[Senate Hearing 107-195]
[From the U.S. Government Publishing Office]
S. Hrg. 107-195
THE BANKRUPTCY REFORM ACT OF 2001
=======================================================================
HEARING
before the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
FEBRUARY 8, 2001
__________
Serial No. J-107-2
__________
Printed for the use of the Committee on the Judiciary
_______
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COMMITTEE ON THE JUDICIARY
ORRIN G. HATCH, Utah, Chairman
STROM THURMOND, South Carolina PATRICK J. LEAHY, Vermont
CHARLES E. GRASSLEY, Iowa EDWARD M. KENNEDY, Massachusetts
ARLEN SPECTER, Pennsylvania JOSEPH R. BIDEN, Jr., Delaware
JON KYL, Arizona HERBERT KOHL, Wisconsin
MIKE DeWINE, Ohio DIANNE FEINSTEIN, California
JEFF SESSIONS, Alabama RUSSELL D. FEINGOLD, Wisconsin
SAM BROWNBACK, Kansas CHARLES E. SCHUMER, New York
MITCH McCONNELL, Kentucky RICHARD J. DURBIN, Illinois
MARIA CANTWELL, Washington
Sharon Prost, Chief Counsel
Makan Delrahim, Staff Director
Bruce Cohen, Minority Chief Counsel and Staff Director
C O N T E N T S
----------
STATEMENTS OF COMMITTEE MEMBERS
Page
Durbin, Hon. Richard J., a U.S. Senator from the State of
Illinois....................................................... 123
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa. 120
Hatch, Hon. Orrin, a U.S. Senator from the State of Utah......... 2
Kennedy, Hon. Edward M., a U.S. Senator from the State of
Massachusetts.................................................. 121
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont. 4
Schumer, Hon. Charles E., a U.S. Senator from the State of New
York........................................................... 109
Specter, Hon. Arlen, a U.S. Senator from the State of
Pennsylvania................................................... 1
Thurmond, Hon. Strom, a U.S. Senator from the State of South
Carolina....................................................... 129
WITNESSES
Becker, Hon. Edward R., Chief Judge, United States Court of
Appeals for the Third Circuit, Philadelphia, PA................ 9
Beine, Kenneth H., President, Shoreline Credit Union, Two Rivers,
WI............................................................. 49
Manning, Robert D., Senior Research Fellow, Institute for Higher
Education, Law, and Governance, University of Houston Law
Center, Houston, TX............................................ 57
Newsome, Hon. Randall J., Judge, United States Bankruptcy Court,
Northern District of California, Oakland, CA................... 19
Sheaffer, Dean, Vice President, Director of Credit, Boscov's
Department Stores, Inc., Laureldale, PA........................ 76
Strauss, Philip L., Principal Attorney, San Francisco Department
of Child Support Services, San Francisco, CA................... 37
Vullo, Maria T., Partner, Paul, Weiss, Rifkind, Wharton and
Garrison, New York, NY......................................... 81
Williamson, Brady C., Attorney, LaFollett, Godfry and Kahn, and
former Chair, National Bankruptcy Review Commission, Madison,
WI............................................................. 43
Zywicki, Todd J., Assistant Professor of Law, George Mason
University School of Law, Arlington, VA........................ 87
QUESTIONS AND ANSWERS
Responses of Philip L. Strauss to Questions from Senator Biden... 130
Responses of K.H. Beine to Questions submitted by Senator
Feingold....................................................... 132
Responses of Randall J. Newsome to Questions submitted by Senator
Feingold....................................................... 134
Responses of Philip L. Strauss to Questions submitted by Senator
Feingold....................................................... 135
Responses of Todd I. Zywicki to Questions submitted by Senator
Feingold....................................................... 137
Responses of Dean Sheaffer to Questions submitted by Senator
Feingold....................................................... 138
Responses of Brady C. Williamson to Written Questions............ 139
Responses of the Administrative Office of the Courts to Questions
submitted by Senator Leahy..................................... 140
Responses of Robert D. Manning to Questions submitted by Senator
Leahy.......................................................... 142
Responses of Todd Zywicki to Questions submitted by Senator Leahy 147
SUBMISSIONS FOR THE RECORD
American Bar Association, Governmental Affairs Office,
Washington, DC, statement...................................... 150
Arnold, Hon. Richard S., U.S. Circuit Judge for the Eighth
Circuit, statement............................................. 152
Association of Financial Guaranty Insurors, statement............ 153
Block-Lieb, Susan, Professor of Law, Fordham University, New
York, NY, statement............................................ 155
Bond Market Association, Washington, DC, statement............... 157
Commercial Law League of America, Chicago, IL, statement and
attachment..................................................... 163
Consumer Mortgage Coalition, statement........................... 166
International Council of Shopping Centers, Alexandria, VA,
statement...................................................... 169
Jones, Hon. Edith H., United States Court of Appeals, Fifth
Circuit, Houston, TX, statement................................ 173
United States Department of Justice, Office of Legislative
Affairs, Jon P. Jennings, Acting Assistant Attorney General,
statement...................................................... 175
Wallace, George J., Eckert Seamans Cherlin & Mellott LLC,
Washington, DC, statement...................................... 176
THE BANKRUPTCY REFORM ACT OF 2001
----------
THURSDAY, FEBRUARY 8, 2001
U.S. Senate,
Committee on the Judiciary,
Washington, DC.
The committee met, pursuant to notice, at 10:10 a.m., in
room SD-226, Dirksen Senate Office Building, Hon. Orrin G.
Hatch, Chairman of the Committee, presiding.
Present: Senators Hatch, Grassley, Specter, Kyl, Sessions,
Leahy, Kennedy, Biden, Feinstein, Feingold, and Schumer.
Chairman Hatch. We are happy to welcome you all out to the
committee this morning. I will give my remarks immediately
after Senator Specter, who wants to introduce Judge Becker from
the Third Circuit Court of Appeals, and then we will move on
from there with the Ranking Member and then to Judge Becker.
STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM THE STATE
OF PENNSYLVANIA
Senator Specter. Thank you very much, Mr. Chairman, for
your courtesy in permitting me to start. I have another
commitment which I have to attend to.
It is a great pleasure for me to present Chief Judge Edward
Roy Becker from the Court of Appeals for the Third Circuit to
this committee. I haven't known Judge Becker very long, only 51
years. We rode the elevated train from northeast Philadelphia
to the University of Pennsylvania.
I am substantially older than Judge Becker. He was a
freshman when I was a senior. He started at the University of
Pennsylvania in the fall of 1950, and I had the opportunity to
coach the University of Pennsylvania debating team when Judge
Becker was a senior.
We went to Boston to debate the Norfolk State prisoners,
Senator Kennedy, and the subject was resolved that the
communist party should be outlawed. The five chief editors from
the newspapers--Irwin Cannon was one of the judges of that
debate, and I am not pleased to tell you that Judge Becker and
I lost to the Norfolk State prisoners. We had a very large
audience, about 1,000 inmates.
Senator Kennedy. Which side were you on, Senator?
[Laughter.]
Senator Specter. They had to take the side of law and order
to urge outlawing the communist party. We had 1,000 people.
That is what you call a real captive audience, the
quintessential.
Judge Becker graduated Phi Beta Kappa from the University
of Pennsylvania and the Yale Law School, where again we were
together in the law school. He graduated in the class of 1957
and he had a very unusual career as an active lawyer, a
business lawyer, a trial lawyer, and a Republican committeeman.
I would say that Judge Becker is one of the few, if not the
only Federal judges to have earned his judgeship both ways, by
merit and by politics. It was a confluence of factors. He was
on the United States District Court for the Eastern District of
Pennsylvania at the age of 37, and he was elevated to the Third
Circuit in 1970 and he is now the Chief Judge, bringing an
enormous number of innovative ideas, one of the real leaders of
the American bar and the American judiciary. If there should
ever be another vacancy on the Supreme Court of the United
States, we could start the confirmation hearing this morning.
As you can tell, Mr. Chairman, it is a long, very intimate
friendship with Chief Judge Becker, and I know that he has some
words of wisdom for the committee.
Thank you very much, Senator Hatch, for permitting me to go
out of order.
Chairman Hatch. Thank you for your kind introduction,
Senator Specter.
That is high praise Judge Becker, and, of course, I am very
familiar and aware of you, as well, and have equally high
esteem for you.
OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM
THE STATE OF UTAH
Chairman Hatch. I would just say good morning to everybody.
We welcome you to today's hearing on bankruptcy reform. We
would first like to thank all of our witnesses for their time
and cooperation, and I hope that this hearing will serve to
reinforce for all of us, especially the new members of the
committee, the pressing need for bankruptcy reform.
Of course, bankruptcy reform is by no means a new issue to
this committee or to the Congress. In fact, the Senate
literally has been engaged in the process of deliberating on
this issue for years, with numerous hearings, markups, and
votes. And we should have these real and needed reforms and
compromises that we have made to this product, one that has
been supported by both Houses of Congress with overwhelming
bipartisan and veto-proof margins.
Following extensive studies by the National Bankruptcy
Review Commission, the comprehensive bankruptcy reform bill was
developed by Senators Grassley and Durbin in the Subcommittee
on Administrative Oversight and the Courts in 1997. We marked
up and reported that bill out of committee in May 1998.
In September 1998, the Senate passed bankruptcy reform by a
vote of 97 to 1. This overwhelming Senate vote in favor of
bankruptcy reform was followed by the appointment of conferees,
negotiation with the House and, in October 1998, a 300-125
House vote for the conference report.
Although the motion to proceed to consideration of the
conference report was agreed to in the Senate by a strong vote
of 94 to 2, the Senate ran out of time for a vote on final
passage before the end of that Congress. So in February 1999,
Representative George Gekas, in the House, introduced
bankruptcy reform again, which passed out of the House in May
1999 by another overwhelming vote of 313 to 108.
Meanwhile, in the Senate, Senator Grassley worked together
with Senator Torricelli, and in March 1999 once again
introduced bankruptcy reform legislation which was again
referred to the Judiciary Committee. The Judiciary Committee
again marked up the bill, and in May 1999 we favorably reported
it out of the committee to the floor.
In February of last year, the reform legislation passed the
Senate by another impressive margin of 83 to 14. The Senate
requested a conference, but the objection of a single member
from the other side of the aisle blocked the appointment of
conferees. As a result, we had to turn to an informal
conference process with the House of Representatives, but
fortunately this process was bipartisan. With a great deal of
dedication of members on both sides of the aisle, we reached a
compromise agreement on well over 400 pages of bankruptcy
reform legislation and on all but two issues among the informal
conferees.
In October of 2000, the House passed the bankruptcy reform
conference report, and in December the Senate passed it by yet
another overwhelming vote of 70 to 28. Later that month, the
President pocket-vetoed the bankruptcy reform legislation.
Now, I provide this elaborate procedural history to make
two points. First, the issue of bankruptcy reform is not a new
one; it is quite familiar to all of us. Many of our witnesses
today have testified before Congress on this issue. We have
studied it, held hearings on it, compromised on it, and come to
a resolution on it with veto-proof margins in both Houses time
and again. An elaborate record sets out the issues, documents
the debate, and makes the compelling case for reform that is
available to anyone who has an interest in giving it their
attention.
This leads me to my second point. Eventually, the process
of deliberation needs to come to a close and the will of the
Congress needs to be exercised. As history has demonstrated
repeatedly, bankruptcy reform is clearly the will of the
Congress and much needed for all American consumers.
I would like to take a moment to thank Senators Grassley
and Sessions for their hard work and dedication to this
important reform legislation over the past years. I also would
like to thank the committee's ranking Democrat member, Senator
Leahy, along with Senators Biden and Durbin, and Senator
Torricelli, for their leadership in the area of consumer
bankruptcy reform, as well as other members of the committee,
both current and former, who have worked so hard on this very
important set of issues.
I am feeling somewhat like a broken record, but I feel
compelled to state once again that we cannot afford to continue
down the harmful path provided by current law, because abusive
bankruptcy filings are harmful to all of us. Bankruptcy ends up
costing all Americans in an amount that has been conservatively
estimated at anywhere from $400 to $550 per household, per
year.
Contrary to what critics of reform would like us to
believe, when someone files for bankruptcy the negative
repercussions go far beyond the credit card companies and big
businesses to whom money is owned but is not paid. The costs
are passed on to all honest consumers who honor their
commitments and who pay their bills. This is an issue that
profoundly impacts the average American. Bankruptcies end up
hurting people who own or work in small businesses, who are
members of credit unions, and spouses and children who are
entitled to child support.
We should preserve bankruptcy to provide a fresh start, but
only for those who truly don't have the means to pay some of
their debts as promised. I look forward to the testimony today
because I believe it will highlight some of the abuses that the
current system allows to take place and will address one more
time the pressing need for this consumer bankruptcy reform
which more importantly provides many new consumer protections.
We are fortunate to be hearing testimony from Judge Edward
Becker, Chief Judge of the United States Court of Appeals for
the Third Circuit, who has some concerns about the bill, some
suggestions for us, and who we decided to put on at the last
minute at the request of other members of the Federal judiciary
and Judge Becker.
We are happy to welcome you here, Judge.
We have Judge Randall Newsome, of the United States
Bankruptcy Court for the Northern District of California;
Philip Strauss, Principal Attorney from the San Francisco
Department of Child Support Services; Brady Williamson, the
former Chair of the National Bankruptcy Review Commission.
We are also fortunate to be hearing from Ken Beine,
President of Shoreline Credit Union, in Two Rivers, Wisconsin;
Dr. Robert Manning, Senior Research Fellow from the University
of Houston Law Center; Dean Shaeffer, Vice President and
Director of Credit for Boscov's Department Stores, in
Pennsylvania; Maria Vullo, an attorney with the firm of Paul
Weiss; and Todd Zywicki, Assistant Professor Law at George
Mason University.
We appreciate all of you appearing today and we look
forward to your testimony.
I will now turn to our Ranking Member, Senator Leahy, for
his opening statement.
OPENING STATEMENT OF HON. PATRICK J. LEAHY, A U.S. SENATOR FROM
THE STATE OF VERMONT
Senator Leahy. Thank you, Mr. Chairman. I know others
perhaps have things to say, but I am pleased that we are having
this.
There are so many competing public policy interests between
debtors and creditors and among competing creditors. Judge
Becker has seen those competing interests probably more than
any one of us around this panel. But we also have a number of
Senators around this committee who have developed expertise in
this area and I do want to hear from them, too, because they
are going to have to help us develop a consensus.
We have tried for 4 years to pass bankruptcy reform
legislation. We all agree that we need some changes in the
bankruptcy laws, but it has failed, I think, each time in the
last two Congresses when we went from bipartisanship to
partisanship.
In the last two Congresses, the final decisions were made
by the Republican majority behind closed doors and did not get
too much of a say in it. There are complex and competing
interests in this that say we have to work in a bipartisan
fashion throughout this process.
I would think that what we should do is look at some of the
mistakes in the past and why we didn't get legislation through.
I think we can avoid those mistakes. Mr. Chairman, I think you
and I can work very closely together with other members of the
committee to have both sides heard.
I think the last two times, we saw that there is a great
deal of bipartisan consensus, and we can follow up on that. So
I hope we do this and craft a balanced and fair bankruptcy
reform law, one that addresses and corrects abuses by both
debtors and creditors. For example, we should provide for more
disclosure of information so that consumers may better manager
their debts and avoid bankruptcy altogether.
I know that Senator Grassley and Senator Durbin, who is
unable to be here today because of a death in the family, and
Senator Schumer and others share a commitment to include credit
industry reforms in a fair and balanced bankruptcy bill.
The millions of credit card solicitations made to American
consumers the past few years have contributed to the rise in
consumer debt and bankruptcies. When we see people who work
here, their 3-year-old and 4-year-old children getting credit
card solicitations, you know that something is wrong.
In addition, many of the most controversial proposals for
change are to benefit the credit card industry and to use
taxpayer-supported bankruptcy courts and the authority of
Federal law to augment and support the credit card industry's
debt collection. Well, if we are going to have the taxpayers
help with their debt collection, it is only fair that the
credit card industry be involved in bankruptcy reform and that
they be asked to show how those changes they seek are going to
benefit consumers through lower interest rates or lower fees.
If we are going to help them collect their debt, if we are
going to have the taxpayers pay to help them collect their
debts, what are they going to do to help the users of their
cards?
President Bush underlined the importance of examining
credit industry practices. He said this week, to quote
President Bush, ``The debt I am most concerned about, however,
is the consumer debt, credit card debt, the debt that burdens
thousands of Americans. And we'd better be really careful about
not recognizing the combination of an economic slow-down, high
energy prices, and debt overhang--what that means to working
people.'' As usual, I agree with President Bush.
I am pleased that Professor Robert Manning is here today to
discuss his recent research and analysis of credit industry
practices and consumer debt. We should also talk about wealthy
debtors who use the overly broad homestead exemption to shield
assets from their creditors. Senator Kohl has been a leader on
this issue and on closing this loophole.
In some States, wealthy debtors have used their State laws
to protect million-dollar mansions from creditors, and it has
been a major problem. In the last Congress, by a vote of 76 to
22, the Senate adopted a bipartisan amendment offered by
Senator Sessions and Senator Kohl to cap any homestead
exemption at $100,000. But, of course, in the final bill that
was gutted. Brady Williamson, the former Chair of the National
Bankruptcy Review Commission, is here to tell us about this
consensus reform and others like it that the Bankruptcy Review
Commission recommended to Congress.
A year ago, the Senate passed the Schumer-Leahy amendment
to prevent the abuse of the bankruptcy system whereby you could
discharge penalties for violence against family planning
clinics.
As I recall, Senator Schumer, that was a vote of 80 to 17,
overwhelming. It was given support this past month by Senator
Ashcroft, who had voted in favor of the amendment. He said he
supported this. Yet, even though it was an overwhelmingly
bipartisan endorsement, in the so-called conference report at
the end of the year there wasn't a single word of it. As a
result, perpetrators of clinic violence can continue to seek
shelter in the Nation's bankruptcy courts. That would be wrong.
Attorney General Ashcroft pledged his support for the
Schumer-Leahy amendment during his confirmation hearing. As
usual, I agree with Attorney General Ashcroft.
I want you to notice my close agreement with President Bush
and Attorney General Ashcroft in these matters, Senator Hatch,
and I hope you will follow the example of the leaders of your
party.
Maria Vullo, a top-rated attorney, will testify about the
need to amend the Bankruptcy Code to stop wasteful litigation
and abuse of bankruptcy filings used to avoid the legal
consequences of violence and vandalism and harassment and to
deny access to legal health services. So we should remember
those things we passed in the past and look back at them.
We should also remember those who use bankruptcy are
usually the most vulnerable of the American class. They are
older Americans who have lost their jobs or are unable to pay
their medical debts. They are women attempting to raise their
families or secure alimony and child support after a divorce.
They are individuals struggling to recover from unemployment.
We need to remember that people use the system, both the debtor
and the creditor.
Judge Becker and Judge Newsome are here today to testify
about how reform legislation will impact on the real people who
use our courts each day, and I think that is very helpful to
us. We need to balance the interests of creditors with those of
middle-class Americans who need the opportunity to resolve
overwhelming financial burdens.
Even though this was put together on very, very short
notice, the minimum notice, I am glad that the witnesses were
able to come here today. I know the House is going to hold 2
days of meetings and amendments. I hope that we will work as
hard as they do, but I would also hope that we would look at
those things that were developed through bipartisan consensus
in the last couple of years and go back to those things as a
beginning point.
Thank you, Mr. Chairman.
Chairman Hatch. Thank you, Senator Leahy.
[The prepared statement of Senator Leahy follows:]
Statement of Hon. Patrick J. Leahy, a U.S. Senator from the State of
Vermont
I am pleased that the Committee is holding this hearing. Bankruptcy
is a complex area of the law with many competing public policy
interests between debtors and creditors and among competing creditors.
I look forward to hearing our witnesses share their insight and
experience with the current bankruptcy system. We are fortunate to have
a number of Senators on this Committee who have developed expertise in
this area, as well. I look forward to hearing from them, to working
with them and to our developing a consensus of the areas of our federal
bankruptcy law that need modification and improvement.
For the past four years, Congress has tried but failed to pass
bankruptcy reform legislation. I believe the legislative process broke
down in the each of the last two Congress when partisanship took over.
Three years ago, as the Senate was considering bankruptcy legislation,
I received assurances that our conferees would support the Senate bill
and the Senate position in conference. Unfortunately, that bill, which
passed with 97 bipartisan votes, and on which Senator Durbin and
Senator Grassley had worked so hard, was abandoned to a poor substitute
that was never enacted.
Last Congress, we again worked for a bipartisan bill. The
Republican leadership extended Senate consideration of the bill over
both congressional sessions when it would not allow votes on two
proposed amendments in 1999. After the new year we returned to see the
Senate vote overwhelmingly in favor of one of those amendments, the
Schumer-Leahy amendment. During Senate consideration we also were able
to improve the bill by adopting the Kohl-Sessions amendment, capping
the homestead exemption.
Because of a Republican amendment that added unnecessary tax
provisions, the House would not conference on the Senate-passed bill
and no formal conference was conveyed. For a time we worked informally
to resolve differences on a bipartisan basis, until the Republican
majority decided to write their own version of a final bill that they
had been warned would result in a presidential veto. They then used a
sham conference to substitute their bankruptcy bill for a State
Department embassy security bill. That bill dropped the Schumer
amendment, revised the homestead exemption and did not address the oft-
articulated concerns of the President, and the exercise predictably
resulted in a veto rather than enactment. Unfortunately, at the end of
each of the last two Congresses, final decisions were made by the
Republican majority behind closed doors.
The complex and competing interests involved in achieving fair and
balanced reforms of our bankruptcy system demand that we work in a
bipartisan manner throughout the legislative process. That is the
lesson to learn from the failed attempts of past reform measures, and
it is all the more relevant as we begin this session with an evenly
divided Senate and an evenly divided Committee. I hope that the
partisan mistakes of the past will give way to real and sustained
cooperation so that this Congress can produce a consensus that can make
changes that are needed to benefit the American people. There is ample
evidence from the last two rounds that bipartisan consensus is possible
on responsible bankruptcy reform.
I look forward to working with all Members of this Committee in a
respectful, bipartisan way from beginning to end--from hearings, to
consideration of legislative ideas, to markup, to Committee report, to
Senate consideration and finally to having a fair and balanced
conference report signed into law. For us to succeed this time, we must
work together from beginning to end.
I believe we can craft a balanced and fair bankruptcy reform law.
One that addresses and corrects the abuses by both debtors and
creditors in the current bankruptcy system.
For example, we should provide for more disclosure of information
so that consumers may better manage their debts and avoid bankruptcy
altogether. I know that Senator Grassley, Senator Durbin, Senator
Schumer and others share a commitment to include credit industry
reforms in a fair and balanced bankruptcy bill. The millions of credit
card solicitations made to American consumers the past few years have
contributed to the rise in consumer debt and bankruptcies. In addition,
many of the most controversial proposals for change are to benefit the
credit card industry and use taxpayer-supported bankruptcy courts and
the authority of federal law to augment and support their debt
collection. As a result, it is only fair that the credit card industry
be involved in bankruptcy reforms and be asked to show how those
changes they seek will benefit consumers through lower interest rates
and lower fees.
President Bush underlined the importance of examining credit
industry practices when he said this week: ``The debt I'm most
concerned about, however, is the consumer debt, credit card debt, the
debt that burdens thousands of Americans. And we'd better be really
careful about not recognizing the combination of an economic slowdown,
high energy prices and debt overhang--what that means to working
people.'' I agree with President Bush. I am pleased that Professor
Robert Manning is here today to discuss his recent research and
analysis of credit industry practices and consumer debt.
Another improvement we should make is to adequately address the
problem of wealthy debtors who use overly broad homestead exemptions to
shield assets from their creditors. Senator Kohl has been a leader on
this issue and a champion of closing down this loophole for the rich.
In some states, wealthy debtors have used their State laws to protect
million dollar mansions from creditors. This has been a real abuse of
bankruptcy's fresh start protection.
In the last Congress, the Senate overwhelmingly voted to close this
loophole in the Bankruptcy Code. By a vote of 76 to 22, the Senate
adopted a bipartisan amendment offered by Senators Kohl and Sessions to
cap any homestead exemption at $100,000. But last year's final bill
gutted this key reform. I am pleased that Brady Williamson, the former
Chair of the National Bankruptcy Reform Commission, is here to tell us
about this consensus reform and others like it that the Bankruptcy
Reform Commission recommends to Congress.
Last year's final bill also failed to address the discharge of
penalties for violence against family planning clinics. A year ago this
month, the Senate passed the Schumer-Leahy amendment to prevent this
abuse of the bankruptcy system by a vote of 80-17. We have been
reminded of this vote often during the past month given Senator
Ashcroft's vote in favor of the amendment. Despite this overwhelming
bipartisan endorsement, last year's so-called conference report
contained not a single provision to end the abusive practice. As a
result, perpetrators of clinic violence can continue to seek shelter in
the nation's bankruptcy courts. That would be wrong.
Attorney General Ashcroft pledged his support for the Schumer-Leahy
amendment during his confirmation hearings. Today, Maria Vullo, a top-
rate attorney, will testify about the need to amend the Bankruptcy Code
to stop wasteful litigation and end abusive bankruptcy filings used to
avoid the legal consequences of violence, vandalism and harassment to
deny access to legal health services.
As we proceed with this legislative process, we should remember the
purpose bankruptcy serves, which is as a safety net for many Americans.
Those who use bankruptcy are the most vulnerable of the American middle
class.
They are older Americans who have lost their jobs or who are unable
to pay their medical debts. They are women attempting to raise their
families or secure alimony and child support after a divorce. They are
individuals struggling to recover from unemployment.
As we move forward with reforms that are appropriate to eliminate
abuses in the system, we need to remember the people who use the
system, both the debtor and the creditor. Judge Becker and Judge
Newsome are here today to testify about how reform legislation will
affect the real people who use our courts every day.
We need to balance the interests of creditors with those of middle-
income Americans who need the opportunity to resolve overwhelming
financial burdens. As the last two Congresses proved, there are many
competing interests in the bankruptcy reform debate that make it
difficult to enact a balanced and bipartisan bill into law.
Although this hearing was scheduled unilaterally with the minimum
notice allowed under Senate rules, I thank our witnesses for responding
to the call on such short notice to be with us today. We did not
receive the names of the four witnesses invited by the Republicans
until Monday afternoon. We did not begin receiving written statements
from those witnesses until yesterday afternoon. Accordingly, I expect
that we will have written follow up questions to be forwarded to these
witnesses within a reasonable time of reviewing their written
statements and of reviewing their comments here today.
I note that the House Judiciary Committee has chosen to hold two
days of hearings on this important topic. I understand that the House
Judiciary Committee has also indicated that it intends to hold two days
of meetings for discussion and amendment of the House bill. I look
forward to working with Chairman Hatch on a schedule that would allow
our Committee, the Senate Judiciary Committee, likewise to do its work
and serve the Senate by fully and fairly considering legislation on
bankruptcy related issues. These are important subjects that can have a
great impact on the lives of many people who have already suffered from
illnesses or divorce or job loss or other personal difficulties. We
ought to take utilize the expertise of the Members of our Committee to
ensure that what we report to the Senate is fair and balanced and that
it will not exact an unintended toll on our neighbors.
I am hopeful that this year, we will work together in a bipartisan
fashion from the beginning of the legislative process to the end to
enact reforms that ensure our bankruptcy laws better serve their
intended goals and corrects abuses by both debtors and creditors in the
bankruptcy system.
Senator Biden. Mr. Chairman, nothing on the merits, but may
I also welcome Chief Judge Becker?
Chairman Hatch. Sure.
Senator Biden. I consider him a friend and I just want to
associate myself with the remarks of Senator Specter. The Third
Circuit is the circuit in which Delaware resides, and I want to
thank the judge for all he has done for the circuit and
accommodating the movement of some judges onto that circuit
from the State of Delaware. Again, I would like to associate
myself with the remarks of Senator Specter. I will not take any
more time.
Senator Leahy. As do I. I think we are fortunate to have
Judge Becker. Even though he has to sit here and listen to all
these speeches, I think we are darn lucky to have him here.
Chairman Hatch. Judge, we are happy to have you here and we
will turn the time over to you. We appreciate and respect the
work you do on the Third Circuit as Chief Judge. We will turn
the time to you and we want to listen very carefully to what
you have to say.
STATEMENT OF HON. EDWARD R. BECKER, CHIEF JUDGE, UNITED STATES
COURT OF APPEALS FOR THE THIRD CIRCUIT, PHILADELPHIA,
PENNSYLVANIA
Judge Becker. Thank you, Mr. Chairman. For the record, my
name is Edward Becker. I am the Chief Judge of the United
States Court of Appeals for the Third Circuit and a member of
the Executive Committee of the Judicial Conference of the
United States, on whose behalf I appear here today. Let me
state, Mr. Chairman, we are very grateful for your making this
spot available to us, and the other members of the committee.
Let me state at the outset that I am here not to discuss
general matters of debtor and creditor, but about some other
real people in our society, Federal judges, and the institution
of the Federal judiciary and the impact of one provision of
this legislation. I am here to talk only about Section 1235,
that dealing with bankruptcy appellate procedure. That
provision would effect a radical change in bankruptcy appellate
procedure by routing virtually all bankruptcy appeals which now
go to the district courts directly to the courts of appeals.
Now, if there is one thing I know a little bit about after
20 years on the courts of appeals, and actually 30 years on the
Federal bench, it is about the workload of the courts of
appeals. We are stretched, we are strained, we work all the
time. We are at our limit, and we simply cannot absorb this new
load of all of these bankruptcy appeals.
It may be quite unusual, but I am here not just on behalf
of the Executive Committee, but I have spoken to every chief
circuit judge, that is the chief circuit judges of all of the
regional circuits who hear bankruptcy appeals. Each and every
chief circuit judge--and they are the ones who are responsible
for management of litigation in the courts of appeals, and as
you know, we are basically the court of last resort in this
Nation because the Supreme Court doesn't hear very many cases.
Each and every chief judge opposes this provision and has
authorized me to speak on their behalf.
Now, we are not sure of the exact numbers. Our best
estimate is probably 3,000 more appeals a year. The heaviest
impact would be on a number of circuits. Frankly, it would be
on the First Circuit, Senator Kennedy's circuit; the Second
Circuit, Senator Leahy and Senator Schumer's circuit; the Third
Circuit, Senator Biden's and my circuit; the Sixth Circuit; the
Tenth Circuit, Senator Hatch's circuit; and the Ninth Circuit,
Senator Feinstein's circuit. In terms of the numbers, we
estimate an increase in caseload between 10 and 20 percent.
Having mentioned the Ninth Circuit, I spoke to Chief Judge
Schroeder yesterday, who is especially concerned about the
impact of this legislation on the bankruptcy appellate panels
which they have so carefully honed, because essentially if
there is the option to go right to the court of appeals, she is
fearful that the BAPs, as they call them, will be simply
bypassed and that that structure will fall into disuse.
Some say, well, give us more judges to take up these
additional cases. Well, this committee knows better than
anybody the history of more judges. The First Circuit hasn't
had a new judge since 1984, and they have a sizable increase.
The Second Circuit would have a 40-percent increase. But I
don't want to go into all of those details.
Let me get down to the matter that this body is concerned
about. You are a policymaking body and you deal with costs and
benefits. Now, I have talked about the cost. In our view, the
cost would be incalculable in terms of the burdens on the
courts of appeals and the need for more judges, which we are
not going to get and we shouldn't get for this purpose.
Let me talk about the benefits. Now, this proposal which
was endorsed by the National Bankruptcy Review Commission is
offered as a simple, neat solution. We say we have a two-tiered
appeal. We have one appeal to the district court or the
bankruptcy appellate panel and another to the court of appeals,
and this is a simple, neat solution.
I hope that the committee will not feel I am irreverent
when I say that to every human problem there is a solution that
is simple, neat and wrong, and this one is wrong. First of all,
there are legal problems with it. I take no position on this as
an Article III judge, but the Department of Justice has long
taken the position that this has constitutional problems. They
believe that meaningful review in the district court is
necessary for it to be constitutional and query whether the 30
days is meaningful review.
Second, this is offered that we need more precedent;
bankruptcy opinions are all over the lot. Give it to the court
of appeals and there will be more precedent. That is the
theory. The theory is that if we have more precedent, we will
have less litigation. I can tell you, after 30 years on the
Federal bench, more precedent only means more litigation, that
being the nature of the beast in terms of lawyers.
