Statement Of
The American Bankruptcy Institute
Before The
Senate Judiciary Committee
Subcommittee On Administrative Oversight And The Courts
On S. 1301
March 11, 1998

Web posted and Copyright © March 11, 1998, American Bankruptcy Institute.

Mr. Chairman and members of the Subcommittee, my name is Deborah D. Williamson, President-Elect of the American Bankruptcy Institute (ABI). ABI is the nation’s largest multi-disciplinary organization devoted to education and research on issues related to insolvency. Our 6,000 members are lawyers, judges, accountants, trustees, lenders, academics and others involved as debtors, creditors and players in the U.S. bankruptcy system.

ABI is non-profit and non-partisan, and thus we take no advocacy positions on pending legislation, although we regularly appear before Congressional committees to assist in the understanding of bankruptcy law and practice. Typical of our activities is the nationally-televised debate we sponsored on Capitol Hill last month on the merits of means-testing consumer bankruptcy, where proponents and opponents of a new system were able to put forth reasoned arguments and counter arguments. To the extent I take a position before you today, it is based on my experience as a bankruptcy practitioner and shareholder with the San Antonio, Texas law firm of Cox & Smith, Incorporated, rather than an official ABI position.

We commend Senators Grassley and Durbin for holding these hearings on consumer bankruptcy and share your interest in finding a fair and practical solution to perceived and real problems in the bankruptcy system. The ABI appreciates the sustained interest the Subcommittee has shown in the bankruptcy laws, as reflected by the high number of hearings held to date, and we commit to you our help as your study continues.

Understanding the Causes of Consumer Bankruptcy

In 1997, a record 1.4 million new bankruptcies were filed in the U.S., up 19 percent from last year’s record level of filings. Roughly 96 percent of these cases were filed by individuals and households (husbands and wives filing jointly). While business cases under Chapter 11 actually declined by 9.6 percent last year, perhaps reflecting the general health of the economy, consumer cases continue to explode, rising by 20 percent. Many commentators see an apparent paradox between rising consumer bankruptcies and an economy in generally good health. Since at least the advent of the modern Bankruptcy Code, however, there appears to be a close correlation between rising levels of consumer debt, measured as a percentage of disposable personal income, and bankruptcy filings.

As the attached chart indicates, consumer bankruptcy filings grew steadily between 1984 and 1992, corresponding to a sharp increase in the consumer debt service burden. [ Debt service is the proportion of after-tax income devoted to principal and interest payments on consumer installment and mortgage debt. This measurement, tracked by the Federal Reserve, is viewed by many economists as a true measure of the major financial obligations facing households because it accurately measures not just the aggregate level of debt, but the financial commitments necessary to meet the repayment schedule on a month-to-month basis.] During much of this period, the national economy experienced a healthy expansion, fueled in part by consumer spending which makes up about two-thirds of the domestic economy. Note that after the debt burden fell (in connection with a mild economic downturn) bankruptcy filings subsequently fell in 1993 and 1994. As consumer spending and debt service rose again beginning in 1994 (helping to sustain the current economic expansion), there has been another corresponding rise in consumer bankruptcy filings during 1995-97.

The Federal Reserve estimates that the current debt service burden stands at about 17.0 percent. Although less than the record 17.6 percent that prevailed at the end of the 1980's, it is substantially higher than the 15.3 percent low that was seen as recently as 1993. Careful observers of these trends are hopeful of a decline in debt service burdens due to falling interest rates and slower credit growth. It is predicted that the result will be 60,000 fewer consumer bankruptcies by the end of 1999. [ Zandi and Chen, Debt Service Relief , Regional Financial Review, February, 1998.]

Significantly, during the entire period depicted on the chart, the bankruptcy law has remained largely the same. Thus the rise in consumer bankruptcy filings does not appear to be caused by the law itself. Other factors -- economic, social and cultural -- may be at work,although some of these factors are difficult to measure.

The General Operation of Consumer Bankruptcy [ ABI acknowledges the assistance of Hon. Eugene Wedoff (N.D.Ill.) in the preparation of this section at this statement.]

The legislation introduced by Senators Grassley and Durbin is one of several major bills proposing changes to the consumer provisions of the Bankruptcy Code (Title 11, U.S.C.). This statement analyzes S.1301 with three aims: first, identifying each of the changes that the bills would make in current consumer bankruptcy law; second, assessing the impact that these changes would have in the operation of the law; and third, suggesting alternative approaches, where appropriate, to achieving the goals of the bill.

In order to discuss the proposed changes and their impact, it is necessary first to have an understanding of how consumer bankruptcy operates under the present law. It is helpful to look at the law as a two-part system, that (1) determines the assets that are available to consumer debtors and (2) divides those assets between the debtors and various classes of their creditors.

The assets available. All consumer debtors have the same two basic types of assets available to them: present assets and future assets. The present assets are what a debtor owns at the time a bankruptcy is filed. These include tangible assets like a home, a car, clothing, furniture, and cash, as well as intangible assets, like savings and retirement accounts and lawsuits for personal injury. The future assets of a debtor are what a debtor might expect to receive after a bankruptcy is filed. These include personal earnings of the debtor, as well as investment income and gifts.

