth Circuit decided that the Bankruptcy Code allows approval of a chapter 11 reorganization plan for a marijuana business. The decision involved an interpretation of the confirmation requirement in section 1129(a)(3) that the plan be “proposed in good faith and not by any means forbidden by law.” Insofar as this language also appears in the section 1325(a)(3) confirmation requirement governing chapter 13 plans, the Cook Investments decision may have an impact on chapter 13 practice as well.

In addition, the Ninth Circuit made another holding in Cook Investments that may have consequences for bankruptcy practice when it declared that we could not appeal an interlocutory order denying dismissal of a chapter 11 case because that motion was not renewed at confirmation. This potentially will add additional and burdensome steps to many chapter 11 cases that do not involve marijuana assets.

It is important to note that the Cook Investments decision does not apply beyond the borders on the Ninth Circuit. Furthermore, some lower courts outside the Ninth Circuit have cast doubt on the Cook Investments decision or narrowly construed it. One court within the Ninth Circuit even limited the impact of the Cook Investments holding.

The USTP will apply the Cook Investments decision within the Ninth Circuit as long as it remains controlling law. Otherwise, the USTP’s position remains steady and we will continue to oppose the administration of marijuana assets in the bankruptcy system in appropriate cases.

It remains very important that chapter 13 trustees continue to refer cases involving marijuana assets to the United States Trustee for appropriate action. That directive remains valid even within the Ninth Circuit because the USTP, not private trustees, should bear the burden of determining how to apply Cook Investments to the facts of the case at bar. Your continued cooperation is both essential and appreciated.

CONCLUSION

That wraps up my report. The chapter 13 trustee community continues to distinguish itself for its diligence and professionalism. Your work makes possible the “fresh start” that Congress provides in law. You help keep families together in their homes and relieve the emotional pain of financial distress. Your work allows creditors, including smaller creditors who lack the resources to withstand non-payment on just debts owed to them, to receive at least partial repayment. Millions of Americans continue to contribute to the national economy because you carry out your important duties.

Thank you for your service to the bankruptcy community. And thank you for your partnership with the United States Trustee Program as we seek to improve the bankruptcy system for debtors, creditors, and all stakeholders. I hope you enjoy a pleasurable and informative annual seminar.

# # #