Working Group Proposals

from the

ABI CONSUMER BANKRUPTCY
REFORM FORUMMay 15, 1997


To comment on this report, send an e-mail to the ABI at info@abiworld.org.


Report from the Consumer Reform Forum, held January 17-18, 1997, in Alexandria, Va.

 


DEFAULT DISCHARGE PROPOSAL FOR FAILING CHAPTER 13 CASES

Ken Crone
Saul Eisen
Hank Hildebrand
Ike Shulman

Statement of Problem

When a debtor seeks Chapter 13 Relief, often that debtor might have qualified for a "no asset" Chapter 7 discharge at the outset. If the debtor elects a Chapter 13 and the Chapter 13 plan subsequently fails, current law allows the debtor to voluntarily dismiss the case, elect to convert the case, or the case is dismissed upon the motion of a party in interest, usually the trustee. If the Chapter 13 is dismissed, the debtor receives no discharge. If the case is converted, the debtor normally incurs additional attorneys fees and filing fees, must file new schedules and statements and must attend a new meeting of creditors. This is so even in a "no asset" case.

The existing system deprives many debtors who attempt to consummate a repayment plan of a discharge to which they would have been entitled had they originally filed a Chapter 7. This skews two policies that Congress has articulated—1) to encourage people to attempt a repayment plan and 2) to provide debtors with a "fresh start."

The proposal below would improve current law in a number of ways. First, it would provide a discharge for numerous Chapter 13 debtors who attempt but fail to complete payment plans to creditors, leaving them in at least as good a position as those debtors who elect Chapter 7 with no payment to creditors. Second, because of the increased number of debtors who will obtain such a discharge, the number of bankruptcy filings nationwide will be reduced, since a certain portion of refilings to obtain the discharge will not be necessary. Third, Chapter 7 administrative costs will be avoided for "no asset" cases, thereby increasing the efficiency of the system.

Proposal

A debtor may elect to dismiss a Chapter 13 case at any time, as under existing law, unless the case was previously converted to Chapter 13 from another Chapter, in which case the debtor may seek court approval of a dismissal.

Upon the failure of the debtor to comply with a confirmed Chapter 13 Plan, the trustee or any other party in interest may file a noticed motion to have the case closed. Upon motion to close, the moving (usually the trustee) must disclose 1) whether the debtor would have been entitled to a discharge of debts under §727 had the debtor filed a Chapter 7 petition, or 2) whether the debtor has met the "best interest" test by repaying a sufficient amount to unsecured creditors during the Chapter 13 Plan. Notice of a hearing would be provided to all parties in interest of the motion to close the case with a basic discharge (equivalent to a current Chapter 7 discharge). This notice would also contain the dates set for parties to bring §§523(a) and 727 complaints. No bar date would be set for claims to be filed in these cases, since no assets would be administered by a Chapter 7 Trustee. Unless a party objected (arguing that the estate should be administered under Chapter 7), a party filed a §727 complaint, or the debtor voluntarily dismissed the case, the motion would be approved by the court at the hearing and the discharge would be entered. At all times during the process, the debtor would retain the right to dismiss the case. If a party filed a §523(a) complaint, the discharge would still be entered with regard to other creditors, and the §523(a) complaint would proceed as under current law.

If the trustee perceives that an unconsummated Chapter 13 case is no longer being funded and that the case should be administered because there are assets sufficient to provide distribution to creditors, the trustee shall move to convert the case to Chapter 7, unless the administration would produce only a nominal result, in which case the trustee shall move to dismiss the case. Unless the case were dismissed by the debtor or the trustee, the case would be converted to Chapter 7 for administration or disposition. Notice of the motion to convert would also contain the dates set for parties to bring §§523(a) and 727 complaints as well as the bar date for claims to be filed.

A debtor would contest the motion to close or convert and would have the right to modify the Chapter 13 Plan or propose a mechanism to cure the Chapter 13 Plan default up to the time that the objection period had passed. If a case were converted, the debtor would be credited for payments to secured creditors as provided under current law (§348).

