By Shannon Garrett, Esq. (Topeka, KS)
As a Debtor’s bankruptcy practitioner, I was encouraged to see Senator Warren’s proposed reform plan. Bankruptcy is one of the few areas where bipartisan support and action are possible, and being a fan of the current structure, I welcome the reform as a chance to make a good system better.
Chapter 7 and Chapter 13 address different aims and concerns and complement each other elegantly. We enjoy a 40-year tradition of modern bankruptcy practice, and we can continue to ensure fair, effective, and efficient debt relief with this existing system. Chapter 10 scraps this system, creating an amalgam between Chapter 7 and 13, blending disparate concepts together and then separating them into 4 separate portions, each with a Plan that would need monitoring. This seems needlessly disruptive and provocative, and I am pessimistic on whether a Republican controlled Senate would pass reform in its present state.
Congress can realize much of the benefits of the proposed reform by making mundane, technical amendments to select obscure statutes. This approach stands a better chance for bipartisan support, prevents the need to scrap the existing system, and as a fringe benefit, quietly revolutionizes consumer bankruptcy practice.
ROUTE 1: This component seems to be the proposed replacement for Chapter 7. The current major barrier to Chapter 7 is the need to pay attorney fees in advance. As I read the proposal, a debtor would have the ability to pay their fees through the Route 1 Plan. This is a sorely needed benefit but comes at the expense of scrapping the current system.
Congress can accomplish the same goal by amending 11 U.S.C. § 1322(d) and 11 U.S.C. § 1325(b)(4)(B) to reduce or eliminate the minimum 3 year applicable commitment period (ACP). The Debtor could pay a Chapter 13 Plan fiscal base, often by a post-petition tax refund, and exit the case cleanly and efficiently. The amendment would get creditors paid more quickly, reduce caseload, and shorten the interval between filing and discharge. The amendment would also resolve the problem of pernicious “fee only” Chapter 13 cases, where low income debtors find themselves locked into a protracted and unnecessary three year obligation when they cannot afford a Chapter 7. Finally, it would choke off the increasing number of shady “end-around” schemes for Chapter 7 fees, such as fee bifurcation.
INCOME ONLY TESTING: The Route 1 track adopts an income-based restriction for the no-asset discharge and disregards the expenses that affect a family’s ability to pay debt. Disposable income, after expenses, is a fundamental concept in family budgeting, both in and out of bankruptcy. Every family is different. To equate a farmer’s income in Nebraska with a commuter’s in Silicon Valley results in arbitrary and unfair outcomes when they file. Consistency and simplicity are important, but the reform should trust local courts, trustees, and counsel to ensure that each case works for the family that files.
Alternatively, Congress can simplify Form 122c, introduce a generous overall standard budget allowance similar to a standard deduction, and relax the standard of review for proposed deviations. Cleaning up 122c would streamline the administration of “no look” cases, but allow debtors to propose budgets where their expenses are unavoidably high.
ROUTE 2: This track introduces separate tracking and paying of vehicle payment and secured claims. The ability to include a vehicle payment in a Chapter 13 is an extraordinarily useful tool. By extending the car’s note length, reducing the interest, or cramming down the unsecured portion, a debtor can reduce the monthly obligation and provide headroom for attorney and administrative fees. If I can craft a Plan payment equal to or lower than the car payment, I have confidence in the debtor’s ability to complete the Plan. Further, paying the vehicle note through the Plan, by income withholding, greatly increases the likelihood that the debtor will maintain the auto payment. In my experience, debtors commonly default on direct vehicle payments when I provide for such in my Chapter 13 Plans.
Debtors have the current ability to propose direct pay on a secured claim by adding a non-standard provision to the Plan. I see no benefit to mandating direct pay, and I believe Congress should simply leave this alone.
STUDENT LOAN DISCHARGES: The proposed blanket student loan discharge sweeps aside genuine issues regarding fairness, the taxpayers’ obligation to indemnify the resulting trillion dollar default, and whether the Federal government should continue to subsidize and guarantee future educational debt. Courts should review each diverse, individual circumstance under the facts. Currently many courts are chafing under the onerous Brunner v. New York State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987) standards and have expressed a desire to take a fresh look at the issue.
Congress can relax the current standard by amending 11 U.S.C. § 523(a)(8) to remove the word “undue” from “undue hardship”. This would effectively nullify Brunner’s precedential weight and provide courts with fresh-tilled soil to generate new procedures for thoughtful, individualized methods of tackling this complicated problem. Let’s let the judges be judges and see how they do.
