Bankruptcy Reform Bills Would Make Things Worse

Many provisions of the bankruptcy reform bills before the House and Senate offer welcome, relatively uncontroversial solutions to persistent problems. But both bills include burdensome requirements that will make it much harder for individuals and families to obtain effective bankruptcy relief. These provisions also will increase the cost of the bankruptcy system by more than $90 million over the next five years, according to a Congressional Budget Office study.

Because most people cannot imagine filing for bankruptcy themselves, they may not think that this debate affects them personally. But financial disaster can befall anyone. All it takes is losing a job or experiencing a serious, uninsured medical emergency. The bankruptcy laws provide a necessary economic safety net for laid-off middle managers with hefty mortgages, failed entrepreneurs, divorced mothers trying to collect child support arrearages--many of whom may no longer qualify for bankruptcy relief under the proposed bills.

Proponents of the current bills contend that the record-high level of consumer bankruptcy filings during prosperity shows that some people are trying to erase debts they could afford to repay. Studies estimate the percentage of such evaders to be 4% and 10% of all consumer bankruptcies. The current bills, however, propose major changes affecting all bankruptcy filings, rather than carefully targeted reforms aimed at evaders.

Most significant is the proposal to subject all individual bankruptcy cases to a complex and arbitrary means test. Using controversial IRS living expense guidelines, strongly criticized by House Judiciary Chairman Henry J. Hyde (R-Ill.), the test assumes that everyone has the same living expenses for housing, transportation, food and other essentials as the average household in their county, ignoring the actual expenses of those needing debt relief. Under the proposed formula, these average, hypothetical expenses are deducted from the individual’s actual income to determine the amount of disposable income assumed to be available to repay creditors through a bankruptcy plan. If the calculation shows available money, the affected individual would be denied access to Chapter 7 of the Bankruptcy Code, the chapter that generally excuses most debts other than mortgages and car loans. If the individual’s true expenses absorb all household income, a Chapter 13 plan--which permits debt repayment over three years or longer--could not be approved either. Thus the proposed means test would leave some people with no bankruptcy remedies at all.

The proposed means test is also unfair. IRS allowances vary dramatically from county to county, especially for housing. A family living in Los Angeles County could file a Chapter 7 case and discharge all unsecured debts, while a San Bernardino County family with identical income and expenses, living just across the county line, would not qualify for Chapter 7 and be forced into a Chapter 13 plan requiring repayment of potentially $15,000 of unsecured debt.

The bills’ other provisions would impose stringent procedural burdens that many deserving debtors cannot satisfy. The means test would require completion of complex forms. For debtors who cannot afford professional help, failure to complete the forms properly would result in dismissal. Other cases would be dismissed upon a debtor’s failure to file three years of tax returns, even if a debtor’s income was so low that no returns were required. Judges would be given no discretion to extend or waive these deadlines.

Finally, by mandating full repayment of certain car loans and many credit cards, these bills would cause many bankruptcy plans to fail. Current law allows discharge of these debts to the extent that they are not secured by the value of the car or purchased goods. According to an expert study, the Senate version would prevent plan confirmation of 20% of current cases, because debtors could not afford to pay the full amount owed for those debts. In another 45% of current cases, payments now going to general creditors, like doctors and service providers, would be redirected to car and credit card lenders, affecting payments estimated at $100 million annually nationwide. These side effects contradict the stated purposes of the reform legislation.

Workable, fair alternatives to these flawed provisions have been proposed by a balanced, nonpartisan panel of bankruptcy experts, organized by the American Bankruptcy Institute. These use more realistic living expense guidelines, permit trustees and judges to exercise appropriate discretion and would result in plans debtors can afford.