Tuesday, March 6, 2007

Debtor's Road Map

"Come on off of your roof top.
Come on down to the street.
I've got something to tell you.
Your secrets I will keep."

-- Miracle to Me
by The Black Crowes

The question was recently posed to me, and I am paraphrasing here, "Ok, Fatboy. You have made your point about ESI and bankruptcy practice. We get it. But for those of us actually preparing to file a small business Chapter 7 bankruptcy, or a small to medium sized Chapter 11, what are we really supposed to do?" This was a question I had hoped would wait for a few months, but alas, it is upon me now, and this is no time for a cut rate, second-tier kind of answer. Indeed, it is time to take stock of the situation, and face these practical questions head on.

For many reasons, the "best practices" type of answer is much easier to address in relation to the Chapter 7. This is largely true because, once the case has been filed, and certainly by the conclusion of the 341 creditor's meeting, the problem becomes one more for the Trustee. Thanks to the oft-cited Jack Seward article Debtor's Digital Autopsy, trustees, and to some extent creditors, have at least a starting point and a road map. For debtor's counsel, at first glance there is no such road map. However, deeper analysis of the debtor's (long-standing) duties regarding ESI reveals that, what is good for the trustee may be good for the debtor as well.

Even though phrases like EDD, ESI or e-bankruptcy do not appear in the Bankruptcy Code, the Code is probably still the best place to start. (PLEASE NOTE: Sections 332-333 and 351 of the Code may not be directly addressed, and those provisions ought to be consulted whenever appropriate).

Sec. 521 of the Code likely provides both a starting place and the loose outlines of that Debtor's Road Map. Sec. 521(a)(1)(B) requires, among other things, that the Debtor file a schedule of assets and liabilities. Sec. 521(a)(3) requires a Debtor's cooperation with a trustee, or an auditor hired by a trustee under 28 USC 586(f)(sec. 603 (e) as referenced therein is effective 18 months after the enactment of BAPCPA), so that the trustee can perform his or her duties under title 11. Note also that 28 USC 586(f) appears to require such an auditor to prepare a report for the Court which includes a clear and conspicuous determination as to whether or not the Debtor made a material misstatement of income, expenditures or assets. If the auditor makes such a finding, either the clerk of the district court, or the clerk of the bankruptcy court will notify creditors of such finding. Material misrepresentations concerning assets may also be reported to the Unites States Attorney under 18 USC 3057.

Sec. 521(a)(4) is a key provision in preparing the small business chapter 7 bankruptcy. This provision requires the surrender of "all property of the estate and any recorded information, including books, documents, records, and papers, relating to the property of the estate...". The provision, by incorporating sec. 344, requires that all such information be turned over, whether or not the debtor has been granted immunity as such may apply to title 18. 521(a)(4), by the way, appears unchanged from its pre-BAPCPA form, which of course pre-dates the ESI-related amendments to the Federal Rules of Civil Procedure. This means that, to the extent the bankruptcy bar has not been doing so, collectively we should have been accountable for ESI-related disclosures long ago.

Sec. 541(a) describes generally the property of the estate. As raised before in this forum, at the very minimum, bankruptcy lawyers must consider ESI in its various potential forms including: "books and records" of the estate, intellectual property of the estate, inventory, assets, etc. Aside from the esoteric, this also means the hardware that belongs to the debtor including servers, laptops, cell phones, digital cameras, zip drives, removable or external storage, voice mail systems, and so on. Keep in mind the limited exception found in sec. 541(f) regarding the assets of a 501(c)(3) organization.

Sections 542 and 543 address the requirements for turning property over to the trustee. Specific to sec. 543, such custodians of property may be Internet service providers, professional service providers, and online data storage providers. "Turnover" of this type of property, so long as the data is adequately secure and well-preserved, may be as simple as providing the trustee a new password in order to access the data. Given that much of this data may be usable only in proprietary software, this is likely a far more practical approach from the standpoint of both the Debtor and the trustee.

Section 554 addresses abandonment of property by the trustee. The implications of this issue are probably deserving of their own separate article. In order to preserve the collegiality of the bar, at the very least, debtor's counsel should at least be knowledgeable enough to alert a trustee when abandonment of estate property might cause unintended harm to third parties. For instance, if a chapter 7 debtor had been using on-line email accounts, such as GMail, what will happen to any confidential data once the trustee abandons the accounts? Who will be responsible for either securing, or destroying, the data of consumers so lovingly mined by vile identity thieves? Related concerns accompany the trustee's liquidation of estate property. Stories continue to run rampant even today of used, "re-formatted" disk drives that can be purchased from any auction or garage sale, where confidential or sensitive information can be easily recovered. If nothing else, professional courtesy demands that debtor's counsel alert the trustee to the location and nature of such information to reduce the chances of accidental disclosure of such information.

Section 704 outlines the duties of the chapter 7 trustee. As debtor's counsel preparing for the small business filing, sections 704(a)(2) and (4) are of particular importance. As we shall see, the key to (a)(2) is core competence and disclosure. Sadly, (a)(4) can sometimes be luck of the draw just as much as it is disclosure. Given the requirements of section 521, to the extent possible, debtor's counsel ought to consider preparing the ESI related schedules and disclosures as though actually working on behalf of the trustee. This approach will bring debtor's counsel full circle, in one sense, to Seward's Digital Autopsy article.

