MEMORANDUM

The Consumer Bankruptcy Working Group has developed two of the three major recommendations the Commission is considering. The first, uniform federal exemptions, will come to a final vote at the Commission meeting on May 16. The second, the basic framework, will be presented to the Commission for initial consideration at the same meeting. The third piece, recommendations on dischargeability, will be discussed in plenary session at the May Commission meeting.

Attached is the latest version of the basic consumer framework. It reflects consideration of the testimony, letters, and advice the Commission has received since the first version of the framework was circulated on March 5. Some parts of the first draft of the framework have been omitted, while others have been strengthened. The draft retains the basic structure, which deals with refiling, repayment, reaffirmations, audits, and education, and more details have been developed based on extensive discussions.

The changes recommended in the framework leave intact the basic debtor-creditor balance. The changes are designed to help improve public confidence in the system and reduce costs for both creditors and debtors. The balance struck here will not please any single interest group, but it reflects loyalty to the principles of fairness and integrity.

CONSUMER BANKRUPTCY WORKING GROUP

May 6, 1997 Draft

Key Concepts

Balancing Debtor and Creditor Interests The approach taken in this framework is not designed to further the interests of either debtors or creditors, but rather to improve circumstances for both. The framework incorporates essential elements gleaned from testimony before the Commission and submissions to the Commission by both creditor and debtor representatives. Some creditors might give up some benefits, such as nearly-unrestricted reaffirmations, but they would receive the benefits of clearer guidelines on repayments in chapter 13 and sharp restrictions on repeated bankruptcy filings. Other creditors that, practically, can never take advantage of the current reaffirmation provisions also would receive these benefits and would be assured of greater equality of treatment on par with all creditors. Debtors would face more constraints in the system, but their fresh start would be better protected and they would have more incentives to undertake repayment plans in chapter 13. The approach would resolve a number of ambiguities that result in litigation, which would reduce cost and delay for both sides. The only "losers" under these proposals would be both the debtors and the creditors who try to abuse the system and who try to use it in ways not originally contemplated in the design of the bankruptcy system.

Restrictions on Refiling This proposal would eliminate the ability of debtors to abuse the process by refiling repeatedly to avoid either foreclosure of their property or eviction by their landlords. Virtually open access to chapter 13--and to its automatic stay--would be eliminated. To the extent that bankrupt debtors are repeat filers, this approach would dramatically decrease bankruptcy filings.

Repayment of Debt The Consumer Bankruptcy Working Group framework would encourage debtors to file for chapter 13 and repay debts, rather than liquidating their debts in chapter 7, in several ways:

1) By using income guidelines, debtors who currently are denied access to chapter 13 because they are unable to pay pre-determined proportions of their debts will have an opportunity to confirm chapter 13 plans based on their incomes. For example, in many districts today debtors who cannot pay at least 50% of their unsecured debt face an informal restriction that denies them the opportunity to confirm a chapter 13 plan. This proposal makes chapter 13 plans based on income, not debt, to make chapter 13 plans accessible to all debtors.

2) Restrictions on reaffirmation of secured and unsecured debt will reduce chapter 7 partial repayment plans that discriminate against some creditors. Debtors who makecommitments to repay debts will do so in chapter 13 under the supervision of the bankruptcy court. For example, debtors who commit future income to repay one car lender, one credit card issuer and one finance company loan in order to keep certain assets and gain access to future credit will be forced to make those arrangements in chapter 13 according to established distribution rules and under the supervision of a trustee.

3) Debtors who today use chapter 7 to make "deals" to restructure defaulted loans will have to make those deals in chapter 13, again under court supervision. For example, debtors who are in default on a car loan and who want to make an agreement for future payment of secured and unsecured debt will have to make those arrangements in chapter 13 according to established distribution rules and under the supervision of a trustee.

4) More debtors will have an incentive to try chapter 13 repayments without becoming worse off for the effort because a debtor who is unable to make repayments in chapter 13 will be automatically converted to chapter 7. In the current system, a poorly advised debtor who is in trouble in chapter 13 often drops out of the system with no protection, facing new attorneys' fees and filing fees to get any help. Under this proposal, even the debtor who does not seek additional legal help or who is poorly advised will not be penalized for trying to repay in chapter 13 rather than filing initially in chapter 7.