And precedent isn't the kind of precedent you make in terms
of broad rules. All precedent is is the decisions are fact-
bound; it is very narrow. All you do is deal particularly with
the facts of the case, and the facts of the case generally are
pretty fact-bound and they don't help anybody. Additionally,
the courts of appeals are so burdened that when we decide
cases, most of them we decide as non-precedential. So you don't
get precedent when you get to the court of appeals these days
because we are so busy.
I can run through my other points very quickly, with your
permission, Mr. Chairman. With respect to cost, it is said that
this would be a cheaper way if you have a unitary appeal
process. But the fact of the business is that it is much more
expensive to take a case to the court of appeals because of our
briefing and all of the requirements. The district court
procedures are simpler, they are much cheaper, and 80 percent
of the cases fall out. We talk about two tiers, but 80 percent
of them are gone at the district court level.
The district courts are doing a good job, so you are making
it more expensive if you do this in terms of time. It is
certainly not easier for the 80 percent because you lengthen
the period with the additional 30 days that are in the statute.
I concede that in some complex cases the two tiers will
take longer. They are basically adversary proceedings. In
Chapter 11, they are traditional, complex litigation. We don't
deny that is a problem and we have offered a solution. Instead
of this broad-based solution which is an over-broad solution,
we offer a targeted solution. And we don't want to stop this
bill. The Congress wants to pass a bill.
All we say is substitute for that bankruptcy appellate
provision a simple provision which says that if the district
court or the bankruptcy appellate panel certifies to the court
of appeals that this is a time-sensitive problem--we have got a
reorganization that is going to stand or fall, we need a
decision--or if there is a precedent that has to be
established, let it be certified to the court of appeals.
Our proposed bill says that acceptance of the certification
is up to the court of appeals. We think that is more sound, but
I am authorized by the Executive Committee to say that the
committee feels that we are bound by the certification. If the
district court or the bankruptcy appellate panel says the
interests of justice require you to take this case, then we
will take it and then we will establish precedent.
So we think that is a targeted solution and we think that
is by far the best solution, and we urge the committee and the
Congress to jettison 1235, as written, and adopted this
alternative proposal which is, as I say, approved by the
Judicial Conference. We think it will really solve the problem.
My statement talks about filing fees, data collection,
income tax returns, bankruptcy rules. We think there are some
other burdens imposed on the court, but I don't want to take
the time of the committee. I will leave that to my statement.
We also urge additional bankruptcy judges. I know that is a
matter Senator Biden is concerned about, and we are because of
the huge bankruptcy load in Delaware. We need more bankruptcy
judges, but they need them a lot of places. I will leave those
matters to the statement.
I thank you so much, Mr. Chairman, and, of course, if
anybody has any questions, I would be pleased to answer them.
Chairman Hatch. Well, thank you, Judge. This Senator is
sympathetic to what you are saying, and your statement, I
think, covers this very, very well.
Unless there are any questions, we appreciate your coming
very much.
Judge Becker. Thank you so much.
Chairman Hatch. And we appreciate your taking time out of,
we know, a very busy schedule. Thank you for being here.
Senator Leahy. Mr. Chairman, I would just note I think a
couple may have some short questions in writing for Judge
Becker.
Judge Becker. Of course.
Chairman Hatch. We will keep the record open, Judge.
Senator Biden. That is what I was about to ask.
Senator Leahy. We like having your expertise available to
us, so thank you very much.
Judge Becker. Thank you so much.
Chairman Hatch. Thanks so much.
We are grateful to have had Judge Becker with us today and
that we could accommodate his schedule.
[The prepared statement and an attachment of Judge Becker
follow:]
Statement of Hon. Edward R. Becker, Chief Judge, United States Court of
Appeals, Third Circuit
Mr. Chairman and members of the Committee:
My name is Edward Becker, and I am the Chief Judge of the United
States Court of Appeals for the Third Circuit. I appear before you as a
member of the Executive Committee of the Judicial Conference of the
United States to present the position of the Judicial Conference with
regard to S. 220, the ``Bankruptcy Reform Act of 2001.'' I thank you
for the opportunity to appear today and would like to address six areas
of concern to the judiciary: appeal of bankruptcy court decisions, need
for new judgeships, re-allocation of revenues generated by filing fees,
mandatory data collection, filing of tax returns with the bankruptcy
court, and amendment of bankruptcy rules.
Direct Appeals
The Judicial Conference strongly opposes section 1235 of the bill
regarding expedited appeal of bankruptcy cases. As proposed, this
provision would revise the basic structure for appeals from the orders
of the bankruptcy court by providing that all bankruptcy court orders
appealed to the district court would become orders of the district
court 31 days after such appeal is filed, unless the district court
decides the case within 30 days or extends the time period for
decision. Functionally, this will result in all appeals from bankruptcy
courts being routed directly to the United States Court of Appeals,
depositing some four thousand new cases per year on these courts.
Turning first to the provisions of section 1235, I note that, as a
general matter, the Judicial Conference opposes statutory litigation
priorities, expediting requirements, or time limitation rules in
specified types of civil cases beyond those few categories of
proceedings already identified in 28 U.S.C. Sec. 1657 as warranting
expedited review.\1\ Mandatory priorities and expediting requirements
run counter to principles of effective civil case management.
Individual actions within a category of cases inevitably have different
needs for priority treatment and are best determined on a case-by-case
basis. In addition, as the number of categories of cases receiving
priority treatment increases, the ability of a court to expedite review
of any of these cases is restricted. Because 28 U.S.C. Sec. 1657
already authorizes the court to expedite a proceeding if ``good cause
is shown,'' additional restrictions on federal courts are unnecessary.
---------------------------------------------------------------------------
\1\ Report of the Proceedings of the Judicial Conference of the
United States, September 1990, p. 80.
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Beyond creating general case management problems by imposing such a
time limit on the district courts, the particularly short time limit
imposed by the proposed legislation would undermine the administration
of justice. The district court would be required either to extend the
30 day period as a matter of routine or to make a determination as to
whether direct appeal is appropriate or not within the 30 day period.
The 30 day period running from the date of filing the appeal is
patently insufficient to allow practitioners the time needed to
adequately brief the issue, much less to allow the district court
adequate time for review. It is clear to me that, as a practical
matter, this provision requires direct review of these cases in the
court of appeals. The 30 day layover in district court only increases
costs to the litigants and will prove to be a meaningless step on the
way to review by the court of appeals.
The Judicial Conference has concluded that the inevitable result of
this provision will be to saddle the courts of appeals with thousands
of new cases. According to a study of the Federal Judicial Center, it
has the potential to increase bankruptcy appeals by 400%. The circuit
courts now handle approximately 1,000 bankruptcy appeals each year.
Under the proposed procedure, the courts may be faced with 4,000 new
cases annually. Such a precipitous increase in the caseloads of the
courts of appeals is utterly unprecedented. All of the chief judges of
the twelve regional circuit courts of appeals strongly oppose this
provision. Many of these courts maintain incredibly high workloads
while being chronically shorthanded. A significant increase in the
volume of bankruptcy appeals exacerbates a grievous problem and
negatively affects the prompt and effective processing of all appeals.
The proposal is particularly unfair to parties to a bankruptcy
appeal. It will most certainly increase the cost of the appeal.
Practice, including briefing, is more complicated and time consuming in
appellate courts than in district courts. Attorney fees and other costs
to the parties will increase in 80% of all appeals, the percentage of
appeals that currently proceed no further than the district courts.
Further, appeals are handled far more expeditiously in district courts
than in courts of appeals. Indeed, the current system is working well;
the district judges by and large do a good job with these cases. In
sum, the proposal provides for increased expense and increased delay
for parties to a bankruptcy appeal, and attempts to fix something that
``ain't broke.''
The Judicial Conference recommends a proposal for expedited appeal
of a targeted number of bankruptcy cases which is attached hereto. This
proposal redresses the primary complaints regarding the existing
statutory scheme for bankruptcy appeals: the need for expeditious final
disposition of appeals in time sensitive cases (where the success of a
reorganization depends upon a quick decision), and putative
inefficiency in the development of binding precedential case law.\2\
The Judicial Conference proposal will solve these problems without
creating the aforementioned unnecessary problems for litigants and the
courts of appeals.
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\2\ The argument is made that direct appeals to the court of
appeals will create more precedent AND that more precedent will lead to
more certainty in the law and less litigation. My thirty years
experience on the federal bench tells me that the opposite is true.
More precedent leads to more litigation.
---------------------------------------------------------------------------
The Conference position is that bankruptcy court orders should be
reviewable directly in the courts of appeals if, upon certification
from the district court or bankruptcy appellate panel, the court of
appeals determines that (1) a substantial question of law or matter of
public importance is presented and (2) an immediate appeal to the court
of appeals is in the interests of justice. This would allow direct
appeal where necessary to establish precedential case law and meet
special needs of parties, while leaving intact the basic bankruptcy
appellate structure. Most bankruptcy appeals are currently resolved
effectively by the district courts or by the parties, as shown by a
Federal Judicial Center review reflecting that 73% of bankruptcy
appeals in the district courts were resolved with little or no judicial
involvement. By preserving the district court as a forum for meaningful
review, the Conference proposal satisfies two objectives-it allows for
timely resolution of appeals at minimal cost to litigants, and it
facilitates the establishment of precedential case law in bankruptcy
without placing undue burdens on the courts of appeals.
Judgeships
Section 1225 of the bill would create 23 new temporary bankruptcy
judgeships and extend the existing temporary judgeships in the northern
district of Alabama, the district of Puerto Rico, and the eastern
district of Tennessee for a period of three years, and extend the
existing temporary judgeship in the district of Delaware for a period
of five years. The section also contains a provision to extend the
temporary judgeship in the district of South Carolina for a period of
three years. Because the term of South Carolina's temporary judgeship
lapsed on December 31, 2000, however, the bill will no longer have its
intended effect with regard to that judgeship. The term of a judgeship
that no longer exists cannot be extended. Therefore, the bill needs to
``re-authorize'' that judgeship by including it among the new
judgeships created by the bill.
The bill falls somewhat short of the needs of the judiciary. The
Judicial Conference recommends authorization of 23 judgeships provided
for in the bill, as well as an additional judgeship in the district of
Maryland and a judgeship in the district of South Carolina to replace
the lapsed judgeship. In addition, the Conference urges that 13 of
these judgeships be established on a permanent basis \3\ and the other
12 on a temporary basis;\4\ that the current temporary judgeships in
the district of Puerto Rico, the northern district of Alabama and the
district of Delaware be converted to permanent positions; and, that the
temporary judgeship in the eastern district of Tennessee be extended
for a period of five years.
---------------------------------------------------------------------------
\3\ District of Delaware (1), District of New Jersey (1), District
of Maryland (3), Eastern District of Virginia (1), Eastern District of
Michigan (1), Western District of Tennessee (1), Central District of
California (3), Southern District of Georgia (1) and Southern District
of Florida (1).
\4\ District of Puerto Rico (1), Northern District of New York (1),
Eastern District of New York (1), Southern District of New York (1),
Eastern District of Pennsylvania (1), Middle District of Pennsylvania
(1), Eastern District of North Carolina (1), Southern District of
Mississippi (1), Eastern District of California (1), Central District
of California (1), Southern District of Florida (1) and District of
South Carolina (1).
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The Judicial Conference is required by law to submit
recommendations to Congress regarding the number of bankruptcy judges
needed and the districts in which such judgeships are needed.\5\ This
requirement has engendered a process whereby the need for additional
judgeships is assessed on a biennial basis. The bankruptcy and district
courts provide recommendations to their respective judicial councils.
The judicial councils' recommendations are then subject to onsite
surveys of the districts for which judgeships are requested.
---------------------------------------------------------------------------
\5\ 528 U.S.C. Sec. 152(b)(2).
---------------------------------------------------------------------------
Under the direction of the Conference Committee on the
Administration of the Bankruptcy System, the surveys include a thorough
review of the dockets in each respective court and interviews with the
chief district judge, the bankruptcy judges, the bankruptcy clerk, the
United States Trustee, and local bankruptcy attorneys. Suggestions for
improvements in case management and methods to achieve greater
efficiencies are solicited by the survey team. The survey team then
prepares a written report and recommendation regarding each respective
district that is submitted to the Committee's Subcommittee on
Judgeships. The Subcommittee reviews each request for additional
judgeships and survey report and then forwards these materials, with
its recommendation, to the requesting appellate, district and
bankruptcy courts for additional comment. All relevant materials are
then provided to the full Committee, which makes recommendations to the
Judicial Conference. The Conference makes its determination on the need
for each requested judgeship and then submits its recommendation to
Congress.\6\
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\6\ It should be noted that in those instances in which Congress
declines to authorize the requested judgeships, the on-site survey
process is not necessarily repeated before the request is renewed.
Nevertheless, review of each request is conducted to determine whether
or not the underlying justification for the request has changed to the
extent that an on-site survey should be repeated.
---------------------------------------------------------------------------
Various factors are considered in this process for determining the
need for new judgeships. The most significant factor is the ``weighted
judicial caseload'' of each bankruptcy court. This figure is derived
from a formula established as a result of a time study of the
bankruptcy courts conducted by the Federal Judicial Center during 1988
and 1989. Absent exigent circumstances, the Judicial Conference
considers requesting an additional judgeship only when the caseload of
a court exceeds 1500 weighted filings per judge. In those instances in
which the addition of a judgeship would result in a decrease of the
caseload below 1500 weighted filings, the Conference seeks a temporary
position; in those instances in which the weighted filings would remain
above 1500 per judge even with the addition of another judge, the
Conference seeks a permanent position.
Other factors which are taken into consideration during this review
process, especially in those districts with case weights near the 1500
weighted filings threshold, include the nature and mix of the caseload
of the court; historical caseload data and filing trends; geographic,
economic and demographic factors; effectiveness of the case management
efforts of the court; and, the availability of alternative resources
for handling the caseload of the court.
Additional bankruptcy judgeships have not been authorized by-
Congress since 1992 when 35 new judgeships were approved. In response
to a substantial increase in case filings, the Judicial Conference has
made recommendations to Congress for additional bankruptcy judgeships
in 1993, 1995, 1997 and 1999. These judgeships have not as yet been
authorized by Congress.
The need for the required additional judicial officers is great.
Bankruptcy filings continue at very high levels and well over a million
cases are pending in our bankruptcy courts. While the judiciary employs
a number of creative strategies to manage ever increasing caseloads,
including the use of temporary bankruptcy judges, recalled bankruptcy
judges, inter- and intracircuit assignments, additional law clerks, and
advanced case management techniques, there remains a dire need for more
judicial resources to handle the burgeoning judicial workload.
Filing Fees
Section 325 of the bill amends the statutory filing fees for
chapter 7 and chapter 13 cases and re-allocates a portion of the
revenues generated by such fees from the judiciary and the Treasury
general fund to the United States Trustee program. This amendment will
reduce revenues to the judiciary of approximately $5 million per year.
While the Judicial Conference takes no position regarding the proposed
reduction of revenue to the Treasury general fund, it strongly opposes
reducing revenue currently allocated to the judiciary and providing it
to the United States Trustees. The existing fee structure takes into
account the significant costs the judiciary bears in administering the
Bankruptcy Code. The costs of the United States Trustees are far
exceeded by the costs of maintaining 324 bankruptcy judgeships and the
staffs and facilities for these judgeships.
The current fee schedule took effect in December 1999.\7\ That
schedule reflects an increase of $25 in the filing fee for both chapter
7 and chapter 13 cases to a total of $155, and allocates the increased
filing fee revenue equally between the judiciary and the United States
Trustee program. Assuming total filings of approximately 1.3 million
per year, as based upon fiscal year 2000 figures, this increase would
annually generate approximately $16.25 million each for the judiciary
and the United States Trustee program. The increase was enacted with an
understanding by the Appropriations Committees that these funds were
required by the judiciary to meet its current statutory
responsibilities, without taking into account any additional funding
that would be required to meet the new responsibilities imposed by the
bankruptcy reform legislation.
---------------------------------------------------------------------------
\7\ Omnibus appropriations bill for fiscal year 2000 (Pub. L. No.
106-113).
---------------------------------------------------------------------------
This bill would further revise filing fees to $160 for chapter 7
cases and $150 for chapter 13 cases and reduce that portion of the
filing fee that is allocated to the judiciary from $52.50 as provided
under current law to $50.00 in chapter 7 cases and $45.00 in chapter 13
cases. Assuming the annual filing of approximately 900,000 chapter 7
cases and 400,000 chapter 13 cases, this provision would have the
effect of reducing revenues to the judiciary by over $5 million per
year, while increasing revenues to the United States Trustee program by
over $7 million per year.
The Judicial Conference strongly opposes this re-allocation of
revenues at a cost to the judiciary of more than $25 million over the
next five years. Not only are these funds required by the judiciary to
meet its current statutory responsibilities, but other provisions of
this bill will require additional expenditures by the judiciary of an
estimated $80 million during the same five year period. Moreover,
revising filing fees that took effect only 14 months ago, with all the
attendant administrative costs and disruptions, would seem to be an
unwise expenditure of taxpayer funds.
Data Collection
Section 601 of the bill directs the clerks of court to collect, and
the Administrative Office to compile and report, financial data of
consumer debtors and certain categories of case event statistics in
consumer bankruptcy cases. The Congressional Budget Office estimates
that this requirement will cost the judiciary $30 million over the next
five years.
The Judicial Conference is opposed to the provisions of the bill
that direct the judiciary to collect and report financial data that is
unnecessary to fulfill its responsibility to report to Congress and the
public information on the adjudication of cases. Under these
provisions, the financial data is to be derived from the schedules and
statements filed by consumer debtors. This information, filed by
debtors at the outset of bankruptcy cases and in many instances without
the assistance of a lawyer, is, at best, of questionable reliability\8\
Both assets and liabilities are frequently valued inaccurately by
consumer debtors, and some debt simply cannot be valued definitively at
the outset of the case because it is unliquidated, contingent or
disputed. Therefore, these provisions will not generate ``improved
bankruptcy statistics,'' but will impose significant costs upon the
taxpayers.
---------------------------------------------------------------------------
\8\ See Report of the National Bankruptcy Review Commission, vol.
1, ch. 4 (October 20, 1997).
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A far superior approach, in our view, is to append the
responsibility to collect, compile and report financial data to the
responsibility of the United States Trustees to conduct audits under
the bill. This approach would have two significant benefits: it would
yield audited, and thus accurate, data, and it would accomplish this at
a fraction of the cost to the taxpayer. We believe that this data would
meet the needs of Congress to conduct a continuing assessment of the
functioning and effectiveness of the bankruptcy system. The staff of
the Administrative Office is prepared to work with congressional staff
to craft an appropriate replacement for the provision that currently
appears in this legislation.
In the event Congress is committed to imposing the responsibility
to collect, compile and report financial data upon the judiciary, we
respectfully request extension of the date upon which this provision
would take effect. Compliance with these new requirements will require
revising official bankruptcy forms, developing new statistical data
fields, training clerks in entering additional data into our computer
systems, devising data extraction programs, and reprogramming
Administrative Office statistical compilation programs. We will also
have to coordinate with forms publishers and software developers so
that the new forms can be made available to attorneys and debtors. In
order for these responsibilities to be met in an accurate and thorough
manner, we recommend that the provisions regarding collection and
reporting of financial data be revised to take effect 24 months after
enactment of the bill, with the first report due to Congress no later
than 36 months after enactment of the bill.
The bill also requires the bankruptcy clerks and the Administrative
Office to collect and report certain case event statistics. While the
judiciary is the appropriate entity to collect and report this
information, this responsibility would similarly pose a significant
problem. Events occurring in bankruptcy cases are reported to the
Administrative Office through the electronic case management systems of
the courts. The current systems, however, are nearing the end of their
useful lives and cannot collect additional information of the sort
required by these bills. To upgrade these systems to meet the
requirements of this legislation would require a major financial
investment, contrary to good government and common sense, and divert
resources from and delay the development and deployment of a new,
modern electronic case management system that is in the process of
being deployed in the bankruptcy courts.
This new system will not be installed and operating in all
districts for at least three and a half years. Accordingly, if the
judiciary is to be required to collect and report these case event
statistics system-wide, we urge that this provision be revised to take
effect 48 months after enactment of the bill, with the first report due
to Congress no later than 60 months after enactment of the bill.
Income Tax Returns
The bill requires chapter 7 and chapter 13 debtors, upon request of
a creditor, to file with the bankruptcy court copies of federal income
tax returns for the three year period preceding the order for relief
and for the period during which the case is pending. The bill further
requires the court to limit access to the returns pursuant to security
procedures promulgated by the Director of the Administrative Office and
requires the court to destroy the returns three years after the case is
closed.
Implementation of this provision would entail development and
maintenance of a filing system separate from the public case files,
with access limited to trustees and parties in interest. Court files,
with the narrow exception of sealed records, are public records
available on request. Because the sealing of records is relatively
rare, sealed records can be easily segregated from the public case
file. The routine filing of tax returns, however, would be problematic.
Recognizing that tax returns are not to be made available to the
public, the bill requires the Director of the Administrative Office to
establish procedures to safeguard the confidentiality of tax
information and to establish a system to make the information available
to the United States trustee, case trustee, and any party in interest.
To carry out this-responsibility, it would be necessary to establish a
separate filing system for tax returns in each clerk's office, as well
as to provide personnel to manage it so that unlawful dissemination of
this information would not occur. This would be a costly undertaking
requiring additional office space and personnel.
As the United States Trustee's files are not public records,
limiting access to trustees and parties in interest would not require
segregating tax returns and creating separate procedures governing
access to them. The Trustee's office also has personnel and procedures
in place to deal with debtors. While the Trustees may well need some
additional resources to meet this responsibility, that cost should be
far less than the cost of establishing a new separate system in each
clerk's office.
Accordingly, the Judicial Conference takes the position that the
bankruptcy courts should not be required to maintain tax returns filed
by debtors, which are typically of no use in the administration of
bankruptcy cases. The Conference believes that responsibility for
collection and maintenance of these tax returns would be more
appropriately assigned to the United States Trustees, who are
responsible for supervising and estates and approving distributions to
creditors.
Bankruptcy Rules
Section 102 of the bill establishes standards governing sanctions
for abusive filings that are inconsistent with Bankruptcy Rule 9011. In
addition, section 319 states the sense of Congress suggesting several
changes to Bankruptcy Rule 9011. The cumulative effect of the
provisions will cause confusion and needless satellite litigation.
Accordingly, they should be deleted from the bill.
There are six provisions in the bill that directly task the Supreme
Court or the Judicial Conference or its Advisory Committee on
Bankruptcy Rules to promulgate a bankruptcy rule or an official form to
implement a new requirement added by an amendment of the Bankruptcy
Code. Section 221 amends section 110 of the Code to require bankruptcy
petition preparers to provide to the debtor a notice, the contents of
which are detailed in section 110(2)(B). The provision states that the
notice shall be an official form issued by the Judicial Conference.
Section 419 requires the Judicial Conference's Advisory Committee on
Bankruptcy Rules, after considering the views of the Executive Office
for United States Trustees, to propose for adoption rules and forms to
assist a debtor to disclose the value, operations, and profitability of
any closely-held business. Section 433 requires the Advisory Committee
to propose for adoption a standard form disclosure statement and plan
of reorganization for small businesses. Section 435 requires the
Advisory Committee to propose for adoption rules and forms for small-
business debtors to file periodic financial and other reports. Section
716 expresses the sense of Congress that the Advisory Committee propose
rules amending Bankruptcy Rules 3015 and 3007 to extend deadlines for
governmental units to object to confirmation of chapter 13 plans and to
restrict the rights of interested parties to object to tax claims until
the filing of a required tax return. Finally, section 1234 takes the
extraordinary step of amending the Rules Enabling Act to prescribe the
form to assist a debtor to report monthly income and expenses required
to implement amended section 521 of the Code.
These provisions are unnecessary because the Advisory Committee
automatically reviews any legislation amending the Bankruptcy Code to
identify and prescribe any needed amendments to rules and forms. More
importantly, directing the Judicial Conference or one of its committees
to amend a particular rule or form bypasses the initial stages of the
Rules Enabling Act process and needlessly undercuts in varying degrees
the proper role of the Judicial Conference and its committees, the
bench and bar, the public, and the Supreme Court in that process.
Conclusion
In conclusion, the Judicial Conference urges the Committee to amend
the legislation to replace the expedited appeal provision with the
Judicial Conference proposal, to re-authorize the lapsed South Carolina
judgeship and provide the other needed judgeships, to leave intact the
current filing fee structure, to re-assign the responsibility to
compile and report financial data and maintain tax returns to the
United States Trustee program, which is better suited to meet these
responsibilities, to extend the effective date for collection and
reporting of case event statistics by the bankruptcy clerks and
Administrative Office, and to delete the provisions regarding amendment
of bankruptcy rules.
Again, thank you very much for this opportunity to appear before
the Committee. I am prepared to answer any questions that you may have.
SEC.______BANKRUPTCY APPEALS
(a) Appeals.--Section 158 of title 28, United States Code, is
amended--
(1) in subsection (c)(1) by striking out ``Subject to subsection (b),''
and inserting in lieu thereof ``Subject to subsections (b) and
(d)(2),''; and
(2) in subsection (d)--
(A) by inserting ``(1)'' after ``(d)''; and
(B) by adding at the end of that subsection the following new
paragraph:
``(2) A court of appeals that would have jurisdiction of a subsequent
appeal under paragraph (1) or other applicable law may, in its
discretion, permit an immediate appeal to itself, in lieu of
further proceedings in a district court or before a bankruptcy
appellate panel exercising appellate jurisdiction under subsection
(a) or (b), if the district court or bankruptcy appellate panel
hearing an appeal certifies, that----
``(A) a substantial question of law or matter of public importance is
presented in the appeal pending in the district court or before
the bankruptcy appellate panel; and
``(B) the interests of justice require an immediate appeal to the court
of appeals of the judgment, order, or decree that had been
appealed to the district court or bankruptcy appellate panel.''
(b) Procedural Rules.--Until rules of practice and procedure are
promulgated or amended 19 under the Rules Enabling Act (28 U.S.C.
Sec. Sec. 2071-2077) to govern appeals to a court of appeals 20
exercising jurisdiction under section 158(d)(2) of title 28, as added
by this Act, the following shall apply:
(1) A district court or bankruptcy appellate panel may enter a
certification as described in section 158(d)(2) during an appeal to
the district court or bankruptcy appellate panel under section
158(a) or (b).
(2) Subject to the other provisions of this subsection, an appeal by
permission under section 158(d)(2) must be taken in the manner
prescribed in Rule 5 of the Federal Rules of Appellate Procedure.
(3) When permission to appeal is requested on the basis of a
certification of a district court or bankruptcy appellate panel,
the petition must be filed within 10 days after the district 10
court or bankruptcy appellate panel enters the certification.
(4) When permission to appeal is requested on the basis of a
certification of a district court or bankruptcy appellate panel, a
copy of the certification must be attached to the petition.
(5) When permission to appeal is requested in a case pending before a
bankruptcy appellate panel, the terms ``district court'' and
``district clerk,'' as used in Rule 5 of the Federal Rules of
Appellate Procedure, mean ``bankruptcy appellate panel'' and
``clerk of the bankruptcy appellate panel.''
(6) When a court of appeals grants permission to appeal, the Federal
Rules of Appellate Procedure apply to the proceedings in the court
of appeals, to the extent relevant, as if the appeal were taken
from a final judgment, order, or decree of a district court or
bankruptcy appellate panel exercising appellate jurisdiction under
section 158(a) or (b).
SECTION-BY-SECTION ANALYSIS
Section.______Bankruptcy appeals
Currently, decisions of bankruptcy judges can be appealed either
to--
(a) the district court for the respective district or
(b) to a bankruptcy appellate panel of three bankruptcy judges. Further
appeals lie from the district court or bankruptcy appellate panel
to the court of appeals for the circuit.
In practice, this approach to bankruptcy appeals has had difficulty
fastening certainty and predictability in bankruptcy law. Unlike those
of a court of appeals, decisions of a district court acting as an
appellate court or a bankruptcy appellate panel have no stare decisis
value or, in other words, are not binding beyond a particular case.
To address that problem without sacrificing the economy to the
parties of review by a single district court judge, this section amends
section 158 of title 28 to permit an appeal to be heard directly by the
court of appeals if the district court or bankruptcy appellate panel
certifies that----
(1) the appeal presents a substantial question of law or matter of
public importance, and
(2) an immediate appeal to the court of appeals is in the interests of
justice, and if the court of appeals agrees to hear the matter.
Since this creates a new route of appeal, this section provides
interim procedures until permanent rules can be prescribed under
the Rules Enabling Act.
This section preserves the option of prompt, inexpensive review in
the district court for cases in which the parties need it--i.e., fact-
intensive cases, small cases, and cases where the parties only want a
quick ``second look'' by another source. It also provides for direct
review by the court of appeals so that binding precedent can be created
in those cases and for those issues meriting that treatment, without
flooding the courts of appeals with all bankruptcy appeals.
Chairman Hatch. Our panel will be Judge Randall J. Newsome,
United States Bankruptcy Court of the Northern District of
California, in Oakland, California; Philip Strauss, Principal
Attorney, San Francisco Department of Child Support Services,
in San Francisco, California; Brady C. Williamson, Esquire,
LaFollett, Godfrey and Kahn, former Chair of the National
Bankruptcy Review Commission, from Madison, Wisconsin; Dean
Sheaffer, Vice President and Director of Credit, Boscov's
Department Stores, in Laureldale, Pennsylvania; Maria T. Vullo,
Esquire, Paul, Weiss, Rifkind, Wharton and Garrison, out of New
York City; Ken Beine, President of Shoreline Credit Union, of
Two Rivers, Wisconsin; Dr. Robert Manning, Senior Research
Fellow, Institute for Higher Education, Law, and Governance,
University of Houston Law Center, in Houston; and Todd J.
Zywicki, Esquire, George Mason University, Assistant Professor
of Law.
We are sorry to have such tight seating arrangements. They
are left over from yesterday's hearing. We had the CEOs of all
the major airlines appearing before us, and apparently the
coach seating kind of upset them just a little bit. [Laughter.]
Chairman Hatch. It has been left over for you today, so we
hope it doesn't upset you as much as it did them.
We will begin with Judge Newsome and go on from there.
STATEMENT OF HON. RANDALL J. NEWSOME, JUDGE, UNITED STATES
BANKRUPTCY COURT, NORTHERN DISTRICT OF CALIFORNIA, OAKLAND,
CALIFORNIA
Judge Newsome. Good morning, Mr. Chairman and distinguished
members of the committee. My name is Randall Newsome and I am a
bankruptcy judge from the Northern District of California.
I should note at the outset that I am here representing
only myself, no other person or organization. My intention this
morning is not to make policy pronouncements or value judgments
about bankruptcy reform. That is the role of Congress, not the
courts. But I think my position as a bankruptcy judge puts me
in a unique position to provide observations about how S. 220
will work as drafted.
My first observation is that the means test in this bill
will move very, very few people from Chapter 7 to Chapter 13.
As the data in my written testimony indicates, only about 15
percent of filers, if that, are above the median income, and
probably no more than 3 percent will actually be forced into
Chapter 13 or dismissed.
Senator Biden. What was that percentage, Judge? I am sorry.
Judge Newsome. Three percent.
Senator Biden. Three percent will be forced into 13?
Judge Newsome. Or dismissed.
Senator Biden. Or dismissed.
Judge Newsome. The problem for 97 percent of those who file
will not be passing the test, it will be taking the test. By my
count, the means test will require at least another five forms
on top of what is already required. It will require the
production of tax returns and a credit counseling certificate
just to get in the courthouse door.
So even if you are like the 65-year-old single woman from
Monticello, Illinois, I discuss in my written testimony making
$657 a month in Social Security, or the cook from Decatur,
Alabama, making $850 a month, or the single mother who draws
Social Security and makes $1,170 per month as a temporary
worker supporting three kids, you will have to get the credit
counseling, file 16 or more forms--it might be 14--and dig out
your tax returns for at least 1 year or more before you can
perfect a filing in bankruptcy court.
The means test form alone will probably be several pages
long. In any event, if you don't submit all the forms on time,
your case will get dismissed automatically, no matter what the
circumstances. And once you get dismissed, the bill makes it
very hard to get back in and stay in. Thus, the overall effect
of the bill is not to promote repayment of debts in bankruptcy;
it is to try to keep people out of the system altogether.
