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Summary of Consumer Bankruptcy Framework Proposals
Proposals Applicable in All Bankruptcy Cases

The Bankruptcy Code should direct trustees to perform random audits of debtors' schedules to verify the accuracy of the information listed. Cases would be selected for audit according to guidelines developed by the Executive Office for United States Trustees.

Courts should be authorized to order creditors who file and fail to correct materially false claims in bankruptcy to pay costs and the debtors' attorneys' fees involved in correcting the claim. If a creditor knowingly filed a false claim, the court could impose appropriate additional sanctions.

A national filing system should be established and maintained that would identify bankruptcy filings using social security numbers or other unique identifying numbers.

All debtors in both chapter 7 and in chapter 13 should have the opportunity to participate in a financial education program.

Proposals Primarily Applicable in chapter 7

Notwithstanding applicable non-bankruptcy law, debtors should not be able to reaffirm personal liability on a debt discharged in bankruptcy. Federal law should prohibit creditors from attempting to collect from the debtor any debt that has been discharged in bankruptcy.

Section 524 should be amended to provide that the filing of a bankruptcy petition or a discharge in bankruptcy alone does not create a post-bankruptcy default on a loan. A creditor could continue to collect payments on a secured debt postpetition without court involvement. After the debtor has received a discharge, nothing in the Bankruptcy Code would prevent a creditor from repossessing property if a debtor defaulted under the loan agreement.

Section 522(f) should provide that a creditor claiming a purchase money security interest in exempt property held for personal or household use of the debtor or a dependent of the debtor in 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 must petition the bankruptcy court for continued recognition of the security interest. The court shall hold a hearing to value each item covered by the creditor's petition. If the value of the item is less than [$500], the petition shall not be granted; if the value is [$500] or greater, the security interest would be recognized and treated as a secured loan in chapter 7 or chapter 13.

Proposals Applicable in chapter 13

A chapter 13 plan could not modify obligations on first mortgages and refinanced first mortgages, except to the extent currently permitted by the Bankruptcy Code.

Payments on all other secured debts should be subject to modification; such payments should be spread over the life of the plan, according to fixed criteria for valuation and interest rates.

Payments on unsecured debt should be determined by guidelines based on a graduated percentage of the debtor's income, subject to upward adjustment to meet the section 1325(a)(4) requirement that creditors receive at least the present value of whatever they would have received in a chapter 7. The trustee or an unsecured creditor should be authorized to file an objection to any plan that deviates from the guidelines, and a court would determine whether the deviation was appropriate in light of all the circumstances.

Debtors who choose chapter 13 repayment plans should have their bankruptcy filings reported differently from those who do not.

Debtors who complete voluntary debtor education programs should have that fact noted on their credit reports.

Trustees should be encouraged to establish credit rehabilitation programs to help provide better, cheaper access to credit for those who participate in repayment plans.

An individual debtor who receives a discharge in chapter 7 should be barred from refiling in Chapter 7 for six years and chapter 13 for two years after the case is closed. An individual debtor who files for chapter 13 should be barred from filing for chapter 7 or chapter 13 for two years after the case is closed. A debtor should be permitted to petition the court to permit a filing in chapter 13 sooner than two years if the debtor could demonstrate a significant change in circumstances since the last filing and proposed a confirmable plan with demonstrable feasibility and a reasonable likelihood of success. Within the time periods listed here, a debtor could not file and receive the protection of the automatic stay without advance court approval.

A case under chapter 13 that otherwise meets the standards for dismissal shall be converted to Chapter 7 after notice and a hearing unless a party in interest objects. Any party in interest may object to the conversion if a previous filing triggered a time bar that rendered the debtor ineligible to file for chapter 7 relief, in which case the chapter 13 case will be dismissed and will trigger the two year bar on refiling in chapter 13. In addition, the debtor may object to conversion without grounds, in which case the chapter 13 case will be dismissed and will trigger the two year bar on refiling. The standards for modification, dismissal, and discharge in Chapter 13 would not otherwise change.

After notice and a hearing, a bankruptcy court should be empowered to issue in rem ordersbarring the application of a future automatic stay to identified property of the estate for a period of up to six years when a party could show that the debtor had transferred such real property or leasehold interests or fractional shares of property or leasehold interests to avoid creditor foreclosure or eviction. A subsequent owner of the property or tenant of the leasehold who files for bankruptcy (or the same owner or holder in a subsequent filing) should be permitted to petition the bankruptcy court for the imposition of a stay to protect property of the estate, which the court would be required to grant to protect innocent parties who were not a part of a scheme to transfer the property to hinder foreclosure or eviction.

Consumer rent-to-own transactions should be characterized in bankruptcy as installment sales contracts.

Proposals Applicable in All Bankruptcy Cases

Audits (new)

The entire bankruptcy system depends on the accuracy of the information in the debtors' files. Creditors' decisions, trustees' actions, and court determinations in each case are based on the representations of income and debt in the schedules. Moreover, all information about the operation of the system and policy decisions that flow from that information are based on aggregated data from the debtors' files. If those data are inaccurate, it is impossible to know whether justice has been done in a particular case, or, more generally, whether the system is functioning overall as Congress intended.

Some witnesses have testified to the Commission that the information reported in the debtors' schedules tends to be unreliable. While chapter 7 and chapter 13 trustees currently attempt to review debtors' schedules and search for assets, there is no formal auditing mechanism in the bankruptcy system. This is one of several proposals to enhance the integrity of the system, to improve the quality of the data and, indirectly, to require debtors and their attorneys to be careful and forthright in completing all schedules.

The Bankruptcy Code should direct trustees to perform random audits of debtors' schedules to verify the accuracy of the information listed. Cases would be selected for audit according to guidelines developed by the Executive Office for United States Trustees.

The chapter 7 and chapter 13 trustees would be directed to perform audits of a sample of the cases assigned to them. Based on initial results, the Executive Office for U.S. Trustees would develop auditing guidelines. Audits should be commenced in a reasonably timely fashion and investigations could be continued for a reasonable period, subject to the U.S. Trustee guidelines. The trustee would report material irregularities to the bankruptcy court. Under section 727, material irregularities may result in the denial or revocation of discharge. In addition, such irregularities might subject the debtor to prosecution by the Department of Justice, depending on the severity of the irregularities and other factual circumstances. The verification of this information would be facilitated by the submission of recent pay stubs, tax returns if available, and other related information.