The classes of creditors. In bankruptcy, the assets available to the debtor are divided between the debtor and several classes of creditors. The various types of creditors are the following:

(a) Creditors holding "secured" claims. Creditors who have liens on property owned by the debtor (like a home mortgage, or a lien on an automobile), are known as "secured creditors." The Bankruptcy Code generally provides that secured creditors are entitled to be paid the value of the collateral that supports their claims before that collateral can be used for the debtor or other creditors. In other words, the debtor and other creditors are only entitled to the "equity" that exists in the property above the amount of the claim for which the property is collateral. In this way, secured creditors are generally first in the distribution of a debtor’s assets. Claims that are not supported by a lien on property of the debtor are known as "unsecured" claims.

(b) Creditors holding "priority" unsecured claims. Certain claims are treated by the Bankruptcy Code as particularly important. Examples include certain tax obligations, expenses of administering a case in bankruptcy, and family support obligations. Although these claims against the debtor may not be secured, the Bankruptcy Code provides that when a debtor’s assets are distributed, these claims should be paid ahead of other unsecured claims, and so they are known as "priority unsecured" or simply "priority" claims, in contrast to ordinary ("general") unsecured claims against the debtor.

(c) Creditors holding "general" unsecured claims. Creditors who do not have liens or priority claims—for example, most credit card issuers and medical care providers—are known as general unsecured creditors. An important concept in the Bankruptcy Code is that a creditor with a lien on property of the debtor can hold both a secured and an unsecured claim if the value of the collateral is less than the creditor’s claim. For example, a creditor with a $10,000 claim, secured by an automobile worth only $7,000, has a secured claim of $7,000 and a general unsecured claim of $3,000.

(d) Creditors holding "nondischargeable" claims. Ordinarily, when the distribution of a debtor’s assets under the Bankruptcy Code has been concluded, the debtor is given a discharge, wiping out the debts that the debtor owed at the time the bankruptcy was filed. Thus, all of the debtor’s future assets, after the distribution, are allowed to be retained by the debtor. However, there is an exception to the discharge for certain types of debt. Some of this debt is of the same nature as priority debt (taxes and family support obligations), but the Bankruptcy Code also excepts from discharge certain debts that were incurred through misconduct of the debtor, such as debts arising from fraud or intentional torts. Thus, "nondischargeable" claims—to the extent they have not been paid from the assets that are distributed during a bankruptcy case—remain payable from the future assets of the debtor.

Chapter 7: distributing present assets to creditors. Since the enactment of the Bankruptcy Act of 1898, the standard operation of a bankruptcy has been for a trustee to collect the debtors’ present assets, liquidate them, and divide the proceeds among the debtors’ creditors, with the debtors, in exchange, being discharged from their debts, so that they retain the right to their future assets, free of claims of creditors. This process is known as "liquidation" or "straight bankruptcy." Allowing the debtors to use future assets free of creditor claims is known as the "fresh start."

There are however, two features of Chapter 7 that vary the general plan of liquidating present assets for distribution to creditors and leaving future assets for the debtor. First, debtors are allowed to retain some of their present assets. The Bankruptcy Code sets forth a list of "exempt" property, deemed necessary for debtors’ maintenance. States may provide an alternative to this list, and then either (a) allow the debtors to choose between the two lists of exempt property (state and federal) or (b) provide that only state exemptions are available -- "opt out." In any event, debtors are allowed to keep some of their current assets as exempt, excluding them from distribution in Chapter 7. Where debtors have no substantial assets beyond those thatare exempt -- the reality in 90 percent of all cases -- there will be no distribution to creditors. Cases such as these are known as "no asset" Chapter 7 cases.

Second, debtors in Chapter 7 are not always discharged from all of their debts. As noted above, debts that are nondischargeable remain enforceable. Creditors holding these claims may seek payment from future assets of the debtor. Moreover, under certain circumstances (generally involving misconduct by the debtor in the course of the bankruptcy itself), a Chapter 7 debtor may be denied a discharge altogether.

Taking all of this into consideration, Chapter 7 generally divides a debtor’s assets as follows:

(1) Secured creditors are given the value of their liens in the debtor’s present assets.

(2) The debtor’s exemptions are deducted from the present assets.

(3) Any remaining present assets are liquidated and distributed, first to priority claims, and then to general unsecured claims.

(4) The debtor is given a discharge, allowing the debtor to have future assets free of creditor claims, subject to nondischargeable claims.

(5) Nondischargeable claims remain payable in full from the future assets.

Chapter 13: distributing future assets to creditors. Chapter 13 is an alternative to a Chapter 7 liquidation. The basic idea of Chapter 13 is to allow debtors to retain all of their present assets, in exchange for paying creditors, out of future assets, at least as much as the creditors would have received if there had been a Chapter 7 liquidation. To accomplish this, the debtor must propose a plan, administered by a trustee, to pay creditors through periodic contributions from the debtor’s regular income. Chapter 13 recognizes that debtors cannot pay all of their income into the plan, since some income will be necessary for the support of the debtors and their dependents. However, all income not necessary for that support is defined as "disposable" income, and a Chapter 13 plan must either pay creditors in full, or devote all disposable income to the plan. A plan that does not provide for full payment of debts must have a duration of at least three years and not longer than five years. Depending on the amount of disposable income, it is possible for Chapter 13 plans to pay much more to creditors than they would have received in a Chapter 7 liquidation.

