Senator Elizabeth Warren has introduced a law to radically change the consumer bankruptcy practice entitled the Consumer Bankruptcy Reform Act of 2020.

This revolutionary document would make dramatic changes to bankruptcy practice.

1. Chapter 7 and 13 is eliminated and replaced with a single system called Chapter 10.
2. Student Loan debts become dischargeable just like any other debt.
3. Discharges are issued immediately upon confirmation of payment plans instead of waiting until all payments are made.
4. Discharges would be issued without the requirement of a payment plan (what Chapter 7 currently offers) to families whose income is less than 130% of the median income for their state.  For a Nebraska family of 4, the current median income level is $96,749, so debtor’s whose family income is less than $125,773 would be eligible for immediate discharge in Chapter 10.  For a single debtor the income cutoff would be $66,101.
5. Credit counseling requirements are eliminated.
6. Past due rent payments are discharged but landlords may not terminate the lease as long as future rent is paid on time.
7. Telephone/Zoom Court hearings. Debtors would no longer have to attend the required trustee meeting in person and the meeting must not conflict with a debtor’s work schedule.
8. Spending habits become irrelevant: Bankruptcy courts would no longer focus on how a debtor spends their money. Rather, median income levels would determine the amount paid back to unsecured creditors with few debtors having to pay back anything at all.
9. Three types of payments plans are created: Repayment Plans for unsecured debts.  Residence Plans for delinquent mortgage payments.  Property Plans for non-mortgage secured debts, like cars or furniture.  A debtor may be enrolled in three plans at the same time.
10. Attorney fees may be paid after the case is filed, but attorneys may not sell their unpaid fees for quick cash.
11. Trustees may not dismiss unpaid cases but rather must enforce a lien. In current chapter 13 cases, a debtor who fails to pay monthly payments may have their case tossed out of court without a discharge.  New Chapter 10 instead issues an immediate discharge upon plan confirmation and gives the trustee a judgment lien that the trustee may use to enforce the plan, which basically requires the trustee to sue and garnish the debtor.
12. Federal property exemption laws would apply to all cases and allow an individual to shield $30,000 of personal property from creditors.

The Chapter 10 proposal is revolutionary to the core.  This is a radical manifesto that would rip through consumer bankruptcy practice. And, unfortunately, because of its radicalness, it probably has zero chance of ever being enacted into law and squanders the current opportunity to achieve real bankruptcy reform.

What is also clear about this proposal which was endorsed by 74 law school bankruptcy professors, is that it rejected any input from those professionals, judges, trustees and attorneys engaged in consumer bankruptcy practice.

There are so many problems with this proposed law that it is hard to begin.  Here is a short sampling of some of the obvious defects of this political manifesto.

