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With Congress poised to pass legislation to stamp out what the credit industry calls rampant abuse of Chapter 7 consumer bankruptcy protection, South Florida experts say a little-noticed program launched by the U.S. Department of Justice is already doing the job. Under the Justice Department’s 2001 “civil enforcement initiative,” bankruptcy trustees in Florida’s Southern District are scrutinizing debtors’ finances with unprecedented rigor, federal officials and bankruptcy lawyers say. The initiative is a creation of the Justice Department’s Executive Office for U.S. Trustees, which administers the nation’s bankruptcy trustees and cases. The department announced the program in October 2001, describing the plan as a “more aggressive use [of] existing civil enforcement methods to curb abuse of the bankruptcy system.” The Executive Office says that in its first year, the initiative resulted in 5,800 successful challenges of Chapter 7 filers. Some experts say the program strikes a reasonable balance between policing abuse and leaving bankruptcy trustees and judges flexibility to evaluate cases on an individual basis. But debtor attorneys complain that the initiative is making it harder for legitimate filers to discharge their debts and that it amounts to a form of means-testing eligibility for Chapter 7 protection. Currently there is no statutory means test or income cap for people who wish to file a Chapter 7 petition. The U.S. Trustee’s office and the U.S. Bankruptcy Court evaluate eligibility based on whether, after comparing a person’s income with allowable expenses, the filer has any disposable income to pay his debts. Under the Trustee’s enforcement initiative, the trustee and the court have been taking a harder look at reported income and expenses. The pending legislation would couple that with a relatively low cap on disposable income, blocking many people who currently are eligible for Chapter 7 from filing. Such means testing is one of the most controversial aspects of the bill. “I never had a single petition inquired about before the [Trustee's enforcement] initiative began,” said Bradley Shraiberg, a partner at Boca Raton bankruptcy boutique Furr & Cohen who represents both debtors and creditors. Now, he estimates that more than 70 percent of his debtor-clients are subjected to inquiry. The chief element of the enforcement initiative is near-universal and intensive review of the income and expense statements of Chapter 7 filers. If the Trustee calculates that the debtor is able to enter a payment schedule with creditors, the petition can be challenged in court and dismissed. The debtor would then have the option of filing for Chapter 13 protection, which, unlike Chapter 7, puts filers on a payment plan for up to five years. Patricia Dzikowski, a partner at Dzikowski & Walsh in Fort Lauderdale, who has served as a private trustee appointed by the U.S. Trustee’s office for more than a decade, said she’s seen a “tremendous” increase in the U.S. Trustee’s scrutiny of debtor’s finances due to the initiative. “Appointed trustees are taking a much bigger role in looking over I and J [income and expense] schedules,” Dzikowski said. Steve Turner, acting assistant trustee for the U.S. Trustee’s field office in Miami, said calculating debtor income and expenses is a big part of the initiative, but stressed that the Trustee’s office continues to consider individual circumstances. “There is no benchmark,” Turner said. “Sometimes you see on its face that a debtor’s expenses are less than their income and they could go to Chapter 13. Sometimes you see a guy driving around in a Mercedes and it doesn’t pass the smell test. It depends on the facts of the case.” BILL LIMITS FLEXIBILITY Critics of the pending legislation in Congress say the success of the U.S. Trustee’s initiative lends credence to their argument that there are effective ways to address bankruptcy abuse without eliminating the flexibility of judges and trustees to evaluate cases individually. Under current law, judges and trustees are required to consider the “totality of the circumstances” faced by the debtor, rather than any specific income and expenses criteria, in deciding whether the person is abusing the Chapter 7 process. “If [the initiative] is implemented fairly, it’s an efficient and equitable way to weed out abuse,” said Chief Judge Robert Mark of the U.S. Bankruptcy Court for the Southern District of Florida, who has publicly criticized the pending legislation. “A means test would be substantially more expensive and potentially quite unfair.” The Bankruptcy Abuse Prevention and Consumer Protection Act of 