Under current law, Chapter 13 is entirely voluntary. Further, only a debtor can propose a Chapter 13 plan, a debtor has an absolute right to dismiss a case that was originally filed under Chapter 13, and a debtor can convert a Chapter 13 case to Chapter 7 at any time. To encourage debtors to choose Chapter 13 (and thus provide greater payment to creditors), the BankruptcyCode has two distinct types of incentives. First, at the conclusion of a Chapter 13 plan, the debtor is given a broader discharge than is available in Chapter 7. This "superdischarge" results in several types of debt (including those for fraud and intentional torts) being discharged that would not be discharged in Chapter 7. Second, debtors are allowed to keep property that is encumbered by liens, even though they are in default on the underlying obligations. A debtor with a home in foreclosure or a car subject to repossession may be able to retain the home or car by making payments to the secured creditors through a Chapter 13 plan. Moreover, except for certain home mortgages, the debtor in Chapter 13 may pay to a secured creditor the value of the collateral, even though it is less than the full amount of the debt and obtain a release of the lien. Chapter 13 contains detailed provisions as to the type of payments required on secured claims.

Plans in Chapter 13 are required to pay priority claims in full, over the course of the plan, and not to discriminate unfairly among general unsecured creditors. Considering all of its provisions, Chapter 13 generally divides a debtor’s assets as follows:

(1) The debtor retains all present assets.

(2) The debtor contributes disposable future assets to a plan for a period of three to five years, or for a shorter period sufficient to pay the debts in full. The payments to be received by creditors must be at least as much as they would have received in a Chapter 7 case. Secured creditors must receive at least the value of their liens. Priority claims must be paid in full.

(3) The debtor retains all nondisposable future assets.

(4) After the completion of the plan, the debtor is given a discharge, allowing the debtor to retain all future assets, free of dischargeable creditor claims.

(5) Nondischargeable claims remain payable in full from the future assets. However, many debts that are nondischargeable in Chapter 7 are able to be discharged in Chapter 13.

Choice of Chapter 7 or Chapter 13. Under current law, consumers have a largely free choice between Chapter 7 and Chapter 13 as a form of relief. However, there are some limitations, the most significant of which are the following: First, a debtor cannot file any bankruptcy case within 180 days after a prior case was dismissed under specified circumstances. Second, Chapter 13 is unavailable to individuals with large amounts of debt (over $250,000 in unsecured debt or $750,000 in secured debt). Third, a Chapter 7 case may be dismissed on motion of the court or the United States trustee if granting Chapter 7 relief would be a "substantial abuse." Fourth, a debtor cannot receive a discharge in a Chapter 7 case if that case was filed within six years of an earlier filing in which the debtor received a Chapter 7 discharge.

The automatic stay. In either Chapter 7 or Chapter 13, an automatic stay goes into effect at the time the case is filed, which generally operates to prohibit any collection activity—including foreclosure and repossession—on debts that were in existence at the time of the filing. In order toobtain the right to proceed with collection activity, a creditor must obtain relief from the automatic stay. In either Chapter 7 or Chapter 13, a creditor is entitled to relief if the value of its collateral is declining or at risk of declining, and no action (known as "adequate protection") is taken to make up for the decline. In Chapter 7, the creditor is also entitled to relief if there is no equity in the property that might be obtained for the benefit of creditors. In Chapter 13, relief is granted if there is no equity and the property is not needed for the debtor’s plan to be effective.

S. 1301 ("Consumer Bankruptcy Reform Act of 1997")

S. 1301 sets out 20 changes in bankruptcy procedure and administration,

arranged in three titles: "Needs Based Bankruptcy" (Title I, in 2 sections), "Enhanced Procedural Protections for Consumers" (Title II, in 5 sections), and "Improved Procedures for Efficient Administration of the Bankruptcy System" (Title III, in 13 sections).

Title I ("Needs Based Bankruptcy")

§ 101 ("Conversion").

The changes. Section 706(c) of the Bankruptcy Code currently provides that the court may not convert a Chapter 7 case to a case under Chapter 12 or 13 unless the debtor requests such a conversion. Section 101 of S. 1301 would make § 706(c) apply only to conversions of Chapter 7 cases to Chapter 12, thus removing the prohibition against conversion from Chapter 7 to Chapter 13 in the absence of a request by the debtor.

The impact of the changes. Under this amendment, § 706(a) would continue to provide that a Chapter 7 debtor has a right to convert to Chapter 13, and § 706(b) would continue to provide that other parties in interest in a Chapter 7 case have the right only to request conversion to Chapter 11. Thus, it is likely that the effect of the proposed change would not be to permit motions by creditors (or trustees) to convert Chapter 7 cases to Chapter 13. Rather, the apparent intent of the proposal is to allow conversion under § 707(b) of the Code, as it would be amended by § 102 of S. 1301, thus providing (at the debtor’s option) an alternative remedy to dismissal. Nevertheless, simply removing the prohibition against conversion to Chapter 13 in the absence of a debtor’s request may create an unnecessary ambiguity, leading some to believe that the proposal intends to authorize involuntary conversion to Chapter 13.