By adding all of these forms and requirements to a simple
Chapter 7 case and by imposing new requirements on bankruptcy
attorneys themselves, the bill will make legal services too
expensive for most consumer debtors to afford. They will be
left trying to represent themselves or will turn to bankruptcy
petition preparers, who frankly have become the bane of the
bankruptcy system.
One thing it will not do is keep people from filing. If
your income is about $21,500 a year, which is the median income
of the bulk of the households in our case surveys, and your
unsecured non-priority debts are about $23,400 a year, the
median debt in our surveys, then bankruptcy is just about your
only option.
Not only will the bill move virtually no one from Chapter 7
to 13, it largely destroys any incentive for debtors to file a
voluntary Chapter 13, with the exception of those seeking to
prevent foreclosure. At present, all Chapter 13 cases are
voluntary. They comprise approximately 30 percent of all cases
filed nationwide, and in some districts especially in the
South, they amount to over 50 percent of the court's docket.
Chapter 13 trustees pay out millions of dollars on unsecured
debt every year. Much of that recovery for creditors may be
lost under S. 220.
If these were the results intended by the drafters of the
bill, so be it. The bankruptcy judge's job is to uphold the law
as it is written and we will, or at least we will try. But
these results are not what I understood bankruptcy reform to be
all about when the process began several years ago.
Thank you for having me today.
[The prepared statement and attachments of Judge Newsome
follow:]
Statement of Hon. Randall J. Newsome, Judge, United States Bankruptcy
Court, Northern District of California, Oakland, California
Mr. Chairman and distinguished members of this committee, I very
much appreciate the opportunity to comment upon the Bankruptcy Reform
Act of 2001. By way of introduction, I have been a bankruptcy judge in
the Oakland division of the Northern District of California since May
of 1988. From October, 1982 until May, 1988 I was a bankruptcy judge in
the Southern District of Ohio sitting in Cincinnati. From October of
1998 until October of 1999, I was the president of the National
Conference of Bankruptcy Judges. However, I want to make it clear that
I appear before you today representing myself only, not the NCBJ.
Before commenting on S. 220, it might be useful to provide some
information about the people who are filing bankruptcies. One of the
problems plaguing the debate over bankruptcy reform has been and
continues to be the lack of empirical data. The anecdotes about
bankrupt movie stars and rock musicians, as well as the catch phrases
being bantered about, all make for, great speeches, but don't move us
any closer to a real understanding of why over a million people filed
for bankruptcy last year. In an attempt to help fill this empirical
void, in 1999 60 bankruptcy judges from 33 different states surveyed
5235 randomly-selected cases that were closed in their districts within
the previous year. That data was analyzed by Professor Gary Neustadter
of Santa Clara University School of Law. Based upon his review of the
3151 cases filed and closed in 1998, he found (among other things) that
the median gross income of debtors was $21,540, some $15,000 lower than
the median income for all U.S. households in 1997. Only 15% of these
debtors had gross annual income equal to or exceeding the national
median income for families of the same size. The median amount of
unsecured nonpriority debt for these same debtors was $23,411. A copy
of Professor Neustadter's findings is attached as Exhibit 1.
I had my staff review all 5235 cases as to several other categories
of information. The results of their review are attached as Exhibit 2.
One of the most disturbing numbers concerns the level of medical debt
reported. The average unweighted percentage of cases reporting over
$1000 in medical debt was 25%. The medical debt numbers are probably
understated, because they don't include medical debts that might have
been charged to a credit card.
The data in the surveys also indicate that a small but significant
number of debtors are either retired or disabled. It is very difficult
to tell just how many people fall into these categories. Often debtors
report receiving social security, but also state that they are
employed, indicating that perhaps some of them are older people who
can't get by without working.
One of the more interesting findings from these cases concerns the
automobiles debtors own. The average model year of all cars and pick-
ups reported in all 5235 cases was not quite 1989. In other words, the
average debtor owns a car that is between 6 and 9 years old. Since the
means test in Sec. 102 of S. 220 allows a deduction from the debtor's
income for monthly contractual payments to secured creditors, and since
many debtors probably need a new car anyway, purchasing an automobile
may become a legitimate form of pre-bankruptcy planning if the bill is
enacted. That may be good news for the automobile industry, but bad
news for auto lenders.
One number that I am unable to provide is how many of the debtors
in these surveys would be dismissed or converted to chapter 13 under
the means test. It seems there are as many ways to apply the test as
there are people studying it. It's not just because some of the numbers
seem to overlap. It's also because the IRS ``Other Necessary Expenses''
allowance appears to encompass anything that is reasonable and
necessary for the health or welfare of the family or production of
income. The alleged inconsistencies in applying the ``substantial
abuse'' test presently incorporated into Sec. 707(b) will seem trivial
by comparison to what is wrought by the means test.
Notwithstanding these misgivings, I tend to agree with those who
have speculated that very few debtors (probably less than 3%) will be
dismissed or forced into chapter 13 by Sec. 102.
If only 15% of all chapter 7 filers will trigger the means test,
and only a handful of that group will be shuttled into chapter 13, why
have the test at all? Putting aside the substantial burden this
complicated construct will impose on the bankruptcy system, consider
what every debtor, regardless of circumstance, will be required to do
in order to obtain relief. I'll use a case from the Central District of
Illinois. This case is fairly typical of what bankruptcy judges see
virtually every day. The debtor is a 65-year-old retired single woman
living in Monticello, Illinois, a small town about 40 miles from
Decatur and 30 miles from Champaign. Her sole source of income is $657
per month in Social Security benefits. She also receives $10 a month in
food stamps. Her monthly expenses total $827 per month, and are
probably understated. She owns a 1987 mobile home and a 1993 Chevrolet
Lumina. Both of these assets are exempted and unencumbered by debt. She
lists $21,739 in unsecured debt on five credit cards and two department
store cards. To characterize her as insolvent does not do her financial
condition justice.
In order to be eligible for chapter 7 relief, she must first obtain
credit counseling from an approved credit counselor within 180 days
prior to filing, or if she has a good excuse, within 45 days after she
files. She will then be required to file a certificate evidencing what
credit counseling services she received, as well as any repayment plan
developed.\1\ Assuming she knows she has to obtain credit counseling,
that the credit counselor must be on the approved list, and she is able
to locate one, what are they going to talk about? She's 65 years old,
she's got almost' $22,000 in debt, and she makes $657 per month. She
needed credit counseling before she went $22,000 into debt, not when
the money's already been spent. Why are we burdening her with credit
counseling on the eve of bankruptcy?
---------------------------------------------------------------------------
\1\ S. 220, Sec. Sec. 106(a); 106(d).
---------------------------------------------------------------------------
For many of the debtors in our 5235 cases, credit counseling would
simply be a pointless exercise. A case from South Dakota involving a
husband and wife who both work and have three children is illustrative.
Their mortgage balance is $12,801, and their payments are $118 per
month. They budget $75 per month for clothes and $25 for recreation.
They own a 1984 Isuzu and a 1988 Pontiac, and report owing money on one
or both cars. They aren't in bankruptcy because of credit card debt--
they don't have any. They apparently filed because of $67,373 in
medical debts. With three dependents and a combined gross income of
just over $2500 per month, it is unlikely that a credit counselor could
do much for them. Nonetheless, S. 220 makes credit counseling a
condition of eligibility for this couple, apparently on the presumption
that their financial condition is the result of their profligate
spending habits. This same presumption apparently applies to the single
parent with three dependents in Lawrence, Kansas who makes $1170 a
month as a temporary worker plus $341 in Social Security, has $249 in
credit card debt but $10,900 in medical debt; and to the couple in
Oxnard, California with one dependent whose only income is $1090 per
month in SSI disability payments, who have no credit card debt, but
report $5307 in medical debt; and to the cook in Decatur, Alabama who
makes $850 per month and whose only unsecured debts are some $26,419 in
medical debt. These cases are neither isolated nor anecdotal. There are
many more just like them among the 5235 cases examined.
In addition to the credit counseling certificate and the extensive
set of forms presently required, the retired woman from Monticello,
Illinois and all other consumer debtors will need to file a means test
calculation form,\2\ an itemized statement of monthly income,\3\ a
statement disclosing any reasonably anticipated increase in income or
expenditures over the next 12 months,\4\ and a certificate of notice of
alternatives under Sec. 342.\5\ Those who are employed will also be
required to file pay stubs for the previous 60 days.\6\ If the debtor
fails to file all of these documents within 45 days of filing the
petition, or within such additional time as the court allows up to
another 45 days, then the case is dismissed automatically the day after
the deadline expires.\7\ If their case gets dismissed for failure to
file any of these documents, and they try to file again within one
year, they'd only be entitled to a 30-day automatic stay, which can
only be extended if they rebut the presumption of bad faith the statute
imposes.\8\
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\2\ S. 220, Sec. 102(a)(2)(C).
\3\ S. 220, Sec. 315(b).
\4\ Id.
\5\ Id.
\6\ Id.
\7\ S. 220, Sec. 316.
\8\ S. 220, Sec. 302.
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Debtors will also have to furnish the chapter 7 trustee with their
most recent tax return by no later than the date first set for the
meeting of creditors. All creditors are entitled to request copies of
those returns. They may also request tax returns for the three years
prior to filing and for returns that are filed postpetition and prior
to the closing of the case.\9\
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\9\ S. 220, Sec. 315(b).
---------------------------------------------------------------------------
The stated intent of the consumer provisions of S. 220 was to
shepherd those who could repay some of their debts from chapter 7 into
chapter 13. But the effect of the provisions highlighted above and many
others in the bill is to make it more difficult for anyone to obtain
bankruptcy relief of any kind. Notwithstanding all of the hurdles and
pitfalls, it is doubtful that many people will be deterred from filing.
The financial condition of the overwhelming majority of debtors is such
as to leave no other viable option.
Despite all of the problems in S. 220, there are many parts of this
bill that would bring about welcome reforms. The provisions regarding
collection of bankruptcy data, the permanent reenactment of chapter 12
and amendments to the preference statute to protect small trade
creditors are representative examples.
Other provisions could be beneficial with some modification.
Everyone agrees that instruction on personal financial management is
sorely needed in this country. The financial management training test
program in the bill is certainly a step in the right direction. If the
program were offered at no cost to debtors immediately after they
attend their Sec. 341 meeting, it probably would be far more effective
than credit counseling obtained on the run to satisfy a bankruptcy
eligibility requirement.
If the bill is to have a means test, it should be similar to the
one proposed by Senator Grassley in the original Consumer Bankruptcy
Reform Act of 1997. It should be enhanced by specific standards for
determining bad faith and the need for specific findings by the court.
The United States trustee should be assigned to enforce the test as one
of her mandatory duties. Creditors and chapter 7 trustees should be
permitted to bring motions to dismiss or convert in any case in which a
debtor earns more than 125% of the median income for comparable
households in the state.
If S. 220 must contain the means test as presently drafted, then
debtors whose incomes are below the applicable median should be
entirely insulated not only from its application, but from its
paperwork requirements as well. All debtors should be required to file
the schedules and statement of financial affairs presently prescribed
by the Bankruptcy Rules in order to initiate their case. They should
also be required to show the United States trustee their tax return for
the previous year at or before the meeting of creditors. If the tax
return and other evidence establish probable cause to believe that the
debtor's income is above the median, then the debtor would be required
to file all of the additional documents prescribed by the means test
and by Sec. 315 of the bill. If no such probable cause is found, then
the debtor would be relieved of any further filing requirements.
This same two-tiered approach should apply to chapter 13 cases. As
presently drafted, S. 220 destroys any incentive to file a voluntary
chapter 13 case, unless the debtor is seeking to save his house from
foreclosure. The enhanced discharge in chapter 13 has been
eliminated,\10\ as has the ability to alter the terms of secured
automobile debts.\11\ When these disincentives are combined with the
continuing duty to turn over tax returns on a yearly basis and to
fulfill other means test reporting requirements, the choice between
chapter 7 and chapter 13 will be obvious to most debtors. If these
provisions must be a part of S. 220, then they should only be
applicable to those who were forced to convert their cases to chapter
13 pursuant to the means test. Voluntary chapter 13 filers who propose
to pay back a substantial portion of their unsecured debt at a minimum
should be given the ability to the modify their secured debts on motor
vehicles purchased more than one year prior to filing. They also should
be able to discharge debts that would be nondischargeable in a chapter
7 case under Sec. 523(a)(2), (4) and (6).
---------------------------------------------------------------------------
\10\ S. 220, Sec. 314(b).
\11\ S. 220, Sec. 306(b).
---------------------------------------------------------------------------
One of the most glaring and widely-publicized abuses in the
bankruptcy system is the ability of debtors in a few states to shelter
most of their wealth through the use of an unlimited homestead
exemption. Section 322 of the bill does not cure this problem. It would
allow wealthy debtors to move to a state with an unlimited homestead,
pour the bulk of their assets into a residence, and then hunker down
for two years until they can file for bankruptcy. The two year
provision should be eliminated, and a uniform $100,000 cap on homestead
exemptions in bankruptcy should be imposed.
A much-needed and relatively uncontroversial suggestion for
improving the bill would be to stop trying to regulate bankruptcy
petition preparers, and simply ban them instead. They are subject to no
standards of practice or conduct, they too often engage in the
unauthorized practice of law and they frequently cause great harm to
debtors and creditors alike.
These ideas for improving the bill are not fully formed, nor do
they exhaust the list of suggestions. As always, I stand ready to
assist this Committee in any way it deems appropriate in its pursuit of
fair and workable bankruptcy reform. Thank you for this opportunity to
appear and be heard.
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Senator Sessions [presiding]. Mr. Strauss?
Senator Hatch has stepped out. He will be back in a minute
and he asked me to keep the panel moving.
STATEMENT OF PHILIP L. STRAUSS, PRINCIPAL ATTORNEY, SAN
FRANCISCO DEPARTMENT OF CHILD SUPPORT SERVICES, SAN FRANCISCO,
CALIFORNIA
Mr. Strauss. I am happy to move.
Mr. Chairman and Members of the Judiciary Committee, good
morning. My name is Phil Strauss. I am the Principal Attorney
of the Department of Child Support Services in San Francisco. I
am authorized today to speak on behalf of the National Child
Support Enforcement Association, the California District
Attorneys Association, and the California Family Support
Council.
Basically, my background is for the last 28 years I have
been an employee of the Office of the District Attorney of the
City and County of San Francisco, and for the last 25 years I
have been with, as it was known at that time, the Family
Support Bureau. That division is now an independent agency in
San Francisco, known as the Department of Child Support
Services.
For the last 13 years, I have been specializing in the
enforcement of support during bankruptcy. I have practiced in
this field, litigated numerous cases, handled numerous appeals.
I write and teach on the issue, and I am here for the limited
purpose of discussing the effect S. 220 will have on the
ability of custodial parents to survive after the non-custodial
parent has filed for bankruptcy protection.
I am very happy that this committee has invited me to speak
today because it is important for you to understand the despair
I see everyday when a bankruptcy petition stops child support
debt in its tracks. I see far too many custodial parents, 95
percent or more of whom are women, in very difficult
circumstances with little or nothing to cushion their fall when
their child support or spousal support suddenly ceases.
I am the one who has to look them in the face and say there
is just nothing I can do to get you the support which you need
and are entitled to, at least in a timely fashion, after a
parent has filed for bankruptcy protection. Much is needed to
be done to protect this most vulnerable population, and these
are basically moms who have custody of children.
Based upon my experience, I have proposed nine changes in
the Code to ensure that support obligations would be paid
during bankruptcy, and that they would be given significant
preferential treatment. These proposals were originally
introduced in the 105th Congress. They were polished and
enhanced by other child support enforcement attorneys like
myself in consultation with the National Association of
Attorneys General. The culmination of that work is the child
support provisions of the 106th Congress which are now in S.
220, Sections 211 through 217. Additional refinements were
added in Sections 218 to 219.
The principles in drafting these provisions were six-fold.
The provisions were intended to be largely self-executing, and
the resulting benefit would be a reduction in the cost of
litigation, better and more efficient use of court time and
public resources, and the protection of custodial parents who
would otherwise simply lose their support rights or sacrifice
them by having to pay large attorney's fees which would in
essence eat up whatever they could recover.
The provisions were intended to ensure that support
payments would not be interrupted by the bankruptcy process. As
members of the child support community, we wish to eliminate,
or at least minimize the statutory conflicts between the
Bankruptcy Code and the child support program.
The next principle is we wanted a clear recognition of the
primacy of child support debts and that all generally
recognized support debts would be entitled to special treatment
under the code.
The fifth principle was the bankruptcy process should be
structured so that the debtor would be able to liquidate non-
dischargeable debt to the greatest extent possible within the
context of the bankruptcy case and allow the debtor to emerge
from the process with as fresh a start as possible.
Finally, the Code would assure that all support owing to a
family would be paid first to the family before the government
would receive any payments due to them for child support. Under
current law, when a bankruptcy petition is filed, support
frequently ceases. Debtors can emerge from the bankruptcy
process with a discharge without paying their ongoing child
support and liens securing the support debt can be lost. This
loss may well doom any prospects for payment of the debt.
With that in mind, I drafted the provisions. I am here to
answer any questions about the provisions, but you should know
that really my expertise is in the field of viewing the
Bankruptcy Code from the point of view of support creditors.
Senator Sessions. Thank you, Mr. Strauss.
[The prepared statement of Mr. Strauss follows:]
Statement of Philip L. Strauss, Principal Attorney, San Francisco
Department of Child Support Services
I welcome the opportunity to discuss the effect the ``Bankruptcy
Reform Act of 2001'' will have on the collection of child support and
alimony when a support debtor has filed a petition for relief under the
Bankruptcy Code. For the past 28 years I have been employed as an
attorney by the City and County of San Francisco, the last 25 of which
have been spent establishing and enforcing support obligations in the
Family Support Bureau of the Office of the District Attorney. At the
end of last year the Bureau became the Department of Child Support
Services, an independent county agency operated in compliance with the
federal child support program under Title IV-D of the Social Security
Act. For the last 13 years I have specialized in the collection of
support during bankruptcy and have taught this subject to attorneys
both in California and nationally. I have litigated bankruptcy support
cases before the bankruptcy court, the district court, the Bankruptcy
Appellate Panel, and the Ninth Circuit Court of Appeals.
Three years ago I drafted amendments to the Bankruptcy Code which
were incorporated in bankruptcy reform legislation of the 105
th and 106 th Congresses. The language of those
amendments was subsequently refined in a collaborative effort between
myself and other child support attorneys in coordination with Karen
Cordry of the National Association of Attorneys General. These
amendments were adopted pretty must verbatim in the bankruptcy reform
conference reports of the 105 th and 106 th
Congresses and in the current bill, S. 220. It is my opinion, and the
opinion of every professional support collector with whom I have
discussed the issue, that the support amendments contained in Sections
211 through 219 of S. 220 will enhance substantially the enforcement of
support obligations against debtors in bankruptcy. These enhancements
will also result in a more efficient and economical use of attorney and
court resources.
The support amendments have been endorsed by many individuals and
organizations, including three national associations whose members
consist of persons whose primary professional duty in the enforcement
of support obligations in the federal child support enforcement program
These organizations include: the National Child Support Enforcement
Association, the National Association of Attorneys General, and the
National District Attorneys Association. In giving my testimony on this
issue, I am authorized to speak on behalf of the California District
Attorneys .Association and the California Family Support Council. The
membership of these organizations carries out the federal child support
enforcement program in California.
During the past 13 years in which I have taught the subject of
support enforcement during bankruptcy, I have appeared continuously in
bankruptcy court, written a manual for support attorneys to use when
dealing with bankruptcy cases filed by support debtors, counseled
support attorneys in handling bankruptcy cases, and have reviewed
virtually every court opinion written. on this subject since the
enactment of the Bankruptcy code in 1978. Based on this experience, I
developed what essentially became a ``wish list'' of amendments to the
Bankruptcy Code aimed at facilitating support collection from
bankruptcy debtors This wish list is reflected in sections 211-217 of
S. 220. In this statement I will discuss not only how these amendments
affect support debtors during bankruptcy, but what they mean in the
larger context of support enforcement generally.
Before discussing specific sections, I would like to comment on the
overall erect of these amendments. I believe they achieve the
following: (1) a reduction in the need to appear in bankruptcy court
and the consequential reduction in the cost of litigation; (2) a
reduction in the current conflicts in law and policy between the
Bankruptcy Code and the federal child support enforcement program
[Social Security Act, Title IV-D]; (3) reasonable insurance that
significant support enforcement mechanisms will not be interrupted by
the bankruptcy process; and (4) a clear recognition of the policy that
all generally recognized support debts are entitled to a preferential
treatment in bankruptcy.
The most important amendment is found in section 214 which removes
several significant collection remedies from the effect of the
automatic stay Of these, the most valuable by far, is a provision
allowing the continued operation of an earnings withholding order as
defined in the Social Security Act. [42 U.S.C. 666(b)]. Since state
courts or administrative agencies have already determined the
appropriate level of support and arrearage payment, the removal of
withholding orders from the reach of the stay will require a support
debtor to design his or her bankruptcy plan to accommodate support
debts--the most serious and primary of all financial obligations. Under
current bankruptcy law the reverse is true. The support creditor is
often forced to take a back seat to other ordinary creditors when a
support arrearage is paid pursuant to a bankruptcy plan.
The importance of this amendment cannot be, underestimated. Federal
law requires all support to be paid by employees through wage
withholding orders. Such orders account for the lion's share of support
collection receipts.\1\ tinder current bankruptcy law, when a debtor
files for protection under Chapters 12 or 13, the collection of ever.
ongoing support is stayed. The economic detriment to a debtor's family,
which is not receiving public assistance, can be devastating Surely
sound public policy must recognize that there are some obligations
which must be met, even when a debtor should be relieved from
obligations to general debtors. Of these, none can be greater than the
payment of support needed for the health and welfare of the debtor's
family.
---------------------------------------------------------------------------
\1\ According to the Committee on Ways and Means. U.S. House of
Representatives, 1998 Green Book, p. 572, 56% of support collected in
the last reported year (1996) was collected through the wage
withholding process.
---------------------------------------------------------------------------
All too often a domestic court may reduce the current support order
to accommodate the payment of arrears In such cases the total amount of
payment through the assignment order may not only be helpful, but
crucial, in providing for the daily needs of the debtor's spouse,
former spouse, and children.
This amendment, therefore, not only insures that the payment of
support by wage earners will not be interrupted. by bankruptcy, it will
also avoid the need to entangle the debtor's family in the bankruptcy
process. Under current bankruptcy law the support creditors would have
to seek relief from the automatic stay in bankruptcy court in order to
re-institute the earnings withholding order and file a claim to collect
arrearage payments from the bankruptcy trustee. And even if these
procedures were preformed by an attorney in the child support program,
delays in support enforcement would be inevitable and the outcome
unsure.
In addition to the removal of the earnings withholding process from
the automatic stay, other federally mandated collection processes would
be exempt under section 214 of the bill. These include the interception
of the debtor's income tax refunds to pay support arrears: the license
revocation procedures for those debtors who are not paying support; the
continued enforcement of medical support obligations; and the continued
reporting of support delinquencies to credit reporting agencies \2\
---------------------------------------------------------------------------
\2\ In addition to the exclusion of enforcement remedies from the
reach of the automatic, other family law issues are excluded from the
stay, specifically (I) litigation of child custody and visitation
issues, and (2) issues relating to domestic violence.
---------------------------------------------------------------------------
Perhaps the second most important and useful amendment to the Code
is found in section 213 of the bill which prevents a debtor from
obtaining confirmation of a bankruptcy plan and a subsequent discharge
if that debtor has not made full payment of all support first becoming
due after the petition date. This section is significant for two
reasons. First it will prevent a support debtor from paying other debts
at the expense of familial obligations. And second, this provision is
self executing. Neither the support creditor, an attorney for the
creditor, nor a public attorney will have to seek enforcement of this
provision in bankruptcy court.
In addition this section allows a support creditor to seek
dismissal of an ongoing plan at any time the debtor fails to pay the
on-going support payment These provisions working together, provide
crucial check points a three stages of the bankruptcy process. At the
earlier confirmation stage, the support debtor will be reminded that
payment of all important current support obligation is a critical step
in getting approval of a bankruptcy plan as well as the lesson that
payment of this obligation is essential to financial rehabilitation. It
will set an example for the debtor early in the bankruptcy process.
Further, since the goal of the debtor is to obtain a discharge of debt,
this debtor will, at the outset of his case, understand that the
failure to meet continuing support obligations will also doom the
prospects of discharge at the end of the bankruptcy process. Finally,
the creditor will have the option to seek a dismissal of the case
during the process if the support debtor ceases to boner payment of on-
going support obligations.
Section 211 of S. 220 provides a definition of support obligations.
This definition is then incorporated in other areas of the Code The
purpose of this definitional addition is to streamline the provisions
of the Code dealing with support debts and to give all debts generally
recognized as deriving from support obligations similar treatment in
the Code. This provision will not necessarily change current law, but
it will resolve many conflicting bankruptcy decisions which turn upon
very technical interpretations of what a support debt is and what it
might not be. Most significantly, highly arcane decisions concerning
the dischargeability of such debts will be made moot and litigation
over these issues minimized. Finally, support debts of all kinds will
be subject to the same dischargeability, lien avoidance, and preference
recovery rules
Under current law only a lien securing unassigned support is
exempted from statutory lien avoidance procedures. With the new
definition of support in section 211, all support obligations will be
excepted from lien avoidance procedures. Not only will this change
protect the tax payer when the debt is assigned to the government, it
may also benefit the support creditor/parent who assigned the debt if
the debt becomes unassigned under the new assignment rules established
in the 1996 welfare reform legislation (the Personal Responsibility and
Work Opportunity Reconciliation Act of 1996 or PRWORAI. For example,
under current bankruptcy law if a support debtor files a Chapter 7 case
when his support obligation has been assigned to the government under
the Social Security Act, the bankruptcy court may rule that a lien
securing this debt impaired the debtor's homestead exemption and then
void it. The debtor would then. be free to sell the property. If this
property were the only known asset of the debtor, the debt would become
uncollectible If tie support creditor then ceased receiving public
assistance, that debt, now unassigned world likewise be uncollectible.
However, under section 216 of S. 220, the lien would not be removed and
the support debt would remain secured and thus collectible.
Under current bankruptcy law if the debtor pays support during the
90 day period prior to filing a bankruptcy petition, the bankruptcy
trustee cannot recover this payment for the benefit of the bankruptcy
estate unless the debt is assigned Under section 217 of S. 220 the
trustee would not be able to recover any support paid by the support
debtor during the preference period This rule significantly benefits
the debtor because this debt is not dischargeable and would otherwise
remain owing if recovered for the estate
No more significant statement of public policy has been made
concerning the primacy of the payment of support debts than that found
in section 212 of S. 220. Here the Code provides child support with the
first priority for payment of unsecured claims. This section is divided
into two sub-priorities so that distribution within the child support
priority will go first to the family of the debtor, then to the
government after the family has been paid, if the support has been
assigned.
When these proposed amendments are considered, it is not difficult
to see why support enforcement professionals so strongly endorse them
and are so thankful to the sponsors of this legislation for their
inclusion. Many of these amendments literally remove bankruptcy as an
obstacle to support enforcement, and they do so in a self-executing
manner. Consequently, no claims or stay litigation is required to
continue the collection of a support debt when an earnings withholding
order is feasible; no confirmation litigation is be needed when the
debtor is not paying a postpetition preconfirmation support order; and
no dismissal or stay relief litigation would be required to insure
postpetition support was paid before a discharge could be granted.
Avoiding bankruptcy court is important to support creditors and
their attorneys. Even when a support creditor is financially able to
hire a bankruptcy attorney, litigation of support issues in bankruptcy
is likely to eat up large chunks of recoverable support. Most support
creditors would be totally lost if required to navigate through the
complex set of rules and procedures to seek relief in bankruptcy court
without counsel And government support attorneys are generally ill
equipped to litigate bankruptcy issues and do not have the luxury of
referring the case to bankruptcy specialists. After all, it should be
remembered that the law of bankruptcy is a speciality with its own bar,
judges, code, rules, procedures and, indeed, its own language.
Some criticism has been raised that bankruptcy reform would be
detrimental to women and children because it would pit them against
banks and credit card companies for collection of nondischarged credit
card debt. Although this argument has some surface logic, no support
collection professional that I know believes this concern to be
serious. Of course, if support and credit card creditors were playing
on a level field, banks with superior resources might have an advantage
However, nonbankruptcy law has so tilted the field in favor of support
creditors that competition with financial institutions for the
collection of post-discharge debts presents no problems for support
collectors.
In the first place the ubiquitous earnings withholding process for
support collection absolutely trumps any financial institution's
attempt to collect this debt from the debtor's wages or salary since
withholding orders have priority, no matter when issued or served. In
most cases if the support collection was 25% or more of the debtor's
wages, the Consumer Credit Protection Act would lock out the financial
institution from collection of its debt from the debtor's wages. Thus,
with respect to creditors of wage earners, there is no conceivable way
that the existence of postpetition credit card debt, dischargeable
under current law, would adversely affect the collection of support.
Even when the debtor is not a wage earner, support creditors have
numerous and highly significant advantages over other creditors While
this list is certainly not exhaustive, support creditors have the
following remedies not possessed by other creditors, and certainly not
credit card or other financial creditors: (a) support debts are already
reduced to judgments and have the advantages of court process to
collect judgments; (b) tax intercept collection; (c) interception of
unemployment benefits/worker compensation benefits; (d) free or low
cost collection services by the government; (e) license revocation for
nonpayment of support; (t) free or low cost interstate collection,
including interstate wage withholding and interstate real property
liens; (g) criminal prosecution or contempt actions; (h) no avoidance
of liens securing the support debt; (i) federal collection and
prosecution for support debts; (j) denial of passports; (k) collection
from otherwise protected sources: ERISA plans, trusts, and federal
remuneration
To say that these advantageous remedies will necessarily result in
the collection of support is not possible. Many support debtors are
actually quite skillful evaders of support obligations. These same
people will probably be just as adept at avoiding collectors from
financial institutions. The point to be made, however, is not that
support debts will necessarily be collected after bankruptcy, but that
the collection of support debt is in no way hampered simply because
credit card debt has survived bankruptcy and financial institutions are
going to attempt to collect it.
Some have argued that after bankruptcy a support debtor will be
inclined to pay credit card debt to retain a credit card and not pay
support Of course, this argument assumes that after bankruptcy the
debtor wilt find an institution willing to extend credit Even if one
did, it seems unlikely that retention of a credit card would be more
important than retention of a driver's license, staying out of jail, or
keeping a passport.
The bottom line as I see it in analyzing S. 220 with respect to its
effect on the collection of support is to note that the advantages
explicit in the bill far outweigh any speculative concerns that some
debtors might not pay support if they are left with credit card debt
after bankruptcy What concerns support collection professionals the
most in carrying out their duties is not competition with financial
institutions outside bankruptcy, but competition with other general
creditors, including financial institutions, during bankruptcy. S. 220
readjusts the relative strength of support creditors during the
bankruptcy process, giving them meaningful, even crucial, assistance
The support provisions of this bill certainly justify the praise given
them by virtually all of the national public child support collection
organizations in this country.
Summary
The support amendments contained in Sections 211 through 219 of S.
220 will enhance substantially the enforcement of support obligations
against debtors in bankruptcy. The overall effect of these amendments
will achieve the following: a reduction in the need to appear in
bankruptcy court and the consequential reduction in the cost of
litigation; a reduction in the current conflicts in law and policy
between the Bankruptcy Code and the federal child support enforcement
program, reasonable insurance that significant support enforcement
mechanisms will not be interrupted by the bankruptcy process; and a
clear recognition of the policy that all generally recognized support
debts are entitled to a preferential treatment in bankruptcy.
This bill allows the continued operation of an earnings withholding
order, thus insuring that the payment of support by wage earners will
not be interrupted by bankruptcy. Other federally mandated collection
processes would also be exempt.
The bill prevents a debtor from obtaining confirmation of a
bankruptcy plan and a subsequent discharge if that debtor stops payment
of support. It provides a comprehensive definition of support and
treats such a debt preferentially throughout the code, including giving
such a dept the first priority in payment.
The support provisions of this bill certainly justify the praise
given them by virtually all of the national public child support
collection organizations in this country. It streamlines the bankruptcy
process for support creditors by removing the need for their
participation in it.
Senator Sessions. Mr. Williamson is an attorney in Madison,
Wisconsin, and former Chair of the Bankruptcy Review
Commission.
