Oregon State Bar Bulletin — APRIL 2006

Debt Doubts
New bankruptcy law is challenging practitioners as well as clients
By Janine Robben

When Portland bankruptcy and immigration law attorney Dagmar Butte read the new federal bankruptcy law, she knew instantly that she didn’t want any part of it.

"It’s bad for consumers," says Butte, who had practiced bankruptcy law for more than a decade before the law went into effect in October 2005.

"It’s bad for business, even though business won’t realize that for a while. And it’s untenable for bankruptcy lawyers."

Butte is not alone in her opinion.

When proponents of the Bankruptcy Prevention and Consumer Protection Act of 2005 finally succeeded in getting it passed after an eight-year battle, their expectation was, in the words of one Congressman, the end to "billions of dollars in losses associated with profligate and abusive bankruptcy filings."1

Instead, say consumer bankruptcy attorneys in Oregon and around the country, the law’s requirements have burdened them and their clients without having any meaningful effect on the number of bankruptcies filed — or the circumstances behind them.

"Congress got bankruptcy reform wrong, dead wrong, as wrong as they could get it," Brad Botes, the head of the National Association of Consumer Bankruptcy Attorneys, said in February when the association released the first nationwide study of debtors under the new law. "They could not have flubbed bankruptcy more if they had deliberately set out to do so. With this data in hand, we can say with authority that the changes are doing no measurable good whatsoever."

Advent of the "Means Test"
Talk to bankruptcy attorneys, and you’ll hear a lot about "fresh starts."

The phrase isn’t just client relations: It is, according to the U.S. Bankruptcy Court’s website, one of the "primary purposes of the law of bankruptcy."

But it was bankruptcy’s other "primary purpose" — the repayment of creditors to the extent debtors have the ability to do so — that was on Congress’ mind when it passed the law in March 2005.

Nationwide, "personal bankruptcy filings have ballooned" over the past two decades, according to an article published in the Boston Globe on Oct. 16, the day before the law went into effect.

That increase was not seen in Oregon, where — despite high levels of unemployment — the total number of bankruptcies filed actually decreased between 2003 and 2004, the last year for which the American Bankruptcy Institute has published data. Of these, the percentage of personal bankruptcies, in both years, was more than 90 percent.

Nonetheless, the law applies to Oregon, along with the other 93 federal judicial districts that have exclusive jurisdiction over bankruptcy matters.

Under both the old and new laws, individual consumers who are considering bankruptcy have two options.

They can file under the bankruptcy law’s "Chapter 7," which allows debtors to discharge most of their debts that remain after their non-exempt assets have been sold and the proceeds distributed to creditors. Or they can file under "Chapter 13," which allows them to discharge some of their debts while setting up three- to five-year payment plans for others.

But the new law made a number of changes to this system.

The changes include requirements that debtors complete a U.S. Bankruptcy Trustee-approved credit-counseling course within six months prior to filing for bankruptcy; pass a "means test" before being allowed to use Chapter 7 bankruptcy; and complete a trustee-approved financial management course before their debts can be discharged under either Chapter 7 or 13.

Of these, the "means test" has attracted by far the most publicity. And — while early figures indicate that it hasn’t significantly reduced the number of debtors who are eligible to file for Chapter 7, it has frightened off some potential clients and made bankruptcy attorneys’ work a lot harder, according to bankruptcy attorneys in Oregon and elsewhere.

"Creditors are telling debtors that ‘Chapter 7 is gone,’ or ‘You can’t qualify," says Butte, whose colleagues continue to practice bankruptcy law while she does exclusively immigration. "That makes me cranky. If people have a legal remedy, they should be allowed to pursue it."

The lull that firms like Butte’s experienced post Oct. 16 was a far cry from the overload that occurred last October, when some bankruptcy attorneys reported working 18-hour days.

"We heard, through the grapevine, how busy they (bankruptcy attorneys) were before the deadline," says Michael Long, attorney counselor with the Oregon Attorney Assistance Program. "People were working night and day."

Their workload was reflected in the number of petitions filed before Oct. 17.

"In the first 16 days of October, we had 10,183 cases filed," says Elizabeth Perris, U.S. bankruptcy judge for the District of Oregon. "Normal would be 1,033 during the same period the year before."

The filers included not just ordinary working — or not working — stiffs, but convicted politician (and former Oregon State Bar member) Dan Doyle and his wife, who filed for Chapter 13 on Oct. 12, and embattled former state legislator Kelley Wirth, who filed for Chapter 7 on Oct. 14.

Perris says the law’s Oct. 17 deadline was followed by a 91 percent drop-off in filings.

"It’s been a roller coaster," she says. "I would say it’s been challenging."

Discouraged debtors
Assuming that bankruptcy attorneys will get clients through the door once that roller-coaster ride levels out, they still must walk them through a complex series of wickets that is the "means test."

