The Volokh Conspiracy - Bankruptcy Reform, The New York Times, and Real v. Hypothetical Bankruptcy Abuse:

A few weeks ago, 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 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 followed the Times over the cliff, running 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).

	[Todd Zywicki, April 1, 2005 at 6:48am] Trackbacks Bankruptcy Reform, The New York Times, and Real v. Hypothetical Bankruptcy Abuse: A few weeks ago, 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 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 followed the Times over the cliff, running 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).