Creditors Unite to Try to Toughen the Nation’s Bankruptcy Code
A large, diverse group of lenders has set aside long-standing differences to band together to accomplish a common goal: revamping the nation’s bankruptcy laws.
Although many members of this bankruptcy reform coalition usually disagree on nearly everything--sometimes to the point of suing each other--on this one issue they are singing the same tune. There is a fundamental flaw in the nation’s bankruptcy code, they chorus. At a time when personal bankruptcies have hit record levels, that flaw must be fixed--and soon.
What bothers them is that some people have learned to take advantage of lenient laws to run up big credit card bills and then declare bankruptcy--even when they could pay off the obligations over a period of years.
The lenders--whose members include the American Bankers Assn., the Credit Union National Assn., the National Retail Federation and the American Financial Services Assn., among others--are lobbying legislators. They also are trying to influence members of a bankruptcy reform panel that is charged under a 1994 law to come up with a report in October on ways to overhaul bankruptcy reform.
The group also is working diligently to explain that bankruptcy affects nearly everyone in the country. That’s because the estimated $30 billion in bankruptcy losses become part of the cost of doing business and are indirectly passed on to consumers in various ways, including higher interest rates and fees. The cost of bankruptcy: roughly $300 per person per year, the creditors agree.
The most obvious symptom of the systemic ills shows up in annual bankruptcy statistics released by the Administrative Office of the U.S. Courts. In 1996, a record 1.1 million individuals filed bankruptcy--that’s up a walloping 27% from a year earlier.
However, what creditors find more troubling is the type of bankruptcy that’s most prevalent. Roughly 70% of all personal bankruptcies are Chapter 7, or liquidation, filings. Under Chapter 7, consumers who are willing to sell their “nonexempt” assets (which include personal effects, such as your clothes, or even a certain amount equity in a car or home) are able to wipe out the vast majority of their debts. But a study done by the Credit Research Center at Purdue University found that nearly half of all Chapter 7 bankruptcy petitioners had the ability to pay a substantial portion of their debts from income.
Indeed, Purdue scholars looked at hundreds of income and debt statements filed in U.S. Bankruptcy Court and found that 5% of the Chapter 7 petitioners had the wherewithal to pay off all of their debts within six months of filing, says Philip Corwin, principal of Federal Legislative Associates, a Washington lobbying firm that represents the American Bankers Assn.
An additional 40% would have been able to pay off an average of one-third of their debts within a three-year period. That would suggest that roughly 45% of the Chapter 7 debtors should have filed a Chapter 13 petition, which establishes a payment plan to pay back all or a portion of the debtor’s obligations.
But the current bankruptcy code does not dole out bankruptcy relief in direct proportion to need.
Instead, U.S. Bankruptcy Court is based on something of an honor system. Debtors and their attorneys are able to choose the type of bankruptcy filing they believe is most appropriate, says William Binzel, vice president of government relations at MasterCard International. Those who have no means to pay back their debts should opt for Chapter 7 liquidation, while those who have enough income to pay some of their obligations are expected to file reorganization bankruptcies--Chapter 13--in which they set up a payment plan to do just that.
However, creditors believe that many consumers simply see Chapter 7 as a convenient way to escape their bills. Once a Chapter 7 bankruptcy filing is accepted, the consumer’s unsecured debts are wiped out. The individual is no longer obligated to pay, no matter how much he or she earns in the future.
“What concerns us is that some significant portion of the increase in bankruptcy is among people whose demographics and income indicate that they can pay off at least some portion of their debts,” says Jeffrey Tassey, senior vice president for government and legal affairs at the American Financial Services Assn. in Washington. “They view bankruptcy as a financial-planning tool. When the obligations they have taken on become inconvenient, they file bankruptcy.”
However, no one wants to make bankruptcy inaccessible to those who need it.
“What we want to do is let people who need complete relief get it, just as they always have,” says Mallory Duncan, vice president and general counsel of the National Retail Federation. “But people who don’t need complete relief should be forced to pay off some of the debt.”
Specifically, what this coalition proposes is to create something of a bankruptcy gatekeeper.
Instead of consumers deciding whether to file a Chapter 7 liquidation or a Chapter 13 reorganization, individuals would simply petition the court for bankruptcy relief. A court official would review the debtor’s assets, debts and income and refer him to Chapter 7 or Chapter 13. In some cases, he could be referred to credit counseling, where he could work out his credit woes without filing bankruptcy, Duncan notes.
“If you incur a debt and you have the ability to repay it, it is fundamentally unfair to allow you to just walk away,” says MasterCard’s Binzel. “What we want to do is change the bankruptcy code to provide only the level of protection that consumers need. No more; no less.”
*
Kathy M. Kristof welcomes your comments and suggestions. Write to her in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com
