Legal Victim Assistance Project1

Tractatus Economica2

Redressing the Economic Damage to Legal Victims and to America from Chapter 11 Bankruptcy:
The Debtor-Creditor Relation and the Misallocation of Capital Assets to the Favor of Legal and Other Bankruptcy Related Consortium Fees

| by Tom Climo3
April 12, 2009
  1. The efficient reorganization of a company under Chapter 11 bankruptcy would leave optimal assets available for the company’s survival and for its profitable continuance.

  2. Creditors would take that part of available company assets that would address their debt at some amount less than whole while leaving the optimal assets as outlined in 1 above. This might include buying into the reorganization plan with a modification of the existing creditor arrangement, either through a lengthening of term and/or reduction of principal and/or interest, or through some new funding method or program created in response to the current difficulties with capital investment availability.4

  3. X less 2 equals 1, the Net Capital Assets from the bankruptcy, where X is Gross Capital Assets.

  4. The result in 3 represents the productive assets that move forward from the bankruptcy.

  5. Productive assets emerge as increases in employment (or re‐employment); increase in sales; increases in operational purchases; and ultimately, through paychecks, invoice payments, and profits, increases in consumer expenditures that advance through a multiplier into an increase in the Domestic Product and Disposable Income of the country of origin, the United States of America. Such productivity increases is something we very much need today.

  6. 1-5 represent in outline an efficiently designed bankruptcy system.


  1. The Legal Victim Assistance Project (LVAP) is a Congressional District Programs, Inc. 501(c) (3) registered public charity. Its website is available at: www.legalvictimassitanceproject.org.

  2. “Tractatus Economica” is the first of three foundational publications of the LVAP. The other two, forthcoming, are “Tractatus Juridica,” by Mary Alice Gwynn, Esq. and “Tractatus Pragmatica” by Karin Huffer and Meryl Lanson. By looking at bankruptcy from economic, legal, and practical points of view, LVAP intends to leave no stone unturned in its stated goal of revamping existing bankruptcy law to the favor of those the law was intended to help. This includes the efficient allocation of valuable resources so as to benefit our country, not our lawyers. Climo, Gwynn, Huffer, and Lanson are co‐owners of the Tractatus documents and all rights are reserved to them in copyright.

  3. A former Professor of Accounting and Finance at the University of Kent at Canterbury in England and a member of the American Academy of Economic and Financial Experts. Professor Climo has provided reports to many governmental bodies, including the M.P. Select Committee on Nationalised Industries in the House of Commons, London, England, the World Bank, Paris, France, and the Euro Commission, Brussels, Belgium. He also prepared in cooperation with the Masters Study Group at Arizona State University a detailed Economic Impact Study for the Kayenta Chapter of the Navajo Nation. He is economic specialist and team member for LVAP.

  4. One example of a useful source of acquiring funds for setting up a stable plan for small company reorganization can be found in the SBA provisions of the American Recovery and Reinvestment Act 2009. Two effective changes have been made for those companies qualifying for SBA funding that should have serious and positive productive results for our economy. The first is the increase in SBA guaranteed shares up from 75% to 90%, and the second is in authorizing the SBA to establish a secondary market for pools of “first lien” not just “second lien” loans under the SBA 504 program. Providing liquidity for these first mortgages will help encourage lenders to continue participating in SBA’s 504 loan programs, which provides a key source of capital for community development and other projects. For an account of this part of the Obama Stimulus package, see SBA News Release No. 09-10 dated February 18, 2009, available at: http://www.sba.gov/idc/groups/public/documents/sba_homepage/news_release_09-10.pdf

  5. To understand economic efficiency in a bankruptcy context, consider it as that asset allocation of productive assets which produces Pareto optimality or the right balance between financial pain and gain for both the debtor and creditor.5

  6. In practice, however, the economic efficiency of Chapter 11 bankruptcy has met its challenge and peril.

  7. Evidence of this challenge and peril arrived with the Bankruptcy Reform Act in 1978 – 11 U.S.C. 1103(a) where Congress addressed a perceived problem with bankruptcy proceedings by placing the requirement of court approval for the employment of an attorney, accountant, or other professionals. The hope was that by doing this the court would help eliminate the abuses and detrimental practices that had been found to prevail. Among such practices was the cronyism of the bankruptcy ring and attorney control of bankruptcy cases. In fact, a Congressional Hearing of that same year went public and stated: “In practice… the bankruptcy system operates more for the benefit of attorneys than for the benefit of creditors.” (9H.R. No. 595, 95th Cong., 2d Sess. 92, reprint in 1978 U.S. Code Cong. & Ad. News 5963, 6053)

  8. In other words, by introducing a necessary element of the bankruptcy system – the legal profession – something occurs to challenge the efficiencies outlined in 1‐5, or 6.

  9. Since law firms are the first port-of-call for those companies experiencing too much debt against their income or cash flow, a desire for those approaching law firms is to be protected from the onslaught of the consortium of advisers that exist to fleece a company from its assets rather than satisfy the optimality of 1-5, or 6.

