Ruminating on the Proposed Bankruptcy Bill

Written by:
Prof. Jack F. Williams
American Bankruptcy Institute
Robert M. Zinman Resident Scholar
Georgia State University College of Law
[email protected]

Like a Kudzu vine in the South, the new bankruptcy bill is about to overcome those who had hoped the darn thing would just go away. Assuming that Congress can get its act together, the overwhelming support for the bill, and the administration's on-record statements that it will support it, all but ensure passage. Once the bill has been signed, it becomes controlling law in 180 days.

Instead of focusing on the specifics of each provision, an endeavor masterfully accomplished already by my colleagues at the ABI, I humbly offer several themes subtly woven through the bill.

"It Is Good to Be King!"

Is there any part of this bill that the government doesn't like? To be fair, the government did not get everything it wanted; however, it does not have to live with anything it really opposed. But not all kings are equal. While the federal government was successful in obtaining a few concessions and in nailing down some annoying inconsistencies (e.g., the appropriate interest rate to use in paying deferred priority tax claims pursuant to a confirmed chapter 11 plan), the states made out like bandits. Whereas the federal government must accept a rate of interest comparable to the market rate, states may continue to assert a rate of interest so far above the market rate as to make the claim punitive, so long as state law permits the interest rate sought. In other words, states may assert a statutory "default" rate of interest that is not subject to state usury laws and no longer subject to detached scrutiny through the bankruptcy lens. This proposed amendment to the Bankruptcy Code will no doubt have a dramatic effect on the number of successful chapter 11 cases, particularly smaller marginal cases, and will reduce the recovery of many unsecured creditors—including tort victims, trade creditors and, in certain cases, employees.

"Oh Lord! It Is Hard to Be Humble When You're Perfect in Every Way"

In bankruptcy, dirt is king! These non-residential real property lessors have the best lobbyists known to the world. First, the shopping center folks forged protections from whole cloth for reasons that are no more sympathetic than those of many other parties in interest in the bankruptcy process. Then, the lobbyists convinced Congress to place a disguised priority provision in §365(d), of all places, so that a debtor must comply with the terms of the non-residential real property lease—including regular rental payments—even if the lease is of no benefit to the estate. Now, §404 of the bill closes the loop. Under §404, an unexpired lease of non-residential real property is deemed rejected if the trustee fails to assume the lease by the earlier of: (1) 120 days after the order for relief or (2) confirmation order. The court may extend the "drop-dead" date for 90 days for cause. Any further extensions would be subject to the lessor's consent. Additionally, a trustee's authority to assign a lease under §365(f) would be subject to the §365(b) requirements.

"Bad Boys"

In a stark departure from the Bankruptcy Reform Act of 1978, the present bill rejects the policy that a debtor may initially choose under which chapter he or she would seek relief and requires that, before a debtor may seek relief under chapter 7, the debtor meet the so-called means-testing provisions. In the abstract, the argument is not without merit. People who have the ability to pay their debts should pay them; notwithstanding the bankruptcy discharge, there remains a moral obligation to do so. Thus, the argument goes, if a debtor has the financial ability to pay at least some of her debts over time, she should be required to seek relief under chapter 13 rather than chapter 7. As usual, however, the devil is in the details.

A multitude of new provisions will impact a debtor's decision to seek relief under chapter 7. First, the grounds for dismissal of a chapter 7 petition has been lowered from "substantial abuse" to just plain "abuse." Second, the presumption in favor of granting the relief sought by the debtor has been replaced with a new improved presumption that abuse exists if a debtor's current monthly income exceeds an amount determined according to a specified formula. Thus, a court must presume abuse if a debtor's current monthly income, less allowed expenses and multiplied by 60, is not less than the lesser of (1) 25 percent of the unsecured claims or $6,000, whichever is greater, or (2) $10,000. Of course, the meaning of many of the key terms in the new test are not self-evident. For example, monthly expenses that may be deducted from current monthly income include those expenses incurred to maintain the safety of the debtor's family from family violence and those expenses associated with the care and support of the elderly, disabled or chronically ill. In addition to these deductions, a debtor make take as an allowance (1) 5 percent of the IRS standards for food and clothing, (2) actual administrative expenses of up to 10 percent of chapter 13 plan payments, (3) $1,500 per child per year of elementary or secondary schooling of a dependent child, and (4) home energy costs. Third, the presumption of abuse identified above can be rebutted only by detailed documentation of special circumstances requiring additional expenses. Finally, the bill includes a controversial requirement that the debtor's counsel reimburse the bankruptcy trustee's fees in prosecuting a dismissal or conversion if a court finds that the bankruptcy petition was filed in violation of certain bankruptcy rules.

The means-testing system is doomed to failure; it is my prediction that it will be largely ignored over time. Most debtors who seek relief under chapter 13 fail. This is a dismal fact of bankruptcy life. These chapter 13 debtors cannot fund the repayment plan and must ultimately convert the case to chapter 7. Do we honestly believe that the success rate will go up once we start forcing more marginal debtors into chapter 13? Rather, one of two things will happen. The first thing is that people will come to believe that a failed chapter 13 is simply a prerequisite to filing a chapter 7 case, a de facto §109 requirement for chapter 7 debtor eligibility. In the end, then, we have increased the time and cost associated with obtaining relief under chapter 7. The second thing is that people will just not file for relief under the Bankruptcy Code. Debt repayment, like the payment of taxes, will simply go underground. We could also expect tensions to increase between debtors and creditors. In short, a debtor that does not qualify for chapter 7 relief does not have to file a chapter 13 petition. She can simply walk away from the process, convert her non-exempt assets to exempt assets under applicable state law and fight with her creditors.