Mr. Williamson?
STATEMENT OF BRADY C. WILLIAMSON, LAFOLLETT, GODFREY AND KAHN,
AND FORMER CHAIR, NATIONAL BANKRUPTCY REVIEW COMMISSION,
MADISON, WISCONSIN
Mr. Williamson. Thank you, Mr. Chairman. Among other
things, I am an appellate lawyer and I don't make it a practice
to disagree with court of appeals judges, at least publicly,
but I think it is necessary here, if I might start with a few
seconds responding to Judge Becker.
The National Bankruptcy Review Commission unanimously
recommended the elimination of the two-tiered bankruptcy
appellate system, and that recommendation is embodied in
Section 1215 of the pending legislation. Section 1215 will save
time, it will save an extraordinary amount of money in legal
fees and costs, and it will improve the development of a law,
because right now a bankruptcy court has no precedential
influence beyond its own courtroom. A district court has no
precedential influence beyond its own courtroom. So we have
literally thousands and thousands of bankruptcy appeals that
only matter to the parties, that do not help develop the law.
While this provision would have a short-term impact on the
caseload in the court of appeals, it would have a salutary
impact on the court caseload in the district courts which are
dealing everyday with drug cases and major civil litigation.
This is a provision in the bill that should be adopted, has
been adopted by the Congress, and I can't recommend it more
forcefully.
Judge Becker did make a point I want to agree with, and
that is that an appeal to the U.S. Court of Appeals, at least
for a practicing lawyer, is a little bit more formidable than
an appeal to a district court judge. It does take more time, it
does take more effort. Because of that, I think we will see
fewer appeals. Litigants in bankruptcy cases will be less
likely to appeal directly to the U.S. Court of Appeals than
they will be to the district court. The single most important
reason for this change is that it will improve the
jurisprudential chaos that now rules in the bankruptcy courts.
Now, on a broader point, this will be the fourth time in a
hundred years that this Congress has undertaken major
bankruptcy legislation--1898; 1938, in the wake of the
Depression; and, of course, 1978. Yet, this legislation may
have a more comprehensive effect, a more dramatic effect on
consumer bankruptcies and on business bankruptcies, which is
the focus of my testimony this morning, than those previous
Congressional efforts to improve the bankruptcy system.
There is relatively little doubt that bankruptcy
legislation will be adopted by both Houses and that it will be
signed into law. And it is that likelihood that leads me to
urge this committee to review very carefully the changes that
are being proposed, not to stop the bill, but to ensure that it
reflects economic reality and that it actually accomplishes the
goals its proponents espouse.
Senator Biden. Brady, have you forgotten about Senator
Kennedy?
Mr. Williamson. I have not forgotten about Senator Kennedy.
In fact, I spoke about this very matter with Senator Kennedy in
Eau Claire, Wisconsin, not long ago.
Senator Biden. I am sure you did.
Mr. Williamson. But it is precisely, Senator Biden, because
this legislation may well be headed for enactment that it
really requires this committee's careful attention. This
legislation is not ready for the floor, and it is not ready for
two overarching reasons.
One is the economy is literally changing around us. This
morning's Washington Post: ``Verizon Lays Off 10,000 People.''
Saturday's Milwaukee Journal Sentinel: ``Record Layoffs Hit
State.'' In December alone, more than 140 businesses in
Wisconsin laid off 50 or more employees. That is the fifth
highest in the country. Whatever the theoretical economists may
tell us about what is happening in the economy, these layoffs
are a harsh financial reality for American families, and for
many they will be a disaster.
But there is also grave concern about the effect of the
economy and this legislation on small business layoffs and the
small business bankruptcies that may follow. We all know about
the major bankruptcies that have occurred just in the last 30
days--a major airline. Health care insolvencies are increasing
rapidly. In Senator Feinstein's State, we have had utilities
threaten to file for bankruptcy.
All of this makes a critical point. The legislation about
which Senator Hatch spoke at the outset, how it passed the
Congress in 1998 and last session, that happened at a time when
we were hitting our economic prosperity. But times have
changed, and that requires this committee to look more
carefully, as President Bush suggested, at this legislation.
Let me focus very quickly, Mr. Chairman, since I began
with--
Senator Sessions. This is not the court of appeals. You
don't disappear into a pit if you go over the light, but we do
try to follow the light as much as possible.
Mr. Williamson. Thank you. They do tell the story about the
Chief Justice of the United States cutting off a lawyer in the
middle of the word ``is'' when his time was up.
Senator Biden. Wasn't there another guy who had trouble
with that word?
[Laughter.]
Senator Biden. That seems to be a complicated word.
Mr. Williamson. You know, Senator Biden, as that anecdote
escaped my lips, I did suspect somebody might make a reference
to it.
Senator Biden. I just wondered.
Mr. Williamson. The bill covers more than 300 pages. It has
almost 200 sections. With respect to its impact on small
business and business generally, I want to point out three
particular provisions that have not gotten a great deal of
attention--Section 912 dealing with asset-based securitization,
Section 708 which gives creditors the ability to argue that a
corporation's obligations to them are not dischargeable.
Now, this notion of non-dischargeability is common in
consumer bankruptcy, but it introduces a major new element into
business bankruptcy that will permit a single creditor--we are
talking about corporate bankruptcy--to allege that the debtor
corporation has issued false and misleading financial
statements, and thereby in effect to stop the bankruptcy, to
stop the reorganization. So this concept of non-
dischargeability in corporate bankruptcies ought to receive
serious examination by the committee.
Now, you can imagine what impact this would have on a small
plastics company that employed 50 people in Mobile, Alabama.
But imagine what this provision might do to a major
reorganization, especially in an industry that produces a
product or a service that is not quite so mundane as plastics--
tobacco, firearms, HMOs, and in California utilities.
Senator Sessions. Mr. Williamson, I appreciate your
comments and I know, serving on the commission, you have a lot
of insight. We will make that a part of the record. If you have
any other things you would like to add to it, what you have
already said, we would be glad to hear it. However, in the
interest of time, it would be good if you could wrap up
shortly.
Mr. Williamson. I do, Mr. Chairman, and I will do it on an
issue that I know that you agree with me on, and that is the
need for this legislation to contain the original Sessions-Kohl
amendment. That amendment, of course, eliminates one of the
grossest abuses in bankruptcy law, which is the unlimited
homestead exemption. It passed this body 76-22, with bipartisan
support.
There has been widely reported in the media another example
of a citizen in the State of Florida using the unlimited
homestead exemption to cheat his creditors. The bankruptcy law
in this country in many ways represents our values, and it
cannot be one of our values that people who are able to use $3
million homes are able to cheat their creditors.
Thank you, Mr. Chairman.
Senator Sessions. Thank you very much, and I share that
view. It is not far from Mobile to Pensacola. It is a shame
that you can simply sell your house in Mobile and buy one only
50 miles away in Pensacola without having to give that house up
after filing for bankruptcy.
Mr. Williamson. Although I don't know why, Mr. Chairman,
anyone would want to move from Mobile to Pensacola.
Senator Sessions. I do not either.
[Laughter.]
Senator Feinstein. Mr. Chairman, he said three sections,
but he only named two, 912 and 708. What is the third one?
Mr. Williamson. Senator, the third would be the sections
dealing with small business bankruptcies. There are a package
of proposals to accelerate the process for small business
bankruptcies. The difficulty with it, I think, is that the
definition of a small business bankruptcy is a corporation that
has less than $3 million in liabilities. And in some States--
Alabama, probably not Delaware or California, but Wisconsin for
certain--that would be 90 percent of all bankruptcies. So it is
not that we are doing a special provision for smaller
bankruptcies. In most States, we are doing a provision that is
going to affect all bankruptcies.
Senator Sessions. As you know, on the homestead we did make
progress with this legislation. We were up against a number of
States whose constitutional provisions were being overridden by
this legislation and Senators from those States were quite
tenacious in protecting their State's law. It was not an easy
task, but in spite of those Senators' tenacity we were able to
craft this much-improved alternative.
[The prepared statement of Mr. Williamson follows:]
Statement of Brady C. Williamson, LaFollett, Godfrey and Kahn, and
Former Chair, National Bankruptcy Review Commission, Madison, Wisconsin
Three times in the last 100 years, Congress has passed major
legislation exercising its Constitutional responsibility to adopt
``uniform'' laws of bankruptcy. The Bankruptcy Act of 1898 gave the
country its first comprehensive system. The Chandler Act of 1938,
adopted in the wake of the Depression, gave American families the
choice they still have today--between liquidation in Chapter 7 and a
multi-year repayment plan in Chapter 13. And, of course, the
legislation adopted in 1978 recreated the bankruptcy code that (amended
in 1984 and 1994) today protects creditors and consumer and business
debtors.
The legislation pending before the Senate Judiciary Committee is no
less comprehensive than the three major ``reforms'' of the last
century--indeed, in many ways, it is more comprehensive. And it will be
more dramatic in its impact on creditors, on consumers with unbearable
debt, and on failing corporations. This legislation, in different
forms, passed both the Senate and the House in 1998 but failed when
there was no agreement on a conference report. This legislation, as a
conference report, passed both the Senate and the House last year but
failed when the President declined to sign it. Now, it is again before
the Congress: S. 220 here and H.R. 333 in the other body.
There already have been hearings, the bill's proponents maintain,
and the Congress already has expressed bipartisan support for the
legislation. With a new President, they contend, the bill is ``ready''
for final passage.
It is not.
There is relatively little doubt that new bankruptcy legislation
will be enacted this year. Yet the legislation before the Committee
should not be sent to the floor of the Senate, let alone adopted there
wholesale, without significant improvements. In fact, the likelihood
that the bankruptcy law will be changed this year should lead the
Committee to review very carefully the pending legislation--not to stop
it, but to ensure that it reflects economic reality and that the bill
actually accomplishes the goals its proponents espouse.
The bill is not ``ready'' for two overarching reasons. First, the
significant changes occurring today in the American economy are not
reflected in the bill. Second, notwithstanding the previous
consideration of the bill, it carries provisions that are self-
defeating and, in particular, the business bankruptcy sections of the
legislation will have significant consequences that have not received
the attention they deserve. Some of the most troubling provisions were
added to the bill late last year without the benefit of any
consideration at all in either body.
Economic Change
Last Saturday, the Milwaukee Journal Sentinel carried this
headline: ``Record layoffs hit state.'' In December alone, more than
140 state businesses laid off 50 or more employees, the fifth highest
in the country. There no doubt have been similar news stories in Utah
and Vermont and New York and many other states because the dramatic
increase in layoffs is a national trend.
Even with relatively high employment, businesses are laying off
American workers in record numbers. Most find jobs elsewhere--although
often only after a period of no income--frequently at lower wages and
benefits. Bankruptcy has become a pace to stop for those on their way
down the economic ladder who want to climb back. Two-thirds of the
debtors is bankruptcy report a significant period of unemployment
preceding their filings. For single-parent households, even a short
period of unemployment can be devastating. Married couples fare
slightly better, but they do not escape employment problems: more than
half of the married couples in bankruptcy reported both the husband and
the wife unemployed preceding the bankruptcy filing.
Whatever the theoretical economists may conclude, the harsh reality
of these layoffs means financial disaster for some American families.
Given the falling national savings rate and the thin financial margin
familiar to many families, the result surely will be more consumer
bankruptcies.
There is also a harsh reality in these statistics for American
business. The layoffs at AOL Time Warner, Lucent Technologies,
DaimlerChrysler, General Electric and other major companies add up, The
Chicago Tribune has just reported, to a ``corporate carnage'' that is
overwhelming. Yet small business layoffs have a far greater cumulative
effect on the economy, and these less-publicized layoffs may well
precede a sharp rise in small business bankruptcies. Unlike consumer
bankruptcies, which have decreased for months, business bankruptcies
have been increasing, and they will only continue to increase.
While the bankruptcy courts are flooded with laid off workers, the
entrepreneur who has struggled to run a small business is also at grave
risk. Creditors will not lend to small businesses without the personal
guarantee of the owners. The legal structure that protects large
corporations offers no debt relief for the owner of a failing small
business. Small business owners are three times more likely to file for
bankruptcy than their wage-earning counterparts.
Business bankruptcies is some areas--steel and heavy manufacturing,
the motion picture theater industry, and the dot-coms so vibrant in the
past--already have reached alarming levels. Another major airline just
filed for Chapter 11. Sunbeam went into Chapter 11 this week. Health
care insolvencies, particularly failing HMOs, continue to increase and,
while the pending legislation addresses limited aspects of that trend
in the health care industry, it does not address more fundamental
questions--whether federal or state law has precedence, for example.
Nor does it address the loss of health care coverage for consumers
already pushed to their financial limit.
And all of this makes this critical first point. This legislation
was largely drafted at a time when this country's economy was at the
height of its prosperity--when business and consumer bankruptcies were
decreasing. That prosperity was the prism through which the Congress
and legislation requires thoughtful analysis in today's light.
President Bush, in an interview on Monday, expressed that very
concern. The Milwaukee Journal Sentinel reporter who took part in that
interview quoted his complete response to a question about the national
debt:
``It's important to pay down the debt at the federal level,'' Bush
said. ``No question about it, and our plan does that. The debt
I'm most concerned about, however, is the consumer debt, credit
care debt, the debt that burdens thousands of Americans. And
we'd better be really careful about not recognizing the
combination of an economic slowdown, high energy prices and
debt overhand--what that means to working people.''
The President said that it was time to be ``really careful,'' and
so it is with this legislation.
Nowehere, perhaps, is the light of today's economy colder or
harsher than in California, where about one of every ten consumer
bankruptcies in this country are filed. There, a new problem has
arisen: major utilities already have threatened to file for
bankruptcy--leaving the state and its ratepayers and the financial
institutions with millions of dollars at risk all potential parties in
a single bankruptcy proceeding before a single federal judge.
Has anyone (besides the legal counsel for the utilities and their
creditors) closely reviewed the bankruptcy code to determine the effect
a utility filing might have? Has anyone (including the legal counsel
for the utilities and their creditors) closely reviewed this
legislation to determine it effect on a utility filing? Everyone has a
stake in these questions, including the pension funds and their members
heavily invested in utility stock.
Five years ago, the U.S. Supreme Court in Seminole Tribe of Florida
v. Florida, 517 U.S. 44 (1996), applied the Eleventh Amendment in a
case about the regulation of gambling that has had significant
repercussions in bankruptcies where state and local government are
often creditors and claimants. If a major utility fails and files for
bankruptcy, whether in California or in any other state, the tension
between federal authority and state autonomy inherent in the
Constitution will have to be resolved in very difficult circumstances.
Over the last two years, the Congressional debate on this
legislation has focused on its consumer provisions--the means test, for
example, and the expanded priority status the bill affords some credit
card debt. That attention was, and it remains, warranted, but the
debate has obscured the sweeping effect of the legislation's Chapter 11
proposals. And those proposals need the same kind of vigorous debate
that has characterized the consumer provisions.
In yet another development, not reflected in the legislation, the
new Study on Financial Privacy and Bankruptcy requires prompt
consideration. Its recommendations should be considered as part of this
legislation to balance the important privacy interest of individual
families and businesses using the bankruptcy system with the public
interest in the open and efficient administration of that system. The
bankruptcy process necessarily involves ``private'' financial
information, and there can be abuse both in disclosing the information
needlessly and in subject it to confidentiality too readily.
Legislative Problems
Too much has happened since the bill was drafted to rush it to the
floor of the Senate, especially at the beginning of a new Congress and
especially with the country's economic direction uncertain. So, even if
the legislation before the Committee were flawless, it still would
require the attention of the Committee's members and staff. But the
bill is far from flawless.
Parts of the bill were drafted in haste in the closing days of the
last session. Parts of the bill were not even considered by the Senate,
let alone by this Committee, and parts of the bill stand in sharp
contrast to the expressed will of the Senate. (This is not the bill
that the Senate initially adopted last year.) While all of that may be
understandable, it should not bind this Committee or the Senate to
adopt the legislation unchanged. Many of the bill's problems arise not
from what the drafters or the proponents intended but from the
unintended consequences of those intentions.
The bill covers more than 250 pages and has almost 200 sections.
While there are more examples, three sufficiently illustrate the point
that the bill requires additional consideration to prevent it from
having harsh or unintended consequences.
The bill section 912 declares that assets transferred as part of an
``asset based securitization,'' including accounts receivable, no
longer will be property of the estate as defined in 11 U.S.C. Sec. 541.
That means these assets no longer will be available to help the
corporate debtor reorganize. This provisions has not been fully
explored, yet it may well prove a significant obstacle to successful
corporate reorganizations that will save jobs.
Section 708 gives creditors the ability to argue that a
corporation's obligations to them are non-dischargeable. While this
concept, non-dischargeability, is common in consumer bankruptcy, it has
not been part of the bankruptcy code since 1978. And for good reason.
The old law permitted a single creditor to disrupt a corporate
reorganization at the expense of other creditors. Indeed, a single
creditor could prevent what almost everyone else desires: a
reorganization that treats all creditors fairly and permits the
corporation to reorganize for the benefit of all of its creditors,
customers and employees.
If the legislation becomes law, a single creditor can stop a
potentially successful reorganization with the charge that a
corporation deliberately made materially false financial statements.
Whether or not the allegation can be provide, there organization
process will slow to the point that it becomes impractical if not
impossible for the corporation to reorganize. Creditors no longer will
be united in interest nor dedicated to a reorganization that treats all
of them fairly. Smaller businesses will be particularly susceptible to
this kind of tactic but, just for the moment, consider it repercussions
not on a plastics company employing 50 workers but on a company
employing thousands of workers with a less mundane product or service--
tobacco products, for example, or firearms or, more recently HMO's and
utilities.
There is no evidence that the provisions was added, late in the
legislative process, to address a particular problem or to affect a
particular industry. Indeed, there is no public evidence at all of the
provision's genesis. The potential impact of this single provisions is
enormous, however, and undeniable. Moreover, it collides with the
provisions of the bill designed to more business bankruptcies through
the judicial system more quickly. And those provisions, too, require
additional attention from this Committee.
The proposal provides accelerated deadlines for the ``small
business debtor'' in bankruptcy, and this is the third--and, perhaps,
best--example of the law of unintended consequences. In addition to its
mandate for speed and new reporting requirements, these provisions
require that the corporate debtor show within six months that, more
likely than not, the court will confirm a plan of reorganization within
a reasonable period of time. Many aspects of this part of the bill
reflect current judicial scheduling practices. Yet the new requirements
will have a dramatic impact on the number of successful reorganizations
and, of no less significance, on the number of successful creditor-
debtor negotiations that lead to successful reorganizations or orderly
liquidations.
The collective impact of these provisions, moreover, regardless of
their individual merit, warrants reconsideration in light of their
virtually universal application. The proposal defines the ``small
business debtor'' as any business with less than $3 million in
liabilities. In some states, that will include every Chapter 11 filed.
Especially in light of current economic conditions, the Committee
should ask whether the inflexibility in the proposed statutory
deadlines for ``small business debtors'' makes sense. Four out of every
five corporations that face a potential Chapter 11 today might well be
subject to these ``special'' provisions.
For these reasons, and others, the legislation has drawn opposition
from creditor groups like the Commercial Law League and businesses
concerned about its practical impact. The National Bankruptcy
Conference, perhaps the pre-eminent independent group in the bankruptcy
field, has reviewed last year's conference report and just released its
analysis. Provision by provision, the NBC's report reviews the areas
where the legislation makes good sense and, in contrast, the areas
where it conflicts with itself or promises consequences neither desired
nor imagined by its proponents.
The Committee already has heard testimony about the need for
careful consideration of this bill--both in light of changing economic
conditions and the consequences, unintended in some instances, of the
proposal. There is another reason the Committee needs to place its mark
on the proposal: it ignores, in some key respects, the expressed wishes
of the Senate. Important provisions adopted by the Senate have
disappeared without a trace. There are several examples, but I'll
conclude with just one.
On November 10, 1999, the Senate by an overwhelming vote of 76 to
22 adopted the Kohl-Sessions amendment limiting the homestead exemption
to $200,000 nationwide. The legislation returned by the other body to
the Senate late year, and the proposal now before this Committee, does
not include that provisions. In its place, there is only a two-year
limitation on a debtor's ability, in some states, to claim an unlimited
homestead exemption. That provision invites the continuation of state-
sanctioned abuse that cheats creditors out of their money and that
cheats this country out of a law that is fair and balanced.
Just last month, a Florida citizen, Paul Bilzerian used that
state's unlimited homestead exemption to cheat his creditors. He filed
for bankruptcy in 1991. He now has filed for bankruptcy again. Yet he
retains his $5 million Florida home, which no one can touch--not the
government and not his other creditors that, together, claim $200
million in debt owed to them. Today, Mr. Bilzerian is in jail, but he
stills owns that home with all of the equity in it. The provisions of
this would not change that. By contrast, if the Kohl-Sessions amendment
were part of this proposal and became law, he might still be in jail,
but his creditors would not be paying part of his penalty.
The National Bankruptcy Review Commission conducted 21 public
hearings and meetings in 1996 and 1997, and it received more than 2,300
submissions from people across the country interested in a fair and
balanced bankruptcy system. A consistent theme emerged from that
process. The bankruptcy system should reflect the values of this
country. Most states, for example, offer a homestead exemption because,
as a society, we place a high value on home ownership and the stability
it can provide. Most states do not offer an unlimited homestead
exemption, however, because creditors are entitled to be repaid if
there is a legal basis for repayment and the debtor has the ability to
repay. Unlike the insolvency systems in many countries, the law of this
country recognizes the economic benefit of a second chance for
businesses and for families: while we are altruistic, we also are
pragmatic.
These are parts of this bill that could be passed today--without
strong objection and with obvious benefit. The family farm bankruptcy
provisions in Chapter 12, the translational insolvency system
established in the bill and the elimination of mandatory district court
appeals provide the best, but not the only, examples. Other parts of
the legislation require serious attention and amendment. While that
might be done on the Senate floor, this Committee--particularly with
the expertise of its members--is in the best position to make the
changes and additions the bill requires and, in the process, to ensure
that the bankruptcy system continues to represent this country's
values.
Senator Sessions. Mr. Beine, I understand you are with
Shoreline Credit Union and have a unique perspective to share
with us. I see that you are a credit union president.
STATEMENT OF KENNETH H. BEINE, PRESIDENT, SHORELINE CREDIT
UNION, TWO RIVERS, WISCONSIN
Mr. Beine. Thank you. Good morning, Chairman Hatch and
other members of the committee. I am Kenneth Beine, President
of Shoreline Credit Union in Two Rivers, Wisconsin, a $50
million State-chartered, federally insured credit union. I
appreciate the opportunity to be here to tell you about our
concerns with bankruptcies and how they are impacting credit
unions, and my credit union in particular.
I am speaking on behalf of the Credit Union National
Association, CUNA, which represents over 90 percent of the
10,500 State and Federal credit unions nationwide. We are very
pleased that the committee is holding today's hearing on
bankruptcy abuse prevention legislation, S. 220.
Credit unions have consistently had three top priorities
for bankruptcy reform legislation: a needs-based formula,
mandatory financial education, and maintenance of the ability
of credit union members to voluntary reaffirm their debts.
Last year's conference report, while a product of
compromise, did a good job of balancing these issues. We
strongly urge the 107th Congress to pass this compromise bill
as soon as possible. Any further dilutions may result in this
bill not addressing the real bankruptcy problems facing
America's consumers.
CUNA strongly supports the provisions in S. 220 that
require a person contemplating bankruptcy to receive a briefing
about available credit counseling and assistance in performing
a budget analysis, and prohibits a Chapter 7 or 13 debtor from
receiving a discharge if the debtor does not complete a course
in personal financial management.
Any sensible bankruptcy reform should include educational
requirements to give debtors the tools they need to make wise
decisions about filing for bankruptcy, and more importantly to
succeed financially after bankruptcy. I am confident that early
financial education would have helped some young adult members
of Shoreline Credit Union to make different decisions than they
did.
In one case, a couple in their mid-20's decided they wanted
a clean slate prior to getting married. They ran up credit card
purchases, one pre-paid on an auto loan with us to have a
cosigner released, the father. Both were employed full-time.
They both then filed Chapter 7. My credit union's share of
their version of financial planning was a write-off of
approximately $3,000 in credit card debt, plus another couple
hundred dollars in disposal of the auto.
Credit unions strongly believe that reaffirmations are a
benefit both to the credit union, which would avoid a loss, and
to the member debtor, who by reaffirming with their credit
union continues to have access to financial services and to
reasonably priced credit.
As not-for-profit financial cooperatives, losses to credit
unions have a direct impact on the entire membership due to a
potential increase in loan rates or a decrease in interest on
savings accounts. CUNA is pleased that S. 220 preserves the
ability of its members to voluntarily reaffirm their loans.
CUNA could not support bankruptcy reform legislation that
undermined the ability of credit unions and their members to
work out reaffirmation agreements.
Perhaps the best demonstration of the credit union
movement's position that reaffirmation benefits both the member
and the credit union comes from another real-life example. We
had a middle-aged couple file for Chapter 7 in 1999 due to
several medical problems and a loss of employment. They
reaffirmed their automobile loans with Shoreline. Although not
required to repay their credit card loans, they were adamant
about doing so, and did so quite voluntarily after discharge.
Needless to say, today they are members in good standing and
only ask to be granted future loans.
Credit unions are very anxious to see Congress enact
meaningful bankruptcy reform, and believe that needs-based
bankruptcy presents the best opportunity to achieve this
important public policy goal. Credit unions believe that
consumers who have the ability to repay all or some of their
debts should be required to file a Chapter 13, rather than have
all their debts erased in Chapter 7.
Therefore, CUNA supports the needs-based provision that is
contained in S. 220. This provision was a compromise developed
out of the bankruptcy reform bill that received overwhelming
support in the 106th Congress. The 106th Congress strongly
supported needs-based bankruptcy, and CUNA supported these
efforts. Today's hearing shows that the 107th Congress is
continuing to move toward passage of bankruptcy abuse reform
legislation, and we hope that bankruptcy reform will become law
in the coming months.
Thank you. I will be happy to answer any questions.
Senator Sessions. Thank you very much.
[The prepared statement and attachments of Mr. Beine
follow:]
Statement of Kenneth H. Beine, President, Shoreline Credit Union
Kenneth Beine, president, Shoreline Credit Union, in Two Rivers,
Wisconsin.
Credit unions have consistently had three top priorities for
bankruptcy reform legislation: a needs based formula; mandatory
financial education; and maintaining the ability of credit union
members to voluntarily reaffirm their debts.
Last year's conference report, while a product of compromise, did a
good job of balancing these issues. We strongly urge the
107th Congress to pass this compromise bill as soon as
possible.
Any further dilutions may result in this bill not addressing the
real bankruptcy problems facing America's consumers.
The current near-record level of filings has occurred in the best
of economic times.
Credit unions are very anxious to see Congress enact meaningful
bankruptcy reform and believe that ``needs-based bankruptcy'' presents
the best opportunity to achieve this important public policy goal.
Credit unions believe that consumers who have the ability to repay
all or some part of their debts should be required to file a chapter
13, rather than have all their debt erased in chapter 7.
CUNTA supports the needs-based provision that is contained in S.
220. This provision was a compromise developed out of the bankruptcy
reform bills that received overwhelming support in the
106 Congress.
CUNTA strongly supports the provision in S. 220 that requires a
person contemplating bankruptcy; to receive a briefing about available
credit counseling and assistance in performing a budget analysis. We
also strongly support the provision in this legislation that would
prohibit the chapter 7 or 13 debtor from receiving a discharge if the
debtor does not complete a course in personal financial management.
Credit unions are not-for-profit financial cooperatives, therefore
losses to the credit union have a direct impact on the entire
membership due to a potential increase to loan rates or decrease in
interest on savings accounts.
Credit unions strongly believe that reaffirmations are a benefit
both to the credit union, which does not suffer a loss, and to the
member/debtor, who by reaffirming with the credit union continues to
have access to financial services and to reasonably priced credit.
CUNTA could not support bankruptcy reform legislation if any
amendment would undermine the ability of credit unions and their
members to work out reaffirmation agreements.
Good morning, Chairman Hatch and other members of the Committee. I
am Kenneth Beine, president of Shoreline Credit Union in Two Rivers,
Wisconsin, and I appreciate the opportunity to be here to tell you
about our concerns with bankruptcies and how they are impacting credit
unions--and my credit union in particular. I am speaking on behalf of
the Credit Union National Association (CUNA), which represents over 90
percent of the 10,500 state and federal credit unions nationwide.
We are very pleased that the Committee is holding today's hearing
on bankruptcy abuse prevention legislation, S. 220. Credit unions have
consistently had three top priorities for bankruptcy reform
legislation: a needs based formula, mandatory financial education, and
maintaining the ability of credit union members to voluntarily reaffirm
their debts. Last year's conference report, while a product of
compromise, did a good job of balancing these issues. We strongly urge
the 107th Congress to pass this compromise bill as soon as
possible. Any further dilutions may result in this bill not addressing
the real bankruptcy problems facing America's consumers.
Shoreline is a $50 million state-chartered, federally insured
credit union. We have a community-based charter, serving everyone who
lives or works in Manitowoc County, and have almost 12,000 members.
Currently we have $38 million in loans to our members-some $14 million
in car loans, more than $16 million in home-secured loans, and almost
one-half million in personal loans. In addition, we have issued about
1,600 credit cards for another $1.5 million.
Nationwide, non-business bankruptcy filings were almost 925,000 in
the first nine months of 2000. While final full-year data is not yet
available, the results from the first nine months suggest that full-
year filings will exceed 1.2 million--very close to the 1.39 million
record level of 1998. The 2000 total is likely to be about 4 percent
lower than in 1999, but viewed in a broader historical context the
results are disturbing: 1.2 million felines is double the national
total in 1989 and four times higher than the total in 1984.
Furthermore, the current near-record level of filings has occurred
in the best of economic times. The U.S. economy grew at its fastest
annual pace in 16 years in 2000 and unemployment rates hovered near 30-
year lows throughout the year. As the economy slows, the number of
filings will undoubtedly begin to climb. We expect overall filings to
grow by roughly 5 percent in 2001, though some industry experts believe
the increases ;will be even higher. In fact, according to SMR Research,
bankruptcy filings are predicted to increase nationwide in 2001 by up
to 20 percent to record heights for a variety of economic reasons.
Credit unions are quite concerned about bankruptcies in the last
few years because they have seen similar trends in the number of credit
union members who file. Data from credit union call reports to the
National Credit Union Administration (NCUA) suggest that roughly
220,000 credit union member-borrowers will file in 2000. This figure is
nearly 66 percent higher than the level of filings we witnessed just
six years ago. In addition, CUNA estimates that over 40 percent of all
credit union losses in 2000 will be bankruptcy-related, and those
losses will total approximately $475 million.
In Wisconsin we expect a 2.5 percent increase in the total number
of credit union borrower bankruptcies in 2000. This translates to a
total of roughly 4,150 filings.
At Shoreline Credit Union, bankruptcy filings and losses have shown
a steady increase since 1996. In 1996 we had 1 member who filed for
bankruptcy; in 1997 we had 3; 1998 brought 5 filings; in 1999 it rose
to 8; and we hit 10 in 2000. We had only one Chapter 13 bankruptcy
filing during the same period. In our case over 60 percent of our
chargeoffs are Chapter 7 filings.
As the number of member bankruptcies has increased, so too have the
dollar losses to my credit union. Our loss from the one bankruptcy in
1996 was only $1,875, but in just one year the losses increased to
$9,883--an increase of over 500 percent. As noted in the Fact Sheet
attached to my testimony, our bankruptcy losses have doubled each of
the past three years.
Shoreline is a careful lender. We cannot afford to be otherwise. We
do a good job with scrutinizing loan applications and carefully
determining that the applicant is creditworthy before extending credit.
We examine credit reports, verify income, and see that a reasonable
debt-to-income ratio is maintained by the borrower. We even look at the
applicant's disposable income to determine that the applicant can make
the payments. We routinely monitor our credit cards and do not make
across-the-board increases to the credit limit.
In an effort to combat the number of bankruptcies at the credit
union, Shoreline has tightened its credit policies. We now use
bankruptcy predictors as part of the credit granting process. We have
increased collateral requirements and opt to require a cosigner or co-
maker on more loans than in the past. We do not reissue cards to those
members who are overextended or have a poor repayment history with the
credit union. We are also looking into introducing ``risk-based
lending'' procedures in the near future.
