Abstract:
When enacted in 1978, the Bankruptcy Code was heralded as a consumer protection victory. It gave families in financial trouble a complex array of legal options, including the ability to repay their debts over a number of years in chapter 13 bankruptcy. That new option was lauded by experts and became popular across the nation. Today over 1 million families are currently in chapter 13 bankruptcy; it remains the first line of defense for families facing foreclosure.
For more than thirty years, research has shown that two in three families drop out of chapter 13 before completing their repayment plans and do not receive a discharge of debts. To rebut this statistic, defenders of chapter 13 argued that success was possible without case completion, for example, by curing a default on a mortgage loan early in a case or by regaining financial footing after a period of living on a strict court-imposed budget. With no data on debtors’ circumstances when their cases ended, chapter 13 endured as key component of America’s policy to address household financial distress.
This article exposes the real outcomes of chapter 13 bankruptcy for the first time. It provides evidence of what problems families tried to solve in bankruptcy and what problems they did solve in bankruptcy. The data come from a new nationwide empirical study of chapter 13 cases did not end as the law intended - with completion of a repayment plan and a discharge of debt. The findings show that most families receive a temporary reprieve from chapter 13: the halt of collection activity and reduction in stress. However, these benefits evaporate just a few weeks after bankruptcy. More than half of homeowners are already in foreclosure, and families are dealing with renewed dunning calls and struggles in making ends meet.
Chapter 13 is a "pretend solution," a term that the author coins to describe a social program that does not work but has escaped critique or reform because its outcomes are hidden. This paper’s data are a clarion call to stop pushing families in financial trouble into chapter 13 and to redesign the consumer bankruptcy system. The data are also a cautionary tale about what happens when well-intention policymakers offer up a generous program but fail to monitor outcomes. A pretend solution can flourish, inoculating policymakers from revisiting the social problem. The paper concludes with a framework for pretend solutions that can be applied in other contexts and a discussion of how policymakers can avoid pretend solutions by focusing sharply on outcomes, not intentions.
For a copy of the paper, please see:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1965680
Commentary:
Much gets made, from this about bankruptcy chapter choice to Judge Johnson's crusade against nearly all Chapter 13 cases being infeasible in the Riverside Division in Central California, of how few Chapter 13 cases "succeed." This success rate largely relies on the estimate that only one-third of Debtors complete a Chapter 13 plan and receive a discharge.
Occasionally, lip service may get paid to the fact that "[e]ven when no discharge is obtained, a chapter 13 can buy more time to stave off foreclosure long enough to relocate." Other reasons for filing Chapter 13 may be also be admitted, but still the touchstone for determining if a bankruptcy is successful is whether the Debtor gets a discharge.
Since the vast majority of Debtors who file Chapter 7 do get a discharge, Chapter 7 is consequently viewed, at least academic studies, as a more effective remedy for Debtors in financial distress.
But what if this focus on the discharge was flipped and instead the other reasons for Chapter 13 were considered as the primary criteria for evaluating the success of the different Chapters? For example, the discharge is of far less value for many Debtors than keeping their home, even for just a few more months or years.
Searching the SSRN website (http://www.ssrn.com/) and there is a relative dearth of studies concerning post-bankruptcy outcomes.
One of the few, however, is "The Failure of Bankruptcy's Fresh Start" by Katherine Porter and Deborah Thorne from 2006. (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=894453) . It "found that just one year after bankruptcy, one in four [Chapter 7] debtors was struggling to pay routine bills, and one in three [Chapter 7] debtors reported an overall financial situation similar to, or worse than, when they filed bankruptcy." If 25%-33% of Chapter 7 Debtors are not better off and still struggling financially after receiving their discharges, the indictment of Chapter 13 based on its dismissal rates would seem to overly harsh, with the more even-handed conclusion being that neither chapter of bankruptcy is a perfect solution to financial distress.
The article "Household Borrowing After Personal Bankruptcy" by Song Han and Geng Li at the Federal Reserve (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1325660) looks at borrowing by Debtors after bankruptcy, but did not separate the experiences of Chapter 13 and Chapter 7 Debtors.
I was not able to find any studies that examined how often Chapter 7 debtors later lost cars to repossession or homes to foreclosure when they had indicated on their Statements of Intention a desire retain or reaffirm the property. This would seem to be a useful means of gauging whether Chapter 7 Debtors were able to meet their stated and often primary goals in filing bankruptcy, viz. retention of assets.
