Whats Wrong With The Commissions Consumer Bankruptcy
Web posted and Copyright © July 18, 1997, National Consumer Bankruptcy
The National Bankruptcy
Review Commission has adopted a package of consumer bankruptcy
proposals for Congressional consideration. Unless these actions are revisited and
substantially revised at the Commissions last meeting in August 1997, its final
recommendations are clear. We believe they are fundamentally flawed and, if enacted into law,
would make filing for bankruptcy much more attractive and would encourage and condone
avoidance of financial responsibility by individuals who could repay a significant part of their
debts. Heres why
Excessive Exemption Levels The Commission has adopted a
proposal for uniform federal bankruptcy exemptions in chapter 7, replacing the current
system under which two-thirds of the states have opted out of the federal exemption
scheme and adopted their own standards.
While we believe the concept of uniform national exemptions is worthy of Congressional
consideration, the exemption levels recommended by the Commission, ranging up to $140,000,
are far too high. They would make filing for bankruptcy much more attractive than under current
law, resulting in an even higher level of bankruptcies than todays record filings. They
would permit debtors to retain substantially more assets after bankruptcy than is permitted by
current law, and would allow debtors to protect substantially more assets in bankruptcy than
could be shielded from collection attempts under current state law exemptions. They would also
encourage a ratio of chapter 7 liquidation plans to chapter 13 plans significantly higher than the 3
to 1 proportion we see under current law. Even if no other Commission recommendations
were adopted, enactment of these excessive national bankruptcy exemptions would invite
major new bankruptcy abuse.
There is simply no evidence that inadequate state exemption levels are a problem for debtors
under current law. At present, 95 percent of all chapter 7 filings result in "no asset"
cases in which the debtor has no equity in property above applicable exemption levels; therefore,
there is no asset liquidation to provide any payments to unsecured consumer lenders.
Consumer lenders are not alone in their concern about this proposal. The National
Association of Bankruptcy Trustees advised the Commission that adoption of similarly generous
exemption levels would have the adverse results outlined above. That association also estimated
that it would result in more than 99 percent of all chapter 7 filings resulting in "no
asset" cases, which would deprive the bankruptcy trustee system of its financial
underpinnings. Finally, it stated that such action would substantially worsen the public perception
of bankruptcy abuse as individuals avoid obligations they have the ability to repay a
prediction with which we agree entirely.
The Departments of Justice and Treasury have also voiced significant concern over this
central Commission recommendation. In a June 18 letter to Commission Chairman Brady
Williamson from Francis M. Allegra, Deputy Associate Attorney General, the Justice Department
made known that it was "concerned that the asset levels tentatively adopted by the
Commission are too high in light of the historical purposes of allowing property to be claimed as
exempt." In regard to the recommended "homestead bonus" of $30,000 per
couple (an additional exemption for personal property for debtors who do not own a home), the
Department stated, "We believe that this figure may be too high and that more careful study
is needed to ensure that the proposed exemption does not encourage debtors to simply walk away
from their obligations." The Department also objected to the proposed exemption for
unlimited amounts in an IRA or 401(k) plan, and noted that "the adoption of generous
exemption levels could also have a negative impact on the ability of the United States to collect
debts outside of bankruptcy."
The Justice Department letter was accompanied by a memorandum from Jonathan Gruber,
the Treasury Departments Deputy Assistant Secretary for Economic Policy. That memo
makes clear the outrageous nature of these recommendations, which would permit a couple to
emerge from chapter 7 discharge with up to $140,000 in home and personal property equity, and
unlimited retirement savings! According to the Treasury Departments calculations,
adoption of the recommended exemption levels would allow a couple to emerge from a chapter 7
bankruptcy with a net worth between the 60th and 75th percentile
for all U.S. households even before adding in the unlimited exemption for retirement
assets! Households with this level of net worth should be encouraged to work out their financial
problems outside of bankruptcy, or be required to commit to a chapter 13 plan in which
unsecured lenders receive substantial repayment. They should not be enticed or permitted to use
chapter 7 bankruptcy as a financial planning tool to enhance their net worth at the expense of
These recommended exemption levels are also too high in comparison to current law. For
example, the Commission recommends a federal homestead exemption ranging from a low of
$30,000 to a high of $100,000, subject to state law determination. But the present federal
homestead exemption was doubled to $15,000, and indexed going forward for inflation, by the
1994 Bankruptcy Reform Act. Thus, the Commissions recommended floor for the federal
homestead exemption is double the maximum ceiling set by Congress just three years ago! As the
Treasury memo points out, the Commission has proposed to raise the homestead exemption in 25
states, and to raise the non-homestead personal property exemption level in 48 states.