Alternatives. To accommodate the amendment to § 707(b), proposed in § 102, § 706 (b) could be amended to provide: "The court may not convert a case under this chapter to a case under chapter 12 of this title unless the debtor requests such conversion. The court may notconvert a case under this chapter to a case under chapter 13 of this title unless the debtor either requests such conversion or consents to such conversion pursuant to section 707(b) of this title."

§ 102 ("Dismissal or conversion").

The changes. Section 707(b) of the Bankruptcy Code currently provides for dismissal of Chapter 7 cases if granting relief under Chapter 7 would a "substantial abuse" of the provisions of Chapter 7. "Substantial abuse" is not defined, and a motion to dismiss on this ground may be brought by the United States trustee or by the court, but "not at the request or suggestion of any party in interest." Section 102 of S. 1301 would change § 707(b) in the following respects:

(1) The proposal would remove the statement that relief under § 707(b) could not be "at the request or suggestion of any party in interest."

(2) The proposal would change the ground for relief from "substantial abuse" to simple "abuse" of the provisions of Chapter 7, and would remove the current presumption in favor of the form of bankruptcy relief chosen by the debtor.

(3) If abuse is found, the proposal would allow—with the debtor’s consent— conversion to Chapter 13 as an alternative to dismissal.

(4) Although "abuse" would continue to be undefined, the court would be given three factors to consider in making a determination of whether there would be "abuse" in granting the debtor relief under Chapter 7:

(a) whether the debtor, on the basis of current income, could pay 20% or more of unsecured, nonpriority debt, pursuant to § 1325(b)(1);

(b) whether the debtor filed the case in bad faith; and

(c) whether the debtor made good faith efforts to negotiate nonbankruptcy repayment of debts or alternative methods of dispute resolution, and, if so, whether the creditors were unreasonable in their response to these efforts.

(5) If a panel trustee brings a successful motion under § 707(b), and if the debtor was represented by an attorney, several consequences would result for the debtor’s attorney:

(a) the attorney would be required to reimburse the trustee for all reasonable costs of prosecuting the motion, including attorneys’ fees;

(b) if the attorney is found to have violated Fed.R.Bankr.P. 9011, the attorney would be required to pay an appropriate civil penalty to the panel trustee or to theUnited States trustee; and

(c) in addition to the requirements now imposed by Rule 9011, the signature of the attorney would constitute a certificate that the debtor’s bankruptcy petition does not constitute an "abuse" under the amended § 707(b).

(6) If a party in interest brings a motion under § 707(b) that the court denies, and the court finds either (a) that the position of the party was not substantially justified, or (b) that the party brought the motion "solely for the purpose of coercing the debtor into waiving a right guaranteed to the debtor" under the Bankruptcy Code, then the court shall award the debtor all reasonable costs in contesting the motion, including attorneys’ fees, and actual damages in an amount not less than $5,000.

The impact of the changes. This proposal contains a number of ambiguities that can be expected to cause conflicting interpretations and the need for significant litigation; the cost-shifting provisions of the proposal may be unfair in light of this ambiguity; and the proposal sets up a confusing relationship with Fed.R.Bankr.P. 9001, that would complicate future rulemaking. Depending on the interpretation of the proposal, it could have the effect of denying Chapter 7 relief to debtors in genuine financial difficulty.

(1) It is the apparent intent of the proposal to allow motions pursuant to § 707(b) to be brought by any party in interest. However, the proposal would retain in § 707(b) the provision that the court may grant relief "on its own motion or on a motion by the United States trustee," without explicitly authorizing motions by other parties. This could lead to disputes concerning the standing of creditors and Chapter 7 trustees to bring § 707(b) motions.

(2) Conversion to Chapter 13 with the debtor’s consent probably does not effect a significant change, since, under current § 706(a), a debtor could voluntarily convert a Chapter 7 case to Chapter 13 "at any time," as long as the case had not previously been converted. However, the interplay between §§ 707(b) and 706 is not clear. Section 706(d) provides that "[n]otwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter" (emphasis added). There is no such limitation in the proposed addition to § 707(b). Hence it might be argued that Chapter 7 debtors found to have filed abusive petitions under § 707(b) might be allowed to convert to Chapter 13 even though they would not otherwise be eligible (e.g., because the amount of their debt exceeded the limitations of § 109(e)).

