Proponents of pending consumer bankruptcy "reform" measures have said that their proposals will not affect low- and moderate-income debtors. Nothing could be further from the truth. Pending consumer bankruptcy reform measures will hurt these debtors the most.

First, bankruptcy practitioners will inevitably increase their fees to meet the complicated new obligations placed on them in the bankruptcy system. Lawyers will have to learn a complex new law, buy new software and treatises, evaluate complicated means-test issues for every client, obtain substantial additional historical information including tax returns, and accept the risk that every case will involve substantial opportunities for creditor-initiated litigation. Since consumer bankruptcy debtors are not known for their ability to pay big retainers, some increased costs of bankruptcy practice will have to be spread among a practitioner's clients in the form of a higher base fee.

The consequence, of course, is that all debtors will pay a higher price for representation. This will exacerbate the existing reality that some debtors with simple cases pay fees that subsidize the representation of others. Poorer debtors who cannot afford the higher base fees will be squeezed out of the bankruptcy system entirely.

The other clear consequence of the pending reforms is that substantial new litigation opportunities will increase creditor leverage against those with limited resources. We already see this problem under current law. Pursuit of a non-dischargeability claim in a chapter 7 case creates leverage to obtain a reaffirmation agreement. Those with the least financial ability to defend a meritless non-dischargeability case are those who are most likely to agree to reaffirm or to be saddled with a default judgment. If pending legislation passes, creditors will obtain new leverage through opportunities to pursue more non-dischargeability claims in both chapter 7 and 13, to litigate over receipt of notice and its effects, to bring motions alleging "abuse" under the means test, and to assert valueless security interests as a basis for reaffirmation. The legislation is littered with other equally pernicious examples.

A Case Study: The Trujillo Family

Mr. and Mrs. Trujillo have long run a landscaping and gardening business that provides their only income. They had a contract to do all the grounds maintenance work for a bank with 30 local branches. After the bank merged, they lost the contract. Building the business back up has been slow.

In an attempt to keep the family business from failing, the Trujillos took out a second mortgage and have used their credit cards to pay family and business debts. However, business income barely exceeds business expenses month after month. They are hopelessly behind on all their debts. Mrs. Trujillo has obtained alternative employment and has made an arrangement that will stretch the family's thin resources to cover their two mortgage payments and prevent foreclosure. However, two credit card lenders have garnished Mrs. Trujillo's wages, thus making a key portion of the family income unavailable for the planned mortgage payments.

Under current law, the Trujillos can file bankruptcy under chapter 7 relatively cheaply in order to get a discharge of the credit card debts and to prevent further wage garnishment. The case would cost about $600 in attorneys' fees and court costs. They can then use all of their future income to save their home. If the pending legislation becomes law, the Trujillos can expect the following additional fees, costs and expenses:

• Means-test motion to determine whether they are eligible for bankruptcy under chapter 7. Because of the business, family income appears artificially high because it includes income used to pay business expenses. Since these expenses are not part of the Internal Revenue Service (IRS) guidelines applicable to means testing, a creditor can bring a motion to have their chapter 7 case converted or dismissed. Although they will prevail on this motion after showing the judge that after family necessities and business expenses they have just enough income to pay the mortgages, they will each lose a day of work and will spend an extra $1,000 to pay their lawyer to litigate the case. This will put them $1,000 further behind on their mortgage agreements.
• Issues related to good faith in mandatory credit counseling. The creditors that had garnished wages assert that the Trujillos never fully pursued mandatory credit counseling. The Trujillos will prevail on this motion by showing the judge that the wage garnishments and foreclosure created an emergency need for bankruptcy. They will lose another day of work and spend $750 to litigate this issue.
• Non-dischargeability of debts used to pay non-dischargeable debts. A credit card lender asserts that its debt cannot be wiped out in bankruptcy because it was incurred to pay non-dischargeable student loans. The Trujillos are told by their lawyer that this case will cost $1,000 and that they may lose since they took out some cash advances around the same time that their student loan payments were made. They will not be able to afford to litigate this issue, because the litigation costs would be the last straw to undermine their mortgage payments. Instead, they will make an agreement to reaffirm this credit card debt. The reaffirmation will allow this creditor to garnish Mrs. Trujillo's wages. The garnishment will involve income that the Trujillo's had planned to use toward the mortgage, thus putting them in the same position they would have been in if they had never filed bankruptcy.