Trustees have commented to at least one commissioner that bankruptcy courts are too lenient in permitting debtors to amend their schedules when they discover material irregularities. The Commission does not perceive a need for a recommended change in the law, but believes that the present laws on denial of discharge should be followed.

In addition to recommending specific statutory changes for auditing debtors' schedules, the Commission also recommends that the Advisory Committee on Bankruptcy Rules of the Judicial Conference revisit the current informational requirements in debtors’ petitions. Creditors have recommended that account numbers and social security numbers accompany all bankruptcyfilings, notices, schedules and other communications to creditors. While the Commission has not explored the feasibility of this request, the creditors’ need to be able to identify debtors quickly, accurately and cheaply is undeniable. In addition, creditors have requested the opportunity to designate addresses of notices, a reasonable request designed to make the whole bankruptcy system operate more efficiently.

The new audit system also presents the opportunity to involve debtors' counsel more directly in monitoring information put into the bankruptcy files. This complements the recent amendment of Rule 9011 of the Federal Rules of Bankruptcy Procedure, effective December 1, 1997, that will make all submissions, whether or not signed by the attorney, subject to the "reasonable inquiry" standard.

False Claims (New)

Consistent with the need to improve the accuracy and consistency of the information debtors provide, this proposal encourages creditors to take increased responsibility for the information they put into the system. The overwhelming majority of creditors who file claims in consumer bankruptcy cases do so accurately and in good faith. A few creditors make mistakes, which, when called to their attention, are quickly corrected. In some cases, creditors refuse to correct their claims and debtors are faced with the choice of paying the excess amount included in the claim or paying more than the excess amount in attorneys’ fees to contest the claim. Some courts have indicated that they do not think the Bankruptcy Code presently authorizes them to award attorneys' fees for the expenses incurred in correcting erroneous and uncorrected claims. Any uncertainty should be eliminated.

Courts should be authorized to order creditors who file and fail to correct materially false claims in bankruptcy to pay costs and the debtors' attorneys' fees involved in correcting the claim. If a creditor knowingly filed a false claim, the court could impose appropriate additional sanctions.

Creditors monitor and record payment and debt information. Debtors typically rely on creditors' statements of amounts owed in determining their outstanding obligations. Some witnesses have testified that some creditors regularly file inflated claims including charges that are not due. False claims can present almost insurmountable problems for a bankrupt debtor. A mortgage lender, for example, may continue to accrue monthly late charges even after a debtor confirms a chapter 13 repayment plan, although the court-approved plan specifies that the debtor is entitled to cure the mortgage arrearage without accruing late charges every month that the cure is not yet complete. A debtor's attorney may be required to go to extraordinary lengths to correct such errors. Without the right to recover their fees if they successfully challenge a false claim, few debtors object to excessive claims and they rarely are in a position to challenge creditors' calculations of remaining loan balances. The recommendation is designed to encourage creditors to review any challenged debt calculations and promptly remedy them if necessary.

This proposal parallels the approach of the Fair Credit Billing Act, 15 U.S.C. § 1666 et seq., which potentially entitles a consumer to actual damages, civil penalties of double the finance charges, court costs, and reasonable attorneys’ fees if a creditor fails to comply with the statute's requirements.

National Filing Registry (new)

Although a national bankruptcy registry would serve a variety of purposes, there has been little impetus to establish a carefully monitored, national filing record because the Bankruptcy Code gives debtors virtually unlimited access to the bankruptcy system. The framework includes a proposal that would restrict consumer debtors' repeated access to the bankruptcy system. The introduction of these constraints creates an essential need for a reliable database to record debtors' bankruptcy filings.

A national filing system should be established and maintained that would identify bankruptcy filings using social security numbers or other unique identifying numbers.

The principal reason for the implementation of this system is to enforce the proposed constraints on refiling. Because debtors could not file subsequent petitions for a period of time, bankruptcy filings would have to be tracked carefully and accurately. This proposal envisions substantial changes in the requirements for monitoring by the clerks' offices. All clerks would need access to a data base containing a multi-year list of nation-wide bankruptcy filings. Pro se debtors would have to present identification when filing, and attorneys would have to present photocopied evidence of such identification at the time of filing. All debtors would have to provide correct social security numbers as presently required by section 342(c), verifiable through the social security administration database. Examples of unique identifiers that could be used as alternatives include driver's licenses and passports. The details of this proposal, including a mechanism to monitor the database and to create an opportunity for debtor or creditor correction, would be developed by a working group of judges, clerks and trustees.

This national filing system would yield other benefits. The unique identifiers would reinforce auditing efforts. The system would make information available so that creditors and other interested parties could monitor the system to detect fraud and abuse more readily. Ultimately, this filing system would enhance other efforts to collect and analyze more reliable data.

Debtor Education (New)

Representatives from every part of the consumer bankruptcy system--creditors, debtors, trustees, judges, and academics--have agreed that debtors should have the opportunity to better understand how to manage consumer credit. Debtors in bankruptcy have failed financially, but they certainly will continue to be involved in consumer credit transactions after bankruptcy. Everyone will benefit if debtors have the chance to learn how to manage financially, an integralpart of the financial rehabilitation process.

All debtors in both chapter 7 and in chapter 13 should have the opportunity to participate in a financial education program.

The need for debtor education in bankruptcy is undisputed. Critics primarily have focused on the scope of such programs, their timing, and funding, and not on the baseline premise that education should be widely available. The details of the education proposal deliberately are not spelled out in this recommendation. Instead, the Commission endorses the exploration of various alternatives. Effective methods of debtor education could be discovered through pilot programs. Part of the development of pilot programs should include the exploration and expansion of successful debtor education programs already in existence, which provide a valuable resource.

Whether debtor education should be mandatory has prompted commentary. The Commission has settled on a recommendation for voluntary education programs, with the emphasis on promoting their availability. This recommendation would not preclude a bankruptcy judge from requiring debtors to participate in education programs in appropriate cases.

The more widespread need for earlier consumer financial education is outside the scope of the Commission’s recommendations, but does not undercut the need for education once a debtor has experienced a financial crisis. Many debtors in bankruptcy have demonstrated that their financial management skills are not adequate. This proposal offers one opportunity for improvement.

