Posted by Todd Zywicki:
Bankruptcy Reform, The New York Times, and Real v. Hypothetical Bankruptcy
Abuse:
A few weeks ago, [1]I posted on the purported problem of bankruptcy
reform and so-called "asset protection trusts." I noted at that time
that I had been unable to find any actual cases of these trusts being
used to shield assets from creditors in bankruptcy (I still haven't
found any). I also asked for examples from readers, but no one has
provided me with any examples (the only examples I received were for
third-party "spendthrift" trusts, not self-settled asset protection
trusts where the debtor retains substantial control over the proceeds
of the trust).
Moreover, it is very doubtful that one of these asset-protection
trusts would actually hold up in bankruptcy. Bankruptcy law already
contains numerous applicable ways of preventing debtors from using
these to abuse bankruptcy. First, courts can, and likely would, attack
them as fraudulent conveyances under sections 544 or 548 of the Code.
Courts could also deny the discharge to any debtor that tried to use
an asset protection trust, which is exactly what courts have done when
confronted with offshore asset-protection trusts.
So at this point, the entire debate about the possibility of debtors
using asset-protection trusts to shield assets in bankruptcy appears
to be wholly hypothetical--there does not appear to be a single case
where a bankrupt has used an asset protection trust to shield assets
from his or her creditors. Nor is there any reason to believe that
under current law a debtor could use an asset-protection trust to get
away with bankruptcy abuse. In fact, most people I have talked with
about these trusts indicate that they are primarily a vehicle for tax
evasion rather than a bankruptcy-proofing vehicle.
Yet, amazingly, many have criticized the Senate for rejecting an
amendment that would have closed this "loophole" as the New York Times
has called it (more on the Times in a moment, as it appears to be
source of all the confusion on this issue).
Instead of pursuing all of the possible hypothetical abuses of the
bankruptcy code, Congress has sensibly enough decided to focus on
attacking real, documented abuses of the bankruptcy system, such as
secretly hiding assets, homestead exemption abuse, and requiring
high-income debtors to repay what they can as a condition for
discharge.
Nonetheless, the legislation has been roundly criticized for the
failure to "do something" about self-settled asset-protection trusts.
(Of course, the Senate did place some limits on fraudulent use of
these vehicles through the [2]Talent Amendment.) A search reveals, for
instance, roughly two dozen newspaper editorials critizing the Senate
for the failure to adopted a proposed amendment closing the imaginary
loophole. Professor Elizabeth Warren invoked the same criticism when I
appeared with her on CNN. Paul Krugman invoked it as well is his
confused criticisms of the legislation.
How did so many people get caught up in a feeding frenzy over such a
phony issue? As is so often the case, it appears that it can be traced
back to the New York Times, ever-gullible when it comes to perceived
efforts by the Republicans to befriend big business and the wealthy.
Beginning with an article in the March 2 New York Times, "Proposed Law
on Bankruptcy Has Loophole" the Times started its intrepid reporting
of asset-protection trusts. My research indicates that this is the
first mention of asset-protection trusts in connection with the
bankruptcy reform legislation. Note--although the bankruptcy reform
legislation has been around for eight years, and the trusts as legal
vehicles have been around since 1997, concern about them appeared this
year for the first time. In that article, Gretchen Morgenson writes:
The bankrutpcy legislation being debated by the Senate is intended
to make it harder for people to walk away from their credit card
and other debts. But legal specilaists say the proposed law leaves
open an increasingly popular loophole that lets wealthy people
protect substantial assets from creditors even after filing for
bankruptcy.
The loophole involves the use of so-called asset proptection
trusts.
Hmmmm, "increasingly popular"? Interestingly, the Times provides no
examples nor any statistics to support this conclusion that this is an
"increasinlgy popular loophole that lets wealthy people protect
substantial assets from creditors even after filing for bankruptcy."
In that article, the Times quotes among others, Professor Warren:
This is just a way for rich folks to be able to slip through the
noose on bankruptcy, and of course, the double irony here is that
the proponents of this bill keep pressing it as designed to
eliminate abuse," said Elizabeth Warren, a law professor at Harver
Law School. "Yet when provisions that permit real abuse by rich
people are pointed out, the bill's propoents look the other way."
"Real abuses"? Now might be a good time for at least one example of
the "real abuse".
The Times returned to the issue on March 4, again pretending like this
was a real, rather than purely hypothetical abuse under current law,
but once again citing no examples of an asset-protection trust holding
up in bankruptcy (and ignoring the tools that bankruptcy judges have
used to police abuse of foreign asset-protection trusts), then
referenced it again on March 9.
A Westlaw search in the Allnews data base indicates that most of the
newspaper editorials around the country then picked up the story and
ran with it after the biased reporting by the Times first alerted them
to this supposed rash of abuse. Reading those stories, none of them as
far as I can tell have provided any evidence either.
In the end, it seems like a pretty specious criticism of the
bankruptcy reform legislation that it doesn't chase down every
hypothetical possible abuse that someone could dream up, especially
when it is pretty clear that the possibility of the hypothetical abuse
becoming a real abuse is really quite slim. The strength of the
bankruptcy reform legislation is that it provides practical, workable
solutions to real bankruptcy fraud and abuse. It is incremental rather
than radical, building on the institutions that we already have in
place. It is balanced and pragmatic. The abuses it targets are
supported by facts and reality, not these sorts of silly distractions.
If the standard for attacking real, documented banrkutpcy fraud and
abuse is that Congress also needs to close every hypothetical loophole
even when current law appears to do the job fine, then yes, the reform
legislation fails to close a lot of other loopholes--it does nothing
about the possibility that someone might be able to protect real
estate acquired on Mars, for instance, and does nothing to address the
possibility that an alchemist might develop a machine that turns lead
into gold and wants to exempt the machine in bankruptcy. It seems to
me that Congress can better spend its time cleaning up real abuse in
the system rather than chasing imaginary rabbits.
If this was a real problem, then Congress could and should act on it.
But to criticize Congress for a failure to attack something that
doesn't even appear to be an actual problem--get real.
And, of course, it more than a bit ironic that critics of the
legislation simultaneously criticize it as a gift to the consumer
credit industry, yet we are supposed to believe that they were unable
to close this supposedly notorious loophole for the wealthy that just
leaves money sitting on the table? It seems like at some point one of
these two mutually-incompatible theories have to give.
A final word--I fear that the bankruptcy bar and bankruptcy industry
has really harmed its credibility over the past few years through its
scorched-earth attacks on the bankruptcy bill, starting with playing
the bogus "women and children" card out of the box, moving onto the
Schumer abortion amendment, and now the phony asset-protection trust
attack. Like the boy who cried "wolf" too often, the complicity of the
bankruptcy bar in schemes to mislead and confuse Congress had, I fear,
forever tarnished its credibility on bankruptcy legislation.
A brief and useful summary of the caselaw on asset protection trusts
is provided by Melanie Leslie, 231 New York Law Journal (Feb. 14,
2005).
References
1. http://volokh.com/archives/archive_2005_03_13-2005_03_19.shtml#1111095475
2. http://talent.senate.gov/%5CNews%5CsingleNews.cfm?NewsID=1159
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