Under the means test, the debtor’s income is averaged for the six-month period prior to filing for bankruptcy.

This average is then compared to the median income figures for the state, which are supplied to the U.S. Bankruptcy Trustee by the IRS. (As of February, the median Oregon income for a family of four was $61,209.)

If the debtor’s six-month average income is less than the state median, he automatically is eligible to file for Chapter 7. If not, more wickets must be cleared to make him eligible for Chapter 7 bankruptcy. Many debtors who are ineligible for Chapter 7 will have to file under Chapter 13 and therefore have to repay at least some of their debts.

So far, the means test has not resulted in a surge of Chapter 13 filings in Oregon.

"People are finding that when the means test is applied to real people, the bulk of them still qualify (for Chapter 7)," says Perris.

That’s also been the experience nationwide: In January, the Washington Post Weekly Edition reported that "Three months after a new bankruptcy law took effect, the overwhelming majority of debtors seen by credit counseling agencies are filing for bankruptcy (under Chapter 7) instead of using repayment plans (under Chapter 13) envisioned by the law’s supporters."

But the fact that the shift from Chapter 7s to Chapter 13, which the law’s proponents predicted, has not taken place has not lessened the impact of the means test on bankruptcy attorneys and their clients.

For one thing, says Portland bankruptcy attorney Ann Chapman, collecting the documentation necessary to take — and pass — the test daunts many debtors.

"They’re doing triage," Chapman says of her clients. "Keeping paperwork in order falls to the bottom. I see a lot of discouraged debtors."

To make her point, Chapman says that she’s met with several potential bankruptcy filers at the Oregon State Bar’s Debtor-Creditor Section’s pro bono clinic since Oct. 17.

"I gave them a list of needed documents," says Chapman. "They just looked at me. I haven’t heard from them (since)."

Once a client produces the necessary documents, the burdens imposed by the new law then shift to the bankruptcy attorney in the form of a requirement making him personally responsible for the accuracy of information used to establish Chapter 7 eligibility.

"Now, in effect, you have to vouch for your clients, which is very unusual in law," says Portland bankruptcy attorney Richard Parker. "There are very many more pitfalls for a bankruptcy lawyer in practice now. It’s still not as hard as immigration law, but it’s harder than it used to be."

Butte, who practices with Parker, says the law’s "due diligence" requirement was one factor in her decision to leave bankruptcy law for a practice devoted exclusively to immigration law.

"I’m not going to fantasize that all of my clients are honest," she says. "Sometimes clients lie and get ratted out by their enemies. That’s the context in which I see the due diligence requirement creating a problem for lawyers. Bankruptcy trustees are sharp. They know when something doesn’t smell right."

In addition, say bankruptcy attorneys, the means test and the law’s due diligence requirement inevitably affect their bottom line.

According to Parker, "almost all" Chapter 7 bankruptcies in the Portland area are billed as flat fees of $700 to $1,400.

"There just isn’t the money (in that fee) to fund the time (the law requires the lawyer to put in the case)," says Parker. "So there’s a tension there about getting all the information that’s needed, but not making a Supreme Court brief out of it."

Butte says the law’s effect on fees also was a factor in her decision to quit bankruptcy work.

"The other thing that scared me — it’s selfish but realistic — is that bankruptcy clients don’t have any money," she says. "Bankruptcy firms hemorrhage money unless — I don’t want to say they’re ‘mills,’ — but unless they are a big practice. I was going to have to do so much additional work. I would have had to raise fees a lot. If you take the due diligence requirement seriously, with the $500-600 I was charging people for bankruptcy, I was going to be filing for bankruptcy."

The New Credit Counciling Requirement
If the new law’s means test has attracted the most publicity, it is its education requirements that seem to generate the most emotion, as bankruptcy attorneys and trustee-approved credit counselors talk about what drives consumers and businesses to file for bankruptcy in the first place.

According to the study commissioned by the National Association of Consumer Bankruptcy Attorneys, "The vast majority of Americans seeking bankruptcy protection are victims of unfortunate circumstances, not imprudent spenders seeking to cancel their debts."

The study, which was based on information provided by counselors at six trustee-approved credit counseling agencies around the country, concluded that "Four out of five consumers (79 percent) seen by credit counseling agencies are suffering from debt ‘caused by circumstances beyond their control’ (e.g., loss of a job, medical expenses, death, divorce…and so on). Only about one in five of the respondents (21 percent) were identified as suffering from debt due to ‘circumstances within their control.’"

The credit counseling agencies, none of which is in Oregon, reported seeing over 61,000 clients between Oct. 17 and early this year.

Speaking at the Feb. 22 press conference at which the study was released, the executive director of one of those agencies sounded on the verge of tears as she described "personally counseling a man who saw his choices as going bankrupt or putting a gun in his mouth and committing suicide."

Chapman says that she is aware of similar situations in Oregon.