Second, why do I think that means testing will be largely ignored? The answer is easy; it cannot work as designed. The allowances are too meager—even the IRS knows this when it deals with the collection of delinquent taxes. Moreover, courts do have some discretion and will eventually become bolder in exercising it as they see greater injustices occur. Over time, the means testing will become one factor in the determination of under which chapter a debtor may seek relief—important, but not all-important.

I do believe there is significant abuse under the present Bankruptcy Code. For example, unlimited state exemptions pervert the process, destroying any uniformity in bankruptcy law and holding the system as presently framed in contempt. Additionally, there are abusive filings by consumer debtors, debtors that could have paid some of their debt through a chapter 13 plan. Some bankruptcy judges did drop the ball on the issue of debtor abuse. But the percentage of abusers is very small. To rework the Bankruptcy Code so that the presumption is that a chapter 7 debtor is presumed "bad" until he can prove he is "good" makes no sense when most are "good" in the first place.

"Don't Tug on Superman's Cape"

Come on. Are we ever going to give the folks that work in the U.S. Trustee's office a break? It seems that with every new amendment to the Bankruptcy Code, their scope of responsibility increases. New warnings to debtors in bankruptcy: No problem, just make the U.S. Trustee do it. Under §439 of the bill, the U.S. Trustee now has a new line of duties. On top of those new duties, the U.S. Trustee must also either (1) enter the educational programming business or (2) develop an educational accreditation wing to review the educational programs that will become a necessity under §105 of the bill. Someone throw the penalty flag—we are now piling on!

"Lien on Me When You're Not Strong"

Small creditors in big bankruptcy cases have small voices. Small creditors in small bankruptcy cases also have small voices. The present bill seeks to change that through several well-meaning provisions. First, §409 of the bill protects certain creditors from the avoidable preference powers where the creditor received a transfer of $5,000 or less in a non-consumer case. Second, §405 permits the bankruptcy judge to order the U.S. Trustee to add to the official committee of unsecured creditors a small business creditor if that creditor "[h]olds claims (of the kind represented by the committee) the aggregate amount of which, in comparison to the annual gross revenue of that creditor, is disproportionately large." Third, §405(b) requires creditors' committees to share information with creditors that are not members of the committee. Fourth, a creditor holding a consumer debt may participate in a §341 meeting without counsel. The list goes on. The sense of Congress that the bankruptcy process is often too costly for small creditors is welcomed.

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By and large, bankruptcy judges do a great job...one need only sit through a couple of weeks of bankruptcy court to marvel at how well the system works.

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"I've Been in the Right Place, But It Must Have Been the Wrong Time"

Time is money. Several new provisions in the bill recognize this aphorism and attempt to speed up the process. Section 402 authorizes the court to dispense with a §341 meeting in pre-pack bankruptcy cases. Section 411 limits the extension of time permitted for filing a bankruptcy plan. Additionally, the small-business bankruptcy provisions also seek to speed up the bankruptcy process by, among other things, limiting the discretion of bankruptcy judges at key points in the reorganization process.

"I Shot the Sherriff! But I Did Not Shoot the Deputy"

The loudest theme is the clear, unmistakable distrust Congress has for bankruptcy judges. Although several provisions do indeed increase the discretion of the bankruptcy judge in the process, most key provisions throttle discretion, relegating the bankruptcy judge to administrator and not judicial officer. I have detailed this observation in great detail in an article published in the ABI Law Review. See "Distrust: The Rhetoric and Reality of Means-Testing," 7 ABI L. Rev. 105 (1999). I will not repeat it here; however, I simply note that the more objectionable provisions still remain in the bill. By and large, bankruptcy judges do a great job. Certainly, judges make mistakes, and bankruptcy judges are not above criticism. Nonetheless, one need only sit through a couple of weeks of bankruptcy court to marvel at how well the system works. At the center of the system is the bankruptcy judge and her staff.

Like any controversial piece of legislation, the bankruptcy bill has its strengths and weaknesses. But with passage of the means-testing and educational components of the bankruptcy bill, the bankruptcy system is designed for failure—too burdensome, too taxing, too complex, too time-consuming.

In this country, we ask the bankruptcy system to act as a safety net—a safe haven, if you will, from the rough and tumble of a highly competitive economy and lifestyle. However, no system, no matter how well-intentioned its designer, can be any better than the people who operate within it. Abuse will always be present. The fact is that a system that would eradicate abuse is impossible. Rather, we should seek to achieve a system that manages abuse efficiently and fairly. Surprise! With some minor tinkerings, that system already exists.

People who claim that bankruptcy carries no stigma with it must simply travel in a more sophisticated circle than I. I have witnessed and studied the emotional and psychological toll that financial distress and bankruptcy takes on people. Many of these people reject any suggestion that they should seek bankruptcy relief. For those of us who have counseled consumer and small-business debtors, these people are the typical vulnerable folks who find themselves in a financial mess complicated by a traditional belief that a person should pay their debts if they are able. Those who do seek relief generally don't parade the fact as a badge of honor. It is an embarrassment, a badge of failure that one wears for the rest of his life. To be sure, I have met people who have abused the system, and I have witnessed judges who let them get away with it. But those people are anomalies. And the overwhelming number of judges that I have visited with are perceptive and quite creative at ferreting out abusers.

There are a number of academics and practitioners that firmly believe the bankruptcy bill is mean-spirited. Please do not put me in that camp. Although I reject the rallying cry that the present bankruptcy bill is mean-spirited, I remain convinced that as a country, it is not our finest hour.