Does this sound familiar? A client contacts you, very upset. A debtor, often a former spouse, significant other or business partner, has filed for bankruptcy. Your client has looked at the debtor’s bankruptcy schedules and noticed one or more of the following: individual assets or whole categories of assets that are valued by the debtor at a fraction of the value “known” to your client, assets that the debtor used to own that do not appear or sources of income that the debtor had previously described to your client that do not appear. Your client wants to stop this possible fraud and recover, to the maximum extent possible, the money that the client is owed by the debtor. What advice should you give to your client, and what should you do?
When the debtor filed for bankruptcy, a bankruptcy estate was created. 11 U.S.C. §541(a). The debtor’s estate consists of “all legal or equitable interests of the debtor in property” with some relatively minor exceptions. Id. The bankruptcy trustee is appointed to “collect and reduce to money the property of the estate…and close such estate as expeditiously as is compatible with the best interest of parties in interest.” 11 U.S.C. §704(a). Therefore, it appears that the discrepancies described above should be called to the attention of the trustee, who has a duty to investigate and collect the undervalued, misdescribed or omitted property, turn it into cash and distribute it to the creditors.
The reality is not so simple. A typical chapter 7 panel trustee will be assigned as many as 1,000 chapter 7 cases each year. The vast majority of these chapter 7 cases will be no-asset consumer debtors, whose bankruptcies proceed without a hitch. However, even in these cases, trustees have formidable responsibilities: They have to review the debtor’s petition and schedules, analyze the debtor’s assets, income and expenses, fill out various statistical and substantive reports and review the other required documentation, including the debtor’s payment advices and tax returns, as well as analyze whether the debtor has made any preferential or fraudulent transfers. For this work, in a no-asset chapter 7 case, the trustee is paid $60.
In a case with assets, a trustee can receive a percentage of the money the trustee administers as additional compensation, as well as reimbursement for expenses, but the trustee also must do considerably more work: collecting and accounting for the money the trustee collects, analyzing filed proofs of claim to determine their legitimacy, selling noncash assets and arrange filing a bankruptcy estate tax return, among other things. Since the trustee is required to administer the estate in a manner that maximizes creditors’ recovery, whenever a trustee learns of an omitted, misdescribed or undervalued asset, the trustee is required to perform a cost benefit analysis. Is pursuing the asset going to be worth the cost? Often, a trustee will decide that the answer is “no” and will leave your client feeling frustrated and questioning the integrity of the entire bankruptcy process. This undesirable outcome is avoidable if you take some preliminary steps before simply turning information about discrepancies in the debtor’s bankruptcy filings over to the trustee.
First, and perhaps most important, you must manage your client’s expectations. Point out that not every omission, misdescription or undervaluing of an asset is of sufficient magnitude to warrant action by a trustee. Try to convey to your client that the “value” of anything, short of an actual arm’s-length sale, cannot be exactly determined and that differences of opinion about value may be different from deliberate distortion. Also, point out that illiquid property such as real estate in a down market, or unique objects such as art or collectibles, may have costs associated with turning them into cash that exceed the recoverable value.[1]
You can enhance the likelihood that a chapter 7 trustee will take action to recover money in response to your client’s information by supplying concrete information about the value of the assets. For instance, if the asset is real property, information about its current market value, the amount of equity (which, of course, must exceed the amount of any allowed exemption) and a willing buyer will almost certainly guarantee action by a trustee.[2] If the omitted, misdescribed or undervalued property is personal property, once again, the most effective piece of information that can be provided to the trustee is a ready, willing and able buyer for the property. It goes without saying that providing the trustee with an accurate description and location of the property is important. For example, the author recalls a situation in which an untitled antique automobile was known to be owned by a debtor who did not list the asset on his bankruptcy schedules. The creditor had information that the antique automobile was located on the debtor’s parents’ farm. The trustee sent an investigator to look for the car at the farm, but it was not to be found. The debtor denied current ownership of the automobile. Since no proof was readily available, the trustee had to abandon the quest.
Many times, discrepancies between the property described on debtor’s schedules and prior financial statements are a fruitful source of inquiry. The financial statements need to be provided to the trustee in advance of the “meeting of creditors.” If the debtor cannot satisfactorily explain what happened to assets that were listed on a financial statement but not listed on the bankruptcy schedules, the debtor risks loss of discharge. See 11 U.S.C. §727(a)(5). While under these circumstances the trustee will move to deny the debtor a discharge, without information about the circumstances under which the missing property “disappeared,” a financial recovery is unlikely. Therefore, any information concerning what happened to the property is valuable and should be provided to the trustee right away.
In summary, to interest a chapter 7 trustee in recovering omitted, misdescribed or undervalued assets, the trustee must be provided with information that goes beyond simply identifying the assets, it must also provide the trustee with “a path to the cash.” The “path” includes the location of the assets and, ideally, a buyer or a market for the assets as well.
[1] Of course, a knowing material misstatement in connection with a bankruptcy filing may disqualify a debtor from a discharge or result in criminal prosecution. However, neither of these two outcomes leads directly to any financial recovery for your client.
[2] The author recalls a recent case in which a debtor significantly undervalued his homestead. The creditor researched the market value of homes in the area, took pictures of the subject property, which was currently being renovated, and even obtained an estimate of what the fair market value of the home would be after the renovations were completed as well as estimates of the cost to complete. Notwithstanding the fact that the creditor’s figures showed a likely equity in the property of several hundred thousand dollars, the trustee in the case refused to take action because the debtor’s first mortgage was in default and the creditor could not locate a buyer who was willing to step forward with sufficient cash to justify the expense that would certainly be incurred by the estate in objecting to the debtor’s exemption and litigating with the debtor over the fair market value of the property.