Is Chapter 13 A Failure?

By Professor Michaela M. White

The Pretend Solution: An Empirical Study of Bankruptcy Outcomes, 90 Texas L. Rev.103 (2011), by Professor Katherine Porter of the University of California–Irvine, recently hit the shelves in old-fashioned print form here in my regular stomping grounds, the Creighton Law School law library. It is also available at http://ssrn.com/abstract =1965680.   Henry E. Hildebrand, III, Chapter 13 Trustee for the Middle District of Tennessee, has already written a response to Professor Porter’s study entitled A Response to a Pretend Solution, and it can be found at http://www.texaslrev.com/seealso/vol/90/responses/hildebrand-iii. In this article, I summarize some of the study’s most important findings and Professor Porter’s arguments that Chapter 13 (at least as we know it) must be abolished. In next week’s issue, I will discuss Mr. Hildebrand’s response, as well as your critiques and comments regarding Professor Porter’s article.

Professor Porter’s article summarizes the findings, methodology and implications of her empirical study of Chapter 13 cases that were dismissed or converted before plan completion.  The purpose of the study is to demonstrate that consumer bankruptcy reform is desperately needed and “that reform efforts must resolutely abandon Chapter 13.” Porter at 156.  However, at least in this article, Porter does not articulate a specific reform proposal. However, the study’s importance cannot be overemphasized because it is likely to frame the discussion about reforming or abandoning Chapter 13 both by its enthusiasts and its detractors for years to come. Whether anyone, least of all Congress, has the heart to “reform” the consumer bankruptcy system yet again remains to be seen, but dramatic reform is precisely what Professor Porter advocates.

The study’s nationwide random sample was comprised of 303 Chapter 13 debtors who filed cases between 2008 and 2010 and whose cases had been dismissed or converted to Chapter 7 in 2010 before plan completion. None of the sample debtors received a Chapter 13 discharge. The study was both qualitative (telephonic interviews) and quantitative (specific data sets from the respondents’ court files were also collected), but the Article focuses on the data gleaned from the interviews. Porter at 120-132. In Professor Porter’s words, her study “expose[s] the real outcomes of Chapter 13 bankruptcy for the first time” and “lay[s] bare, against theories and conjecture, what really happens to families that file Chapter 13 bankruptcy.” Porter at 111.

The primary goal of the study’s telephonic interviews of the sample debtors was to assess the reasons or goals the debtors had in filing Chapter 13.  Over half (51.5%) of the sample debtors identified saving a home as the primary reason they filed Chapter 13.  The second most prevalent goal in filing Chapter 13 was to gain control of finances and reduce financial stress. Porter at 135-39.

Over two-thirds (68.5%) of the sample debtors agreed or very much agreed that their single most important goal was accomplished. Only 3 in 10 debtors (31.5%) felt their goals had not been accomplished.  Porter at 139. Debtors whose cases were converted were more positive about whether it had been a good decision to file Chapter 13 (55%).  Debtors whose cases were dismissed were, however, less elated. Only 43% thought that filing Chapter 13 was a good decision. Porter at 141.  Professor Porter concludes that when taken together, these data (the sample debtors’ goals, whether they had been achieved and whether the decision to file was wise) support the theory that Chapter 13 success cannot be measured solely by discharge. Porter at 141.

The study found that the sample debtors’ objectives in filing Chapter 13 were only temporarily accomplished.  Although most homes were retained and the debtors’ financial stress reduced during the time they remained in Chapter 13, within a few weeks after case dismissal, 14% of homeowners had lost their homes and another 59% were in default and on the path to foreclosure. Since 74.4% of the sample cases were dismissed, the respite from collection calls and efforts soon began anew. Porter at 112 n.52; 145.

Porter concludes that drastic reform of consumer bankruptcy is necessary because of the startling rate at which Chapter 13 cases fail.  She calculates the percentages of Chapter 13 case “failures” as follows:

.

From a policy perspective, Chapter 13 should be evaluated against Chapter 7, the other primary bankruptcy option. The data on Chapter 7 show a discharge rate exceeding 95%. One in three Chapter 13 filings ends in discharge. Among the remaining fraction, those examined in this study, only approximately 20% to 25% achieve relief without a discharge. This works out to about 16% of all Chapter 13 filings ending in relief without discharge. Summing the 33% of discharged cases with the 16% of self-reported positive outcomes in nondischarge cases, I estimate the success rate of Chapter 13 to be less than 50%.

Porter at 153 (footnotes omitted).

Professor Porter argues that it is time to face the music – Chapter 13 does not work as intended. In her view, the astronomical debt loads carried by modern American families demand “a radical new approach to addressing the problem of overwhelming consumer debt.” Porter at 154.  She writes:

The new consumer bankruptcy system should be much simpler. It is not possible to solve every problem in a high-volume legal system. Undoubtedly, a simpler system would eliminate some of the “debtor friendly” tool of the Bankruptcy Code. In its place would be a system of rough justice, but one in which the rough justice is nearly universally delivered. Policy makers need to move beyond the traditional model of sophisticated lawyers providing tailored legal advice and accept that cost concerns mean that consumers will have only very limited access to legal counsel. To make that counseling worthwhile, lawyers need to spend their time gathering factual information from clients. In the current system, counseling by a lawyer who is guided by conventional norms of professionalism likely entails mapping out the twists and turns of the Bankruptcy Code to help the client consider options.

The new consumer bankruptcy system should reject the idea of broad consumer choice. The idea of free and informed section between Chapter 7 and Chapter 13 was never realistic, given the hours of education and counseling required to help consumers understand the benefits and burdens of the two chapters. William Whitford has observed that this framework creates a new consumer protection problem within the consumer bankruptcy system because of inadequate processes to guide the choice of chapter. Most importantly, adding choices and options does not mean that people actually achieve additional relief.

Porter at 154-55 (footnotes omitted).

Next week, I will discuss Mr. Hildebrand’s response to Professor Porter’s study and, ideally, incorporate or publish some of your reactions to her article. As always, we want to hear from you!  Just type your comment in the “Add New Comment” box below to post your own reactions to this important study.

No Author Biography has been linked to this Article.

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