Many debtors, creditors, interested parties and their attorneys in Chapter 7 bankruptcies fail to consider the incentives of the Bankruptcy Code as it relates to the compensation of the Chapter 7 Trustee. Understanding these incentives will help litigants navigate the path of negotiating with a Chapter 7 trustee, which can be particularly risky since the Trustee can hire their own attorney, whose fees may make settlement even more difficult.
“Congress further defined compensation for trustees by limiting the amount a court may award a trustee for his or her services under § 330(a)(1) to a percentage based upon the amount of moneys disbursed or turned over in a specific case. 11 U.S.C. § 326(a) (1988). In addition to compensation for services, under § 330(b), trustees in a Chapter 7 case receive $45. 11 U.S.C. § 330(b) (1988). These provisions clearly set forth a statutory scheme in “asset” cases, whereby Chapter 7 trustees will be compensated for their services according to § 330(a)(1) and § 326(a) and will receive an additional $45 pursuant to § 330(b). In “no-asset” cases, Chapter 7 trustees will merely receive the $45. “In re U.S. Trustee, 32 F.3d 1370, 1373–1374 (9th Cir. 1994). Some trustees may refer to this small fee in no-asset cases as a loss leader. In other words, the real money is made in the assets cases.
The incentives of a Trustee for asset cases can be explained by the Bankruptcy Code, 11 U.S.C. § 326(a)(1), which provides the statutory maximum on compensation to the Trustee. It provides that: “In a case under chapter 7 or 11, the court may allow reasonable compensation under section 330 of this title of the trustee for the trustee’s services, payable after the trustee renders such services, not to exceed 25 percent on the first $5,000 or less, 10 percent on any amount in excess of $5,000 but not in excess of $50,000, 5 percent on any amount in excess of $50,000 but not in excess of $1,000,000, and reasonable compensation not to exceed 3 percent of such moneys in excess of $1,000,000, upon all moneys disbursed or turned over in the case by the trustee to parties in interest, excluding the debtor, but including holders of secured claims.“
There are two critical elements. The first is the graduated payment scale, which incentivizes a trustee to disburse or turn over in the case as much as possible to parties in interest, excluding the debtor. While the statute provides that the graduated payment scale is a percentage “not to exceed,” as a practical matter, the trustee is generally paid that percentage so long as their are sufficient assets to pay something to unsecured creditors, which is to say the estate is not administratively insolvent. Indeed, the Ninth Circuit Bankruptcy Appellate Panel reversed a Bankruptcy Court order awarding a trustee less than the statutory maximum, ordering the lower court to award “the full amount [the trustee] had requested based on the compensation rates set forth in § 326(a).” In re Salgado-Nava, 473 B.R. 911, 922 (B.A.P. 9th Cir. 2012).
The more interesting part is that the trustee is paid that percentage “upon all moneys disbursed or turned over in the case by the trustee to parties in interest, excluding the debtor, but including holders of secured claims.” What this means is that a Chapter 7 Trustee will be paid a percentage on the amounts paid through escrow to first, second and third trust deed (mortgage) holders on a house that has hundreds of thousands of dollars of equity. In those situations, it would seem likely that all of those creditors would have been paid regardless of the trustee’s efforts, e.g., if the house were sold at a trustee’s sale (foreclosure) auction. One rare exception is that a trustee does not receive compensation for a credit bid by a secured lender, though this does not commonly occur. In re Hokulani Square, Inc., 776 F.3d 1083, 1088 (9th Cir. 2015).
Because of these financial incentives, debtors and interested parties may be surprised to find that the trustee is selling a house with only a small amount of equity to pay creditors of the bankruptcy estate. To the extent those parties are trying to save those assets from administration by the trustee or simply trying to maximize the value of those assets when they are sold, it is important to work with a skilled bankruptcy attorney who has represented and opposed trustees. Working with an attorney who knows these financial incentives and the other reasons that trustees act will provide the best possible result.