5) Debtors who repay some debt in chapter 13 would receive more favorable treatment in their credit reports than debtors who file in chapter 7. For example, chapter 13 filings will be listed differently than chapter 7 filings. This should be a significant incentive to use chapter 13.

6) chapter 13 systems would include opportunities for credit rehabilitation for debtors. Chapter 13 trustees will be authorized to develop programs that include access to credit as part of the ongoing educational programs for bankrupt debtors.

Saving Homes This approach would advance the national policy of helping homeowners make their mortgage payments and stay in their homes. The proposal has several features designed to protect homeowners.

1) By disallowing selective reaffirmation agreements that encumber a debtor’s future income, debtors would have more future income available to deal with their mortgage debts if they faced financial problems down the road. A debtor who has received a true fresh start following a bankruptcy filing in either chapter 7 or chapter 13 is more able to continue to make future mortgage payments.

2) Debtors would be able to treat second and third mortgages against the home like all other secured debt. To the extent the second or third mortgagee is fully secured, this creditor would have to be repaid in full. Debtors with second and third mortgages that exceeded the value of their homes would not face losing their homes if they could not repay the unsecured portion of these loans.

3) By implementing a standardized income-based repayment plan, the approach would eliminate the practice in a number of districts of denying debtors the opportunity to deaccelerate and cure secured debt obligations if they could not make certain percentage repayments to their unsecured creditors.

4) Restrictions on refiling put a premium on debtors solving their home mortgage problems within the framework of an existing chapter 13 plan, and if the debtor has a reasonable possibility of making mortgage payments, the proposal protects both the right to modify a plan when necessary and to ask the court for reimposition of a stay following a dismissal. The proposal does not, however, make bankruptcy a haven to delay foreclosure or eviction when the debtor does not have a reasonable likelihood of paying off the mortgage.

While it provides increased homeowner protection, the proposal also furthers the policy of protecting lenders in the primary mortgage market, particularly by the strict restrictions on refiling, enhancing the availability of home mortgages at lower cost and for marginal borrowers.

Integrity of the System This proposal would impose, for the first time, auditing requirements to verify the accuracy of the information available to the court, the trustees and the creditors. Inaccuracies could result in a denial or revocation of discharge and possible prosecution. In addition, improved computerized monitoring of debtors' filing records would enhance the ability to detect fraudulent activities. The proposal would eliminate most unlimited exemptions so that debtors in some states could no longer put a million dollars in an exempt home or in an annuity contract on the eve of bankruptcy. At the same time, the law would proscribe certain abuses, such as economically ill-advised reaffirmation agreements, including "post-bankruptcy reaffirmations." Secured creditors would receive postpetition repayments of debt in a chapter 13 plan to the full extent of their security and would receive pro rata distribution for the remainder along with all other unsecured creditors.

Reduced Cost Secured creditors would have more expedient access to the courts to protect their collateral and to have the automatic stay lifted promptly when debtors could not make their payments. The proposal also would eliminate ambiguities and issues that are the subject of much litigation, such as proper valuation, appropriate interest rates, and calculation of disposable income.

Increased Uniformity This framework would eliminate many non-uniform practices that result in very different treatment for similar debtors and creditors in different regions and districts. The adoption of a repayment template would end the dispute on whether "zero-payment plans" are confirmable or whether courts could demand minimum percentage payments (of widely varying amounts) to unsecured creditors within chapter 13. The proposal would sharply reduce the disparity in the amount of property that debtors could keep, so that, for example, all debtors would be entitled to some exemptions, but not unlimited ones. The dispute over the "ride through" of secured debt, currently permitted in some circuits and prohibited in others, would be resolved. Similarly, the standard for valuation would be settled legislatively.

Debtor Education In addition to providing an opportunity to participate in a financial education program, the establishment of specific amounts that debtors could be expected to repay in a chapter 13 plan would encourage debtors to develop realistic budgeting skills. They would be free to save and to reestablish their financial integrity. The projected budgets would leave some flexibility to deal with the true emergency and the courts would be relieved of making routine investigations into each debtor's lifestyle.

