Past due: Middle-class debt relief

Balancing protections for creditors and debtors is the goal of American bankruptcy law. Late last year, when the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) went into effect, it upset that delicate balance, according to members of a panel discussion on bankruptcy policy and the middle class held at Harvard Law School on Monday (March 20).

For the past century, American bankruptcy law served as a social safety net, rescuing debtors from their creditors. “As early as 1898, American bankruptcy law promised the honest but unfortunate debtor relief from debt and a fresh start,” said Ingrid Hillinger, professor of law at Boston College Law School. She described the two types of bankruptcy that individuals can file: “The Chapter 7 debtor says, ‘I give up, here take my nonexempt assets, sell them, distribute the proceeds to my creditors, give me my postpetition income and give me a discharge.’ Chapter 7 is asset-based bankruptcy relief. Creditors rely on debtor’s nonexempt assets for payment.” Chapter 13 relief is different – debtors keep their assets and, for a three- to five-year period, commit a portion of their postpetition income to the payment of the prepetition debt. So, Chapter 13 creditors rely on a debtor’s postpetition income for satisfaction of their claims.

After the bankruptcy reform act of 1978, which made it easier for individuals to file for bankruptcy, Hillinger says there was an “avalanche of bankruptcy filings, and each year broke the record from the year before.” And in the overwhelming number of Chapter 7 cases, she said, unsecured creditors got nothing because the debtor had no nonexempt assets to relinquish. Chapter 7 had become purely a debtor protection process.

“There was a perception – and we don’t know the source,” said Hillinger, “that many folks were abusing the bankruptcy system: They were filing Chapter 7s and getting a discharge even though they could repay some or all of their debt.” Perhaps in response to this perceived imbalance, MasterCard, Visa, and a coalition of creditors pushed for the passage of the BAPCPA, which was signed into law last year. According to some panelists, it’s the middle-class debtor who is the loser.

This act limits access to Chapter 7 relief. In fact, the premier goal of the creditor community in supporting this legislation, according to John Rao, staff attorney at the National Consumer Law Center Inc., is to have overall bankruptcy filings go down.

Under the act, several new steps are required in the bankruptcy process. A means test for those who earn more than their state’s median income is required. Credit counseling is now required. “The main effort here,” said Rao, “is that if there are enough obstacles to getting bankruptcy relief … then consumers simply won’t file bankruptcy.”

He noted that there were a great many news reports on how much harder it is to file bankruptcy under the new rules, and he detailed misinformation purveyed by credit counselors and debt collectors.

“So, where can consumers who are on a debt treadmill turn at this point?” asked Rao. Congress has said that they need to turn to credit counselors, who can offer a debt management plan. But “they only deal with one type of debt – unsecured credit card debt. They’re not dealing with foreclosures and other problems,” said Rao. “But the real problem is that they don’t work, because creditors are not offering the concessions that are needed. For someone in deep financial trouble, they need that debt to be waived or some portion of that … the best they [credit counselors] can offer is an interest rate reduction and maybe the removal of some late fees.”

Panelist Alan Resnick, Benjamin Weintraub Distinguished Professor of Bankruptcy Law at Hofstra University School of Law, said changes in the bankruptcy laws affect businesses as well as individuals. But the losers do not seem to change. Resnick noted that when big businesses go through bankruptcy proceedings, some of the costs that may get cut are medical and pension plans, thus affecting members of the middle class.

Judge William Hillman of the United States Bankruptcy Court for the District of Massachusetts rounded out the panel somewhat acerbically: “All debtors in this country have seen ‘Gone with the Wind’ because they all know the last line, which says, ‘Tomorrow is another day.’ Debtors never do anything until it’s obvious that there is no tomorrow. And that’s when they file bankruptcy.”

The bankruptcy panel was followed by another panel that talked about how housing market conditions are also affecting the increasing financial vulnerability of the middle class. The panels comprised the Journal on Legislation’s (JOL) annual symposium. The JOL is published semiannually by Law School students and specializes in the analysis of legislation and the legislative process.