2003, which overwhelmingly passed the House on March 19 and is now pending in the Senate, would eliminate much of the judges’ and trustees’ flexibility in considering Chapter 7 petitions. The credit card and credit union industries have been pushing for the legislation, citing an increase in Chapter 7 filings involving consumer debt, particularly unsecured credit card debt. Such filings make up the large majority of total bankruptcy filings, which have increased with the downturn of the economy during the past two years. Nationally, according to the American Bankruptcy Institute, total bankruptcy filings grew from 1,253,444 in 2000 to 1,577,651 in 2002. Chapter 7 filings have constituted two-thirds of the total throughout that period. Debtors currently can choose freely between Chapter 7 and 13. Debtors usually prefer Chapter 7 because it allows them to liquidate their assets and discharge their debts quickly without losing their house or car. Creditors prefer Chapter 13 because it requires debtors to repay a portion of the money they owe within five years. The pending legislation in Congress would establish a tough means test that would essentially limit Chapter 7 protection to low-income people and tightly restrict allowable expenses. Under the legislation, anyone who earns in excess of the state median income for a similarly sized family and who has $100 to $167 per month in disposable income, as determined using Internal Revenue Service expense standards, would have to file under Chapter 13 rather than Chapter 7. The legislation is nearly identical to that which passed both chambers last year but never was reconciled. The measure was held up over a provision relating to the ability of anti-abortion protesters to discharge judgments arising from lawsuits filed by abortion clinics. The legislation is pending in the Senate Judiciary Committee, whose chairman, Orrin Hatch, R-Utah, “has not yet determined what step to take next,” according to committee spokeswoman Margarita Tapia. It’s expected that Senate Democrats will try once again to attach the abortion-related provision along with other amendments, including a measure to make it harder for wealthy people to shield unlimited assets in a homestead in Florida, Texas and a few other states. But the Democrats may have a hard time doing so this year because they no longer control the Senate. The legislation has been widely criticized as draconian by bankruptcy judges, the bankruptcy bar and academic experts since it was originally proposed in 1994. “The premise, fears, and conditions underlying the original perceived need for bankruptcy reform six years ago do not exist,” Judith Greenstone Miller, representing the bankruptcy section of the Commercial Law League of America, a creditors’ rights group, told Congress last month. While filings may have increased “incrementally” since 1994, Miller said, the economic climate has worsened since then and Americans are filing for bankruptcy because of life setbacks such as divorce, medical bills, loss of jobs, the Sept. 11 terrorist attacks, displaced military personnel and corporate downsizing, and “not merely to escape one’s obligations.” She argued that Congress instead should crack down on growing bankruptcy abuse by corporate officers and directors who’ve been involved in financial misconduct. Some supporters of the Trustee’s enforcement initiative say the program works so well that Congress should drop the statutory means test from the new legislation and rely on the program’s rigorous scrutiny of income and expenses to root out fraud and abuse. But some debtor attorneys say the new enforcement program unfairly makes bankruptcy more difficult and expensive, and constitutes a back-door means test. “I have clients with unexpected reverses in circumstances beyond their control,” Shraiberg said. “It seems indecent to deny worthy candidates a fresh start.” TARGETING DEBTOR MISCONDUCT The Trustee’s enforcement initiative has two components, described last month in testimony to Congress by Lawrence A. Friedman, director of the Executive Office for U.S. Trustees. One is directed at “consumer protection … from unscrupulous bankruptcy petition preparers and attorneys.” The other targets “debtor misconduct,” including “inaccurate financial disclosure” and “concealment of assets.” Friedman boasted of the initiative’s success. He reported that during fiscal year 2002, the U.S. Trustee’s field offices overall took more than 50,000 civil enforcement and related actions that yielded about $160 million in debts not discharged. Nationally, he said, the program prevented the Chapter 7 discharge of almost $60 million of debt, led to the denial of a