  10. These advisers consist of extra-legal services such as trustees, accountants, experts, liquidators and claims buyers, all working in concert with the Debtor’s law firm, usually under undisclosed conflicts of interest. These conflicts of interest are in violation of the mandates enacted by Congress, and, through the sheer greed and overindulgence of their billings and fees occasion or cause the ultimate destruction of the honest Debtor's business, the loss of employment from that business, and, eventually, the demise of any chance for Pareto optimality by leaving only pennies on the dollar for the debtor and creditors.

  11. Common sense tells us that surely one of the more important roles for legal Counsel in Chapter 11 bankruptcy is awareness of this arrangement of extra-legal consortium costs and to negotiate down these servicing fees so as to leave more not less assets available for debtor-creditor resolution.

  12. Capital assets, once identified, can be parsed without an onerous amount of time hence billings from the attorneys involved in the bankruptcy.

  13. Capital assets once parsed can be liquidated if it is cash that is sought or made part of a reorganization plan if future profits are sought.

  14. Surely, much like real estate commissions, 6% of capital assets as a legal fee would not be significant enough to usurp the efficiencies outlined in 1-5, or 6.

  15. Adding in the extra-legal consortium service fees, not even 10‐12% would usurp this desired efficiency.

  16. However, with legal and extra-legal consortium fees approaching and sometimes exceeding 75% of capital assets, clearly the legal profession is grossly mishandling the efficiency of bankruptcy proceedings.

    17. 5 Given a set of alternative allocations of, say, goods or income for a set of individuals, a change from one allocation to another that can make at least one individual better off without making any other individual worse off is called a “Pareto improvement.” An allocation is “Pareto efficient” or “optimal” when no further Pareto improvements can be made. The concept is named for Vilfredo Pareto, its inventor.

  17. Legal and other servicing fees at 75% of capital assets represents a huge misallocation of otherwise productive resources taking valuable assets from their intended productive and national purpose into instead a fattening of the wallets of law firms and their consortium partners.

  18. Research is required in an empirical form from a sizeable sample of Chapter 11 bankruptcies statistically demonstrating both individually and as a group that legal and extra-legal fees are disproportionate to the efficient allocation of assets between Debtor and Creditors. The exact “takings”6 the legal profession has wrangled with its consortium cohorts from the available capital assets in bankruptcy will then no longer be a topic for folklore but one of fact. No amount of waffling from the advocates of the legal profession will any longer camouflage, as in the past because of our naivety and ignorance, the size of this takings as being anything other than plain overcharging for services rendered.

  19. The recommended size of the sample in this research will be detailed in the research findings, but, at a minimum, it must include Chapter 11 bankruptcies in the thirty year period 1978-1993, 1994-2004, and 2005-2008. The years are parsed in conformity with the United States Code Title 11 and passage of the Bankruptcy Reform Act of 1978 as amended in 1994 and renewed again in 2005. Chapter 11 has never really changed in concept from its origins in the Corporate Reorganization Act of 1934. While English law was prevalent in the United States since its inception, and English law attributed blame and dishonesty to bankruptcy debtors, the United States forged its own separate and well-earned benevolent identity on the assumption that the debtor might be honest but unfortunate.

  20. The anticipated result of the research indicated in 20 and 21 will tell the following tale: three-quarters of the capital assets reorganized with the purpose of becoming productive assets of our country have been compromised owing to legal and extra-legal fees.

  21. This compromise represents a heavy social opportunity cost.

  22. The social opportunity cost is the loss in Domestic Product and Disposable Income, at one-quarter of what it ought to be, representing a serious misallocation of our national resources from productive assets to windfalls for attorneys and their consortium cohorts involved in counselling the bankruptcies.

  23. Therefore, without any “skin” in the game, unlike the Creditors who are owed money, unlike the Debtor who no doubt has operated a business for many years, attorneys and their adviser cohorts dive fresh into the proceedings taking the majority of the proceeds for themselves without regard to the fairness or efficiencies intended by the very system they are there to implement.

  24. Such behaviour is both a fraud on the Court as well as a violation of fiduciary trust on the part of the legal profession.

  25. Worse, such behaviour has probably rendered impossible through the shortage of operational money now available to the Debtor of the Debtor effectively making good on the reorganization; and, in the case of the Creditors, have left them well below the otherwise partial hit they were prepared to take for the sake of the national good, or, where they were agreeable to reorganization, contingent on the success of a firm now lacking the required funds to succeed. Legal and extra-legal fees are paid first out of the assets of the bankruptcy estate, which, at existing rates, leaves pennies to pay creditors and virtually no working capital for the honest debtor to survive much less prosper.

    26. 6 The concept of “takings” is usually reserved to indicate how eminent domain permits the transfer of title of real estate or resource rights for the common good. Here “takings” is meant in reverse, how for-profit partnerships and legal entities conspire to transfer title from real estate and other valuable assets into cash for their own interest quite separate from any consideration of the common good.

