New Bankruptcy Law Could Exact a Toll on Storm Victims

After virtually every major hurricane of the last 25 years, bankruptcy filings have grown significantly faster than usual as victims sought to shake off old debts in order to rebuild their economically ruined lives.

But unless changes are made to an overhaul of the nation’s bankruptcy law due to kick in next month, many of those affected by Hurricane Katrina and the resulting floods will have a substantially harder time winning court relief from loans they incurred for homes and businesses that are now gone, according to a variety of judges, lawyers and policy experts.

“Just because your house or car is somewhere in the Gulf of Mexico doesn’t mean that your auto loan or mortgage went with it,” said Brady C. Williamson, who was appointed by President Clinton to head a national bankruptcy commission in the mid-1990s.

UCLA professor Kenneth N. Klee said, “The new law is going to make it much more difficult for people to put their lives back together.” Klee is a former Republican congressional staffer who was a chief author of the previous major bankruptcy-law change in the late 1970s.

House and Senate Democrats are expected to propose, perhaps as early as today, delaying the effective date for the new measure and easing some of its most stringent requirements. When it passed the bankruptcy overhaul last spring, the Republican-controlled House rejected an exemption for victims of natural disasters.

The link between bankruptcies and disasters has long been assumed, but the extent of the tie is only now becoming clear in findings by Robert M. Lawless, a law professor at the University of Nevada, Las Vegas.

Lawless examined the 18 hurricanes and tropical storms since 1980 that the National Oceanic and Atmospheric Administration said caused $1 billion or more in damage in the United States. He studied the pattern of bankruptcy filings in the states where the storms made landfall and compared that with patterns in surrounding states and the rest of the country. He looked at the effects in the first, second and third year after the event.

His key finding: that bankruptcy filings, which have been rising nationally for 25 years, climbed in landfall states at more than 1 1/2 times the pace of unaffected states and remained stuck at that rate even three years after the disasters.

“Armchair economic analysis suggests that natural disasters are actually good for local economies because they spur reconstruction,” Lawless said. “What these numbers show is the extent of the financial distress underneath whatever overall economic improvement there may be.”

Bankruptcy overhaul supporters asserted Tuesday that the law would not impose undue hardship on victims of the Gulf Coast catastrophe. “There’s nothing in here that is going to make it more difficult for people to get complete bankruptcy relief,” said Jeff Tassey, the Washington lobbyist who headed a group of credit card companies, banks and others at the vanguard of the eight-year fight for the measure.

Tassey said the law included language that would allow bankruptcy judges to take into account “special circumstances” such as the recent hurricane and flood. “There is plenty of flexibility to cope with situations like this,” he said.

But critics of the new law say many filers will not be able to qualify for leniency because of paperwork rules, among other reasons. The law says the debtor “shall be required to itemize each additional expense or adjustment to income and to provide ... documentation ... and a detailed explanation” under oath.

“There’s no way many people are going to be able to provide all this paperwork; it’s underwater,” said Keith Lundin, a federal bankruptcy judge for the eastern district of Tennessee and a longtime opponent of the overhaul.

At root, the first principles of the new measure, which hold that Americans should accept greater responsibility for their spending and not readily use bankruptcy to escape debts, appear to be at odds with conditions that now exist in Louisiana, Mississippi and part of Alabama.

“The law is premised on the notion that we’re all authors of our own economic fates,” said Klee, the former Republican congressional staffer. But as the hurricane and flood demonstrate, “there are periodic catastrophic incidents that can strike any of us at any time and any place and deliver economic ruin.”

Much of the debate over the law focused on the so-called means test, which will make it much harder for financially distressed Americans who earn more than the median income in their states to qualify for Chapter 7 bankruptcy, in which filers can forfeit most of their assets in return for cancellation of most debts and a “fresh start.” The only alternative for those who do not qualify is to file for Chapter 13 bankruptcy, in which they get to keep most of their property but must continue paying on a portion of their debts for up to five years.

The median income for a family of four in Louisiana last year was $51,402, according to the U.S. Census Bureau. The median income in Mississippi was $49,893.

Tassey, the lobbyist, said the means test would have little effect on the largely poor and black victims who stayed or were left behind to bear the brunt of the hurricane’s wrath and have figured prominently in coverage of the disaster. That is because most presumably made less than the median income and so would qualify for Chapter 7.

But Tassey also said that, absent a court ruling of special circumstances, the law could have a substantial effect on those making the median or above, not least because the measure’s income gauge is not what debtors make now but what they made over the last six months.

John Rao, a lawyer with the National Consumer Law Center, said, “There are going to be a lot of people who were making good livings before the hurricane who have lost their jobs and their employers and have very little prospect of getting back to work in the foreseeable future.”

The law also will impose much stricter limits on businesses, especially small businesses, filing for Chapter 11 bankruptcy protection, under which they could continue operating while coming up with a plan to partially repay creditors.

Under current law, businesses with court permission can continue operating -- sometimes for several years -- before settling on a repayment plan. But under the new law, big businesses would have only 18 months.

Small businesses, such as the many dry cleaners, variety stores and restaurants drowned by the flood, would have just 10.

Though thousands of financially distressed families and businesses elsewhere are rushing to file before the Oct. 17 effective date, those in the flood-ravaged Gulf Coast have lost their chance, with the bankruptcy courts shuttered, their lawyers unavailable and their records destroyed.

That means that unless Congress intervenes, many victims of the Gulf Coast storm will have to file under the new law.

“With no jobs or cars or houses, all these people have is debt. The only way they can get out from under it is if they can file for Chapter 7,” said Williamson, the former bankruptcy commission head. “It will be a travesty if someone who could file for Chapter 7 today won’t be able to simply because they missed the deadline.”

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More misery

After previous hurricanes, there were sharp increases in bankruptcy filings in the affected states, compared with unaffected ones. Here are estimates of the percentage increases for all hurricanes since 1980 causing more than $1 billion in damage:

Time after hurricane

1 year

Landfall states: 11.6%

Other affected states: 12.0%

Unaffected states: 7.0%

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2 years

Landfall states: 29.9%

Other affected states: 22.5%

Unaffected states: 18.1%

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3 years

Landfall states: 46.2%

Other affected states: 33.7%

Unaffected states: 28.1%

Source: Robert M. Lawless, University of Nevada, Las Vegas School