If a member is experiencing financial problems and mentions
bankruptcy to us, our loan officers inform the member of the downside
to such an action--damaged credit, loss of services--and let the member
know that the credit union is there to help them through the financial
difficulty. We attend all 341 hearings, where creditors are permitted
to question the debtor, and encourage reaffirmations by offering
debtor-friendly terms.
Credit Unions Support Financial Education
Credit unions clearly recognize the value of financial counseling
for their members. According to a recent CUNTA bankruptcy survey, 70
percent of credit unions counsel financially troubled members at the
credit union. A similar percentage of credit unions may also refer
members to an outside financial counseling organization, such as the
Consumer Credit Counseling Service (CCCS), and many do both. Shoreline
regularly refers members who are experiencing financial difficulties to
the local CCCS and have found the program to be beneficial for the
members and their families. We also try to educate our members about
alternatives to bankruptcy. We address credit issues in our newsletter
and recently added a consumer credit session to our annual spring Home
Buying Seminar series.
CUNA strongly supports the provision in S. 220 that requires a
person contemplating bankruptcy to receive a briefing about available
credit counseling and assistance in performing a budget analysis. We
also strongly support the provision in this legislation that would
prohibit the Chapter 7 or 13 debtor from receiving a discharge if the
debtor does not complete a course in personal financial management. Any
sensible bankruptcy reform should include education requirements to
give debtors the tools they need to make wise decisions about filing
for bankruptcy and to succeed financially after bankruptcy.
We also strongly support amendments to Section 527 that would
require a debt relief agency providing bankruptcy assistance to analyze
the benefits of different forms of debt relief with the debtor and to
emphasize the need for full and accurate disclosure of assets,
liabilities and income.
CUNA is also an active supporter of the Youth Financial Education
Act (H.R. 61) as introduced by Representatives David Dreier (R-CA) and
Earl Pomeroy (D-ND). This legislation would authorize the U.S.
Department of Education to provide grants to state educational agencies
to develop and integrate youth financial education programs. It would
also require these funds to be used to carry out programs for students
in kindergarten through grade 12, based on the concept of achieving
financial literacy through the teaching of personal financial
management skills, and the basic principles involved with earning,
spending, saving and investing.
Credit unions recognize that financial education needs to be
available early on and before consumers experience financial problems.
We are pleased that a financial management training test program is
included as part of S. 220, as well as the provision encouraging states
to develop personal finance curricula for elementary and high schools.
Financial education is a high priority for our national trade
association. Last year, CUTA and the National Endowment for Financial
Education (NEFE) entered into a partnership whereby credit union
volunteers teach financial education in our nation's schools. It is
based on the philosophy that discipline in managing money is best
achieved if it is learned early in life. Many credit unions had already
been working with their local schools, as well as devoting office space
for consumer libraries that enable members to use a wide range of
financial periodicals, manuals, and books to learn more about money
management.
Credit Unions have also differentiated themselves from other
financial institutions in terms of giving college students credit
cards. Many credit unions offer educational sessions on budgeting and
using credit wisely on college and university campuses at various times
during the year, including freshmen orientation and classes. Education
is, the key in helping college students to avoid falling into debt at
an age where their main focus is on obtaining a college degree. By
educating these students, credit unions help them to positively handle
their personal finances and to make them even more attractive
candidates for credit products such as auto loans and mortgages later
in life. Many colleges and universities welcome credit union
representatives to teach these courses on their respective campuses and
continually ask these representatives to come back year after year.
I am confident that early financial education would have helped
some young adult members of Shoreline Credit Union to make different
decisions than they did. In one case, a couple in their mid-twenties
decided that they wanted a ``clean slate'' prior to getting married.
They ran up credit card purchases. One prepaid on an auto loan with us
to have the cosigner released. (Both were employed full-time.) They
both then filed for Chapter 7. My credit union's share of their version
of financial planning was a write-off of almost $3,000 in credit card
debt plus another couple of hundred dollars on the disposal of the
auto.
In another case, an expectant young mother who lived at home with
her parents (with a stable part-time job and a small automobile loan at
Shoreline) wanted to quit her job, but didn't want to ``burden her
child with her credit problems,'' and asked if we would accept the car
in full payment of the loan balance. My loan officer offered to rewrite
the loan terms or suspend payments for several months and also informed
her that she would still be responsible for the remaining balance on
the loan after the sale of the car. She was not interested. She
subsequently filed Chapter 7 and turned over the vehicle to us. We
incurred about a $3,000 loss.
Even with financial counseling, I recognize there are instances in
which bankruptcy may be the only alternative for some members, the way
for them to get a much needed ``fresh start.'' But I am not convinced
that in either of these examples, bankruptcy was the right solution.
Credit Unions Support Reaffirmations as a Benefit Both to the Member
and to the Credit Union
Because we are not-for-profit financial cooperatives, losses to the
credit union have a direct impact on the entire membership due to a
potential increase to loan rates or decrease in interest on savings
accounts. Credit unions strongly believe that reaffirmations are a
benefit both to the credit union, which does not suffer a loss, and to
the member/debtor, who by reaffirming with the credit union continues
to have access to financial services and to reasonably priced credit.
CUNA could not support bankruptcy reform legislation if any amendment
would undermine the ability of credit unions and their members to work
out reaffirmation agreements.
CUNA strongly supported the original House-passed bankruptcy bill
in the 106th Congress, which did not materially amend the
reaffirmation provisions. The bankruptcy bill that eventually passed by
both houses and presented to the President in December, however,
contained a lengthy disclosure statement for reaffirmations, which is
contained in Section 203 of S. 220. The form is intended to assure that
debtors entering into a reaffirmation agreement understand all aspects
of signing that contract. CUNA appreciates the work of this committee,
and the work of Senators Jeff Sessions (R-AL) and Jack Reed (D-RI), to
recognize in the Section 203 language the unique relationships that
credit unions have with their members.
Shoreline, like most credit unions, has a policy that if a member
causes a loss to the credit union, services to that member, aside from
maintaining a share account, will be withheld. Most credit union
members take this seriously and continue to reaffirm on their credit
union loans. However, we are beginning to see that some members do not
care if they cause a loss and are denied service because they believe
they can get credit elsewhere--even though it may be at a higher rate.
We continue to see more surprise bankruptcies, where the member is a
long-time member and is current on his or her debt at the time the
bankruptcy petition is received.
Perhaps the best defense of the credit union movement's position
that reaffirmation benefits both the member and the credit union is to
provide another real life example. We had a middle aged couple file for
Chapter 7 in 1999 due to several medical problems and loss of
employment. They reaffirmed their automobile loans with Shoreline.
Although not required to repay their credit card loans, they were
adamant about doing so, and did so quite voluntarily after discharge.
Needless to say, today they are members in good standing, and need only
ask to be granted future loans.
Credit Unions Support Needs-Based Bankruptcy
Credit unions are very anxious to see Congress enact meaningful
bankruptcy reform and believe that ``needs-based bankruptcy'' presents
the best opportunity to achieve this important public policy goal.
Credit unions believe that consumers who have the ability to repay all
or some part of their debts should be required to file a Chapter 13,
rather than have all their debt erased in Chapter 7. Therefore, CUNA
supports the needs-based provision that is contained in S. 220. This
provision was a compromise developed out of the bankruptcy reform bills
that received overwhelming support in the 106th Congress.
Let me tell you about a case at my credit union that illustrates
why needs-based bankruptcy and its provisions are needed. A young woman
had an automobile loan from Shoreline Credit Union, with her mother as
a co-signer. The daughter fell behind on the payments, and the mother
offered to take over the loan completely if the credit union was
willing to remove the daughter's name from the loan. Since the mother
had a good credit and employment history, we agreed to do so. The woman
filed for Chapter 7 before the due date of the first payment. We lost
$6,000. We eventually learned that she had previously filed for
bankruptcy and ``didn't want her daughter to have the same credit
problems.''
What this member did borders on fraud. People should not be able to
use the bankruptcy code as a tool to avoid inconvenient obligations by
transferring their debts to fellow consumers--my members--your
constituents. This is wrong. This is abuse.
You have the power to make it right.
Again, let me say that I am pleased you are holding this hearing
today. Credit unions are very anxious to see Congress enact meaningful
bankruptcy reform and believe that a needs-based bankruptcy system
presents the best opportunity to achieve this important public policy
goal. The 106th Congress strongly supported needs-based
bankruptcy, and CUNA supported these efforts. These hearings that are
being held on S. 220 show that the 107th Congress is
continuing to move toward passage of bankruptcy abuse reform
legislation, and we hope that bankruptcy reform will become law in the
coming months.
Thank you, and I will be happy to answer any questions.
FACT SHEET
Total Assets: $50.5 million (data as of December 2000)
Members: 11,700
Total Loans: 38.0 million
Losses Due to Bankruptcy:
2000 522,375
1999 534,577
1998 15,309
1997 9,883
1996 1,875
Number of
Filings: Chapter 7 Chapter 13 Total
2000 10 0 10
1999 7 1 8
1998 5 0 5
1997 3 0 3
1996 1 0 1
George R. Yacik
SMR Research Corporation
Hackettstown, NJ 07890
Bankruptcies Will Rise Strongly in 2001; Research Firm Predicts ``Flood
of Filings''
Hackettstown, NJ 09/21/00. Personal bankruptcy filings will begin
to rise this year and are likely to grow by 10% to 20% in 2001, SMR
Research Corp. forecast today.
The new rising trend will mark the end of a mild bankruptcy down-
cycle. Personal filings reached record levels in 1998, and then receded
a bit in 1999. In the first two quarters of 2000, bankruptcies
continued to decline, but only slightly.
SMR said it expects data for the third quarter of 2000 to show a
slight increase in personal filings from June levels, followed by a
stronger increase in the fourth quarter. In 2001, there will be a flood
of fillings, SMR predicted.
Total filings in 2001 probably will set a new national record,
exceeding those of the prior record year, 1998.
SMR is a market research and predictive modeling firm that
specializes in consumer financial subjects. SMR operates a database of
bankruptcy filings and trends at the national, state, county, and metro
area levels, updated quarterly and with a history back to 1989. SMR
makes annual forecasts on national trends in personal bankruptcies.
``What we're now seeing is the impact of the new interest rate
cycle, made a little worse by rising energy costs,'' declared SMR
President Stuart A. Feldstein. Changes in long-term interest rates tend
to impact the bankruptcy rate with about a 1-year lag, so rising rates
in 1999 are now starting to hit home.
In news releases in 1998 and '(999, SMR correctly forecast the
bankruptcy decline in 1999, and also the impending increase in the
second half of 2000.
Interest rate movements are not the major cause of bankruptcy
filings, but do modify the trend. Most of the central causes of
bankruptcy have been growing worse since the mid-1980s, as has the
overall bankruptcy filing rate. The main causes, highlighted in various
SMR published studies, include:
Growth in consumer debt relative to income caused by too much
spending;
A host of worsening socio-economic problems, including a long-
time increase in the percent of adults who are divorced and
increased numbers of Americans lacking any form of health
insurance;
A decline in household liquid savings as a ``rainy day''
cushion--especially among middle class people;
Increased advertising promotion of bankruptcy by lawyers, and
Increased credit-risky behavior, such as casino gambling.
In calendar 1998, total personal filings reached a record high at
1.38 million, not counting U.S. territories or persons living overseas.
This number was up from only 0.77 million as recently as 1994.
In 1999, filings fell to 1.26 million. But for 12 months ended
March 31, 2000, the number of filings was 1.24 million, showing that
the declining trend of 1999 had nearly petered out.
Based on its research, SMR believes that third quarter 2000 data
will show the annualized filing rate to be up slightly from the second
quarter of 2000. Fourth quarter 2000 numbers, when available, should
show a well-developed upward bankruptcy trend.
The danger for 2001 is that it will mirror events in 1996, when
bankruptcies exploded by more than 28% from the prior year. In the
interest rate cycle, 2000 looks similar to 1995 and 2001 may look a lot
like 1996. Calendar 1995 was the last time a bankruptcy decline leveled
off, and in 1996 the floodgates opened.
``This time around, the snap-back in 2001 could be powerful,''
Feldstein said. ``Aside from interest rates, we now have fast-rising
energy and electricity costs. These impact people in danger of
bankruptcy more than they impact highly solvent consumers.''
Indeed, SMR's bankruptcy forecast for 2001--a 10%-20% filings
increase might have been even higher. However, the increase in interest
rates in 1999 and 2000 hasn't been quite as severe as it was in the
fast period of rising rates.
Interest rate changes modify what otherwise has been a long-term
increase in bankruptcies, SMR noted. Since 1985, bankruptcies have
declined only in years following periods of sharply reduced long-term
interest rates. They never declined as low as in previous troughs. And
when rates rose again, bankruptcies increased sharply about one year
later.
SMR's forecast is based on the assumption that federal bankruptcy
laws will be unchanged. Bills to toughen bankruptcy rules have been
pending in Congress for the last few years, but haven't been passed.
One reason is that when passage seemed most imminent in 1999, the
number of filings fell. Some legislators hoped the problem in
bankruptcies was about to fix itself.
``People who still think that will be in for a rude awakening very
shortly,'' said SMR's Feldstein. ``Nothing has changed in the
underlying causes of personal bankruptcy, nearly all of which continue
to worsen.''
If new and tougher bankruptcy legislation is passed in 2001, SMR's
forecast would change.
As currently written, the legislation would take effect six months
after passage. During those six months, there likely would be an
explosion of filings, as lawyers would advise their clients to make use
of the existing law. Afterwards, the effect of new legislation would
depend on its precise content.
Senator Sessions. Dr. Manning, you are a Senior Research
Fellow at the Institute of Higher Education, Law, and
Governance at the University of Houston Law Center. We are glad
to hear from you now.
STATEMENT OF ROBERT D. MANNING, SENIOR RESEARCH FELLOW,
INSTITUTE FOR HIGHER EDUCATION, LAW, AND GOVERNANCE, UNIVERSITY
OF HOUSTON LAW CENTER, HOUSTON, TEXAS
Mr. Manning. Thank you, Mr. Chairman and members of the
committee. I would like to share a somewhat different
perspective as an economic sociologist and some of my research
of the last 15 years of studying the impact of U.S. industrial
restructuring on the standard of living of various groups in
American society.
Over the last 10 years, I have been particularly interested
in the role of consumer credit in shaping the consumption
decisions of Americans, as well as the role of retail banking
in influencing the profound transformation of the financial
services industry.
I have studied the rise of the credit card industry, in
general, and the emergence of financial services conglomerates
such as Citigroup during the deregulation of the banking
industry in 1980, and the results of my research are summarized
in my new book Credit Card Nation.
I think if we take a somewhat global perspective, I would
like to use the analogy of the American economy as an athlete
who uses steroids to temporarily exaggerate muscle mass and to
boost physical strength.
The U.S. economy, I believe, has been perilously inflated
through the enormous increase of debt over the last two
decades. Across all sectors of U.S. society, whether it is
household, government or corporate, access to easy credit has
led to pervasive dependence on debt.
Like the myriad of medical maladies that eventually afflict
steroid abusers, the negative long-term consequences of social
debt have been neglected during the past decade of
unprecedented economic growth. Indeed, what we have seen is a
tremendous shift in emphasis from savings to debt, the
emergence of products such as the City Sony credit card, the
currency of fun, the emergence of young adults that refer to
their credit card as yuppie food stamps.
The economic expansion of the last decade, I do not believe
was as strong as described by leading economic indicators due
to bank lending policies that promoted inflated consumer
expectations through easy access to high-cost consumer loans,
whose interest rates far exceed the pace of household income
growth.
I think the point that I want to make very clear is it is
not just debt, but it is the cost of this debt that is going to
have such a profound impact on whether this economic slowdown
will progress to a consumer-led recession. Indeed, similarly,
the economic indicators do not necessarily imply a consumer-led
recession if leading financial services conglomerates like
Citigroup and Bank of America, J.P. Morgan and Chase do not
overreact to the abrupt decline in national economic growth.
The concern is that these financial service corporations
may tighten their lending policies for small businesses, the
primary generator of U.S. jobs, and the heavily indebted
families that previously were considered acceptable credit
risks. I can't overestimate what I think is the importance of
this issue today.
This may not only limit future levels of business
investment and household consumption which could exacerbate a
downward spiral in macroeconomic growth, but it could also
force tens of thousands of financially distressed households
into personal bankruptcy, due to unforeseen events. As the most
comprehensive analysis of bankruptcy in the early 1980's shows,
most bankruptcy filings are attributed to unforeseen events,
such as job loss, health and medical expenses, and divorce,
rather than simply excessive consumer spending patterns.
Surprisingly, the consumer financial services industry has
responded by reducing the fair share contributions to non-
profit consumer credit counseling organizations and the need
for financial education at the same time that the demand for
these services are rapidly escalating.
Like replacing small business loans with high-interest
credit cards, the question is whether the financial service
industry is truly committed to reducing the national rate of
consumer bankruptcies by supporting institutionally responsible
policies that balance the often unrealistic consumption desires
of American households.
The renewed efforts of the financial service industry to
enact more stringent personal bankruptcy laws could lead
bankers to exacerbate a national economic slowdown by forcing
financially insolvent households to continue paying off a
portion of their consumer debt years after filing for personal
bankruptcy. This is not a propitious time for enacting such a
painful and often devastating policy on some of America's most
vulnerable households.
The present legislative proposals tend to reflect a
societal context of rapid economic growth rather than current
realities of an unexpected economic slowdown. The U.S. economy
needs greater stimulation through increased consumer demand
rather than curtailing the future buying power of a large
segment of the U.S. population.
The industry's call for greater individual responsibility
belies its disregard for its own traditional underwriting
criteria. For the record, I have provided excerpts of the
hundreds of interviews that I have conducted in terms of
perceptions of easy access to credit. Indeed, what is striking
about the credit card nation is that grandparents with stellar
past job histories are often rejected for credit cards, while
their grandchildren who have never had a full-time job are
inundated with solicitations while in college. Similarly,
recent college graduates may be rejected for credit cards after
graduation, but as soon as they do graduate their low salaries
lead them to a rejection for their credit card debt.
A striking finding of my study of credit cards among
students and their debt levels is that recent graduates of the
late 1980's and early 1990's were more likely to assume most of
their credit card debt while seeking gainful employment rather
than when they were enrolled in college. Today, college
students are routinely graduating with credit card debts of
$5,000 to $15,000 before they even have a full-time job, plus
their student loans, before they enter the job market.
With the specter of a tight job market in the near future
and the continued corporate promotion of inflated consumer
expectations, it can be expected that the bankruptcy rate of
recent college graduates will continue to soar, with
potentially disastrous long-term consequences. Indeed, the
fastest growing group of bankruptcy filers last year were
individuals under 25 years old.
The recent assumption of tremendous levels of consumer debt
provided by financial service institutions that have routinely
ignored their traditional underwriting criteria--and I
especially refer to the marketing of credit cards to college
students--requires accountability and financial responsibility
from both sides, borrowers as well as lenders. Lending policies
that routinely require the poor and heavily indebted to
subsidize the low and even free cost of credit card loans to
the affluent through escalating interest rates and penalty fees
does not reflect an appropriate policy of shared individual as
well as institutional responsibility.
In fact, the increasing financial obligations of filers to
their creditors after bankruptcy could encourage banks to
continue extending easy credit to those least able to assume
their financial responsibilities during a period of economic
uncertainty and distress.
Senator Sessions. Dr. Manning, the time has expired, if you
will wrap up I would appreciate it.
Mr. Manning. Banks and other financial institutions should
share the pain as well as the gain associated with liberal
extension of high-cost consumer credit. Otherwise, consumer
lending policies of financial institutions may continue to
discourage the promulgation of prudent and responsible
underwriting policies. It is my hope that the final form of
this legislation will promote personal responsibility as well
as corporate accountability.
Thank you.
Senator Sessions. Thank you.
[The prepared statement of Mr. Manning follows:]
Statement of Robert D. Manning, Senior Research Fellow, Institute for
Higher Education, Law and Governance, University of Houston Law Center,
Houston, Texas
I would like to thank the Committee for this opportunity to
contribute to ongoing discussions over proposed legislative reforms of
existing consumer bankruptcy law. As an economic sociologist, I have
spent the last 15 years studying the impact of U.S. industrial
restructuring on the standard of living of various groups in American
society. Over the last 10 years, I have been particularly interested in
the role of consumer credit in shaping the consumption decisions of
Americans as well as the role of retail banking in influencing the
profound transformation of the financial services industry. In regard
to the former, my research includes indepth interviews and lengthy
survey questionnaires with over 800 respondents. In terms of the
latter, I have studied the rise of the credit card industry in general
and the emergence of financial services conglomerates such as Citigroup
during the de-regulation of the banking industry beginning in 1980. The
results of this research are summarized in my new book, CREDIT CARD
NATION: America's Dangerous Addiction to Consumer Credit and are
updated on my web site at www.creditcardnation.com.
The Explosion of U.S. Consumer Credit:
long-term performance enhancer or short-term miracle drug?
Like an athlete who uses steroids to temporarily exaggerate muscle
mass and to boost physical strength, the U.S. economy has been
perilously inflated through the enormous increase of debt over the last
two decades. Across all sectors of U.S. society (household, government,
corporate), access to easy credit has led to a pervasive dependence on
debt, much like American's addiction to low cost energy supplies. And,
like the myriad of medical maladies that eventually afflict steroid
abusers, the negative long-term consequences of societal debt have been
neglected during the past decade of unprecedented U.S. economic growth.
Most Americans would be surprised to learn that total consumer
debt, including home mortgages (over $6.5 trillion), exceeds the
cumulative U.S. national debt ($5.7) trillion. And, like the sharp
increase in federal borrowing that augmented the modest growth of
federal revenues over the last 20 years (U.S. national debt totaled
($940 billion in 1981), consumers have become increasingly dependent on
unsecured or ``revolving'' credit (about $55 billion in 1981) to
compensate for stagnant real wages, increasing employment disruptions,
and higher costs for big ticket items such as automobiles, college
tuition, insurance, housing, and health/medical costs. Although the
finance charges on the national debt have grown substantially (from
$292.5 billion in 1993 to $362.0 billion in 2000), accounting for over
12 percent of the current federal budget, heavily indebted consumers
are facing a more serious financial burden since their loans are more
likely to be in the form of higher interest credit cards (average of
over 18% APR) versus more modest Treasury bonds (5%-6%).
At the same time that ``one-stop'' financial shopping has provided
greater convenience and lower prices for a small minority of U.S.
households, the most economically disadvantaged or financially indebted
are increasingly relegated to the ``second tier'' of the financial
services industry (pawnshops, rent-to-own stores, `payday' lenders)
where interest rates typically range from 10 to 40 percent--and more--
PER MONTH! Significantly, this fastest growing segment of the financial
services industry features the participation of some of the largest
``first-tier'' banks such as Wells Fargo, Goleta National Bank, and
Bank of America. To the dismay of most Americans, the deregulation of
the financial services industry has led to record revenue growth and
profits for banks while providing more complex pricing systems, less
personalized service, and sharply increased costs to the majority of
consumers. In sum, while U.S. wages in general and household income in
particular have typically declined over the last two decades, the
effective demand of American consumers has been enhanced by their
access to increasingly higher cost credit. This trend is especially
significant since the U.S. post-industrial economy has been fueled by
the growth of consumer related goods and services--accounting for about
\2/3\ of America's economic activity (Gross Domestic Product). As long
as U.S. consumer demand has increased, stagnant real wages (from mid-
1970s to late 1990s), declining labor benefits (health, pension), and
the growth of temporary or ``contingent'' workers (from 417,000 in 1982
to 1.22 million in 1989 and to 2.66 million in 1997) have been obscured
by the unprecedented extension of consumer--especially ``revolving''
credit.
Like steroid abuse, the dramatic decline in the U.S. personal
savings rate (from nearly 8.5% in the early 1980s to less than zero
today) and the sharp rise in consumer debt could have long lasting
effects on the U.S. economy. Since the end of the last recession (1989-
91), the Federal Reserve reports that total installment consumer debt
(credit cards plus consumer loans such as autos and appliances) rose
from $731 billion in 1992 to about $1.5 trillion today. This includes a
huge increase in unsecured credit card debt: from $292 billion in 1992
to $654 billion at the end of 2000. A remarkable trend since credit
card debt was only $50 billion in 1980. Together with the sharp
increase in stock market valuations during the 1990s (``wealth effect
'') and the corporate promotion of immediate gratification (``Just Do
It'' consumption) which inflated consumer expectations, Americans have
tended to purchase more than they could possibly afford on their
household income. Not surprisingly, this was facilitated by the
aggressive marketing of bank and retail credit cards to traditionally
neglected groups such as college students, senior citizens, and the
working poor. It is sobering that the recent decade of economic growth
and falling unemployment has featured a perplexing phenomenon: personal
bankruptcy rates in the late 1990s (peaking at 1.4 million in 1998)
soared to nearly ten times the rate of the Great Depression.
Not only are most U.S. households being squeezed by mounting
mortgage and consumer debt, but the ``real'' cost of borrowing has
risen dramatically since the de-regulation of banking in 1980. For
instance, the real cost of corporate credit (prime rate) has increased
only marginally (2.5%-3.0%) whereas the real cost of consumer credit
card debt has more than doubled (less than 6% to over 11 %) since the
early 1980s--not to mention soaring penalty fees (about one-third of
all credit card revenues). Furthermore, even the robust wage increases
of the last three years do not compensate for the rising cost of
financing personal debt; only home mortgage related interest is tax
deductible.
Today, three out of five U.S. households are responsible for the
approximately $560 billion in outstanding credit card debt.\1\ Among
these ``revolvers,'' credit card debt averages over $11,000 per
household. Hence, a four percent increase in the annual median income
of U.S. family households (about $50,000) is nearly the same as the
average cost of financing household credit card debt (18% excluding
fees) or approximately $2,000. And, this does not include the
tremendous growth of finance companies (over 24% APR) and the rising
cost of ``second-tier'' banks. The enormous profits of the latter
explain the recent entry of the largest ``first-tier'' banks into
providing second-tier financial services. For instance, Wells Fargo
formed a joint venture with Cash America (largest U.S. pawnshop
company) in 1997 to develop a state-of-the-art system of automated,
payday loan kiosks. Overall, credit card interest charges, penalty
fees, and second-tier finance costs could total over $140 billion in
2001. This is an enormous transfer of income to an industry that has
slashed jobs, cut wages, and raised consumer prices. In terms of
sustaining the current economic expansion, the effect could be a
significant reduction in the effective demand of U.S. households as the
purchase of goods and services is subordinated to the payment of rising
finance charges attributed to previous consumption.
---------------------------------------------------------------------------
\1\ This figure is based on a conservative estimate that
approximately 9 percent of credit card debt is paid off before
incurring interest charges and another 5 percent is not credit card
debt. The monthly Federal Reserve Bulletin, which reports revolving and
nonrevolving consumer debt levels, is available at www.bog.frb.fed.us.
---------------------------------------------------------------------------
Before reporting on the experiences of people who have been
encumbered with high levels of consumer debt, it is important to note
the recent trends and institutional policies in the consumer financial
services industry. First, in contrast to descriptions of the credit
card industry as highly competitive with 6,000 competitors, the reality
is that the last decade has witnessed a dramatic consolidation of
credit card issuers. In 1977, the top 50 banks accounted for about half
of all U.S. credit card accounts. The impressive revenues of most
credit card portfolios has precipitated massive mergers and
acquisitions over the last decade. For instance, Bank One's acquisition
of credit card giant First USA in 1997 was followed by Citibank's
purchase of AT&T's credit card subsidiary--the eighth largest in 1998.
Today, the top ten card issuers control over three-fourths of the
credit card market and nearly 70 percent of the over 1.3 trillion in
credit card charge volume. Not surprisingly, competition for clients is
less likely to be expressed in the form of lower prices. Indeed, it is
striking that the average cost of consumer credit card debt has
actually risen over the last five years.
Second, the enactment of the 1998 Financial Services Modernization
Act has precipitated a new trend in the formation of consumer financial
services conglomerates. For instance, the 1998 merger of Citicorp with
Traveler's Group has created a new role for consumer credit cards:
compiling consumer information files. Credit cards provide a lucrative
revenue stream for conglomerates such as Citigroup as well as strategic
information for the cross-marketing of other financial services such as
insurance, investment services, student loans, home mortgages, and
consumer loans. By combining different sources of consumer activities
from various corporate subsidiaries (e.g. Traveler's Insurance, AT&T
credit cards, Solomon Smith Barney investments), plus the forging of
strategic partnerships with specific corporate retailers, these
conglomerates are developing increasingly cost-effective marketing
campaigns for persuading customers to use their credit for purchasing
products from members of the conglomerate's extended corporate
``family.'' It is not surprising, then, that the major credit card
associations recently have begun marketing credit cards to teenagers--
with the required financial contract signed by their parents or
guardians. This card program is ostensibly designed to help promote
financial responsibility by encouraging parents to discuss financial
purchases/budgets with their minor children. Of course, financial
education could be promoted through the use of debit cards or personal
checks. Indeed, the key objective is to promote credit card use at an
early age, especially purchases through virtual internet shopping
malls. Furthermore, this credit card program facilitates the collection
of consumer information at an earlier age as well as the direct
marketing of teenagers without the filter and/or confusion of
distinguishing the purchases of children from their parents. By issuing
credit cards in a teenager's name, companies are seeking to shape
consumption behavior and corporate loyalties at an earlier age while
minimizing the influence of their parents.
Third, the growth of subprime credit cards has led to outrageous
financial terms for the most naive and inexperienced market of the
working poor. With annual percentage interest rates of over 30 percent
and costly ``hidden'' charges, even large issuers have been formally
reprimanded and even sued over duplicitious advertising. For example,
the sixth largest credit card issuer, Providian National Bank, agreed
to an out-of-court settlement for a record $300 million in June 2000.
According to the U.S. Comptroller of the Currency, John D. Hawke Jr.,
``We found that Providian engaged in a variety of unfair and deceptive
practices that enriched the bank while harming literally hundreds of
thousands of its customers.'' They include a `no annual fee' program
that failed to disclose that the card required the purchase of $156-a-
year plan credit-protection plan; customers who complained were
informed that the plan was mandatory unless a annual fee was paid.
For those who desperately seek a credit card as a ``bank account of
last resort,'' the terms that are required of subprime applicants--
especially the working poor--include unwanted educational materials and
high membership fees with little available credit. This is illustrated
by the conditions of the United Credit National Bank Visa. It's direct
mail solicitation declares, ``ACE VISA GUARANTEED ISSUE or we'll send
you $100.00! (See inside for details.)'' For those who bother to read
the fine print, and a magnifying glass would be useful in this case,
the terms of the contract are astounding,
``Initial credit line will be at least $400.00. By accepting this
offer, you agree to subscribe to the American Credit Educator
Financial and Credit Education Program. The ACE program costs
$289.00 plus $11.95 for shipping and handling plus $19.00
Processing Fee--a small price to pay compared to the high cost
of bad credit! The Annual Card Fee [is] $49.00. . . For your
convenience, we will charge these costs to your new ACE
Affinity VISA card. [They] are considered Finance charges for
Truth-In-Lending Act purposes.''
Unbelievably, an unsuspecting applicant could pay $369 for a net
credit line of only $31 at a moderate 19.8 APR. It is no wonder that
those households who are most desperate for consumer credit often give
up on the financial services sector after they realize the exploitative
terms of these contracts.
A final issue concerns the trend of consumer financial services
conglomerates of replacing traditional, low cost consumer and small
business loans with higher cost substitutes. For instance, in low-
income neighborhoods, this may result in the closing of a first-tier
bank branch and its replacement with high cost, finance companies (such
as Citigroup's newly acquired Capital Associates) or second tier
``fringe banks'' such as check cashing outlets, pawnshops, and rent-to-
own stores. Especially disconcerting is the application of this policy
to the small business sector. Today, the number one source of start-up
financing for small businesses is credit cards followed by home equity
loans. Aspiring entrepreneurs--especially women and minorities--are
routinely denied small business loans and encouraged to assume higher
cost, credit card debt. As one owner of a computer supply company
explained, ``1 wanted a business loan [from Wells Fargo] but all 1 got
was a[nother] credit card instead.'' This trend has potentially serious
consequences as credit cards have dramatically changed from the credit
of last resort to the initial source of start-up financing. Since small
businesses are the primary source of net job growth in the U.S.
economy, this trend could have severe repercussions during the next
economic downturn. That is, small entrepreneurs may not be able to
survive unfavorable economic conditions after exhausting their high
cost lines of consumer credit at the same time that the economy needs
to generate more jobs. This restrictive corporate lending policy could
exacerbate an economic slowdown and possibly contribute to a recession.
