Strange New World
It was early 2005, and G. Victor Tiscornia II was thinking about how to broaden the scope of his law practice. This solo practitioner in Salem, Ore., handled mostly trust and estate work, but he was planning to expand his sideline in bankruptcy work. That plan was shot down, however, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. When the law went into effect in October of that year, the landscape of bankruptcy law changed.
For Tiscornia, it was like starting from scratch. He decided against expanding his practice in the direction of bankruptcy law because, he says, “I didn’t want to learn it over again.”
Tiscornia isn’t alone. Many lawyers around the United States have stopped handling bankruptcy matters since the 2005 bankruptcy act went into effect, says Joseph R. Prochaska, a lawyer in Nashville, Tenn., who chairs the Consumer Bankruptcy Committee in the ABA Section of Business Law.
“Lawyers who did bankruptcy work only once in a while have stopped doing that,” says Prochaska. “They’ve left the field [to] the specialists.”
The changes wrought by the act, Pub. L. No. 109-08, 119 Stat. 23, are daunting for practitioners inexperienced in the field, says Henry J. Sommer, a Philadelphia lawyer who is president of the National Association of Consumer Bankruptcy Attorneys. “It’s like tax law,” he says. “If you don’t do a lot of it, there’s a steep learning curve.”
But there is widespread unhappiness with changes introduced by the 2005 act even in the ranks of experienced practitioners. Among the concerns are new restrictions and mandates that the law imposes on practitioners. Under the law, attorneys who help individuals in bankruptcy matters:
• Must identify themselves as “debt relief agencies” in advertising and other communications to the public. • Must verify the truth of their clients’ financial information. • Are forbidden to provide certain advice to their clients, even though it is otherwise lawful. • Face heavy penalties if they provide erroneous information or make mistakes in the papers they file in bankruptcy court.
Some wonder whether the 2005 act is bringing significant benefits to any of the players in the bankruptcy process. For lawyers who represent individual debtors, the law has made filing bankruptcy petitions more complicated and confusing, requiring far more paperwork and motion practice to get debtors through the process. While these changes have caused difficulties for attorneys, they’ve been even harder on clients. And the law may not be helping creditors that much, either. Many are getting less from debtors than before the 2005 law went into effect, according to bankruptcy experts like Prochaska.
“The ultimate consequences of the act are not what people originally intended,” he says.
AT ODDS OVER INTENT
The purpose of the 2005 bankruptcy act has been widely debated. Supporters claim the law was needed to stop debtors from gaming the bankruptcy system to be released from their debts too easily. Opponents contend the law enabled its main backers—such as banks, credit card companies and other business interests—to squeeze more money out of people in real financial distress, which was often caused by illness, divorce or job loss rather than frivolous spending on consumer goods and vacations.
It is indisputable, however, that when Congress passed the act in March 2005 after eight years of struggle, it was the most comprehensive revision of U.S. bankruptcy law in more than a quarter-century. And a clear aim of the law was to make it tougher for individuals to escape their liabilities by filing for bankruptcy.
These are some of the key changes introduced by the 2005 bankruptcy act:
Moving individuals into Chapter 13. The 2005 act introduced a means test to determine whether an individual may file under Chapter 7 or Chapter 13 of the U.S. Bankruptcy Code. The goal was to force more individuals to file under Chapter 13, which presumably allows creditors to recover more money.
Chapter 7 provides for the discharge of debts that can’t be paid after certain assets are liquidated, giving the debtor a fresh start right off. Chapter 13, on the other hand, requires the debtor to pay as much as possible to creditors over a period of years under a court-approved payment plan. At the end of that time, any remaining debts are discharged.
Under the 2005 act, an individual may file under Chapter 7 if his household income, for the six months prior to filing for bankruptcy, is less than the median income for other households of the same size in the same state. If the debtor’s income is at or above the median, the debtor may file under Chapter 7 only by satisfying the requirements of a complicated test to determine the debtor’s disposable income (after allowable expenses) and how that income compares to amounts owed to creditors.
For individuals seeking bankruptcy relief, Chapter 13 is far more onerous than Chapter 7. That’s because Chapter 13 repayment plans allocate all available money for creditors, with no allowance for unanticipated costs or drops in income. So if the debtor’s air conditioner breaks or he’s out of work for a month, he must still make his Chapter 13 payments—or persuade a judge to modify the plan. If he doesn’t make the payments on time, the debtor will be thrown out of Chapter 13, and all his creditors may attempt to recover the full amounts they are owed.
