To amend title 11 of the United States Code, and for other purposes. An Analysis of the Consumer Bankruptcy Provisions of H.R. 3150
Proposed Bankruptcy Reform Legislation (Revised) Written by:
Hon. Eugene R. Wedoff
United States Bankruptcy Court
Northern District of Illinois
Chair, Consumer Bankruptcy Committee

Prepared for the American Bankruptcy Institute
Web prepared, posted and Copyright © April 6, 1998, American Bankruptcy Institute.

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Revised critique points out problems with the means-testing procedure of H.R. 3150.
H.R. 3150, presently pending before the the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee, would add "means-testing" as a prerequisite for Chapter 7 relief, denying that relief to individuals who can pay a defined portion of their future income to general unsecured creditors. The procedure for means-testing in H.R. 3150 adopts standards used by the Internal Revenue Service in collecting unpaid taxes. According to a revised critique of H.R. 3150, written by Bankruptcy Judge Eugene R. Wedoff, these IRS standards do not operate effectively in the context of H.R. 3150, and hence the means-testing procedure of the proposed legislation may be unworkable. The critique discusses the means-testing procedure in connection with §101 of H.R. 3150.

Introduction: The general operation of consumer bankruptcy.

H.R. 3150, currently pending before the 105th Congress, proposes major changes to the consumer provisions of the Bankruptcy Code (Title 11, U.S.C.). Similar changes have been proposed by two other bills, H.R. 2500 and S. 1301, that are the subject of an earlier analysis published by the American Bankruptcy Institute. Like the earlier analysis, this paper reviews the proposed legislation with three aims: first, identifying each of the changes that the bill would make in current consumer bankruptcy law; second, assessing the impact that these changes would have in the operation of the law; and third, suggesting alternative approaches, as appropriate, to achieving the goals of the bill. Where the provisions of H.R. 3150 are substantially the same as those of H.R. 2500 or S. 1301, the comments from the earlier analysis are reproduced here, to avoid the need for cross-reference.

In order to discuss the proposed changes and their impact, it is necessary first to have an understanding of how consumer bankruptcy operates under the present law. It is helpful to look at the law as a two-part system, that (1) determines the assets that are available to consumer debtors and (2) divides the assets, allowing the debtor to retain some of those assets, and using other assets to pay the debtor’s creditors.

The assets available. The Bankruptcy Code views consumer debtors as having two basic types of assets: present assets and future assets. The present assets are what a debtor owns at the time a bankruptcy is filed. These include tangible assets like a home, a car, clothing, furniture, and cash, as well as intangible assets, like savings and retirement accounts and lawsuits for personal injury. Future assets are those to which a debtor first becomes entitled after a bankruptcy is filed. The principal future assets of most debtors are the personal earnings to which they become entitled after the bankruptcy filing; other future assets include gifts received or lawsuits accruing after the filing.

The classes of claims. In a bankruptcy case, the assets available to the debtor are divided between the debtor and the debtor’s creditors. The share of each creditor depends on the type of claim the creditor holds. The Bankruptcy Code sets out several different classes of claims.

(a) Secured claims. Debts that are supported by liens on property owned by the debtor (like a home mortgage, or a lien on an automobile), are known as "secured claims." The Bankruptcy Code generally provides that secured claims must be paid at least the value of the collateral that supports them before that collateral can be used by the debtor or paid to other creditors. In other words, the debtor and other creditors are only entitled to the "equity" that exists in the property above the amount of the claim for which the property is collateral. In this way, secured claims are generally first in the distribution of a debtor’s assets. Claims that are not supported by a lien on property of the debtor are known as "unsecured" claims.

(b) Priority claims. Certain claims are viewed by the Bankruptcy Code as being especially entitled to payment. Examples include certain tax obligations, expenses of administering a case in bankruptcy, and family support obligations of the debtor. Although these claims against the debtor may not be secured, the Bankruptcy Code provides that when a debtor’s assets are distributed, these claims should be paid ahead of other unsecured claims, and so they are known as "priority unsecured" or simply "priority" claims, in contrast to ordinary ( "general") unsecured claims against the debtor.

(c) General unsecured claims. Unsecured claims that do not have priority status—"general unsecured" claims—are involved in nearly every consumer bankruptcy case. Examples include most credit card debt and medical bills. However, even a creditor secured by a home mortgage or automobile lien may hold a general unsecured claim. An important concept in the Bankruptcy Code is that, whenever the value of collateral is insufficient to cover the entire amount owed on the creditor’s claim, the creditor holding the lien has both a secured claim (to the extent of the collateral value) and an unsecured claim (in the amount of the deficiency in the value of the collateral). Thus, a creditor with a $10,000 claim, secured by an automobile worth only $7,000, is treated as having a secured claim of $7,000 and a general unsecured claim of $3,000.

(d) Nondischargeable claims. Ordinarily, when the distribution of a debtor’s assets under the Bankruptcy Code has been concluded, the debtor is given a discharge, wiping out the debts that the debtor owed at the time the bankruptcy was filed. Thus, all of the debtor’s future assets, after the distribution, are allowed to be retained by the debtor. However, there is an exception to the discharge for certain types of debt. Some of this debt is of the same nature as priority debt (taxes and family support obligations), but the Bankruptcy Code also excepts from discharge certain debts that were incurred through misconduct of the debtor, such as debts arising from fraud and intentional injuries. These "nondischargeable" claims—to the extent they have not been paid from the assets that are distributed during a bankruptcy case—remain payable from the future assets of the debtor.

Chapter 7: distributing present assets to creditors. Since the enactment of the Bankruptcy Act of 1898, the standard process of a bankruptcy case has been for a trustee to collect the debtors’ present assets, liquidate them, and divide the proceeds among the debtors’ creditors, with the debtors, in exchange, being discharged from their debts, so that they retain the right to their future assets, free of claims of creditors. This process, set out in Chapter 7 of the current Bankruptcy Code, is known as "liquidation" or "straight bankruptcy." Allowing the debtors to use future assets free of creditor claims is known as the "fresh start."

There are, however, two features of Chapter 7 that vary the general plan of liquidating present assets for distribution to creditors and leaving future assets for the debtor. First, debtors are allowed to retain some of their present assets. The Bankruptcy Code sets forth a list of "exempt" property, deemed necessary for debtors’ maintenance. States may provide an alternative to this list, and then either allow the debtors to choose between the two lists of exempt property (state and federal) or else provide that the state exemptions are the only ones available. In any event, debtors are allowed to keep some of their current assets as exempt, excluding them from distribution in Chapter 7. Where debtors have no substantial assets beyond those that are exempt, there will be no distribution to creditors. Cases such as these are known as "no asset" Chapter 7 cases.

Second, debtors in Chapter 7 are not always discharged from all of their debts. As noted above, some debts are nondischargeable, and these remain, after bankruptcy, so that the creditors holding these claims may seek payment from future assets of the debtor. Moreover, under certain circumstances (generally involving misconduct by the debtor in the course of the bankruptcy itself), a Chapter 7 debtor may be denied a discharge altogether.

Taking all of this into consideration, Chapter 7 generally divides a debtor’s assets as follows:

(1) Secured creditors are given the value of their liens in the debtor’s present assets.

(2) The debtor’s exemptions are deducted from the present assets.

(3) Any remaining present assets are liquidated and distributed, first to priority claims, and then to general unsecured claims.

(4) The debtor is given a discharge, allowing the debtor to have future assets free of creditor claims, subject to nondischargeable claims.

(5) Nondischargeable claims remain payable in full from the future assets.

Chapter 13: distributing future assets to creditors. Chapter 13 is presented in the Bankruptcy Code as an alternative to the standard Chapter 7 liquidation. The basic idea of Chapter 13 is to allow debtors to retain all of their present assets, in exchange for paying to creditors, out of future assets, at least as much as the creditors would have received if there had been a Chapter 7 liquidation. To accomplish this, the debtor must propose a plan, administered by a trustee, to pay creditors through periodic contributions from the debtor’s regular income. Chapter 13 recognizes that debtors cannot pay all of their income into the plan, since some income will be necessary for the support of the debtors and their dependents. However, all income not necessary for that support is defined as "disposable" income, and a Chapter 13 plan must either pay creditors in full, or devote all disposable income to the plan. A plan that does not provide for full payment of debts must have a duration of at least three years, and five years is the maximum length of the plan. Because of the disposable income requirement, Chapter 13 plans may be required to pay much more to creditors than they would have received in a Chapter 7 bankruptcy.

Under current law, Chapter 13 is entirely voluntary. Only a debtor can propose a Chapter 13 plan; a debtor has an absolute right to dismiss a case that was originally filed under Chapter 13; and a debtor can convert a Chapter 13 case to Chapter 7 at any time. To encourage debtors to choose Chapter 13 over Chapter 7 (and thus provide greater payment to creditors), the Bankruptcy Code has two distinct types of incentives. First, at the conclusion of a Chapter 13 plan, the debtor is given a broader discharge than is available in Chapter 7. This "superdischarge" results in the discharge of several types of debt (including those for fraud and intentional injuries) that are not discharged in Chapter 7. Second, debtors are allowed to keep property that is encumbered by liens, even though they are in default on the underlying obligations. A debtor with a home in foreclosure or a car subject to repossession may be able to retain the home or car by making payments to the secured creditors through a Chapter 13 plan. Moreover, except for certain home mortgages, the debtor in Chapter 13 may pay to a secured creditor the value of the collateral, even though it is less than the full amount owing, and obtain a release of the lien. Chapter 13 contains detailed provisions as to the type of payments required on secured claims.

Plans in Chapter 13 are required to pay priority claims in full, over the course of the plan, and not to discriminate unfairly among general unsecured creditors. Considering all of its provisions, Chapter 13 generally divides a debtor’s assets as follows:

(1) The debtor retains all present assets.

(2) The debtor contributes disposable future assets to a plan for a period of three to five years, or for a shorter period sufficient to pay the debts in full. The payments to be received by creditors must be at least as much as they would have received in a Chapter 7 case. Secured creditors must receive at least the value of their liens. Priority claims must be paid in full.

(3) The debtor retains all nondisposable future assets during the time of the plan.

(4) After the completion of the plan, the debtor is given a discharge, allowing the debtor to retain all future assets, free of dischargeable creditor claims.

(5) Nondischargeable claims remain payable in full from the future assets. However, many debts that are nondischargeable in Chapter 7 are able to be discharged in Chapter 13.

Choice of Chapter 7 or Chapter 13. Under current law, consumers have a largely free choice between Chapter 7 and Chapter 13 as a form of relief. However, there are some limitations, the most significant of which are the following: First, a debtor cannot file any bankruptcy case within 180 days after a prior case was dismissed under specified circumstances. Second, Chapter 13 is unavailable to individuals with large amounts of debt (over $250,000 in unsecured debt or $750,000 in secured debt). Third, a Chapter 7 case may be dismissed on motion of the court or the United States trustee if granting Chapter 7 relief would be a "substantial abuse." Fourth, a debtor cannot receive a discharge in a Chapter 7 case if that case was filed within six years of an earlier filing in which the debtor received a Chapter 7 discharge. However, a debtor may receive a discharge in a Chapter 13 case regardless of whether or when a discharge was granted in any prior bankruptcy case. The absence of such limits on Chapter 13 discharge is a third incentive encouraging debtors to choose Chapter 13 over Chapter 7.

The automatic stay. In either Chapter 7 or Chapter 13, an automatic stay goes into effect at the time the case is filed, which generally operates to prohibit any collection activity—including foreclosure and repossession—on debts that were in existence at the time of the filing. In order to obtain the right to proceed with collection activity, a creditor must obtain relief from the automatic stay. In either Chapter 7 or Chapter 13, a creditor is entitled to relief if the value of its lien is declining or at risk of declining, and no action (known as "adequate protection") is taken to make up for the decline. In Chapter 7, the creditor is also entitled to relief if there is no equity in the property that might be obtained for the benefit of creditors. In Chapter 13, relief is granted if there is no equity and the property is not needed for the debtor’s plan to be effective.

Summary: major effects of the consumer bankruptcy provisions of H.R. 3150.

As discussed in the section-by-section analysis that follows, H.R. 3150 appears designed to reduce bankruptcy filings and increase payments to creditors in bankruptcy. A number of features would increase the cost of bankruptcy filing and administration. Among the significant changes proposed in H.R. 3150 include the following:

1. The ability of a debtor to obtain successive discharges would be substantially limited. After a debtor received a bankruptcy discharge, the debtor would be ineligible for any bankruptcy relief for a period of five years, and ineligible for Chapter 7 relief for a period of 10 years. §171.

2. Chapter 7 relief would be denied to certain debtors, based on their ability to pay a specified portion of their debt. Debtors with relatively large debt would remain eligible for Chapter 7 relief, but those with smaller debt would be ineligible. Testing for eligibility would be required for most debtors. §§101, 103.

3. Chapter 13 would be changed by increasing minimum plan terms and eliminating the superdischarge. §§102, 410, 508.

4. Debtors would be notified about alternatives to bankruptcy, and of their obligations in filing bankruptcy. These obligations would include submission of tax returns to the United States trustee (with disclosure to any interested party), and the filing of detailed information regarding income, expenses, and assets, subject to formal audit. §§111, 404, 407.

5. In both Chapter 7 and Chapter 13 cases, secured creditors would receive payment of their claims in an amount no less than the retail value of the collateral that secures the claim, and, in some circumstances, the full amount of the claim, regardless of collateral value. §§128, 129, 130, 162. Relief from stay would be granted in certain circumstances without regard to equity available for distribution to creditors generally. §§121, 124.

6. Credit card debt would be nondischargeable, on the ground of fraud, if the debtor did not have a reasonable ability to repay the debt at the time it was incurred, regardless of the debtor’s subjective intent to repay. Such debts would be nondischargeable in both Chapter 7 and Chapter 13 cases. All debts incurred by a debtor within 90 days of a bankruptcy would be presumed to have been incurred fraudulently. §§141, 142, 143, 145.

7. New deadlines would be established for important events in consumer bankruptcy cases, but there are conflicting provisions regarding the time for confirmation of a Chapter 13 plan. §§401, 405, 406, 409.

8. Bankruptcy court decisions would be appealable directly to the Circuit Courts of Appeals. §412.

9. A detailed program would be established for the centralized collection and dissemination of bankruptcy data. §§441-43.

10. Only minor changes would be made in the exemption provisions of the Code. §§181, 502.

The consumer bankruptcy provisions of H.R. 3150: specific proposals.

