Author: A.J. Webb, Articles Editor, University of Cincinnati Law Review
In November 2011, W. Steve Smith traveled to New Orleans, Louisiana, to attend a bankruptcy hearing for IFS Financial, for which he served as a bankruptcy trustee in a chapter seven liquidation.[2] While the hearing lasted only one day, Smith extended his stay by three additional days. This decision ultimately cost him his job as a trustee on all of his bankruptcy cases.[3] The Bankruptcy Court for the Southern District of Texas removed Smith as a trustee under Bankruptcy Code (Code) § 324, a provision that allows the court to remove a trustee for cause after notice and a hearing.[4] The District Court for the Southern District of Texas recently affirmed this decision.[5] The decision by the district court highlights three important issues with regard to bankruptcy trustees. First, it demonstrates the willingness of courts to remove trustees for relatively minor improprieties. Second, it demonstrates the fundamental principle of a trustee’s job in bankruptcy: to protect estate assets and ensure their distribution to creditors. Finally, it raises the question as to whether trustees have a “right” to their job under the Code or the United States Constitution.
Expensing the Estate
Smith’s involvement with IFS Financial’s bankruptcy was complex and varied. He represented the company in several adversary proceedings that resulted in judgments for the bankruptcy estate, helping reduce the debts owed by IFS Financial to its outstanding creditors. When one of these judgments was appealed, Smith hired his wife, an attorney, to help handle the proceeding.[6]
In November 2011, Smith and his wife traveled to New Orleans to prepare for a proceeding in the IFS bankruptcy. He brought their two children along with him due to “severe behavioral issues.”[7] After the hearing, Smith sought reimbursement from the bankruptcy estate for $3,486 in travel expenses: $2,121 in lodging, $900 in airfare, $245 in parking and taxis, and $220 in food. Allegedly, Smith did not expense the estate for his children’s attendance at the hearing.[8] A creditor of IFS Financial objected to these expenses, and the bankruptcy court held a hearing to determine whether Smith improperly expensed the estate for the trip.[9] The court found that Smith was unfit to be a trustee because he attempted to convert the estate’s assets and because he willfully breached his fiduciary duties, and so removed Smith from all his cases under § 324(a) of the Code.[10] Section 324 allows a bankruptcy court to remove a trustee for cause, after notice and a hearing.[11] If a trustee is removed from one case, it is expected that the trustee will be removed from all other active cases, unless the court grants otherwise. Smith appealed to the district court.[12]
Smith’s Arguments Fail on Appeal
On appeal, Smith first argued that the Code’s use of “for cause” is ambiguous because the Code does not define what constitutes “cause.” Smith argued that his actions had to amount to gross negligence in order to be removed.[13] The district court flatly rejected this argument, finding that the Code only requires “an articulable justification based on cogent facts and rigorous reasoning” to remove a trustee.[14] According to the court, Smith’s visit to New Orleans acted as a “family vacation”—he admitted to doing no work on two of the four days in New Orleans and conceded that his fees were improper.[15] The district court noted that the Code “does not require egregious misconduct for removal.”[16] Rather, the bankruptcy court is entrusted to determine in each case what constitutes cause. The district court found Smith’s actions worse than “poor judgment,” and were sufficient enough to warrant removal.[17]
Smith then argued that the Code is ambiguous because it does not define what constitutes “adequate notice and hearing.” This argument was also rejected by the court, because Smith conceded that he was told of the hearing, had time to prepare, and had an opportunity to be heard. Smith asserted that he was not informed that the court was going to question him for self-dealing in other bankruptcy cases. Because Smith did not object during the hearing when the court discussed his trusteeship on other bankruptcy cases, the district court held that he waived those objections.[18]
Smith’s more compelling argument, however, was that § 324(b) of the Code—which removes a trustee from all cases if a trustee is removed from one case under § 324—is unconstitutional because it deprives Smith of his liberty without due process of law.[19] According to Smith, the Fifth Amendment to the Constitution provides him with a liberty interest in working as a trustee, and the bankruptcy court interfered with that right by removing him from all of his cases. The district court summarily rejected this argument. According to the court, Smith was afforded all that he was due: notice, hearing, and an opportunity to explain himself. Smith argued that he should have been entitled to separate hearings for each of his cases, but the court noted that “trusteeship is unitary within the court” and Smith was only entitled to one hearing.[20] Therefore, the court upheld Smith’s removal from all his bankruptcy cases.
No Room for Error
Based on the facts of the case, it is clear that Smith was neglectful in his duties as a trustee and that he improperly charged the estate for his stay in New Orleans—Smith himself even conceded as much.[21] Although Smith’s neglectful actions resulted in his dismissal as trustee, bankruptcy courts have recognized that the removal of a trustee is an extreme measure.[22] Trustees are not to be removed on account of a mistake in judgment.[23] On appeal, the district court should have considered the relatively minor mistake in judgment Smith made and reversed his removal on all bankruptcy cases.
Trustees are charged with maintaining the bankruptcy estate. As part of those duties, trustees must ensure that money in the estate is properly preserved for distribution to creditors, and, if necessary, to help the debtor reorganize. Smith violated this duty when he expensed the estate for excessive travel costs in New Orleans. Certainly Smith should have been required to reimburse the estate for this unnecessary expense. He should have also lost his job as the trustee in the IFS Financial case. A public reprimand by the bankruptcy court and the district court, as happened here, was also warranted.