These various expenses will make the case a total failure. By undermining the already shaky situation involving the mortgage, the Trujillos get little benefit from bankruptcy and lose their home. Chapter 13 is as problematic as chapter 7, since litigation costs will undermine their plan. Moreover, their agreement with the mortgage lender to reinstate their mortgage outside of bankruptcy is far cheaper than curing the default in chapter 13.

A Few Specific Issues That Will Impact Poorer Debtors

Although a complete evaluation of the legislation is beyond the scope of this article, I will address a few issues that will have an outsized impact on less-fortunate debtors if the legislation passes. For additional analysis of the pending legislation by this author, see http://www.abiworld.org/legis/bills/s625/conbank1.html.¹

Means Testing and the Safe Harbor. While it does make sense to ask debtors with real financial capacity to make their best efforts to pay their creditors, the test that Congress is considering to find those debtors is expensive and unworkable. Only well-to-do debtors (the small minority) are likely to have the resources necessary to negotiate the complexity of a motion seeking dismissal under the means test.

In both the House and Senate bills, means-testing provisions purport to deduct household expenses from household income at the time of filing to determine if the debtor retains sufficient resources to repay unsecured debt.² However, neither income nor expenses are defined in a fair or sensible way for the great majority of American families.

On the income side, for example, both bills require that the debtor(s) use an average of the six most recent months of household income to artificially determine "current income." For many debtors, particularly those whose bankruptcies are precipitated by job loss, seasonal work or divorce, the average of six prior months' income is not an accurate reflection of current income.

On the expense side, IRS-generated standards would limit many common expenses unless the debtor could prove a basis to deviate from them. Since the IRS developed its standards as guidelines for its own debt collectors, subject to individually exercised latitude for discretion and exceptions, it is unclear how these standards (made rigid by operation of law) are expected to apply evenly and fairly to all families in bankruptcy.

Under either bill, debtors would be forced to litigate to establish the basis for any deviation from the IRS expense standards. A debtor would be required to prove higher-than-average food expenses, for example, by establishing a medical need for a more expensive diet. Similarly, the IRS standards do not cover children's orthodontia. Does Congress expect the courts to rule on any case involving children's dental work and to substitute its judgment about the necessity of that work for that of the debtor/parents? Would a trial be necessary? (Should the judge get down off the bench and look in the kid's mouth?)

Both bills contain "safe harbor" provisions that purport to protect low-income debtors from the expenses associated with means testing. The House provision, at present, is stronger than the Senate provision. It would protect debtors below median income from motions by any party under the means test, and from creditor motions that cases are an abuse of the provisions of chapter 7. The Senate bill, as amended, would protect debtors below median income from motions under the means test by creditors but not those brought by a trustee.

Under the Senate provision, a trustee would be required to pursue means-test motions against low-income debtors in some circumstances even if success would result in very low payments to unsecured creditors. The difficulty, of course, is that many such debtors may be able to avoid the impact of means testing by establishing legitimate expenses outside the IRS guidelines, but may not have the economic means to do so. And the analysis may be especially unfair—the IRS guidelines provide for lower permissible spending levels for debtors with lower income.

In addition, neither bill prevents a creditor from filing motions alleging that a low-income debtor is not eligible for the safe harbor. For this reason, when the legislation passes, it is likely that some lenders will press borrowers to fill out a credit application showing income in excess of the median in order to provide that creditor with a colorable basis for a means-test motion, if the borrower later files bankruptcy.