Proposals Primarily Applicable in chapter 7

Reaffirmation Agreements (11 U.S.C. §524(c), (f))

The 1973 Report of the Commission on the Bankruptcy Laws of the United States recommended a flat prohibition on reaffirmation agreements in bankruptcy. The Commission's reasons were equally unambiguous: reaffirmation agreements violate the principle of equality of distribution to creditors that underlies the bankruptcy system, and the ability to seek reaffirmations invites some creditors to engage in practices that undermine a debtor's financial rehabilitation in bankruptcy. Congress decided not to ban reaffirmation agreements outright in 1978. It chose instead to permit reaffirmations in very limited, highly constrained circumstances. In 1984, the credit industry endorsed amendments to eliminate some of the barriers to obtaining reaffirmations, and section 524 was amended further in 1994 to make reaffirming even easier. The experience with reaffirmations under the 1978 Code has demonstrated that the statutory constraints do not always protect debtors and that reaffirmation agreements have magnified the differential treatment of similarly-situated creditors.

Notwithstanding applicable non-bankruptcy law, debtors should not be able to reaffirm personal liability on a debt discharged in bankruptcy. Federal law should prohibit creditors from attempting to collect from the debtor any debt that has been discharged in bankruptcy.

[Commissioner Jones does not believe that the reaffirmation process is in need of significant reform and suggests the following alternatives to banning reaffirmations outright: retaining current law; prohibiting only reaffirmations of unsecured debt; or, requiring bankruptcy judges to review and approve all reaffirmation agreements before they become effective and limiting the number of allowable reaffirmations to two per case.

Commissioners Williamson and Ceccotti believe that the ban on reaffirmations is central to the balance required within the framework proposal. They have concluded that prohibiting reaffirmations levels the playing field among all debtors and among all creditors. It gives debtors what they could have today if they were advised by their attorneys to refuse reaffirmation solicitations, and gives creditors clear guidance on permissible collection practices.]

Under this proposal, as under present law, a debtor always could voluntarily repay a debt after bankruptcy, and the creditor is free to keep payments that the debtor willingly remits. However, with the inability to enter a new binding agreement based on dischargeable debt, a discharged debt would remain legally unenforceable.

Currently, debtors are emerging from bankruptcy with liability on a significant amount of debt, both secured and unsecured, contrary to the original intention of Congress when it enacted the Bankruptcy Code of 1978. According to a study being conducted by the Credit Research Center at Purdue University, over 42% of the debtors in the study proposed to reaffirm one or more debts. The amounts of the proposed reaffirmations were significant: average housing debtreaffirmed was $69,408, and average non-housing debt was $11,311. According to the Purdue Study, the average income for these debtors is $19,284 annually. According to the same source, the debtors monthly incomes averaged $1,607, while their monthly expenses averaged $1,711. Preliminary results of the bankruptcy reaffirmation project at Creighton University School of Law paint a similar picture. Those researchers’ preliminary findings indicate that 30% of the cases in their three-district sample contained at least one reaffirmation agreement, and the principal amount reaffirmed averaged 37.9% of annual net income from wages. At least 20% of the reaffirmations were for completely unsecured debts. This level of encumbrance undercuts the purpose of the discharge and substantially hinders debtors’ ability to regain productivity.

At the same time, reaffirmations discriminate against some creditors because a reaffirmation essentially constitutes a postpetition preference of one creditor over another. While reaffirmations are very beneficial to the creditors who get them, the creditors who do not spend the time, energy, or resources to pursue the debtors in bankruptcy are closed out from any dividend in what was supposed to be a collective bankruptcy proceeding where the "pain" and the available resources are fairly shared.

Moreover, any debtor who sees a benefit in repaying some creditors has little reason to file for chapter 13 if that benefit can be obtained through a chapter 7 discharge coupled with one or two privately negotiated reaffirmation agreements. Currently, well-counseled debtors can structure a very beneficial bankruptcy using a combination of chapter 7 and reaffirmations of debt. Indeed, reaffirmations may be one of the leading disincentives for debtors to file chapter 13 and repay more of their debts.

Creditors have suggested that reaffirmations can be in a debtor's financial interest, particularly when the creditor offers new credit on better terms than it would without the reaffirmation. In virtually every case cited, however, the economic effect of the reaffirmation of discharged debt is substantially worse than if the debtor paid higher interest rates for postpetition credit. A debtor who reaffirms $1,500 of debt in order to receive a credit line of $2,500 (including the $1,500 of pre-bankruptcy debt) at 15% rather than at 21% is not receiving a bargain. Moreover, the widespread availability of consumer credit, even for those who have been through bankruptcy, means that credit should be available in the absence of reaffirmations.

One creditor group distinguishes itself in its approach to consumer credit: non-profit credit unions. They more closely scrutinize their members before issuing unsecured credit, and they work more with their members facing financial difficulty. The results of their practices pay off: credit unions' chargeoffs are only a tiny fraction of the losses of most credit card issuers. For example, a credit union representative who testified before the Commission reported an overall default rate of a fraction of one percent, compared with industry default rates more than 600% higher. Non-profit credit unions are often a source of consolidation loans as part of their effort to help their members work through financial trouble. If a debtors files for bankruptcy, they use reaffirmation agreements to cut their losses on these riskier loans and as a tool in their efforts to work with bankrupt members. While nothing in this proposal bars debtors from voluntarilyrepaying a debt as they work with their credit unions, and credit unions are free to deny their services to those who do not pay, the underlying question presented here is whether non-profit credit unions may warrant different treatment overall. It may be worthwhile for Congress to study more closely the question of whether non-profit credit unions that work with their bankrupt debtors as part of an education and credit rehabilitation program should be treated differently from other creditors.

Secured Debt -- Post-Discharge. (11 U.S.C. § 524)

An effective ban on reaffirmations increases the importance of secured claims and enhances their status and value. Creditors holding enforceable security interests always should retain the ability to repossess collateral after the discharge, but should not be able to convert a security interest into personal liability that was discharged in bankruptcy.

Section 524 should be amended to provide that the filing of a bankruptcy petition or a discharge in bankruptcy alone does not create a post-bankruptcy default on a loan. A creditor could continue to collect payments on a secured debt postpetition without court involvement. After the debtor has received a discharge, nothing in the Bankruptcy Code would prevent a creditor from repossessing property if a debtor defaulted under the loan agreement.

To be effective, the recommendation to eliminate reaffirmations requires another component. It becomes necessary to deal with continuing obligations on collateral. Not all debtors will want to turn over all property subject to security interests, nor will creditors want all property returned. It is critical, however, that the debtor be able to continue making payments under the secured contract following bankruptcy, assuming that the debtor meets all other contract terms, including insurance requirements, and ultimately pays the secured loan in full.