`Plastic Money for Real People'
--college marketing campaign by associates national bank
The lack of individual responsibility in the assumption of
escalating levels of consumer debt is the cornerstone of the credit
card industry's argument for the reform of existing bankruptcy laws.
The emphasis on ``if you play then you should pay'' belies the dramatic
shift in the promotion of high interest, unsecured lines of credit
which are most efficiently provided through universal or bank credit
cards. As the credit card industry successfully increased the ``real''
cost (net of inflation) of consumer credit and saturated middle-class
households in the 1980s, the spectacular profits of the consumer-debt
driven economy led to banks to finance enormous marketing campaigns
that sought to penetrate nontraditional markets in the late 1980s. The
abrupt change in the industry's underwriting standards for these loans
raises the question of whether these new, far less stringent lending
criteria are encouraging American households to borrow more money than
banks know they can ever possibly repay. Ironically, these new groups
tend not to be engaged in full-time employment nor are they adequately
educated on the lending policies of the financial services industry:
college students and senior citizens.
In terms of college students, the lack of information on their
consumer debt levels (obscured by student loans, private loans, direct
parental payments, and other forms of family assistance), has led to
the surprising discovery that the fastest growing group of bankruptcy
filers is 25 years old or younger. The credit card industry has funded
research studies that present an idyllic world of tech savvy and
financially responsible college students that belie the escalating
social problems associated with credit card debt. Through the ``rose
colored glasses'' of the credit card industry, which claims that
approximately 3 out of 5 college students pay off their charges at the
end of each month, the credit card is portrayed as a ``knight in
shining armor'' a la Jerry Seinfeld's advertisements for American
Express. Instead, the flawed research methodology of these few industry
sponsored studies ignores such crucial trends as the use of student
loans to pay credit card debts (80% of college students are enrolled in
public schools), surveys that explicitly exclude students that have
dropped out of college due to high credit card debts, informal family
loans or payments for reducing high interest credit card debt,
supplementary private loans for paying off credit card debts, and
inclusion of parents' credit cards (where students are secondary card
users that are not responsible for monthly charges).\2\ Furthermore, by
focusing on the lifestyle enhancements that credit cards offer to
``mature'' students, public attention has been directed away from the
social problems that have emerged from their unprecedented expansion
over the last decade. These include physical maladies (from anxiety,
excessive smoking and drinking, depression), parental authority
conflicts, loss of scholarships due to extra jobs for monthly payments
(low grades), job rejection, denial of auto and home mortgage loans,
rejection for student loans for graduate and professional school,
decline of apartment rental applications, increasing defaults on
federal student loans, and, in the most extreme cases, student
suicides; the latter was recently reported in a Sixty Minutes II
program (www.cbs.com and www.creditcardnation.com). Not incidentally,
the sharp increase in consumer debt among college students has defied
the recent decline in consumer bankruptcies; last year, the number of
bankruptcy filers 25 years old or younger jumped to nearly 150,000. In
view of the enormous increase in consumer credit offered to college
students and the ongoing slowdown in the U.S. economy, the experiences
of recent college graduates offers instructive insights into industry
responsibility in the rapidly growing group of bankruptcy files.
Significantly, the case-studies reported in my 1999 study include
students whose parents emphasized the importance of credit as a
convenience and debt as a moral vice.\3\ Even in these cases, the
promotion of credit cards on college campuses--where universities
``earn'' multi-million dollar annual royalties for exclusive credit
card marketing agreements--quickly erodes cautious family values toward
the use of consumer credit and the accumulation of debt.
---------------------------------------------------------------------------
\2\ See Robert D. Manning, ``Credit Cards on Campus: Current Trends
and Informational Deficiencies,'' Consumer Federation of America, 1999
available at www.creditcardnation.com.
\3\ See Robert D. Manning, ``Credit Cards on Campus: The Social
Consequences of Student Debt,'' Consumer Federation of America, 1999
available at www.creditcardnation.com and Robert D. Manning ``Credit
Cards on Campus: The Social Consequences of Student Credit Dependency'
in Credit Card Nation: The Consequences of America's Addiction To
Credit (Basic Books, 2000).
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For example, beginning with his middle-class upbringing in Indiana,
where his father inculcated the Midwestern values of frugality and debt
avoidance, Jeff entered Georgetown University in 1995 with a commitment
to conduct his financial affairs on a cash-only basis. Initially, he
socialized with students like himself--from moderate income Midwestern
families--whom shared similarsocial backgrounds and cultural
experiences. But, Jeff soon realized that he wanted to transcend his
family background and enjoy the more exciting lifestyle of his more
affluent and urbane friends such as his roommate. At first, his
adherence to the `cognitive connect' (i.e.; that his income/resources
must determine consumption) made him ``stand out'' among his peers. For
instance, Jeff's father always paid restaurant bills in cash. His motto
is, ``if you don't have the cash then you shouldn't buy it.'' Jeff's
new friends, however, associated this behaviorwith the quaint and
backward cultural practices of Depression era farmers. Rare is the
situation when their parents use cash for common financial
transactions.
This clash of cultures led Jeff to apply for a credit card. He
received two credit cards his first semester including a Gold
MasterCard. Although Jeff initially obtained his credit cards for
convenience, he was impressed by the favorable response of others to
his Gold credit card, ``It made me feel like I had made it. . .
people treated me different when they saw [the Gold card].'' Jeff
acknowledges that this new respect was premature, since he did not yet
have a `real' job, but perceived it as an early recognition of his
future social status as a graduate from a prestigious university.
Significantly, Jeff first began using his credit cards like cash,
paying off the balances at the end of the month, ``Why pay cash.
[Afterall] what's the point of having a credit card.'' His other reason
for obtaining credit cards was for emergencies. Hence, as long as
Jeff's savings and loans could finance a carefree lifestyle, his credit
cards served as a modern convenience that befitted his status as a
student at an elite, private university. Of course, this situation
quickly changed when his financial resources were exhausted in the fall
of his sophomore year.
As a freshman, Jeff saw his credit cards as his best friend, an
angel of mercy during crisis situations, ``At first, I decided that my
credit cards would only accumulate debt in case of emergencies, such as
being stranded in an airport and needing a [plane] ticket. After a
while, i decided that it was okay to charge necessary things like books
and other school related expenses. . . Then, after charging for
'needs;' it was just so easy.. I decided that it was okay to charge
anything I damn well wanted.'' As his debt increased, with 8 new credit
cards during his sophomore year, Jeff became disheartened. Although
they enabled him to rebel against the strict social control of his
father, Jeff was now encumbered with several thousand dollars of debt.
Over time, Jeff confounded his pursuit of personal independence with
the rejection of the cultural ethos of the 'cognitive connect.'
Afterall, he argued, consumer debt it is a common--even modern--trend
of professionally successful people and ``everyone else I knew was in
debt. . . and so were many of their parents.'' Among his peers, they
rationalized their indolent spending behavior by emphasizing ``the
great jobs that we will get [after graduation] that will enable us to
pay off our credit card [debts].''
At the onset of his college career, Jeff's conservative Midwest
background made him a most unlikely candidate for accumulating a large
credit card debt. However, with tuition over $23,000 per year at
Georgetown University, Jeff quickly exhausted the $40,000 ``loan'' that
his parents saved for his college education. And, with a combined
household income of over $100,000, his financial aid was primarily
limited to student loans. Unlike students at less costly public
colleges, moreover, Jeff was not able to transfer any of his personal
debts into student loans. This is because Jeff's student loans paid
only a fraction of Georgetown's tuition while his duties as an on-
campus resident hall advisor (RA) provided his room and board. Jeff's
family inculcated the importance of adhering to the `cognitive connect'
of consuming only what could be paid in cash; credit card use was
acceptable only if one had sufficient savings or earnings that ``could
back up your purchases.'' initially, Jeff succumbed to the temptations
of credit cards for non-economic reasons. They offer emotional security
in case of personal ``emergencies'' and alleviate social status anxiety
because ``people treat me so much better when they see my Gold
[American Express, MasterCard] cards.'' Jeff's first credit card was an
impulsive response to a Citibank advertisement ``that was hanging on
the wall in the dorm.'' The Visa card offered a credit limit of $700
with an introductory rate of 4.9%. By the end of his freshman year,
Jeff had received three credit cards which were used primarily for
entertainment-related activities.
The shift from using credit cards for convenience to financing an
inflated standard of living was a normal extension of Jeff's college
experience. As he explains, ``Everyone has to take on debt to go to
college. . . everyone is expected to have student loans. . . Even
in my Midwestern [culture] which emphasizes that debt is bad, college
loans are viewed as good debt. . . Low interest rates. . . High
price of college equals high value. . . [produces] a greater return
on your investment.'' By the middle of Jeff's sophomore year, he had
exhausted his parents' college ``loan.'' At this point, he confronted a
profound crossroads in his college career. Either he fundamentally
altered his consumer oriented lifestyle or abandon his familial
attitudes toward debt. Faced with the choice of losing his more
``sophisticated'' and urbane friends, whom view debt as a necessary
means to a justifiable end, Jeff easily accumulated 8 more credit cards
in 1997.
The most striking feature of Jeff's credit card use is how quickly
he abandoned the virtue of frugality as a necessary means for
establishing his own social identity outside of his father's strict
control. Afterall, the culture of consumption that permeates collegiate
life views saving as a practice of ``hicks'' while debt is the
``breakfast of champions.'' By the end of his sophomore year, Jeff had
accumulated a couple of thousand dollars in credit card debt. Instead
of beginning his junior year with savings from his summer job, most of
Jeff's earnings were used to pay off his credit cards. Significantly,
as his credit card balances rose, Jeff received congratulatory letters
from credit card companies extolling his good credit history and
raising his credit limits as a ``courtesy to our best customers'' so
that he could avoid over limit fees. Although he has never earned
$10,000 in annual income, the deluge of credit card offers obscured the
fragility of his Jeff's financial circumstances, ``with the constant
arrival of new `pre-approved' credit card applications AND the raising
of my credit limits the credit card companies made it seem like [my
level of debt] was okay. . . When I started to fall behind, I even
received letters that allowed me to `skip a payment' because the
company `understood' that sometimes debts can back-up such as during
the holidays.'' It was during this period that Jeff eagerly embraced
the marketing ploys of the credit card industry so that he could
accumulate ``miles'' or ``points'' for frequent flier and consumer gift
programs. More importantly, this practice led to ``surfing'' or
transferring debt from high to low interest ``introductory rate''
credit cards.
As Jeff learned to ``tread water'' by ``surfing'' in this period,
he learned the next lesson of the credit dependent: the ``credit card
shuffle.'' That is, paying his credit card bills with other credit
cards through monthly balance transfers and `courtesy checks.' This
acceptance of his new debtor status was ``disheartening. . . but I
rationalized it by telling myself that everyone else is in debt. . .
Afterall, I'm going to get a great job and pay it off.'' The ``good''
or ``responsible'' credit card debt such as school related expenses, a
personal computer, and work suits was soon taken over by entertainment
on weekends, restaurant dinners, spring break in Florida and then
London and Canada. With one ten-day vacation costing over $5,000, ``I
even charged the passport application fee,'' Jeff found himself on the
verge of exhausting his available cash and credit. Fortunately, the
university credit union is willing to assist students like Jeff whom
find themselves ``drowning in credit card debt. . . most of the
people I know that go to the credit union are getting loans to pay
their credit cards.'' Without the option of federally guaranteed
student loans to service his credit card debts, Jeff received a $10,000
loan at a moderate 11.9 percent. This credit union loan essentially
``bought some time'' for Jeff before entering the job market--an option
not available to most college students. Not incidentally, a condition
of the loan disbursement was that $3,000 had to be used to pay off one
of his credit cards. The balance of the loan was spent on school
expenses as well as catching up on his other monthly credit card
payments.
During his junior year, Jeff began to engage in riskier and more
creative credit card schemes. For instance, he began ``surfing'' which
entails transferring debts from high interest rate cards to those with
much lower albeit temporary `introductory' rates. As Jeff learned how
to lower his monthly payments through this technique, he began to
exhaust his lines of credit. Instead of triggering cautionary warnings
from his credit card companies, Jeff received new ``Pre-Approved''
credit card solicitations and congratulatory letters announcing that he
had ``earned'' an increase in his credit limits. He even began
receiving letters that encouraged him to miss a payment, such as during
holiday gift-giving seasons, while lauding his good credit history.
These mixed messages are easy for college students to misinterpret.
Indeed, Jeff rationalized that his accumulating debt was not very
serious since the the credit card companies ``made it seem that
everything was okay by sending new applications and raising existing
credit limits.'' During this period, moreover, Jeff became so dependent
on ATMs (his parents never used them) that he did not even think about
the transactional costs ($1.50-$3.00). As cash advances became more
frequent, he did not want to know that the fees and higher interest
rates made their cost comparable to short-term pawnshop loans.
Eventually, he ``hit the [financial] wall'' when his meager stipend as
a residence hall advisor made it difficult to send even minimum credit
card payments. The $10,000 debt consolidation loan from the university
credit union temporarily averted an economic crisis. But, this proved
to be only a temporary financial ``band-aid.''
Ironically, a contributing factorto his financial crisis was two
failed business ventures with his roommate which were intended to
eliminate their debts. The first was a service to translate resumes of
Mexican and other Latin American students whom were seeking internships
or applying to colleges in the United States. Encouraged by friends
seeking their assistance, they purchased all the necessary office
equipment of a high-tech company: computer, fax machine, cell phones,
executive chairs, high quality business cards and fliers, web site
fees, P.O. box, and legal fees for incorporation in Delaware. After
several months without clients and rapidly depreciating business
technology, Jeff and his ``partner'' opted to ``cut our losses'' and
terminate the business. Each lost over $2,500. To add further financial
insult, they had to pay additional legal fees to dissolve their
corporation and are still paying the contract for their listing with an
internet ``search engine.''
Following this entrepreneurial debacle, they sought to recoup their
losses through the stock market. Instead of becoming more cautious
about debt, ``our credit cards allowed us to get too big for our
britches'' According to Jeff, ``my roommate found out that his company
was going to be bought out. So, he was convinced that we would make a
quick profit if we bought some stock before [the acquisition]. . . a
sure winner! We each bought $5,000 worth of stock with cash advances
from our credit cards. . . with e-trade we even saved on brokers'
commissions. . . The company was bought-out alright but then it was
cannibalized and the stock fell. . . We each lost over $3,000.'' When
asked why they pursued such risky ventures while still in school, Jeff
responded, ``Because we could! The courtesy checks gave us the
opportunity act on our impulses.''
By the end of Jeff's junior year, the social empowerment provided
by his 11 bank and 5 retail credit cards had changed dramatically: they
had evolved from friends to foes. The social ``doors'' that they had
previously ``opened'' were now increasingly closed. Jeff was ``so
concerned about meeting the right people and fitting in with them. .
. that [he] did not think twice about $50 bar tabs and spending spring
break in London. . . To think otherwise would have meant certain
social death.'' Fortunately, Jeff was forced to confront his situation
after realizing that ``I no longer had control over my credit cards.
Now, they controlled me.'' The earlier freedom to ``act like an adult''
had been replaced with the financial responsibility of paying for his
earlier excesses. Indeed, rather than enjoying his final year at
college, Jeff is enduring social hell by working full-time while taking
a normal course load and applying/interviewing for jobs. He works at
least 30 hours perweek at two part-time jobs (in addition to his
position as a resident advisor) simply to make the minimum payments on
his $20,000 credit card debt and $10,000 debt consolidation loan. Most
of his friends have stopped calling to make plans for the weekend
because he is ``shackled to my credit cards. . . I can't go out with
them like I used to because I have to work. . . ultimately, to pay
for the fun that I charged on my credit cards a couple of years ago.''
Today, Jeff views his credit cards with complete disdain, ``I hate
them.'' He is delinquent on many of his accounts and has threatened to
declare bankruptcy unless the banks offer him more favorable interest
rates. Ironically, Jeff's social odyssey of the last four years has
brought him ``full-circle'' in affirming his father's mantra toward
debt: ``if you can't afford it, don't buy it.'' What angers him the
most about credit card marketing campaigns on campus is that they extol
the benefits of `responsible use' but neglect to inform impressionable
and inexperienced students about their ``downside'' such as the impact
of poor credit reports on future loans and even prospective employment.
This is crucial, according to Jeff, because he now understands that
``the credit card industry knows exactly what it is doing [in
encouraging debt] while taking advantage of students whom are trying to
learn how to adjust to living away from home, often for the first time.
. . Let's face it, how can these banks justify giving me 11 credit
cards on an annual income of only $9,000. These include a Gold American
Express and several Platinum Visa cards.''
Although Jeff does not dismiss his financial responsibility, he
states that ``I almost feel victimized. . . giving credit cards to
kids in college is like giving steroids to an athlete. Are you not
going to use them after you get them?'' Furthermore, as a dorm Resident
Advisor (RA), Jeff emphasizes that the university offers an wide range
of student informational programs and services but with one notable
exception, ``there if nowhere to go for debt counseling. . .
everything is discussed in Freshman Orientation or incorporated in
Resident Advisor training and residence hall programs. . . AIDS,
suicide, eating disorders, alcohol, depression, peer pressure, sex ed,
academic pressures, learning handicaps. . . all but financial crisis
management.''
As Jeff has ``gone full circle'' in his attitudes toward credit
cards, he is now coping with the unexpected ``pain'' of his past credit
card excesses. Over $20,000 in credit card debt (plus his $10,000 debt
consolidation loan and over$30,000 in student loans), Jeff has washed
ashore from his ``surfing'' escapades. Although working two part-time
jobs during his senior year, Jeff is now delinquent on several of his
16 credit cards. A business major, Jeff is anxiously awaiting the
outcome of his job search. He is optimistic as some of his peers have
already received starting salaries that range from $40,000 to $55,000
per year. In addition, several have received signing bonuses between
$3,000 and $10,000. For Jeff, the latter is especially important
because he plans to use this money to reduce his credit card debt.
Unfortunately, Jeff's promising career is encountering obstacles
from an unexpected source--his credit cards. During a recent interview
with a major Wall Street banking firm, Jeff was asked, ``how can we
feel comfortable about you managing large sums of our money when you
have had such difficulty in handling your own [credit card] debts?''
Jeff was stunned. It was obvious that the interviewer had reviewed his
credit report--without prior notification--in evaluating Jeff's
desirability to the firm. ``Can you believe it,'' Jeff declared, ``they
want an explanation about my personal finances in college and yet they
lost over $120 million last year! ''
In their decision not to offer him employment, Jeff wonders how
much was based on his GPA and how much on the ``score'' calculated by
the consumer credit reporting agency. This is certainly not a potential
consequence that is explained by the credit card industry when it
exclaims, ``Build your credit history. . . you'll need [it] later for
car, home or other loans.'' As Jeff passes by the MBNA Career Center on
campus, which is named after the credit card company that he owes
several thousand dollars, the irony of his ``catch-22'' situation is
not lost on him, ``how can I pay them back when their credit reports
are hurting my chances of getting a good job!'' It is not surprising
that growing numbers of students like Jeff are increasingly using
sexual analogies in describing their unforeseen circumstances. More
bluntly, they are denouncing the predatory policies of the credit card
industry as a form of ``financial rape.''
As Jeffs experience shows, student financial strategies are
becoming increasingly complex as credit card companies offer ``the
[financial] freedom to hang ourselves.'' Even students at expensive
private schools are finding ways to transfertheir credit card debt into
supplementary loans without the knowledge of their parents. This
increasingly popular practice helps to explain the wide vacillation in
student credit card balances due to infusions of cash from other
sources of loans. In addition, Jeff demonstrates how access to credit
facilitates costly purchases that would not have been considered under
the financial constraints of a typical student budget. The latter is
especially disconcerting. It reflects the strong influences of
escalating peer consumption pressures as well as sophisticated
marketing campaigns that target the youth culture. One of the most
seductive is the Sony advertisement, ``Don't deny yourself. Indulge
with the Sony [Visa] Card from Citibank. . . The official currency of
playtime,'' Or, more succinctly, the ubiquitous NIKE slogan, ``Just Do
It.'' Although Jeff has so far avoided personal bankruptcy by securing
a well-paying job with a commercial real estate developer, he notes
with concern that some of his classmates have already been laid off due
to the slowdown of the economy. In fact, some of his highest salaried
classmates have become victims of the ``reality check'' that many
dotcom companies are only recently confronting. If Jeff is forced into
the ranks of the unemployed for an extensive period, he anguishes over
the prospect that bankruptcy may be his most realistic option.
When the `Magic of Plastic' Expires:
bankruptcy in the age of financial ignorance
Unlike Jeff, Cris has not been so fortunate in evading the
dangerous financial shoals of consumer bankruptcy. This situation is
especially surprising since her parents are both medical professionals
with a combined household income of over $100,000. At the University of
Maryland, Cris enjoyed the freedom of college life (with its promotion
of a consumer lifestyle) which contrasted sharply with the harsh
discipline of living at home. At the time, Cris' parents were oblivious
to her new college lifestyle since she was limited to her meager
savings from high school. Unbeknownst to them, however, the credit card
industry was aggressively expanding into the previously ignored market
of ``starving students'' in the late 1980s. For her father, it was
ludicrous to think that major banks would give essentially unsecured
loans to unemployed teenagers whom lacked experience in managing their
economic affairs or discipline in controlling their consumption.
Ironically, he was naive when it came to student finances and bank loan
policies. Indeed, banks were eager to make high interest loans to
students and credit cards became their financial `vehicle' of choice.
Ultimately, credit cards became the personal junk bonds of Generation
X.
Cris' initial encounter with ``plastic money'' began early in the
fall of 1989--her first semester of college. Citibank Visa
advertisements ``were plastered allover the university'' and she
thought that there was nothing to lose in submitting an application.
Besides, Cris was curious about the ``power of plastic'' since her
parents would not permit her to use a credit card in high school and
she did not want to provoke an argument by asking now. Furthermore, all
of her friends were receiving financial assistance for college from
their parents and thus they had considerably more discretionary
resources for ``play.'' Emboldened by the prospect of financial
independence, Cris eagerly filled-out the form which did not require
the consent of her parents--only a copy of her student ID. At the time,
Cris was 18 years old and working part-time at a telephone answering
service for about $5.00 per hour. To her surprise, Citibank granted a
$500 line of credit, which she immediately used to pay a large library
fine and ``buy a bunch of clothes at the mall that I couldn't otherwise
afford.'' More importantly, Citibank's decision had a much more
profound impact on Cris than the monetary value of its loan because,
``it made me feel emotionally and financially mature. . . [The credit
card] helped me become independent [in my relations] with my family and
my friends. . . It made me realize that I deserved to be responsible.
That i should not have to beg my stepfather for money or call my
grandfather for [financial]] help.''
Cris' new social and economic empowerment transformed her attitudes
toward consumption and debt. No longer forced to ``earn'' the ability
to consume through work related savings (`cognitive connect'), Visa
also ``liberated'' her from the social control of her parents. At
first, Cris limited her charges to school expenses and personal items.
By the end of the academic year, Cris was routinely using her credit
card for mall excursions, restaurant meals, bar tabs, concert and
professional sports tickets, and weekend trips to the beach. These
activities underscored Cris' newfound ``freedom'' and were reflected in
her rising credit card debts. Indeed, the ``power'' of Cris' first
credit card convinced her to get a second by the end of the fall
semester and two or three more in the spring. During this period, Cris
learned the flip side of the ``power of plastic:'' the need to refuel
its financial engine with monthly infusions of cash. By the second
semester, Cris' top priority was maintaining her lifestyle and she
began working full-time at the answering service company.
Not surprisingly, Cris' grades plummeted. For the first time in her
life, she received a `D' and an 'F' which resulted in academic
probation from the university. As conflicts with Karl intensified over
her social activities, Cris moved into an apartment with some of her
college girlfriends. These additional financial pressures reinforced
Cris' dependence on her credit cards. As her most dependent ``asset,''
Cris saw them as both her personal ``savior'' and ``best friend.'' When
she needed economic help, they were always there for her. And, they did
not ask questions about why she needed the money or moralize about her
spending patterns. The only problem is that they are ``high
maintenance'' friends with a small financial price to pay for their
invaluable assistance. At least that was what Cris thought at the time.
Cris enjoyed a largely carefree summer and, to reduce her expenses,
she enrolled in a local community college forthe fall semester. Already
over $3,000 in debt and earning only $5.00 per hour, Cris was deluged
with ``Pre-approved'' credit card offers. She attributes her
desirability to the credit card industry by her prompt remittance of
minimum monthly payments. During this period, Cris began to view her
credit cards differently. ``After spending my paycheck, I used my
credit cards like savings. . . I used them for everything . . .
books, tuition, gas, food, hotel rooms at the beach. . . whether for
school, emergencies or simply to enjoy an evening with friends.'' This
intermingling of credit and earnings was reinforced by unexpected
situations such as car repairs and medical emergencies. Afterall, she
had to get her car fixed in order to drive to work and her health
deserved immediate attention or she could not perform her job.
During this period, Cris began to engage in more creative and
costly credit card practices that would foreshadow her eventual debt
crisis. First, she began to regularly use her credit cards to generate
additional cash flow. This strategy usually entailed charging all of
her friends' meals at a restaurant and then collecting their money
afterwards. Second, she began to routinely take cash advances from her
credit cards ``when I realized that I could.'' Initially, Cris would
use cash advance checks to pay bills like rent, utilities, or car loan.
As she got further into debt, however, Cris learned a sophisticated
version of the ``credit card shuffle.'' She would take cash advances at
the end of the month and then deposit the money into her checking
account so that she could send the minimum payments to the credit card
companies. According to Cris, ``it got to the point where I had written
down all of the PIN numbers of my credit cards and, at the same ATM, I
would take cash advances and then deposit the money directly into my
[checking] account.'' Significantly, this financial management
``system'' was encouraged by her credit card companies whom profit from
high interest rates, cash advance fees, and over limit penalties,
``Every time I began to bump against my limit, the banks would raise
them. [Because of this practice] it did not become a crisis early when
I could have realized the seriousness of my situation.'' At the same
time, market-ing inducements such as 10% off with a new retail credit
card such as Hechts or a free Orioles bag with an application for an
MBNA MasterCard were ``too easy'' to pass up.
Over the next two years, Cris' credit card debt jumped from about
$5,000 to over $15,000. Cris marveled as she reflected on how she was
unaware of the amount of debt that had accumulated on her 8 or 9 credit
cards: ``after being relatively stable for a couple of years it just
[tripled] overnight.'' She moved back with her parents to reduce
expenses which now included payments on a stereo, VCR, and TV. However,
the recurrent conflicts with her stepfather ensured that this was only
a short-term move. The following year, she moved in with her boyfriend.
Although Cris had received a moderate raise to $6.50 per hour and
earned as much overtime as possible, the economic burden of rent and
utilities plus her car payment led to a sobering realization: her basic
expenses exceeded her income. At the time, Cris had been content to
send minimum payments on her credit cards because she had convinced
herself that she would soon get ``a good job and pay them all off.''
Instead, at 21 years old, Cris was forced to accept the reality that
she would have to wcrk full-time and remain a part-time student while
attempting to reduce her credit card debts. A $5000 debt consolidation
loan offered only temporary relief.
As Cris slipped closer to her financial abyss, she was astounded by
a debt counseling announcement that she saw on television. It explained
that merely sending minimum payments would require over 30 years to pay
off existing credit card balances. ``With no end in sight,'' Cris'
attitude toward her credit cards changed dramatically. From being her
``best friend,'' they became her worst enemy--``I hated them.''
Dependent on the credit card shuffle to ``simply get by,'' Cris sought
help at a local debt counseling agency. What she received was a
``shock. . . I thought that they could help anyone. . . instead,
they told me that they could not help me at all. . . that I should
declare bankruptcy. I was mad, they implied that I was beyond help. .
. I had nowhere else to go. . . I could not believe that this was
happening to me.'' Cris did not want to abandon her debts but, on the
other hand, she could not find anyone whom was interested in helping
her ``put my life back together'' unless she ``started over again.'' In
fact, the first bankruptcy lawyer that she consulted recommended that
she ``max-out'' all of her credit cards before filing for bankruptcy.
Cris was appalled by his suggestion. Afterall, she emphasized, ``I am
not irresponsible. I was not looking for an easy way out. . . He made
me feel bad about myself and the whole [bankruptcy] process. . . I
was doing it because there was no other option.'' Cris declined his
offer to represent her during the bankruptcy proceedings.
In December 1994. at the age of 23, Cris' bankruptcy petition was
approved. With the guidance of her attorney, which cost $695, the court
discharged a total of $22,522 from 13 credit cards and a $5,000
consumer loan; she ``reaffirmed'' two credit cards and continued
payments on her car loan. According to Cris, ``I felt awful about
abandoning my debt. Afterall, I tried to renegotiate through Debt
Counselors but no one was interested in helping me renegotiate my
debts.'' Indeed, the striking feature of Cris' story is her emphasis on
individual responsibility while at the same time criticizing credit
card companies for aggressively marketing excessive lines of credit to
naive and emotionally vulnerable students, ``I admit that I charged way
too much. . . my debts were all my fault. . . [However] they should
NEVER have given me all those credit cards at my age [under 22]. . .
There was just too little effort to get them. The banks make it too
easy to get into debt.''
Fortunately for Cris, bankruptcy was a prudent decision because it
enabled her ``to put the pieces of my life back together.'' In fact,
she was able to complete her junior college studies as a full-time
student and is now enrolled to a four-year university. In May 2001,
almost twelve years after receiving her first credit card, Cris is
scheduled to graduate with a BA in accounting. For those whom contend
that the consequences of bankruptcy are too lenient, Cris' experience
is instructive. Although she agrees that the social stigma is
diminishing, Cris emotionally responds that,
``you don't know how bad [bankruptcy] is. They said [my bad credit]
would last only 7 years but it will take ten years before the
bankruptcy is erased from my credit report. . . I can't get a
real credit card, AT&T just rejected me for their card, and
forget about a house mortgage. . . I've talked to people who
are thinking about declaring bankruptcy for only $4,000-$5,000
of debts. As little as they knew about credit cards, they know
even less about bankruptcy. . . Kids need to understand the
future repercussions of accumulating multiple credit cards.
Many young people see only the immediate benefits/
gratification. They are so [financially] ignorant. It is so
sad.''
`It's The Economy, Stupid'
shuffling and surfing in the turbulent seas of economic uncertainty
Even students who eventually obtain steady, well-paying jobs after
college graduation, the financial albatross of credit card debt may be
insurmountable--especially those entering a less favorable job market.
This increasingly common trend of employment disruption, which has been
``regularized'' through the enormous growth of temporary or
``contingent'' workers, has fundamentally changed the nature of
employee loyalty and, in the process, created often unmanageable
personal debt burdens. For a generation that has never witnessed an
economic downturn, the perceived lack of an imperative to accumulate
financial reserves (savings, lines of credit) suggests a potential
social crisis when they must endure extended periods of un- and
underemployment. The prospect of a potential recession in 2001, which
belies the aggressive marketing of credit cards to college students,
underscores the instructive experiences of ``Daniel'' whose graduation
from college in the early 1990s resulted in unfulfilled expectations,
disappointing job prospects, and insurmountable consumer debt
obligations.
At the beginning of the employment life-cycle, ``Daniel''
illustrates how the impact of credit card debt acquired in college can
be obscured by the middle class squeeze after graduation. That is,
recent graduates tend to assume greater levels of consumer debt during
their job search. This includes employment related expenses (resumes,
business clothing, transportation) as well as personal living expenses
(rent, food, car, entertainment). Significantly, recent graduates that
are financing their lifestyle with credit cards are neither classified
as students or new workers. It is during this transitional period that
personal credit card debt often grows at a rapid rate--especially
during a `tight' labor market.
Daniel's unexpected odyssey into the financial depths of credit
card debt began innocuously when he was offered a Citibank Visa
application by a corporate representative while walking through the
student center. A sophomore at a Howard University, he was struggling
to pay for his college expenses and enjoy a modest social life in
Washington, D.C. Daniel's middle-class, professional family is from
Kenya and his goal was to become an accountant. With limited funds,
Daniel was eager to receive ``free money'' but was skeptical that a
major bank would give him a credit card since he was several years away
from earning a middle class salary. From Daniel's perspective, an
undergraduate college student is a major loan risk.