If the debtor fails to obtain confirmation of a plan, the option of closing with discharge would not be available. The debtor could dismiss or convert to Chapter 7, and any party in interest could seek to have the case dismissed or converted.

Current protections against involuntary conversion for farmers would be maintained.


CHAPTER 13 SUPERDISCHARGE

Ken Crone
Saul Eisen
Hank Hildebrand
Ike Shulman

Stop Further Erosion of the Superdischarge The Chapter 13 superdischarge was intended to be an important incentive to encourage debtors to elect Chapter 13 and Chapter 7 when the Bankruptcy Code was enacted in 1978. Debtors who could propose a confirmable plan would be able to discharge almost all debts by paying all unsecured creditors a pro rata dividend. However, since 1978 the superdischarge has been eroded through piecemeal amendments to the Code, making Chapter 13 less attractive to debtors. These debtors, unable to solve their financial problems through Chapter 13, are more likely to find it necessary to file Chapter 7, resulting in no dividend to most unsecured creditors.

Proposals have recently been made to cut back even further on the superdischarge, specifically regarding certain tax debts. These proposals have been advanced by tax authorities notwithstanding the fact that Chapter 13 has provided tax agencies with substantial revenues at low collection cost. Further restrictions on the superdischarge such as this will remove Chapter 13 as a viable option for many more debtors, thus limiting the ability of those debtors to obtain financial rehabilitation and eliminating repayments to most of their unsecured creditors.

Given additional classes of creditors nondischargeable status harms the interest of both debtors and most general unsecured creditors. Therefore, it is recommended that no further restrictions on the Chapter 13 superdischarge be enacted.

Restore the Superdischarge for Student Loans Until 1990 most student loans were dischargeable in Chapter 13, providing an incentive for debtors to choose Chapter 13. That year, however, Congress enacted new legislation making most student loans nondischargeable in 13. This legislation never underwent scrutiny in the Judiciary Committees of Congress, thus depriving interested parties of the ability to comment on the effects of such a change on debtors and creditors alike. Many debtors today simply have no way to repay their student loans from their current income, and also have little prospect for significant financial improvement in the near future. In some cases these debtors attended trade schools, after unscrupulous sales tactics by those schools.

To provide these debtors with a chance for financial rehabilitation and to encourage more Chapter 13 plans where all unsecured creditors share in a debtor's repayment, it is recommended that the superdischarge be restored for student loans in Chapter 13 cases.


CREDIT BUREAU REFORM

Steve Holiga
Bob Mitsch
Ike Shulman

Our suggestions for credit bureau reform are:

  1. Bankruptcies must be reported by Chapter.
  2. Completed Chapter 13 plans must be reported by the percentage of the unsecured debt which was repaid. The reporting on this would have to come from the Chapter 13 Trustees to the credit bureaus.
  3. If the debtor completes a Chapter 13 and the credit reporting on all the debts included in the bankruptcy plan has expired, the credit bureau should delete the reporting on various debts and delete the Chapter 13 Bankruptcy, as well.
  4. Completion of a consumer finance education program would also be recorded in the credit bureau history.
  5. The intent of these suggestions is to increase the attractiveness of a Chapter 13 over that of Chapter 7 by giving more favorable reporting in the credit bureaus. The ABI participants encourage and welcome any further ideas that contribute toward this end.



PROPOSAL ON REPEAT FILINGS

Judge William Brown
Prof. Jeff Morris
Henry Sommer

The goals of an effort to deal with serial bankruptcy filings are:

  1. to sort out the abusive cases from the nonabusive cases;
  2. to quickly deny the automatic stay to debtors who file abusive cases, thereby also eliminating the incentive to file such cases;
  3. to avoid imposing costs on debtors who are not filing abusive cases that might make it more difficult or even impossible for them to obtain needed relief; and to avoid imposing costs on creditors or lessors who are delayed from exercising their rights by abusive bankruptcy cases.