Although some have expressed concern about the repercussions of permitting "ride through," or retention of property without reaffirmation, this proposal will not bring about a significant change in the Fourth and 10^th Circuits, where debtors already are permitted to retain property without reaffirming the underlying debt. See In re Belanger, 962 F.2d 345 (4th Cir. 1992); Lowry Federal Credit Union v. West, 882 F.2d 1543 (10th Cir. 1989). At the same time, because three circuits have held to the contrary, see In re Johnson, 89 F.3d 249 (5th Cir. 1996), In re Taylor, 3 F.3d 1512 (11th Cir. 1993), In re Edwards, 901 F.2d 1383 (7th Cir. 1990), this proposal, in combination with the proposal to eliminate reaffirmations, resolves a split in the circuits over whether this is permissible, while it clarifies the courses of action available to the creditor to protect its interest.

This recommendation makes clear that a 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 filing (excluding a default based on the fact of the filing itself) or if the secured creditor waived any defaults in writing at the time of the bankruptcy. If the debtor subsequentlyceased making payments or defaulted on other contract obligations, the creditor would be entitled to seek relief from the stay prior to discharge or to repossess the collateral post-discharge. Because this proposal would not prohibit a creditor from contacting a debtor directly regarding postpetition contract defaults, there is some risk that a new form of unmonitored reaffirmation would reemerge in the bankruptcy system.

The Commission received testimony that the ride-through of secured debt without reaffirmation would not be problematic if debtors still had to comply with all contractual obligations (e.g., the obligation to insure) to keep the car and if creditors were permitted to contact the debtor in the event of a post-bankruptcy default. The Commission also received testimony from a representative from the Federal Home Loan Mortgage Corporation who indicated that mortgage lenders' interests would be protected if they had adequate access to their collateral; for this reason, heightened restrictions on refiling, recommended later in the framework, are more useful to them than preservation of the right to pursue a deficiency judgment against an already-bankrupt debtor. Regardless of the size of their loss, secured lenders rarely seek deficiency judgments against debtors, and approximately fifteen state legislatures already have partially or completely limited the ability of mortgagees to collect deficiency judgments.

Redemption under section 722 would remain unchanged by this recommendation.

Determination of Post-Bankruptcy Secured Status (New)

To assess a creditor's right to collect from a debtor postpetition, there must be further inquiry into secured and unsecured status. Bankruptcy law has a long tradition of distinguishing security interests held as collateral for asset-based lending from security interests obtained to extract payments in circumstances where the collateral would yield little for the creditors on repossession.

Section 522(f) should provide that a creditor claiming a purchase money security interest in exempt property held for personal or household use of the debtor or a dependent of the debtor in 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 must petition the bankruptcy court for continued recognition of the security interest. The court shall hold a hearing to value each item covered by the creditor's petition. If the value of the item is less than [$500], the petition shall not be granted; if the value is [$500] or greater, the security interest would be recognized and treated as a secured loan in chapter 7 or chapter 13.

[Commissioner Jones objects in principle to the avoidance of purchase money mortgages on any consumer goods. If the framework is adopted nonetheless, Commissioner Jones believes that the appropriate limit should be $100 because $500 gives debtors too much leeway to avoid security interests. Commissioners Williamson and Ceccotti are concerned that creditors with securityinterests in goods worth less than $500 are not truly asset-based lenders; in effect, they have made unsecured credit decisions and should be treated as unsecured creditors.]

The Bankruptcy Code has an unambiguous policy to enforce security agreements to the extent that loans are made on an asset basis, while it voids nominal security agreements that provide little more than creditor collection leverage. The strip down of secured debts to the value of the collateral in both business and consumer cases under current law reflects this policy.

When creditors take security interests in cars and home mortgages, procedures for obtaining and perfecting the security interest are relatively elaborate and creditors generally are careful in their documentation. Debtors are aware that they have given security interests as part of the loan agreement and that they will lose the property if they do not pay. Valuation of the collateral is an important part of the loan transaction and the interest rates are typically lower than unsecured credit, reflecting the asset-based nature of the loan.

By contrast, security interests in household goods, wearing apparel, and other similar items are taken less formally. A purchase money security interest in such consumer goods is often automatically perfected under state law, making these security interests cheap and easy to obtain and perfect. There is nothing inherently wrong with a lender making a secured consumer loan, but there is ample evidence that lenders are not making asset-based loans on these consumer goods.

A debtor with a retail charge account at some stores might be surprised to learn that every purchase is technically a secured purchase and the creditor could repossess everything bought with the credit card, from pantyhose to shampoo. Some creditors’ loan applications purport to give the creditor a security interest in goods bought on credit. For other retailers, every charge slip contains boilerplate language granting a security interest in items purchased. There is no evidence that credit issuers who take security interests in household goods are charging less for credit than those who lend on an unsecured basis; most revolving charge loans are made on the same terms whether they are nominally secured or unsecured. Moreover, creditors taking automatic security interests make no differentiation between credit purchases of items with no resale value (e.g., pantyhose) and items that might have some value to a subsequent purchaser (e.g., jewelry), reinforcing the inference that such lending is not asset-based.

While such procedures are of questionable validity under some state laws, the practice of taking such security interests persists nationally. Because conversion of property subject to a security interest can result in denial of discharge on that loan under section 523(a)(6), claiming a security interest on certain property can be translated into "pay or we'll bring a nondischargeability action." This can occur when nominally secured creditors allege that the debtor has given away, destroyed, or lost an item purchased on a retail charge card that supposedly gave the creditor a security interest in the item. Inability to produce the nightgown or toys purchased under the agreement brings allegations of conversion and a demand that the loan be repaid in full notwithstanding the bankruptcy. Yet, when debtors file for chapter 13 (and are able to stripdown secured loans to the value of the collateral), only a few creditors present themselves as secured creditors based on their blanket security interests in household goods, again suggesting that creditors recognize that there is little residual value in the collateral.

Some creditors do rely on the value of the collateral purchased when they extend purchase money credit for household goods. Some home appliances, for example, may have some resale value following a default and repossession. Even when such items would bring some money at resale, the costs of repossession under state law are sufficiently high that many items would not net any money for creditors following a forced sale.

