Good evening. Let me begin by thanking Judge Silverstein and the Delaware Bankruptcy American Inn of Court for the invitation to join you tonight to provide an update on some of the priorities of the U.S. Trustee Program (USTP or Program) and to hear your perspectives on the state of the bankruptcy system. I am pleased to be here with members of the bar and in the company of the bankruptcy bench in Delaware.
I also am happy to be joined by our Acting United States Trustee Andy Vara, along with other colleagues from our Wilmington office who are well known to all of you who litigate in bankruptcy court here. They are among the most dedicated and outstanding public servants you will find anywhere. They work very hard, often without any public recognition, to advance the USTP’s mission to promote the integrity and efficiency of the bankruptcy system for the benefit of all stakeholders – debtors, creditors, and the public.
THE DELAWARE BANKRUPTCY BENCH
This occasion provides me an opportunity to express my appreciation for the Delaware bankruptcy bench. Bankruptcy is a rough and tumble area of law. There are time urgencies that do not apply in other areas of the law. In addition, there are numerous parties to a case with a multitude of competing interests who are fighting for their share of the limited estate pie. And quite frankly, occasionally there are times when bankruptcy judges get caught up in the combat, but that does not happen here in Delaware. In this court, all parties receive a respectful hearing. The judges listen to what the parties have to say, and the court does not expect the USTP to stay silent on issues even when those parties with a pecuniary interest in a case line up on the other side. Regardless of the outcome of a particular decision, all parties know that their views were thoughtfully considered.
ROLE OF THE USTP IN THE BANKRUPTCY SYSTEM
The role of the USTP in the bankruptcy system is unique among federal agencies. As Congress noted in the Program’s legislative history, we are the “watchdog” of the bankruptcy system. We do not represent the Government as a claimant in a case. Instead, we are a neutral enforcer of bankruptcy law.
Our institutional role is to advocate for what we consider to be the most faithful reading of the Bankruptcy Code. We endeavor to act with prudence and judgment, and our purpose always is to ensure that all participants in a case comply with statutory requirements. As you well know, that sometimes makes us the “skunk” of the bankruptcy garden party.
Earlier this year, Deputy Attorney General Rod Rosenstein spoke about the importance of ensuring compliance with the law. In a speech to a group of compliance professionals, the Deputy Attorney General compared good lawyers to “nitpickers.” He went on to say:
“[T]he law demands precision and close reading. We are the dotters of I’s and the crossers of T’s. Small details like commas and semicolons matter to us. In discussing the attributes of a lawyer, the great Supreme Court Justice Antonin Scalia explained that ‘[o]ne of the distinctive skills of our profession is to discern ambiguities, inaccuracies, and insufficiencies that would not occur to the ordinary’ person.”
I could not agree more with Deputy Attorney General Rosenstein. We in the USTP proudly wear the mantle of “nitpicker of the bankruptcy system.” So it is in that role that we want to ensure that the commands of Congress as expressed in the Bankruptcy Code are followed by all participants, large and small, from individual debtors to international corporations, from bankruptcy boutiques to behemoth professional firms.
Although we hope to prevail on every legal issue we bring to the court, we aspire to an even higher goal. Our role is to promote the coherent and consistent application and development of bankruptcy law throughout the country. We believe we succeed if we identify issues and present the law and facts, so that the courts can adjudicate matters with the benefit of a fully developed record of facts and arguments. This necessarily requires that sometimes we appeal. In fact, each year, we participate in about 100 appeals, including about two dozen before the circuit courts and the Supreme Court just this past year.
Administrative, Regulatory, and Enforcement Responsibilities
The USTP carries out a wide range of administrative, regulatory, and enforcement responsibilities. A great deal of our resources are devoted to core duties under the Bankruptcy Code, such as appointing and overseeing chapter 7 and 13 trustees, approving credit counselors and financial education providers, determining whether consumer debtors qualify for chapter 7 relief under the means test, and reviewing chapter 11 operating reports.
On the enforcement side, in the aggregate, last year the USTP took more than 30,000 actions, in and out of court, for a potential monetary impact of $2.8 billion. Since we began tracking these data 15 years ago, we have taken more than 775,000 actions with a potential impact of more than $21 billion.