The subcommittee agreed that the barriers to serial filings should not be applicable to the second bankruptcy case a debtor files. It was our consensus that the second case is far more often legitimate than abusive, and that even in the case where in hindsight it becomes clear the second case was abusive, that rarely can be readily determined when the second case is filed. Our proposal would not prevent a creditor or lessor who wishes to allege an abuse in a second case from filing a motion for relief from the stay or a motion to dismiss, and even seeking expedited relief, as that creditor or lessor can do under current law.

However, if a debtor files a third case within a five year period, and that case is filed within 180 days of the dismissal of the second case, a new barrier would be erected. In such a case, the automatic stay would terminate 15 days from the petition filing unless no objection was filed to the continuation of the stay by any creditor, lessor, or the trustee. (Calendaring the hearing would be left to local practice.) Thus, creditors and lessors would have a quick and easy way to trigger a prompt review of the debtor's filing, and debtors would have little incentive to file a case that could not be justified, since the stay would be lost almost immediately.

If no objection to the debtor's motion was filed, the court would continue the stay without a hearing, subject to current relief from stay procedures. If an objection was filed, the debtor would have the burden at the hearing of proving that there was a reasonable prospect of a feasible plan being completed. Absent such a finding the stay would not be continued as to the objecting creditor or lessor. (If the trustee objected, the court could consider factors such as any change in circumstances since the prior cases, level of effort in the prior cases, amount of arrears, reasons for failure of prior cases, the debtor's honesty with the court, and differences in Chapter 13 plans between the prior cases and the current case.

For any bankruptcy case filed by a debtor after the third case within a five year period, there would be no automatic stay. The debtor could seek a stay from the bankruptcy court and would have the same burden of proof as in the case.

Court's Power to Issue In rem Orders

The subcommittee agreed that the bankruptcy court must have a limited power to issue in rem orders granting relief from the stay with respect to a particular property for future cases filed by debtors other than the debtor in the case before it. This power is necessary in order to prevent schemes in which a property is transferred and subdivided for the purpose of repeated bankruptcy filings by different debtors invoking a new automatic stay with respect to the property in each case.

Under this proposal the court would have the power, on motion of a creditor or real property lessor, to issue in rem order that would make the automatic stay inapplicable to a particular property in a subsequent bankruptcy case.

This order could be issued only upon a finding that the property had been transferred after a prior bankruptcy case in which the stay was applicable to the property for the purpose of the transferee obtaining an automatic stay that could not otherwise be obtained with respect to the property (for example, under the first part of this proposal, if the transferor had filed two prior cases and could not making the showing necessary to obtain a stay in a subsequent case.) The order could be entered only after notice to all known entities having an interest in the property and a hearing.

The order could be recorded by the moving party in the appropriate registry for real estate, and if it was recorded it would be deemed constructive notice of its terms to any transferee who received an interest in the property after the order was recorded. The order would remain effective until the earlier of 1) the expiration of six years from the date of the order or 2) the moving party realizing its collateral or, in the case of the lessor, obtaining possession of the property.

A transferee or co-owner of the property who is innocent of any scheme to abuse the automatic stay could move for relief from the order. Such relief could be granted by the court in its discretion after notice to the party that sought the order and a hearing.


DISPOSABLE INCOME

Ken Crone
Hank Hildebrand
Gary Klein
Prof. Jeff Morris

Presently, a debtor must dedicate "all disposable income" to fund a Chapter 13 plan upon the application of the trustee or an unsecured creditor (see §1325(b)). A debtor may avoid this obligation by proposing a plan which satisfies all unsecured claims in full, within a three year period. Issues have been raised as to what types of expenses are to be included in a debtor's budget, since "all disposable income" is statutorily defined as funds which are not "reasonably necessary to be expended...for the maintenance or support of the debtor or a dependent of the debtor." Courts have disagreed as to what types of expenses are appropriate or "reasonably necessary." Courts have also applied varying standards as to the amount of expenses which are appropriate.

One proposal under serious consideration is the establishment of a standard template which fixes the amount of funds which a debtor must dedicate to pay to unsecured claim holders. The standard template would be national in scope and adjusted to family size and for geographic differences.

