Consumers who formerly could escape their debts through Chapter 7 bankruptcy would be barred from doing so if Congress passes proposed legislation that markedly alters current bankruptcy laws. The Senate is now debating a bill that would require debtors who can repay some of their debt to declare Chapter 13 rather than Chapter 7 bankruptcy. The bill is similar to a House bill that passed in May.
Chapter 7 relieves debtors of most obligations, whereas those who file Chapter 13 repay a percentage of their debt. The percentage is based on disposable income, which the court determines by subtracting “reasonable” living expenses from the debtor’s gross pay.
Beyond Cash Donations: How New Forms of Giving Are Transforming Not-for-Profit Accounting
Evolving Funding Landscape for Not-for-Profits Not-for-profit organizations are being asked to do more with less,…
Learn More
By far, Chapter 7 was the vehicle of choice for the 1.3 million Americans who filed for personal bankruptcy last year, according to the American Bankruptcy Institute, a non-partisan, nonprofit group based in Arlington, Va. Chapter 7s made up 71.65 percent of all personal bankruptcies in the 12 months that ended June 30, according to the institute.
Nationwide, personal bankruptcies soared – up 84.2 percent from 1990 to 1998, when personal bankruptcies hit 1.4 million. Though it seems counterintuitive that filings would jump while the economy is expanding, institute Executive Director Samuel J. Gerdano said increases in bankruptcy filings have been following economic booms since World War II, in part because consumer spending accounts for two-thirds of the nation’s gross domestic product.
Rhode Island mirrors the national trends. In 1990 there were 2,325 bankruptcy filings. By 1998 that number had leaped to 5,378, according to the U.S. Bankruptcy Court for the district of Rhode Island. And of the 5,378 total bankruptcies, 5,078 were Chapter 7s.
The proposed legislation aims to reverse these trends. By applying a “means test” to debtors who file for Chapter 7, lawmakers hope to force more people to pay off their debts. Now, the court determines who will be permitted to file Chapter 7 on a case by case basis. Every Chapter 7 application is examined to see if there appears to be an abuse on the part of the applicant, according to the Bankruptcy Court for the Rhode Island district.
But lawmakers want a more stringent test of debtors’ means.
“The goal is to close the loopholes that allow debtors who could repay at least some of the money they owe to walk away scot-free,” said the bill’s sponsor, U.S. Sen. Charles E. Grassley, R-Iowa, in a statement. He added that the bill targets “irresponsible consumerism, lax bankruptcy laws, and lawyer-run bankruptcy mills.”
Indeed, “Every phone bill, electric bill, mortgage, furniture purchase, medical bill, and car loan contains an implicit ‘tax’ on the rest of us to subsidize those of us who do not pay their bills,” George Mason law professor Todd J. Zywicki and University of Michigan law professor James J. White told the Senate Judiciary Committee in a Sept. 16 joint letter.
In addition to making it harder for people with steady incomes to file Chapter 7, the bill also would require bankruptcy lawyers to inform clients about alternatives to bankruptcy, such as credit counseling. It would also alter the “cramdown” provisions of the bankruptcy code, allowing secured creditors to pursue full payment of what they are owed, as opposed to simply the value of the good being repossessed.
But while few dispute that some people abuse the system, consumer groups charge that the bill is seriously flawed, and that Congress is bailing out a consumer credit industry that has overextended itself in recent years, awarding credit to customers who would not have been deemed creditworthy in the past.
“The whole problem from the beginning (is that) the debate has been one-sided,” said Travis Plunkett, legislative director for the Consumer Federation of America, a Washington, D.C. group. He added that consumer groups cannot keep pace with the multi-million dollar lobbying effort put forth by the consumer credit industry.
While the bill’s supporters argue that anywhere from 10 to 15 percent of those who file Chapter 7 could afford to repay at least some of their debt, Plunkett and others point to an American Bankruptcy Institute study that showed the percentage is much lower, about 3 or 4 percent. If the percentage is that low, Plunkett argued, Congress should be considering specific measures, not sweeping reform.
“They’re considering Draconian restrictions on bankruptcy that are going to hurt the average American,” he said.
For one, the bill would give creditors more leverage in convincing consumers to sign reaffirmations – in which the debtor voluntarily agrees to repay his debt, even if he declares bankruptcy, Plunkett said. And since the bill would allow more unsecured debts to survive bankruptcy, women who are seeking child support from bankrupt former spouses will be forced to compete with even more creditors, some say.
“There are really multiple problems with this bill,” said Joan Entmacher, vice president and director of family economic security for the National Women’s Law Center in Washington, D.C. “There are a lot of parts of the bill that give creditors more leverage over consumers.”
But the bill’s supporters dispute the charge that the bill would hurt women, noting that numerous other debts already survive bankruptcy, including student loans, taxes, and debts incurred fraudulently. Law professors Zywicki and White also note that the bill contains several provisions designed to protect women and their children, including a provision that excepts state child support collection authorities from the automatic stay that applies to other creditors when a debtor files for bankruptcy.
But other critics charge that the bill is too broad to accomplish what is sets out to do, even if its intent is well placed. Rick Johanson, a former president of the Commercial Law League of America, an organization of collections, creditors’ rights, and bankruptcy professionals based in Chicago, said several aspects of the bill are good ideas in theory, but may not work in practice.
Means testing is an example, he said. While it’s a good idea to try to get the maximum amount for creditors during bankruptcy, the proposed bill may not benefit creditors because debtors who file Chapter 13 instead of Chapter 7 may end up paying only a tiny percentage of their debt.
“Unless you’re very careful with how you draft this law, you’re going to end up with a potential for (creditors) getting even less money,” Johanson said. He added that while the commercial law league finds many of the provisions of the bill to be good, there are also several aspects which are too broad to meet the infinite number of individual circumstances that arise in bankruptcy cases.
Even if the bankruptcy overhaul bill passes this year, however, it will not have much of an effect in Rhode Island, said Benjamin M. Scungio, a lawyer for the Providence firm of Brennan, Recupero, Cascione, Scungio & McAllister, which represents both individual debtors and mortgage companies around the country.
The reason, Scungio said, is that the Bankruptcy Court and the U.S. Bankruptcy Trustee’s office have gotten tougher on Chapter 7 filings in recent years, steering more and more debtors toward Chapter 13. A better way for Congress to curb filings, he added, would be to limit credit card companies’ ability to extend credit to people who are poor risks. Many of the people who come to see him carry from $40,000 to $70,000 worth of unsecured credit card debt, Scungio said.
Despite their debt loads, “The credit card applications continue to pour in to these people,” Scungio said.
But those people are the minority, said Robert Towne, vice president, governmental relations for Visa USA Inc. More than 96 percent of credit card users pay their debts as agreed, Towne said, while only 1 percent end up in bankruptcy court.
“To say the lending is not responsible would be inaccurate,” Towne said. He added that Visa believes that the bankruptcy system needs to be reformed so that people who can afford to repay their debts will be forced to do so. The Senate bill, “takes a step in the right direction,” he said.