“Chapter 13 has an unbelievably large failure rate,” says Susan B. Hersh, a bankruptcy attorney in Dallas. “Historically, 85 percent of people fail to make it through.”
Longer Chapter 13 repayment plans. Prior to adoption of the 2005 act, Chapter 13 repayment plans lasted between three and five years. The act mandates that, unless a debtor completely repays his debts in a shorter period of time, the Chapter 13 plan must last for five years whenever the debtor’s current monthly income is above the median in his state.
Bankruptcy available less often. Under the 2005 act, an individual whose debts are discharged in a Chapter 7 bankruptcy must wait eight years before he may seek another discharge under Chapter 7. Previously, a debtor could seek a new Chapter 7 discharge in just six years. The 2005 act also boosted the minimum period between Chapter 13 discharges from six months to two years.
Fewer debts wiped out. The 2005 act cut back on the types of debts that may be discharged in any bankruptcy. Now, a student loan from a private lender, for instance, may no longer be discharged absent special circumstances.
In addition, the act creates a presumption of fraud whenever a debtor receives a cash advance of $750 or more and then files for bankruptcy within the next 70 days. Unless successfully rebutted by the debtor, this presumption prevents the debtor from wiping out the amount owed on the cash advance. A similar presumption applies whenever a debtor incurs debt for luxury goods costing more than $500 and then files for bankruptcy within the next 90 days.
CAUGHT IN THE DRAFT
It doesn’t help, say many bankruptcy law experts, that Congress didn’t do a particularly good job of drafting the 2005 act. Although Congress has passed 300 pages of technical corrections, numerous parts of the statute remain confusing and are producing conflicting court rulings on a plethora of issues.
“Confusion has been the major result, particularly in the consumer arena,” says David A. Greer of Norfolk, Va., vice chair of the Consumer Bankruptcy Committee in the ABA’s Business Law Section. As a result, he says, creditors, debtors and their counsel often can’t anticipate the results of a bankruptcy proceeding.
“How it comes out is like flipping a coin,” he says, “but all at the expense of debtors, who really can’t afford to pay for test cases.”
One major source of confusion is the calculation of debtors’ income and expenses. Before the 2005 act was passed, courts used a debtor’s anticipated income and expenses to determine how much the debtor could afford to pay his creditors in a Chapter 13 bankruptcy. The act replaced that formula with perplexing new rules for determining income and expenses.
Now, a debtor’s earnings are defined as his “current monthly income”—the average amount the debtor earned in the six months before filing for bankruptcy. But what happens if a debtor held an extremely well-paying job until recently, and now is unable to work? Does the debtor still have to pay creditors based on his CMI even if that figure is far beyond what the debtor will earn in the foreseeable future?
Or what if a debtor had very little income until recently, but now has a job that pays decent wages? Can the debtor get away with paying his creditors only a small percentage of what he’s currently earning?
The courts are split almost 180 degrees on this issue, says Henry E. Hildebrand III, a bankruptcy trustee in Nashville. “Some courts say we must look at what Congress said—CMI—even though it makes no sense,” notes Hildebrand. “Other courts say we must look at what the debtor will earn going forward [essentially the test before passage of the 2005 act]. The difference between these two numbers is vast when we talk about what debtors get.”
In Hildebrand’s view, the source of the confusion is clear. “The language used in the statute is deeply flawed,” he says. “The Chapter 13 trustees as a group warned Congress that this is defective language—this isn’t doing what you think you’re doing.”
The language in the 2005 act also has created confusion about debtors’ allowable expenses. Instead of using a debtor’s actual expenses (the prior formula), the act requires that allowable expenses be based on standards set by the Internal Revenue Service, which has set fixed allowances for housing, utilities, food and other necessities, based on median values for similarly situated families in the debtor’s state.
The problem is that many debtors don’t have costs equal to the state’s median. Some debtors live in cities with above-average costs of living, while other debtors live in rural areas with below-average costs. As a result, the median-based formula is creating difficulties for both debtors and creditors.
“It can be unfair to people living in high-cost areas,” says David A. Skeel Jr., a professor at the University of Pennsylvania Law School and a scholar in residence at the American Bankruptcy Institute in Alexandria, Va. “It also can have the reverse effect—giving people credit for expenses they are not really incurring. A bunch of cases are raising those issues. Should debtors get credit for expenses they don’t really have?”