More than 40 of the sections of H.R. 3150 affect consumer bankruptcy cases. These provisions are included in three of the bill’s titles. Title I ( "Consumer Bankruptcy Provisions"), Title IV ( "Bankruptcy Administration"), and Title V ( "Tax Provisions"). This analysis deals with each of these sections in the order of presentation; cross-references indicate areas in which one proposal affects another. An indication is also given where the substance of the proposal is similar to a provision of H.R. 2500 or of S. 1301.

Title I ( "Consumer bankruptcy provisions")

Subtitle A ( "Needs-Based Bankruptcy")

§101 ("Needs based bankruptcy") (see H.R. 2500, §101; S. 1301, §102).

The changes. This section of the bill would institute "means-testing" for Chapter 7 relief, eliminating the choice of Chapter 7 bankruptcy for debtors who can pay a defined portion of their future income to general unsecured creditors. Subsection 101(3) of the bill would add a new provision to §109(b) of the Code. The new provision would prohibit an individual from being a debtor under Chapter 7 if the individual had "income available to pay creditors." The remainder of §101 sets up a procedure for determining "income available to pay creditors" and a mechanism for implementing the denial of Chapter 7 relief to debtors who have such income.

Means-testing. Whether a debtor has "income available to pay creditors," and thus is ineligible for Chapter 7 relief, involves a three-step determination. The first step compares the debtor’s "current monthly total income" (all of the debtor’s income from any sources, averaged over the six months preceding bankruptcy) against a national median income established by the Census Bureau. The debtor’s income must be at least 75% of the national median, based on household size, in order to be subject to exclusion from Chapter 7 relief. Because the Census Bureau’s reports deal with pre-tax income, rather than "take-home pay," this provision of the bill presumably deals with pre-tax income as well.

In the second step, the debtor’s total monthly income is reduced by three "automatic" categories of payments to obtain "projected monthly net income," i.e., the amount available to pay general unsecured claims. The three payment categories are: (1) general living expenses for the debtor and the debtor’s dependents, according to standards established by the Internal Revenue Service for purposes of collecting unpaid tax obligations; (2) all of the payments on secured debt that will come due during the five years after filing, divided by 60 (to obtain a monthly average); and (3) all of the priority debt owed by the debtor, again divided by 60.

Finally, in the third step, projected monthly net income may be further reduced by a "personalized" category of expenses, resulting from "extraordinary circumstances" established by the debtor.

A debtor will be found to have "income available to pay creditors"—and hence be ineligible for Chapter 7 relief— if, in addition to meeting the total income test, the debtor’s "projected monthly net income" is both greater than $50, and is "sufficient to repay twenty per cent or more of unsecured non-priority claims during a five-year repayment plan."

Implementation. Section 101 of the bill contains two mechanisms for implementing means testing. First, Chapter 7 trustees are given the additional duty of investigating and verifying the debtor’s projected monthly net income and filing a report with the court as to whether the debtor is disqualified for Chapter 7 relief under the "income available" standard.

Second, if the debtor asserts extraordinary expenses, a statement to that effect is required to be included with the debtor’s bankruptcy petition, together with an itemization and detailed description of each expense, and a sworn statement by the debtor and the debtor’s attorney that the statement is true. Any party may object to the statement within 60 days after the debtor makes the disclosures required by § 521 of the Code (as expanded by §407 of the bill, discussed below), and if such an objection is made, the bankruptcy court is to determine the matter, with the debtor having the burden of proof.

A third implementation of means-testing is contained in §103 of H.R. 3150. As discussed below, this provision would amend §707(b) of the Code to allow creditors to seek dismissal or conversion of Chapter 7 cases that they believe fail the means test.

Chapter 13. Finally, Subsection 101(6) of the bill sets out a provision unrelated to means-testing. This final change would impose on Chapter 13 trustees the additional responsibility of investigating and verifying the debtor’s monthly net income, and filing annual reports with the court as to whether the debtor’s plan should be modified because of changes in the debtor’s net income.

The impact. Means-testing in general. The means-testing incorporated in Section 101 of H.R. 3150 would effect a major change in bankruptcy policy. That policy has traditionally allowed debtors in financial difficulty to obtain an immediate fresh start in exchange for surrendering their nonexempt assets. Accordingly, current § 707(b) denies Chapter 7 relief only where this relief would be a "substantial abuse" of the provisions of Chapter 7, and it provides that there is a presumption in favor of granting the relief sought by the debtor. The means-testing provisions of H.R. 3150 would change this, denying an immediate fresh start to a significant category of debtors in genuine financial difficulty—unable to pay their current bills from available income—because their future income is sufficient to pay 20 percent of their debt over five years. Thus, at a given income level, those who have accumulated relatively small amounts of debt would be denied Chapter 7 relief, while those who have accumulated relatively large amounts would remain eligible. It can be anticipated that this change would decrease the number of Chapter 7 bankruptcies, with a corresponding increase in Chapter 13 cases or in nonbankruptcy resolutions of consumer debts. In this way, means-testing may lead to greater payments to creditors. But it may also have unintended consequences. For example, at the present time, many debtors are able to avoid bankruptcy by working out voluntary arrangements with creditors through credit counseling services. The willingness of creditors to cooperate in such voluntary arrangements may be influenced by the fact that the debtors otherwise have the option of Chapter 7 bankruptcy. If that option is removed, the creditors may be less willing to enter into the voluntary arrangements. Means-testing may also increase home foreclosure rates, since debtors now able to remove other debt in Chapter 7 would be denied that option, and may be ineligible for Chapter 13 or unable to complete a Chapter 13 plan.

The threshold for means-testing. Median household income, varying with size of the household, is used in the proposal to establish a threshold below which there is no need to examine income on an individualized basis: an individual whose total household income is less than 75% of the median income, as determined by the Census Bureau for a household of the same size, would not be disqualified from Chapter 7 relief regardless of the household expenses. However, there are two difficulties with the use of Census Bureau medians. First, the information may be outdated. For any given year, the proposal states that household income is based on the most recent Census Bureau figures available as of January 1. As of January 1 of any year, the Census only has information available for the second year before that date. Thus, 1996 income figures are presently the most recent. In this way, the threshold under the proposal compares a debtor’s current income to the median income that existed up to two years earlier. In times of high inflation, this would greatly increase the number of cases subject to individual scrutiny. (Similarly, the six-month average used to determine the debtor’s current income will result in an artificially high income figure whenever the debtor’s income has declined shortly before the bankruptcy filing.)

A second problem has to do with household size. The proposal employs median household income, varying with the size of the household, with the apparent intent of allowing a higher threshold income for larger households. In reality, however, median household income changes erratically with household size. The median income for a single individual (in 1996, the last year for which Census Bureau figures are currently available) was $18,426, so that any single individual earning over $13,819.50 would be subject to individualized scrutiny under the proposal. This is only about $4,500 more than the federal poverty level of $9,260. But median income for a household of two was $39,039, producing a threshold for scrutiny, under the proposed bill, of $29,279.25, more than twice the poverty level of $12,480. The median income continues to increase with household size for households of three and four persons, but household income decreases for families of five and six persons. The median family income for a household of six persons was $44,782 in 1996—less than the median income for a family of three—which would result in a threshold for scrutiny, under the proposed bill, of $33,586.50, compared to a poverty level of $25,360. Thus, for single individuals and individuals in large households, the bill is much more likely to require individualized scrutiny than for individuals in households of two to four persons. (Income figures are drawn from U.S. Bureau of the Census, P60-197, Money Income in the United States: 1996, Table 1 (1997). Poverty figures are from the Annual Update of the HHS Poverty Guidelines, 63 Fed.Reg. 9235, 9236 (1998).)

The means-testing process—IRS collection standards. For those debtors whose income is above the threshold, §101 of H.R. 3150 prescribes a two-part means test for determining how much of the debtors’ projected monthly income during the five-year period after the bankruptcy filing is "net income," available to pay general unsecured debt. In the first part of the means-testing process, a debtor’s projected total monthly income is reduced by a set of "automatic" deductions: (1) monthly expenses allowances defined by Internal Revenue Service collection standards, (2) monthly payments on secured debt, and (3) monthly payments on priority debt. To avoid double deductions, §101 specifies that payment of debt should be excluded from the IRS allowances. In the second part of the process, further deductions are allowed where the debtor can establish extraordinary expenses. The balance that remains after the two sets of deductions is the "projected monthly net income" available to pay general unsecured debt.

There are several problems with this process—resulting primarily from the incorporation of the IRS standards—that render it unworkable or inequitable. The IRS collection standards are set out in the Internal Revenue Manual ("Manual") §5323 (CCH 1995), and incorporate a number of exhibits also set out in the Manual (Exhibits 5300-45 to 5300-51). More recent versions of some of the exhibits may be found at the IRS website, e.g.:

http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-other.html

As reflected in §101, the expense allowances under the IRS collection standards fall into three categories: national standards, covering food, housekeeping supplies, clothing, services, personal care products, and miscellaneous expenses (Manual §5323.432); local standards, covering housing and transportation (Manual §5323.433); and other necessary expenses, covering taxes, health care, court-ordered payments, involuntary wage deductions, accounting and legal fees, and secured debt, with provision for other necessary expenses (Manual, §5323.434).

The difficulties in applying the IRS standards within the procedures of §101 include the following:

•The IRS standards are not automatic. The Manual defines the "necessary expenses" category as including any expense necessary to "provide for a taxpayer’s and his or her family’s health and welfare and/or the production of income." Manual § 5323.12. The "other necessary expense" category thus includes all necessary expenses (such as costs of health care) that do not fall within the national and local standards. Id. For all such expenses, the Manual requires a discretionary determination of reasonable amounts for the expense: "Since there are no nationally or locally established standards for determining reasonable amounts, the [Internal Revenue] Service employee responsible for the case must determine whether the expense is necessary and the amount is reasonable." Id. Thus, review of a debtor’s schedules—presumably by the Chapter 7 trustee—will be necessary whenever a debtor lists "other necessary expenses" under the IRS standards.

•There is no way to distinguish between the"other necessary expenses" category of the IRS standards and the category of "extraordinary circumstances that require allowance for additional expenses" established by §101 of H.R. 3150. Section 101 makes a substantial distinction between expenses covered by the IRS standards and those arising from "extraordinary circumstances." If an expense is within the IRS category, §101 simply provides for its deduction from the debtor’s income. But if an expense arises from "extraordinary circumstances," then the debtor must provide detailed explanations of the expense, subscribed to by counsel, and subject to challenge by the trustee and creditors. However, as noted above, the IRS category includes any necessary expense not otherwise treated by the Manual, specifically including health care, and hence would appear to cover many expenses that could be considered "extraordinary."

•There is no way to determine what portion of the IRS allowances reflect payment of secured debt. The means-testing proposed in §101 deducts from the debtor’s household income all monthly payments made on account of secured and priority claims, and so, to the extent that the IRS standards allow deduction for debt payments, §101 provides that payments for debt should be excluded from the IRS allowances. In many situations, however, this exclusion will be impossible. The IRS local standards specify a single monthly allowance for all housing expenses, including mortgage or rent, property taxes, interest, parking, maintenance and repair, insurance, condominium fees and all utilities—including heating and cooking fuel, electricity, and telephone. Manual, Exhibit 5300-46. Thus, for example, the current IRS local standard for the District of Columbia allows total monthly housing expenses, for a family of four or more, in the amount of $1397, while a household of two in rural Illinois is allowed less than $500. (See website listings at http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-dc.html and http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-il.html.) This single housing allowance is intended to include any mortgage and property tax payments—which would be payments of secured claims—but there is no way to separate an allowance for those claims from the total housing allowance.

Similarly, the IRS’s local standard provides a single monthly allowance covering all transportation expenses, including payment for vehicles (either by purchase or lease), insurance, maintenance, fuel, registration, vehicle inspection, parking fees, tolls, drivers’ licenses, and public transportation costs. The current monthly transportation expense allowed for the District of Columbia, for a debtor with two cars, is $357, while a debtor with one car in Buffalo is allowed $179. (See website listings at http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-trans.html.) Again, for a debtor with auto loans, some part of these totals would be attributable to payments on the loan, but it is not possible to determine what part.

For both housing and transportation expenses, it might be thought that there could simply be an exclusion from the IRS standard in the amount of whatever mortgage or car loan payments are actually being made by the debtor. That approach, however, cannot be used in any situation where the debtor’s secured debt payments approach or exceed the IRS allowance, since excluding the secured debt payment would leave insufficient allowance for the other expenses included in the category.

•The means-testing process would impose burdens disproportionately on debtors without secured debt. The means-testing of §101 excludes secured debt payment from projected monthly net income, and so mortgage and auto loan payments are automatically deducted from income available to pay creditors, even if they are much higher than average for the community in which the debtor resides. However, rental payments are not secured debt, and so would only be excluded to the extent that they were part of the standard levels of expense established by the IRS. Housing expenses in particular vary widely from community to community within a metropolitan area, yet the IRS allowances are based on county wide figures. Thus, the proposal would require all debtors in higher than average rental communities to declare and prove "extraordinary" expenses, with the potential for litigation concerning the extent to which bankruptcy courts should allow as "extraordinary expenses" rental payments at a level higher than that determined by the IRS.

Similarly, a debtor could buy a new car on credit without affecting the means-testing of §101, but if the debtor leased a car with payments that caused the IRS transportation allowance to be exceeded, there would again be a need to declare an extraordinary expense in order to retain the car.

Finally, costs of rental housing may rise very quickly in a given area, but, as with Census Bureau data, the IRS standards will necessarily lag. Thus, debtors in rental housing may be required to establish "extraordinary circumstances" simply to continue to rent an average apartment for their area.

• The means-test leaves unresolved recurring questions regarding the appropriateness of various categories of expense. Currently, questions about the reasonableness and necessity of expenses claimed by a debtor arise under §1325(b) of the Code, which requires that Chapter 13 debtors contribute to their repayment plans any income not "reasonably necessary" for their support and the support of their dependents. In applying this standard, the courts have struggled to determine whether debtors should be allowed to claim expenses for private school tuition, religious and other charitable contributions, and care of elderly relatives or others whom the debtor may not be legally obligated to support. See 2 Keith M. Lundin, Chapter 13 Bankruptcy §§ 5.36-5.37 (1994 & Supp. 1997). None of these questions are resolved by the means-testing proposed in §101 of H.R. 3150. To the contrary, the IRS collection standards make clear that private school tuition and charitable contributions are generally not allowed as "other necessary expenses," and that care for the elderly, invalid, or handicapped only "is necessary if there is no recourse except for a taxpayer to pay the expense." Manual, Exhibit 5300-46. Thus, a debtor seeking to make any of these payments would be required to list them as extraordinary expenses, with the potential for litigation.

