Implementation of the Needs-based Review

Implementation of the Needs-based Review

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The concept of a "needs-based" consumer bankruptcy law has generated numerous reactions, studies and debates. Most of these have focused on the need for a change in the bankruptcy system's approach to granting relief to consumer debtors, the extent to which abuse exists in the current system and whether using the living allowances established by the Internal Revenue Service (IRS) is appropriate or workable. However, the implementation of any needs-based standard requires a gatekeeper—a person or group to review each case to determine whether debtors "fit" within the guidelines and are therefore eligible for bankruptcy relief. To achieve the gatekeeper review, the several versions of the Bankruptcy Reform Act require the filing of a "report" at a time close to the initial meeting of creditors.

This report will clearly become the initial focal point of every chapter 7 case, and the effectiveness of the report process will determine whether needs-based reform can produce the intended results. It is therefore appropriate to consider (1) whether the "report-filer" will be given sufficient resources to properly make the judgment call in each chapter 7 case, (2) whether there will be impediments to hinder the process, and (3) whether the required information will reliable.

Who Files the Report?

First, the two bills differ in their designation of the responsible party for this report. The Senate bill (S. 625) delegates this duty to the U.S. Trustee and requires the filing of the report 10 days before the §341 hearing. The House bill (H.R. 833) requires the panel trustee to file a report. Both alternatives have their problems.

The U.S. Trustee Program (USTP) is already over burdened, understaffed and underbudgeted. Although it currently has the responsibility to review cases for abuse under §707(b), most regional and local offices do not act on a case unless information is presented to the appropriate U.S. Trustee official by a panel trustee. It is unlikely that bankruptcy reform will increase staffing and resources for the program, so it is probable that the USTP will continue to rely on a review of eligibility by panel trustees. The initial report could be created by a panel trustee and the U.S. Trustee official could sign off on the report in order to comply with the law. Thus, the responsible party will probably not be doing the initial review.

The House apparently recognized this issue and designated the panel trustee to file the eligibility report. This approach also has its drawbacks, considering that a panel trustee only receives a flat $60 fee for administering each no-asset case. Although trustees always review debtor's schedules, including the Income and Expense Schedules, the resources available to the trustee do not allow an "in-depth" verification of such information as appears to be intended by both bills. Trustees rely heavily on the information provided (under penalty of perjury) by debtors, and cannot conduct extensive discovery in every case to insure the accuracy of the core data being used to apply the needs-based formulas.

Ensuring Accurate Information

Since it is doubtful that Congress will include an increase in the financial resources available to trustees in no-asset cases, it becomes imperative that trustees are provided with the necessary information (in a concise manner) such that the formula can be easily applied. Schedules I & J need to be drastically modified, with a debtor's actual expenses and income lined up beside the guidelines, and a debtor's cash flow during the preceding 180 days documented as an exhibit, which would consolidate this information. This compilation of information in the schedules is far more useful than "dumping" tax returns and bank statements on the trustee. The trustee must rely upon something to prepare this report, and the debtor is the only party who can provide this information in a concise manner. Without a change to schedules, most trustees will have to rely upon the current "estimates" in Schedules I & J, which is probably less than the minimal review anticipated by Congress.

Timing of the Trustee Report

Next, there are two major impediments to the implementation of this system in the Senate bill, which could seriously hinder its effectiveness. First, S. 625 requires the trustee to file the report 10 days before the §341 hearing. This time frame simply does not work. Although trustees routinely check cases for conflicts, or cases with assets needing immediate attention, most trustees do not focus on any chapter 7 case until they begin preparing for the §341 docket. Referrals of cases for §707(b) review never take place until after the meeting of creditors, and after a trustee has examined the debtor under oath and further examined the disposable income of the debtor (if circumstances warrant). Filing this report before this examination is not only burdensome, it is premature and would require risky judgment calls before all the relevant information is obtained.