The current section 522(f) already reflects Congress' understanding that much nominally secured consumer credit has only "hostage" value. The provision presently enables the debtor to avoid all nonpossessory, nonpurchase-money security interests to the extent they impair an exemption in the items previously listed. The provision does not provide perfect justice, treating some loans that are genuinely asset-based as unsecured because they fit within the definition and treating some nominally secured loans as asset-based because the collateral is not on the statutory list of goods. Nonetheless, the provision has functioned with little controversy and is analogous to a Federal Trade Commission rule, promulgated several years after the enactment of section 522(f), which extends similar protection to non-bankrupt debtors by making it an unlawful practice to take non-purchase money security interests in household items. 16 C.F.R. § 444.2.

The recommended bright line rule extends section 522(f)-type protection to purchase money security interests, albeit with a lower dollar cap. A secured creditor intending to pursue a security interest following a debtor's chapter 7 discharge would have to identify the item claimed as collateral and show the court it has adequate value to be worth the costs of repossession. An item worth more than $500 would remain subject to the security interest. When the property is worth less than $500, the loan would be treated as unsecured.

Proposals Applicable in chapter 13

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

Repayment requirements would be modified, depending on the nature of the debt. Distributions to unsecured debtors would be standardized to ensure fairness to creditors and debtors.

A chapter 13 plan could not modify obligations on first mortgages and refinanced first mortgages, except to the extent currently permitted by the Bankruptcy Code.

Payments on all other secured debts should be subject to modification; such payments should be spread over the life of the plan, according to fixed criteria for valuation and interest rates.

Payments on unsecured debt should be determined by guidelines based on a graduated percentage of the debtor's income, subject to upward adjustment to meet the section 1325(a)(4) requirement that creditors receive at least the present value of whatever they would have received in a chapter 7. The trustee or an unsecured creditor should be authorized to file an objection to any plan that deviates from the guidelines, and the court would determine whether the deviation was appropriate in light of all the circumstances.

The payment rules recommended here affect three kinds of loans--home mortgages, all other secured credit, and unsecured credit. Each is considered in turn.

Homes

[Commissioner Jones objects to treating second mortgages on homes the same as all other secured debt. She notes that families often take out second mortgages to finance important expenses, such as sending children to college or paying for a family member's extended care, and anything that might increase costs for certain lenders would affect loan rates for all borrowers. She also notes that if property dropped in value so that the loan was undersecured at the time the debtor filed for bankruptcy, a debtor could obtain a windfall if the property later recovered in value.]

The Working Group suggests no change in current law regarding the ability of a homeowner in chapter 13 to deaccelerate and cure a mortgage in default and the inability to otherwise modify first and refinanced first mortgages.

The Working Group recommends that subsequent mortgages should be treated like all other secured debts, thus the secured claim would be calculated under section 506. This means that second mortgages would be protected in full when they do not exceed the value of the home. If the loan secured by the second mortgage exceeded the value of the home, debts secured bysecond mortgages could be bifurcated into secured and unsecured portions. The reasons for this approach are set forth below.

The Code already treats some holders of liens on homes like other secured creditors. For example, some home mortgages can be stripped if the house is not the debtor’s "primary residence." Likewise, chapter 13 does not prohibit modification of a mortgagee’s loan if the loan is secured by additional collateral. In addition, since the 1994 amendments, section 1322 has authorized stripdown of an undersecured residential mortgage if final payment will become due during the chapter 13 plan, a provision that makes most balloon-payment mortgages eligible for stripdown. Moreover, prior to the United States Supreme Court decision in Nobleman v. Am. Savings Bank, 113 S. Ct. 2106 (1993), many courts, including several circuit courts of appeal, permitted lien stripping of home mortgages -- first mortgages and subsequent mortgages.

Special treatment for certain mortgagees has been justified by the laudable goal of preserving families’ access to financing for purchasing homes. This policy extends to first mortgages, but not to subsequent mortgages, of which only a small fraction are actually purchase-money mortgages. The first mortgage market is unlikely to be affected adversely by the ability to modify second mortgages. Although the Federal Home Loan Mortgage Corporation is authorized to purchase second mortgages to package into securities, for example, it buys extremely few - only a small fraction of one percent of its portfolio are second mortgages.

Banks that engage in second mortgage lending grant home equity lines of credit on strict underwriting standards, and thus are much less likely to be undersecured since the maximum combined home loan to value ratio for bank mortgages generally falls around 75%. Securities backed by these traditional home equity lines of credit are sold in a different market than securities backed by the new high-loan-to-value ratio second mortgages. The latter type of loans, a relatively new phenomenon, permit and encourage debtors to borrow over 100% --and sometimes up to 125% -- of the value of their homes, thus are blended loans with an unsecured component from the inception. These clearly involve a greater element of risk from the start, which is spread through this securities market.

There is no empirical evidence that treating second mortgages like all other secured debt would affect the price of other traditional second mortgages. In predicting the effect of different collection laws on mortgage rates, empirical studies of state mortgagor protection statutes (e.g., anti-deficiency laws) have demonstrated that mortgage interest rates are relatively insensitive to the existence of mortgagor protection laws. See, e.g., Michael H. Schill, "An Economic Analysis of Mortgagor Protection Laws," 77 Va. L. Rev. 489 (1991) (50-state empirical analysis of mortgage protection laws and mortgage rates). Professor Schill has argued that, if anything, such mortgagor protection laws might promote economic efficiency because they encourage lenders to value risk correctly.

Permitting modification of partly unsecured second mortgages comports with the continuing effort to treat like creditors alike. Enabling certain unsecured mortgagees to remain entitled to payment in full on account of a partly unsecured lien diverts assets from other creditors and prefers one creditor over another. High loan-to-value home equity loans are priced more like credit card lending, with interest rates of around 14% and higher, as compared to banks’ more traditional home equity loans with 8.5-9% interest rates. Whether the bankruptcy system should treat such loans like other secured consumer debts, when the loans frequently are used to consolidate unsecured debts or to finance regular consumer debt and deduct the interest from their income tax obligations, is a question for the Commission to address.

The ability to bifurcate second mortgages into secured and unsecured portions is consistent with underlying federal policies promoting home ownership. Unlike first mortgages, second mortgage loans are more likely to put homeownership at risk as the loan-to-value ratio continues to climb. To the extent that creditors who lend far in excess of a home’s value can demand full repayment or can force a foreclosure, some homeowners will lose their homes, and debtors with second and third mortgages that exceed the value of their homes are less likely to confirm a chapter 13 plan, thereby yielding no payments to any creditors.

