Published April 18, 2005

The fury of the bankruptcy bill

Malissa Giles: 'There is going to be a perception out there that people won't be able to file bankruptcy.'
The new federal bankruptcy reform bill, known as the "Bankruptcy Abuse Prevention and Consumer Protection Act," is a hot potato; make that a haba¤ero-hot pepper. Supporters and detractors are fighting mad-about whether or not reform is necessary, about who is going to benefit and about who is going to suffer.

The voices in the fray include banks and credit card companies, bankruptcy attorneys, credit counselors, retailers and consumer groups. However, one voice is not being heard from directly, that of bankruptcy filers themselves. As Roanoke bankruptcy attorney Malissa Giles says, "This group won't stand up and say, 'Listen to me! I'm filing bankruptcy!'"

Basically, debtors who file for Chapter 7 bankruptcy are allowed to wipe out most of their unsecured debts, while those who file under Chapter 13 are required to pay back at least a portion of their debts under a repayment plan. One of the primary goals of the legislation is to compel those with means to file under Chapter 13. The bill is expected to go into effect early next year. Says bill co-sponsor Congressman Rick Boucher (D-Abingdon), "The bankruptcy laws have been badly abused in recent times, primarily by people running up very large debts for vacations, expensive cars and televisions-then they declare [Chapter 7] bankruptcy."

How did this happen? Why weren't they filing under Chapter 13? "There was no requirement to do so," says Steve Higgs, a Roanoke-based bankruptcy attorney who represents creditors. In fact, "there's no requirement to be bankrupt to file bankruptcy." "Part of the problem is [the attorneys'] infomercials about how easy it is to file bankruptcy," says Ray La Mura, director of Government Relations for the Virginia Association of Bankers. "They're encouraging people to file bankruptcy as a first action instead of a last resort."

Adds Boucher, "Bankruptcy has lost its stigma.

"The abuse of the bankruptcy laws has been estimated to cost the typical consumer approximately $400 per year in the form of higher interest to cover the cost of the people abusing [those] laws," says Boucher. The credit card industry is widely acknowledged as the force behind the new legislation. Investor's Business Daily cited a credit card analyst in a March article, saying: "MBNA last year earned $2.7 billion and took $1.1 billion in provisions against bad loans. If the bill is passed, MBNA could save $130 million annually."


The National Association of Consumer Bankruptcy Attorneys does not believe that these savings will be passed on to consumers. In a 2003 position paper, the organization contends, "Credit card companies have never shown that interest rates have risen or fallen due to increases or decreases in bankruptcy filing rates or changes in bankruptcy laws."

Other opponents insist the bill would hurt the most vulnerable, protect wealthier individuals and put debtors at the mercy of creditors.

"Someone who owns a really expensive house can keep that house," says Irene Leech, "but a renter will end up with nothing." Leech is Associate Professor of Consumer Affairs at Virginia Tech, as well as president of both the Virginia Citizens Consumer Council and the Consumer Federation of America.

Bankruptcy filings have doubled over the past decade, with a record of 1.66 million filings set in 2003. Leech does not find the numbers shocking, in themselves. Over time, she says, "The percentage of bankruptcies versus the amount of outstanding credit has not changed."

According to a recent Consumer Federation of America fact sheet, "studies by the Congressional Budget Office, the Federal Deposit Insurance Corporation and independent economists link the rise in consumer bankruptcies directly to the rise in consumer debt."

"[The bill's proponents] blame the consumer," Leech adds. "It's creating a situation that protects the companies that are pushing more credit on consumers. But in my experience, consumers assume that if they're extended credit, they can afford it. The issue is, that's probably not true." Says Leech, "This legislation will give credit card companies an edge, when other creditors will have to do without. It will put credit card debt on the same level as child-support and alimony."

However, banking lobbyist La Mura says, "There are a number of provisions ensuring that domestic obligations are accorded first priority."

"I think the bill is a bad bill," says attorney Giles, who represents debtors. "There is going to be a perception out there that people won't be able to file bankruptcy." She adds, "It's going to be more expensive to file, with higher filing fees and higher legal fees."

Attorney liability

A particularly vexing aspect of the bill says Giles, is that "it puts liability on the attorney for the debtors' mistakes. I'll have to investigate and certify all my clients' claims, which puts me in an adversarial position with my clients. [Furthermore], if we litigate and we lose, I have to pay their legal fees."

She says that creditors currently can only make objections related to individual debts owed to them, whereas with the new law, "creditors can object, based on a means test, to the [idea of bankruptcy]. They can force you to dismiss the case, convert from a Chapter 7 to a Chapter 13, or to put up a fight. Imagine if we were up against someone like MBNA?"

Will the new law have an impact on her practice? "We don't know yet," says Giles, who practices with her husband Tracy Giles. "We may learn another area of practice. We'll have to see if there will be enough bankruptcy work to sustain us."

David Embry says that he is "irritated" about the new legislation. He is a Lynchburg-based bankruptcy attorney who represents both creditors and debtors. Although a mild-mannered person, he does not mince words on the subject, saying: "I object to the influence of the banks and the credit card companies, and the amount of money they stuffed into the legislators' pockets to get this legislation. The debtors have less influence, and little or no organization. "I think there is some [bankruptcy] abuse, but not much. Most of the bankruptcies I've handled don't involve credit card abuse," he says. "Instead the main factors I see are job loss, uninsured medical expenses and divorce." Indeed, a Harvard study reported that medical expenses contributed to about half of consumer bankruptcy filings in 2001.

Credit counseling

The bill will also institute mandatory credit counseling. Clark Jefferson is a credit counselor with Consumer Credit Counseling Service (CCCS), a Lynchburg nonprofit entity affiliated with the Alliance for Families and Children. He is frustrated by what is missing from the law. "Why don't they start financial counseling sooner, like in the high schools? These are the people who are going to be consumers. No one teaches them [financial management] skills."

He describes the clients he sees as "overwhelmed by either credit cards, medical bills or unsecured loans." He estimates that about a third of clients are victims of expenditures that were beyond their control.

The credit counseling industry has been under fire recently for taking financial advantage of vulnerable clients. Jefferson suggests some questions to ask when seeking a reputable agency:

* What kind of services does it offer?

* Is there face-to-face, local counseling, or is it all done over the phone?

* Are there any free services, such as the initial consultation or budget counseling?

* How are fees levied? Some agencies require a hefty set-up fee; for example, if a monthly debt repayment amount is $500, they take a $500 fee up-front, before any debts are paid. CCCS charges $20 per month, regardless of payback amount.

* Does the agency work with local attorneys and employee assistance programs?

* Is the agency nonprofit or for-profit? Or is it a nonprofit linked to a larger for-profit organization?

Ultimate Impact

Boucher does not expect dire consequences from the legislation. He characterizes it as a "very modest bill that will not deny the complete liquidation provision [of Chapter 7] to those who really need it." He says it will factor in both ordinary, routine expenses as well as extraordinary expenses such a divorce or serious illness. "In addition, we require that credit card companies disclose the effect of only repaying the minimum amount that needs to be repaid; that is, that interest would continue to accrue. This is a very important consumer protection."

But according to a February 2005 statement from a coalition of 92 law professors who oppose the bill, "...the bankruptcy filing rate is a symptom. It is not the disease. ...[it] reveals holes in the Medicare and Social Security systems, as seniors and aging members of the baby-boom generation declare bankruptcy to deal with prescription drug bills, co-pays, medical supplies, long-term care and job loss."

(Deborah Nason is a contributing editor to the Journal. She lives in Roanoke County.)

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