(3) The change from "substantial abuse" to simple "abuse" and the removal of the presumption in favor of the debtor’s choice of relief would indicate that motions pursuant to § 707(b) should be granted more freely. However, the grounds for such relief are not clearly indicated. Three factors are listed—the debtor’s ability to pay unsecured debt, bad faith by the debtor in filing, and the debtor’s prior negotiations with creditors. However, these factors are simply required to be considered by the court. Whether each factor is sufficient by itself torequire a finding of abuse, and how the factors interrelate, is not specified. Bad faith might always be a sufficient ground for relief, regardless of the presence or absence of the other two factors, or it may be that the court should consider whether a denial of discharge might be a more effective sanction than dismissal of the case. Furthermore, the relative weight of the remaining factors is not apparent. For example, a debtor might have the ability to pay unsecured debt as specified by the proposal, but might also have presented a nonbankruptcy repayment plan to creditors, before filing the Chapter 7 case, which the creditors unreasonably refused to negotiate. Which is controlling of abuse, the debtor’s ability to pay debts, or the creditors’ refusal to negotiate? Similarly, a debtor may lack the specified ability to repay, but have made no efforts to negotiate any repayment plan. Which controls, the debtor’s inability to pay or the debtor’s failure to negotiate outside of bankruptcy? Unless the relative weight of the factors is specified, conflicting interpretations can be anticipated.

(4) There is substantial ambiguity in the "ability to pay" factor itself. This applies, as a factor in determining "abuse" under the proposal, when the debtor has the ability to pay 20% of general unsecured debt from current income, as determined pursuant to § 1325(b)(1) of the Bankruptcy Code. Section 1325(b)(1)(B), in turn, states that if a Chapter 13 plan does not pay unsecured claims in full, the plan is subject to denial of confirmation unless it provides that all of the debtor’s projected disposable income will be applied to make payments under the plan for a period of three years. This incorporation of § 1325(b)(1) presents two significant ambiguities:

(a) Section 1325(b)(1) currently deals with "projected disposable income," and thus would appear to require a determination of any likely changes in the debtor’s income over the three year period to which it applies. The proposal states that the debtor’s ability to pay should be measured "on the basis of the current income of the debtor."

(b) The definition of "disposable income" for purposes of § 1325(b)(1) is set out in § 1325(b)(2), to mean (for debtors not engaged in a business) "income which is received by the debtor and which is not reasonably necessary to be expended for the support of the debtor or a dependent of the debtor." This definition has given rise to substantially different applications, with courts disagreeing on matters such as the following: (1) to what extent are payments on particular secured debts (luxury cars, boats, expensive homes) reasonably necessary for support? (2) to what extent should debtors be allowed to continue living at the standard to which they were accustomed prior to bankruptcy? (3) to what extent are religious or other charitable contributions "necessary" expenses? or (4) what educational expenses (private school tuition, college expenses for debtor or the debtor’s dependents, graduate school expenses) should be deemed "necessary"?

These ambiguities will create considerable uncertainty regarding the application of the proposed legislation. For example, consider a debtor whose present income is sufficient to meet current expenses and pay at least 20% of unsecured debt, but who anticipates retiring or changing jobs inthe year following bankruptcy. Should any anticipated reduction in income be considered in determining the debtor’s ability to pay? A more common example would be a debtor who bought a luxury car, in good faith, in the year before bankruptcy, taking a three year loan. Should payments on the car be deducted from disposable income, and the debtor allowed only what a less expensive car would cost? Should it matter if the debtor could show an inability to purchase a less expensive car after filing bankruptcy?

(5) In light of the ambiguities set out above, the proposal may be substantially unfair to debtors’ counsel in automatically imposing on attorneys the costs of a successful motion by a panel trustee. The effect of such cost-shifting would likely be a reluctance by any debtors’ counsel to file any Chapter 7 petition that might be challenged as an abuse under the proposal.

(6) In contrast to the automatic shifting of costs against a represented debtor, the proposal allows a shifting of costs in favor of the debtor only when the position of the moving party was not substantially justified. Further, the proposal allows fee shifting in situations of coercion by a creditor only when the coercion is the sole purpose for the creditor’s filing of the motion. These aspects of the proposal appear weighted against debtors. Even so, case trustees in particular may be reluctant to move for relief under the proposal where there is a possibility of an adverse ruling in applying ambiguous law.

(7) The relationship between the proposed statutory language and Fed.R.Bankr.P. 9011 is confused. Rule 9011 is the bankruptcy equivalent of Rule 11 of the Federal Rules of Civil Procedure. It requires, among other things, that an attorney representing a debtor sign every petition filed under the Bankruptcy Code, and it provides that this signature constitutes a certificate, among other things, "that the attorney . . . has read the document [and] that to the best of the attorney’s . . . knowledge, information, and belief formed after reasonable inquiry it is well grounded in fact and is warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law." The rule requires sanctions for its violation that may, but need not, include a civil penalty. The proposal contains language that (1) requires a civil penalty if the court finds a violation of Rule 9011 in connection with a § 707(b) motion, and (2) states that the signature of an attorney in connection with a Chapter 7 petition constitutes a certification with different effects than those specified by Rule 9011. Thus, if a Rule 9011 motion is brought in connection with a Chapter 7 petition, it will be unclear whether: (1) the terms of the rule or the terms of the proposed statute would apply, (2) whether the penalty required by the proposal applies only to violations of the terms of Rule 9011, or whether it applies to violations of the signature requirement set out in the proposed statutory language; and (3) whether, if Rule 9011 were amended in the future, the penalties imposed by the statute would apply to the amended language of the rule.