Finally, large families get the least protection from the safe harbor. Although the safe-harbor provisions in each bill are written so that debtors with a family size of more than four get an additional $583 per family member before creditor means-testing kicks in, it is unclear whether this is a monthly or annual amount. If courts determine that Congress intended for the $583 supplement to be annual, the amount does not even begin to approximate the extra expenses associated with family members in larger households. These families will thus be means-tested more aggressively than other debtors.

Of course, pursuing any motion under means testing gives the lender leverage to obtain a reaffirmation agreement or other relief because the costs of defending the motion are likely to be more than the creditor's claim. This is especially true under the Senate bill. It has only narrowly drawn provisions for shifting fees for abusive creditor motions that are inapplicable to creditors with claims of less than $1,000.

Non-dischargeability Provisions. Both the House and the Senate bills contain provisions that would expand the presumption of fraud related to the non-dischargeability of credit card debts.³ Under the Senate bill, fraud would be presumed for debtors that incur $250 for luxury goods within 90 days or $750 in cash advances within 70 days before bankruptcy. Under the House bill, a $250 cap applies to both luxury goods purchases and cash advances within 90 days before bankruptcy.

The burden of these provisions would fall most heavily on low-income debtors who do not have the financial resources to overcome the presumption and on debtors with genuine financial emergencies who do not have the ability to plan the date for their filing to place their purchases or cash advances outside the presumption.

Both bills would also make debts incurred by fraud or willful and malicious conduct non-dischargeable in chapter 13 cases.⁴ This provision is problematic not because debtors that have committed fraud should have a right to a discharge, but because there are significant litigation costs involved in defending against meritless claims of fraud or malicious conduct.

No provision in either bill explains how a low-income family in chapter 13 can afford costs of defense when their income is fully committed to necessities, mortgage payments and plan payments under chapter 13. Thus, creditor pursuit of even meritless claims against low-income families is likely to result in reaffirmation agreements or default judgments.

Affordability of Credit Counseling and Education. Both bills would require pre-bankruptcy credit counseling as a condition of eligibility and post-bankruptcy education as a condition for discharge. Although there will be some U.S. trustee oversight of counseling and education providers, very little provision is made in either bill for families with limited financial resources.⁵ Each provision also has limited exceptions for exigent circumstances applicable to pre-bankruptcy credit counseling, but no exceptions for post-bankruptcy education. The latter is likely to prove a particular hardship for rural debtors, the home-bound and debtors who will lose wages to take time off to attend a required education program.

Limits on Stripdown. Both bills include provisions that would greatly limit a debtor's ability to strip down secured claims in bankruptcy to the value of the collateral. Since most home mortgage debts are already protected from stripdown, these provisions largely affect car loans and department-store debts in chapter 13.

At best, these provisions would take money that can currently be directed to unsecured creditors in a plan and redirect it to those undersecured creditors who would be deemed fully secured. At worst, for many lower-income chapter 13 debtors there is an insufficient cushion in a feasible plan; increasing the obligation to undersecured creditors will require money that is currently being committed to make mortgage payments or pay for other necessities of life. These latter plans will fail and more debtors will lose homes.⁶

Under the Senate bill, a debt could not be stripped down if it is secured by a motor vehicle acquired within five years of filing.⁷ Since most car loans have a duration of five years or less, virtually all debtors would have to treat their car loans as if the balance were fully secured. Other secured debts would be protected from stripdown if any non-vehicle collateral was acquired within six months of filing. Since most department stores claim to take collateral in everything purchased with their store card, these debts may be treated as fully secured under the Senate provision if the debtor used the card at all within six months of filing.

The House bill would preclude strip-down of any debt if the collateral is acquired within five years of bankruptcy.⁸ Under this provision, virtually all department store debts are likely to be deemed fully or substantially secured no matter what the current value of the collateral is. Unlike the Senate bill, the House provision would apply in all chapters and would therefore affect redemptions currently available under §722. Most redemptions by low-income debtors would become unaffordable, leaving surrender or expensive reaffirmation agreements as the only real options in many jurisdictions.

