Bankruptcy

Lawsuits in Chapter 7 Bankruptcy Cases

By Joseph McDaniel, Esq.

Like you were going to give it a chance to get stale.

But a Chapter 7 bankruptcy is also like a probate estate.

An estate is created when a decedent becomes a decedent, or when a debtor files and becomes a debtor; there is a Court with jurisdiction over the Estate, and the Court, with the help of a fiduciary, is ultimately going to decide who is going to get paid from and who is going to pay money into the estate.

And there are specialized statutes that give the fiduciary in both sorts of estates the right to sue people or entities to bring money into the estate.

In a Chapter 7 bankruptcy case, the trustee has various tools for suing in his lawsuit. They include preference laws, fraudulent transfer laws, turnover statutes concerning property of the estate that was or wasn't listed in the case by the debtor, and a bundle of other specialized statutes.

But a trustee's lawyer in a bankruptcy case has a little bit of risk when he files a lawsuit to collect money or property.

He might lose. And if the case is a no-asset case, there's nothing to pay the attorney for the trustee in the Chapter 7 bankruptcy.

That's not a big deal for a personal injury lawyer; he files lawsuits and doesn't collect with some frequency, and it doesn't bother him much, because the profit margin on cases when he does collect makes all the "dry well" lawsuits unimportant.

A trustee's lawyer, on the other hand, is normally billing on an hourly basis.

The reason that works adequately for a bank lawyer is that the bank lawyer is typically going to get paid for every dollar he bills.

But the best a trustee's lawyer can hope for is to get paid for all the hours he spends in most of the lawsuits he files.

This is not to try to make anybody feel sorry for a lawyer who represents trustees. Most folks (like me) are rooting for the poor debtor, if they root for anybody, because the trustee is the guy who goes after a preferential payment to mom. And anybody who sues mom with any frequency will develop some bad press and some bad karma.

But once there is money in a bankruptcy estate, from any source (a non-exempt car; a tax refund received after the filing, for instance), the lawyer for the trustee can afford to be a little more adventurous.

Which translates to: the debtor gets sued. Because if there's bunch of litigation, the trustee's lawyer may well get paid for it, even if there's no recovery for the estate.

Now, I didn't say a trustee's lawyer will "churn" the estate by filing unnecessary litigation; the trustee's lawyers I've known over the years have been models of decorum and ethical conduct. But knowing that there's cheese in their haversacks makes a trustee's lawyer more likely to pull the trigger on a suit than when the cupboard is bare.

So why would you get sued by the trustee in a Chapter 7 case?

Well, it's often a preference theory, or a fraudulent transfer theory.

And the lawsuit may be against mom, for getting paid on a pre-existing debt within a year of filing the Chapter 7 (because mom is an insider), or the lawsuit may be against a sister, for receipt of a fraudulent transfer because the debtor gifted her the Corvette within four years of the bankruptcy filing.

And a smart trustee's lawyer will often stack causes of action, hoping that if one legal theory for collection of money or property into the estate doesn't work, the other one will.

There are three ways to deal with any such lawsuit, if you're the lucky target.

And luck has a lot to do with it, because a trustee has vast discretion to sue, or not; and to settle, or not.

I recently had a case where the trustee returned a $1,000 tax refund check to the debtor. Knocked me flat on the floor. The debtor had brought the check to the first meeting of creditors in her case, and the trustee looked at the spaghetti-complex estate, and said, I don't want to take a thousand dollars only to have to spend twenty thousand dollars of time administering an estate this complicated.

My debtor was so overcome she was close to tears.

And tears of joy are rare in bankruptcy cases.

But that's where luck comes in; I've seen that once, in thirty years.

And once you're lucky enough to get sued by a trustee, you have to ask, why me?

Well, as lousy as it seems to get sued by a trustee, or to have an exemption objected to, and as little comfort as this may be on your way to your fresh start, it's not that bad, yet.

If you're scraping off a million or two in overall debt, and you've kept all your personal assets, and you're on track to get a discharge or have gotten a discharge, you're doing pretty well, even if you or mom gets sued for a preference, or for a fraudulent transfer, or if the trustee has objected to an exemption, major or minor.

Because you're in this for the discharge, and it's good to keep your eyes on the prize.

And whenever you get sued, you get to consider at least three different strategies, all of which have their place.

One is to do nothing. If the trustee has you dead to rights, having your lawyer call and negotiate a surrender with terms to get back the Corvette from sister and to get it to the trustee so he can sell it for the benefit of creditors is a good choice.

But that's not really doing nothing. Doing nothing means to let the complaint go to a judgment by default, and then let the trustee's lawyer get started collecting the judgment, by garnishment, or some other technique.

That's probably a dumb alternative in most cases; but I can think of a few scenarios where I might suggest it. Darn few, however.

Another alternative is to fight the complaint like it was World War III.

In general, spirited litigation in a sucker's game, no matter what, because the litigator gets paid win or lose in a non-contingency case. That doesn't mean a Complaint isn't answered. Ordinarily, you get one extension to answer (I prefer open-ended extensions with a ten day written notice of termination of extension, and lawyers I've worked with over the last thirty years are generally okay with that. Some law firms won't give extensions as a matter of policy, so poo on them and their offspring), in order to see if a quick settlement can be reached.

If no settlement appears to be forthcoming, then litigation will proceed. And a couple of years down the road, depending on the Court and the complexity of the case and the money that gets poured into the litigation, an answer to the question flows from the Judge in the case.

If you're curious, and you ought to be, you should know that nothing is right, wrong, or sideways until the Judge says it is. Lawsuits in Bankruptcy Court are based on differences of opinions on, often, very technical issues that don't even exist outside of bankruptcy law (like preferences, for instance).

