National Association of Attorneys General
Congress' New Year's Resolution
The New Congress and What’s Coming Up With Bankruptcy
In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”). Currently, it is considering further limited changes to the Bankruptcy Code to provide mortgage relief in response to the ongoing financial crisis. But, if it chooses to move forward with any of the pending bills in that, the States should hope that it takes the change to revisit the bankruptcy area more broadly. In doing so, it can reconsider some of the policy choices it made in enacting the BAPCPA. It can also correct the many drafting errors that were made in the BAPCPA in attempting to implement those policy choices and, equally importantly, it can address the many issues that existed before the bankruptcy review process began in 1994 and that still exist today. Not an inconsiderable set of tasks to be sure, but ones with many possible benefits. Congress could cut through the Gordian knot that has made delivering foreclosure relief to homeowners so difficult. It could reduce dramatically the work load on the courts and bankruptcy lawyers who are forced to try to construct a coherent reading of a statute that often reads exactly the opposite of what its drafters likely intended. And, finally, a new bill could look beyond the limited concerns of the creditor-oriented groups that were the impetus for the BAPCPA and resolve a number of problems that have faced government entities since the Bankruptcy Code was passed in 1978 (as well as settling other disputes that have plagued the system for decades).
The Bankruptcy Code was a complete overhaul of the Bankruptcy Act that had initially been enacted in 1898, and amended several times over the next eighty years. The Code was several years in the making, was thoroughly vetted and was, on the whole, a consistent and coherent approach to bankruptcy. Even so, it had its own drafting problems that had to be addressed with a technical corrections bill shortly thereafter. Moreover, from many creditors’ viewpoint, though, it was consistently too favorable to debtors. Accordingly, beginning in 1984, numerous substantive amendments were enacted, each of which largely served to make filing bankruptcy more difficult for debtors (consumer and business), and/or to provide benefits to special constituencies, all in the interest of discouraging unnecessary bankruptcy filings and better returns to creditors.
In 1992, a National Bankruptcy Review Commission (“NBRC”) was proposed to carry out a global review of the Code with an eye towards restoring that original coherency, albeit with perhaps a less debtor-oriented slant. It took three tries, but, eventually, at the very end of the 1994 session, Congress passed a bill creating the NBRC. At the same time, against the advice of a number of bankruptcy professionals, it also answered a number of specific interpretation issues that had been plaguing courts at that time, rather than leaving those matters to the NBRC. Doing so turned out to be a wish choice, in that most of those issues just needed an answer and the system benefitted by not waiting 11 years to get it.
The NBRC was slowed initially by the untimely death of its original chair, former-Rep. Mike Synar (D-OK.) in early 1995, but eventually did proceed, from 1995 through 1997, with numerous hearings, committee discussions, proposed language drafts and re-drafts, and a final report in October 1997. Unfortunately, by then, the Commission was deeply split with a five-member majority producing a report that harkened back to the spirit of the 1978 Code, and a four-member minority taking a more creditor-oriented view, at least as to consumer bankruptcies and producing a lengthy dissent. Notwithstanding that split, the commission did examine many areas beside consumer filings and produced many useful recommendations in other areas of the Code, particularly with respect to business bankruptcies.
As is often the case with blue-ribbon commission reports, though, this one was DOA when it hit Capitol Hill (not least because of the inability of the NBRC to reach consensus positions on the controversial issue). Indeed, even before it was submitted, legislation had been introduced that took a profoundly different tack on those consumer issues from the NBRC majority and formed the core of what was eventually passed eight years later. The intent was to ensure that bankruptcy was “needs based,” i.e., that one did not receive more debt relief than necessary and to ensure that those who could pay some or all of their debts did so. That goal was implemented through various provisions, including requirements that consumers receive credit counseling before filing a case, the imposition of a “means test” to determine if a consumer should be denied the right to liquidate in Chapter 7 (so that they would be forced to file in Chapter 13 and make payments), and many provisions intended to protect secured creditors. It did very little, however, to address any of the matters that had been taken up by the NBRC outside the consumer areas or to include many matters of interest to governmental counsel.
The first bills were not voted on in 1997 but there were new versions, drafts, revisions, amendments, and added provisions over the next few years and the bills were voted on several time over the next few years, passing each time by veto-proof majorities. Finally, in 2000, the House voted on a final measure, but the Senate held back, trying to avoid a filibuster and talk the White House out of a veto threat. While it did eventually pass the bill overwhelmingly, that did not occur until the last day of its session in December 2000 so that it was too late to have an override vote when the bill was vetoed as promised by President Clinton. When Congress returned, abortion-related provision were added and gridlock ensured for four years until the additional Republicans elected in 2004 pushed the bill through in April 2005. Despite the extended time between 2000 and 2005, the bill changed very little. In particular, despite cogent analyses that pointed out glaring flaws in the drafting, the sponsors refused virtually all suggested changes, perhaps fearing they would undermine the bill. However, while many of those raising issues were no fans of the BAPCPA, that did not change the fact that they had raised valid issues. The drafters informally reassured doubters that, while they did not want to disrupt a fragile coalition by changing the existing language, a “technical corrections” bill would then be used to fix all of those problems.