ELEVATING THE PRACTICE OF CONSUMER BANKRUPTCY LAW
One of the top priorities of the USTP is to address what appears to be an all too pervasive problem of underperforming consumer debtor lawyers who harm their clients, creditors, and the entire bankruptcy system. Based on the almost unanimous views shared with me during a series of meetings I held a few years ago with stakeholders – including judges, trustees, and my own colleagues within the USTP – we launched an initiative to investigate and combat such abuse by consumer debtors’ attorneys. The Program increased the number of actions it brought by 30 percent in 2016, and we have maintained an elevated level of activity ever since. By addressing this issue in a coordinated manner, we seek to improve the entire bankruptcy system.
This is both a local and national priority. Most action remains at the local level against poorly performing attorneys who operate in one jurisdiction. For example, just last month, the bankruptcy court in Delaware sustained our motion against an attorney who bifurcated her services and inflated the fee she charged chapter 7 debtors who could not pay her up front. For those debtors, the attorney used a third-party fee factoring service, which the debtor contracted with to pay the higher fee over time. The court found the attorney’s fees to be unreasonable inasmuch as they were inflated to offset the cost of the factoring service, and reduced the fees accordingly.
Nationally, we focus on firms that advertise to consumer debtors primarily through the Internet and that operate in many states. The best example is our litigation against one firm whose lawyer has accused us of nitpicking. We have brought actions against this firm in a number of jurisdictions. We have proven in court that the firm has engaged in a plethora of improper practices, including: entering into an improper scheme with a towing company that took custody of debtors’ automobiles in a way that harmed both debtors and creditors who were deprived of their collateral; failing to oversee non-attorneys who employ high-pressure sales tactics and engage in the unauthorized practice of law in order to “close” sales of bankruptcy services to potential debtor clients; and entering into “partnerships” with attorneys who fail to satisfy even minimal professional standards for representation of their clients.
In the words of one judge who ruled in the USTP’s favor and imposed a five-year practice ban and severe monetary and other sanctions, the firm’s business model emphasized “cash flow over professional responsibility.” The judge also called the towing company scheme “a scam from the start.” We have prevailed in one appeal by this defendant in the district court, and the firm has appealed to the circuit court of appeals. Another appeal to the district court remains pending.
The Program also has brought actions based on a wide array of other improper activities that include abusive use of appearance counsel, the improper bifurcation of services, and factoring arrangements that inflate fees beyond what is reasonable under section 329 and may deprive debtors of a “fresh start” by subjecting them to collection actions. I commend to you an article that appeared in the October issue of the ABI Journal, written by Associate General Counsel Adam Herring, which discusses many of the bad practices by some consumer debtor attorneys that we have been pursuing.
Some say that our insistence on compliance with the rules governing proper attorney practice and compensation would price consumer lawyers out of the market and threaten “access to justice.” I have sympathy for the economic plight of attorneys who conscientiously and skillfully represent consumer debtors. But “access to justice” does not justify substandard bankruptcy mill practices. Nor does it justify sharp or slipshod practices that ill-serve the debtor and waste the resources of private trustees, the USTP, and the courts. In the view of the USTP, “access to justice” should be about the client, not the lawyer. Period.
In the end, the bankruptcy system needs a coordinated effort that encompasses enforcement and education to uniformly elevate the practice of consumer bankruptcy law. We all have a part to play.
CHAPTER 11 PRACTICE
Turning to the chapter 11 side of our practice, there are many issues I could address – from creditor committee formation to the appropriate scope of the disclosure of investments by professional firms seeking employment in a bankruptcy case. Tonight, I limit myself to just three issues of some currency within the USTP: the employment of chief restructuring officers (CROs); the more active role of the USTP in asbestos bankruptcies; and current questions and answers about the new chapter 11 quarterly fee schedule that became effective at the beginning of 2018.
Chief Restructuring Officers
All of us are well aware of the critical role that CROs play in the financial rehabilitation of businesses, both inside and outside of bankruptcy. Debtors rely on their specialized expertise to preserve assets and, optimally, to turn around a business that otherwise was headed to a fire sale liquidation. Under the Bankruptcy Code, CROs are hybrid creatures, acting as a professional for some purposes and as management for other purposes. These mixed duties were not contemplated by the draftspeople of the Code who set forth standards for the employment of debtor professionals. Section 327 would preclude such employment because a prepetition CRO would not be disinterested since the CRO is an officer and therefore an insider of the debtor. In addition, the CRO may be a creditor.