The Treasury memo states, "We would favor more modest asset exemption levels,
applying to a combined asset amount." It suggests a range of $30-50,000 for combined
homestead and personal property, which would allow debtors to emerge from chapter 7
bankruptcy between the 41st and 51st household net worth
percentile. That prudent suggestion, rather than the Commissions excessive
recommendations, should be the starting point for Congressional consideration. One guiding
principle for your future actions should be that chapter 7 should not permit borrowers to wipe out
their unsecured creditors and emerge with a net worth in the top half of all American households.
No Screening of Abusive chapter 7 Filings Consumer lenders
repeatedly urged the Commission to recommend adoption of a needs-based bankruptcy
system to curb growing chapter 7 abuse. Such a system would continue to make chapter
7 relief available to those in need of it, but would require those with the income and
ability to make substantial repayment to their lenders to do so. New data was presented
to the Commission documenting that a significant percentage of current chapter 7 filers have
the ability to make substantial repayment, but are not required to do so by the current
Despite all this input, the Commissions adopted recommendations have failed to
address the needs-based bankruptcy proposal. They have even ignored our suggestion that
conflicting court decisions regarding the proper definition of "substantial abuse" of
chapter 7 be reconciled, and that lenders no longer be barred from bringing evidence of substantial
abuse to the attention of the judge or trustee.
The failure to address chapter 7 abuse, in combination with the excessive chapter 7
exemptions discussed above, will shift even more bankruptcy filings out of chapter 13 repayment
plans and into chapter 7. If the Commissions recommendations were to be adopted, the
only debtors likely to begin and complete a chapter 13 plan would be those requiring that
Chapters "superdischarge" of obligations obtained through fraud (including
tax fraud), misrepresentation, and intentional torts.
Reaffirmations Banned Currently, a chapter 7 debtor may
reaffirm; that is, legally recommit to pay a debt that would otherwise be discharged in
bankruptcy. Debtors entering into legally binding reaffirmations receive a host of
procedural protections against unwise decisions. Reaffirmations are an important recovery
tool for lenders. But, as the Commission heard from debtors attorneys, they are
also an important tool for those debtors who wish to retain an asset securing a loan,
such as an auto used to commute to work, or to maintain a line of credit or charge
account necessary to maintain a business or household.
The Commission has recommended that all chapter 7 reaffirmations be banned. Adoption of
this recommendation in regard to unsecured debt would deprive creditors of potential recovery
and debtors of the ability to maintain a line of credit that may be a critical component of a
meaningful "fresh start." We also believe that this proposal raises a Constitutional
issue by substantially impairing freedom of contract without serving a significant or legitimate
In regard to valuable property which secures loans, such as autos, the Commission has
recommended that debtors be permitted to keep and use them without legally obligating
themselves to make full payment! Debtors would be allowed to keep an auto or other expensive
asset so long as they maintained regular payments. This would place secured lenders in a position
of unacceptable risk. If the property were damaged or destroyed in an accident, or developed
maintenance problems, the borrower could simply cease payments and the creditors only
recourse would be to repossess the damaged goods.
Rather than banning this important restructuring tool in chapter 7 cases, Congress should
extend the availability of reaffirmations to chapter 13.
Cramdowns of Second Mortgages Under the Supreme
Courts 1993 Nobleman decision, and subsequent
Congressional action, all loans secured solely by residential real estate are protected against
"cramdown" in bankruptcy. This means that the makers of home equity
loans and other second mortgages know that they will retain a full security interest in the
realty regardless of temporary fluctuations in property values. As a result, these loans
are a low-cost and important refinancing tool for individuals seeking to consolidate
higher interest debt, make home improvements, start their own business, or finance
The Commission has recommended providing protection against cramdown only to purchase
money mortgages. This would make second mortgage lending substantially more risky. As a
result, the supply of home equity loans would contract and their pricing would increase. This
proposal is also particularly unfair because it would apply to bankruptcies filed, not loans made,
after the effective date, placing tens of billions of dollars of existing mortgages into a higher risk
category than was contemplated and underwritten at the time they were extended.