Other Secured Debt A secured creditor always should be entitled to full repayment of the present value of its allowed secured claim. Valuation is a matter that has raised a good deal of litigation and once again has caused both debtors and creditors around the country to encounter different legal rules. The Commission recommends a single rule for valuation of personal property pegged at the median point between wholesale and retail, a point chosen as a compromise. However, the Commission may wish to reconsider this particular recommendation if the United States Supreme Court speaks to this issue in the upcoming weeks. Associates Commercial Corp. v. Rash, 68 F.3d 113 (5th Cir. 1996), cert. granted, 117 S.Ct. 758 (1997). Valuation of real property would remain unchanged from current law.

The rate of interest also would be determined according to national guidelines. The Commission recommends that the guidelines use a nationally recognized rate such as six-month treasury bills as the suggested starting point for the interest rates. With respect to the cure of a default on any debt pursuant to a plan, including a mortgage debt, interest under section 1322(e) would run at the non-default contract rate.

The unsecured portion of these debts would receive a pro rata distribution in the chapter 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, with the secured creditor always able to seek to reclaim its collateral in the event of a default.

Unsecured Debt Debtors would pay a fixed amount to unsecured creditors concurrently with secured debt throughout the chapter 13 plan, a minimum of three years. This structure should provide greater assurance of payment to unsecured creditors.

Section 1325 currently provides that a court can confirm a chapter 13 plan over the objection of the trustee or a creditor if the debtor commits her next three years worth of "disposable income" to paying unsecured creditors under the plan. This concept was introduced into the chapter 13 system by the Consumer Credit Amendments in 1984. The inherently flexible notion of "disposable income" has facial appeal because it connotes that each chapter 13 debtor will pay unsecured creditors the maximum he is able, creating the inference that chapter 13 is a successful repayment mechanism. However, this concept has been problematic for several reasons.

Calculating what portion of the debtor’s income is "disposable" invites scrutiny of the expenses that the debtor insists are necessary. This is an inherently subjective determination. Some people believe that private schools are necessary, while others do not. Orthodontia, piano lessons, college tuition, home repairs, tithing, dry cleaning, newspapers, utility payments, and food allocations are just a few of the subjects of judicial inquiry in this context. Because the inquiry is so fact-specific and non-legal, published opinions have little precedential value, and litigation continues to multiply. Many courts or chapter 13 trustees develop guidelines on acceptable necessary expenses. This may ameliorate some inefficiencies of this process, but creates de facto rules that differ widely even judge to judge or trustee to trustee in the same district. Even if judges conduct "disposable income" analyses on a debtor-by-debtor basis, which entails an enormous commitment of judicial resources, two debtors with the same set of expenses and the same amount of debt who draw different trustees or judges may pay dramatically different amounts to unsecured creditors, and one debtor may be expected to forego many more items or expenses than the other. Unsecured creditors should find it unpalatable that the amount of their distributions depends on the views held by a particular judge or trustee regarding certain expenses. Yet, the economic efficiency of challenging these rulings is highly questionable when the expected pro rata distribution hardly would cover the costs of the objection or appellate process.

Predicating statutorily required payments on discretionary expenses already built into debtors’ budgets by the debtors themselves creates incentives that are at odds with the goals of the chapter 13 system. Under the current system, a debtor who has heavily encumbered her income will have a smaller obligation to repay creditors than another debtor with the same adjusted gross income but more modest expenses. A disposable income test encourages the retention of expenses that many debtors already have shown they cannot afford; there is little impetus to downsize when any excess will go to unsecured creditors.

Given the systemic pressures created by the disposable income test, it is not surprising that the Commission has received testimony that debtors’ budgets sometimes are constructed in an attempt to limit the amount of income that could be considered "disposable" without sacrificing the feasibility of the plan. Budgeting also may be done mindful of the trustee’s or judge’s de facto rules on acceptable expenses. The practice, which has flourished under the current rules, is inconsistent with the Commission’s goal of promoting the accuracy of schedules filed in connection with bankruptcy cases and enhancing the integrity of the system.

The disposable income requirement also has taken on a counterpart in some jurisdictions: some courts and trustees have developed informal "guidelines" on the minimum percentage of unsecured debt that must be paid for the plan to satisfy the good faith requirement of section 1325(a)(3) -- nothing in some districts, 50% in others. Because the percentage requirements differ widely from district to district and trustee to trustee, plans that would be confirmable in one court are unacceptable in a neighboring court. These informal requirements focus primarily on the amount owed to creditors, not on what the debtor’s disposable income or budget really can bear. Such provisions run counter to the original premise of the disposable income requirement. High debt percentage expectations can preclude plan confirmation, notwithstanding a debtor’s compliance with all Bankruptcy Code standards for secured and priority claimants. Debtors with similar income but disparate amounts of unsecured debt not only may get a different bargain in chapter 13, but may have varying access to chapter 13 relief in the first place.

Ironically, because debtors can exit the chapter 13 system at will and because debtors currently can cure secured debt arrearages before commencing payments to unsecured creditors, the high percentage-of-debt requirements imposed in some regions ultimately are of little or no benefit to unsecured creditors. Notwithstanding the commitment theoretically made in the plan pursuant to local expectations, debtors can cure secured debt arrearages and have their cases dismissed without paying a dime to unsecured creditors, just like zero-payment plans that pay nothing to unsecured creditors, which some courts routinely permit.

This proposal seeks to establish a principled basis for determining the payments to which unsecured creditors are entitled throughout the course of chapter 13 plans. It diverges from both the disposable income test and the percentage-of-debt "good faith" test and introduces the notion of a standardized payment based on a graduated percentage of adjusted gross income. The trustee or any unsecured creditor could file an objection to a plan that deviated from the guidelines, and a court would determine whether the circumstances justified the deviation. For example, it may be appropriate to authorize a lower percentage payment if a debtor had an extraordinary drain on his income on account of a chronically ill dependent or if the local cost of living were considerably higher than the national average. A sample guideline that has provided a point of departure for the Commission’s discussion would require nominal repayment by debtors with incomes below $20,000, and a graduated repayment requirement climbing to about 5% of adjusted gross income annually for debtors with incomes at above $75,000. The percentage guideline would be adjusted based on the number of dependents claimed for income tax purposes.