In an effort to harmonize the Code with the facts of a CRO retention, the USTP entered into a settlement in 2001 with Jay Alix & Associates and its affiliates. The Delaware bankruptcy court approved the settlement, which provided that we would not object to a CRO retention under section 363 (which governs transactions outside the ordinary course of business) as long as certain key disclosure and conflict provisions contained in section 327 were followed. Thus was born the so-called “J. Alix Protocol.”
The USTP’s policy on CROs has been transparent. It has been widely disseminated and we have consistently followed it over the past 17 years so the CRO industry and bankruptcy lawyers would not be ambushed by unexpected USTP objections. By and large, the courts have adopted the Protocol and created settled law – even without deciding disputes over the fundamental provisions of the Protocol.
Importantly, the Protocol appears to have provided a satisfactory and principled approach that protects the estate against self-dealing, while allowing the firm to perform mixed professional and management duties. A few courts have favored a stricter application of section 327, but, by and large, the Protocol has been adopted by the courts and it has worked.
Nonetheless, we recognize that time moves forward and industries change. So, about two years ago, we began to engage stakeholders on whether those industry changes may militate in favor of revisions to retention terms in bankruptcy cases. We have received valuable ideas for tweaks, but do not expect to make major shifts in our legal position. I have said in numerous public fora that we would alter the Protocol only after a public process involving publication of draft changes, public comment, a public meeting, and later publication of a new Protocol setting forth any modifications to the USTP’s legal position. The press of competing priorities has slowed that process, but again, there should be no surprises.
Recently, I became concerned about the future of the Protocol when a bankruptcy court in the Southern District of New York overruled an objection of the U.S. Trustee in the Nine West bankruptcy case. The court entered an order that allowed for the employment of a CRO under section 363 even though the applicant had served on the company’s Board of Directors for more than two years up until the eve of bankruptcy. The opinion suggests that section 363 alone may be a sufficient basis to employ a CRO.
There were unusual facts in the Nine West case – namely, a principal of the CRO admitted that he served on the debtor’s Board, but asserted that he failed to perform his duties as a Board member and therefore was eligible for subsequent employment by the debtor company. I had to think about the implications of that position for a minute – a director who performs his duties would be disqualified, but one who does not discharge his duties would be eligible for employment. We reject that position.
We also were concerned that if every retention requires a fact intensive review as suggested by the applicant in Nine West, then consistency would be replaced by ad hoc review and inconsistent results. In other words, we would return to the uncertainty and inconsistency that the Protocol successfully replaced 17 years ago.
Beyond the court’s holding, I was disturbed by the court’s suggestion that the USTP was backing away from the Protocol. A key provision of the conditions for applying the Protocol was that the USTP would object under section 327 if a CRO failed to adhere to every provision of the Protocol. As I have said, a major benefit of the Protocol is the transparency and consistency of the USTP’s legal position. So let me make it clear: the USTP does and will continue to follow the Protocol assiduously. And, if we decide to alter our legal position because of changes in the industry, we will do so deliberatively and only after following a public process.
Retention of Liquidators
There are other important issues percolating that do not directly implicate the CRO Protocol, but which require the courts to decide “who is a professional” requiring employment under section 327. In this court, judges in two cases handed down separate, but essentially contemporaneous, decisions – one at the end of September and another in early October – pertaining to the employment status of liquidators. Our view was that the scope of employment went beyond an “ordinary course” professional and thereby mandated application of the disclosure and disinterestedness requirements of section 327. In their decisions, the judges disagreed and overruled the objections.
Our actions and the court’s decisions illustrate my earlier point about the role of the USTP in teeing up issues for judicial resolution. As a result of our efforts, the court ruled and provided criteria for determining who is a “professional.” A close question of law and fact was resolved reasonably, there was no appeal, and now all parties should comply. That provides certainty and consistency going forward, which is beneficial to all stakeholders.
Like all of you, we are instructed by the court’s opinions. We will now go about the business of continuing to police these engagements to ensure that transparency and accountability are preserved and that parties who “push the envelope” further, beyond the boundaries set by the court, are met by an objection from the U.S. Trustee.
The Department of Justice (DOJ) recently garnered some press attention with public statements and court filings in bankruptcy cases involving asbestos trusts. The DOJ filed a Statement of Interest and an objection to the debtor’s disclosure statement in a case pending in the Western District of North Carolina. In the statement, DOJ clearly set forth its objections to plan provisions that we view as inviting fraud and abuse to the detriment of future claimants and the integrity of the bankruptcy process. Workers and customers who manifest asbestos disease long after their exposure frequently are short-changed because the trust is unfairly depleted.