Costs of the proposed means-testing. Largely because of the difficulties outlined above, the means-testing proposed by §101 can be expected to generate substantial additional cost:

(1) A substantial burden would be placed on the Internal Revenue Service to maintain current expense standards, for each distinct economic area in the country, These determinations by the IRS may well require formal rulemaking procedures. While the Internal Revenue Manual, under current law, is simply an intra-agency document giving direction to IRS employees, §101 would transform the collection standards into an administrative rule. (The definition of "rule" in the Administrative Procedure Act, 5 U.S.C. § 551(5), includes "an agency statement of general . . . applicability and future effect designed to implement . . . law or policy.")

(2) An increased burden would be placed on bankruptcy professionals. The proposal requires Chapter 7 trustees to investigate and report on the debtor’s net income in each Chapter 7 case. The vast majority of Chapter 7 cases involve no assets for distribution to creditors, and hence only a nominal fee for the trustee. The new investigation and report will substantially add to the work required of trustees in no-asset cases, with no provision for additional compensation. The trustees will also have to review the appropriateness of any expenses claimed by the debtor under the IRS’s "other necessary expenses" category. (The investigation and reporting requirements for Chapter 13 would increase the costs of the Chapter 13 trustee, reducing the portion of plan contributions available to creditors.) Similarly, the proposal requires debtors’ counsel to swear to the accuracy of any extraordinary expenses claimed by a Chapter 7 debtor. Unless this oath is simply based on the statement of the debtor (in which case it would add nothing to the debtor’s oath), this requirement would impose on debtors’ counsel the obligation of independently verifying all of the extraordinary expenses claimed by the debtor, thus increasing the cost of the bankruptcy and the time required to file the case.

(3) The proposal would lead to increased "bankruptcy planning." The formula employed for determining net monthly income is subject to manipulation by debtors. Most obviously, because secured debt is excluded from projected monthly net income, a debtor can reduce the income available to pay debts simply by taking on additional secured debt. For example, assume that a debtor with $30,000 in unsecured, nonpriority debt owns a three-year old car with no outstanding car loan, and that the debtor has $300 in monthly net income as defined in the proposed bill. Over five years, that income would total $18,000, well over 20% of the unsecured debt. However, if the debtor trades in the three-year old car for a new one, and finances $12,000 for three years at 5% interest, the debtor will need to make payments on the secured car loan of about $13,000, reducing the total "net income" over the five years after filing to about $5000, less than 20% of the unsecured debt. Similarly, a debtor with projected income that is slightly over 20% of outstanding unsecured debt could increase the amount of that debt to arrive at a point where disposable income is less than 20%. Finally, debtors may be able to manipulate income, by terminating second jobs, reducing hours, or changing employment.

(4) The proposal would lead to greater court involvement in Chapter 7 cases. The court will be required to hear any disputes regarding "other necessary expenses," or extraordinary income, as well as any questions of good faith arising out of the kind of bankruptcy planning discussed above. These hearings will generate additional expense for the courts and the parties involved in them.

Alternatives. The Bankruptcy Code has limited the availability of Chapter 7 relief in situations of improperly incurred debt by creating exceptions to discharge in Chapter 7. To obtain relief from the improperly incurred debt, the debtor is then required to complete a Chapter 13 plan. Rather than making Chapter 7 relief unavailable to a large class of debtors (many of whom will have incurred their debt in good faith), it may be preferable to define the type of debt (such as excessive credit card debt) that is improper, and make that debt nondischargeable in Chapter 7, regardless of the disposable income currently available to the debtor. Alternatively, if there are to be thresholds for denial of Chapter 7 relief based on household income, those thresholds should be based on some formula (such as a multiple of poverty level) that is not tied to median household income.

§102 ("Adequate income shall be committed to a plan that pays unsecured creditors") (see H.R. 2500, § 102).

The changes. Section 102 of H.R. 2500 proposes essentially two major changes in the operation of Chapter 13.

Plan length. First, §102 imposes an increased minimum plan length for most debtors. Instead of the current three-year minimum, the proposed legislation provides that, if the debtor’s total income is 75% or more of the national median income, based on household size, the debtor’s plan must have a duration of at least five years. If the debtor’s total income is less than 75% of the national median income, the three year minimum is retained. (These provisions are elaborated in §410 of the proposed bill which sets out maximum plan lengths of two years in addition to the minimum plan length set forth here.)

Minimum payments to unsecured creditors. The second major change proposed by §102 replaces the current "disposable income test" of Chapter 13 with a two-part formula requiring minimum payments on unsecured nonpriority debt. Under the first part of the formula, the plan must provide for payments of at least $50 per month to unsecured nonpriority creditors who are not insiders. The second part of the formula defines "monthly net income" for purposes of a Chapter 13 plan, and creates a mechanism for requiring that "the total amount of monthly net income" is paid to unsecured nonpriority creditors during the minimum plan period, less only expenses of administering the case.

The definition of "monthly net income" created by §102 is similar to "projected monthly net income" established under §101—it starts with total monthly income and deducts expense allowances pursuant to Internal Revenue Service collection standards, with the potential for adjustment if the debtor has extraordinary expenses or loss of income. In contrast to §102 of H.R. 2500, secured debt and priority debt are also deducted from net income.

To assure that all monthly net income is paid through a plan to unsecured nonpriority creditors (and administrative claimants), §102 requires that the debtor itemize extraordinary expenses or loss of income in a statement sworn to by the debtor and the debtor’s attorney. The debtor’s statement of extraordinary expenses could be challenged by objection, and the prevailing party in a hearing on the objection could be awarded fees and costs. If the debtor files such a statement, the statement must be refiled, to reflect current conditions, no less than annually during the duration of the plan. All Chapter 13 plans would also be required to provide that future net monthly income will be paid as reasonably determined by the Chapter 13 trustee, with at least annual reviews to determine whether net income has increased or decreased. [This last provision is inconsistent with §101 of the proposed bill. As noted above, §101 imposes a duty of the Chapter 13 trustee to report annually to the court as to whether any increases or decreases in the debtor’s net income should result in modification of the debtor’s plan. Under the terms of §102, increases or decreases in the debtor’s net income, as determined by the trustee, would automatically result in changes in payments to creditors, without plan modification.]

The impact. Three substantial impacts that can be anticipated as a result of the changes made in §102 of the bill:

Plan length. The new five-year minimum plan length would be arbitrarily imposed, depending on size of household. This new plan length is required whenever the debtor’s household income is at least 75% of the median household income determined by the Census Bureau, according to the number of persons in the debtor’s household. As discussed above, in connection with §101, median income varies erratically with the number of persons in the household. Single individuals would be required, using currently available census figures, to propose a five-year minimum plan whenever their gross annual income was at least $13,819.50, but the trigger point for a married couple would be $29,279.25. Individuals in a household of four would not face the five-year minimum until their household income reached $40,278; but in a household of six, the five-year minimum would be triggered by income of $33,586.50.

Where the five-year minimum plan length is imposed, it may increase payments to general unsecured creditors; however, the longer length can be expected to increase the number of cases that fail for default in payment. A five-year minimum term may also have the effect of discouraging any Chapter 13 filing, giving debtors additional incentive for prebankruptcy planning to meet the proposed new filing requirements for Chapter 7. As discussed above in connection with §101, these limitations may be met by increasing debt and decreasing income prior to filing.

The substitution of "net income" for "disposable" income. Current law requires Chapter 13 debtors to contribute all of their disposable income to the Chapter 13 plan, and, after payment of secured and priority claims, this income would be used to pay general unsecured creditors. Disposable income is very generally defined in the Code (§1325(b)(2)), and courts have varied in their interpretation. The proposed change would require that all of a debtor’s "net" income be used to pay general unsecured creditors. Because secured priority claims are deducted from the calculation of net income, the principal difference introduced by the proposed legislation is that standard expense allowances would be determined, in the first instance, by the IRS—rather than by the courts—subject to individualized exceptions, reviewed annually. This process could reduce the arbitrariness associated with the disposable income test; for this reason, some use of general guidelines for determining appropriate levels of Chapter 13 plan contributions has been recommended by the National Bankruptcy Review Commission. National Bankr. Review Comm’n, Bankruptcy: The Next Twenty Years 262-73 (1997) ("Final Report"). However, the application of the IRS standards is very uncertain, for the reasons listed in the discussion of §101, above, and can be expected to generate substantial cost and litigation.

Minimum monthly payments of $50 to general unsecured claims of noninsiders. The $50 minimum payment to general unsecured creditors, proposed by §102, applies to all Chapter 13 debtors, even those who have no net income, or less than $50 in net income. This minimum payment may make Chapter 13 unavailable, or at least discourage its use, by lower income debtors.

The situation of low or nonexistent net income is common in Chapter 13—for example, debtors emerging from a divorce may have very great difficulty in making both required support payments and mortgage payments. In order to save their homes or automobiles, Chapter 13 debtors are often willing to attempt to live on substantially less than what would be considered an appropriate level of expense for necessities. Plans proposing food budgets of $100 for a family of four are not uncommon, with all or almost all of the plan payments going to secured or priority creditors. The $50 minimum for unsecured debt may render such marginal plans completely impossible.

A second problem exists for lower income debtors who owe unsecured debts both to family members and others. Section 102 would require that the first $50 of every monthly payment go to the nonfamily members (since family members are insiders). The $50 minimum thus provides substantial incentive for debtors with low net income to choose Chapter 7, where all of their debts will be discharged, so that they can repay debts owing to family members voluntarily.

Alternative. As suggested by the National Bankruptcy Review Commission, the objective of obtaining payment for general unsecured creditors might be advanced by requiring that payments proposed for general unsecured claims in a Chapter 13 plan be made in equal installments throughout the plan, rather than paid only after secured and priority claims. See Final Report at 262.

§103 ( "Definition of inappropriate use") (see H.R. 2500, §115; S. 1301, §102)

The changes. This section makes five changes to §707(b) of the Bankruptcy Code. Section 707(b) currently allows for dismissal of Chapter 7 cases that are a "substantial abuse" of the provisions of Chapter 7. Section 103 of H.R. 3150 would change the operative term from "substantial abuse" to "inappropriate use." Next, the section would require a finding of "inappropriate use" if the debtor is disqualified from Chapter 7 filing by the "ability to pay" provisions of §101, discussed above, or if "the totality of circumstances of the debtor’s financial situation demonstrates such inappropriate use." The third change made by this section would allow creditors and Chapter 7 trustees to bring motions under §707(b). Currently, such motions may only be initiated by the United States trustee or the court. Fourth, the section would allow conversion to Chapter 13, with the debtor’s consent, as an alternative to dismissal of the bankruptcy case. Finally, the section would allow the court to award fees and costs against a creditor who brought a motion seeking dismissal for substantial abuse, upon a finding by the court that the allegations of the motion were unsubstantiated.

The impact. The proposed changes principally provide a means of enforcing the limitation on Chapter 7 relief proposed in §101 of the proposed bill. Current law limits the right to bring §707(b) motions based on the understanding that debtors should generally be able to choose to obtain an immediate fresh start when they are in financial difficulty, and this understanding would be changed by §101, as discussed above. If creditors are allowed to bring motions for substantial abuse, the fee shifting provision may help to reduce creditor motions brought merely to exert leverage on debtors. Just as current law does not define "substantial abuse," the proposed change would retain a large degree of judicial discretion by allowing courts to grant relief based on the "totality of circumstances." The option of conversion to Chapter 13 would usually exist under present law, pursuant to §706(a), which generally gives a Chapter 7 debtor the option of converting the case to Chapter 13 "at any time."

Subtitle B ( "Adequate Protections for Consumers")

§111 ( "Notice of alternatives") (see H.R. 2500, §103; S. 1301, §301).

The changes. The major change involved in §111 is to assure that each consumer bankruptcy debtor is given a written notice that both discusses the option of consumer credit counseling and lists credit counseling services with offices in the district in which the bankruptcy is filed. The list would be prescribed by the United States trustee and questions about whether a particular counseling service should be included in the list would be determined by the court.

The impact. This proposal can result in relevant information being made available to debtors, although it is likely that debtors consulting an attorney will place more weight on the attorney’s advice than on the information in a form given to them by the attorney. The proposal will probably have the greatest impact on pro se filers. Difficulties may exist in describing the services available from credit counselors, at least if the description includes any comparison of credit counseling and bankruptcy in satisfying debt or in maintaining or reestablishing credit. The need to administer the list of credit counselors will involve some additional cost to the United States trustee.

§112 ( "Debtor Financial Management Training Test Program") (new)

The changes. This section of H.R. 3150 would require the Executive Office of the United States Trustee (1) to develop a program to educate debtors on the management of their finances, (2) to test the program for one year in three judicial districts, (3) to evaluate the effectiveness of the program during that period, and (4) to submit a report of the evaluation to Congress within three months of the conclusion of the evaluation. The test program is to be made available, on request, to both Chapter 7 and 13 debtors, and, in the test districts, bankruptcy courts could require financial management training as a condition to discharge.

The impact. Debtor financial education was a recommendation of the National Bankruptcy Review Commission, but the Commission did not recommend any methodology for implementing it. See Final Report at 114-16. There are two potential problems with the methodology suggested here. First, one year may not be a long enough time to assess the effectiveness of any program. Success in financial management would be indicated by such factors as completion of a Chapter 13 plan, ability to reestablish high quality credit, and (most importantly) avoidance of further financial difficulty. None of these bench marks can be assessed after one year. Second, the power to compel debtor education as a condition for discharge is accorded without specifying the circumstances in which it should be exercised, with the potential for widely varying application. Some judges might require debtor education in all consumer cases, while others never require it. Compulsory education in pilot districts also would be subject to constitutional challenge, as nonuniform bankruptcy legislation. See Railway Labor Executives' Assn. v. Gibbons, 455 U.S. 457, 469-71 (1982) (invalidating bankruptcy legislation that applied to a single railroad).

Alternatives. A study could be conducted of the effectiveness of the existing debtor education programs, based on their past experience. Compulsory education should be imposed only after an education program is available nationwide, and should be imposed only in situations defined by law.