• Student Loans.  Is it really wise or fair to allow students to discharge their entire student loan debt two seconds after they graduate college? Wouldn’t it be wiser to delay eligibility for student loan discharges for a period of 10 or more years? I cannot see how voters would approve of allowing privileged college students to immediately discharge taxpayer subsidized education without making any effort to repay a single dime of debt.
• 130% of Median Income Qualification.  Under current consumer bankruptcy law, the court may require a debtor who clearly can afford to repay some or all of their debt to enter a payment plan.  Not so with chapter 10.  Under chapter 10 we no longer review a debtor’s spending choices or ability to pay.  Rather, we only require debtors with income over 130% of median income levels to pay back anything to unsecured creditors.  Under this rule the vast majority of higher income debtors who currently must offer payment to creditors would immediately qualify for a no payment case.  Would voters approve of that change?
• Unpaid Rent Dischargeable.  Chapter 10 proposes that past due rent be dischargeable but that landlords be forced to continue the lease as long as future rent is paid on time. But doesn’t this just encourage debtors who must file bankruptcy to stop paying rent knowing that they can stop evictions and skip paying past due rent when the bankruptcy is filed? Will this cause landlords to increase the amount of security deposits charged to all renters?
• Mass Resignation of Trustees.  I would anticipate that the majority of trustees now serving in chapter 7 and 13 cases would consider resignation if chapter 10 were passed. Why?  Chapter 13 trustees who mange payment plans could no longer dismiss cases for nonpayment but would rather be required to enforce a judicial lien through garnishments. Is that feasible? Probably not. Chapter 7 trustees could almost never claim property under chapter 10 since new federal exemptions would protect almost every debtor’s property.  And since trustee meetings must now be scheduled when they do not interfere with a debtor’s work schedule, do we really expect trustees to conduct meetings during evening hours or weekends? This is madness!
• Attorney Fees.  The chapter 10 proposal to allow attorneys to collect fees after this case is filed is sensible, but this proposal prohibits attorneys from selling their unpaid fees to investors.  What these law professors do not seem to understand is that this proposal changes nothing since the risk of not being paid has not changed.  Bankruptcy attorneys are not going to start filing complicated cases on an installment plan just because they are allowed to.  Only the most financially stable debtors will be able to take advantage of this change, but for lower-income debtors the attorneys will still have to collect all their fees up front since the risk of not being paid is not alleviated.  That is why allowing attorneys to factor their receivables is actually a good thing for lower-income debtors since it encourages attorneys to file cases for little money down if a market for their unpaid receivables exist.  Rather than outlawing the selling of receivables the better option is to allow the US Trustee and the courts to review the factoring arrangement for reasonableness.  When law professors and lawmakers fail to gather input from those who actually prepare cases, this is the type of misguided legislation that results.
• Enforcement of Payment Plans.  Under the current payment plans offered in Chapter 13, the failure to make payments will result in a dismissal of the case.  Not so with Chapter 10.  Rather, the Discharge of debts is immediate upon plan confirmation and the bankruptcy trustee is given a Judgment Lien to enforce payment.  This is completely unrealistic. Bankruptcy trustees are not going to take the extraordinary steps to garnish debtors who fail to make the bankruptcy payment.  Honest but unfortunate debtors lose jobs and relocate frequently.  Tracking down judgment debtors is a difficult and expensive process.  Bankruptcy trustees depend on a steady flow of payments to fund their office, and taking away the power to dismiss cases will result in a devastating cash flow crisis that will cause trustees to resign from office at alarming rates.  The only reason a majority of debtors make the monthly bankruptcy payment is the fear that a dismissed case will allow creditors to resume garnishments and foreclosures.  Take away that fear and payments to trustees will slow overnight.
• $30,000 Property Exemption.  The proposal to give every debtor a $30,000 property exemption will virtually eliminate a claim of assets in the vast majority of cases. As a result, income for bankruptcy trustee’s will decline substantially.  Several chapter 7 trustees tell me that their profits have shrunk considerably over the years due to greater reporting duties imposed on them and from greater property exemption laws approved by state legislatures.  Some trustee’s say they make little to no income from their trustee duties and they already question why they keep the job.
• Remote 341 Hearings.  I fully endorse the concept of making remote Section 341 meetings with the trustee permanent.  Since COVID-19 these hearings are currently conducted via telephone conference calls, and the process is working well.  However, the new requirement that the hearings not conflict with a debtor’s work schedule is just nonsense.  These hearings only take a few minutes to complete and the debtor is given a month advance notice of the hearing date.  Many debtors complete these hearings on a cell phone by taking a half-hour break from work.  If necessary the hearing are rescheduled if the debtor is not able to attend.  To require that trustees conduct meetings when the debtor is off work in the evening or on weekends is insane.  Trustees will resign before they agree to this.
• Post-Petition Mortgage Payments.  When a debtor falls behind on mortgage payments after a case is filed, the bank will normally file a Motion for Relief from the Automatic Stay when three or four payments are missed.  The proposed Chapter 10 law says that creditors may not take advantage of state law enforcement procedures until a post-petition mortgage payment is 120 days past due.  So does this mean that the automatic bankruptcy stay is automatically lifted when payments are 120 days past due? If so, this represents a great weakening of the protection to homeowners.  In chapter 13 cases the banks don’t even request relief until a loan is 60 to 120 days delinquent, and when that happens we routinely work out payment plans to cure the default over 6 months.  Under Chapter 10, however,  no such repayment agreements are available if the bank just waits until an account is 120 days past due.  This is less protection.
• Median Income Calculations.  Chapter 10 still requires debtors to submit six months of paystubs and other income verification documents to their attorneys to determine their median income level.  What???  This is horrible. Do these law professors have any idea how difficult it is to obtain six months of financial records? This is what the Bankruptcy Reform Act of 2005 imposed and it directly resulted in the cost of bankruptcy cases to double and triple.  It is so obvious that the writers of this legislation have never actually prepared a bankruptcy case.  Why is it necessary for a minimum wage worker to submit a six-month income calculation when it is perfectly obvious from their last paystub and tax return that they only earn minimum wage? Such debtors do not keep paystubs and they change jobs frequently. The nightmare of collecting income documents stays the same under this “reform” bill.

I remember preparing bankruptcy cases prior to the Bankruptcy Reform Act of 2005. Bankruptcy fees were cheap and we didn’t have to collect six months of paystubs or bank statements or tax returns.  But we did have to prove up on every case and explain how we determined a debtor’s income.  Bankruptcy trustees did a good job of reviewing monthly budgets and they frequently pushed higher income debtors out of chapter 7 if they felt a payment could be made to creditors.

In some ways the practice before 2005 was too lax. It does make sense to require debtors to submit a recent paycheck stub, tax return and bank statement to the trustees for review.  It does make sense to impose a duty on bankruptcy attorneys to verify the accuracy of the petition they file.  Some reforms were overdue, but the reform act of 2005 was 99% punitive and unwise.  The law was so poorly drafted that it took a decade of court appeals to figure out what it even said.

The Bankruptcy Reform Act of 2020 is some of the worst written law I have ever read.  This legislation would destroy the current system and lead to mass confusion and trustee resignation. The drafters of the legislation seem not to see how vague and uncertain it’s provisions are and this will lead to massive litigation to figure out what the darn document says, just like the 2005 reform bill did.  But what is worse, 40 years of case law interpreting chapter 13 cases will be thrown into the trash and courts will struggle to interpret the mechanics of the new law.

Bankruptcy attorneys will, however, greatly benefit from the confusion this new law will usher in.  Bankruptcy fees will soar with the complexity of these cases while immediate discharge orders will make them seem like magicians to their clients who are ostensibly immune from not making required payments.  This law is nothing less than a radical economic manifesto that no sensible Congress should ever consider enacting into law.

 

Image courtesy of Flickr and Mark Ramsay