We fail to see how subjecting home lenders to greater risk and reducing the availability of
low-cost consumer credit serves any valid public purpose.
Automatic Conversion to chapter 7 Under current law a
debtor who has filed in chapter 13 must complete his repayment plan to receive a
bankruptcy discharge. The Commission has proposed to let debtors file in chapter 13,
utilize its financial restructuring benefits, and then convert to chapter 7 and receive a full
discharge in that Chapter. Creditors could only object if the conversion violated the
inadequate time bars against repeat filings in chapter 7 (discussed below). The
proportion of completed Chapter 13 plans would undoubtedly decline if automatic
conversion/discharge was made available, reducing lender recovery and excusing
borrowers from their own proposals for financial self-restraint and responsibility.
Furthermore, automatic conversion to a chapter 7 discharge for defaulted chapter 13 plans
will strip creditors of many rights and provide debtors with a short cut around many due process
safeguards in the present bankruptcy system. First, automatic conversion/discharge will not
provide enough time or opportunity for creditors to research and file a complaint objecting to
discharge on the basis of such grounds as fraud, load up, false financial statements, or for
objections to exemptions. There is no provision for a new meeting so that creditors can examine
the debtor. In addition, we see little or no opportunity to negotiate reaffirmations (if they are still
available) with debtors, and no provisions for the liquidation of non-exempt assets which is a
condition for the normal chapter 7 discharge. In short, this automatic conversion creates a
massive escape hatch for debtors to feign a chapter 13 and then obtain a chapter 7 discharge in
violation of a broad array of creditors legal rights.
We believe that debtors who have filed in chapter 13 and utilized its restructuring benefits
should only be permitted to convert to chapter 7 if there has been a material change in their
financial circumstances which makes it impossible to fulfill their repayment obligations.
Unnecessary Valuation Hearings Under current law,
creditors retaining a security interest in goods purchased with their credit extensions
need only file a proof of claim with the court to protect themselves in a chapter 7 case.
The Commission has recommended that such security interests be automatically voided
in regard to all property valued at less than $500. Further, the recommendations would require
the creditor to petition the court for continued recognition of the security interest in
each and every item for which a security interest is claimed, and would require the court
to hold a valuation hearing in regard to each item.
This recommendation would raise a substantial new procedural bar to lenders
maintenance of valid security interests and would place a very large and unnecessary new burden
on a bankruptcy court system which is already strained to the breaking point. We find it
remarkable that some members of the Commission voiced objections to our proposal for a
needs-based bankruptcy system incorporating a simple administrative screening of chapter 7 cases
on the grounds that it would place too large a burden on the system, yet are willing to call for
judges to hold hundreds of thousands of separate hearings annually to determine the value of a
riding mower or home theater system.
Inadequate Repayment Template The Commission would
require debtors in chapter 13 to make repayment based on a graduated template keyed
to adjusted gross income (AGI). As discussed above, the ability to automatically convert
to chapter 7 and receive a discharge would substantially reduce the percentage of
chapter 13 filers completing repayments. And, while we support the concept of uniform
repayment guidelines for chapter 13, the formula advocated by the Commission is far
too generous to debtors.
The Commission contemplates nominal repayment by debtors with adjusted gross income
(AGI) of less than $20,000, rising to a maximum of 7 percent for AGIs of $75,000 or above. This
means that a debtor with monthly AGI of $6,250 would be required to make monthly payments to
unsecured creditors of only $437.50. Such a repayment schedule is far too lenient for a debtor
with such substantial income.
In its June 18 letter to Chairman Williamson, the Department of Justice observed that
"the template approach currently under consideration...may well be too lax for most
debtors." We concur.
"False Claims" The Commission has
recommended that the courts be authorized to order lenders who file "materially
false claims" to pay costs and the debtors attorney fees even if the filing was an
unknowing mistake. There is no corresponding provision providing for sanctions against
debtors who file false schedules of debts, income, and assets. This unbalanced
recommendation is curious, as the Commission received little testimony about false
claims by creditors, but heard repeatedly that debtors filings were often
incomplete and generally unreliable. In fact, one bankruptcy judge told the Commission
that debtors schedules were often "fiction."
Again, the Justice Department characterized this as "a new and troubling proposal...
We neither understand the purpose, scope or effect of this proposal, and are concerned about
creating a new one-way fee shifting provision, especially if it covers mistakes... We would prefer
that the Commission abandon this concept entirely."