Alternate Proposal:
If the purpose of bankruptcy is to, at a minimum, get "the honest but unfortunate debtor" a discharge, there are currently options to do so, that would "only" take a change in behavior by Chapter 13 Trustees. This might be a viable solution to the problems raised by this and other articles, especially since for the enactment of a"single portal bankruptcy", see for example, A Fresh Start for Personal Bankruptcy Reform: The Need for Simplification and a Single Portal. (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=912561), the biggest initial obstacle to such a change would be, as one advocate for such a changed has written, "the difficulty of the politics of attaining any positive change through legislation cannot be overstated."
Normally, when a Chapter 13 Debtor falls delinquent in his or her plan payments, the response of the Chapter 13 Trustee is to move to dismiss the case. This leaves the Debtor not only open to foreclosure and repossession on his or her secured debts, but as vulnerable to their unsecured creditors again. Any time and money spent in Chapter 13 is largely for naught.
As only a vanishingly small number of Chapter 13 Debtors fail to make their plan payments because they have more than enough money, this opens them to collection when they are likely less able to pay than they were before filing Chapter 13 in the first place. The result is not that those dismissed Debtors suddenly pay their bills. Instead, they usually either refile another Chapter 13 (which has an even lower likelihood of success than their first case), file a new Chapter 7 (which at a minimum usually requires a $306 filing fee, plus counts as a 2nd bankruptcy and delays a clean credit report for another 10 years) or to go underground with in "gray market" bankruptcy, dodging creditors and not starting over.
The same section of the Bankruptcy Code that provides for dismissal of a Chapter 13 case, 11 U.S.C. § 1307(c)(6), however, also allows a Trustee to seek conversion of the case to Chapter 7 for "material default by the debtor with respect to a term of confirmed plan." Normally, a Chapter 13 Trustee will only seek conversion to Chapter 7 when the Debtor has substantial equity above exemption, otherwise viewing such conversion as pointless.
If, however, Trustee's sought conversion instead of dismissal, this would at the very least get the Debtor (who again is unable to pay his or her debts) a Chapter 7 discharge. Since § 1307(b) allows the Debtor to voluntarily dismiss a case at any point prior to conversion, this option would still be open to a Debtor. (Perhaps, if Marrama is read broadly, subject to bad faith.)
An fair question is why debtors’ attorneys are not already routinely converting these failing cases. A part of the answer to this is obviously the additional attorneys fees for handling the conversion, fees that a debtor, who is unable to make plan payments, would struggle to pay. A difficult question would be whether the Debtor's Chapter 13 attorney would be compelled to represent the Debtor following the conversion or if (and then how) the attorney would be paid. One option would be for courts to modestly increase the "no-look" Chapter 13 fee to basically include "conversion insurance" for the cost of attorneys' additional representation in every case. (Regarding other costs of involuntary conversions to the Debtor, again there is no filing fee charged for involuntary conversions.) If a Debtor were to file a subsequent Ch. 13, he or she would end up paying more attorneys' fees in the next case, but that's true currently following dismissal.
Further, however, it is often difficult to not only convince a Debtor to voluntarily convert, but even difficult to contact a debtor facing dismissal. A debtor’s attorney, bound by professional ethics, cannot force a debtor to convert against his or her desire or even without the debtors’ consent.
There are very few circumstances in which conversion and a subsequent Chapter 7 discharge would result in the Debtor being in a worse situation than outright dismissal. The few I can think of include:
As to secured debts, conversion would likely delay foreclosure or repossession, as secured creditors would need to seek relief from the automatic stay in the Chapter 7 case. (There is case law that allows a Debtor to be in an active Chapter 7 and an active Chapter 13 at the same time, so the Debtor could even refile another Chapter 13, while the Chapter 7 is pending.)
Some taxes could become non-dischargeable, even if a subsequent Chapter 13 is filed closely on the heals of the Chapter 7.
Mortgage strip-offs would be complicated if the Debtor wasn't eligible for a discharge in a subsequent Chapter 13.
The limited number of cases where conversion was not the best option, could instead just opt for dismissal. (Voluntary dismissal might not be attractive if a Motion for Relief from Stay has been filed, since § 109(g)(2) might impede refiling.)
