Trustee’s Office Becoming a Debtors’ Haven : Bankruptcy: Tight budgets, crushing workload make it difficult to uncover hidden assets. One official tells creditors they are basically on their own.
Most hearings in the U.S. bankruptcy trustee’s office here--a Spartan assembly room where debtors without assets go to plead their cases--are dispatched in minutes. But a recent session took a remarkable turn.
Instead of upholding the debtor’s statement that he had no money, bankruptcy trustee Charles Daff bore down, demanding amplification where simple “yes” or “no” answers usually suffice. After an hourlong examination, he refused to approve the business owner’s request to be relieved of his obligation to repay debts of more than $600,000.
Daff said he suspected that some assets might have gone unreported--perhaps had even been hidden away intentionally in anticipation of the bankruptcy filing.
Then, in a 15-minute discourse, he told the 40 or so assembled creditors that they should not expect much help from the bankruptcy system. If they wanted to recover the money they said they were owed, he told them, they should pool their remaining resources, hire a lawyer or an accountant who specializes in finding hidden funds, and conduct their own search.
Daff acknowledged that trustees are supposed to be the people’s watchdog to ensure that debtors’ claims of insolvency are truthful. But there often is little they can do, he said, to prevent abuse.
The main reasons, Daff and others in the bankruptcy system say, are the courts’ crushing workload and tight budgets that leave judges and trustees little choice but to close cases as quickly and economically as possible. As a result, creditors seeking payment find that they are pretty much on their own.
“The message we got was that the system isn’t going to help us and certainly isn’t going to punish” the debtor, said Debby L. Zajac of Long Beach, one of the creditors at the hearing over which Daff was presiding.
“We are all mad as hell,” she said, “but most of us just don’t have any money left to hire an attorney.”
The three federal bankruptcy judges assigned to Orange County received 14,030 new cases last year. For the three previous years, the system had handled more than 40,000 cases. Their main assistants are the trustees--eight of them for the entire county. Hearing schedules require each trustee to handle as many as 2,100 cases a year--an average of 175 a month.
Furthermore, the trustees--private lawyers who specialize in administering debtors’ estates--have little financial incentive to pursue complicated cases in which they suspect fraud. They are paid a flat $45 fee for each so-called no-asset filing. If they choose to search for hidden assets, they are entitled to keep 3% of whatever they recover. Meanwhile, they must foot all the bills themselves. If they recover nothing, they are paid nothing.
As Daff explained during his speech to creditors, his office is certainly willing to help, but he has no resources to tackle a case on his own.
“There’s a lot of pressure from the U.S. trustee’s office to go after frauds when we see them, but the paradox is that private trustees don’t get paid for doing that,” said Robert Mosier, a Costa Mesa lawyer.
Mosier recently withdrew from the trustee panel in Orange County. “The reality is that, unless the creditors come in and point out the fraud and then track down the money, you just can’t do it,” he said.
Other trustees, bankruptcy lawyers and judges uphold Daff’s position that creditors in Orange County who want to recover funds from a debtor intent on not paying will likely have to organize and do their own hunting.
That Daff even questioned a debtor’s claim to have no assets may have been largely because that particular hearing drew a large and vocal contingent of angry creditors, bankruptcy professionals said.
“We work fundamentally on an honor system,” said Marcy J.K. Tiffany, chief U.S. trustee for the Central District, which includes Orange, Los Angeles, Riverside and San Bernardino counties and is the busiest in the nation, with 98,000 cases filed last year.
As a result, using the bankruptcy system as a haven is “incredibly easy,” Tiffany said, for scam artists and unscrupulous business operators who take clients’ money, use it for lavish corporate trappings or personal belongings, then file for bankruptcy protection when the customers begin complaining.
“How many no-asset cases really involve a debtor with no assets?” Tiffany asked in a moment of introspection during a recent interview. “We have absolutely no way of knowing.” And at the rate the government pays trustees “we just can’t afford to find out.”
Tiffany estimates that 20% of the bankruptcy filings in the Central District last year were legitimate efforts by individuals or businesses to regain their financial footing. The rest, she said, were efforts to use bankruptcy to halt legitimate foreclosures and evictions, block civil litigation and sometimes to seek shelter from civil or criminal investigations.