§113 ( "Definitions") (new)

§114 ( "Disclosures") (new)

§115 ( "Debtor’s Bill of Rights") (new)

§116 ( "Enforcement") (new)

The changes. These four sections of H.R. 3150 set up a new system for regulating the providers of consumer bankruptcy services. Section 113 defines the term "debt relief counselling agency" to include both lawyers and non-lawyer providers of consumer bankruptcy goods or services, and the remaining sections establish regulations bearing on these providers. Section 114 would place a new §526 in the Bankruptcy Code, imposing a set of disclosure obligations on consumer bankruptcy providers. The disclosure would include (1) the availability of consumer credit counseling services, (2) the need for a truthful listing of assets and income in bankruptcy, subject to audit and criminal sanctions, (3) the obligation of the provider to issue a contract specifying the services that will be provided and their cost, together with a list of the services that might be needed, and (4) directions on how to complete bankruptcy schedules. Copies of the first two of these notices would be required to be maintained by the provider for two years after the notice is given, or two years after a discharge is received, whichever is longer.

Section 115 would add a new §527 to the Code, with further regulation of consumer bankruptcy providers. It would require a written contract for bankruptcy-related services, with a copy for the client, and specify that the advertising of consumer bankruptcy providers include a conspicuous disclosure that they are engaged in bankruptcy filing. Finally the section would prohibit consumer bankruptcy providers from (1) failing to perform promised services, (2) negligently making or counseling to be made any false statement in a bankruptcy filing, (3) misrepresenting the services to be provided, or the benefits or detriments of bankruptcy, and (4) advising the incurring of debt to pay for bankruptcy related services.

Section 116 would enforce the new regulations on consumer bankruptcy providers. It provides debtors may not waive the provisions of "section 526" and that contracts not complying with "section 526" are void. [This is apparently a drafting error, since proposed §526 governs notices, while proposed §527 governs the content of contracts and the performance of services on behalf of debtors.] The section would further impose sanctions on consumer bankruptcy providers who engage in prohibited conduct. There is a mandatory sanction of loss of all fees previously paid by the debtor, and a potential sanction of being required to continue the representation of the debtor without further fees. The prohibited activities include intentional or negligent failure to comply with any applicable requirement of the Code or the Federal Rules of Bankruptcy Procedure applicable to consumer bankruptcy providers, and providing assistance to a debtor whose case is dismissed or converted under §707(b), or dismissed for failure to file bankruptcy papers. The section would allow enforcement of the provisions of §526 by officials of state government, in either federal or state court, with actual damages awarded to the debtors affected, and with the consumer bankruptcy provider required to pay the costs and fees of any successful enforcement action. Finally, the section specifies that its provisions do not supersede any state regulation of consumer bankruptcy services except to the extent of any inconsistency.

The impact. The likely impact of the new regulations imposed by H.R. 3150 on the providers of consumer bankruptcy services can be divided into three classes.

First, some of the requirements reiterate existing obligations or good practices. In this category are the obligations (1) to provide written contracts specifying the services to be performed and their cost and (2) to perform the promised services. (Fees and services of petition preparers and attorneys are presently regulated by §§110, 329, and 330 of the Code.) The restatement of these obligations may be helpful, particularly as coupled with defined sanctions.

Second, some of the requirements may impose unnecessary costs on the providers. For example, the requirement to retain copies of each notice provided to a client or prospective client for at least two years involves substantial cost with no apparent benefit. Similarly, the requirement of "conspicuous notices" in all advertisements could impose unnecessary costs in connection with advertisements in newspaper classifieds and in telephone directories.

Third, some of the regulations may have a chilling effect on the provision of consumer bankruptcy services. For example, the automatic denial of fees in any case dismissed under §707(b) can be expected to discourage attorneys from filing Chapter 7 cases in situations where eligibility for Chapter 7 relief was questionable. Similarly, automatic denial of fees in cases dismissed for failure to file documents may discourage attorneys from filing cases whenever the debtor’s ability to produce documents is doubtful. Finally, the provision that a provider may never counsel borrowing to pay for bankruptcy fees may be overbroad, prohibiting appropriate advice necessary to permit a bankruptcy filing. While a debtor should never be counseled to borrow money fraudulently, with the intent of discharging the debt, it may be entirely appropriate to enter into a secured loan for the purposes of financing a bankruptcy filing, and a loan from a friend or relative (intended to be repaid despite the discharge) may also be proper.

Alternative. This provision might be limited to addressing specific misconduct by providers of consumer bankruptcy services that is not adequately addressed by existing law. For example, if it is found that bankruptcy providers are misrepresenting their services as not involving bankruptcy, that misconduct could be specified as a ground for mandatory sanctions.

Subtitle C ( "Adequate Protections for Secured Lenders").

§121 ( "Discouraging bad faith repeat filings") (see H.R. 2500, §109; S. 1301, §303).

The changes. This section provides (1) that the automatic stay will terminate after 30 days in cases of repeated bankruptcy filings within one year, unless a party in interest demonstrates that the filing of the later case was in good faith, and (2) that the bankruptcy court have discretion to enter orders granting relief from the stay "in rem," providing that the automatic stay will not apply in subsequent cases filed by the same debtor or in cases filed by other parties with specified knowledge of the order.

The impact. The role of the automatic stay differs substantially in Chapter 7 and in Chapter 13. In Chapter 7, the stay has the effect of allowing a trustee to determine whether property of the debtor should be liquidated for the benefit of creditors. For example, a home that is about to be sold in a foreclosure sale, might, in the trustee’s judgment, be able to be sold by a broker for a higher price, sufficient to pay the mortgage and generate a surplus for distribution to unsecured creditors. The automatic stay prevents a foreclosure from taking place in a situation like this, while allowing the mortgagee to seek relief from the stay by showing that there is in fact no equity in the property. In Chapter 13, the automatic stay has the effect of allowing a debtor to propose and carry out a plan that deals with secured claims in such a way that the debtor is allowed to retain the collateral, even if there is no equity. A debtor who has no ability to deal with a secured claim properly in Chapter 13 may nevertheless file repeated bankruptcy cases in order to prevent a foreclosure or repossession from going forward, by invoking the automatic stay repeatedly. The proposal seeks to limit debtors’ ability to use this tactic, and many of its features would be helpful. However, the proposed changes do not reflect the different roles that the automatic stay plays in Chapter 7 and Chapter 13, and thus may have unintended consequences.

In Chapter 7 cases, regardless of whether there was a prior case, the issue involved in application of the automatic stay should be limited to the question of equity. To allow the automatic stay to remain in effect, a Chapter 7 trustee should simply be required to show that there is equity in the property at issue; the good faith of the debtor in filing the case is not relevant. To see the problem with the proposal in this connection, consider the following example: a debtor with limited income has taken out a home equity loan on the family home, and cannot keep up with the payments. The lender files a foreclosure action, and the debtor seeks to save the home in Chapter 13, but fails to make plan payments, so that the bankruptcy case is dismissed and the foreclosure action is recommenced. This time, again to stop the foreclosure, the debtor files a Chapter 7 case. There is considerable equity in the home. Under the proposal, there is a presumption (since the debtor failed to make plan payments) that the second case is filed in bad faith, and if the Chapter 7 trustee wants to keep the automatic stay in effect beyond 30 days, the proposal would require the trustee to establish, by clear and convincing evidence, that the case was filed in good faith. If the trustee is unable to do so, the foreclosure will go forward, and the estate will lose the higher value that could have been obtained in a conventional sale, outside of foreclosure.

On the other hand, the good faith standards set out in the proposal are reasonably applicable to Chapter 13 cases, requiring that the debtor establish good faith for repeatedly invoking the automatic stay.

The impact of the "in rem" provision is difficult to determine, because no standards are set out for the entry of in rem orders. These orders would be most appropriate as applied to property in which there was no equity, and as to which there had been a pattern of bankruptcy filings. In such situations, the orders could help to prevent debtor abuse. In other situations, the orders might again prevent sales by Chapter 7 trustees to the benefit of unsecured creditors. Also, the proposal does not state whether the court would be authorized to vacate an in rem order in a subsequent case upon a showing that the case was filed in good faith. Absent such specification, there may substantial litigation to determine the issue.

Alternatives. The 30-day termination of the automatic stay should be postponed in Chapter 7 cases upon a request by the trustee for a hearing on the question of equity. In rem orders for relief from stay should be limited to situations in which there is no equity in the property and in which the property has been the subject of more than one bankruptcy filing.

§122 ( "Definition of household goods and antiques") (see H.R. 2500, §119).

The changes. The proposed legislation would add a definition for "household goods" to the definitions of §101 of the Code. "Household goods" are a category of debtors’ assets that may be exempted under §522(d), and as to which certain liens may be avoided under §522(f). The proposal would define "household goods" by incorporating the definition that appears in 16 C.F.R. §444.1(i). That regulation of the Federal Trade Commission defines "household goods" as:

Clothing, furniture, appliances, one radio and one television, linens, china, crockery, kitchenware, and personal effects (including wedding rings) of the consumer and his or her dependents, provided that the following are not included within the scope of the term "household goods": (1) Works of art; (2) Electronic entertainment equipment (except one television and one radio); (3) Items acquired as antiques; and (4) Jewelry (except wedding rings).

[Although the heading of the proposed section mentions antiques, no definition of "antiques" is given in the text.]

The impact. Section 522(f) allows the avoidance of nonpurchase money, nonpossessory liens on certain items of exempt household property. The policy underlying this provision is that when a lender extends credit on the basis of used household goods in the possession of the debtor, it is unlikely that there would be any substantial resale value in the collateral, and that the lender is primarily relying on the difficulty that the debtor would face in replacing the items. The Bankruptcy Code made the determination that such liens should not be enforced. It appears to be the intent of the proposed legislation to strictly limit the type of property that may be excluded from nonpossessory, nonpurchase money security interests. The FTC definition of household goods would exclude such common items as home computers, CD players, speaker systems, earrings, and framed prints. If so, it would be unduly restrictive. To some extent, the limitations of the FTC definition would not restrict §522(f), "because household goods" is only one of the categories of personal property as to which liens may be avoided under that subsection. Other categories include "household furnishings," and "jewelry." The major impact of the change may be to give rise to new litigation as to whether particular items not within the FTC definition of "household goods" constitute "household furnishings."

Alternative. In order to protect nonpurchase money lenders who genuinely rely on the value of the debtor’s personal property in extending credit, Section 522(f) could be amended to exclude from lien avoidance any items of personal property not within the FTC definition whose resale value exceeds a specified amount (for example, $1000).

§123 ( "Debtor retention of personal property security") (see H.R. 2500, §112).

The changes. Some courts have held that debtors in Chapter 7 may redeem personal property in installments. The proposed change would require that redemption take place by payment in full at the time of redemption. In addition, this section proposes that if the debtor does not redeem personal property that is collateral for a claim, or enter into a reaffirmation agreement with respect to the property, that the property will be deemed abandoned by the Chapter 7 trustee, so that the creditor may repossess the property or take other action allowed by nonbankruptcy law.

The impact. Although debtors rarely have equity in personal property that is collateral for debt, there can be situations where equity does exist, as in jewelry or luxury cars. This proposal, perhaps unintentionally, would remove property from the estate even if there was equity in the property. As applied to property in which there is no equity, the impact of the proposal would be to create an appropriate incentive in favor of Chapter 13 filings whenever a debtor wished to retain property that could not be redeemed, and as to which a reaffirmation agreement could not be negotiated.

Alternative. The proposal should be amended to allow a trustee to require that abandonment take place only after notice to the Chapter 7 trustee, with an opportunity for the trustee to be heard on the question of whether there is equity in the property.

§124 ( "Relief from stay when the debtor does not complete intended surrender of consumer debt collateral") (see H.R. 2500, §208).

The changes. Section 521(2) of the Bankruptcy Code currently requires Chapter 7 debtors to make an election as to their property which serves as collateral for consumer debts: they must indicate that they intend to retain or surrender the property, and "if applicable" state that the property is claimed exempt, that the debtor intends to redeem the property, or that the debtor intends to reaffirm the debts secured by the property. The law further indicates that the debtor is obligated to carry out the specified choice within 45 days of filing its notice of the election as to the property involved. Section 124 of the H.R. 3150 would make a number of changes in the operation of this provision:

(1) The section would be made applicable to all collateral, not merely collateral securing consumer debts.

(2) The time for performing the election would be changed from 45 days after the filing of the notice to "30 days after the first meeting of creditors under section 341(a)."

(3) The option for retaining the property and claiming it as exempt is eliminated, so that the only options given the debtor for collateral are: (1) surrender, (2) redemption, and (3) reaffirmation or lease assumption.

(4) A failure by the debtor to timely perform its election would result in termination of the automatic stay as to the property involved unless the debtor chose reaffirmation and the creditor refused to reaffirm on the original contract terms.

(5) If the automatic stay terminates pursuant to the above provisions, it is specified that the creditor should be allowed to proceed with any state law remedies for default based on the filing of the bankruptcy. Thus, the fact that the debtor was current in payments would not be grounds to prohibit repossession or foreclosure if state law allowed these remedies based on the filing of a bankruptcy. This provision would not be applicable as to property for which a lien was avoided in the bankruptcy case. [In this connection, there appears to be drafting error—including §553 of the Code in a list of sections under which a lien might be avoided. Section 553 terminates certain setoffs, which can function like liens in some circumstances, but the provisions of §521(2), sought to be enforced by this proposal, have nothing to do with setoffs.]

The impact. Current law has no enforcement mechanism for §521(2), and this section provides the most reasonable enforcement mechanism—relief from the automatic stay. Similarly, expressly allowing repossession based on the bankruptcy filing (if permitted by state law) addresses creditor concern that the collateral will not be maintained once the debtor is no longer personally liable for any deficiency. However, the proposal does not deal with the situation in which there may be equity in the property. Thus, in the situation of a home mortgage where there is equity in the property, the failure of the debtor to comply with the requirements of §521 results in relief from the automatic stay with no opportunity for the trustee to oppose that relief.

Moreover, the proposal would interfere with the debtor’s option to retain exempt property without reaffirmation or redemption. Debtors are allowed by §522(f) of the Code to avoid liens on certain exempt personal property secured by nonpossessory, nonpurchase money security interests. A requirement that the debtor surrender, redeem, or reaffirm debt as to this property would contradict this lien avoidance provision. Under the proposal, the automatic stay would terminate as to property exempted under §522(f) when the debtor failed to redeem or reaffirm the debt, even though no discharge had yet been granted the debtor. The debtor would presumably have a defense of lien avoidance if the creditor pursued state law remedies as to the property in question, but there is no reason why the automatic stay should not remain in effect in this situation.