(8) If the proposed statute were applied to deny Chapter 7 relief to debtors based solely on their ability to repay a portion of their unsecured debt, it would mark a significant change in bankruptcy policy. Such change may lead to substantial increases in "bankruptcy planning" by more sophisticated debtors so as to avoid a finding of ability to pay (e.g., increasing expenselevels, making purchases with secured credit, or increasing outstanding unsecured debt).

(9) The proposal can be expected to substantially increase demands on the Bankruptcy Court. There will be litigation over a debtor’s entitlement to Chapter 7 relief, with a potential for hearings into the debtor’s disposable income and good faith.

Alternatives. Some ambiguities can be addressed with consistent use of provisions found currently in the Bankruptcy Code. For example, the statute could use "projected disposable income" in lieu of "on the basis of the current income of the debtor." Similarly, having Rule 9011 specifically apply to petitions would give the Courts the ability to "sanction" counsel without strict liability over a Court’s interpretation of disposable income or the definition of abuse. The proposal could provide that the motion could be brought by any party-in-interest.

Title II ("Enhanced Procedural Protections for Consumers")

§ 201 ("Allowance of claims or interests").

The changes. This section allows reasonable fees and costs to the debtor in connection with a claim objection filed by the debtor that results either in (1) the claim being disallowed, or (2) the claim being reduced by more than 5% "of the amount of the initial claim filed by a party in interest." If the court finds that the position of the claimant was not substantially justified, the court is required to award punitive damages in the amount of $5,000, in addition to fees and costs.

The impact of the changes. This provision may discourage the filing of improper claims by encouraging the filing of claim objections by the debtor. The provision has ambiguities that would impair its effectiveness and potentially cause unfairness to creditors. First, the provision refers to the filing of "claims" rather than the more appropriate term, "proof of claim," pursuant to §§ 501 and 502 of the Code. Second, the provision does not appear to address the possibility of parties other than the claimant filing a proof of claim. Subsections (b) and (c) of § 501 allow, respectively, codebtors and the trustee to file proofs of claim on behalf of a creditor; subsection (c) also allows the debtor to file such a claim. While it may be obvious that the debtor should not be awarded fees and costs for objecting to a proof of claim that the debtor filed on a creditors’ behalf, the situation is less clear when another noncreditor party files the claim. The circumstances under which codebtors or trustees should be liable to a debtor for filing improper proofs of claim simply is not specified.

Additionally, under § 506(a) of the Code, proof of a partially secured claim may include an unsecured claim in the amount of the difference between the value of the security and the total claim. For example, a $10,000 loan secured by an automobile worth $7,000 generates a secured claim of $7,000 and an unsecured claim of $3,000. The standards for valuing collateral in thiscontext are not clear and the creditor may not have current knowledge regarding the condition of the collateral. Automatic awards of costs and fees in this context, simply because the secured creditor’s estimate is reduced by more than 5%, may be unfair to creditors.

Alternatives. The provision should be clarified to be limited to proofs of claim filed by the creditor holding the claim. In the context of proofs of partially secured claims, costs and fees might be awarded only where the court finds that the estimate of value employed by the creditor was unreasonable, under these circumstances.

§ 202 ("Exceptions to discharge").

The changes. This section allows reasonable fees and costs to the debtor in connection with any unsuccessful complaint to determine the dischargeability of a debt. In addition, if the court finds that the position of the creditor in pursuing such a complaint was not substantially justified, the court is required to award, in addition to fees and costs, either treble damages or $5000, whichever is greater.

The impact of the changes. The changes should have the effect of discouraging groundless or uninvestigated complaints to determine dischargeability. In the absence of such a provision, a debtor’s lack of resources may result in the debtor’s settling or defaulting in response even to unfounded dischargeability complaints. An automatic award of fees and costs may be unfair. Meritorious complaints might be discouraged in such situations.

Alternatives. The proposal might be amended to allow, but not mandate, an award of fees and costs even where the creditor’s position was found to be substantially justified.

§ 203 ("Effect of discharge").

The changes. This section of the proposed bill makes three additions to § 524, which defines the effect of a discharge in bankruptcy. First, the section would provide that the failure of a creditor to treat plan payments in the manner specified by a plan of adjustment (including crediting the amounts required by the plan) will constitute a violation of the discharge injunction. Second, "[e]xcept as provided in paragraph (2)," a creditor is prohibited from charging a debtor "for attorneys’ fees or costs for work performed in connection with a case brought under this title." Finally, the section provides that any individual injured by either (1) a creditor’s violation of the requirements for a reaffirmation agreement or (2) any willful violation of the discharge injunction "shall be entitled to recover" either treble actual damages or $5000, whichever is greater, together with costs and fees.

The impact of the changes. The first addition to § 524 proposed by this section of S. 1301 would affect long term indebtedness treated under a plan of adjustment. One of the ways inwhich a plan might propose to deal with long term debt is by curing defaults and maintaining current payments, leaving the balance of the debt to be paid after completion of the plan. Section 1322(b)(5) specifically authorizes the treatment of long term indebtedness in this fashion, and it is the only manner in which most long-term home mortgages can be treated in Chapter 13, pursuant to § 1322(b)(2). The impact of this proposal is to require that the creditor treat payments received under a plan with respect to long term debt in the manner provided by the plan, so that, at the conclusion of the plan, the creditor may not claim to be owed more than the plan provides. Failure of the creditor to treat the payments as required by the plan would constitute a violation of the discharge injunction, for which this proposal establishes a statutory remedy.