The percentage payable would be distributed pro rata to unsecured, non-priority creditors holding dischargeable and/or nondischargeable debts, although a debtor would be free to pay additional amounts to creditors holding nondischargeable debts. The debtor would still be required to meet the "best interest" test to confirm a chapter 13 plan and as a result debtors might have to pay more than the income guideline amount to meet that requirement. Debtors also would be free to pay more if they voluntarily chose to do so. However, the standardized baseline recommended in this proposal is intended to supersede the minimum percentage of debt requirements currently imposed by some courts.

All debt repayments would be monitored and distributed by the chapter 13 trustee. The trustee would be obligated to verify income and to annually review a debtor's income for changes and possible modification -- upward or downward -- of the required amounts. To this end, debtors would be expected to provide any supplementary documentation at the request of the trustee.

This principled approach should yield certainty, which will bring other benefits. For creditors that lend nation-wide, their chapter 13 entitlements become much clearer and more consistent. Although the proposal would not bar deviation from the standards when the circumstances so required, it would establish a clear uniform starting point, something absent in the current chapter 13 system. By eliminating the need for judicial inquiry into the necessity and propriety of children's braces and church contributions, for example, the sources of deviation would be sharply reduced. Judicial resources could be put to more efficient use in deciding other legal disputes.

Income-based unsecured debt payments also should complement other efforts to improve the budgeting practices of chapter 13 debtors, while they promote debtor autonomy in determining what expenses fit their budgets. As part of the bargain in chapter 13, debtors would have a reasonable fixed payment through the life of the plan and could budget accordingly. This may help more debtors complete more realistic repayment plans. Because the amounts required by the guideline are a percentage of income and not dollar for dollar, the system would not discourage debtors from increasing their productivity.

In addition, attorneys’ fees payment methods in chapter 13 currently differ widely around the country and should be standardized. Some courts prohibit debtors from paying attorneys’ fees in the plan. Other courts permit payment on only a pro rata basis through the life of the plan. Still others allow certain plan payments to be applied exclusively to attorneys’ fees. Although the Working Group could find no justification for the diversity, it has not determined an appropriate single practice to recommend. The Working Group invites further comment on this issue.

Consequences of Completion of a Plan of Repayment (15 U.S.C. § 1681 et seq.)

One of the ironies of the current bankruptcy system is that debtors who try to repay their debts in chapter 13 may have worse credit histories than those who quickly discharge debts in chapter 7. Few credit reporters identify debtors who tried to repay or even those who, in fact, completed substantial repayments.

Debtors who choose chapter 13 repayment plans should have their bankruptcy filings reported differently from those who do not.

Debtors who complete voluntary debtor education programs should have that fact noted on their credit reports.

Trustees should be encouraged to establish credit rehabilitation programs to help provide better, cheaper access to credit for those who participate in repayment plans.

The Consumer Bankruptcy Reform Forum of the American Bankruptcy Institute unanimously endorsed this recommended change in credit reporting. The group felt strongly that more information in the credit system would help debtors re-establish credit following a bankruptcy and help creditors make more informed credit-granting decisions.

Debtors who choose chapter 13 repayment plans should have their bankruptcy filings reported differently from those who do not, and the Commission recommends that the Fair Credit Reporting Act be amended accordingly. Both the fact that the debtor attempted a repayment plan and that the debtor attended a debtor education program would be useful information for creditors making subsequent lending decisions. Moreover, differential reporting would give debtors some incentive to undertake repayment in chapter 13 that they might otherwise not attempt.

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. Once again, existing successful programs would provide a model for study as trustees take on this important task.

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

The current bankruptcy system provides all debtors with unlimited access to the bankruptcy courts. Such a system is easy to administer, but it creates opportunities to abuse the system in ways not originally contemplated. A significant number of individual debtors in some districts obtain repeated access to the bankruptcy system with little intent to reorganize their financial affairs, seeking only the temporary shelter of the powerful automatic stay. The Commission believes it is important to retain initial access to the bankruptcy court for debtors in financial trouble and that this access yield meaningful relief to those in need, but it recommends the imposition of significant constraints on the ability to re-file for individuals who recently have been in the bankruptcy system.

An individual debtor who receives a discharge in chapter 7 should be barred from refiling in Chapter 7 for six years and chapter 13 for two years after the case is closed. An individual debtor who files for chapter 13 should be barred from filing for chapter 7 or chapter 13 for two years after the case is closed. A debtor should be permitted to petition the court to permit a filing in chapter 13 sooner than two years if the debtor could demonstrate a significant change in circumstances since the last filing and proposed a confirmable plan with demonstrable feasibility and a reasonable likelihood of success. Within the time periods listed here, a debtor could not file and receive the protection of the automatic stay without advance court approval.

A case under chapter 13 that otherwise meets the standards for dismissal shall be converted toChapter 7 after notice and a hearing unless a party in interest objects. Any party in interest may object to the conversion if a previous filing triggered a time bar that rendered the debtor ineligible to file for chapter 7 relief, in which case the chapter 13 case will be dismissed and will trigger the two year bar on refiling in chapter 13. In addition, the debtor may object to conversion without grounds, in which case the chapter 13 case will be dismissed and will trigger the two year bar on refiling. The standards for modification, dismissal, and discharge in Chapter 13 would not otherwise change.

After notice and a hearing, a bankruptcy court should be empowered to issue in rem orders barring the application of a future automatic stay to identified property of the estate for a period of up to six years when a party could show that the debtor had transferred such real property or leasehold interests or fractional shares of property or leasehold interests to avoid creditor foreclosure or eviction. A subsequent owner of the property or tenant of the leasehold who files for bankruptcy (or the same owner or holder in a subsequent filing) should be permitted to petition the bankruptcy court for the imposition of a stay to protect property of the estate, which the court would be required to grant to protect innocent parties who were not a part of a scheme to transfer the property to hinder foreclosure or eviction.

[Commissioner Ceccotti does not support this recommendation as written. She recognizes the need for some restrictions on multiple refilings, but believes that the more problematic instances of refiling occur on the third or later filing. She notes that debtors in financial chaos cannot always straighten out their problems on the first or even second try; they lose jobs, or face other crises. If debtors are not receiving good legal advice, their cases may be dismissed when they fail to move quickly for plan modification or otherwise skillfully negotiate the complex consumer bankruptcy system. Instead of an automatic ban on chapter 13 refiling, she would prefer a less onerous mechanism that imposes some limits on access in a third (or later) filing by making the automatic stay subject to challenge in those instances. Commissioner Ceccotti supports the current restrictions on refiling for debtors who have received a chapter 7 discharge, and she also supports the recommendation of in rem orders.]

