The Failure of the United States Trustee Program in Chapter 11

04/30/21

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.

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