Following the involuntary conversion due to inability to make plan payments, the Means Test would not likely be a real problem, as better line of cases hold that § 707(b) only applies to "a case filed by an individual debtor under this chapter" and thus no means test is needed for conversion (which were filed under Ch.13)
Getting a involuntarily converted Debtor to attend a the Meeting of Creditors could be difficult. § 341(a) requires that "[w]ithin a reasonable time after the order for relief in a case under this title, the United State trustee shall convene and preside at a meeting of creditors." A sympathetic and pragmatic reading of this section would be that the § 341 Meeting from the original Chapter 13 case could, absent any other factors, be sufficient for the Chapter 7 Trustee. This would save the converted Debtors from repeat appearances. If the Chapter 7 Trustee did have questions, he could request a §341 Meeting of Creditors or conduct a 2004 exam. (As attendance at § 341 Meetings seems really, really important to the UST (and the BA here in North Carolina) this might not even be worth raising.) If the Debtor doesn't come to the § 341 Meeting for the Chapter 7, then he or she will get dismissed, just like they were going to be from the Chapter 13.
A Statement of Intentions would need to be filed following the conversion, but that is a relatively easy task. Reaffirmations, if offered and desired, would need to be completed and filed.
Conversion would not cause Debtors to lose their home to foreclosure or their car to be repossessed any more quickly than dismissal would. In either case, if they were current on payment or can work out an arrangement, they'll keep the stuff. Otherwise, they will lose the collateral. They would, however, still be protected until either discharge or the creditor obtained relief from stay, allowing the debtor at least another 30 days to keep the property.
A massive increase in conversions could put a strain on Chapter 7 Trustees and would cost the federal court system revenue, since no additional filing fee is paid in a forced conversion and the Chapter 7 Trustees would still get their $60.00 "no-asset" fee for the vast majority of cases. As these bankruptcies have already, presumably, been reviewed and vetted by the Chapter 13 Trustee, they really would not require much further review by the Chapter 7 Trustee.
Filing a subsequent Chapter 13 would actually be easier in most cases:
The limited stay for a refiled case under §§ 362(c)(3) and (4) would not apply, eliminating the need for Motions to Extend Stay.
Most unsecured debt would be discharged, so even in jurisdictions that normally insist on some dividend as a sign of good faith, that burden would be lifted. It would also seem likely that as these Chapter 33s (Ch. 13 converted to Chapter 7 refiled as Chapter 13) with 0% cumulative dividends became more common, courts that surcharge Ch. 13 debtor with a minimum dividend might come to realize that such dividends are really just punitive requirements on folks that wait until they're behind on secured debts to file CH. 13 compared to those that file Ch. 7 sooner.
The 3 or 5 year Applicable Commitment Periods of § 1325(b)(4), would also not apply in most cases. § 1325(b)(1)(A) allows plans of shorter length that the Applicable Commitment Period when the Debtor pays all allowed unsecured claims. Since most of a Debtor's unsecured debt would have been discharged by the conversion, with the most common exceptions being priority taxes, child support or non-dischargeable student loans, the Debtor's subsequent Chapter 13 would commonly be a 100% dividend to the $0 of unsecured debt and the Debtor could get done with this Chapter 13 case more quickly.
Those refiles with Student Loans or other non-dischargeable debts following conversion, could always stick with their subsequent Chapter 13 only long enough to cure mortgage arrearage and pay secured and priority claims, then voluntarily dismiss. Since they wouldn't be discharging the student loans anyways, the discharge (even if available due to the 4 year minimum gap) wouldn't be necessary.
Again with most unsecured debt discharged, this would allow any projected disposable income to be directed towards student loans, so the Debtor could make progress on those debts while in Chapter 13, rather than remaining in limbo for 3-5 years or, with accrued interest, actually falling further into student loan hell.
If a Debtor were to file a subsequent Ch. 13, he or she would end up paying more attorneys' fees in the next case, but that's true currently of any refile following dismissal.
I'm sure that I may be missing both some pros and cons in the consideration of forced conversions, but this would seem like an option that would only require a sympathetic Chapter 13 Trustee to implement, rather than Congressional action, which regardless of which party controls the levers of government, is unlikely to be pro-debtor.
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