Debtor Rehabilitation/Equality of Distribution The proposal retains the essential features of consumer bankruptcy that have been the mainstay of debtor-creditor policy for more than a century. Debtors can come into the bankruptcy system to discharge their debts, to get the fresh start that encourages them to continue to work, to care for their families and to avoid welfare. Creditors can count on the system to terminate the "race of the swift" of state law that characterizes individual debt collection and to distribute the debtors' assets on a pro rata basis that benefits all creditors equally and protects collateral.

Amendments Applicable to Both chapter 7 and chapter 13

Audits (New) All debtors would be subject to random audits to verify the accuracy of the representations made in the debtors' schedules. Audits could be conducted anytime until 90 days following the section 341 meeting with creditors. Irregularities might result in the denial or revocation of discharge or prosecution by the Department of Justice. Based on initial results from audits, the Executive Office of the U.S. Trustee would develop auditing guidelines. In addition, to enhance the capacity to detect debtor fraud and abuse, a national filing system using social security numbers or other unique identifying numbers would be established so that debtor refiling (in the same or other districts) and debtor fraud could be detected more easily. The U.S. Trustee would designate special audit agents, and additional resources should be allocated to fund such audits and to monitor audit compliance.

False Claims (New) Courts would be authorized to require creditors who file false claims in bankruptcy to pay the debtors' attorneys' fees involved in correcting the claim. If a creditor knowingly filed a false claim, the court could impose appropriate sanctions.

Filing Protocols (New) Because the Code would restrict re-filings--not merely subsequent discharges--requirements for monitoring in the clerks' offices would change substantially. All clerks would need access to a nation-wide data base that would contain a six year list of bankruptcy filings. Pro se debtors would have to present identification when filing a petition, and attorneys would have to present photocopied evidence of such identification at the time of filing. All debtors would be required to provide correct social security numbers; such numbers would be verified through the social security administration database. The details of this proposal, including a mechanism to monitor the database and to create an opportunity for debtor or creditor correction, could be developed by a specialized working group of judges, clerks and trustees.

Education (New) All debtors, both in chapter 7 and in chapter 13, would have the opportunity to participate in a financial education program. Pilot programs would be established to develop effective methods of debtor education. Bankruptcy judges would have the power to order debtors to participate in education programs in appropriate cases.

Amendments Applicable to chapter 7

Ride-through of Secured Debt. (11 U.S.C. §§ 362, 524(c), 722) A debtor would not be permitted to make a legally enforceable obligation to be personally liable to repay a debt discharged in bankruptcy. The debtor could continue to make payments on a secured loan according to the contract terms without further involvement of counsel or the court and retain the property, if the debtor were not in default on the contract at the time of the bankruptcy (other than by the bankruptcy filing itself) or if the secured creditor waived any defaults inwriting at the time of the bankruptcy. If the debtor subsequently ceased making payments or defaulted on other contract obligations, such as the obligation to insure, the creditor would be entitled to seek relief from the stay prior to discharge or to repossess the collateral post-discharge. A creditor would be permitted to contact a debtor directly regarding post-petition contract defaults. Redemption under section 722 would remain unchanged.

Secured and unsecured debts (New, 11 U.S.C. § 522(f)) For purposes of determining the secured and unsecured status of certain loans in bankruptcy, loans secured by household furnishings, wearing apparel, appliances, books, animals, crops, musical instruments, jewelry, implements, professional books, tools of the trade or professionally prescribed health aids for the debtor or a member of the debtors' household that are worth $2,500 or less in value for each item, shall be deemed unsecured.

Postbankruptcy Payments--Unsecured Debt (11 U.S.C. § 524(c), (f)) Any debtor could voluntarily repay any debt, including an unsecured debt, that had been discharged in bankruptcy. A debtor would not be permitted to reaffirm personal liability on a debt discharged in bankruptcy, and federal law would make it an unlawful practice for a creditor to make any postpetition effort to collect from the debtor a debt that already had been discharged in bankruptcy.

Amendments Applicable to chapter 13

Repayment Plans (11 U.S.C. §§ 1322, 1325)

Repayment requirements would depend on the nature of the debt. The concept of disposable income would be changed.

Homes The chapter 13 debtor would have the opportunity to deaccelerate and cure a mortgage in default, just as the debtor can do under current law. The restrictions in section 1322(b)(2) would be limited to first mortgages and refinanced first mortgages. Payments on a mortgage arrearage would be spread over the three to five year life of the plan, in equal monthly payments, along with payments to unsecured creditors.