  26. Attorneys charging and allowing these kinds of outrageous fees, as based on the worth of capital assets, are as much an enemy of the good name of the country they live in as a traitor who knowingly exchanges trade secrets that have valuable and quantifiable advantages to his country.

  27. The Legal Victim Assistance Project (LVAP) is here to argue that attorneys can no longer rule the roost in bankruptcy proceedings; that they and their extra-legal cohorts should have their fees fixed as in real estate sales; and that the interest of the Debtor‐Creditor relation and its economic impact for the reorganized and productive use of capital assets is paramount, even if the legal and extra-legal fees are alleged to exceed the permitted legal percentage as charged.

  28. Better for the legal and extra-legal professions to take a discount than the national economy.

  29. This is the credo of the Legal Victim Assistance Project. It is to become our demand and plea.

  30. Once we have completed the research indicated in 20 and 21, and created Table A contrasting Gross Capital Assets against distributions to debtor, creditors, and legal and extra-legal fees, a second Table B will then recalibrate Table A in terms of reduced legal and extra-legal fees at a fixed percentage rate (6% for legal and 6% for extra-legal, or total fees of 12% of Gross Capital Assets).

  31. The difference in the Net Capital Assets in Tables A and B and the multiplier that difference could create equals the social cost of legal an extra-legal fees to Chapter 11 Bankruptcies. This becomes a measure of how the behaviour of law firms, owing to their failed fiduciary responsibility, has contributed to the downturn and potential economic ruin of our country.

  32. Sure Bernard Madoff and Stanford Financial and all the other crooks that have made a name on the wanted posters of the financial regulatory bodies have blame. Sure the misapplied analysis of banks and investment houses regarding sub-prime loans and credit swap defaults are also factors in the Great Downturn of 2007‐2009. No doubt printing more money in a one-year period than we did in the forty years before helped occasion the onset of disbelief in the value of our dollar. But at billions to a trillion dollars of lost opportunity in the use of capital assets from Chapter 11 bankruptcies, we find a simple expedient for quickly resolving one large swath of trees in our forest of economy recovery. By lowering legal and extra-legal fees to a mandated small percentage of the available capital assets in a Chapter 11 bankruptcy, we are putting back into the economy a large, and not inconsiderable productive asset base.

  33. The social opportunity cost indicated in 33 spoke of a multiplier. To measure this multiplier and the effects of the multiplier, we will require a fully detailed Economic Impact Study. This Study will show the total economic good that will accrue to the American economy and the American people from the recommendation of lower mandated legal and extra-legal fees.

  34. Reiterating Congress’ long‐ago concern about the deficiency in the existing bankruptcy proceedings, the Legal Victim Assistance Project through its research and findings will request the following of Congress:
    (a) Setting up a bankruptcy proceeding that identifies the optimal capital assets required of the Debtor for successful reorganization;
    (b) Appealing to the Creditors to take less from the Gross Capital Assets to permit this optimal allocation to the Debtor;
    (c) An understanding of the priority of (a) and (b) by the legal profession;
    (d) Who will heretofore charge only a reasonable percentage fee of the Gross Capital Assets as outlined in this Tractatus, ensuring the same of those they solicit for extra-legal assistance. 5

  35. In conclusion, the high assessed capital value of bankruptcy assets restructured through Chapter 11 are being diminished by wholly unwarranted legal and extra-legal fees to such an extent that our country is losing productive assets as much as seventy-five cents on the dollar because of nothing more significant than the desire of the legal profession and its cohorts to widen and deepen their own purse. The day for re-routing these onerous fees into productive assets has arrived. It is through productivity not legal fees that recessions end.7

    36. 7 LVAP has a four-fold agenda for accomplishing its goal of re-introducing Chapter 11 capital assets into our economy and not into the pocket of legal and extra-legal professional firms. The preliminary agenda consists of a grant proposal in line with the three Tractatus documents together with a Request for Funds. The intermediate agenda consists of the completed grant, its research and findings together with recommendations for legislation to Congress. The penultimate agenda consists of our lobbying Congress to enact this legislation. On successful enactment of legislation, the final agenda is for monitoring the success of this legislation, both in the manner Chapter 11 lawsuits are proceeding as well as a careful scrutiny to ensure Trustees do not forfeit their obligation by allowing legal fees to rise once again. We will need to be as vigilante in preventing further legal victims and economic inefficiencies arising from a reformed Chapter 11 bankruptcy as occasioned our concern and the creation of LVAP in the first instance. After all, the 1978 law never contemplated a situation where lawyers and other professionals took the majority of Chapter 11 capital assets. It was good law, but bad monitoring. The fact that 1994 and 2005 had an opportunity to rectify this travesty but failed to do so mean a different, more ruthless legislation is in order. At stake is the economic survival of our very country. We are at no less a juncture at this point in time than the bold revolutionaries that founded our great country. The success that the Legal Victim Assistance Project intends to achieve will go down in history as a momentous period when the American people claimed back their legal and Court system. We will be hailed as the second generation of Patriots.