With very few limitations, debtors may file for bankruptcy under current law whenever they present the appropriate papers to the clerk of the court and pay the filing fee. Imposing limitations on access to the bankruptcy system would be an historic and important change.

The framework includes this significant change in debtors’ access to consumer bankruptcy partly based on evidence that some debtors repeatedly seek bankruptcy relief to use the tools that enable them to continuously defeat their creditors’ collection efforts without making the commitment required either in chapter 7 or chapter 13 to resolve their financial problems. The proposed restrictions also are premised on the principle that frequent and repetitive access to the tools of bankruptcy should be discouraged if one trip to the bankruptcy system provides the relief that Congress intended. For the repeat filings that some parties believe are justified, this proposal puts the burden on the debtor to prove that justification. However, these proposals do not contain a recommendation to limit the initial access to any chapter in the bankruptcy system. Bytightening the system generally, limiting refiling, and capping exemptions, the system remains available for those who really need bankruptcy relief but becomes significantly less attractive for those who do not.

If individual debtors are precluded from returning to the bankruptcy system for two years, as the framework provides, it becomes especially crucial that debtors emerge from the bankruptcy system with a genuine fresh start. The framework provides that failed chapter 13 cases presumptively should be converted to chapter 7 to enable all debtors to do what debtors with active legal counsel already can do under the present system. Rather than penalizing debtors who attempted to repay their debts in chapter 13, this presumption would enable them to get the discharge they would have received had they originally filed under chapter 7. Of course, there would be an opportunity for notice and a hearing, and a debtor’s case could not be converted if the debtor was not eligible for chapter 7 relief.

The proposal preserves a debtor’s option to have her chapter 13 case dismissed, without converting to chapter 7, and be subject to the two year bar notwithstanding her lack of discharge. Peculiar circumstances, e.g., securing lucrative employment or winning the lottery, may warrant this route. A debtor then could work with her creditors at state law, bearing in mind that he presumptively is barred from returning to the bankruptcy system for relief for two years. In such a situation, the debtor’s credit reports should reflect that the debtor did not discharge any debt. This presumptive conversion proposal is consistent with the unanimously-approved recommendation in the report of the American Bankruptcy Institute Consumer Bankruptcy Reform Forum.

The proposal contemplates that other parts of the chapter 7 and chapter 13 system would not be changed. The grounds for dismissing or converting a chapter 13 case, for example, would remain intact, as would the effects of dismissal and conversion, except for the bar on refiling. Similarly, the proposal does not change either the current "best interest" standard or the chapter 7 requirements for debtors whose cases were converted from chapter 13.

In addition, this proposal recommends that bankruptcy judges be authorized to issue in rem orders to deal with a narrow, but significant category of abuse. The practice of transferring fractional ownership shares to multiply access to bankruptcy and the automatic stay, although still relatively rare, is not defensible in any circumstance and should be prohibited. Bankruptcy court in rem orders could be filed in the state recording system to provide notice to purchasers and other parties.

Landlords also have had trouble with the abusive practices identified here. Thus, the in rem proceeding also should be available if a debtor transferred a fractional share in a leasehold. Whether done by owners or tenants, transferring fractional shares to evade the application of state and federal laws is inappropriate and the Commission recommends this approach to curtail this practice.

Some courts already use in rem orders. See, e.g., In re Snow, 201 B.R. 968 (Bankr. C.D. Cal. 1996). However, not all courts believe that they have the authority to issue these orders, and some have indicated that they would not do so absent direct statutory authorization. The Commission takes no position on the legality of the current practices regarding in rem proceedings, but it notes the utility of these orders in especially egregious circumstances to preserve the integrity of the system.

Rent-to-Own Contracts (11 U.S.C. § 101)

The Bankruptcy Code determines the secured and unsecured status of consumer loans and also establishes when a transaction is appropriately characterized as a loan secured by a purchase money security interest and when it is another type of contract. The distinction is particularly critical in the context of "rent-to-own" agreements. According to the American Bankruptcy Institute’s Consumer Bankruptcy Reform Forum report, a majority of courts treat them as installment sales contracts/secured loans and a minority treats them as true leases subject to section 365. The ABI Forum, which included debtors, creditors, judges, academics, and trustees, unanimously recommended that such contracts be treated as secured loans rather than as leases.

Consumer rent-to-own transactions should be characterized in bankruptcy as installment sales contracts.

[Commissioner Jones objects in principle to dealing with rent-to-own transactions in the Bankruptcy Code. She believes that the appropriate treatment of such transactions should be determined elsewhere in law. Commissioners Williamson and Ceccotti concluded that the question of how to treat these contracts is a bankruptcy question and that the Commission should make a recommendation in accordance with the bankruptcy principle of equality of treatment among creditors.]

In the development of this proposal, the ABI report indicates that "many instances were cited where the use of [rent-to-own] 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 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."

Whether rent-to-own contracts should be permitted under consumer protection laws is beyond the scope of this Commission’s work. However, the characterization and treatment of such contracts in bankruptcy is well within the province of the Commission. This proposal would resolve the dispute in the courts and recommend that Congress adopt the majority view treating such contracts as security interests, a view that is more in keeping with Bankruptcy Code principles of equality of distribution.

The economic consequences of the characterization will be extremely relevant to all parties in a bankruptcy case. The secured and unsecured creditor representatives who participated in the ABI forum were particularly concerned about the favorable treatment received by rent-to-own creditors premised on the ambiguous nature of the transaction under state law. If a rent-to-own contract is considered a "lease," it then would be governed by section 365. If debtor wanted to keep the property, she would have to assume the contract and pay the contractual obligation in full, which would be entitled to administrative expense priority. The vendor not only would receive superior treatment to other purchase money security interest holders by being entitled to one hundred percent payment, but the vendor would get the lion’s share of assets that otherwise might be available for pro rata distribution to all unsecured creditors. If, however, the transaction is characterized as a purchase money security interest/installment sale, the vendor would be entitled to an allowed secured claim under section 506(b) to the extent of the value of the collateral, like other secured creditors. Treating the rent-to-own agreement as an installment sale, which apparently is the underlying function of these agreements, would create greater parity among similarly situated creditors.