The second addition made in this section is unclear. The proposal is that creditors be prohibited from charging their bankruptcy related fees and costs to the debtor. This provision would appear to conflict with § 506(b) of the Code, which allows an oversecured creditor to increase its secured claim by the amount of its contractually allowed costs and expenses, up to the value of the collateral securing the claim. Furthermore, Fed.R.Bankr.P. 9011 may result in an award of a creditor’s fees and costs against the debtor. Whether the proposal is intended to operate notwithstanding these provisions cannot be determined, because "paragraph (2)" is specified as an exception to the proposal, and there is no "paragraph (2)" allowing the charging of creditor fees and costs to the debtor. The "paragraph (2)" connected to this part of the proposal simply provides that any charge made by a creditor in violation of the subsection will be considered a violation of the discharge injunction.

The final change made by this section is to provide a statutory remedy for violations of the discharge injunction. Under current law, violation of the discharge injunction is sanctioned as a contempt of court. The power of a bankruptcy court to enter punitive contempt sanctions is not clear, and so this section would both define and limit the extent of the court’s power to impose penalties for discharge violations. The phrasing of this provision may be unclear, however. Other provisions for enforcement sanctions in S. 1301 provide that "the court shall award" the required sanctions if specified facts are found. The different wording here, that the injured party "shall be entitled" to the enforcement sanctions might be read to imply that the court has discretion to award the sanctions.

Alternatives. The provision regarding charging of creditor fees and costs should be clarified to exclude specific cost shifting provisions like Fed.R.Bankr.P. 9011, as well as § 506(b), from its coverage. The statutory remedy for violation of the discharge injunction should specify that "the court shall award" the specified remedy.

§ 204 ("Automatic stay").

The changes. This section provides that an individual who prevails in a motion to remedy a willful violation of the automatic stay "shall be entitled to" treble actual damages or $5,000, whichever is greater, in addition to costs and attorneys’ fees. The right of such an individual toreceive punitive damages in appropriate circumstances (as provided in current law) is retained.

The impact of the changes. This proposal would apparently impose a mandatory minimum sanction for willful violation of the automatic stay. Under current case law, a creditor with actual knowledge of a bankruptcy in time to prevent a violation of the automatic stay is deemed to have acted willfully. With this type of "strict liability," a creditor with a number of offices or departments may be found to have violated the stay willfully under circumstances where a particular employee, not knowledgeable about bankruptcy law, failed to notify the appropriate personnel. Concerns about sanctions in situations like this lead to proposals for requiring special notice to creditors of the pendency of a bankruptcy case, such as suggested in § 309 of S. 1301. The special notice requirements may greatly complicate litigation over violation of the automatic stay.

Alternatives. As with the preceding section, mandatory sanctions might be more clearly indicated by language providing that "the court shall award" the required sanctions. However, to reduce the need for special notice provisions, courts might be allowed not to impose sanctions (or to limit sanctions to actual damages) in situations where the creditor violating the automatic stay did not have effective notice of the bankruptcy and otherwise acted in good faith.

§ 205 ("Who may be a debtor").

The changes. This section would add a new provision to the end of § 727, which deals with discharges in Chapter 7 cases. The new provision would allow reasonable fees and costs to the debtor in connection with any unsuccessful motion to deny relief to the debtor under this section. In addition, if the court finds that the position of the creditor filing such a motion was not substantially justified, the court would be required to award, in addition to fees and costs, either treble damages or $5000, whichever is greater.

The impact of the changes. The impact of the provision is uncertain, due to its ambiguous language. The title of the proposed section, "Who may be a debtor," would appear to refer to § 109 of the Code, which is entitled "Who may be a debtor," rather than to § 727. Furthermore, relief for creditors under § 727 is not obtained by motion, but rather by adversary proceeding, pursuant to Fed.R.Bankr.P. 7001(4), and the language of the proposal could be meaningfully applied to motions challenging a debtor’s entitlement to bankruptcy relief under § 109. On the other hand, the new provision is specified as being "paragraph (F)," and neither § 109 nor § 727 currently end with a paragraph (E), although § 727 does currently end with a subsection (e). The impact of the section cannot be ascertained without knowing the creditor action that it is intended to affect.

Finally, it is not clear whether the award of fees and costs is to be assessed against any party filing an unsuccessful motion with the court (including the trustee) or whether it applies only to motions brought by creditors.

Title III ("Improved Procedures for Efficient Administration of the Bankruptcy System")

Note: Each of the sections of Title III of S. 1301 is similar in title and content to one or more sections of H.R. 2500.

§ 301 ("Notice of alternatives").