The House bill appears to correct this problem by delaying the filing of the report until 10 days after the meeting of creditors. This is an important modification; it not only permits the trustee to reach a more informed judgment but also allows the panel trustee to incorporate the report into the "bundle" of tasks that must be completed at the end of every §341 docket. This creates more efficiency, less burden and better results.

Trustee Liability

The other problem in the Senate bill is the lack of a "trustee liability" provision. It is probable that trustees will make occasional mathematical errors, or may simply overlook an income source or a large expense item, which could affect the result in the needs-based formula. Without protection, panel trustees could face claims against their bonds from creditors, who will allege that they should have received distribution from a debtor who could have been barred from a chapter 7 discharge and induced to a repayment plan in a chapter 13.

The House recognized that panel trustees would be exposed to enormous potential liability in filing this report, and in making a finding of eligibility. The House bill contains §117, titled "Limiting Trustee Liability," which specifically protects trustees from exposure for filing this report and limits liability to situations where the trustee has committed gross negligence. Since trustees are the chief facilitators of the system, it is only appropriate that they not face unlimited exposure for their good-faith efforts to administer chapter 7 cases.

The Senate bill does not include a trustee liability provision (which may explain why the trustee was designated as the responsible party for filing the report). While it may be correct that the liability provisions are less imperative if the trustee assumes ultimate responsibility for this task, a real problem could ensue if the final legislative product adopts the House proposal requiring a panel trustee to file the report, but does not adopt the corollary section that would protect the trustees in this process. Left unanswered is the question of how much trustee liability risk there is if the U.S. Trustee delegates this function to panel trustees. In this respect, the selection of the responsible party as the gatekeeper must be coupled with consideration of the liability provisions.

Problems in Application

Finally, the substantive provisions of the needs-based formula may be difficult to apply, particularly in cases where the debtor's eligibility is questionable. The gatekeeper must determine a debtor's projected income using the debtor's actual income for the last 180 days (not six months, not one year, not any normal taxable period). If a debtor's monthly income is variable (such as commission-based pay) or if the debtor works overtime on a non-routine basis, there is practically no way that the income for exactly 180 days can be determined. Tax returns are of no help; pay stubs (monthly, weekly or biweekly) do not break the amount earned down on a daily basis. It is often the commission-based employee and the workers with the capacity to earn overtime who might well have sufficient income to exceed the median average. Accuracy in these situations becomes important. Unfortunately, the practicality of the typical case will almost always require some "extrapolation" or "estimating" that will produce unfair (or inconsistent) results. Trustees should not be forced to make these judgment calls.

On the expense side, the problems are equally disconcerting. If IRS guidelines are to be used as the standard, the trustee must evaluate the appropriateness of those expenses that are not directly covered by the guidelines, such as insurance premiums and child care. Furthermore, the regional and local standards are only intended as "maximums" and the actual expenses must be used if an expense amount is less than the maximum. Finally, the IRS manual allows "other necessary expenses," including those that are necessary for the health and welfare of the debtor or are necessary to maintain the production of revenue. How is a trustee supposed to make an objective judgment in applying these subjective factors?

The treatment of secured claims in this calculation is also not realistic. If the monthly payments on secured claims are totaled and divided by 60, the resulting amount is not equivalent to the adequate protection payments that could be incorporated into a confirmable chapter 13 plan. (For example, if one year of $400 payments remains on a car note, this would result in a monthly expense item of $80 (400x12/60). However the principal on that loan must be paid with interest for five years, thereby producing a monthly payment under the plan of approximately $96.70. The means-testing formula does not adequately determine if a debtor can confirm a chapter 13 plan.

The formula is not one that chapter 7 trustees could apply objectively and efficiently. The result would be a report that would seldom be accurate. If this report is to be a catalyst for creditor or trustee action, or a debtor's admission ticket to chapter 7 relief, more attention should be focused on providing the responsible party with the tools and resources needed to effectively perform this task.

Journal Date: 
Wednesday, December 1, 1999