For example, she describes a client whose small business, she says, ran into trouble after 9/11.

"He mortgaged his house, he used credit cards to keep afloat," Chapman says of the client, who ultimately filed for bankruptcy. "(His financial situation) wasn’t because he was irresponsible. It was circumstances beyond his control."

But even opponents of the new law concede that some debtors get into trouble not because of uncontrollable events like 9/11, job loss or major illness, but because they never learned to manage money.

"Frugality used to be an art," says Chapman. "(Now) we live in a culture where people want what they want when they want it. People have developed an entitlement attitude."

Chapman says that lack of consumer education, especially among young people, also is a factor.

"If you don’t talk to your parents, and don’t learn it in high school, where are you going to learn (about money)?" she asks. "The school of hard knocks. That’s life."

Chapman says that — contrary to popular beliefs about bankruptcy — she sees "many people who have perfect credit.

"They do that balance transfer thing (from one credit card to another) to lower interest," she explains. "They’re so caught up in the juggling game, paying the minimum. I say, ‘Hold on. How much do you pay on the principal?’ They just sort of look at you. The goal is not just to maintain payments. The goal is to pay off debt."

Jan Safley, executive director of the trustee-approved Consumer Credit Counseling Service of Southern Oregon, says she’s seen similar situations with her agency’s clients.

"In the past, we sent mom off to work," says Safley of how people make ends meet. "Now people look at the availability of credit as another wage earner. Very low (required) payments haven’t helped. People haven’t realized the situation they’re getting themselves into."

Safley says that most of her agency’s clients have no experience with financial planning.

"When you have the ability to get money, you don’t have to plan as well," she points out.

Whether the education components of the new law will have any meaningful effect on debtors is subject to debate.

To some, non-profit programs like Safley’s are inherently suspicious because they get some of their funding from credit card companies.

In September, Susan Keating, president of the National Foundation for Credit Counseling, announced that 16 of the nation’s largest-credit card companies and lenders had agreed to give $10 million, through an industry lobbying group, to trustee-approved educational agencies, with an additional $20 million possible this year.

Chapman says that so far, her feedback from clients is that the credit counseling now required before bankruptcy petitions can be filed has been "fairly useless.

"Clients are there, in part, because they’re financially challenged," she says. "They’re really looking for something to help them with this piece. That’s not happening."

But Matt Conens, a teacher at Safley’s agency, says that his students — most of whom have not had any consumer education — have benefited from the classes.

"Would these people be coming to us if the law didn’t require them to? I really don’t think they would," he says. "But a lot of people are not aware of the consequences (of bankruptcy): how hard it will be to get affordable credit, and how vulnerable they’ll be to predatory lenders.

"We can’t force people to learn," he says. "We want them to know that they’re in a very vulnerable position and how they can protect themselves."

Conens calls the credit counseling classes "a bit of a learning process, for the attorneys and somewhat for us. The attorneys have been working really well with us."

Safley adds that in her experience, the debtors who attend the classes do want to learn.

"I had a preconception that these persons would be somewhat resentful of having to jump through the hoops," she says. "It’s been the opposite. Almost everyone I’ve seen has been appreciative of the opportunity to get information."

What’s next?
What the law’s long-term effect on bankruptcy attorneys, their clients and on the businesses that advocated for it remains to be seen.

In both Butte’s and Chapman’s view, even business will not — in the long run — get what it wanted from the law.

"Ultimately, it will be disastrous for business," predicts Butte. "You can’t get blood from a stone."

According to Butte, most of the bankruptcy clients whom she saw were filing for the first time and never filed for bankruptcy again.

"After years and years and years of credit card companies deluging them with offers, with no means test, this slams the door on them, tells them there’s no fresh start," she says. "Those people, who otherwise would be re-integrated into the financial economy, will just not pay bills. I don’t think that’s what they wanted to accomplish."

Chapman concurs.

"Bankruptcy is the safety valve of the capitalistic system," she says. "To encourage people to take risks, you have to have a dignified way for them to file bankruptcy if the risk doesn’t pay off."

As for whether the new law ultimately will drive other attorneys like Butte out of the business, Perris says, "I can tell you what I’m hearing. The people I see are still doing the practice and waiting to see where this all shakes out. Lawyers are sorting out for themselves how to revise their own practice procedures in terms of the amount of time they have to spend to get forms in order and how to comply with due diligence.

But Chapman, at least, says she knows she’s staying.

"We’re too old," she laughs. "We’re old dogs; can’t learn too many new tricks."

The she adds, more seriously, "I love what we do. As a bankruptcy lawyer, what I dispense every day is hope. This law makes it harder to dispense hope, but I’m still doing it."

Janine Robben is a frequent contributor to the Bulletin. She has been a member of the Oregon State Bar since 1980.

1. House Judiciary Committee Chairman F. James Sensenbrenner Jr. (R-Wis.)

© 2006 Janine Robben

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