Among the objectionable practices cited are:
- Lack of transparency in the claims process that precludes parties from monitoring whether non-meritorious claims are being submitted, approved, or paid.
- Claims procedures that appear to invite fraud and abuse, such as by allowing the indiscriminate filing, withdrawal, and refiling of claims. Such practices may allow present claimants to thwart state court discovery and collect from multiple trusts and state tort actions without having to disclose that they are seeking multiple recoveries based upon inconsistent assertions of exposure or medical evidence of disease.
- The failure to require independent, mandatory audits of trust operations and claims.
- And the absence of safeguards against conflicts of interest and excessive professional fees in the claims administration process.
Because these trusts have paid claims in near total secrecy for such a long time, it was impossible to tell how much of this depletion was due to fraud or improper action. But when the bankruptcy court in the Western District of North Carolina in the Garlock Sealing Technologies case finally was able to partially pull back the curtain and look into selected trust claims, it found nothing less than a “startling pattern of misrepresentation” in which attorneys were filing claims based on representations that contradicted their statements in other cases. As a result, the court reduced the claims estimation by 90 percent. The Garlock case was a game changer.
It is not often that a debtor company challenges the plaintiffs’ lawyers in an asbestos case. The company usually pays a sum certain and offloads its tort liability to a trust that will pay only a fraction of the potential liability. The tensions that operate in other chapter 11 cases are absent. The debtor has no financial interest in the operational and financial integrity of the post-confirmation asbestos trust. In fact, the debtor usually allows the tort lawyers to run the case and to impose standard trust provisions that exhibit the flaws just described.
In the past, the USTP has participated in asbestos cases in a more narrow way. We are well aware that the authority of both the courts and the USTP is very limited at the post-confirmation stage of a case. But as we analyzed the depth of the problems in asbestos cases, we determined that we should try to do more at the front end of the case. Accordingly, you can expect that, consistent with DOJ’s statement, the USTP will participate in newly filed asbestos cases in at least two ways.
First, we will carefully scrutinize the proposed appointment of a Future Claimants Representative (FCR) and urge bankruptcy courts to adopt an open and transparent selection process rather than automatically approving the handpicked nominee of the debtors and the plaintiffs’ bar. We also will object if the candidate put forth by the debtor and plaintiffs’ lawyers lacks the independence necessary to protect the trust from fraud and abuse. The FCR is a fiduciary bound to protect those whose symptoms have not yet manifested. The interests of those claimants conflict with those of putative present claimants who are represented by plaintiffs’ lawyers who essentially control the case.
It is an open secret that FCRs and other trust fiduciaries are usually selected from a small pool of professionals who have approved boilerplate provisions in previous trusts and are promised lucrative service to the post-confirmation trust. In fact, I saw an article earlier this year in Forbes magazine describing an episode of the popular cable television show “Billions” in which real-life asbestos trust fiduciaries made cameo appearances. One of the characters described a favor he was about to do for a friend: “I have lined up a seat for you on the . . . asbestos trust, rubber-stamping claims. . . . that’s a nice little sinecure.” https://www.forbes.com/sites/legalnewsline/2018/06/06/art-imitates-life-billions-describes-six-figure-part-time-jobs-on-asbestos-trusts/#adfe2b1301b0
In our view, the debtor and plaintiffs’ lawyers have no right to select the FCR. By law, it is an appointment made directly by the bankruptcy court as distinguished from the application process for the debtor’s estate-paid professionals under section 327. We vehemently disagree with the view that the court must approve the candidate put forward by the debtor and plaintiffs’ attorneys unless an objecting party can prove a disqualifying conflict of interest.
Not long ago, we filed our first objection to an FCR who has served in that role in a number of other cases. Although the court said that it would insist that the FCR consider negotiating modifications to the proposed plan, the court overruled our objection to the debtor and plaintiffs’ lawyers’ selection. We have appealed that decision.
Second, we will object to any disclosure statement and plan that does not fully explain the terms of the trust. And we will object to the absence of provisions to provide transparency and to prevent fraud and abuse. In our view, these omissions would render the plan unconfirmable on numerous grounds, including that the plan was not proposed in good faith and would be implemented by means prohibited by law.
