For nearly a decade, proponents of overhauling the nation’s bankruptcy laws have described their aim as ensuring that Americans who enter bankruptcy court do not escape bills that they can truly afford to pay.
But only weeks before Congress is likely to approve the long-sought overhaul, bankruptcy judges across the country warn that the measure would undermine the very section of the law under which debtors are now repaying more than $3 billion annually to their creditors.
These judges say the effect of the overhaul would be to discourage most forms of personal bankruptcy, which for nearly two centuries has served as a safety net for people in economic trouble.
“The folks who brought you ‘those who can pay, should pay’ are pulling the stuffing out of the very part of the bankruptcy law where debtors do pay,” said Keith Lundin, a federal bankruptcy judge in the eastern district of Tennessee in Nashville and an authority on bankruptcy repayment plans.
“The advocates aren’t trying to fix the bankruptcy law; they’re trying to mess it up so much that nobody can use it,” Lundin charged.
In interviews, a dozen current or former bankruptcy judges, whose names were suggested by proponents as well as opponents of the overhaul legislation, described what they saw as the problems that could result from key provisions of the new measure.
Judges now have broad discretion to determine how much a debtor must pay to creditors and on what schedule after declaring bankruptcy under what is known as Chapter 13. But under the legislation, that discretion would be substantially curtailed.
The new legislation would bar courts from reducing the amount that many debtors would have to repay on their cars and other big-ticket items. It would also extend the length of time people would have to make repayments and impose repayment schedules that critics describe as so onerous that many debtors would fall behind.
The result, the judges said, would be the collapse of more repayment plans, forcing debtors out of bankruptcy court protection. Creditors then could try to force debtors to pay the full amount owed -- not the reduced amount a judge had ordered -- by moving to repossess their belongings or bringing legal actions. Many people would have to pay creditors far into the future, the critics said, and thus be unable to restart their economic lives, a long-held aim of bankruptcy.
Repayment plans “are pretty fragile documents to begin with, but they’re going to get a lot more fragile under these conditions,” said Ronald Barliant, a former bankruptcy judge from the northern district of Illinois in Chicago.
“It’s going to take away of lot of the incentives” for people to enter repayment plans, said David W. Houston III, a bankruptcy judge from the northern district of Mississippi in Aberdeen.
Overhaul proponents respond to such criticisms by contending that the current bankruptcy system is rife with fraud and abuse and is stacked against creditors. Many proponents are deeply scornful of bankruptcy judges, who they charge have let the system spin out of control.
“They’re part of the ... problem,” declared Jeff Tassey, a Washington lobbyist who heads the coalition of credit card companies, banks and others that has spearheaded the overhaul drive.
“They’re not real judges, not Article 3 judges,” Tassey said. He was referring to Article 3 of the U.S. Constitution, under which judges in the regular federal court system are appointed for life. Bankruptcy judges are appointed under Article 1 to 14-year renewable terms.
As matters now stand, financially distressed Americans generally have two options in bankruptcy. They can file a Chapter 7 case, in which they forfeit most of their assets in return for cancellation of most debts and a debt-free “fresh start.” Or, they can file a Chapter 13 case, in which they get to keep most of their property but must agree to repay a portion of their debts over a period of time.
Some advocates for changing the system have contended that these provisions should be rewritten to address a kind of moral laxness in bankruptcy practices.
“When you have seen a system that has gone from a few hundred thousand cases to 1.5 million last year -- most of that increase during the fat years of the Clinton administration -- you must conclude something is not right,” said Edith H. Jones, a federal appellate court judge in Houston who served on a blue-ribbon panel to review bankruptcy law in the 1990s and is widely believed to be seen as on President Bush’s short list for a position on the Supreme Court.
“People have been encouraged to see bankruptcy as an easy way out of uncomfortable situations,” Jones said.
Overhaul proponents have also said that the new measure is so narrowly cast that it would affect no more than 15% of bankruptcy filers.
The legislation would require courts to check whether people make more than their state’s median income and can pass a “means test,” which gauges whether they have enough to cover allowable living expenses, pay secured creditors such as mortgage lenders and still have some left over for unsecured creditors such as credit card companies. Those who are above the median and have the means would no longer be allowed to file under Chapter 7 and wipe out most of their debts, but would have to file Chapter 13 cases and agree to a repayment plan.