This section essentially combines the provisions of §§ 103 and 210 of H.R. 2500. However, the disclosure requirements thus imposed on debtors are unconnected to the present section’s title (which refers to notice of the availability of alternatives to bankruptcy). Moreover, the incorporation of the disclosure provisions into S. 1301 creates a drafting error. One of the provisions of § 210 of H.R. 2500 incorporated here is a requirement that the debtor file a statement of "extraordinary expenses". Section 101 of H.R. 2500 sets out the elements that would be included in a statement of extraordinary expenses—and would impose on debtors the obligation of filing such statements—by adding a new § 109(h)(3) and (4) to the Bankruptcy Code. S. 1301 does not incorporate § 101 of H.R. 2500, and hence does not add § 109(h)(3) and (4) to the Bankruptcy Code. Nevertheless, § 301 of S. 1301 states that debtors must file, "if applicable," statements pursuant to § 109(h)(3) and (4).

§ 302 ("Fair treatment of secured creditors under Chapter 13").

Section 302 recognizes that a partially secured debt might be paid in full (i.e., payment of both the secured and unsecured claims resulting from the debt) prior to the debtor’s discharge, and the section would allow the creditor’s lien to be avoided at the completion of payment, rather than at the time of discharge. The impact of the change, however, is largely identical to that of §105 of H.R. 2500.

§ 303 ("Discouragement of bad faith repeat filings").

This section is substantially the same as § 109 of H.R. 2500, with the only differences being in the way that the substantive provisions are numbered.

§ 304 ("Timely filing and confirmation of plans under Chapter 13").

This section is substantially the same as § 114 of H.R. 2500, discussed above, with only minor wording changes.

§ 305 ("Application of the codebtor stay only when the stay protects the debtor").

This section is similar to § 118 of H.R. 2500, but it contains one substantive difference. Section 118 of H.R. 2500 provides that the codebtor stay in Chapter 13 would simply not apply in situations where the debtor did not receive the consideration for a particular cosigned debt. In contrast, § 305 of S. 1301 provides that, where the debtor did not receive the consideration, the codebtor stay would terminate automatically 30 days after the bankruptcy was filed, unless the debtor was "able to demonstrate that the receipt of the property was not part of a scheme to defraud or hinder any creditor." Section 305 would make the same change to the codebtor stay respecting leased personal property as would § 118 of H.R. 2500.

The impact of the changes. Like § 118 of H.R. 2500, the changes proposed by § 305 of S. 1301 would impose a burden on the debtor to define the scope of the codebtor stay. The difference is that S. 1301 would leave the stay in effect for 30 days unless the creditor sought relief during that time. Thereafter the creditor could enforce its claims against a codebtor or against property not in the debtor’s possession, unless the debtor made the showing that "receipt of the property was not part of a scheme to defraud or hinder." The impact of this provision is unclear, and requires a review of the policy underlying the codebtor stay.

The codebtor stay is intended to protect nondebtors who cosign as an accommodation to the debtor. For example, the debtor may have purchased a car, with the loan documentation cosigned by a friend. The idea is that the debtor should be allowed to pay such debts in full through a Chapter 13 plan. However, if the nondebtor actually received the consideration for the debt (for example, if the debtor cosigned an auto loan for a friend’s purchase), there is no need for "protection"—the creditor should be allowed to pursue collection against the nondebtor. Thus current law allows a creditor to obtain relief from the codebtor stay upon a showing that the codebtor, rather than the debtor, received the consideration. The proposal would confuse the law in this regard by providing an opportunity to the debtor to keep the codebtor stay in effect, even if the debtor did not receive the consideration for the debt, upon a showing that the receipt of the property securing the debt was not part of a scheme to defraud or hinder the creditor. Whether or not there was any scheme to defraud or hinder, there is no apparent reason for a codebtor stay when the nondebtor received the consideration for the debt.

The provision regarding leased property has the same problem as § 118 of H.R. 2500—if the debtor received the consideration for the lease, the debtor should be allowed to pay the debt arising from the lease in full, so as to protect the accommodation party, even if the debtor proposes to surrender or abandon the property.

§ 306 ("Improved bankruptcy statistics").

This section is substantially the same as § 201 of H.R. 2500, except that it adds a provision requiring reporting on the extent of creditor misconduct and the amount of any punitivedamages awarded for creditor misconduct.

§ 307 ("Audit procedures").

This section is substantially the same as § 202 of H.R. 2500.

§ 308 ("Creditor representation at first meeting of creditors").

This section is substantially the same as § 205 of H.R. 2500.

§ 309 ("Fair notice for creditors in Chapter 7 and 13 cases").

This section is substantially the same as § 206 of H.R. 2500.

§ 310 ("Stopping abusive conversions from Chapter 13").

This section is substantially the same as § 108 of H.R. 2500.

§ 311 ("Prompt relief from stay in individual cases").

This section is substantially the same as § 207 of H.R. 2500.

§ 312 ("Dismissal for failure to file schedules timely or provide required information").

This section is substantially the same as § 211 of H.R. 2500 except that (1) the drafting error regarding the effective date of dismissal is corrected; (2) the court is allowed to extend the debtor’s time for filing information, on request of the debtor, for 20 days rather than 15; (3) the finding necessary to allow such an extension is "justification" rather than "compelling justification"; and (4) the sanction of dismissal for failure to supply postpetition tax returns and financial information is not included.

§ 313 ("Adequate time for preparation for a hearing on confirmation of the plan").

This section is substantially the same as § 213 of H.R. 2500.