Other Secured Debt A secured creditor would be entitled to full repayment of the present value of its allowed secured claims. Valuation of personal property would be pegged at the median point between wholesale and retail. Valuation of real property would be valued at fair market value less the cost of foreclosure or sale. The rate of interest would be set by the court using guidelines; a suggested starting point for the interest rate is treasury bill plus three points, but the amount would vary with market conditions and risk factors. Interest under section 1322(e) would run at the contract rate. The unsecured portion of these debts would receive a pro rata distribution in theChapter 13 plan along with all other unsecured debts. Payments to secured creditors would be spread over the three to five year life of the plan.

Unsecured Debt Debtors would make secured and unsecured debt payments simultaneously. Debtors would repay a fixed amount to unsecured creditors throughout the life of the chapter 13 plan, which would be a minimum of three years in length. The amount to be repaid would be determined by guidelines, which would be based on a graduated percentage of income. The trustee or any unsecured creditor could file an objection to any plan that deviates from the guidelines, and a court would determine whether the deviation was appropriate in all the circumstances (e.g., a debtor with a chronically ill dependent might have much higher expenses than average and pay a lower fraction of income). (A sample guideline will be attached in a later draft, but it provides for a nominal repayment for debtors with incomes below $20,000, and a graduated repayment climbing to about 7% of adjusted gross income for debtors with incomes above $75,000. The guideline has a multiplier for the number of people claimed as dependents for income tax purposes and for regional variations in the cost of living.)

The percentage payable would be distributed pro rata to unsecured creditors holding dischargeable and/or nondischargeable debts.

The trustee would be obligated to verify income and to review, at least annually, a debtor's income for changes and possible modification -- upward or downward -- of the required amounts. In addition, debtors could attempt to pay more of their unsecured debt, either to meet the "best interest" test or because they voluntarily chose to do so. Any such debt repayments would be monitored and distributed by the chapter 13 trustee.

Tax Debt and Other Nondischargeable Debt Discussion of nondischargeability and the treatment of nondischargeable debts will be the subject of a session at the Commission's May meeting.

Consequences of Completion of a Plan of Repayment

Credit Reporting (15 U.S.C. § 1681 et seq.) Debtors who choose chapter 13 repayment plans would have their bankruptcy filings reported differently from those who do not. For debtors who complete repayment plans, bankruptcy filings would be reported for a shorter period of time.

Credit Rehabilitation Trustees would be encouraged to establish credit rehabilitation programs to help give debtors better, cheaper access to credit for those who participate in repayment plans.

Dismissal/Conversion/Refiling (11 U.S.C. §§ 1307, 362, 109)

Grounds. The grounds for dismissing or converting a chapter 13 case will be the same as under current law, but the effects of dismissal and conversion will change.

Chapter 7. After filing for chapter 7, a debtor could not file again for chapter 7 for six years or for chapter 13 for two years, except as noted below.

Chapter 13. After dismissal, discharge, or plan completion in either chapter 7 or chapter 13, a debtor could not file again in chapter 13 for two years. A debtor dismissed from chapter 13 would be automatically converted to chapter 7, with claims against the estate and property of the estate determined at the time of conversion. A debtor could petition the court to permit a filing in chapter 13 sooner than the two year time bar following a chapter 7 or chapter 13 if the debtor demonstrated a significant change in circumstances since the last filing and proposed a confirmable plan with demonstrated feasibility and a reasonable likelihood of success.

In rem orders. On a motion and a hearing, bankruptcy courts would be empowered to issue in rem orders barring the application of a future automatic stay to identified property of the estate for a period up to six years. In rem orders could be issued on a showing that the debtor had transferred property or fractional shares of property to avoid creditor foreclosure or eviction. A subsequent owner of the property who files for bankruptcy (or the same owner in a subsequent filing) could petition the bankruptcy court for the imposition of a stay to protect the property. The court would lift the ban and impose a stay to protect innocent parties who were not a part of a scheme to transfer the property to hinder a foreclosure or eviction. Bankruptcy court in rem orders could be filed in the state recording system to provide notice to purchasers and other parties.