In 1988, however, Citibank was aggressively marketing credit cards
to college students like Daniel whom it viewed as potentially lucrative
customers for high interest, consumer loans. Citibank was so desperate
to expand its credit card portfolio that it abandoned the industry
policyof requiring parental co-signatures for unemployed students.
Banks realized that they could ``persuade'' parents to pay for their
children's credit card debts with threats of lawsuits and today
``inform'' parents of the disastrous consequences to their children's
credit reports if their credit card debts are not repaid. By only
requiring a copy of his university ID, Daniel quickly completed the
application and received a $600 line of credit. He immediately used all
of his ``new money'' for school books, food, and an occasional cash
advance. At the time, Daniel thought that his ``plastic cash'' had been
exhausted and he would have to survive on his previous ``starving
student'' budget. Instead, to Daniel's surprise, he began receiving new
credit cards in the mail--a peculiar reward for maxing-out his Citibank
Visa. Over the next seven months, Daniel received Citibank MasterCard
and Visa ``Gold cards'' with rapidly rising credit limits as well as
several retail credit cards. For Daniel, it was amazing that all of
these credit card applications were ``pre-approved'' before he had
applied for his first job. Apparently, he thought, this reflected the
banks' confidence in his future earning ability.
By the time Daniel finished his B.A. degree in 1990, he had over
five thousand dollars in credit card debt. Although he does not
remember most of these purchases, Daniel is grateful that his credit
cards enabled him to enjoy a middle class lifestyle before he had a
well-paying job. In fact, this consumer debt did not seriously concern
Daniel because he was convinced that he would earn a good salary soon
after completing his studies. This is why he justified the frequent
payment of his consumer debts through cash advances and balance
transfers from bank cards--the credit card ``shuffle.'' Over the next
two years, Daniel used students loans and credit cards to finance his
Masters' degree in accounting. Upon graduating in fall 1991, Daniel had
amassed over $15,000 in credit card debt. As a Certified Public
Accountant (CPA), Daniel expected that he would be able to quickly
payoff these high interest consumer debts. To his shock, however, the
1989 recession severely affected his employment prospects. Daniel spent
the summer interviewing for jobs as an accountant and paid his living
expenses with his credit cards. Although no longer a student but still
looking for his first job, Daniel's credit card debts were approaching
$20,000 when he took a ``temporary'' position as a security guard.
Daniel was stunned that his first annual salary of approximately
$15,000 was less than his total credit card debt
Even when a ``good job'' did not materialize, Daniel did not
perceive his credit card debt as a serious problem. He was certain that
it was simply a matter of time before he became financially solvent.
Undeterred by his escalating consumer debt, Daniel's full-time job and
extensive credit history enabled him to obtain even more credit and
``buy whatever I wanted. In stores, I would apply for instant credit
cards and be set to buy in a few minutes.'' Unfortunately for Daniel,
his temporary position lasted nearly two years. As he explains,
``During this time, I was basically surviving off credit cards. They
paid my rents, entertainment, gas, and shopping...'' In 1993, Daniel
finally joined a Washington, D.C. firm as an accountant. As a CPA, his
initial salary was over $50,000 and he believed that he could begin
reducing his over $25,000 in credit card debt. However, Daniel's
newfound professional success persuaded him to ignore his original goal
of escaping credit dependence and he quickly accepted ``pre-approved''
offers for Chevy Chase Gold Visa, American Express, and Diner's Club
cards. Emboldened by his new buying power, Daniel bought a condominium
and furnished it with his credit cards. He rationalized the condominium
as a good investment and, after all, the mortgage unlike his credit
card debts is tax deductible. After a couple of salary increases,
Daniel's rising standard of living soon included a new car and of
course auto loan payments in 1994. Now Daniel felt like his hard work
was being rewarded as a tax paying member of the American middle class.
By 1996, even with an annual salary of nearly $60,000, Daniel's
credit card debts exceeded $30,000--and rising. According to Daniel,
``My paycheck could only pay my condo, car, and credit cards. Then I
had to depend on the credit cards for gas, groceries or anything else I
wanted to buy. No savings. [Over] a few months, I would make thousands
of dollars in credit card payment and the debts were not going
anywhere.'' Efforts to replace his high interest credit card debts with
lower interest debt consolidation loans were time consuming and
ultimately fruitless. Banks were reluctant to approve new consumer
loans with such a high debt to income ratio. Reluctantly, Daniel
believed that he had no other option but to file for personal
bankruptcy. In early 1997, his Chapter 7 filing was approved by the
D.C. bankruptcy court and all of his credit card debts were discharged.
Today, Daniel is recovering from the personal pain of bankruptcy
and thankful for the opportunity to rebuild his financial future.
``Without it [bankruptcy], I would still be increasing my credit card
debt and they [banks] would still be increasing my credit limits. . .
instead of relying on cash [advances] from my credit cards I can now
get cash from my savings account.'' Daniel still uses ``plastic'' but
only for convenience and ``prestige.'' That is, to minimize suspicions
about his past financial problems; he has a debit card and a `secured'
Visa credit card. The credit line on his collateralized secured card
has been raised twice and Daniel hopes that he will be approved soon
for a retail credit card following two previous rejections. Although
the days of ``easy credit'' are temporarily over, Daniel knows that it
is only a matter of time before he is able to rejoin the ranks of the
middle class with the full privileges of a Gold credit card.You know
office politics.'' In sum, a review of Daniel's bankruptcy petition
portrays a well-paid professional who appears to have been unable to
control his consumption desires. In reality, however, about two-thirds
of his credit card debt was accumulated during college and his initial
job search. Hence, the roots of Daniel's financial insolvency were sown
by his credit dependency as a university student and the unforeseen
difficulty in obtaining a job in the aftermath of the 1989 recession.
The Arrival of the `Magic of Plastic' in the Golden Years:
patching the social safety-net of elderly survival
Among America's senior citizens, the credit card industry has
encountered the most formidable challenge to its promotion of easy
credit.\4\ The debt abhorrent behavior of the parents and grandparents
of America's Baby Boomers was profoundly shaped by their personal
experiences during the Great Depression. Today, however, many seniors
are confronting formidable economic realities that are challenging
their longstanding attitudes toward ``easy'' consumer credit. The fact
that the credit card industry began aggressively marketing its products
to senior citizens in the late 1980s, including lucrative agreements
with the American Association of Retired Persons (AARP), illuminates
the intense resistance of these generations to the social shame of
personal debt. Not surprisingly, according to the 1995 Survey of
Consumer Finances, older Americans are the least likely to revolve debt
on their credit cards. In answering `yes' to the question, ``Do You
Almost Always Pay Off Your Credit Card Balance,'' the response by age
of respondent is revealing: under 35 years old (40.2%), 35-44 (40.7%),
45-54 (47.1 %), 55-64 (59.3%), 65-74 (72.0%), and 75 and older (85.8%).
And yet, with stagnant retirement incomes and rising rent and medical
costs, credit cards increasing are becoming the financial glue of the
crumbling social safety-net of America's senior citizens. This sudden
receptivity reflects both industry policies (reluctance to give
conventional, low-interest ioans to retirees and aggressive credit card
marketing campaigns) as well as the growing desperation and
socialisolation of the elderly--especially widows. This trend is
illustrated by 78 year old Jeannie May Lawson.
---------------------------------------------------------------------------
\4\ For an extended discussion of credit card use among senior
citizens, see Robert D. Manning, ``Aging Into Debt'' in Credit Card
Nation (Basic Books: 2000).
---------------------------------------------------------------------------
Jeannie May has worked hard, all of her life, to raise three
children and generally to ``just get by.'' Divorced for over 40 years,
she survives on asocial security check of $648 per month and part-time
work in the ``old folks home'' where she lives in a small town in
upstate Illinois; the rent for her subsidized, one-bedroom apartment is
$196 per month. Unlike many of her generational peers, Lawson lacks an
accumulated ``nest egg'' for retirement. Her low-income, blue-collar
jobs did not offer a private pension and divorce deprived her of the
opportunity for greater household savings. More importantly, the modest
home that she and her husband purchased with a VA loan after The War,
was sold years ago. This seemingly uneventful decision has had a major,
unforeseen impact on Lawson's ``Golden Years.'' That is, home equity is
the most important source of personal wealth for retirement, especially
among working class families. Today, nearly four out of five (79.1 %)
seniors over 64 years old are home owners and only 8 percent are still
paying on their first mortgages while 28 percent have various home
equity and second mortgages. Not surprisingly, home equity accounts for
most assets of older adults.
Jeannie May symbolizes the plight of America's working class
elderly. Born in 1915, the United States was still a largely rural
society--especially in the Midwest--when she was growing Lap in
northern Illinois. The youngest of five children, her parents worked
the small family farm that produced mostly corn, and some vegetables
for the market as well as pigs, cows, and chickens primarily for
household consumption. Money was scarce as the family, second-
generation immigrants from England, struggled to make ends meet in a
local farm economy where credit was informally negotiated and debts
were commonly satisfied through bartered exchanges. For example, the
local dentist was frequently paid for his services ``in-kind'' with
eggs, butter, and freshly dressed chickens while the school teacher
received food and housing which was supplemented with a small monetary
salary. This practice of non-monetary exchange was especially common
during the 1930s when Lawson's most vivid memories concerning credit
and debt were molded. ``Moneywas hard to come by in those days. . .
many people were losing their farms and even their homes. . . it was
tough times.''
Jeannie May's rural life experiences, Calvinist religious
upbringing, and recollections of the Great Depression profoundly shaped
her attitudes toward personal debt. On the one hand, the economic
rhythms of the seasonal farm economy required rural families to rely on
credit for agricultural and household supplies during the planting and
fallow seasons and then repay their debts after harvesting the corn or
selling some livestock in the cash economy. Hence, even among yeoman
farmers, credit and debt were ``natural'' features of their modest
lifestyle. On the other hand, the local Protestant churches emphasized
the Calvinist values of hard work and frugality as evidence of a
virtuous life. This emphasis on savings as a ``sign'' of potential
spiritual salvation contrasts sharply with the negative views toward
leisure activities and personal consumption. Lawson remembers sermons
in the little white church that chastised ``idle hands'' and indolent
``material desires'' as moral sins that would lead to disastrous
personal debt. Together with the painful experiences of the Great
Depression, when friends and family members ``lost everything to the
banks,'' Lawson entered her ``golden years'' with very conservative
attitudes toward credit and debt.
At 78 years old, Jeannie May still enjoys an active lifestyle that
belies her age. Unlike her affluent brother, John, she was unable to
translate the generational advantages of rising wages, inexpensive
housing, and low educational costs into economic security in
retirement. This is partially due to Jeannie May's divorce and
inability to re-marry which forced her to assume the economic
responsibility of raising her three children on a single income.
Although national poverty rates among older adults at least 65 years
old have been falling over the last two decades, from 15.7 percent in
1980 to 10.8 percent in 1996, older women are nearly twice as likely as
older men to live in poverty. Also, African American and Latino seniors
are nearly three time as likely as Whites to live in poverty; Asian and
Pacific Islander rates are nearly the same as Whites (9.7 versus 9.4%).
For Lawson, her fragile financial circumstances mean that she can
not enjoy a leisurely life in her final years; she would prefer to
catch up on her ``patchin' [a quilt] or kniftin' [an Afghan]'' for a
newborn nephew or niece. Instead, when her health permits (she has
diabetes and high blood pressure), Jeannie May works 15 to 30 hours per
week in the ``[retirement] home's'' kitchen as well as housework and
errands for ``neighbors'' who are usually several years younger.
Lawson's experience, of course, is not unusual. The U.S. Census Bureau
reports that 8.6 percent of women and 17.1 percent of men over 64 years
old are still ``officially'' employed in 1997, with projected increases
in 2006 to 8.7 percent for senior women and 17.8 percent for senior
men. Significantly, this rate for men has declined from 19.0 percent in
1980 whereas it has risen from 8.1 percent for women. 15 Although
Lawson occasionally receives small financial gifts from a son in
Seattle, her older brother is the only source of economic assistance
that she can depend on in case of an emergency. That is, until the day
that she received that miraculous piece of plastic in the mail--her
secret financial savior.
Jeannie May does not recall the first VISA solicitation that
arrived in late 1987. What she does remember is her excitement over the
financial ``freedom'' that it offered. Afterall, as a struggling single
mother, Lawson was always grateful for the higher standard of living
that installment credit had provided for her and the children in the
1940s and 1950s. TheVA home mortgage loan, used car loans from finance
companies, corporate loans for appliances and furniture, store credit
from local merchants for clothing, and a charge card for gasoline.
Lawson confides that she rarely paid off the balance of her credit
accounts at the end of the month and was often late with her payments.
Although she accepts most of the responsibility as a poor ``budget
keeper,'' she laments that her ex-husband's irregular child support
increased her dependence on consumer credit by ``stretching'' her
meager earnings.
Unlike her past experience with proprietary credit cards (Sears,
Montgomery Ward), the new ``universal'' VISA card offered herthe
``magic'' of purchasing items nearly anywhere she wanted and whenever
she wanted them: local merchants, mail order, and even over the
telephone. More importantly, it enabled Lawson to the avoid the
scrutiny of her financially secure brother (a successful dentist) and
his condescend ing wife who frequently criticized Jeannie's lifestyle
when ``helping'' with her financial crises. Hence, by avoiding such
embarrassing financial assistance, Jeannie May did not have to confront
the Calvinist guilt that would eventually erupt from her escalating
mountain of consumer debt. This attitudinal denial was reinforced by
the marketing strategies of the the credit card industry. As long as
she ``paid her minimums [monthly credit card payments],'' Jeannie May
convinced herself that she was satisfying her financial obligations and
thus adhering to her generation's moral code of conduct.
Unaware of the technological advances in mass marketing, Lawson was
flattered by the personalized ``invitations'' for bank cards that
arrived in her mailbox. Jeannie's limited education (she did not
complete high school), low self-esteem (modest family background),
meager income as a divorced, blue-collar worker (``scarred'' credit
history), and respect of authority figures (bankers), made her
especially susceptible to the marketing ploys that affirmed her self-
worth as a ``valued'' client. Even after violating her own Calvinist
values and life experiences during the Great Depression, by. consuming
more than she could afford, Jeannie willing accepted the banks'
explanation that she was credit worthy and that she ``deserved'' to be
``rewarded'' with a higher line of credit. After all, she did what she
was told, at least for the first few years: promptly remit the minimum
payment at the end of each month. As Lawson recounts,
``I never really looked at the credit card bills much. What was
important [to me] was what I had to pay at the end of the
month. . . I didn't really keep track of how much I owed. I
paid 'em what they wanted [minimum payment]. They were happy
and I was happy.''
What is striking and especially disturbing about Jeannie May's
experience is the ease of manipulating her to assume debt levels that
she was incapable of financing much less eventually able to pay-off.
Indeed, the predatory marketing strategies of the credit card companies
are very effective in exploiting the low self-esteem and falling
standard of living of America's senior citizens. As a divorcee who
never remarried, for example, Jeannie May's material lifestyle had
plunged below that of her brother and even her children--especially
after her retirement. Although she accepted the Calvinist ethos of hard
work and frugality, Lawson yearned for some of the indulgences that
members of the middle class take for granted: vacation trips, new cars,
household furniture, restaurant outings, gift-giving, and even
chocolate candies. With few friends (most deceased or in nursing homes)
and a disconnected extended family (children in Seattle, Milwaukee, New
York), she began coping with her loneliness by embracing material
rewards during her leisure time. In the process, Jeannie May sought to
emulate the consumption privileges of many middle-class wives (such as
her sister-in-law), whom balanced their husbands' economic success as
``producers'' by being the primary household ``consumers.''16 It was
through the magic of Jeannie May's piece(s) of plastic that she was
able to finally enjoy a comfortable life that previously had been
withheld from her.
For Lawson and millions of elderly citizens, credit cards are
serving increasingly important purposes during the current era of
fragmented families and an increasingly fractured social-welfare
system. Indeed, Jeannie May did not use her credit cards frivolously by
middle class standards, at least at the beginning. The car needed
repairs and new tires, her automobile insurance premiums were raised,
her diabetes and high blood pressure medications were more costly, she
replaced her reading glasses, and finally bought anew winter coat.
Lawson's newfound purchasing power also unleased the ability to satisfy
other ``wants'' that she felt had been unfairly denied. This led to
such purchases as a sofa and dining room table for her apartment, a set
of pots and pans for the kitchen, new clothes, knitting and sewing
materials/supplies, restaurant dinners, and small gifts for family
members during the holiday season.
Although supermarkets did not initially accept credit cards, she
charged groceries and household supplies at drug stores and even mail-
order steaks (delivered by dry ice) from Nebraska. Later, Lawson began
making purchases over the telephone via the Home Shopping Network.
Jeannie May described with irrepressible glee her anticipation of the
UPS truck as it made its appointed deliveries of her eagerly awaited
``surprises.'' For Lawson, the magic of plastic offered the opportunity
to enjoy the consumer lifestyle promoted by mass advertising yet denied
by Social Security.
By the time Jeannie had maxed out her first credit card in late
1988, about $3,000 in less than a year, she truly believed the banks'
form letters that extolled her responsible credit history. In fact, she
began to accept the ``pre-approved'' credit card solicitations that
arrived in her mail box with the now familiar logos of VISA and
MASTERCARD, as these were not just any banks that were ``callin' on
her.'' Esteemed financial institutions such as Citibank, First Chicago,
Continental Bank, and Chase Manhattan were actually vying for her
business. According to Lawson, ``I figured if the banks keep on sending
`em to me, then I figured I'd keep on usin' em. . . [Afterall]
they're in the business of lending money. I. trusted 'em. I thought
they knew what they were doing.'' And they did. Instead of eliciting a
financial warning after reaching her credit card limit, Jeannie's
``mature'' account status triggered a second and then a third card in
1989 followed by a fourth credit card in early 1990. By 1991, Lawson
had a huge credit card debt and was having difficulty ``making all my
[minimum] payments.''
Jeannie May really did not know how much debt she had accumulated
(over $12,000) or even how bad her financial situation was at the time.
What she did admit was that the infirmities of old age were finally
catching up to her. ``I never thought of myself as one of the old folks
[in the retirement home]. . . I could get around on my own and even
helped them with their own chores. With my car and job, my life really
hadn't changed much [in retirement]. . . I just didn't have to work
as hard [at a full-time job].'' The reality, however, was that she
could not live adequately on her Social Security income--even with
participation in public programs for the elderly such as subsidized
housing and medical care. As a result, it became increasingly difficult
to budget her modest monthly income due to rising health-related
expenses and an uncertain level of supplementary earnings. On the one
hand, her high blood pressure and diabetes required more costly
medicines--even with Medicaid assistance--which increased her need to
work. On the other, her poor health meant that she could not work
regularly at ``the home'' and thus could not rely on extra earnings to
supplement her meager Social Security check. Although Jeannie's
children remain in contact with her, they provide little financial
help; occasionally they send money, but it amounts to only a ``couple a
hundred dollars a year.'' Hence, with a limited family support system
and America's shrinking social safety-net, Lawson's credit cards became
her most reliable form of assistance against the unforeseen and
debilitating exigencies of the aging process.
it was primarily for economic reasons that Jeannie May ignored her
doctor's advice to ``slow down'' and stubbornly continued to work part-
time. For Lawson, employment was crucial to maintaining her newfound
independence. That is, work enabled her to shield the escalating credit
card debt from outside scrutiny while continuing to enjoy her
relatively comfortable lifestyle. Unfortunately, the combination of
financial duress, failing health, and a long life of arduous manual
labor finally culminated in a mild stroke at the end of 1991. Already
stretched to her financial limit, the temporary end of her part-time
job forced Jeannie May to finally confront the reality that she could
no longer make the minimum payments on her credit cards. While
convalescing at home, moreover, the tone of her credit card statements
shifted radically--from friendly to concerned and then to threatening.
It was at this time time that Lawson desperately sought help from the
source of last resort: her brother. And, she knew that this decision
would require a humiliating explanation as well as the end of her
credit reliant lifestyle. For Jeannie, her Calvinist guilt and personal
shame would soon be supplanted with the punishment of her previously
spartan lifestyle.
Lawson's brother, John, remembers the phone call that led to his
dismay over the predicament of his sibling. John lived in a posh,
northside suburb of Chicago and immediately made the three-hour drive
to Jeannie's apartment. He had always been protective of his youngest
sister and was surprised by her agitation over what he assumed was a
relatively minor problem. Afterall, she was a frugal person and there
were no obvious warning signals to indicate a sudden change in her
lifestyle. In fact, John was unaware that Jeannie May had any bank
cards. Upon reviewing her credit card charges, he found not one but
four separate accounts. Furthermore, John was able to reconstruct her
consumption patterns. What were normal and modest purchases for him
were often unnecessary or too costly for Jeannie. Even so, John was
impressed by the general pattern of essential charges: car repairs,
gasoline, medicine, groceries, clothes, insurance, and other necessary
household items.
After compiling all of Lawson's outstanding credit card bills, John
was shocked by what they revealed. In less than five years, Jeannie May
had amassed over $12,000 in consumerdebt. Fear and shame had led her to
ignore the cumulative outstanding balance while the marketing campaigns
of the credit card industry continued to persuade Lawson that she was a
``good'' customer. For Jeannie May, her elevation to a middle class
standard of living proved to be a temporary respite. After paying the
rent, Lawson's Social Security check barely covered the minimum
payments of her credit card accounts. Clearly, if she ever was to
regain economic self-sufficiency, Jeannie May had to escape from this
financial albatross and return to her more modest lifestyle. With the
help of John's lawyer, Jeannie May filed for personal bankruptcy and is
no longer responsible for her past credit card debts. In addition, John
purchased a small annuity that supplements Lawson's retirement income
(about $200/month) for the rest of her life. Although a compassionate
and foresightful act, John's recent death of a heart attack at age 87
means that Jeannie May has lost her only dependable source of economic
assistance. For her and increasing numbers of the impoverished elderly,
the ability to secure a bank credit card is the most realistic strategy
for obtaining a modicum of financial security in their later years.
And, this is not an unlikely prospect in view of the intensifying
competition by credit card companies over new accounts of revolvers.
Consumer Debt:
individual versus institutional responsibility
In conclusion, the economic expansion of the last decade was not as
strong as described by leading economic indicators due to bank lending
policies that promoted inflated consumer expectations through easy
access to high cost consumer loans whose interest rates far exceed the
pace of household income growth. Similarly, the economic indicators do
not necessarily imply a consumer-led recession if the leading financial
services conglomerates like Citigroup, Bank of America, and J.P. Morgan
Chase do not overreact to the abrupt decline in national economic
growth. The concern is that these financial services corporations may
``tighten'' their lending policies for small businesses (primary
generator of U.S. jobs) and heavily indebted families that previously
were considered acceptable credit risks. This may not only limit future
levels of business investment and household consumption--which would
exacerbate the downward spiral in macro-economic growth--but it may
also force tens of thousands of financially distressed households into
personal bankruptcy due to unforeseen events. As the most comprehensive
analysis of consumer bankruptcy in the early 1990s shows,\5\ most
filings are attributed to unforeseen events (job loss, health/medical
expenses, divorce) rather than excessive consumer spending patterns.
Surprisingly, the consumer financial services industry has responded by
reducing its ``fair share'' contributions to nonprofit consumer credit
counseling organizations at the same time that the demand for these
services is rapidly escalating. Like replacing small business loans
with high interest credit cards, the question is whether the financial
services industry is truly committed to reducing the national rate of
consumer bankruptcies by supporting institutionally responsible
policies that balance the often unrealistic consumption desires of
American households.
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\5\ Teresa Sullivan, Elizabeth Warren, and Jay L. Westbrook, The
Fragile Middle Class: Americans in Debt (Yale University Press, 2000).
---------------------------------------------------------------------------
With the renewed efforts of the financial services industry to
enact more stringent personal bankruptcy laws, bankers could exacerbate
a national economic slowdown by forcing financially insolvent
households to continue paying off a portion of their consumer debt--
years after filing for personal bankruptcy. This is certainly not a
propitious time for enacting such a painful and often devastating
policy on some of America's most vulnerable households. Indeed,
legislative proposals tend to reflect an societal context of rapid
economic growth rather than a sudden and unexpected economic slowdown.
The U.S. economy needs greater stimulation through increased consumer
demand rather than curtailing the future buying power of a large
segment of the U.S. population.
The industry's call for greater individual responsibility belies
its disregard for its own traditional underwriting criteria. For
example, grandparents with stellar past job histories are often
rejected for credit cards while their grandchildren who have never had
a full-time job are inundated with solicitations while in college.
Similarly, recent colleges students may be rejected for credit cards
after graduation when their entry-level salaries suggest an inability
to service higher levels of debts. Indeed, a striking finding of my
study of college student credit card debt is that recent graduates of
the late 1980s and early 1990s were more likely to assume most of their
credit card debtwhile seeking gainful employment than while enrolled in
college. Today, college students routinely graduate with credit card
debts of from $5,000 to $15,000 plus student loans before they enter
the job market. With the specter of a tight job market in the near
future and the continued corporate promotion of inflated consumer
expectations, it can be expected that the bankruptcy rate of recent
college graduates will continue to soarwith potentially disastrous
long-term consequences. Indeed, the faster growing group of bankruptcy
filers last year were individuals 25 years old or younger.
Clearly, the recent assumption of tremendous levels of consumer
debt--provided by financial services institutions that have routinely
ignored their traditional underwriting criteria--requires
accountability and financial responsibility from both sides: borrowers
and lenders. Indeed, lending policies that routinely require the poor
and heavily indebted to subsidize the low and even free cost of credit
card loans to the affluent through escalating interest rates and
penalty fees, does not reflect an appropriate policy of shared
individual and institutional responsibility. In fact, increasing the
financial obligations of filers to their creditors after bankruptcy
would encourage banks to continue extending ``easy'' credit to those
least able to assume their financial responsibilities during a period
of economic uncertainty and distress. Banks and other financial
services institutions should share the pain as well as the gain
associated with the liberal extension high cost, consumer credit.
Otherwise, consumer lending policies of financial services institutions
may continue to discourage the promulgation of prudent and responsible
underwriting policies. It is my hope that the final form of this
legislation will promote personal responsibility as well as corporate
accountability. Thank for you for this opportunity to present the
implications of my research before the Committee prior to its
deliberations on this legislation which will impact millions of
vulnerable citizens.
Robert D. Manning, Ph.D.
Institute for Higher Education Law and Governance
University of Houston Law Center
Senator Sessions. Mr. Dean Sheaffer is the Vice President
and Director of Credit for Boscov's Department Stores, in
Laureldale, Pennsylvania.
Mr. Sheaffer?
STATEMENT OF DEAN SHEAFFER, VICE PRESIDENT, DIRECTOR OF CREDIT,
BOSCOV'S DEPARTMENT STORES, INC., LAURELDALE, PENNSYLVANIA
Mr. Sheaffer. Thank you very much. Good morning. My name is
Dean Sheaffer. I am Vice President and Director of Credit for
Boscov's Department Stores. Boscov's is a family owned Mid-
Atlantic chain with stores in Maryland, New Jersey, two stores
in Delaware, three stores in New York, and more than two dozen
stores in our home State of Pennsylvania.
I am testifying today on behalf of the National Retail
Federation. I would like to thank the Chairman for providing me
with the opportunity to testify before this distinguished
committee.
Between 1995 and 1999, national bankruptcy filings rose
more than 60 percent. Last year, there were nearly 1.25 million
bankruptcy filings. At Boscov's, we have significantly
tightened our credit standards. Between 1996 and 2000, we
closed, reduced the credit limit, or took other preemptive
action on nearly 41,000 accounts, in direct response to
increased bankruptcies.
Despite these actions, Boscov's combined January and
February 2001 bankruptcy write-off will be more than 40 percent
higher than January and February of last year. Part of the
problem is that higher-income people who do not really need
Chapter 7 relief are using that chapter to wipe out all of
their debts. These people are not on the margin.
Our response, tightening credit, is a very blunt
instrument. It does hurt the people who are at the margin--the
young, the old, the low- to moderate-income. It limits their
access to credit, but it does not get at the higher-income
individuals who are filing bankruptcies of convenience.
Mr. Chairman, I would like to put these numbers in
perspective. If the current rate of filings holds, within the
next decade one in every seven American households will have
filed for bankruptcy. The system is seriously flawed. It is
estimated that over $40 billion was written off in bankruptcy
losses last year, which amounts to the discharge of at least
$110 million every single day. This money does not simply
disappear. Last year, to make up for these losses, it cost each
of our households several hundred dollars. Estimates suggest
this year's numbers will be 10 percent higher, and next year's
filings yet another 20 percent higher.
We cannot eliminate all of these losses. some of them are
unavoidable. Bankruptcy must remain an option for those who
have experienced serious financial setbacks, such as
catastrophic accident, illness, divorce, or job loss, from
which they cannot otherwise recover.
Finally, most people who file for bankruptcy do need
relief. We must be very careful to distinguish the average
filer who uses the system properly from the smaller but
significant group of others who misuse the system for their
benefit.
For many years, we tracked the payment history of those of
our customers who use the Boscov's card. The vast majority of
our customers pay as agreed. In the past, however, we could
occasionally see a customer who might fall behind a few months,
make payments to catch up, fall behind again, attempt to
recover, and so forth. We monitored these accounts and
intervened as necessary, perhaps by suggesting consumer credit
counseling or by limiting their credit to minimize the damage.
Today, however, we see a very different picture. Often, the
first indication we receive than an individual is experiencing
financial difficulty is when we receive their notice of
bankruptcy petition. In a 1998-99 study at Boscov's, almost
half of the bankruptcy petitions we received were from
customers who were not seriously delinquent at the time they
made the decision to file bankruptcy. It appears that
bankruptcy is increasingly becoming a first step rather than a
last resort.
Senator Biden. Could you repeat that again? I am sorry. I
am not sure I understood what you just said about those who
filed were not seriously----
Mr. Sheaffer. When they made the decision to file
bankruptcy, their account at Boscov's was not seriously
delinquent.
Senator Feinstein. Was not seriously----
Senator Biden. Delinquent.
Mr. Sheaffer. Delinquent, past due.
Senator Biden. In other words, they were not in trouble yet
at Boscov's.
Mr. Sheaffer. Right.
In today's law, individuals have a choice as to whether to
file in Chapter 7, which generally wipes out all their
unsecured debts, or to file in Chapter 13. Instead of wiping
out everything, a Chapter 13 filer attempts to pay as much as
her or she can afford and then the court discharges the rest.
Not surprisingly, most people file in Chapter 7, but many
people who are filing in Chapter 7 do have the ability to pay
some or all of what they owe. I understand that various studies
have pegged this number at anywhere from 30,000 filers per year
to nearly a quarter of a million.
Why are so many persons asking the court to make others pay
for their debts? Part of it is lawyer advertising. We have all
seen the ads on TV by lawyers promising to make individual's
debts disappear. Some do not even mention bankruptcy; they talk
about restructuring of finances. I question whether these
aggressive advertisers inform their clients about the serious
downsides of filing bankruptcy. I also believe part of the
problem is the declining social stigma associated with filing
for bankruptcy.
Finally, these changes have revealed a flaw in the system
itself. Our Bankruptcy Code allows individuals to choose the
chapter they wish to file in, regardless of need. If shame will
not keep the subgroup of filers who could pay from either
filing or from filing on the wrong chapter, Congress must
establish a mechanism that will, and that is simple, fair and
efficient.
In 1998, we strongly supported the bill introduced by Mr.
Gekas and Mr. Moran, H.R. 3150. It provided a very simple, up-
front, needs-based formula that allowed the overwhelming
majority of those who needed bankruptcy relief in Chapter 7 to
have it. But for that subgroup of filers, for those higher-
income individuals who would abuse Chapter 7, the needs-based
test would have said no, pay what you can afford, then society
will wipe out the rest.
Last year, we supported the conference report that passed
both the Senate and the House, but died while Congress was out
of session. We continue to support both S. 220 and H.R. 333,
which are identical to last year's conference report. However,
we are deeply concerned that if these heavily negotiated bills
are further watered down, the intended benefits are lost.
We are also deeply concerned that some wish to attach
amendments regarding essentially unrelated issues. While these
issues may be important, they should stand on their own merit.
In the context of bankruptcy, their primary effect is to derail
the critical, needed changes to bankruptcy law.
In closing, I want to say that we offer credit to help our
customers purchase merchandise. In fiscal year 2000, we
received thousands of bankruptcy petitions amounting to $3.5
million. For a retailer our size, that cannot continue.