And people who desperately want their day in Court often wish they hadn't had that day, because nobody knows exactly what the Judge is going to do until she does it.

The third way to deal with Complaints is to settle them.

I tend to favor settlements, because this ain't my first rodeo.

I worked for two U.S. Bankruptcy Judges for a year each, after working for a brilliant, hard-working, fearless State Court Judge for six months or so, waiting to see if I'd passed the bar in Arizona without taking the bar review course, because I was too poor to afford that course. Passed anyway, but I don't recommend that strategy.

But having worked for three different Judges with very active calendars, I now know the Truth(tm): it's very, very difficult to guess at the front end of litigation what the tail end will reveal.

Putting it a different way, Judges are hard to predict; that's what makes a lawsuit a horse-race.

But what we do know for certain is that litigation is the most time-consuming and expensive way to determine an outcome.

Sometimes a settlement is impossible, because of acrimony on the part of the opposing clients (that just means they hate each other; you see it a lot in divorce cases), and sometimes everybody gets together over cookies and looks at the numbers and makes it all go away.

Even advocates from the Dark Side like cookies, you know?

Another thing that will interfere with an intelligent, rational settlement process is when the lawyer for one side is in love with the case, and can't bring himself to let go.

You tend to see that among youngsters. It generally takes only one or two learning experiences for lawyers to understand that litigation is expensive and the results unpredictable, except that the lawyers doing the litigating get paid.

That frustrates some clients, but most understand that if a lawyer is going to jump in front of a bus for you, he'll want to be paid for the privilege.

The good part of paying lawyers (and, of course, there isn't any) is that the inevitable five to twenty-five thousand dollar cost of a moderate piece of litigation that moves efficiently helps a client make rational economic decisions, and eventually make it to the other side of the litigation and repose and a fresh start.

Now, heart attacks are funny things, unless you have one.

I discovered early on that when people had heart attacks, particularly when they were smokers, or overweight, or old, there were two standard emotional responses.

They got sad. Or they got mad.

Now, depression and anger are normal human emotions, and they are a normal part of coping with unpleasant events. And eventually, they lead to resignation and then tranquility, which is a much better place to be than the Land of Anger or Sadness.

A lawsuit of any kind is a lot like a heart attack to some clients; they respond to the lawsuit with anger or sadness, and either one makes it a good deal harder for them to think effectively about the suit and help themselves.

I'm pretty used to clients who become suicidal ("Let them take a judgment against me! I just don't care anymore!") or very, very angry ("I don't understand! How could this happen? Why did this happen to me?").

And I know that such clients will require a cooling off period before they can think clearly enough to help me in helping them.

Some simply refuse to cope, and some have real problems, like chemotherapy, but those are special cases that I'll address later.

But when a client comes back to the surface after a lawsuit, coaching them to think about a reasonable offer (and remember, there's no requirement that the guys on the other side be reasonable) becomes possible.

The easiest way to think of an offer in any lawsuit is to think about how much the bad guys are going to get, and over what period, if they prevail on every point.

After all, it's darned hard to squeeze blood out of a turnip, you know?

So if a trustee gets a judgment, how will he collect?

Well, not out of a 401(k), in all probability. The usual route is garnishment. And in the usual bankruptcy case in Arizona, all the assets owned by the debtors at the front end of the case are exempt.

Garnishment of wages is the usual way to to try to collect from of a consumer client.

And garnishment is a technique that lets a creditor get paid, but only a little at a time, over a fairly long stretch.

So that leads us to present value calculations, years to retirement calculations, and uncertainty of the economy considerations.

If somebody is a real estate seller, for instance, and you get a judgment against them, how easy will it be to collect such a judgment?

Not very easy, I should think. Not during a depression, in any case.

And this depression isn't going away for years, as I see it.

So when you look at settling any lawsuit at any time, you look at the ability of a creditor to collect. That's one issue.

Another is time and cost to get to the judgment. In the same way that a rational bankruptcy trustee will sometimes discount "excess equity" amounts in a car to account for time value of money and costs of sale, a trustee will certainly consider how long the estate must be held open to collect money for creditors by garnishment, and how much it could cost the estate to obtain the judgment.

And then there's the human factor. If you knew you were going to be garnished for ten years, would you work harder, or would you work less?

I know one stunningly beautiful registered nurse who has been the subject of collection activity for a non-dischargeable student loan; she hasn't worked for a decade, and is a pet, for economic analysis purposes, of another very nice medical professional.

And I know of a son of a wealthy man who didn't make money for a decade because he was the subject of a judgment, who lived as an economic pet in his dad's property, driving one of dad's cars.

In general, in Bankruptcy Court, a lawsuit involving the debtor is simply a part of the "let's make a deal process", and if you let your lawyer help with the negotiation, you're likely to spend less in legal fees as you progress down the road.

Or you can stay very depressed, or very angry, and expect a less-than-optimal result.

Your choice!

NOTHING HERE CONSTITUTES LEGAL ADVICE RE A CHAPTER 7, CHAPTER 13, CHAPTER 11, OR CHAPTER 12. FIND AN ARIZONA BANKRUPTCY LAWYER WHO IS BOARD CERTIFIED IN BANKRUPTCY LAW, AV RATED, AVVO 10 RATED, ON SUPERLAWYERS, OR JUST VERY EXPERIENCED AND A FORMER CHAIR OF SOME BANKRUPTCY SECTION OR COMMITTEE. NOTHING HERE MAY BE USED AS LEGAL ADVICE IN CONNECTION WITH ANY BANKRUPTCY, WHETHER THAT BANKRUPTCY IS IN PHOENIX, GLENDALE, TEMPE, MESA, SCOTTSDALE, OR ANYWHERE ELSE.

Full post as published by Arizona Bankruptcy Attorney Blog on June 13, 2010 (boomark / email).