In a recent case, for example, the Federal Trade Commission sued and reached a settlement with a Sacramento-area man, William Moreland, who was marketing gold-mine interests by phone.Moreland agreed to shut down and to reimburse investors fully after FTC agents accused him of selling securities illegally.
But the ink had barely dried on the settlement papers when Moreland filed for bankruptcy protection, effectively canceling out the reimbursement agreement.
The FTC went to bankruptcy court and again argued its case--but to no avail. The court ruled that the bankruptcy filing was not fraudulent and relieved Moreland of the obligation to honor the settlement and repay investors.
The bankruptcy court system is clogged, Tiffany said, mainly because of efforts to avoid liability.
Lawyers who handle bankruptcy cases don’t deny that there is a problem, but some of them maintain that getting a debtor into bankruptcy court provides creditors with more--not less--control of the situation.
“Sure, the number of scams is up. It’s the recession--the time is ripe for people to be taken advantage of,” said Ronald Rus, whose Irvine firm, Rus, Miliband, Williams & Smith, specializes in representing trustees and creditors.
“The thing people have to understand is that you are better off if a bad guy does file bankruptcy. That puts him under the jurisdiction of the court and gives you an opportunity to see if there is anything to collect to pay the creditors. That’s the real issue in bankruptcy,” Rus said. “Are there assets to collect?”
But that’s just where the system is most likely to break down today, said Newport Beach lawyer Theodor Albert, a member of the trustee panel in Orange County.
“We’re attempting to achieve two perhaps opposite goals,” he said. “We have to deal with a massive volume of filings, and we are trying to be more efficient with quicker and less expensive resolution of cases.
“If it is our priority in society to catch every single culprit,” he said, “then we have to alter the compensation so someone has the incentive to do that. With what we have now, some crooks will make it through the net.”
That’s what Daff said in his impromptu civics lecture.
“We have people here who have lost substantial sums of money,” he said. “But does the debtor have assets that we can trace and recover, through litigation and hours and hours of expensive work by accountants?”
Pointing out that he is not an government employee, Daff explained that he takes such cases only on contingency. “I could go broke” spending much time on a case, he said, so “any creditors that want to participate with me, that want to discuss sharing the costs . . . are welcome.”
The creditors have the right to hire private counsel and file claims with the bankruptcy court in an effort to recover hidden assets, Daff said, but that rarely occurs.
“Typically what happens in these cases,” Daff said, “is that if I get 50 people together, everybody with substantial losses, everybody says, ‘ I can’t afford another dollar, ‘ and we all leave the room and nothing happens. Truthfully. It goes on and on.” And it is the creditors, not the debtor or the trustee, who suffer, he said.
At one point in his plea, Daff stopped and looked down at a recorder taping his speech: “I’ve said too much already.”
But Tiffany and others who work with the bankruptcy court say that Daff’s comments could be a wake-up call.
“Sometimes the system is blind to everything but the protection of the debtor,” Tiffany said. “That causes the courts to hesitate too long to take control.”
Trustee Albert said: “I think Chuck Daff’s point is well taken. . . . All he was saying is that the trustee is not a policeman. Nobody is paying his salary. He is a civil litigant, just like the creditors, and he has to make a case pencil out financially.
“The creditors who already are in the soup have a lot more incentive than the trustee to invest money in chasing down assets.”
Bankruptcies Still High
Orange County bankruptcy filings declined slightly in 1993, but the total remains nearly twice as high as five years ago.
1989: 8,306
1993: 14,030
How Bankruptcies Break Down
1989 1990 1991 1992 1993 Chapter 7 5,957 7,314 9,918 12,066 11,874 Chapter 11 362 309 457 416 393 Chapter 12 0 0 0 0 1 Chapter 13 1,987 1,719 1,993 1,838 1,762
Bankruptcy Glossary
Chapter 7: Allows businesses and individuals to keep some personal property and, in some instances, a home and automobile. Other assets must be sold to pay off at least part of debt.
Chapter 11: Businesses protection from crditors while reorganizing operations and establishing payment plan.
Chapter 12: Special category for farms.
Chapter 13: Allows individuals protection from creditors and allows extended payments up to five years.
Source: U.S. Bankruptcy Court; Researched by JANICE L. JONES / Los Angeles Times