Not surprisingly, though, no corrections bill has emerged in the three and a half years since the BAPCPA passed. Instead, all of the problems identified by the critics and many more have come to light. Ironically, the poor drafting has often resulted in the BAPCPA not providing protections for creditors that they undoubtedly thought they were writing into the law. To be sure, courts could use the doctrine of “absurdity” to try to read the language in a way that was closer to what was likely intended, but when many of them were not happy with the bill to begin with, they often could not resist deferring to Congressional drafting and leaving it hoist on its own petard. Since, in many cases, Congress was warned of precisely the problems that were being seen – and chose not to change the problematic language – those courts insist that they are bound to find that Congress wanted that result, no matter how absurd or abusive.
The most obvious example can be see in the drafting of the “means test.” That test was intended to determine whether a Chapter 7 filing was abusive and, as a general principle, there is nothing wrong with having some form of uniform, objective test for that issue. Bankruptcy is constitutionally required to be uniform and it is not unreasonable to set some limits on judge’s discretion in this regard. Before the BAPCPA, there were as many “means tests” as there were judges to devise them, and their severity varied widely. Moreover, to the extent that an objective test is used as a “quick and dirty” screening method, and supplemented with a “smell test,” the combination serves the purpose of pushing abusive filed slackers out of Chapter 7 and into 13.
In drafting that test, Congress chose to use the standard expense allowances created by the IRS – but forgot to tell the courts to use the IRS interpretations as to how those allowances are to be applied. Thus, the IRS has a capped allowance for a car ownership allowance – but makes clear that it allows only the actual payment if it is less, than the cap. By definition, then, nothing is allowed if the taxpayer does not actually have a car payment. (There is a separate allowance for operating costs). By leaving out the notion that the allowance is a cap and not a guarantee, the courts are left with a test that, read literally, allows debtors to deduct a $400 allowance where their payment is only $200 – or even nothing at all if the car has been paid off. Indeed, many courts hold that the debtor may deduct an ownership payment even if he is surrendering the car to the secured creditor and will no longer even own it after the petition date! Those results, while mind-numbingly odd, are not such a problem in Chapter 7 because the court can use the “smell test” to hold that a debtor who has $400 in monthly income should be paying creditors.
The greater problem arises in that the same test is used in Chapter 13 for above-median income debtors. (Below-median income debtors are judged, as before, on their actual income and expenses, with the judge reviewing them for reasonableness.) Again, using a totally literal reading of the statute, about half the lower courts and at least one Court of Appeals find that above-median income debtors can – and must – be allowed to reduce their disposable income by wholly fictional expenses. As a result, they may show a calculated negative income, when, in reality, they have as much as $1,000 or $2,000 a month in actual disposable income. In turn, those courts may also find that, despite the new requirement that high-income debtors must have five year plans, these debtors have no obligation to pay anything to their creditors and no set time limit before they can receive the broader Chapter 13 discharge. And, finally, those courts find, since Congress decreed this system, it cannot be bad faith to take advantage of it. On the other hand, below-median income debtors are judged on their actual expenses and income and so may pay far more than their wealthier brethren.
This is the worst example, but others abound in the BAPCPA At a minimum, Congress needs to thoroughly review the law to fix the many errors and ambiguities that have been found since its passage. When it does so, it can then decide whether the law’s single-minded focus on making bankruptcy filings more difficult, costly and time-consuming for consumers, while providing additional relief to creditors, is the best approach to the problems of overstretched consumers. For instance, the BAPCPA requires consumers to receive credit counseling before they can file a case and makes it virtually impossible to resolve the problem if they file without the counseling, even if they do so to avoid an imminent foreclosure. To be sure, consumers should know their options before filing and should try to resolve their problems before the sheriff is on the doorstep – but people in desperate financial straits don’t always do what they “should.” Nor is it at all clear that getting counseling can change the reality of the debtor’s finances. There are many other examples of new requirements, harsh timelines, and mandates that cases be dismissed for relatively minor or curable failings. And, after a case is dismissed, the BAPCPA penalizes debtors that seek to correct the problems and refile. Reviewing all of these changes with an eye to distinguishing between reasonable measures to limit abuse, and which are simply bureaucratic overkill, and then correctly drafting language with regards to the measures that are retained would be a great first step in truly “reforming” bankruptcy law.