Personal bankruptcy filings were on a steady rise in the years before the 2005 law was enacted. The act changed that trend dramatically.
“Since the law went into effect, bankruptcy filings went down by two-thirds,” says Philip S. Corwin, a Washington, D.C., lawyer who does lobbying work for the American Bankers Association, a key supporter of the 2005 law.
Proponents of the act cite that trend as evidence of the statute’s success in reducing abusive bankruptcy filings. “We would have expected a 10 to 20 percent decline” in filings, says Corwin, who chairs the Legislation Committee in the ABA’s Business Law Section. “This sharp drop-off reveals there were far more abusive and unnecessary filings than we would have suspected.”
Others maintain that the 2005 act will have only a temporary effect on the number of personal bankruptcy petitions being filed. In October, for instance, the National Association of Consumer Bankruptcy Attorneys issued a report stating that more than two-thirds of the lawyers responding to a survey said their bankruptcy filings had increased during the third quarter of 2006 compared to the first half of the year. More than half of the lawyers responding to the survey said they expect bankruptcy filings to reach the same levels by the end of 2007 that they were at just before the 2005 act went into effect.
All sides agree that the 2005 act has ended some abusive filings. Some individuals, for instance, used to file for bankruptcy repeatedly, with no intention of completing the process, because filing a bankruptcy petition created an automatic stay that prevented creditors from seizing the debtor’s assets or wages. By making one filing after another, these people could game the system and keep their creditors at bay almost indefinitely.
This abuse has been largely eliminated, thanks to the act.
But experts express concern about provisions in the act that make filing for bankruptcy considerably more difficult, time-consuming and costly.
Individuals seeking bankruptcy must file much more information now than they did before the 2005 act went into effect—about 30 forms documenting assets, income, expenditures and debts, among other things. Some people are unable to provide all the necessary information or documents, while others postpone filing to gather them.
At the same time, Prochaska says, “More is required of debtors’ attorneys. They must do more investigation [of clients’ finances] before filing and after filing, and they must engage in more motion practice to take a filing to confirmation and to discharge.”
The time an attorney must spend on a typical bankruptcy case has shot up dramatically, according to the recent survey conducted by the National Association of Consumer Bankruptcy Attorneys. Nearly 77 percent of the respondents said they are spending at least 50 percent more time on each case now than they did before the 2005 act went into effect. Some 27 percent of the respondents said they spend twice as much time on a typical bankruptcy than they did prior to 2005.
Not surprisingly, attorneys have raised their fees for handling bankruptcies. “Impressionistic studies have shown that attorneys’ fees have gone up at least 50 percent in most districts,” Skeel says, “and in some they have doubled.”
The effect may be to put bankruptcy beyond the reach of those who need it the most. “The effect of the law is to drive out the bottom tranche of filers because of the cost,” says Hildebrand. “The poorest people can’t afford to go broke. They can’t afford lawyers.”
The means test introduced by the 2005 act to steer more bankruptcy filers from Chapter 7 to Chapter 13 has gotten much of the blame for making the process more difficult and expensive. And many experts maintain that the means test hasn’t helped either debtors or creditors.
“The means test doesn’t catch very many people,” Skeel says. “Between zero and 10 percent of people who file are affected.”
The primary impact of the means test, according to some experts, has been to make the bankruptcy process more difficult. “It created a cumbersome process for very little results,” says Greer, who represents creditors. “It’s not in anyone’s interest to have cases go through roughly, instead of smoothly.”
One of the main goals of the 2005 act was to require debtors to pay more money to unsecured creditors, such as banks and credit card companies. To the disappointment of creditors, however, that isn’t necessarily happening. In some cases, such as In re Rotunda, No. 06-60054 (Bankr. N.D.N.Y. Sept. 1, 2006), courts have approved Chapter 13 plans where unsecured creditors get nothing at all. Before passage of the 2005 act, creditors likely would have received significant payments in those cases.
Still, the 2005 act might be a net plus for unsecured creditors. “The bill is causing people to file later rather than sooner, or not file at all, so banks are getting more opportunity to receive payments prebankruptcy,” says Skeel.
But it is unclear how much this additional opportunity is benefiting creditors because debt collection often becomes easier once an individual files for bankruptcy. “When a debtor goes into bankruptcy,” Greer says, “it can help creditors get their money.”
At a time when the growing complexities spawned by the 2005 act are putting a premium on legal assistance for individuals considering bankruptcy, some lawyers are pulling out of the field. The overall complexity introduced by the 2005 act is just part of the problem, say practitioners. Other—and perhaps deeper—concerns are the restrictions and mandates that the act imposes on bankruptcy practitioners.
