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The Failure of the United States Trustee Program in Chapter 11

posted by Adam Levitin

The United States Trustee settled with three large law firms that failed to disclose the nature of their relationship with the Sackler Family Purdue when they were engaged by Purdue in its bankruptcy. The result is that these firms will return $1 million in fees.  This action has produced headlines like "Bankruptcy Watchdog Bares Teeth at BigLaw in Purdue Ch. 11," but I have a completely different take on the story. I see this settlement as an indictment of the US Trustee Program as a complete failure in chapter 11. 

In Purdue, the UST is focused on a measly million of fees, and is AWOL on the issues that affect billions in creditor recoveries. And the story is hardly limited to Purdue.

When was the last time you saw the UST file a motion to dismiss a case because of improper venue? No such filing with NRA, with BSA, or even with Purdue, where the case should not have been assigned to Judge Drain under the SDNY Local Rules. And when was the last time the UST filed a motion for a trustee or an examiner even in cases that cry out for one, such as NRA and Purdue? What set of facts would be required before the UST filed such a motion? 

The problem here is that the UST has developed a Javert-like obsession with professionals' fees (and consumer debtors' concealing assets), while failing to weigh in on the big issues affect the fundamental integrity of the bankruptcy process. If an attorney double bills for an hour, yes, it's stealing from the estate, but it's not a threat to the system's integrity, and the compliance costs for firms when preparing their billing statement could well exceed the costs of overbilling. But there is a real threat to the system's integrity when debtors can handpick their judge or move for DIP financing that gives away the farm or get away with having a supposedly "independent" board committee manage investigations or get endless 105(a) injunctions against creditor suits against nondebtors or file a "plan" that is facially deficient ("analysis to come") and use it to claim continued exclusivity, or do a 24-hour in-and-out bankruptcy. That sort of behavior has become regularized to the point that attorneys and judges take it for granted. And because so many of the big cases appear before just a handful of carefully shopped judges, no chapter 11 professional in his right mind would dare raise the problem because he knows that he's likely to be back in front of that same judge in another case in the next year and doesn't want to piss off the judge. So who does that leave to defend the integrity of the system? The United States Trustee. And the US Trustee is off hunting rabbits when there's a wolf on the loose.

Now to be sure, there is the occasional surprise, when the UST does spring into action. For example, I was heartened to see the UST object to Belk's 24-hour in-and-out bankruptcy. But then the UST settled for a "due process preservation order" that didn't actually preserve due process, but shifted the burden of proof onto creditor to show that they've been prejudiced, when the Bankruptcy Rules give the creditor an entitlement of certain minimum process. Was Belk really going to have to liquidate if it had to stay in Chapter 11 for a month or two? A short stay in the chapter doesn't melt the ice cube, as GM and Chrysler showed.

The US Trustee Program has adopted an exceedingly narrow vision of what it means to protect the integrity of the bankruptcy process, and it's a vision that is unduly deferential to creditors and bankruptcy professionals.  The UST's attitude tends to be that if creditors don't raise an issue themselves, then there really isn't a problem. In other words, the UST has drunk the "market knows best" Kool-Aid in big chapter 11s. The problem with that approach is that there's a host of reasons why the large chapter 11 market doesn't work perfectly, starting with conflicts that arise from having a small repeat-player bar appearing before just a handful of the nation's 375 bankruptcy judges.

It's really time for the UST program to be revitalized.

Comments

It is also worth noting that, as I understand this settlement, the law firms are reducing their fees by $1 million not paying $1 million into the bankruptcy estate. Law firms routinely reduce fees to make clients or courts happy, so often that the cynic might suspect that the discount is cooked into the initial bill. There is also the psychological and optical value of having malfeasors have to write a check. Query- do shouldn't appropriate state bars also investigate this for disciplinary action for lack of candor before a tribunal?

There is just a lot of fraud and nonsense in the name of the bankruptcy estate. The U.S. Trustee system is a failure. They have a cosmetic presence and they are biased. I am involved in a chapter 11 case [of a church], wherein the appointed trustee sold the Church for 2.8 million--gave 2m to one creditor and took the rest as her legal fees. The Church is gone and the Christian members are praying from their homes. It's an incredible system of loot with the mantra of the estate. The estate that was finally left for the Church members is fiction. And so is this U.S. trustee system of supervisory drama.

I think this is a really important post. For various reasons, truth-telling about the UST program is rare. People within the system are (understandably) reluctant to critique. I hope that Prof. Levitin and others will follow this post up with further work.

As to the third paragraph, I think you may have your answer. Yesterday in the NRA case.

Lisa Lambert tore into Wayne LaPierre like there was no tomorrow and took no prisoners. She did call for either a dismissal or court ordered oversight.

Yes, it was nice to see the UST springing into action in NRA, but that was the exception, not the rule. It was also rather late in the game. The UST should have been objecting on day one in that case, but better late than never.

Lisa Lambert did object from nearly day one, opposing the appointment of Bill Brewer as special council to NRA for a cool $3m. She also opposed the NRA restructuring officer scam. That said, given the manifest incompetence of NRA and Judge Journey's lawyers it's regrettable that she elected not to ask obvious questions of witnesses.

This is a refreshing take. At the same time, I can think of a few examples during the last year or so when the UST sprung into action:

UST recently objected to Cowen's motion for retention [to represent the equity committee] in the Garrett Motion Ch 11 case. The objection alleged Cowen didn't run a complete conflicts check according to Rule 2014. The US Trustee objected to UBS Rx Group's application for retention in the LATAM UCC for the same reason.

In Town Sports (dba NY Sports Club), the UST publicly raised concerns about the disclosure statement not including information regarding the feasibility of the plan. It complained because the disclosure statement didn't include a liquidation analysis, showing whether creditors would receive more or less in a liquidation scenario.

In Le Tote (Lord & Taylor parent), the UST called the plan 'patently unconfirmable' because it didn’t specify that administrative claims would have been paid in full, it didn’t provide enough information to creditors, it included overly broad third-party releases, and improperly counted creditors that didn’t vote on the plan as acceptance votes.

There are probably many others, including countless objections to bonus motions. Although none address the major concerns you raised like venue shopping.

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