discharge for more than 800 debtors on the grounds of serious misconduct, successfully took action against fraudulent petition preparers in more than 1,500 cases, and launched an audit effort to identify the scope of fraud and abuse. But he also testified that the fraud and abuse provisions in the House bill would increase the effectiveness of his office’s enforcement initiative, particularly the means testing and debtor audit provisions. He said a statutory means test would establish a more objective and consistent basis for defining abuse. Nailing 5,800 abusive Chapter 7 filers may not seem like much when there were an estimated 1.5 million personal bankruptcy petitions filed in that period. The credit industry contends that the cases are a small percentage of actual abusers. But supporters of the U.S. Trustee’s initiative point out that the program is new and has great potential. The initiative’s primary tool for attacking debtor misconduct is Section 707(b) of the U.S. Bankruptcy Code, which allows the court to dismiss petitions when debts “are primarily consumer debts” and their discharge under Chapter 7 would be “a substantial abuse” of the code. In his testimony, Friedman defined “substantial abuse” as “seek[ing] discharge of debts despite an ability to repay.” But Shraiberg said that Friedman’s definition conflicts with case law in the 11th U.S. Circuit Court of Appeals, which has jurisdiction in South Florida. According to Shraiberg, judges there have traditionally interpreted “substantial abuse” in light of “the totality of the circumstances” rather than “ability to repay.” Despite the U.S. Trustee’s initiative, several South Florida bankruptcy judges say they’ve seen few 707(b) challenges. Judge Mark recalled trying just one such action in his 12 years on the bench. U.S. Bankruptcy Judge Steven Friedman in West Palm Beach called them “a rarity” and said he’d seen “no increase.” No log of such challenges is kept by the U.S. Trustee’s field office in Miami. The only Section 707(b) dismissal listed on the Internet site for the Southern District of Florida in the last five years is a January 2001 ruling by U.S. Bankruptcy Court Chief Judge Emeritus Judge A. Jay Cristol. He dismissed a Chapter 7 petition filed by a police officer who had debt of $66,000 but who used part of his annual income of $60,000 to care for two retired police horses. Judge Paul Hyman, who sits in Fort Lauderdale and West Palm Beach, said he’s seen “more than 10 but less than 20″ 707(b) challenges since the Trustee’s initiative began. Hyman said only one led to a petition being dismissed. UNPRECEDENTED DOCUMENTATION The rarity of 707(b) dismissals misses the point, according to Shraiberg. He says the Trustee’s office and private trustees are wielding their new hammer of tougher scrutiny outside the courtroom. Shraiberg and other consumer bankruptcy attorneys report a sharp increase in their receipt of letters of inquiry about Chapter 7 petitions from the assistant U.S. Trustee’s Miami office and from private trustees appointed by the office. The letters focus on debtors’ income and expenses as enumerated under bankruptcy court Schedules I and J. They are demanding exorbitant levels of supporting documentation, Shraiberg said. The letters contain the “implicit threat” of a court challenge to the petitions, Shraiberg said. That’s objectionable, he added, in light of the Section 707(b) language that “there shall be a presumption in favor of granting the relief requested by the debtor.” “It’s unfair to individuals already in financial distress,” Shraiberg said. “I tell clients upfront that it’s going to cost them a minimum of $1,500 to contest a challenge.” That’s in addition to the $1,500 to $3,000 he said he charges to file for Chapter 7 exclusive of challenges. Shraiberg said the U.S. Trustee’s tougher new income and expense analysis fails to account for debtors’ individual circumstances. “They questioned one of my clients over a $100 monthly cell phone bill,” he said. “He was a FedEx driver with a serious illness in the family. Was he supposed to spend all day looking for pay phones to call home?” The client won Chapter 7 protection — but only after demonstrating that his debts were not consumer debts. Clients who are discouraged from filing for Chapter 7 protection by the prospect of a 707(b) challenge are left with two alternatives, Shraiberg said. Those with no financial resources give up on bankruptcy and resign themselves to living with creditors hounding them. A second group, with greater resources, file for Chapter 13 protection. But Chapter 13 filings cost significantly more in attorney fees and often commit the filer to an onerous repayment