A final difficulty with the proposal is its ambiguity in establishing the date by which a debtor must make the §521(2) election. The language "30 days after the first meeting of creditors under section 341(a)" might mean (1) 30 days after the first date set for the meeting (see Fed.R.Bankr.P. 3002(c)), (2) 30 days after the date on which the meeting is actually commenced, or (3) 30 days after the meeting is concluded (see Fed.R.Bankr.P. 4003(b)). This ambiguity, if uncorrected, can be expected to generate litigation.

Alternative. Failure by debtors to exercise their obligations under §521 could be made grounds for relief from the automatic stay, but relief awarded only on notice to the trustee. Relief would not be awarded where there is equity in the property and the trustee wishes to sell the property. The provision should also include as an option the retention of property with lien avoidance under §522(f), and should specify that the debtor must make the election within 30 days from the first date set for the creditors’ meeting.

§125 ( "Giving secured creditors fair treatment in Chapter 13") (see H.R. 2500, §105; S. 1301, §302).

The changes. Current case law interpreting Chapter 13 is in disagreement about the time at which a lien should be deemed released under a plan. This provision would resolve the dispute by amending §1325 of the Code to state that a lien can only be released at the time the debtor is discharged under §1328, or until the claim secured by the lien is fully paid, whichever is earlier. The provision also states that, in the event of conversion or dismissal of a Chapter 13 case, the lien would remain to the extent recognized under nonbankruptcy law.

The impact. This change would primarily affect automobile loans. Frequently an auto loan in a Chapter 13 case is in an amount greater than the value of the automobile. In such a case, the debtor is allowed to pay the value of the car in satisfaction of the secured claim, with the balance of the claim treated as unsecured. The plan may provide that as soon as the secured portion of the claim is satisfied, the creditor is required to release its lien. Thereafter, the debtor may fail to complete the plan, so that the creditor does not receive full payment of the unsecured portion of its claim. This provision would allow the creditor to retain its lien to secure payment of that unsecured portion.

The provision contradicts the bankruptcy policy requiring equal treatment of creditors. To the extent that a secured creditor has a claim not supported by collateral value, the Bankruptcy Code treats the creditor’s claim as unsecured, and entitled to the same treatment as other unsecured claims. This provision would allow the unsecured portion of a secured claim a preferential position—even though the value of its secured claim was paid, the creditor would be able to take action against property of the debtor to enforce its unsecured claim, a right that no other unsecured creditor would have.

The effect of conversion or dismissal of a Chapter 13 case is treated in separate provisions of the Bankruptcy Code, §§348 and 349. See §127 of H.R. 3150, discussed below. If changes are made regarding the effect of conversion or dismissal and not placed in those sections, questions may arise as to which section controls.

Alternative. Payments on account of unsecured claims can be required to be made in equal installments throughout a plan, so that the unsecured portion of a bifurcated claim is paid during the same time that the secured portion is paid, and all unsecured claims are treated in the same way. Changes in the effect of conversion or dismissal should be made in §§348 and 349 of the Code.

§126 ( "Prompt relief from stay in individual cases") (see H.R. 2500, §207; S. 1301, §311).

The changes. This section would provide that in individual bankruptcy cases under Chapters 7, 11, or 13, the automatic stay would terminate 60 days after a request for relief from the stay, unless (1) the court denies the motion, or (2) all parties in interest agree to a continuance of the stay beyond that time, or (3) the court makes a finding that continuance of the stay is required by compelling circumstances.

The impact. This provision does not substantially change existing law, which requires that all motions for relief from stay must be heard initially within 30 days, and that if the initial hearing is not final, the final hearing must commence within 30 days after the conclusion of the preliminary hearing. Both present law and the proposal allow extensions by the court for compelling circumstances.

§127 ( "Stopping abusive conversions from Chapter 13") (see H.R. 2500, §108; S. 1301, §310).

The changes. This section of the proposed legislation has two parts. First, under §348(f) of the Bankruptcy Code, when a debtor converts a Chapter 13 case to a case under Chapter 7, the valuation of allowed secured claims is carried over from the Chapter 13 case to Chapter 7, with the amount of the secured claim reduced by whatever payments were made on account of that claim to the secured creditor. The proposed bill would change this result, providing that to the extent any amount remains owing to the secured creditor at the time of the conversion, the entire amount owed will be secured by the collateral. Second, the section provides that, to the extent that any default in payments is not fully cured, the default "shall have the effect given under applicable nonbankruptcy law." [Note: This section of the proposed bill contains a drafting error. Section 348(f) of the Bankruptcy Code applies to all cases converted from Chapter 13 to other chapters of the Code. Section 108 is intended to leave the terms of §348(f) in place as they apply to Chapter 13 cases converted to Chapter 11 or 12, and then set out new terms, in a new subsection 348(f)(C), for cases converted from Chapter 13 to Chapter 7. Thus, the new subsection should have been introduced by the phrase "with respect to cases converted to Chapter 7." Instead, the new subsection is introduced by the redundant and confusing phrase "with respect to cases converted from Chapter 13."]

The impact. The first proposed change has a very narrow impact. In Chapter 7, pursuant to the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992), a debtor cannot simply pay the secured portion of any secured creditor’s claim and retain the collateral. Rather, a Chapter 7 debtor can only exercise this right in the context of a redemption, pursuant to §722 of the Code. This section allows a debtor to pay the amount of the "allowed secured claim" in order to redeem "tangible personal property intended primarily for personal, family or household use, from a lien securing a dischargeable consumer debt, if the property is exempted . . . or has been abandoned." When a case is converted from Chapter 13 to Chapter 7, a question may arise as to how much is required to be paid by the debtor in order to redeem tangible personal property, such as an automobile. Current law provides that the amount of the secured claim, fixed during the Chapter 13 case at the value of the collateral, continues to be the amount of the secured claim for purposes of the case on conversion to Chapter 7, and that any payments made on account of the secured claim during the Chapter 13 case reduce the claim on conversion. For example, if the debtor owed $10,000 on a car loan at the outset of a Chapter 13 case, and the car was valued by the court at $7,000, the lender would have had a secured claim of $7,000 in the Chapter 13 case and an unsecured claim of $3,000. If the debtor paid $2,000 on the secured claim through the Chapter 13 plan, and then converted the case, current law would provide that, on conversion, the lender had a secured claim of $5,000 (the original $7,000 claim reduced by the $2,000 payment). Thus, if the debtor wished to redeem the automobile in Chapter 7, the price for redemption would be $5,000, even if the car was worth more than that amount at the time of redemption. Under the proposed change, the intent appears to be that the creditor would have an $8,000 claim secured by the automobile (the total claim of $10,000 less the $2,000 paid during the Chapter 13 plan). In order to redeem, the debtor would then have to pay the entire value of the automobile, up to $8,000. In this way, the secured creditor could receive, as a price for redemption, a total compensation greater than the value of the collateral at the time of the filing of the case.

The second provision of the section, dealing with the cure of default, is unclear. Under nonbankruptcy law, a default gives secured creditors certain rights to the collateral, which may include immediate repossession or commencement of a foreclosure action. In a Chapter 7 bankruptcy, those rights are stayed. It may be that this provision is intended to terminate the automatic stay in a case converted from Chapter 13 to Chapter 7 whenever there is an uncured default. If so, the provision would violate the principle that the Chapter 7 trustees are allowed to sell property in which there is equity, for the benefit of all creditors.

Alternatives. Bad faith conversion from Chapter 13 is currently penalized by §348(f)(2), which provides that the Chapter 7 trustee in the converted case may liquidate all of the nonexempt property in the possession of the debtor at the time of conversion. This penalty could be made more effective by uniform exemption laws. Another alternative would be to allow denial of conversion in situations of bad faith.

§128 ( "Restraining abusive purchases on secured credit") (see H.R. 2500, §110).

The changes. This section of the proposed bill would change the bifurcation of any secured claim resulting from the debtor’s incurring secured credit within 180 days of the bankruptcy filing. Instead of the secured creditor having a secured claim only to the extent of the value of its collateral, with an unsecured claim for the difference, the secured creditor would be given a secured claim in the amount of the entire indebtedness outstanding at the time the bankruptcy was filed. If the creditor is also secured by other property, purchased more than 180 days prior to the bankruptcy, the claim would be bifurcated, but the resulting secured claim could not be less than the debt outstanding as a result of the purchase made within the 180 day period.

The impact. The section is not limited to situations of bad faith purchases—it applies in any case in which the debtor files bankruptcy after making a credit purchase. For example, if a debtor purchased an automobile in January, was laid off in February, and filed bankruptcy in May, this provision would result in a change in the operation of the Bankruptcy Code with respect to the claim secured by the automobile. In Chapter 7, one impact of this provision is to increase the cost of redemption. Instead of paying the value of the collateral at the time of redemption, the debtor would be required to pay the entire outstanding indebtedness. Another impact may be to reduce the recovery of the secured creditor in any Chapter 7 case where there is a distribution. Under existing law, any secured creditor would be viewed as having a secured claim to the extent of the value of the collateral, and an unsecured claim for the difference between the value of the collateral and the total claim. Thus, in the example given above, if $25,000 was the outstanding loan balance, and the car was valued at $20,000, current law would allow the creditor both to repossess the car and have a $5000 unsecured claim, payable through sale of the debtor’s other assets. Under the proposal, the creditor’s claim would be treated as fully secured, and repossession would be the sole recovery.

In Chapter 13 cases, the impact of this provision would be to prevent "strip down" of the affected secured claim. As a result, a greater portion of the debtors’ contributions to the Chapter 13 plan would go to pay the secured claim, and a smaller amount would be paid to unsecured creditors. For example, an automobile purchased six months before a bankruptcy may have substantially depreciated. If the automobile was purchased at a high interest rate with a long amortization, the amount owing on the car at the time of the bankruptcy may be close to the original purchase price. If the debtor missed one or more payments, the debt may exceed the original purchase price. The proposal would require that the debtor, in order to retain the automobile, pay the total amount due, rather than what the car was worth. Assuming that the debtor plan makes less than full payment of all claims, the effect is to increase the amount paid on the auto loan and reduce the amount paid to other creditors.

Alternatives. Current law allows both Chapter 7 and Chapter 13 cases to be dismissed for lack of good faith. The Code could be amended to provide that a case shall be dismissed for lack of good faith where a debtor is shown to have made a purchase on secured credit with the intent of filing bankruptcy shortly thereafter.

§129 ( "Fair valuation of collateral") (see H.R. 2500, §111).

The changes. This provision of the proposed bill would amend the claim bifurcation provision of the Bankruptcy Code (§506(a)) to provide that collateral in Chapter 7 and 13 cases is always valued at the cost to replace the property, without deducting the costs of sale or marketing, and that this replacement cost, for property "acquired for personal, family, or household purpose" is "the price a retail merchant would charge for property of that kind."

The impact. The impact of this proposal differs, depending on whether it is applied in Chapter 7 or in Chapter 13. In Chapter 7, the most common reason for bifurcating a claim is in redemption: a debtor is allowed, in Chapter 7, to retain personal property that cannot be sold for the benefit of unsecured creditors (because there is no equity in the property, or because it is exempt), by paying any creditors secured by the property the amount of their allowed secured claims. In this way, instead of obtaining the property, as they would by repossession, the secured creditors receive the value of the property, which may be less than the total amount owed. To the extent that the creditors receive less than the total amount they are owed, they are given an unsecured claim for the difference. Under current law, there is no explicit direction as to how to value the collateral being retained by the debtor. However, since redemption is a substitution for return of the collateral, there is no apparent reason why secured creditors should receive, in a redemption, any more than they would receive if they did repossess the collateral. Valuing the collateral at the price it would cost the debtor to replace it gives an arbitrary increase in collateral value to the secured creditor, with the amount of the increase depending on how expensive it would be for the debtor to replace the property involved. Using retail price as the measure for replacement cost exacerbates this problem, since, as the Supreme Court noted in its recent Rash decision, retail price may include "items such as warranties, inventory storage, and reconditioning," that are in no sense part of the collateral that secures a creditor’s claim. Associates Commercial Corp. v. Rash, 117 S.Ct. 1879, 1886 n.6 (1997). Finally, in the context of redemption, the creditor has no risk of nonpayment, and so there is no reason for any increase in the amount of the secured claim to compensate for risk of nonpayment. Chapter 7 cases involving a distribution

In Chapter 13, the principal reason for bifurcation is in "stripping down" liens to the value of the collateral and paying the reduced secured claim over the course of the plan. Here, the impact of bifurcation is to divide the plan payments between secured and unsecured creditors. The debtor must either pay all claims in full (including the unsecured portion of a secured claim) or else must pay all disposable or "net" income into the plan. To the extent that a secured claim is valued at a higher level, less of the plan payments will go to unsecured creditors. So, in this context, "fairness" requires a balancing of the rights of secured and unsecured creditors. Again, the value of collateral to a secured creditor is best measured in terms of what that creditor could get for the collateral. To the extent that the creditor could only obtain part of what is owed from the collateral, the creditor is best seen as unsecured, just like the other unsecured creditors, regardless of how much it might cost the debtor to replace the property. In contrast to redemption, however, the secured creditor in Chapter 13 does not receive immediate payment of its claim, and so the creditor does have a risk of nonpayment. This can be addressed by amending the Code to provide that payments of secured claims in Chapter 13 plans should carry an interest rate sufficient to offset the risk of nonpayment.

On the other hand, in both Chapter 7 and Chapter 13 cases, this provision may have the effect of reducing secured creditor recovery in situations where the collateral is repossessed. A creditor who repossesses collateral after the case is filed would be given a secured claim for the retail value of the collateral, even though the creditor could not obtain retail value in disposing of the collateral. The artificially high secured claim would, in turn, reduce the unsecured claim for the creditor would receive a distribution.

A final difficulty with the proposal is that many items of collateral (unlike automobiles) do not have an established retail market as used items. For example, a creditor may be secured by a five year old washing machine. There are unlikely to be readily ascertainable retail markets for such machines. The proposal would leave no guidance as to the proper valuation method in this situation.

Alternative. To create a fair valuation of collateral, the Code could be amended to provide that a secured creditor receive a secured claim in the amount that the creditor could establish that it would receive using any method of sale available to the creditor. If the claim is not paid immediately, the creditor should receive an interest rate on the secured claim sufficient to offset the risk of nonpayment. A similar standard of valuation has been proposed by the National Bankruptcy Review Commission. Final Report at 243-58.

§130 ( "Protection of holders of claims secured by debtor’s principal residence") (see H.R. 2500, §120).

The changes. Section 130 of H.R. 3150 would (1) provide that a claim is not subject to modification if it is secured "primarily" (rather than "only") by a lien on property used as the debtor’s principal residence at any time during the 180 days prior to the bankruptcy, (2) define "debtor’s principal residence," and (3) exclude continuances of mortgage foreclosures from the operation of the automatic stay.