The judge for the district court, however, appeared to use this particular case as a chance to ensure Smith’s removal based upon alleged improper dealings in other bankruptcy cases. This punishment is arguably excessive in light of Smith’s actions. The only specific findings of fact that the district court adopted were Smith’s course of dealings with respect to IFS Financial. Under the Code, if a trustee is removed from a single case, a trustee must be removed from all other bankruptcy cases unless the court grants otherwise. However, here, the court should have allowed Smith to remain active on his remaining bankruptcy cases.
Smith’s $3,486 in travel expenses is simply too minimal to warrant removal from all of his cases, and it pressures trustees to spend additional time (with resulting delays) excessively scrutinizing their own expenses. While trustees are prohibited from breaching their fiduciary duties, removing Smith as a trustee in the IFS Financial bankruptcy and requiring him to repay his expenses is enough of a remedy to deter future violations. It also fulfills the aim of the bankruptcy court and the Code in restoring honesty in trusteeships without burdening Smith’s ability to maintain employment. The district court should have considered reversing and remanding the bankruptcy court’s decision and requiring further determinations on Smith’s actions in his other cases.
Is There a Right to Bankruptcy Trusteeship?
Smith argued that his removal as trustee deprived him of his liberty under the Fifth Amendment without due process of law.[24] There is little doubt that he was afforded due process concerning his activities as trustee in IFS Financial’s estate. Nothing in the Code affords Smith the right to be a trustee; however, he is expressly afforded the right to due process under the Code prior to his removal.
According to Smith, he was entitled to separate hearings on each of his cases before removal. This protection is not afforded under the Code, which only provides that a trustee is entitled to “notice and a hearing.”[25] It does not make mention of multiple hearings for each case that the trustee has been assigned. In a separate case, a bankruptcy trustee argued a position similar to Smith’s, but this position was ultimately rejected by the Eight Circuit Court of Appeals.[26] In that case, the Eight Circuit implicitly found that the Code mandated that a trustee is only entitled to a single notice and a hearing, which the trustee received. After the hearing, she was removed from all of her cases.[27] The Fifth Circuit Court of Appeals, in which the IFS bankruptcy is pending, has not addressed the issue.
Smith’s Next Hurdle
Smith maintains that he will appeal this case to the Fifth Circuit,[28] and if so, the Fifth Circuit will likely uphold the district court’s ruling. While Smith’s removal over a nominal charge to the estate is questionable, his removal from all cases was automatic and the discretion to remove him from only the IFS Financial case rested with the bankruptcy court. The Fifth Circuit is unlikely to reverse the bankruptcy court’s decision to remove Smith from all cases, given the explicit language in the Code and the prior ruling by the Eight Circuit. Furthermore, while Smith was entitled to due process rights, he was only entitled to a hearing, which he received. The Fifth Circuit would likely agree that the text of the Code only requires a single hearing, particularly in light of the Eight Circuit’s recent decision on the matter. While Smith’s plight is peculiar, it highlights the willingness of courts to remove trustees quickly for any seemingly improper action. It also highlights what little protections or rights the Code and the United States Constitution afford trustees.
[1] Smith v. Robbins (In re IFS Financial Corporation), H-13-1447 (S.D. Tex. Aug. 11, 2014).
[2] Id. at ¶ 2.
[3] Id. at ¶ 1.
[4] 11 U.S.C. § 324 (“The court, after notice and a hearing, may remove a trustee, other than the United States trustee, or an examiner, for cause”).
[5] Smith v. Robbins (In re IFS Financial Corporation), H-13-1447 at ¶ 28.
[6] Id. at ¶ 2.
[7] Id. at ¶¶ 2-4. Despite Smith’s claim that his children had severe behavioral issues which required intervention by a therapist, the court noted that Smith’s children did not visit a therapist at any point during the trip. Id at ¶ 4 (internal quotations omitted).
[8] Id at ¶ ¶ 2-4.
[9] Id. at ¶ 5.
[10] 11 U.S.C. § 324 (“The court, after notice and a hearing, may remove a trustee, other than the United States trustee, or an examiner, for cause”).
[11] Id.
[12] See 11 U.S.C. § 324(b).
[13] Smith, H-13-1447 at ¶ 9.
[14] Id. at ¶ 8.
[15] Id. at ¶ 14.
[16] Id. at ¶ 15.
[17] Id. at ¶¶ 9-10.
[18] Id. at ¶ 18.
[19] Id. at ¶ 22.
[20] Id. at ¶ 26.
[21] Id. at ¶ 12.
[22] See In re JMW Auto Sales, 494 B.R. 877, 889 (S.D. Tex. 2013) (“Removal of a trustee is an extreme measure.”).
[23] See In re Haugen Const. Service, Inc., 104 B.R. 233, 240 (D. N.D. 1989).
[24]Smith v. Robbins (In re IFS Financial Corporation), H-13-1447 at ¶ 22. This argument stemmed from the idea that bankruptcy trusteeships are public employment, and as such, Smith has a liberty interest in employment as a trustee. Furthermore, Smith had a right to due process afforded to him by the Code.
[25] 11 U.S.C. § 324 (“The court, after notice and a hearing, may remove a trustee, other than the United States trustee, or an examiner, for cause.”) (emphasis added).
[26] See Morgan v. Goldman (In re Morgan), 573 F.3d 615 (8th Cir. 2013).
[27] Id. at 628.
[28] See John Council, Judge Lynn Hughes Removes Bankruptcy Trustee Over Family Trip to New Orleans, Texas Lawyer (Aug. 20, 2014), http://www.texaslawyer.com/id=1202667514010/Judge-Lynn-Hughes-Removes-Bankruptcy-Trustee-Over-Family-Trip-to-New-Orleans?slreturn=20140809224836 (Smith maintaining he will appeal).
