By Paul Gowder
On April 20, George W. Bush signed into law the most sweeping changes to the bankruptcy code in over 25 years. Unfortunately, the measure throws aside real reform in place of short-sighted swipes at the middle-class and the working poor, all at the behest of the finance industry.
The act provides for a presumptive conversion to chapter 13 if a chapter 7 debtor has income above the state median and "surplus" income anywhere between $100- $170 (depending on the debt load) over the monthly budget established by the IRS for tax delinquents. It requires debtors to see credit counselors before filing, sets longer payment terms for chapter 13 plans, ends chapter 13 "cramdowns" (reducing secured debt to the value of the collateral), and imposes FRCP 11-type factual inquiry duties on counsel.
The means test amounts to an elimination of discharge for the middle-class and working urbanites. The median income is based on an unrealistic statewide standard, despite wide variation in cost-of-living within states – penalizing city-dwellers. The IRS guidelines are notoriously stingy. Since studies have found that as many as two-thirds of chapter 13 plans fail — a number that will only increase with the end of the cramdown right and longer plans – such a debtor can expect to struggle for years to comply before losing his or her discharge.
The means test is also unnecessary, since bankruptcy judges already had broad discretion to convert chapter 7 cases where there was evidence of abuse, as when a debtor had the income to pay his debts. This provision thus amounts to an attack on judicial independence as well as punishment for the urban employed.
Key to understanding the act is a recognition that all debtors, and not just bankruptcy filers, will suffer. Consumers frequently suffer temporary income loss, go into default, and later negotiate payment plans or lump sum discounts with creditors and collection agencies. As any consumer law practitioner can attest, aggressive negotiation can yield substantial discounts. Implicit in every such negotiation is the threat of bankruptcy. Without this weapon, creditors can be expected to impose much harder terms even on debtors who never plan to seek bankruptcy protection.
The act will also push the economy further into recession. Many small businesses are financed with personal debt, so entrepreneurship can be expected to decline without a bankruptcy fallback option. Moreover, the push into chapter 13 means that more of consumers’ income, for a longer period of time, will be devoted to nonproductive interest on past consumption instead of savings or investment.
On the other hand, the finance industry will benefit richly. Advocates of the act repeatedly claimed that all consumers, except the highest-risk borrowers, would benefit as finance industry profits were passed on in the form of lower interest rates – yet they have been unable to explain why the record profits of the credit card industry in recent years were accompanied by increased interest and fees. Credit card industry profits in 2004, measured by return on assets, were at their highest since 1988. If past behavior is any guide to future behavior, the profit increases attributable to this act will similarly not be passed on to consumers.
Ironically, the credit card industry has driven much of the supposedly "irresponsible" behavior that they and their Congressional allies condemned. Every fall, college campuses are saturated with credit card company representatives giving out t-shirts and beer coolers to induce college freshmen with no income, no work history and no financial education or experience to accept credit cards. Not surprisingly, those students frequently incur huge debt loads. In 1997 and 1998, Oklahoma college students Sean Moyer and Mitzi Pool committed suicide because they were overwhelmed with credit card debt. (Bankruptcy "reform" will increase this "irresponsibility": with less bankruptcy, risk lenders have even more incentive to exploit students.) Even off-campus, widespread "irresponsibility" is a myth. A recent study by professors at the Harvard Law and Medical Schools showed that fully half of bankruptcies were related to medical expenses, not "irresponsibility."
It is too late to stop the act, all we can do now is try to elect representatives to repeal it in 2006. In the meantime, bankruptcy practitioners should advise your clients to file now. The draconian provisions in this act do not take effect until 180 days after signing, and are (with few exceptions) not retroactive. Anyone with income above the state median who is considering filing for chapter 7 bankruptcy protection should do immediately.
Some forms of secured debt may be included in the IRS budget, so skillful planning might permit debtors who are slightly over the means test line to make chapter 7 available to themselves, but watch for fraudulent transfer claims from unsecured creditors. Bankruptcy attorneys should also develop relationships with ethical credit counselors. Fraudulent credit counseling organizations seem to appear as quickly as the FTC and IRS can shut them down, and debtors will need guidance in selecting honest providers to meet this new pre-filing requirement.
Unfortunately, bankruptcy attorneys can expect their client base to shrink as their fees increase to cover the increased frequency of expensive chapter 13 filings and the increased costs of verifying the information on debtor schedules. Debtors can expect the "fresh start" long promised by the bankruptcy law to be increasingly out of reach.
ABOUT THE AUTHOR
Paul Gowder practices civil rights litigation on the East Coast and is a former staff attorney for Oregon Law Center.
© Paul Gowder