The current call for change, though, deals with a requirement that is not new – namely, the ban of modifying primary residence mortgages. This has been justified as a way to ensure that creditors feel safe in loaning such funds so that they will make the loans at lower rates. It is not clear that this really occurs and, even if it does, in these extraordinary times, many suggest this creditor protection can no longer be maintained. A major problem with resolving foreclosures is that often there are many parties involved and it may not be possible to obtain the consent of all to a modification. A bankruptcy court ruling could bind the parties and force the change on all of them. A second problem is that it is difficult to write a broad standard that can give relief to those who truly need help without going too far and relieving those who have only themselves to blame. Giving an independent party the discretion to examine the issues on a case-by-case basis (within established guidelines) could help steer between those two pitfalls.
It is not to say that such a change would be a panacea – bankruptcy is a drastic measure that imposes significant burdens and costs on debtors and creditors alike. To require a party to declare bankruptcy merely to modify a mortgage may be more change than is needed. Moreover, while the bankruptcy courts have handled as many as 1.5 million cases a year prior to BAPCPA, the number of defaulting mortgages may be far larger than that and could overwhelm bankruptcy courts if they became the primary focus for granting relief. All that said, it is clear that there is likely to be significant consideration of this issue when the new Congress convenes. The States’ primary interest should be in ensuring that consideration of bankruptcy does not begin and end with this provision – because they have had many other issues on their plate for many years.
Some changes they would like to see are relatively straightforward and procedural – bankruptcy is a uniform national system, yet creditors in general and states in particular are haled into courts all over the country and then required to file pro hac vice motions and obtain local counsel to protect themselves from the debtor’s actions. Multidistrict litigation does not impose those burdens; there is no reason why bankruptcy should not also allow other parties to appear without taking those steps, perhaps by some form of national admission. Other changes are matters of substance that have been debated for years with nothing being done to address them. Most prominent among these, probably, is the treatment of environmental claims in bankruptcy. Despite the great importance of ensuring that other parties are not harmed by pollution coming from the debtor’s facilities or its waste products, the Code provides no special treatment for such claims, whether by virtue of priority, or exception from discharge and the proper treatment of such claims remains distinctly unclear. Environmental claims are one example of a problem faced by government – namely, to what extent they can force debtors, whether reorganizing or liquidating, to comply with the law during the case with respect to pre-existing problems, and what is the status of any payments debtors must make to correct those problems. The lack of clarity in this area confounds debtors and the government and engenders unnecessary litigation.
There are numerous other areas to be considered. There is no clear provision for how workers’ compensation payments are to be treated and governments, claimants, and coverage providers may all lose out under current law. Going out of business sales are occurring with great frequency and the same issues come up in case after case – yet the Code has no specific language dealing with those sales. As a result, there is no clear basis to decide the extent to which debtors are bound by – or can override – contractual and/or statutory provisions. The result is, again, unnecessary uncertainty, delay, and litigation that could be resolved once and for all with specific action. Another area that could be addressed are the terms for credit card debt. While not specifically a bankruptcy issue, high credit card debts are almost invariably a precipitating factor for a bankruptcy filing. In the past, the emphasis has tended to be on disclosure of terms – but disclosures are often not read or understood and, in any event, do not really solve the problem. Even if one understands that a credit card company intends to raise one’s interest rate to 30% if there is a default on some other card, that mean the debtor can do anything to change that fact. And, it is a virtual certainty, that if one is having problems paying off credit cards at 15%, it will be impossible if the rates leap to 30%. Some issues can only be solved by setting substantive terms, not mere disclosure of their unfairness.
In short, there are a myriad of issues that are related to the current mortgage and credit crisis that are likely to be addressed in the upcoming session. The States have much interest and expertise that they can offer on many of the issues from the consumer protection side. In addition, they have many other government-related issues that need to be addressed (and that have been ignored during the 14 year period since the NBRC was first established). The BAPCPA did address some areas of concerns for states – primarily taxes and collection of domestic support obligations. It should be a priority for them to address their remaining issues when (not if) the BAPCPA is reopened next year.
 It might thus seem surprising that, ever since 1984, the growth in bankruptcy filings has accelerated substantially. Although there have been ticks upward during hard times, and downwards during particularly good economic times, the number of filings continued to march upwards inexorably, and, by 2005, had reached close to six times the number of filings in 1984. Researchers have concluded that one explanation is that, as filings are purportedly made more difficult, lenders become more confident and extend more credit than they would have otherwise, creating more filings when those marginal borrowers inevitably begin to default.