The impact. These changes largely resolve conflicts in the case law respecting the treatment of home mortgages in Chapter 13. Section 1322(b)(2) provides that, generally, secured claims can be modified in Chapter 13. This allows the plan to pay, as a secured claim, only the value of the collateral. To protect lenders of home mortgages, the right to modify is denied when the lender is secured only by a mortgage on the debtor’s principal residence. Some decisions have held that a multi-unit building would constitute security other than the debtor’s principal residence, or that a mobile home would not be a residence. The proposed change would include loans on such property within the scope of the protection. Similarly, there have been reports of situations in which debtors have vacated their homes shortly before filing Chapter 13 cases, so as to remove the protection given to the mortgage lender. The proposal negates such a tactic by applying the protection to homes used as the debtor’s principal residence during a 180 day period prior to the bankruptcy.

A final issue regarding the application of the non-modification provision has to do with other security issued in connection with a home mortgage. Current law applies nonmodifiability where the claim is secured "only" by a lien on the debtor’s principal residence. Questions have arisen as to whether security incident to a mortgage (such as an assignment of rents) results in the loss of nonmodifiability. The proposal deals with these questions by requiring only that the claim be primarily secured by a homestead mortgage. This change may be overbroad. Debtors sometimes give home mortgages as additional security in connection with a business loan—clearly not the kind of loan for which the special protection was found necessary—and the business lenders could argue (particularly if the business fails) that the home mortgage was their "primary" security.

The remaining change made by this section involves the automatic stay. Some decisions have held that, in order to avoid violation of the automatic stay, a lender with a foreclosure pending at the time of a bankruptcy filing would have to dismiss the proceeding. Then, if the automatic stay were terminated, the lender would be required to serve all required notices and otherwise recommence the proceeding. The proposal would allow, instead, a simple continuance of the proceeding as of the time of the bankruptcy filing, so as to allow immediate recommencement in the event of termination of the stay.

Alternative. Instead of providing for nonmodifiability whenever a homestead is the "primary" security for a loan, the needs of mortgage lenders could be addressed by a provision applying nonmodifiability to any loan secured only by a mortgage and by interests associated with the mortgage.

Subtitle C ( "Adequate Protections for Secured Lenders")

§141 ( "Debts incurred to pay nondischargeable debt") (see H.R. 2500, §106).

The changes. Current §523(a)(14) provides that debts incurred to pay nondischargeable tax obligations are nondischargeable. This provision would expand §523(a)(14) to apply to all nondischargeable debt and would further provide that the debt to pay nondischargeable debt would have the same priority as the debt it was incurred to pay.

The impact. The impact of this proposal could be an arbitrary imposition of nondischargeability. The provision is not limited to debts incurred fraudulently, which are already nondischargeable under §523(a)(2). Thus, this proposal would apply to debts incurred in good faith, and would render them nondischargeable based simply on how the debtor chose to use the borrowed funds. If the debtor used borrowed funds to pay rent, and other funds to pay child support, the debtor would have no nondischargeable debt. But if the debtor used the same borrowed funds to pay child support, and the other funds to pay rent, the borrowed funds would be a nondischargeable debt, required to be paid as a priority.

Moreover, the provision presents substantial tracing problems. Section 523(a)(14) has had little impact thus far, perhaps because of the difficulty in tracing the source of cash used to pay taxes. It would similarly be difficult to trace the source of cash used by a debtor to pay nondischargeable obligations, such as child support, whenever these obligations were paid from an account into which the debtor deposited both borrowed funds and funds received from other sources.

§142 ( "Credit extensions on the eve of bankruptcy presumed nondischargeable") (see H.R. 2500, §107).

The changes. Current §523(a)(2)(C) provides that if a debtor borrows more than $1000 from a single creditor for items that are not needed for the support of the debtor or the debtor’s dependents, or takes cash advances of more than $1000, within 60 days of the filing of a bankruptcy, the debt is presumed to have been obtained by fraud. In keeping with the consensus reflected in In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996), this would mean that the debtor is presumed to have incurred the debt without intending to repay it. The proposed change would expand this presumption to all consumer debts incurred within 90 days preceding the bankruptcy. [Note: the proposed language continues to include the phrase "consumer debts owed to a single creditor." In view of the fact that there is no longer a minimum borrowing requirement for invoking the exception, this phrase serves no purpose and may be confusing—e.g., creating the impression that only one creditor could assert the presumption.]

The impact. The impact of the presumption, under current law, would be to require debtors to carry the burden of establishing, in response to a creditor complaint alleging fraud, that they did intend to repay each debt incurred by them within three months of the bankruptcy filing. The expanded presumption would have an impact far beyond the credit card matters to which the presumption now applies, applying, for example to medical debts, grocery bills, and rent obligations. The impact of this provision would be increased by §143, which makes debts arising from fraud nondischargeable in Chapter 13. Finally, §145, discussed below, would change the standard for fraud in the use of credit cards, significantly increasing the burden of the debtor under §142.

Alternatives. The present law could be amended to make clear that the misconduct leading to nondischargeability is incurring debt with an intent not to repay the debt. With this understanding, other circumstances might be set out in which debt incurred shortly before bankruptcy is presumed to be nondischargeable: for example, debt incurred to finance casino gambling, or debt incurred in excess of some percentage of the debtor’s ordinary expenses.

§143 ( "Fraudulent debts are nondischargeable in Chapter 13 cases") (see H.R. 2500, §104).

The changes. This section would limit the superdischarge available in Chapter 13 by excluding from that discharge debts incurred by fraud (as defined by §523(a)(2) of the Code); by fraud or defalcation while acting as a fiduciary, embezzlement, or larceny (as defined by §523(a)(4)); and intentional torts (as defined by §523(a)(6)). [Note: the rationale of this section would require that debts covered by §523(a)(3)(B) also be nondischargeable in Chapter 13. Subparagraph (a)(3)(B) governs debts nondischargeable under §523(a)(2), (4), and (6), as to which notice was not given to the creditor in time to file a timely complaint to determine dischargeability.]

The impact. This provision would increase the recovery of certain creditors after the completion of a Chapter 13 case. However, the provision would also largely eliminate the superdischarge of Chapter 13, thus removing a major incentive for filing Chapter 13 cases, and increasing the need for court hearings.

The largest number of nondischargeability complaints brought before bankruptcy courts in recent years has been on account of alleged fraud by debtors in the use of credit cards. The courts have struggled with the application of the fraud provisions of §523(a)(2) of the Code to credit card debt, but a consensus has emerged that the use of a credit card is fraudulent if the debtor had an actual intent not to repay the credit card charge at the time the card was used. See In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996). This, in turn, presents a question of fact that can require a trial. Rather than incur the expense of such a trial, a debtor may, under current law, seek relief under Chapter 13, and, if the plan is successfully completed, the debtor will be discharged from the credit card debt regardless of the circumstances under which it was obtained. Under the proposal, the question of the debtor’s intent (and the dischargeability of the debt) would remain in Chapter 13, thus providing no incentive for the debtor to choose that chapter, and presenting the courts with the potential for more hearings on the dischargeability of credit card debt. Similar incentives to file Chapter 13 exist when the debtor has engaged in conduct that might give rise to claims for breach of fiduciary duty or intentional torts. All of these incentives to file Chapter 13 are removed by this provision. It can thus be expected to increase the incentives to file Chapter 7—discharging all other debts without payment—leaving only the questionable debt to be dealt with outside of bankruptcy.

§144 ( "Applying the codebtor stay only when it protects the debtor") (see H.R. 2500, §118; S. 1301, §305).

The changes. Under present law, if a Chapter 13 debtor is liable with another party on a particular debt, the creditor is automatically stayed from taking action against the other party, but the creditor may obtain relief from this codebtor stay if the codebtor received the consideration for the claim. Section 144 of H.R. 3150 would change this situation by providing that the codebtor stay would never go into effect if the debtor did not receive the consideration, so that the creditor, in that circumstance, could take action against the codebtor or property not in the possession of the debtor. The section also provides for termination of the codebtor stay as to any rented property that the debtor’s plan proposes to abandon or surrender.

The impact. Contrary to the title of this section of the proposed bill, the codebtor stay in Chapter 13 never protects the debtor. Actions against the debtor are stopped by the automatic stay invoked in all chapters of the Code. Rather, the codebtor stay allows the Chapter 13 debtors to pay, through the plan, debts for which they are primarily responsible, and protects codebtors who did not receive the benefit of the debt (that is, true accommodation parties) from collection actions. Under current law, if the creditor believes that the nondebtor obligor was the one who really obtained the benefit of the debt, the creditor may seek relief from the codebtor stay to allow action to be brought against the codebtor (and property owned by the codebtor). The proposed change states that the codebtor stay never goes into effect when the codebtor received the benefit of the transaction. When the debtor and another party jointly incur a liability (like a joint loan, or a cosigned loan), it may not be clear which of the parties received the benefit of the transaction. Current law protects true accommodation parties by requiring that the creditor seek court permission before acting against them on the belief that they were the ones receiving the benefit of the transaction. The change would allow creditors to take action without court permission, and require that debtors seek sanctions for violation of the stay if the debtor was the actual beneficiary. It is not clear which approach is most efficient. The issue is not a common one.

There is no apparent reason why a surrender of leased property should eliminate the need for the codebtor stay. Where a nondebtor signed a personal property lease as an accommodation to the debtor, the debtor would—under current law—retain the right to pay whatever obligations arose from the lease in full through the plan, regardless of whether the debtor kept the leased property. In such a situation, the party who signed the lease as an accommodation should continue to be protected from collection actions while the debtor was making plan payments.

§145 ( "Credit extensions without a reasonable expectation of repayment made nondischargeable") (new)

The changes. Current law deals with misuse of credit cards as a type of fraud, and, accordingly, the courts have generally held that misuse of a credit card is only nondischargeable if the debtor did not intend to repay the charges made before filing bankruptcy. Thus, a debtor who uses a credit card foolishly, but in good faith, is able to obtain a discharge of the resulting debt. See In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996) (applying this interpretation). Section 145 of H.R. 3150 would change this rule to provide that if the debtor used a credit card "without a reasonable expectation or ability to repay," the resulting debt is nondischargeable. In this way, the debtor’s financial situation would be reviewed as of the time the credit card was used, and, if a reasonable person would have concluded that the debtor was unlikely to be able to repay the debt, the debt would be nondischargeable.

The section makes a second change not related to its title, dealing with false written statements about the debtor’s financial condition. Current law makes such statements the basis for nondischargeability only when, among other things, the debtor intends to deceive the creditor. The proposal would change this standard of intent to one of negligence, allowing a finding of nondischargeability if the debtor did not take reasonable steps to assure that the statement was accurate.

The impact. This proposal would make a major change in dischargeability law. In general, debts have been held nondischargeable under the Bankruptcy Code in only two situations: (1) where the debt is one that must be repaid for the good of society, such as taxes and family support, and (2) where the debtor has engaged in intentional wrongful conduct. Negligence, except in situations involving fiduciary duties, has not been a ground for nondischargeability. This proposal would institute a negligence standard for fraud, both in the use of credit cards and in the completion of financial statements.

The change with respect to credit card debt is the most significant, because so many of the nondischargeability cases now before the courts involve this issue. The impact of the change is to render nondischargeable all use of credit cards beyond the reasonable ability of the debtors to repay.

The impact of the proposed change is magnified by two of the other changes proposed by H.R. 3150: the presumption of nondischargeability that would be created by §142, and the extension of nondischargeability to Chapter 13, proposed by §143. The combined effect of these provisions is to render all use of credit cards within 90 days of bankruptcy nondischargeable, in both Chapter 7 and Chapter 13, unless the debtor can prove that there was a reasonable prospect for repaying the charges.

Subtitle E ( "Adequate Protections for Lessors")

§161 ( "Giving debtors the ability to keep leased personal property by assumption") (see H.R. 2500, §116).

The changes. This section would make two principal changes to the Bankruptcy Code. First, it would remove from the estate (i.e., abandon) all leased personal property as to which the lease is not assumed. In Chapter 7, this abandonment would occur when the lease is rejected by the trustee (which occurs automatically, under existing law, if the trustee does not assume the lease within 60 days of the filing of a voluntary case). [Note: the section states that "the leased property is no longer property of the estate and the stay under section 362(a) of this title is automatically terminated." This language is redundant, since §362(c)(1) already provides that the stay terminates as to property of the estate when the property is no longer property of the estate. By including the extra language terminating the stay, this provision might lead to confusion, for example, the erroneous belief that the stay was terminated as to personal actions against the debtor arising out of the lease.] In Chapter 13, the abandonment would occur if the lease was not assumed in the plan and the codebtor stay would also terminate on lease rejection.

The second effect of the section is to permit the equivalent of reaffirmations with respect to leased property through assumption of the leases, and to eliminate the automatic stay as it would apply to discussions regarding such assumptions. Under the procedure set out by the section, the debtor would have to initiate discussions regarding assumption of a lease through a written notification.

The impact. The provisions regarding abandonment of leased property make explicit the implication that leased property as to which the lease is rejected is no longer part of the bankruptcy estate.

The provisions regarding assumption of leases by the debtor in Chapter 7 may require additional safeguards. Reaffirmations of debt have been a sensitive subject under the Bankruptcy Code, since they involve debtors repaying debts that otherwise would be discharged. To prevent overreaching by creditors in this regard, the Code presently contains a number of safeguards applicable to reaffirmation, including information that must be given to the debtor, determinations by debtor’s counsel that the reaffirmation is in the debtor’s best interest, and court authorization of reaffirmations for unrepresented debtors. Unless similar protections were enacted in connection with assumed leases (with cure of past due indebtedness) creditor overreaching could be a similar problem.

§162 ( "Adequate protection of lessors and purchase money secured lenders";) (see H.R. 2500, §212).

The changes. This section of the proposed bill would create a new provision in Chapter 13, requiring payments to secured creditors and lessors of personal property. These payments would be in the amounts and frequency specified by the applicable contract unless the debtor sought a court order reducing the amounts and frequency. However, the court would be required to order payments no less than monthly in an amount no less than the depreciation of the property involved. These payments would be required to continue until the creditor began receiving "actual payments" under the Chapter 13 plan.

The section would also clarify the right of creditors to retain possession of the debtor’s property, if it was properly obtained before the bankruptcy was filed, until the creditor receives the first adequate protection payment required by the section.

Finally, the section requires that debtors in Chapter 13 must provide proof of insurance of leased property and collateral within 60 days of the filing of the bankruptcy.

