Abstract:
Bankruptcy has broadly failed to deliver “fresh starts” to debtors. Too often, debtors return to states of financial distress following bankruptcy. Although bankruptcy delivers a clean slate through the discharge of debts, the efficacy of a fresh start depends on a second factor: property exemptions. While discharge frees a debtor from her existing debts, property exemptions determine what property the debtor retains upon exiting bankruptcy. For many debtors, insufficient and suboptimal property exemption laws undermine fresh starts. In fact, under current bankruptcy law, each state can reject federal bankruptcy exemptions by opting out. Bankrupt debtors in “opt-out” states are forced to rely on general state exemptions—often stingy and focused on preserving homesteads—that were not designed for bankruptcy.
Existing literature explores two lines of criticism against the federal opt-out provision: (1) arguing that the law should be struck down as repugnant to constitutional notions of uniformity, supremacy, or both, and (2) making the case for repeal on normative and fairness grounds. For decades, neither solution has been forthcoming. The opt-out scheme, at first aberrant and controversial, has proved a perdurable feature of bankruptcy law.
This Article advances a different approach and proposes diffusive, state-based reform solutions. Under this approach, each opt-out state would undertake a meaningful review of its existing exemptions regime in light of the federally-declared rehabilitative function of bankruptcy. I propose a model, to be used in this review, involving three factors—nominal sufficiency, housing agnosticism, and allocative flexibility - as a conceptual framework for reforms. Addressing constitutional concerns, this Article argues that these innovative “bankruptcy-specific exemptions” schemes should survive constitutional scrutiny. The Article ends with discussion of the model and proposed reform framework.
Commentary:
This article provides a thorough historical summary not only of exemptions and bankruptcy, but also the closely linked issue of the Constitution authorization for uniform bankruptcy laws.
In terms of exemptions, contrasted with the fresh start and rehabilitative goals of the original Bankruptcy Code, this article identifies the purposes of state judgment exemptions, collectively referred to as the “Independent Subsistence Function,” to instead be:
(i) preventing debtors from becoming wards of the state;
(ii) providing a guarantee of some minimal level of subsistence; and
(iii) serving the societal function of preserving families.
From there the article then proposes that states should revise their exemptions (or, following the example of Michigan, their bankruptcy specific exemptions) based on the following factors:
(a) Housing Agnosticism: This refers to the imbalance in available exemptions between homeowners and renters, etc., arguing for an increase in the availability and amount of “wild card” exemptions.
(b) Nominal Sufficiency: This relates to providing guaranteed minimums of protected assets. Unmentioned in this article is the suggestion that the Bankruptcy Code could be amended to provide such minimums, while still allowing states to provide greater exemptions where appropriate.
(c) Allocative Flexibility: This again argues for a broader wild card exemption that would allow debtors the choice of what property to exemption.
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