Finally, in another provision aimed virtually exclusively at low-income debtors and the elderly, mobile-home liens would not be subject to stripdown whether they were purchase-money liens or not. These liens would have the same protection available to other residential mortgages under Code §1322(b)(2).⁹

The Rights of Tenants. Both the Senate and House bills contain provisions that would eliminate the automatic stay for many tenants facing eviction, even if they are paying rent after bankruptcy.¹⁰ Under either provision, the landlord would have the authority to decide that the criteria that nullify the automatic stay apply in order to commence or continue an eviction case in state court.

The Senate provision creates exceptions to the automatic stay for landlords if:

• an eviction case is commenced pre-petition;
• an eviction case has not yet commenced, but the rental agreement has terminated "under the lease agreement or applicable state law;" or
• an eviction case is "based on endangerment to property or person or the use of illegal drugs."

The House provision is slightly better. It includes the latter two exceptions from the Senate bill and creates additional exceptions for landlords if:

• an eviction case is commenced pre-petition and the tenant does not make post-petition rent payments, or
• if the debtor had filed a previous case within the last year and "failed to pay post-petition rent during the course of that case."

Unlike the Senate bill, the House bill does not include an automatic exception from the stay for all eviction cases that are filed pre-petition.

These provisions eviscerate the automatic stay for most tenants, thus negating the right to cure residential lease defaults under the Bankruptcy Code. In addition, by eliminating the automatic stay with respect to the family shelter, tenants will get less relief than homeowners. Since tenants, on average, are more likely than homeowners to have low incomes, this becomes another way that the bills are likely to have a disproportionate impact on poor debtors.

And finally, in many cases, the landlord's purported grounds for relief from stay will be disputed. A tenant may believe, for example, that the lease is not terminated or that a landlord's claim of injury to property is fabricated. Under the provisions as presently structured, the tenant will have the burden of initiating potentially expensive declaratory judgment litigation in bankruptcy court to obtain a determination that the stay applies. At the same time, there are likely to be costs of proceeding in state court until the bankruptcy court rules that the stay applies.

Conclusion

All of the recent studies, no matter how they were funded, show that the vast majority of consumer debtors have low or moderate income. Unfortunately, these are the debtors who will suffer the most from having the limited resources to navigate the complicated procedural and substantive hurdles that Congress is poised to enact.

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Footnotes

¹ Additional information may also be available on the National Consumer Law Center's web site at www.consumerlaw.org. Return to article

² This is §102 of each bill. Return to article

³ S. 625, §310; H.R. 833, §133. Although both bills are now called H.R. 833, for ease of reference this article will continue to refer to the Senate bill by its old bill number, S.625. Return to article

⁴ All tax debts would also be made non-dischargeable in chapter 13. S. 625, §§314(b), 707; H.R. 833 §§127, 807. Return to article

⁵ S. 625, §105; H.R. 833, §302. The Senate bill does require that certified counseling agencies provide services to those unable to pay. It is unclear whether oversight of this provision would be available. It is also unclear whether it applies to post-bankruptcy education requirements. Return to article

⁶ One informal study by Hank Hildebrand, a chapter 13 trustee in Nashville, shows that the changes to the stripdown provisions, if enacted, will preclude more than one-fifth of cases that can currently be filed under chapter 13. Virtually all of these cases would be those of low-income debtors. Return to article

⁷ S. 625, §306. Return to article

⁸ H.R. 833, §122. For those few debts that would not be subject to this provision because the collateral is more than five years old, valuation at the retail price would be required. H.R. 833, §123. Since this provision applies in chapter 7, redemption rights under Code §722 would be affected. There is no similar provision in the Senate bill. Return to article

⁹ S. 625, §306(c); H.R. 833, §302(e). Return to article

¹⁰ S. 625, §311; H.R. 833, §136. Return to article