The Chapter 13 Business Model

By John M. Hauber, Chapter 13 Standing Trustee (Indianapolis, IN)

I have recently written an article for the NACTT Quarterly, that may or may not be published at the time of this writing, which is simply a stream-of-conscious style response to Senator Elizabeth Warren’s desire to modify the Bankruptcy Code based upon her perception that debtors’ attorneys get rich off the backs of minorities by inordinately steering minorities toward Chapter 13 cases.i Due to time constraints and the target audience of that article, I did not provide any background regarding my own path into the bankruptcy system, or how I may be so confidently assured that Senator Warren’s conclusions are woefully inaccurate. However, I feel compelled to provide some background to my Chapter 13 trustee colleagues, some of whom may have never operated a high-volume debtors’ practice and might not be aware of day-to-day financial issues that many debtors’ counsel experience. If you will indulge me for a moment of redirection, I have found that many consumer advocates have similar background stories which explain why many attorneys seek a career helping people over the possibility of immense wealth.

The year was 1977, and I was twelve years old, when my father married my stepmother which added two stepsisters to our new, comingled family. My sister and I quickly realized that there were inequities regarding how the rules applied amongst the children. Especially for my sister, the perceived injustice of the situation grew into indignation over how the judge (my stepmother) doled out chores and enforced penalties. I decided to represent my sister and plead with the court for more equity for all the household children. I drafted my arguments and practiced before the mirror. Once I was fully prepared and briefed, I garnered up the courage, respectfully approached, and spelled out clearly and concisely our chosen points and request for reconsideration. Without any hesitation, she looked down at me and simply said, “life’s not fair.” There would be no appeal to my father who would have only reviewed her decision based upon an abuse of discretion standard. I eventually went to law school with an idea in the back of my mind that life should be fair, and law school would surely prove that maxim accurate. After studying many subjects with little satisfaction, I found great comfort in the area of consumer protection and bankruptcy. Finally, an equitable statute. The debtor would honestly and accurately list all assets and sources of income, and the court would determine whether the debtor had anything worth selling in a Chapter 7 or any available income to repay a portion of the debts in a Chapter 13. With that knowledge in hand, I decided to practice in the area of bankruptcy and have been here over twenty-five years helping thousands of debtors reorganize their lives.

After I started that business, it was not long before I soon realized that law school may teach the law but fails students regarding how to actually operate a business. Before long, my firm had three locations, four attorneys, twelve staff members, and a significant presence on the Yellow Pagesii, which meant that I had substantial monthly expenses regardless of revenue. I was able to earn a decent wageiii by working evenings, Saturdays, and holidays, but cash flow was always a problem. Sales, marketing, and “closing the deal” became as integral for success as simply providing the best customer services. Taking a monthly salary without knowing what the next month’s revenue would generate became stressful enough that I eventually went to my local bank to apply for a business loan to cover any shortfalls that may occur (especially during Q4 when filings fell annually). The bank manager asked that I provide valuation of the business and a business plan which included cash flow and accounts receivable. That requirement was really the first time that I had to stop and think about the Chapter 13 business model in great detail. I was confident that my business had real value.

Chapter 7 cases follow a traditional business model for almost any service industry. That is, the attorney collects money up front and bills against that retainer as work progresses, or at least contract a flat fee to cover all services. Once the work is complete, the money is transferred from the trust account to the operations account. In other words, like any normal business operation, the money is available to be paid for quality legal services. It is a business model which makes sense, is easy to calculate, and provides a correlation between time invested and revenue earned.

I did not receive as significant of a business loan as I had calculated due to what I believed was the bank manager’s lack of understanding about the Chapter 13 business model. After I had explained the cash flow situation to the bank manager and my significant accounts receivable as an asset, he may have actually laughed at me and stated that he understood why I was not making any money. In a Chapter 13 model, I was giving away significant time.

First the bank manager asked how much I was collecting up front. I explained that there was a time many years prior, when I was generally able to collect between $500.00 and $1,000.00 up front, but the market had changed. That is, so many attorneys were under-selling each other that almost every case had to be a no-money down filing, and some attorneys were even financing the filing fee. So, the bank manager then asked whether there was less work to get the case filed. I explained that it was just the opposite. While I had the same initial requirements, including providing all the required upfront disclosers; meeting with clients to determine the problems and financial goals; examining the debtor’s financial records, assets, preferential transfers, and income sources; and looking for and removing judgment liens, the Chapter 13 required even more. The means test had to be completed to determine whether there was disposable income, and a plan had to be drafted which determined the most favorable way to treat all secured and priority claims. Then there were always the additional meetings negotiating with the clients to see what expenses they could eliminate to make the plan feasible, all while carefully watching monthly income to make sure that the disposable figure would not change. After filing the case, the work involved to strip off mortgages, deal with creditor valuation objections, motions to compel creditors to file secured claims, fighting with the IRS over allegedly unpaid taxes, and meeting with the trustee over the dividend to unsecured creditors meant that there would be many extra hours to finally get a confirmed plan.