The impact. Secured creditors are entitled to seek adequate protection, pending plan confirmation, under existing law, and are entitled to relief from the automatic stay if adequate protection is not provided. This provision would give secured creditors a presumptive right to more than adequate protection payments, because the underlying contract (for example, a mortgage or an auto note or lease) generally provides for payments at a level greater than necessary to offset depreciation. The debtor would be required to present a motion to reduce the presumptive payments to the actual level of depreciation (if any). That would involve significant additional cost in most Chapter 13 cases.

Under existing law, it may be unclear whether a creditor in rightful possession of a debtor’s property at the outset of a bankruptcy case must return the property in the absence of adequate protection. The proposal would make it clear that adequate protection is required.

The requirement for periodic proof of insurance may be an unnecessary burden on debtors, since creditors are generally informed by insurers as to any lapse in coverage. Moreover, if the creditor is not assured of such notice, the creditor would have to take action to ascertain the status of the insurance before 60 days had elapsed from the date of the bankruptcy filing. Proof of insurance by the debtor at the conclusion of the 60 day period would add little protection to the creditor.

§163 ( "Adequate Protection for Lessors") (new).

The changes. Despite its caption, this section deals with an exception to the automatic stay. Under current law, lessors of nonresidential real estate (for example, shopping center lessors) may proceed with eviction proceedings after the lessee files a bankruptcy case, without violating the automatic stay, if the lease has terminated by expiration of its stated term prior to the bankruptcy filing. Section 163 of H.R. 3150 would expand this exception to cover all rented real estate. Thus, landlords would be allowed to evict Chapter 13 debtors from their apartments, without obtaining relief from the automatic stay, if the leases expired prior to the bankruptcy filing.

The impact. There is no reason for the automatic stay to apply to an expired residential lease. A lease can only be assumed by a debtor in Chapter 13 if it is unexpired, pursuant to §§365(a) and 1322(b)(7). However, a debtor and landlord may well be in dispute about whether a lease has expired. Many leases have automatic renewal terms, contingent on notice being given or the lease not being in default. If there is a dispute about lease expiration, then, under current law, the landlord would be required to obtain relief from the automatic stay before going forward with an eviction proceeding in state court. See, e.g., Robinson v. Chicago Housing Authority, 54 F.3d 316 (7th Cir. 1995) (affirming an order granting relief from the stay to pursue eviction). Under the proposed change, the landlord, in the event of such a dispute, would be able to go forward with the eviction, requiring the Chapter 13 debtor—believing that the lease was still in effect—both to defend the eviction proceeding and to bring a proceeding in bankruptcy court to have the landlord found in violation of the automatic stay. If the debtor prevailed, fees and costs would be awarded, pursuant to §362(h), but the debtor may have difficulty in the first instance in obtaining the funds to pursue proceedings in both courts. Although this is not a situation that arises frequently, it may be preferable to continue to require that evictions in situations of residential leases be subject to the automatic stay.

On the other hand, the proposed exception could be applied in Chapter 7 cases without harm to the rights of the debtor, since Chapter 7 debtors have no right to assume defaulted leases.

Alternative. The expanded exception could be applied in Chapter 7 cases only.

Subtitle F ( "Bankruptcy Relief Less Frequently Available for Repeat Filers")

§171 ( "Extended period between bankruptcy discharge") (see H.R. 2500, §121).

The changes. Current law allows a Chapter 7 discharge to be entered only once in six years. The proposal would change this to a 10 year interval. Current law imposes no limit on Chapter 13 discharges, although the discharge can only be entered at the completion of a plan, and most plans require a three to five year period to complete under current law. The proposal would require that a Chapter 13 discharge not be granted if the debtor received any bankruptcy discharge within the five year period prior to filing the Chapter 13 case.

The impact. These proposals would render large numbers of debtors unable to obtain any bankruptcy relief for an extended period of time, and would substantially reduce the incentives for using Chapter 13.

It is entirely possible for individuals to require bankruptcy relief on more than one occasion with a span of a few years. Job loss, medical problems, and divorce can each cause financial difficulties that an individual cannot overcome. Under current law, the individual can obtain a Chapter 7 discharge to address these problems only once in six years, but could submit to a Chapter 13 repayment plan and obtain relief within the six year period. The availability of such a discharge is one of the major incentives for the use of Chapter 13. That possibility is removed by the proposed provision, leaving the individual with no means of requiring creditors to accept pro rata payment of the debtor’s available funds. The result would be the "race to the courthouse" that bankruptcy was intended to avoid, with the more aggressive creditors getting the larger share of wage garnishments and judgment lien foreclosures. The incentive for creditors to cooperate with consumer counseling services in these situations would also be greatly reduced, since the debtor would not have the option of bankruptcy in the event of noncooperation, and noncooperating creditors would have an advantage over those who did cooperate.

Alternative. The required period between Chapter 7 discharges could be extended without imposing limits on Chapter 13 discharges.

Subtitle G ( "Exemptions")

§181 ( "Exemptions") (see H.R. 2500, §113).

The changes. This section impacts the perceived problem of debtors changing their residence in order to obtain more favorable homestead exemptions. Current law applies the exemption law of the place where the debtor’s domicile was located for the largest part of the 180 days preceding the bankruptcy. Thus, a debtor could obtain a homestead exemption by establishing a domicile in a new state 91 days prior to filing a bankruptcy. The change would increase the 180 day period to 365 days, requiring that a debtor, seeking a homestead exemption in a new state, must establish a new domicile 183 days before filing bankruptcy.

The impact. This proposal will likely have very little impact. Only a few, wealthy debtors are likely to change state of domicile in order to obtain larger exemptions, and those debtors are likely to be able to wait for six months before filing bankruptcy.

Alternatives. The fundamental issue regarding exemptions is whether they should be more uniform, so that debtors do not receive significantly differing treatment in bankruptcy depending on their state of domicile. Greater uniformity would reduce the incentive for debtors to change domicile before filing bankruptcy petitions. Such a change in exemption law has been proposed by the National Bankruptcy Review Commission. Final Report at 117-44. H.R. 2500 proposes a new commission to study the question.

Title II ( "Business Bankruptcy Provisions")

Title III ( "Municipal Bankruptcy Provisions")

These titles do not involve consumer bankruptcy issues and are therefore not treated in this analysis.

Title IV ( "Bankruptcy Administration")

Subtitle A ( "General Provisions")

§401 ( "Adequate preparation time for creditors before the first meeting of creditors in individual cases") (see H.R. 2500, §204).

The changes. This section would amend the Bankruptcy Code to provide that first meetings of creditors take place between 60 and 90 days after the filing of voluntary individual bankruptcy cases, unless the court orders an earlier meeting.

The impact. Under current law, set out in Fed.R.Bankr.P. 2003(a), the first meeting of creditors must take place between 20 and 40 days after case filing in voluntary Chapter 7 and 11 cases, and between 20 and 50 days in a Chapter 13 case. The proposal would delay these times by more than a month. This may allow greater creditor involvement in consumer bankruptcy cases, but it would have the drawback, particularly in Chapter 13 cases, of delaying payouts to creditors.

§402 ( "Creditor representation at first meeting of creditors") (see H.R. 2500, §205; S. 1301, §308).

The changes. This provision would allow nonattorneys to represent creditors at creditor meetings.

The impact. This proposal would have the potential for increasing creditor involvement in any areas where appearances by nonattorneys are currently prohibited.

§403 ( "Filing proofs of claim") (see H.R. 2500, §209).

The changes. This section changes the law that currently requires the filing of a proof of claim in order for a creditor to share in the distribution of payments in Chapter 7 and 13 cases. Under this provision, a proof of claim would be deemed filed as to all debts scheduled by the debtor as other than disputed, contingent, or unliquidated.

The impact. Frequently, consumer debtors have poor records of what they owe. Accordingly, the debtors often schedule debts that either are not owed, or are owed in smaller amounts than scheduled. The requirement of a proof of claim by the creditor assures that an actual debt is paid in an appropriate amount. Treating all scheduled debts as proofs of claim may result in overpayments of claims, or payment of claims that are not owing, reducing the payments to creditors with actual, accurate claims.

The requirements for filing proofs of claims, as well as the results of untimely filing, were extensively treated in the 1994 Bankruptcy Reform Act. This provision would undo what has only recently become settled law.

§404 ( "Audit procedures") (see H.R. 2500, §202; S. 1301, §307).

The changes. This section of the proposed bill would establish a system for random audits of the accuracy and completeness of schedules and other information required to be provided by debtors in bankruptcy. The proposal would require that at least 2% of all cases be audited "in accordance with generally accepted auditing standards . . . by independent certified public accountants or independent licensed public accountants." The proposal requires the Attorney General to establish procedures for fully funding the audits, but does not specify a source of funding. The report of each audit is to be filed with the court, the Attorney General, and the United States Attorney, and if the audit report discloses any material misstatement of income, expenses, or assets, notice of the misstatement is required to be given to creditors and to the United States Attorney for possible criminal investigation. [Note: the sentence of the proposal dealing with material misstatements requires rewriting to correct syntactical errors.]

The impact. This proposal reflects a recommendation of the National Bankruptcy Review Commission (Final Report at 107-110), and would provide an incentive for debtors and their counsel to provide accurate and complete information. However, formal audits by licensed accountants would also generate substantial costs. With bankruptcy filings exceeding 1 million per annum, an audit cost of only $500 per case would impose an additional cost of at least $10 million per annum; at $1000 per case, a more likely figure given the poor record-keeping of many consumer debtors, the 1.4 million bankruptcies filed last year would generate an audit cost of $28 million. Since the proposal does not identify a source for funding the audits, the impact of the cost is uncertain. If the cost were treated as an administrative expense, creditors would pay for the audits in the form of reduced payments on their claims. A fairer way to pay for audits would be through the fees currently collected from debtors (at the time of filing) and creditors (seeking relief from the automatic stay), but to allow payment from current fees, the cost of the audits would have to be restrained.

Additionally, the requirement that audit reports be filed in multiple locations will impose additional costs for document retention on offices inolved, and, depending on the detail of the reports, involve unnecessary intrusions on the debtors’ privacy.

Alternatives. In order to reduce costs, audits could be conducted by trained employees of the United States trustee, rather than by licensed accountants, according to regulations established by the Executive Office of the United States Trustee, rather than generally accepted auditing standards. With costs controlled, the source of funding for the audits can be specified as the existing fees collected in bankruptcy cases, without an increase in those fees.

§405 ( "Giving creditors fair notice in Chapter 7 and 13 cases") (see H.R. 2500, §206; S. 1301, §309).

The changes. The primary change made by this section is a requirement that creditors be given notice of a bankruptcy filing at their preferred addresses. Under current law, if a creditor actually receives notice of a bankruptcy case, it may be liable for sanctions for willful violation of the automatic stay if it thereafter takes action to enforce its rights against collateral or otherwise collect a debt owed by the debtor. This provision would eliminate sanctions for violation of the stay (or failure to turn over property of the estate) in situations where notice of the bankruptcy was sent to an address of the creditor other than the last address it provided to the debtor for correspondence regarding the debtor’s account. This elimination of liability would only apply if (1) the creditor had a designated person or department for receiving bankruptcy notices, (2) the creditor had a reasonable procedure for directing bankruptcy notices to that person or department, and (3) despite the reasonable procedures, the creditor’s designated person or department did not receive the notice in time to prevent the collection activity from taking place.

The impact. This proposal would eliminate sanctions for violation of the automatic stay in situations where notice of a bankruptcy was received by personnel of the creditor who were unable to prevent subsequent collection action. However, it would also complicate litigation regarding violations of the automatic stay. If a creditor took collection action after the bankruptcy case was filed, there would be questions subject to litigation concerning (1) the last address specified by the creditor in a communication, (2) whether the creditor had reasonable procedures in place for directing the communication to a particular person or department, and (3) whether that person or department received the notice in time to prevent the collection activity from taking place. Most of the information relating to these matters would be exclusively in the possession of the creditor, making it difficult for debtor’s counsel to determine whether an intentional violation of the automatic stay had occurred without substantial discovery. Lacking the resources to pursue such discovery, debtors might be unable or unwilling to pursue enforcement action.

§406 ( "Timely filing and confirmation of plans in Chapter 13") (see H.R. 2500, §114; S. 1301, §304).

The changes. This section would set a time limit for Chapter 13 debtors to file plans—30 days after the filing of the bankruptcy case. The section would also require that hearings on the confirmation of the plan take place within 45 days of the filing of the plan. In each situation, the court could order the deadline altered.

The impact. Under current law, Fed.R.Bankr.P. 3015(b), a plan is required to be filed either with a Chapter 13 petition or within 15 days thereafter, unless extended by the court for cause. The proposal would increase the time in which a debtor would be allowed to file a plan. This, in turn, would delay payments into the plan, which are required by §1326(a) of the Code to commence within 30 days after the plan is filed. There is no current time limit for the hearing on confirmation, but some courts have determined to delay confirmation until after the deadline for filing claims has passed. The proposed change would require that these courts enter orders extending the time for hearing if this practice were to be continued. This section conflicts with other provisions of H.R. 3150. See the discussion in connection with §409, below.

Alternatives. In order to effectuate timely confirmation of Chapter 13 plans, the 15 day time limit for plan filing might be enacted as part of the Code itself, rather than being part of the bankruptcy rules.

§407 ( "Debtor to provide tax returns and other information") (see H.R. 2500, §210; S. 1301, §301).

The changes. This section would add several items to the information that individual Chapter 7 and 13 debtors are required to provide in connection with a bankruptcy case, unless ordered otherwise by the court. These items include (but are not limited to) the following: (1) copies of any federal tax returns, including schedules and attachments, filed by the debtor during three years prior to the bankruptcy case; (2) copies of any tax returns and schedules filed during the pendency of the case, either for current tax years, or for the three years preceding the filing; (3) any amendments of the returns set out above; (4) evidence of payments made by any employer of the debtor during the 60 days prior to the filing of the case; and (5) a certificate regarding the debtor’s receipt of the proposed required notice regarding consumer credit counseling services. In addition, a Chapter 13 debtor would be required to file annually a statement of the debtor’s income and expenditures in the preceding year and the debtor’s monthly net income during that year, showing how calculated, disclosing the amount and sources of income, the identity of the persons responsible with the debtor for the support of any dependents, and any persons who contributed (and the amounts contributed) to the debtor’s household. Also, debtors would have the obligation to provide copies of their petition, schedules, statement of affairs, and any plan and plan amendments to any creditor on request of the creditor, and any copies of such filings made subsequent to the request. Tax returns would be filed with the United States trustee; the other information would be filed with the court. All of these filings, including the tax returns and amendments, would be available to any party in interest for inspection and copying.