Although it may be new for the USTP to take such an active part in asbestos cases, our objections are not new. As in non-asbestos cases, we are seeking to protect the rights of the less powerful stakeholders and, in doing so, are advancing the integrity of the bankruptcy process. In other words, you will see the same notes we traditionally play, just in a different melody. So, stay tuned for more USTP actions in asbestos cases.
The final topic I will address pertains to quarterly fees paid by chapter 11 debtors in amounts that vary according to disbursements made each quarter. As you know, Congress recently enacted an increase in quarterly fees for the largest chapter 11 cases. That increase became effective in January 2018. Some practitioners have raised questions about the application of the increase, many of which are temporal because the fee increase applied to transactions that were devised prior to congressional action. But I think some facts about the new fee schedule may shed some useful light on the matter.
Most of the quarterly fee revenues are deposited into the U.S. Trustee System Fund (Fund). Debtor filing fees, certain fines, and income from Treasury bond investments also are deposited into the Fund. The USTP does not spend this money. We spend only what Congress appropriates to us – and not one penny more. The Fund offsets appropriations to satisfy the congressional objective that the bankruptcy system be funded by those who enter the system.
The recent quarterly fee increase has four parts:
- The increase only applies to debtors with disbursements of $1 million or more. The fee is now set at the lesser of one percent of disbursements or $250,000. This rate remains lower than the rate charged to many smaller estates.
- The increase will sunset after five years.
- Even before the sunset, the increase will not apply in any year following a fiscal year for which the ending balance in the Fund exceeds $200 million.
- Two percent of all quarterly fee revenue – not just limited to the fee increase – is now allocated to the courts to fund 18 bankruptcy judgeships, including two new judgeships and the extension of five others here in Delaware.
Let me provide a few numbers that help us measure the impact of the fees:
- The fee increase affects only about 10 percent of new cases filed each year. That is about 750 newly filed cases annually and a total of 1,500 cases pending at any given time.
- Only about 10 percent of that 10 percent pay at the maximum rate for some portion of the year. That is about 75 newly filed cases and a total of about 150 cases pending at any given time.
- And about half of those, or 40 new filers and 80 of all pending debtors, pay the maximum amount for the entire four quarters of the year.
Despite these small numbers, some lawyers have raised concerns about the impact on certain middle-market cases. We look into every case in which we hear about a specific concern. In general, the middle-market cases that have been cited had the following characteristics
- an administrative insolvency wholly apart from an increase in fees;
- an attorney fee burn rate of $1 million per month or more; or
- the cases were jointly administered and one or more affiliates paid the maximum rate, which means that the combined debtor enterprise disbursed at least $100 million per year and was not a middle-market case.
Some lawyers have raised the issue of the impact of the fees on roll ups, whereby a pre-petition lender conditions post-petition financing on being paid on its pre-petition loan and leapfrogs over other creditors in priority of payment. First, I would note that the American Bankruptcy Institute’s Commission on the Reform of Chapter 11, on which I served as an ex officio member, recommended a ban on many kinds of roll ups because they may be unfair to creditors and debtors alike. Second, those who now complain about quarterly fees on roll ups argue that the payment of the pre-petition loan was not a bona fide economic transaction. But if they had admitted that when they sought court approval of the roll up, the request should have been denied. Proponents of roll ups cannot have it both ways.
One court recently redefined “disbursements” to exclude money paid on a form of roll up. The USTP took a contrary position that “disbursement” essentially means any “payment.” We are appealing the bankruptcy court’s decision. Our position reflects law that has been well settled for about 20 years. I would note that if we redefine “disbursement,” we will be in uncharted territory. The term “disbursement,” or a variation, is used six times in title 11, pertaining to both consumer and business cases.
The USTP is always interested to hear about the functioning of the bankruptcy system. We remain interested in knowing about the impact of the quarterly fee increase. I suspect, however, that much of the impact is short-term in nature and pertains to a modest-sized universe of cases.
I am grateful for your time and attention this evening. The USTP has an independent role to play as watchdog. As such, we do not expect to win any popularity contests. However, we will not, and should not, compromise our independence or participate in a case like other stakeholders who act to vindicate their financial interests. To us, bankruptcy practice is not about making a deal. It is about vindicating the integrity of the law as we understand the words of the law that Congress, and only Congress, can make.
I wish you another successful year with the Delaware Bankruptcy American Inn of Court. Thanks again for having me here tonight.
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