schedule, he said. Fran Sheehy, a Coconut Creek bankruptcy attorney, shares Shraiberg’s assessment of the U.S. Trustee’s initiative. She said she’s experienced a “blizzard of paperwork” under the program. “It used to be all you had to do in Chapter 7 was file, unless [the debtor's] numbers were really off the wall,” she said. Now, “each trustee has their own version of a means test. They’re comparing I and J schedules with IRS guidelines, with little regard for the totality of [the debtor's] circumstances.” She said even before the initiative was launched, the U.S. Trustee’s office had the necessary tools to weed out abusive filings. In her view, the new program is excessive. “[The initiative] is wasting resources,” she said. “It makes the Trustee a collection agency for the credit card companies.” A spokeswoman for the Executive Office for U.S. Trustees defended the program and denied that the more aggressive use of Section 707(b) challenges constitutes a back-door means test. In a statement sent by e-mail, Jane Limprecht said Section 707(b) “is intended to prevent debtors who are undeserving or capable of repaying a significant portion of their debts from receiving a discharge in Chapter 7. “While the Civil Enforcement Initiative does not implement �means testing’ with respect to Section 707(b) actions, the U.S. Trustee Program strives to reach consistency of practice, and many offices are endeavoring to identify or develop objective standards to assess whether debtors’ expenses are excessive.” BETTER THAN A MEANS TEST Some prominent bankruptcy attorneys who represent debtors say the Trustee’s enforcement initiative has its virtues, particularly compared with the legislation in Congress. “Clearly there’s a major new effort under way to weed out abuse of the system,” said Patricia Redmond, a shareholder at Stearns Weaver Miller Weissler Alhadeff & Sitterson in Miami. She said she’s “not bothered” by the Trustee’s program, and prefers it to the means test contained in the House bill. “The 707(b) inquiries are not a means test, which would be much more rigorous,” Redmond said. “I much prefer the case-by-case method of the initiative to a one-size-fits-all approach.” Arthur Rice, a partner at Rice Pugatch Robinson & Shiller in Miami, said even though he believes creditors’ claims of rampant bankruptcy abuse are overblown, he’s a “big fan” of the initiative’s more thorough income and expense scrutiny. “The question is, how do you effectively police the system?” he said. “I’m not in favor of a means test. But what is a trustee supposed to do when they get income schedules with no records?” Even critics of the initiative like Shraiberg say they prefer it to a rigid means test. But the criteria for determining abuse should be codified by Congress rather than left to the discretion of each bankruptcy trustee and judge, Shraiberg argued. Surprisingly, those who say the pending legislation is too rigid and harsh haven’t seized on the U.S. Trustee’s enforcement initiative as a more flexible alternative for addressing bankruptcy abuse. During the House Judiciary Committee’s hearings on the bankruptcy bill early last month, alternatives to means testing were discussed — but not in the context of the U.S. Trustee’s program, said an aide to U.S. Rep. Jerrold Nadler, D-N.Y., who, along with 111 other House Democrats, voted against the bill. Instead, most Democratic criticisms have centered on its failure to address the role of credit card companies, which are accused of offering cards too freely. In an e-mailed comment to the Daily Business Review, Nadler said the U.S. Trustee’s civil enforcement initiative “makes clear � that a radical and inflexible overhaul of the current system would be both unnecessary and counterproductive.” But a spokesman for a group that strongly supports the House bill, Joe Rubin, public affairs director of the U.S. Chamber of Commerce, argued that means testing is the best solution. “The Trustee’s initiative used a lot of resources,” he said. “But abuse is so prevalent that a statutory means test makes sense.” Rubin insisted that critics’ fears about the fairness of the means test are overblown. “Means tests are not as ironclad as they’re made out to be,” he said. “Chapter 7 will still be there for filers who really need protection.” Judge Cristol couldn’t disagree more. He called the proposed legislation an “abomination” and said means testing would undercut the core purpose of bankruptcy court. “Forgiveness of mistakes and the debts they lead to is central to our mission,” he said. “I like to hope we’ll always be the most humane branch of the judicial system.”

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