With these statutory obligations in mind, and incorporating by reference herein the more practical matters of the form and format of debtor's schedules and statements of financial affairs, how can the prudent debtor's attorney proceed with the small business chapter 7, making all the reasonable and necessary ESI related disclosures, and in fulfillment of counsel's duties as an officer of the court?

The first step likely begins in the initial debtor interview, and is a continuous process all the way through discharge. Most small businessmen and women, in fact if not in law, do tend to operate as though the person and the entity are one. This means that the company pays their cell-phone bill, company business is managed from a computer located at home, or worse, the company has purchased the owner a wonderful laptop computer with all design of wireless gadgets which the owner uses for all business, both personal and company related. Either the owner, a part-time book keeper, or a retained accountant have Quicken at one or more locations. Old, out of date computers are stashed in a broom closet, or were given to the secretary's college bound son last year. Even though the company may have an on-again off-again website, the employees all use web-based emails. Some of the employees communicate with family, friends, vendors or customers, through instant messaging (IM). Some, having no other real source of contact with their teenage children, maintain there own MySpace.com page, which gets flooded with email, comments and more instant messaging at the end of each school day. The universe of potential ESI sources of even the smallest company can be mind-numbing, and given the greater likelihood of reduced controls, the greater the likelihood of failing to meet one or more of the Debtor's duties.

The practitioner's first step then, likely ought to be the plain admonition and instruction that the computers, the laptops, the cell phone, the emails, the instant messages, E-EVERYTHING belongs to the company. The working assumption is that all these things, the E-Everything will also soon be in the control and possession of the trustee. Many will no doubt be surprised to discover that months worth of "deleted" emails and logs capturing word for word IM conversations will also, at first blush, be going to the trustee. To a great degree, this is merely an extension of bankruptcy lawyers have always done, by beginning the process of having the debtor accurately disclosing and accounting for the books and records, as well as the property, of the debtor. The inescapable duties simply require a greater degree of sophistication, and a collective advance in the bar's understanding of modern work processes and technological developments. If done correctly, Debtor's Schedule B will likely look more like an inventory from a Radio Shack store than the traditional debtor's schedule of assets.

Counsel must also establish early on, as has always been the case, that the company is the initial master to be served - not the owner. Aside from making the owner understand that "my laptop" is not really mine, the duties owed to the company and to the estate dictate that the owner, or perhaps his idiot brother-in-law the self-proclaimed computer guru, are absolutely prohibited from selectively destroying, altering or removing any type of file, email or other ESI-type data. In essence, the safest course may be to instruct the debtor to treat pre-petition data as though subject to a traditional "litigation hold". In this manner, even if the trustee is ultimately inundated with emails about last evening's American Idol, or IM's gossiping about the drunkard at the company Christmas Party, debtor's counsel has at least cut off one avenue of claims about failure to preserve, maintain or disclose the books and records. Even though the ESI turned over may prove damaging or embarrassing, in the long run preservation and disclosure may prevent spoliation/adverse inference/sanctions rulings. Disclosure and effective advocacy almost always trump destruction and deceit (except on the television program The Shield, which will almost certainly cut into the time I have set aside this year for "goofing off").

It is now imperative that debtor's counsel inquire as to whether or not the debtor has, or has had, a document retention policy (DRP). The reasons for this are many, and sound. A well-crafted DRP, at least initially, should provide counsel with a summary of the company's digital enterprise and at least a cursory explanation of how the internal systems work together. Additionally, if third-parties such as customers or vendors have external systems that interact with the debtor's digital enterprise, this should be summarily explained in the DRP as well. More importantly, a good DRP will include an inventory of the hardware and software used within the enterprise, and will further identify those individuals within the organization that know where all the digital skeletons are hidden.

From the perspective of the typical small chapter 7 business filer, the "new era" of ESI likely does not create any new or additional burdens on the debtor or on debtor's counsel. The emerging recognition and importance of ESI does mean that debtors, and their counsel, must exponentially improve their understanding of business practices and technological advances, and how those fit into bankruptcy jurisprudence.

True understanding of modern business practices and the attendant uses of technology make up that "core competence" that those who have gone before me have advocated. See Today's Bankruptcy Litigation Calls for Greater Technological Competency: Understanding Electronic Data Discovery, ABI Journal, Vol. XXVI, No. 2, March 2007. This knowledge, this core competency is vital because the ultimate answer to the small business chapter 7 is disclosure. We cannot fully or adequately disclose that which we do not understand.

In the vast majority of chapter 7 business cases, it is highly unlikely that pre-petition, either the debtor or debtor's counsel will be compelled to employ extensive forensic investigations or services to comply with their statutory obligations. Obvious exceptions include fraud, or any unauthorized use or transfer of estate property (you know, theft).

Generally, small commercial chapter 7 debtors must then satisfy modernized versions of the duties under the Bankruptcy Code that they have always had: 1) requisite knowledge of the debtor's affairs; 2) disclosure; and, 3) cooperation with the officers of the estate.

In the next post, we can explore how the small and medium Chapter 11 debtor cases can be so similar and so disparate at the same time.

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