The impact. This section has the potential for making information available to trustees and creditors that may be significant in the administration of the debtor’s case. However, Fed.R.Bankr.P. 2004 currently allows information regarding the debtor’s financial condition—including tax returns—to be obtained, as required, with disclosure limited to the parties who need the information, and with the potential for court orders limiting further disclosure. The general disclosures required by the changes proposed here would impose two significant burdens not part of current law: (1) There would be a potentially difficult and expensive provision of information in every case, regardless of the need for the information. Since debtors in financial distress often fail to retain financial documentation, it is likely that they will not have ready access to their tax returns for the three years preceding the bankruptcy, or to their pay stubs for two months preceding bankruptcy. Similarly, during a bankruptcy, debtors are likely to have difficulty maintaining detailed records regarding their expenditures and sources of income. (2) The changes would involve a significant intrusion into the privacy of the debtors. Tax returns are not public documents, and are ordinarily disclosed in litigation only when they are particularly relevant to a dispute, and only to the parties with a need to review them. This provision would require debtors to make several years of their tax returns available for review by any creditor, and the creditors would be free to make whatever use they wished of the information contained in the returns, including compiling and disseminating it. Both the difficulty and cost of assembling the required information and the intrusion on privacy would act as substantial barriers to good faith bankruptcy filings.

The requirement that debtors provide copies of petitions, schedules and plans to all creditors on request may encourage routine requests for such documents by creditors who do not require these documents for their participation in the bankruptcy case (current law requires notice to creditors of the essential events in the case), imposing additional expense on debtors and their counsel.

The provision that the required information need not be supplied if the court orders to the contrary creates the potential for substantial variations in practice from court to court. Some judges may determine that certain of the information (or all of it) is not required unless requested by a creditor with cause; other judges may routinely deny any request by debtors to limit the information. No standards are supplied.

Finally, the need to file all of the additional documents in each consumer case would impose a substantial additional cost on the clerks’ office and offices of the United States trustee.

§408 ( "Dismissal for failure to file schedules timely or provide required information") (see H.R. 2500, §211; S. 1301, §312).

The changes. This section creates a new ground for dismissal of Chapter 7 and 11 cases—failure to provide the information required by §407. Failure to file initial documents (including past tax returns and pay stubs) results in mandatory, automatic dismissal on the 46th day after filing, subject only to a timely request by the debtor for an extension of up to 15 days. The court is required to enter an order confirming the dismissal if requested by any party. Failure to file (or supply to creditors on their request) any subsequently required documents is also subject to mandatory dismissal, upon request of any party in interest. The deadline for compliance with a creditor request is to be set by the court within 10 days of the request, and may not exceed 30 days.

The impact. The difficulty of complying with the proposed initial disclosures (of tax returns and pay stubs) is noted in the discussion of §407, above. Section 408 would impose automatic dismissal as a penalty for failure to comply with these disclosure requirements, without providing notice to the debtor of any deficiency in the filing. Although the debtor is given an opportunity to seek an additional 15 days to comply, no further extensions are authorized. Given that it may take more than 60 days to obtain copies of tax returns from the Internal Revenue Service, these provisions may result in dismissal of cases filed in good faith. In connection with enforcing the requirements for postpetition copies and tax information, the court is also given no discretion. It must order the information produced and dismiss the case if the order is not complied with. These provisions would discourage good faith filings at the outset, and may result in dismissal of cases that are filed and prosecuted in good faith.

Rather than making debtors subject to such dismissal, some courts may generally order that the documents need not be filed, but, as noted above, in the discussion of §407, no standards are provided for orders of nonproduction, and practice among courts can be expected to vary widely.

Alternative. The failure of a debtor to provide information ordered by a court to be produced to a creditor in connection with an examination pursuant to Fed.R.Bankr.P. 2004 could be specified as a ground for dismissal of both Chapter 7 and Chapter 13 cases.

§409 ( "Adequate time to prepare for hearing on confirmation of the plan") (see H.R. 2500, §213; S. 1301, §313).

The changes. This section provides that the hearing on confirmation of a Chapter 13 plan must take place no sooner than 20 days and no later than 45 days after the first meeting of creditors.

The impact. H.R. 3150 is internally inconsistent in setting the time for the hearing on confirmation of a Chapter 13 plan. Section 406 requires that the hearing on confirmation take place within 45 days of plan filing, which may be no later than 30 days after the filing of the case. Thus, §406 requires that the confirmation hearing take place no later than 75 days after the bankruptcy filing. However, under Section 401, the earliest that the creditors’ meeting can take place is the 60th day after case filing, and §409 requires that the confirmation hearing take place no earlier than 20 days thereafter, or no earlier than the 80th day after filing. It is impossible to comply with both sets of provisions.

Present law, which requires prompt filing of plans (within 15 days of the filing of a Chapter 13 case), and prompt creditor meetings (between 20 and 50 days after case filing), with no deadline for the confirmation hearing, allows (1) the creditor meeting to take place after the plan is filed, and (2) the creditor meeting to take place prior to confirmation. There does not appear to be any need to change these time frames. The different times provided for by the proposed bill would delay plan confirmation in many cases, without assuring more time for creditor review of the plan.

Alternative. If a change is to be made in the time frames of current law, the various provisions now included in H.R. 3150 must be harmonized.

§410 ( "Chapter 13 plans to have a 5-year duration in certain cases") (see H.R. 2500, §117).

The changes. This section would increase the term of Chapter 13 plans from the present range of three to five years to a new range of five to seven years, for all debtors with total monthly income equal to at least 75% of the national median for their household size. The proposal would retain the three-to-five year range for those earning less than 75% of the applicable median. In each situation, plans lasting longer than the minimum plan term would require court approval. These provisions should be read in conjunction with §102 of the proposed bill, discussed above, which requires that all net income of the debtors be paid to general unsecured creditors for the minimum plan term.

The section also amends §1329 of the Code, which governs modified plans. Although an original plan is allowed, with court approval, to have a duration two years beyond the minimum term, the amendment would prohibit this extension for modified plans.

The impact. Consistent with §102 of H.R. 3150, this section would have the effect of lengthening the minimum Chapter 13 plan term from 3 to 5 years for most Chapter 13 debtors. This increase in minimum plan length may result in increased payments to creditors, but only if the plans are completed. Increased plan length may discourage use of Chapter 13 by debtors who have the choice of Chapter 7, and may decrease successful plan completion by those who do choose Chapter 13.

Extending plans beyond the minimum term is sometimes in the debtor’s interest—in order to cure large mortgage arrearages or retire nondischargeable debt. There is no apparent reason why this extension should be prohibited in modified plans.

§411 ( "Sense of the Congress regarding expansion of Rule 9011 of the Federal Rules of Bankruptcy Procedure") (new).

The changes. Fed.R.Bankr.P. 9011 is the bankruptcy analog to Rule 11 of the Federal Rules of Civil Procedure. It requires the signature of the attorney (for a represented party) or of the party (if unrepresented) on documents filed with the court, and provides that this signature constitutes a certificate that the document is, among other things, well grounded in fact—based on the signer’s knowledge, information, and belief, formed after reasonable inquiry. Currently, Rule 9011 does not apply to schedules, apparently with the understanding that debtors’ attorneys are not economically able to independently verify the accuracy of the information supplied by their clients. This section suggests that the Rule be modified to apply to all filings, specifically including schedules.

The impact. Requiring independent verification by debtors’ attorneys of all of the schedule information required of their clients would delay bankruptcy filings and increase the cost of legal services, thus discouraging good faith filings. In light of the auditing requirement proposed both by this bill and by the National Bankruptcy Review Commission, it is questionable that attorney verification of schedules is needed to assure accuracy. Any determination of the need for such a change in the law could be made after the initial results of the audits become available.

§412 ( "Jurisdiction of Courts of Appeals") (new)

The changes. Under present law, appeals of decisions of bankruptcy courts are heard by the district courts or by Bankruptcy Appellate Panels, composed of bankruptcy judges. This section would grant jurisdiction over such appeals to the Circuit Courts of Appeals.

The impact. The current system of appeals generates appellate decisions that are largely without binding precedential impact. Decisions of the Courts of Appeals would be binding on all courts within the circuit, promoting intercircuit uniformity.

Subtitle B ( "Data Provisions")

§441 ( "Improved bankruptcy statistics") (see H.R. 2500, §201: S. 1301, §306).

The changes. This section would require the Director of the Executive Office for United States Trustees to compile bankruptcy data in specified categories and require the Administrative Office of the United States Courts to specify the form of the data and make it public.

The impact. Although this provision would be costly to implement, it has the potential for making useful information available to those interested in the functioning of the bankruptcy system. The National Bankruptcy Review Commission (Final Report at 921-43) recommended that a similar program of data collection and reporting be implemented. One potential problem in the proposed legislation is in its specification of matters for data collection and reporting. The Review Commission suggested a pilot program to develop effective programs, and this might be preferable to establishing categories for data collection by legislation. As an example of the problem with legislative specification, the proposal includes a requirement that data be collected and reported as to "the number of [Chapter 13] cases in which a final order was entered determining the value of property securing a claim less than the claim." Such a report would likely yield little useful information, since in many situations of the cramdown of secured claims the parties negotiate an appropriate bifurcation, with no court order entered.

Alternatives. It may be preferable to implement the Review Commission’s recommendation of a pilot program to determine effective categories and methods of data collection and reporting.

§442 ( "Bankruptcy data") (see H.R. 2500, §203)

The changes. This proposal would require the Attorney General to issue regulations for uniform reporting of bankruptcy cases on standard forms, designed to facilitate both physical and electronic access to the information contained in the reports. Detailed contents of the reports are specified.

The impact. A consistent reporting system would provide many benefits, and has been recommended by the National Bankruptcy Review Commission as part of a national bankruptcy filing system (Final Report at 105-07).

Alternatives. It may be preferable to allow the details of any reporting system to be developed by the office administering the system, rather than specifying them in the statute.

§443 ( "Sense of the Congress regarding availability of bankruptcy data") (see H.R. 2500, §203).

The changes. This proposal effectively recommends that Congress establish a national bankruptcy filing system.

The impact. A nationwide reporting system would provide many benefits, and has been recommended by the National Bankruptcy Review Commission (Final Report at 105-07).

Title V ( "Tax Provisions")

Most of the sections of Title V do not involve consumer bankruptcy issues and are therefore not treated in this analysis.

§502 ( "Enforcement of child and spousal support") (new)

The changes. This section adds additional language to a provision of Section 522(c) that excepts certain tax and family support obligations from the general rule that exempt property is not liable for debts. See In re Davis, 105 F.3d 1017, 1022 (5th Cir.1997) (allowing enforcement of child support against property exempt under state law).

The impact. Although the proposed language is apparently intended to clarify the meaning of the statutory provision, it does so by creating an exception to the exception already in the statute, and may therefore engender additional confusion.

§503 ( "Effective notice to government") (new)

The changes. This section specifies that all notices from a debtor to a governmental agency (as well as the original scheduling of the agency as a creditor) must contain detailed information regarding the nature of the agency and its claim. For example, a real estate tax claim is required to be identified by real estate parcel number. The clerk of court is required to maintain a register of "safe harbor" mailing addresses that may be used by debtors. The Advisory Committee on Bankruptcy Rules of the Judicial Conference is required to propose "enhanced rules" for providing notice to governmental agencies, incorporating the provisions earlier set out in the section. Notices not in compliance with the proposed requirements would have no effect unless, among other things, the debtor showed either that notice was sent to the safe harbor address, or both that no safe harbor address had been specified and that there was actual notice to a responsible officer of the appropriate agency. If notice of the commencement of the case was not given in compliance with the requirements of the section, governmental violations of the automatic stay and turnover provisions of the Code would not result in any sanction.

The impact. The provision would provide surer notice to governmental agencies. Some of the detail required, however, may unnecessarily increase the cost of case filing, and litigation can be anticipated on issues of whether notices were in compliance with the requirements. See the discussion in connection with §405, above.

§508 ( "Chapter 13 discharge of fraudulent and other taxes") (new)

The changes. This section would make the tax obligations that are defined by §523(a)(1) of the Code nondischargeable in Chapter 13 cases as well as in Chapter 7 cases.

The impact. Together with §143, this section of H.R. 3150 has the effect of largely eliminating the superdischarge of Chapter 13. See the discussion of this issue in connection with §143, above.

§514 ( "Tardily filed priority tax claims") (new)

The changes. The Bankruptcy Code was amended in 1994 to provide that tardily filed tax claims are entitled to priority in Chapter 7 cases until the time that the trustee commences distribution. This section would provide, instead, that tardily filed tax claims are entitled to priority until the court approves the trustee’s final report and accounting.

The impact. This section would create severe problems of administration for trustees. The section would apply in situations where the trustee had already made payments to creditors in a Chapter 7 case, but before the trustee’s final report had been approved. In this situation, the section provides that a late-filed priority tax claim would retain its priority. As a result, the trustee would have to pay the tax claim ahead of other claims of lower priority, even though distributions were already made on account of those claims. Accordingly, the trustee would have to attempt recovery of the previously distributed funds, generating substantial additional administrative expense and consequently reducing the overall distribution. There is no apparent justification for this result.

§517 ( "Requirement to file tax returns to confirm Chapter 13 plans") (new).

The changes. This section would impose on Chapter 13 debtors the obligation to file, as a condition for confirmation, all prepetition tax returns. Deadlines are specified for the filing of the returns (at least 120 days from the filing of the bankruptcy case), and failure to comply is specified as a ground for conversion or dismissal of the case. The taxing body is given 60 days after the filing of a return to submit a timely claim for the tax involved in the return. Finally, it is suggested that the Federal Rules of Bankruptcy Procedure be amended to allow objections to confirmation to be made by a taxing body "on or before 60 days after" the debtor files all of the required tax returns.

The impact. These provisions are largely reasonable, and will assist the debtor and the taxing bodies in resolving past due tax obligations. However, the suggested change in the bankruptcy rules further complicates the already very confused issue of when a confirmation hearing is supposed to take place under the provisions of H.R. 3150. See the discussion in connection with §409, above. In order to allow the suggested objection based on the filing of a tax return 120 days after the bankruptcy filing, confirmation hearings would have to be scheduled six months after the filing of the case.

Title VI ( "Miscellaneous")

This title does not involve consumer bankruptcy issues and is therefore not treated in this analysis.