At the January ABI forum, there was a general (though not unanimous) feeling that, with some exceptions, the idea of paying "all disposable income," determined on a case-by-case basis works reasonably well, providing flexibility for debtors in fashioning Chapter 13 relief around their own circumstances, subject to the scrutiny of trustees and creditors.

The participants at the ABI forum have articulated problems, however, with the uniformity of the application of the §1325(b) test. Judges can differ radically on what might be reasonable and necessary.

Proposal

The definition of disposable income will still be those funds not reasonably necessary for the maintenance and support of the debtor and the debtor's household dependants. The debtor would list expenses incurred in several broad categories, which type of expense would be presumptively necessary, and the reasonableness could be subject to challenge. These categories are:

  • Food expense
  • Housing costs (and housing related expenses)
  • Clothing
  • Laundry and Cleaning
  • Utilities and Telephone
  • Medical Expenses
  • Insurance
  • Taxes
  • Support
  • Transportation

Whether such expenses are reasonable would depend upon the debtor's family reasonable needs and the reasonable living expenses of a family of similar size, with similar income living in the same geographic area. Any party challenging the reasonableness of such expenses by a debtor's family would bear the burden of proof to demonstrate non-reasonableness.

For a self-employed debtor or a debtor engaged in business, expenses related to the production of income would be presumptively necessary. Whether the expenses are reasonable would depend upon the expenses incurred by similar businesses in the same geographic area.

If a debtor incurs other types of expenses (tuition costs, entertainment, gifts, etc.) Such could be reasonably necessary, but, on request of the trustee or any unsecured creditor, the debtor would bear the burden of proof to demonstrate the reasonableness and the necessity of the proposed expense.

If the debtor's plan meets the requirements of §1325(b), confirmation of the plan should not be denied solely because the plan fails to meet any minimum payment requirement beyond that required by §1325(a)(4).


TREATMENT OF RENT-TO-OWN CONTRACTS

Steve Holiga
Richardo Kilpatrick
Gary Klein
Henry Sommer

This proposal is forwarded pursuant to the discussions held with Henry and Gary on our conference call which was held on April 24, 1997.

Treatment of Rent-to-Own Contracts

There has been continuing debate over how to treat rent-to-own contracts which do not fit neatly into the definition of "lease" or the definition of "sale" outside of bankruptcy.

Through discussions held during our conference call, many instances were cited where the use of these contracts have created problems throughout the country for low income consumers. In rent-to-own transactions, consumers enter into agreements to rent various household and personal items for low payments over extended terms designed to, in essence, purchase the item through the agreement. These rent-to-own contracts appear to be an attempt, by those who engage in this practice, to avoid various state laws regulating interest rates and lending practices.

These same issues arise in bankruptcy cases with varying results. The majority of courts have treated these obligations as installment sales subject to §§722 and 1325. A minority of courts have treated these as "true leases."

During our conference call, it was agreed by consensus that these types of obligations should be recharacterized as installment sales to allow the treatment as afforded under the applicable provisions of the code. The recharacterization of rent-to-own contracts must be crafted in a manner to avoid any negative impact on "true leases".

It is possible that the simples method of dealing with the problem in bankruptcy is to treat the transaction as an installment sale, regardless of its characterization under state law, for purposes of bankruptcy. This could be accomplished by an amendment in §365, or elsewhere, providing that in a case where an individual debtor is the lessee of consumer goods other than a motor vehicle, the debtor may have the transaction considered as a sale, according the lessor an allowed secured claim in the amount of the value of the property or the present value of the remaining payments, whichever is less. The lessor would have a deficiency claim allowable as an unsecured claim for the present value of the remaining payments due under the lease minus the allowed amount of the lessor's allowed secured claim.

The most practical way of doing this may be to amend the definition of "security interest" to include the rights arising out of rent-to-own transactions. The transactions would then be subject to the statement of intentions section in Chapter 7, §521(2), and the redemption provision in §722.