Again, we concur entirely.
Student Loan Discharge At the start of this decade,
responding to abuses in the student loan program, Congress revised upward the amount
of time, from five to seven years, that guaranteed student loans would have to be paid
before being eligible for a bankruptcy discharge. The Commission has now adopted a
recommendation that student loans (other than for medical school) be treated the same
as any other unsecured loan. That is, a student loan could be discharged in a chapter 7
bankruptcy without a single dollar of repayment having been made.
While our member institutions participate in the federal guaranteed student loan program, the
risk of this reckless proposal would fall directly on American taxpayers, who back both
guaranteed and direct student loans. Student loans are generally extended to individuals with little
or no employment or credit history, and with nominal income. They are made on the assumption
that the education gained through the proceeds of the loan will help enable the individual to earn a
higher future income and thereby repay the loan. Allowing students to discharge their student
loans entirely, without any significant repayment having been made, by filing for chapter 7 shortly
after graduation would invite substantial abuse of the program and result in multi-billion dollar
losses to taxpayers.
While this unjustifiable proposal creates major risk for the taxpayers, not our members, it is
strikingly illustrative of the excessively permissive approach which permeates the
Commissions consumer bankruptcy recommendations. It should be rejected as creating
excessive risk to taxpayers. We believe that the proper policy is not only to retain the seven year
repayment requirement for guaranteed loans, but to extend such protection to private sector
higher educational assistance.
Inadequate Positive Provisions We would be remiss if we failed to note
that the Commission did make some recommendations which we support. Yet even
these fail to go far enough, and do not even begin to counterbalance the negative
provisions discussed above.
The authority for bankruptcy courts to issue in rem orders barring the application of
the automatic stay to identified property could help end the "rent skimming" scams
which have victimized debtors in various regions.
The proposal for random audits of debtors filings lacks enforcement teeth. We
believe that when a random audit reveals that debtors have made material misstatements, their
bankruptcy discharge should be revoked.
A national filing system identifying bankruptcy filings by Social Security number is long
overdue, although its efficacy will be undercut by the ease with which unscrupulous individuals
can obtain new Social Security numbers and other false identification.
The Commissions call for debtors to have "the opportunity to participate in a
financial education program" is inadequate. Participation in such a program should be a
mandatory condition for obtaining a bankruptcy discharge. Just as bad drivers are required to
attend traffic school to retrieve their licenses, those who have had financial accidents should be
required to learn the economic rules of the road.
The Commissions call for a bar on abusive serial refiling, while welcome, is
inadequate. Rather than maintaining the current bar against receiving a chapter 7 discharge once
every six years, the wait should be raised to ten years. One bankruptcy discharge per decade is all
the law should sanction. And the Commissions call to permit chapter 13 filings every two
years or less would permit too much continued abuse.
Finally, while the consumer lending industry will work with Congress in regard to
preferential credit reporting for chapter 13 filers, such benefits should only be available to those
who complete a payment plan. And, as explained above, any incentive that credit reporting might
provide for filing in chapter 13 would be completely overwhelmed by the Commissions
other recommendations, which would encourage more chapter 7 filings as well as rapid
conversions of chapter 13 cases to chapter 7.
In conclusion, the Commission has assembled a package of proposed consumer
bankruptcy "reforms" which would benefit unscrupulous or undeserving
debtors at the expense of lenders and responsible borrowers, and would encourage more
chapter 7 bankruptcy filings. Its recommendations condone and encourage outrageous
and irresponsible financial behavior. Adoption of these proposals would substantially
increase lenders risk and result in consumer credit becoming less available and
more costly. The publics overwhelming view that those who have the ability to
repay should do so would be thwarted. And the public would likely view the resulting
Bankruptcy Code as a perverse system of debt forgiveness on demand for the financially
The members of the National Consumer Bankruptcy Coalition are firmly
opposed to Congressional adoption of these recommendations. We urge Congress to
reject them and to turn its attention to establishing a needs-based bankruptcy system
which will reduce the burden on the bankruptcy courts and restore public confidence in
If you have further questions about this matter, please contact any of the following legal
advisors to the NCBC:
Philip S. Corwin
Federal Legislative Associates
George J. Wallace
Eckert Seamans Cherin & Mellott
Robert F. Mitsch
Mitsch and Crutchfield, P.A.