MORTAGE CRAMDOWN: The proposal provides for a cram down of residential mortgages. This would be of tremendous benefit to homeowners in distress but would inject considerable litigation into the Plan confirmation process. Here in Topeka, debtors and creditors have an uneasy understanding about how to value vehicles for 506 purposes, in part because all parties recognize that the costs of evidentiary hearings outstrip the amount at issue. This would not be the case in home values – with deficiencies up to $100,000 on the line, the litigation required to confirm a Chapter 13 Plan would massively increase. If the debtor could not afford to pay the additional costs up front, debtor’s counsel would be required to sink even greater amounts of time and expense to confirm the case, before getting paid. Further, the need for evidentiary hearings would delay confirmation to an intolerable extent.
Congress can provide this necessary reform by permitting the Debtor to use the Plan to amend the mortgage rate to Till or the contract rate, whichever is less. Congress could permit the Debtor to file an adversary proceeding to adjudicate the real estate value and confirm the Plan notwithstanding. In most cases, with a note that exceeds five years, the ultimate value of the home will not impact the administration of the Plan. The Plan can proceed, and Debtor can hire a side specialist in the now-burgeoning field of mortgage cramdown to litigate the value – arranging for payment in a way that prevents someone else from fronting the costs.
BLANKET FEDERAL EXEMPTIONS: A one-size-fits-all set of Federal exemptions would not address the diverse economies, constituents, and challenges our 50 states represent. Rhode Island, Oklahoma, and California must be able to craft exemptions that fit the needs of their unique citizens, with local input from their state residents.
Further, a $35,000 wildcard exemption is excessive. Here in Topeka, it would effectively eliminate the collection of assets. This exemption would impair the ability of a liquidating Trustee to make a living. Currently, Chapter 7 Trustees receive a nominal fee for review of a file. They fund their practice through administering asset cases. Relatively prosperous Chapter 7 debtors essentially subsidize the less prosperous, non-asset debtors, making Chapter 7 affordable for the poor. If Congress intends to retain competent attorneys as Trustees, Congress would need to globally raise administrative fees for all cases, shifting the cost of relief to those who could least afford it. Further, such a generous exemption would lead to an increase in the “keep the yacht” cases that corrode the public’s opinion of the bankruptcy system.
Congress can amend 11 U.S.C. 522(d) to include a $1,500 wildcard exemption. Congress can similarly exempt the EIC, the child tax credit, and health savings accounts at the Federal level. These corrections would adequately protect poor debtors from unfair asset cases, prevent excessive sheltering of luxury assets, and preserve our existing exemption structure.
910 CAR LOANS: We often see a debtor in distress who was compelled to purchase a vehicle from a predatory car dealer, and now is saddled with an undervalued car and an unbearable interest rate. This problem needs urgent addressing. However, shortening 910 loans to 90 days is too heavy handed. A debtor could purchase a marked up full-size truck or SUV, roll negative equity into the loan, make a single payment, dodge the repo man, and stand a good chance of feeding the creditor a $15,000 – $20,000 loss on the day the debtor files. This is a standard of behavior, authorized by statute, that dips below the minimum threshold of good faith.
Congress could amend the hanging paragraph to cap the balance of a 910 claim to 125% of the fair market value of the collateral, and to shorten the 910 period to 365 days. The adjustment would alleviate the harm from a predatory loan, but ensure the Debtor is not abusing the system by incurring dischargeable debt in anticipation of filing.
WAIVER OF RENT: Allowing renters to discharge six month’s back rent, while continuing to reside in the property, will just make landlords generally more hostile to debtors in bankruptcy. In Topeka, the large corporate renting agencies would simply absorb and pass the costs on to other tenants. However, our essential mom-and-pop landlords, who use the rent as a way to make the corresponding mortgage payment, would be hit hardest, and be twice shy when renting to a Chapter 13 debtor. My people have a hard enough time finding places to rent, without dealing with a resentful landlord constituency.
Congress can maintain the existing ability to cure the lease default over time, and perhaps be on good terms to renew when the lease expires. That is a fair balance.
In conclusion, as a person allergic to committees, I make an inept politician. I may not understand whether this proposal is meant to be a glorious and symbolic loss. If effective and practical reform is indeed desired, a number of technical amendments, perhaps quietly inserted into a larger relief bill, will accomplish what the reform intends. Overall, I applaud Senator Warren’s desire to bring needed relief to those suffering in our current economy, and I share her hopes for success.
Shannon Garrett is a consumer bankruptcy practitioner in Topeka, Kansas. He is a graduate of University of California at Santa Cruz, and Kansas University School of Law.