One of those provisions requires attorneys to verify the accuracy of financial information that clients submit to the bankruptcy courts. If an attorney fails to do so, the court may dismiss the bankruptcy petition, order the attorney to refund any fees paid by the client and face other possible sanctions as well.
But verifying information provided by clients isn’t easy. “If a debtor says his furniture is worth $500, what does a lawyer have to do to verify this?” Greer says. “A lot [of attorneys] are getting appraisers. This has added a new layer of time and expense. It has also put a lot of exposure on lawyers and driven a lot of them out of the business.”
The 2005 act also classifies attorneys as “debt relief agencies” if they are paid by clients to provide assistance on bankruptcy matters.
That classification triggers a number of mandates on lawyers, including a requirement that they identify themselves as debt relief agencies in advertising and other communications to the public.
But even though mandated by the act, such statements often are inaccurate when applied to lawyers. Jason C. McBride, for instance, must describe himself as a debt relief agency even though he doesn’t help clients file for bankruptcy. The solo practitioner in Salem, Ore., handles divorces and advises clients regarding the Fair Credit Reporting Act and the Fair Debt Collection Practices Act.
And like other lawyers who handle divorce or consumer debt work, McBride often advises his clients to consider filing for bankruptcy. Under the bankruptcy act, that’s enough to trigger a debt relief agency designation.
McBride bristles at being forced to make what he considers misleading statements to the public. “There’s a potential that I would lose clients if I have to say I’m a debt relief agency and I’m not,” he says. “My main concern is my ability to advertise what I am and what services I perform.”
As so-called debt relief agencies, attorneys are instructed to advise clients that they may choose to represent themselves in bankruptcy matters because, in the language of the statute, “Although bankruptcy can be complex, many cases are routine.”
This forced disclosure has upset many bankruptcy attorneys, who claim it is misleading and harmful to the clients’ best interests. Filing pro se is a disaster for the client, Greer says. “Few clients can handle the complex federal proceedings by themselves.”
Moreover, the act prohibits lawyers, as debt relief agencies, from advising clients to incur any more debt, even though doing so may make good economic sense.
“It may be helpful for my client to refinance the mortgage on his house” as a way of reducing mortgage payments, says Dallas attorney Hersh. Under the bankruptcy act, however, “The client’s postman can tell that to him, but I can’t.”
HOPING FOR RELIEF
The debt relief agency provisions in the 2005 act are being challenged in the courts. A federal bankruptcy court judge in Georgia, for instance, issued an advisory opinion in 2005 that attorneys are not debt relief agencies under the act because Congress did not explicitly override the traditional power of the states to regulate lawyers. If it had intended to do so, wrote Judge Lamar W. Davis Jr., Congress “would have used the term attorney and not debt relief agency.” In re Attorneys at Law and Debt Relief Agencies, 332 B.R. 66 (Bankr. S.D. Ga.).
Two other courts, however, have concluded that attorneys do qualify as debt relief agencies under the 2005 act. But in both cases the courts struck down provisions prohibiting lawyers from advising clients on whether to incur additional debts, on grounds that the restrictions violated lawyers’ First Amendment rights. Olsen v. Gonzales, No. 05-6365-HO (D. Or. Aug. 11, 2006); Hersh v. United States, No. CIV.A. 3:05-CV-2330 (N.D. Tex. July 26, 2006). Appeals are expected in both cases.
Given all the different criticisms of the 2005 act, the gloomy assessment from many bankruptcy experts is not surprising.
“I don’t think the statute has helped anyone,” declares Hildebrand. “Costs have gone up. The amount of work has gone up. The statute may have helped improve the truthfulness of debtors, but I’m not sure about that.”
Supporters of the law say it is too soon to pass judgment on it. “We will need to live with this law for several years to see how everything is working,” Corwin says.
That’s the view in Congress, too. The 2005 act was a major piece of legislation, and Congress seems likely to give it at least a few years to prove itself. Moreover, most legislators are in no hurry to reopen the political battles that were fought before the 2005 bankruptcy act was finally passed.
Critics, however, already yearn for major changes in the new bankruptcy law structure that was created by the act.
“I’m hopeful that Congress will take a serious look at this to make the system work better,” says Hildebrand. “And when they do, I hope they will listen to us trustees and judges, rather than to creditors.”