The banker asked whether I could then expect a regular, monthly payment at confirmation. I chuckled and replied that while I kept track of what I would get paid, I might not see a penny for many years, if at all. I explained that I kept track of my accounts receivable, and I had over $50,000 of accounts receivable at that time which should be sufficient for a loan. However, as the ongoing mortgage payments and adequate protection on secured claims had to be current before I would start receiving money, I had to stand in line behind these super-priority creditors. He asked if I was receiving or incurring any interest on the past due accounts, and I said no. He asked about my collection practice if the case dismissed or converted to Chapter 7. If the case converted, my accounts receivable would be discharged even though I never got paid. If the case started to fail, I would usually spend many additional hours of time trying to save the case by objecting to motions to dismiss, objecting to motions for relief from stay, and modifying the plan to roll in missed payments (and then paying the postage to send notice to the creditors). I invested the additional work to try and help the struggling debtor reorganize and a dwindling hope that I might be paid anything for my time. Ultimately, if the case failed, I did not try and collect from a largely judgment proof debtor. The debtor would likely need to refile at some point in the future and I did not want to lose that business. Also, over 50% of my clients came from referrals, and I did not want to lose the only inexpensive marketing stream available.

The bank manager may have rolled his eyes while he explained that I had no idea what the term “accounts receivable” meant. Specifically, an account receivable meant that I had completed the work and was owed money for work that had been completed. If I had to invest more legal time in order for a chance to get paid, that would not be considered an account receivable. It was, instead, my absolute promise to the court that I would continue to provide legal services with no promise whatsoever that I would be paid for those services. In short, the bank manager would not lend money with a business model of financing virtually unlimited legal services at o% interest over an unknown period of time with no specific repayment terms to assist insolvent clients who I clearly knew at the time did not likely have the resources to pay me in the first place.

I did not walk away from the practice at that time but stuck with it for years after bankruptcy filings fell, and I had to become a general practice firm in order to keep the lights on. Even with the atypical business model of giving away legal services and hoping that things work out financially, I have never hesitated to help a debtor file a Chapter 13 and fight like hell to help debtors retain assets, get more affordable terms on secured claims, and keep creditors at bay for years on end. My assistance helping debtors file under Chapter 13 has literally saved marriages, saved businesses, and has even saved at least one life according to the debtor. While I know firsthand that life is not always fair, I have done my part to help make life fairer for thousands of men and women who have been financial harmed. Chapter 13 is not a means by which attorneys are going to profit, but debtors’ counsel will continue to help debtors file under Chapter 13 because that is a solution.

__________________________

[i] Senator Warren’s conclusion fails to explain why debtors’ attorneys would not desire to get rich off the backs of all clients regardless of race.

[ii] Once the Yellow Pages were decimated by Internet search engine, trying to learn SEO (search engine optimization) became the bane of my existence and eventually the time to leave.

[iii] By “decent wage,” I mean that I still would have been considered a below-median income wage earner for a household of five people.

__________________________

hauberJohn M. Hauber was appointed as the Chapter 13 Standing Trustee for the Southern District of Indiana, Indianapolis Division on April 1, 2015. Prior to this appointment, Mr. Hauber was a partner in the Indianapolis, Indiana office of Tom Scott & Associates, P.C. His practice included business and consumer bankruptcy, debtor and creditor’s rights including financial restructuring and workouts, and all aspects of bankruptcy litigation. Mr. Hauber received his A.B. from Wabash College in 1990 and his J.D. from Indiana University Robert H. McKinney School of Law in 1993. He worked for the Indiana Attorney General’s Consumer Protection Division from 1993 through 1997 as a Deputy Attorney General and was a member of the National Association of Consumer Advocates and the Indiana Home Defense Task Force. He worked in private practice from 1997 through 2002 emphasizing the representation of consumer bankruptcy debtors. Mr. Hauber was a staff attorney for Chapter 13 Trustee Robert A. Brothers in December 2002 before returning to consumer bankruptcy practice in August 2008. Mr. Hauber is currently an adjunct professor at the I.U. McKinney School of Law. He has lectured on all aspects of consumer bankruptcy for the American Bar Association, ICLEF, the Indianapolis Bar Association and the Office of the United States Trustee for Region 10 since 2002. Mr. Hauber also offers free continuing legal education quarterly for members of the local bankruptcy bar. He is admitted to all Indiana state courts, federal courts for the Northern and Southern Districts of Indiana and the 7th Circuit Court of Appeals.

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