Nearly all congressional Republicans, together with many Democrats, support the overhaul measure, which the president has warmly endorsed and said he would sign. The Senate passed the measure this month in a 74-25 vote. Approval from the House is expected next month.
However, largely overlooked in the debate has been a series of proposed changes in Chapter 13 that critics say would make it harder for debtors to stick with repayment plans -- the opposite effect of what supporters say they want.
Critics, including bankruptcy judges in California, North Carolina, Massachusetts, and Florida say there is nowhere near the fraud in the system that advocates claim.
They cite a study by the nonpartisan American Bankruptcy Institute, which concludes that only about 3% of those who wipe out their debts in Chapter 7 could afford to repay a portion in Chapter 13. Lobbyists for the credit card and banking industries estimate that 10% or more would be able to pay.
Those opposed to the changes contend that most people who file for bankruptcy are truly distressed financially -- and say the success that courts have in collecting as much as they do under Chapter 13 shows the system is working.
According to figures from the U.S. Trustee Program, a Justice Department agency, Chapter 13 debtors repaid almost $3.6 billion in 2003, the latest year for which figures are available.
But critics say the courts’ success with Chapter 13 is threatened by several little-noticed elements of the proposed legislation:
Under current law, those who file under Chapter 13 must repay car loans only up to the amount the car is worth at the time they enter court, or they risk losing the vehicle. A debtor who bought a $24,000 sport utility vehicle and filed for bankruptcy two years later, for example, might have to pay far less because the vehicle had depreciated.
By reducing what debtors owe auto lenders in this fashion, the law ensures more money for other creditors. And, according to bankruptcy experts, it means that auto lenders are treated on an equal footing with other “secured” creditors -- they are promised repayment only to the value of the item they could repossess.
Under the new measure, debtors would have to pay the full amount on any vehicle purchased within 2 1/2 years of bankruptcy, or risk losing the vehicle. The change may seem minor to an outsider, but not to Chapter 13 debtors or bankruptcy judges. “That’s going to be a big deal,” predicted A. Thomas Small, a bankruptcy judge for the eastern district of North Carolina in Raleigh. It would mean that many repayment plans that work now would fail under the new measure, he said.
Under current law, the debtor and his lawyer work out a repayment plan that they think represents the most the debtor can pay and still cover basic living expenses. A bankruptcy judge must eventually approve the plan, which usually has reduced or stretched-out payments to creditors. In the meantime, the debtor immediately begins making payments to a court-appointed trustee.
Under the legislation, many debtors would have to make full payments on such big-ticket items as houses, furniture and appliances. They would have to make those payments directly to the lenders. And at the same time, they would have to start paying the court-appointed trustee for debts to doctors, credit card companies and other unsecured creditors.
Many bankruptcy judges say debtors who come before them often do not have enough income to make both sets of payments.
The result, they warned, would be that many debtors’ plans would quickly fail.
Under current bankruptcy law, two guiding principles are that debtors should not be required to repay indefinitely, or they effectively become indentured servants to their creditors, and that they should eventually be given a debt-free “fresh start” on their economic lives.
The legislation would require debtors to agree to repayment plans with a five-year minimum repayment schedule, up from the current three-year minimum. It would also boost the chances that debtors would be required to continue paying some debts even after a plan’s successful completion.
Todd Zywicki, a law professor at George Mason University in Virginia, said the shift away from the “fresh start” philosophy is justified because another bedrock American value -- that people who incur debts should pay them -- is being sullied under the current system.
But many bankruptcy judges and independent experts warn that equally compelling values would be lost if the proposed measure becomes law.
Practically, they warn, debtors who would no longer qualify for Chapter 7 and fail to complete Chapter 13 repayment plans would either have to keep paying creditors indefinitely or drop out.
“If you’re confronted with a mountain of debt and have no hope of getting out from under it, you’re either going to go underground or turn to crime,” said Kenneth N. Klee, a former Republican congressional staffer who was one of the chief authors of the last major bankruptcy law change in 1978 and now teaches law at UCLA.
More broadly, say judges and others, the ability to start over after running into financial problems should not be discounted.
“Loads of people have filed bankruptcy -- Mark Twain, Buster Keaton, Walt Disney,” said Lundin, the Nashville-based bankruptcy judge. “Bankruptcy is a very American safety net.
“It’s part and parcel of the American dream.”