On behalf of the National Retail Federation, we urge
Members of Congress to swiftly pass legislation to address the
problems confronting the Nation's bankruptcy system in the form
of S. 220 without amendment. If we are not careful, the costs
of the rising tide of discretionary filings may tax society's
compassion for those in genuine need. We must not allow that to
happen.
Thank you very much.
Chairman Hatch. Thank you.
[The prepared statement of Mr. Sheaffer follows:]
Statement of Dean Sheaffer, Vice President, Director of Credit,
Boscov's Department Stores, Inc., Laureldale, Pennsylvania
Good Morning. My name is Dean Sheaffer. I am Vice President and
Director of Credit for Boscov's Department Stores and Chairman of the
Pennsylvania Retailers' Association. Boscov's is primarily a Mid
Atlantic department store chain. In addition to Maryland and New
Jersey, we have 2 stores in Delaware, 3 stores in New York, and more
than two dozen stores in our home state of Pennsylvania. I am
testifying today on behalf of the National Retail Federation. I would
like to thank the Chairman for providing me with the opportunity to
testify before this distinguished committee.
The National Retail Federation (NRF) is the world's largest retail
trade association with membership that comprises all retail formats and
channels of distribution including department, specialty, discount,
catalogue, Internet and independent stores. NRF members represent an
industry that encompasses more than 1.4 million U.S. retail
establishments, employs more than 20 million people--about 1 in 5
American workers--and registered 2000 sale (2000 sales of $3.1
trillion. NRF's members and the consumers to whom they sell are greatly
affected by the recent surge in consumer bankruptcies.
Bankruptcies are still out of control. Between 1995 and 1999,
national filings rose more than sixty percent (60%). In Pennsylvania
where we are based, Chapter 7 bankruptcies grew by 90 percent in that
same time period. Nationally, filings continue to exceed the one
million filing record set in 1996. Last year there were nearly 1\1/4\
million bankruptcy filings, the overwhelming majority of which (more
than 95 percent) were consumer filings. and the latest trends are up
dramatically.
At Boscov's, we have--credit. Between 1996 and 2000 we closed or
reduced the credit limit or took other pre-emptive action on almost
41,000 accounts in direct response to increased bankruptcies. Many of
those people would have been good customers, but we had to restrict
their access to credit because that is the only tool at our disposal.
We did not want to do it. And yet despite these hesitations, if the
current trend continued, Boscov's combined January and February 2001
bankruptcy write off will be more than 40% higher than January and
February of last year.
Part of the problem is that higher income people, who do not really
need Chapter 7 relief, are using that chapter to wipe out their debts
regardless. These are not people at the margin. This is plain misuse.
Tightening credit is a very blunt instrument. It hurts people at the
margin-it limits their access to credit--but it does not get at the
higher income individuals who are filing bankruptcies of convenience.
That is why we need this legislation, to target bankruptcy misuse.
Mr. Chairman, I would like to put these numbers in perspective.
Bankruptcy filings are more than triple now than they were during the
much worse economic conditions that existed in the 1980's. If the
current rate of filings holds within the next decade, 1 in every 7
American households will have filed for bankruptcy. The system is
seriously flawed.
It is estimated that over $40 billion was written off in bankruptcy
losses last year, which amounts to the discharge of at least $110
million every day. This money does not simply disappear. The cost of
these losses and unpaid debts are borne by everyone else. When an
individual declares bankruptcy rather than pay the $300 they may owe to
Boscov's, or the thousand dollars they may owe in state taxes or other
bills, they force the rest of us to pick up their expenses. Everyone
else's taxes are higher, everyone else's credit is tighter, and
everyone else pays more for merchandise as a result of those who choose
to walk away. The nation's 100 million households ultimately pay that
$40 to $50 billion. Last year, to make up for these losses, it cost
each of our households several hundred dollars. Estimates suggest this
year's number will be 10% higher and next years filings another 20%
higher. If these bear out, bankruptcy will truly be out of control.
Now I want to be clear. We cannot eliminate all of these losses.
Some of them are unavoidable. Bankruptcy must remain an option for
those who have experienced serious financial setbacks and who have no
other means of recovering. The bankruptcy system exists to help those
who have suffered a catastrophic accident, illness, or divorce, or
those who have experienced the loss of a business or job from which
they cannot otherwise recover. It is both the safety net and the last
resort for people in trouble. The knowledge that the bankruptcy system
exists to catch them in a financial fall, even though it might never be
used, is important. Finally, most people who file for bankruptcy need
relief. We must be very careful to distinguish the average filer, who
uses the system properly, from that smaller, but important group of
others who misuse the system for their benefit.
It is this trend which we must be concerned. We believe changing
consumer attitudes regarding personal responsibility and inherent flaws
in our bankruptcy process have caused many individuals, who do not need
full bankruptcy relief, to turn to the system regardless. They use it
to wipe out their debts, without ever making a serious effort to pay.
Some of this change in usage results from a decline in the stigma
traditionally associated with filing for bankruptcy. Some of it results
from suggestions by other who urge individuals to use bankruptcy to
``beat the system.'' Whatever the cause, it must be stopped.
My experience at Boscov's, and that of credit managers at other
stores with whom I have spoken, convinces me of this fact. For example,
for many years we tracked the payment history of those of our customers
who carry and use the Boscov's card. The vast majority of our customers
pay as agreed. In the past, however, we would occasionally see
customers whose payment patters were more erratic. They might fall
behind by a few months, make payments to catch up, fall behind again,
attempt to recover, and so forth. This kind of payment history
suggested to us that the customer was experiencing some sort of
financial difficulty. We would monitor the account and intervene as
necessary, perhaps by suggesting consumer credit counseling or by
limiting their credit line to minimize the amount of damage, prior to
their experiencing a financial failure.
Today, however, we see a very different picture. Often the first
indication we receive that an individual is experiencing financial
difficulty is when we receive notice of his bankruptcy petition. In a
1998/1999 study at Boscov's, almost half of the bankruptcy petitions we
receive were from customers who are not seriously delinquent with their
accounts. The first indication of a problem is the notice that they
have filed for bankruptcy. It appears that bankruptcy is increasingly
becoming a first step rather than a last resort.
Individuals must have a good credit history to qualify for and
continue to use a Boscov's card. Yet we, and other retail credit
grantors, have been receiving bankruptcy filings without warning from
individuals who have been solid customers for years. We all experience
temporary financial reversals in life. Most of us learn that, if you
grit your teeth and tighten your belt a notch, you can get through it.
But many people no longer see it that way. The rising bankruptcy filing
reflect this. Professor Michael Staten at Georgetown University
analyzed thousands of Chapter 7 petitions in courts all over the
country. His review of debtors' own financial statements gives a strong
indication of what is going wrong.
Individuals have a choice as to whether to file in Chapter 7, which
generally wipes out all their unsecured debts, or to file in Chapter
13, often known as a wage-earner plan. Instead of wiping out
everything, a Chapter 13 filer attempts to pay as much as he or she can
afford and the court discharges the rest. Not surprisingly, most people
choose to file in Chapter 7.
But many people who are filing in Chapter 7 do have the ability to
pay some or all of what they owe. I understand that various studies
have pegged this number as being anywhere from 30,000 filers per year
to eight time that number. Whatever the figure, we should not treat
bankruptcy as a ``get out of debt free'' card that can be used by tens
of thousands of filers every month, with virtually no questions asked.
Why are so many persons asking the court to make others pay their
debts for them? Why aren't they ashamed to go into bankruptcy court? We
think that there are a number of factors.
Part of it is lawyer advertising. We have all seen the ads on TV by
lawyers promising to make individuals' debts disappear. Some do not
even mention bankruptcy--they talk about ``restructuring'' you
finances. I question whether these aggressive advertisers inform their
clients about the serious downsides of filing for bankruptcy. There are
also bankruptcy petition preparers: clerk typists who simply fill out
forms for filers. The client may never meet a lawyer. And with the
widespread use of the Internet, websites that proclaim ``File
bankruptcy for as little as $99'' are multiplying. I firmly believe
these low costs ``bankruptcy mills'' are part of the problem.
I also believe that part of the problem is the declining social
stigma associated with filing for bankruptcy. At a time when 1 in every
80 households files for bankruptcy, everyone knows someone, or knows of
someone, who has recently declared. Many of these individuals keep
their house and their car. They seem to have access to credit (although
in many cases whet they actually line''). And their friends and
neighbors, not seeing the details of their life that bankruptcy
disrupts, assume that bankruptcy is not the devastating situation they
always thought. There have also been a number of high profile celebrity
bankruptcies in recent years. I cannot help but think that this sends a
message tot he public that the stigma of bankruptcy is fast
disappearing.
Finally, these changes have revealed a flaw in the system itself.
Out bankruptcy code allows individuals to choose the chapter they wish
to file in, regardless of need. If shame will not keep the subgroup of
filers who could pay from either filing, or from filing in the wrong
chapter, Congress needs to establish a mechanism that will. It must be
simple, fair and efficient.
In 1998, we strongly supported the bill introduced by Mr. Gekas and
Mr. Moran, H.R. 3150. It provided a very simple, up front needs-based
formula that allowed the overwhelming majority of those who needed
bankruptcy relief in Chapter 7 to have it with virtually no questions
asked. But for that subgroup of filers, for those higher income
individuals who would use Chapter 7 to push their debts onto other
regardless of the filer's ability to pay, the up front, needs-based
test would have said, ``No. Pay what you can afford, and society will
wipe out the rest.'' Last year we supported the conference report that
passed both the Senate and House, but died while Congress was out of
session. We continue to support the both S. 220 and H.R. 333 which are
identical to last years' conference report. However, we are deeply
concerned that if these heavily negotiated bills are further ``watered
down'' the intended benefits will be lost. We are also deeply concerned
that some wish to attach amendments regarding essentially unrelated
issues. While these issues may bear important, they should stand on
their own merit. In the context of bankruptcy their primary effect is
to derail the critical, needed changes to Bankruptcy law.
In closing, I want to say that we offer credit to help our
customers purchase our merchandise. Out typical retail balances are not
large, but we have lots of customers. In fiscal year 2000 we received
thousands of bankruptcy petitions amounting to 3\1/2\ million dollars.
For a retailer of our size, that cannot continue. On behalf of the
National Retail Federation, we urge members of Congress to take swift
legislative action to address the problems confronting the nation's
bankruptcy system. Otherwise, in the not too distant future, we may
find that among a large segment of our society, bankruptcy filings will
become the rule rather than the exception. If we are not careful, the
costs of the rising tide of discretionary filings may tax society's
compassion for those in genuine need. We must not allow that to happen.
I believe that it is imperative for Congress to pass common sense
bankruptcy reform legislation in the form of S. 220 without amendment,
now.
Chairman Hatch. Ms. Vullo?
STATEMENT OF MARIA T. VULLO, PARTNER, PAUL, WEISS, RIFKIND,
WHARTON AND GARRISON, NEW YORK, NEW YORK
Ms. Vullo. Thank you, Mr. Chairman and Senator Leahy and
Senator Schumer, for inviting me to appear before this
committee today. My name is Maria Vullo and I am a partner with
the law firm of Paul, Weiss, Rifkind, Wharton and Garrison. I
was the lead counsel for the plaintiffs in the case in
Portland, Oregon, in which a jury rendered a $100 million
verdict against anti-choice extremists who had threatened my
clients' lives.
I am here in support of the Schumer-Leahy amendment to the
Bankruptcy Code which would make violence and threats of
violence against family planning clinics non-dischargeable in
bankruptcy. This amendment is needed to prevent further abuse
of the bankruptcy system.
Senator Sessions mentioned before Mobile, Alabama, and
Pensacola, Florida, on a different issue. But what is
significant, in my view, about those two locations is that an
abortion doctor was killed in Mobile, Alabama, and two were
killed in Pensacola, Florida, in 1993 and 1994. Those who
perpetuate that type of violence and who threaten similar
violence should not have the benefit of this Nation's
bankruptcy laws.
I speak to this issue from extensive personal experience as
a lawyer involved in litigating this precise issue for more
than a year. Although I certainly do not seek out this honor, I
suspect I might be the legal expert on the current willful and
malicious injury exception to discharge under the current
Bankruptcy Code, and why the existence of that exception simply
is not a sufficient answer to the problem that the Leahy-
Schumer amendment seeks to remedy.
I have litigated this issue in six different bankruptcy
courts resulting from the judgment that my clients obtained in
Portland, Oregon, in February 1999. I filed that case on behalf
of those clients in October 1995. After 3 1/2 years of delays
and other tactics, the jury, in February 1999, awarded over
$100 million in damages under the FACE statute which Congress
passed and the President enacted in 1994.
My clients were two reproductive health care clinics and
four individual physicians. They have faced constant attack by
anti-choice extremists who have threatened their lives and who
believe that they are not required to follow the laws of this
country. As a result, my clients had to spend hundreds of
thousands of dollars for security devices to protect themselves
from violent attack. That included bullet-proof vests, bullet-
proof windows, wigs, disguises, and motion detection devices at
their homes.
The jury's damage award included full compensation for
those out-of-pocket losses, as well as significant punitive
damages to deter future violations. However, my clients have
not collected a single cent of that award, and the tactics
continued after trial by an abuse of the bankruptcy system.
There were 12 individual defendants in the case, and 6 of
them filed for bankruptcy after the verdict in 6 different
places across the country. I have litigated in Baltimore,
Maryland; Greenbelt, Maryland; Norfolk, Virginia; Jackson,
Mississippi; Chattanooga, Tennessee. The last one is escaping
me at the moment, but I have litigated in six different
bankruptcy courts the exact same issue that I tried in a jury
trial that lasted a month and that I tried after 3\1/2\ years
of pre-trial proceedings in that court.
The proposed amendment, in my view, would do a lot to
prevent further abuse of the Bankruptcy Code. Unfortunately,
the current Code, however, allowed the defendants the
opportunity to abuse the system. The actions of these
defendants are totally inconsistent with the objectives of the
Bankruptcy Code to give honest debtors a fresh start.
There was no question in my case that every one of the
defendants who filed for bankruptcy did so precisely to avoid
my clients' collection efforts. Five of them filed on the eve
of their depositions. One of them filed on the day of his
deposition, and he is Michael Bray, who has also served time in
Federal prison for bombing abortion clinics, seven of them.
These defendants have vowed never to pay any award obtained
by an abortion provider. They claim not to be subject to the
laws of this Nation. Unlike the honest debtor whom the
Bankruptcy Code is intended to protect, these defendants never
sought to work out a payment plan to pay any part of the
judgment. They simply sought a discharge in bankruptcy so that
the jury's verdict would be a complete nullity and they would
be able to thumb their noses at the system. This is an abuse of
the bankruptcy laws.
I litigated it in six different bankruptcy courts.
Fortunately, I have been successful. We have won in four of
those bankruptcy courts on the dischargeability question, on
the willful and malicious injury concept. We have won that,
however, over a year of litigation, where I had to relitigate
and relitigate over and over again the exact same issues that
were tried in the Oregon case. This is standing the doctrines
of res judicata and collateral estoppel on their heads.
My firm did all of this for free. We volunteered our time,
over 3,000 lawyer hours, just in these bankruptcy cases over
the course of a year, not to mention the out-of-pocket
expenses. However, it is unfortunate that few private lawyers
would be willing to undertake this task, and my clients, who
are individual physicians, cannot do this themselves. It simply
costs too much.
I expect that critics of the amendment will ask why it is
needed, given that I have won in four of the bankruptcy cases.
To this, I have two brief responses. First, an amendment that
will make clear what the law already provides should not be
controversial.
Secondly, the amendment is needed so that people will not
be able to abuse the Bankruptcy Code again by invoking the
automatic stay, by causing the relitigation and relitigation
over and over again. This is sanctionable conduct and it should
not be permitted to happen again.
The FACE statute was passed overwhelmingly by Congress in
1994 to protect women and their physicians from violence and
intimidation. The statute has been effective in reducing clinic
violence. My clients have further protection because of that
statute, and the judgment and the injunction that they obtained
under the FACE statute has gone a long way to ensure their
personal safety.
The Senate passed the Schumer-Leahy amendment just last
year with 80 votes in favor of its passage. My personal
experience both before and since that vote only confirms that
the Senate was absolutely correct then in voting in favor of
this amendment and it should do so again now. Those who commit
acts of violence should not be permitted to perpetuate their
illegal conduct by abusing the bankruptcy system.
Abortion clinic bombers should not be able to even argue
the willful and malicious injury issue. Like those convicted of
driving while intoxicated or failure to pay child support,
sound public policy compels that those who commit violence
against abortion clinics must be held accountable without
recourse to bankruptcy. The amendment will also reinforce the
utmost importance of protecting women's reproductive health.
I ask that my full written statement be made a part of the
record, and I thank you, Mr. Chairman.
Chairman Hatch. Without objection, we will put it in the
record.
[The prepared statement of Ms. Vullo follows:]
Statement of Maria T. Vullo, Paul, Weiss, Rifkind, Wharton and
Garrison, New York, New York
I appear before this Committee today because of my involvement in
opposing the efforts by extremists to abuse the bankruptcy process and
avoid paying judgments obtained under the Freedom of Access to Clinic
Entrances Act (FACE). I was lead counsel for the plaintiffs in Planned
Parenthood of the Columbia/Willamettee, Inc., et al. v. American
Coalition of Life Activists, et al., No. 95-1671-JO (D. Or.), a case in
which a Portland, Oregon jury, on February 2, 1999, awarded $109
million against the defendants for their illegal treats against the
plaintiffs' lives. The jury's verdict was rendered under FACE and the
Racketeer Influenced and Corrupt Organizations Act (RICO), and included
compensatory damages for plaintiffs' out-of-pocket security expenses
plus punitive damages and treble RICO damages.
After the verdict, the federal district judge, the Hon. Robert E.
Jones, issued an injunction to prevent further threats threats against
the plaintiffs and the judge included findings of fact to support that
injunction. Among other findings, the trial judge found as follows:
I conclude from my independent review of the evidence produced at trial
that plaintiffs have proven by clear and convincing evidence
that each defendant, acting independently and as a co-
conspirator, prepared, published and disseminated the ``Deadly
Dozen'' Poster, the Poster of Dr. Robert Crist and the
``nuremberg Files'' with specific intent and malice in a
blatant and illegal communication of true threats to kill,
assault or do bodily harm to each of the plaintiffs with the
specific intent to interfere with or intimidate the plaintiffs
from engaging in legal medical practices and procedures.
41 F. Supp. 2d at 1154.
At a one-month trail, the jury and the judge found that three
separate items constituted illegal threats under the Face statute and
extortion under RICO. Briefly, defendants threats consisted of
``wanted'' style posters that followed a pattern of similar posters
targeting three physicians--Drs. David Gunn, George Patterson and John
Bayard Britton--who were murdered following the distribution of the
``wanted'' posters naming them. These ``wanted'' poster threats are
addressed in the legislative history of the FACE statute.
The RICO enterprise, and the organization through which the
defendants issued their illegal threats, was called the American
Coalition of Life Activists (ACLA), an organization that required its
leaders to be ``judgment proof.'' Following the enactment of FACE, in
January 1995, ACLA released the first threat involved in the Oregon
case, which was called the ``Deadly Dozen List.'' The Deadly Dozen List
issued by ACLA contained the names and home addresses of thirteen
physicians from around the nation--three of whom were plaintiffs in the
Oregon suit. Immediately after the issuance of this threat, the FBI and
the United States Marshal's Service contacted the physicians on the
List, informing them that they should consider this a serious threat to
their lives, advising them to take security measures, and offering them
24-hour federal marshal protection.
At an event later that year in August 1995 held in St. Louis,
Missouri, the defendants issued their second direct threat, again under
the ACLA name. This ``wanted'' style poster targeted another of our
physician clients and included his photograph and other personal
identifying information. Again, the doctor named on this ``wanted''
poster was contacted by law enforcement and undertook significant
precautions to ensure his and his family's personal safety.
The third threat involved in the Oregon case was called the
``Nuremberg Files.'' After unveiling these Files in hardcopy form at an
ACLA conference held in January 1996, ACLA arranged for this material
to be posted on the Internet. Amidst images of dripping blood, the
``Nuremberg Files'' website contained the names and addresses of
doctors and other health care workers around the country who provide
reproductive health services, some including their children's names.
Doctors who are still working appear in plain text; those who have been
wounded are ``greyed out''; and those who have been murdered--have a
line crossing out their names. After learning of this website, the FBI
again contacted the named physicians and advised them accordingly.
As the jury learned during the course of trial, my clients no
longer enjoy the basic freedoms that most of us take for granted.
Although they are medical professionals who live and work in relatively
safe communities around the country, they have been forced to live as
if under constant threat of imminent attack: they have purchased and
regularly wear bullet-proof vests; they have installed extensive
security systems including bullet-proof glass and reinforced steel in
their homes and offices; they have warned their children's teaches of
the threats by defendants; they have developed emergency plans should
they come under attack, Including instructing a young child to hide in
the bathtub should he hear gundshots; they vary their routes to and
from work to protect themselves from assailants; they have installed
window coverings to thwart snipers; they have purchased and wear
disguises to avoid being recognized; and they are ever-vigilant in
public. They are not secure in their homes or in their offices. They do
not sit by windows in restaurants. And they even refrain from hugging
their children in front of open windows.
The passage of FACE has had a significant impact on the lives and
safety of reproductive health care workers. But FACE and other statutes
that are intended to combat violence of all forms will not be fully
enforceable if those who are found liable for clear violations of the
law are able to evade their obligations by filing for bankruptcy and
avoiding the consequences of their illegal actions. The proposed
amendment to the Bankruptcy Code is one important way to ensure that
FACE is not rendered a nullity because of defendants' continued efforts
to violate the law.
I have been extensively involved in litigating the very issue
before this Committee in six different bankruptcy courts across the
country. Following the jury's verdict in February 1999, my firm faced
the important task of enforcing the judgment that our clients had
obtained after years of litigation and a month-long trial. Following
the jury's verdict, several of the defendants announced that they did
not intend to pay any of the amount awarded by the jury. For example,
defendant Timothy Dreste--from St. Louis, Missour--announced to the
press that he would not pay any part of the judgment against him. He
stated: ``I have no means of paying it, and even if I did, I would
never pay it.'' Later that year, Dreste pleaded the Fifth Amendment to
every question regarding his assets during this judgment enforcement
deposition.
These statements are consistent with defendant's own Constitution,
which specifically required the organization's leaders to be judgment
proof. At page 4 of the document, under the heading ``Doctrine and
Character,'' the ACLA Constitution states that members of the
organization ``must. . .have their assets protected form [sic] possible
civil lawsuits (judgment-proof).'' Thus, the members of ACLA, including
the defendants in our lawsuit, intentionally have made themselves
judgment proof precisely to avoid having to pay any part of the
judgment that my clients obtained. These are not honest but
disfortunate debtors who find themselves in dire financial straits
through acts beyond their control. They are not the individuals that
the Bankruptcy Code was enacted to protect.
Defendant Michael Bray--who served time in federal prison for
multiple clinic arson attacks--was one of the six defendants to seek
bankruptcy protection following the jury's verdict in the Oregon case.
Bray responded to the Judge's injunction by saying, ``I have no plans
to submit to those kinds of unconstitutional edicts.'' Bray also stated
that ``there's no money to be had'' and that he has no intention of
changing his behavior although, he said, ``I may have to get creative
about it, though.'' In a newsletter written by Bray after he filed for
bankruptcy in December 1999, Bray discussed the deposition for which he
never appeared and noted with respect to the Court's discovery orders
requiring the production of documents, ``I am good with matches.'' Bray
sought relief in bankruptcy court--and I submit he, too, has abused the
Bankruptcy Code well beyond Congressional intent.
Despite the jury's verdict, and the District Court's explicit
findings of specific intent and malice, the defendants expected to
obtain a ``discharge'' in bankruptcy--and thus not pay a single cent to
the plaintiffs in satisfaction of the judgment. After months of trying
of trying to obtain discovery of their assets, and after both the
District Court and the Ninth Circuit denied defendants' motions for a
stay of the judgment and injunction pending appeal, six defendants
filed for chapter 7 bankruptcy in six different bankruptcy courts.
These filings, themselves, were a mockery to the bankruptcy laws and
the FACE statute. Fortunately, their efforts have been in vain, as we
have won the dischargeability question thus far in four of the
bankruptcy cases. But the process of litigating and relitigating the
same issues in each of the bankruptcy courts demonstrates precisely why
the proposed amendment is necessary.
In the two years since the jury's verdict, my firm has committed
enormous resources to enforcing the judgment, including by representing
the plaintiffs in the six different bankruptcy courts. With the
District Court entering discovery orders requiring full disclosure of
their assets on risk of sanctions, six defendants filed for bankruptcy
in different venues, precisely to trigger the automatic stay of the
Bankruptcy Code and thus put a hold on our collection efforts. Five of
these six defendants filed for bankruptcy on the very eve of his
scheduled deposition, with one (Michael Bray) filing on the day of the
deposition itself. In connection with these bankruptcy proceedings, the
defendants' lawyers have taken the position that the jury's verdict is
fully dischargeable in bankruptcy, despite the ``willful and malicious
injury'' exception to discharge that currently exists in the bankruptcy
Code. These filings, and the litigation we have endured, demonstrate
the utmost importance of the proposed amendment to the U.S. Bankruptcy
Code.
Donald Treshman was the first defendant to file for bankruptcy, and
he did so on November 2, 1999, just two days before his ordered
deposition. Treshman had previously filed for bankruptcy in Texas in
1995, after another Planned Parenthood clinic obtained a judgment
against him following a full trial and after Treshman transferred his
house to an acquaintance. Treshman's earlier bankruptcy petition was
dismissed when he abruptly moved to Maryland. This time, Treshman filed
for bankruptcy on the heels of a series of rulings by the District
Court in Oregon requiring full disclosure of his assets and compliance
with the Court's injunction.
Three additional defendants filed for bankruptcy in the same week
in December 1999 on the heels of court orders requiring full financial
disclosure. Charles Wysong filed in the Eastern District of Tennessee
(Chattanooga) on December 6, 1999; David Crane filed in the Eastern
District of Virginia (Norfolk) on December 8, 1999; and Michael Bray
filed in the District of Maryland (Greenbelt) on December 9, 1999. Each
of these defendants was scheduled for a deposition that same week, but
filed for bankruptcy to avoid that deposition and frustrate our
legitimate collection efforts. Similarly, on January 18, 2000, right
before his and his wife's depositions were to take place in Jackson,
Mississippi, triggering the automatic stay. The last defendant to file
for bankruptcy protection was Joseph Foreman, who filed in Roanoke,
Virginia in February 2000 after we garnished his bank account but
before we could collect on that garnishment in Virginia.
Because the proposed amendment does not currently exist, the
defendants were able to invoke the protection of the automatic stay of
the Bankruptcy Code, and force litigation and relitigation of the
``willful and malicious injury'' issue in the various bankruptcy courts
across the country. This has been a lengthy and expensive process,
involving a separate trustee and a separate judge in each case--each of
whom has had to familiarize himself with this case. Because these
defendants live in different parts of the country, my law firm has had
to proceed against them in six different bankruptcy courts. In each
case, we have had to commence an adversary proceeding in bankruptcy,
file motions for summary judgment setting forth the prior proceedings
and legal principles, and appear in those courts for multiple hearings.
To date, my firm has expended over 3,200 attorney hours in litigating
these bankruptcy proceedings, in addition to the time spent by local
counsel in each jurisdiction and the substantial expense of filing
fees, service fees, and travel around the country.
Thus far--after extensive litigation and considerable expense--we
have won the ``willful and malicious injury'' issue in four of the
bankruptcy courts. Despite these victories, enactment of the proposed
amendment to the Bankruptcy courts. Despite these victories, enactment
of the proposed amendment to the Bankruptcy Code is necessary because
defendants should not have been given the opportunity to litigate the
issue of their discharge in bankruptcy when they have clearly violated
the FACE statute as intended by Congress. There is no doubt that these
defendants did not seek relief from the bankruptcy courts as part of
the good faith effort to work with plaintiffs on a payment plan for the
judgment. Rather, defendants made it clear that they intended to seek a
full ``discharge'' in bankruptcy and thus not pay one cent to their
creditors. Without enactment of the proposed amendment, this type of
abuse will continue.
As this Committee knows, Section 523(a)(6) of the U.S. Bankruptcy
Code currently provides for an exception to discharge for debts
resulting from ``willful and malicious injury.'' As we have
demonstrated to four of the bankruptcy courts thus far, the jury's
findings of intention to intimidate and its punitive damages award,
coupled with the trial judge's findings by clear and convincing
evidence that the defendants acted with malice and with specific intent
to threaten, satisfy the ``willful and malicious injury'' standard of
the current Bankruptcy Code. We have argued successfully that those
findings are entitled to collateral estopped effect, and that the
defendants cannot relitigate those findings in Bankruptcy Court.
although we have been victorious, defendants' filings constitute an
abuse of the bankruptcy system that needs to be corrected--and which
can be corrected in the future by an amendment tot he Bankruptcy Code.
The fact that my case--with express findings going directly to the
willful and malicious standard--still has required protracted
litigation to determine again and again that these debts were
nondischargeable underscores the important of the amendment. Not every
FACE case will yield such explicit findings. Indeed, the specter of
endless bankruptcy litigation in even the most straightforward cases
will deter aggrieved physicians and other victims of abortion clinic
violence from bringing FACE case will yield such explicit findings.
Indeed, the specter of endless bankruptcy litigation in even the most
straightforward cases will deter aggrieved physicians and other victims
of abortion clinic violence from bringing FACE cases in the first
instance.
Thus, it is my considered position, based upon my personal
experience litigating the current law of ``willful and malicious
injury,'' that the Bankruptcy Code should be amended so that the
bankruptcy process is not abused again as it has been abused by the six
defendants in my case who filed for bankruptcy. Whatever one's position
on abortion, we all can agree that anit-abortion extremists should not
get away with their violence and threats of violence in violation of
the FACE statute. My clients are entitled to compensation for their
injuries--which include the purchase of bulletproof vests and other
security devices. Defendants have continued to resist every effort to
obtain satisfaction of any part of the money judgment--and they have
abused the bankruptcy process as part of this improper effort.
I am confident that no defendant in my case will ultimately obtain
a discharge in bankruptcy for my clients' judgment. Nevertheless, we
should not be in the position of relitigating the matter over and over
again because the current Bankruptcy code contains a loophole that
permits this type of abuse. While defendants relitagate the ``willful
and malicious injury'' exception to discharge in six different
bankruptcy courts, judicial resources are expended to address these
issues six times and who knows how many appeals will follow. The
evidence at trial was undisputed that, upon the release of defendants'
threats, with the advice of law enforcement, my clients purchased
bulletproof vests, installed extensive security systems at their homes
and offices, and took other security precautions because of defendants'
actions. The jury awarded my clients their security costs as
compensatory damages, and also awarded punitive damages under FACE
against each of the defendants to prevent and deter further illegal
activities. Allowing these defendants to abuse the bankruptcy process
to dalay enforcement of the judgment totally undermines the effective
enforcement of the FACE statute and the true purposes of the Bankruptcy
Code.
The many months of litigation that I have endured in these
bankruptcy courts confirms the need for an amendment to the Bankruptcy
Code that precludes further litigation over the meaning of the words
used in the current statute. The amount of time and expense necessary
to relitigate these issues has been extraordinary, and the risk of
inconsistent results has been real, despite my victories. The only way
to prevent this from happening again is for an amendment to the
Bankruptcy Code to be enacted that unambiguously provides that FACE
violations are nondischargeable in bankruptcy. Without such a clear
statement, future defendants in FACE actions will continue to file for
bankruptcy in order to delay any efforts to hold them responsible for
the illegal actions. The proposed amendment to the Bankruptcy Code is
therefore necessary so that Congressional intent in enacting the FACE
statute is fully effectuated and the bankruptcy process is not abused.
Thank you for you consideration.
Chairman Hatch. Mr. Zywicki, we will take your testimony.
STATEMENT OF TODD J. ZYWICKI, ASSISTANT PROFESSOR OF LAW,
GEORGE MASON UNIVERSITY SCHOOL OF LAW, ARLINGTON, VIRGINIA
Mr. Zywicki. Thank you, Mr. Chairman and distinguished
Senators. I want to thank you for moving this legislation so
quickly this term and placing it with such a high priority
because I think it really is an important piece of legislation
and I am pleased that it is moving forward.
I have attached to my statement a time series that really
sort of blows the mind when you look at it. The upward spiral
in bankruptcy filing rates just since 1980 is really quite
striking. We have seen a brief respite in recent years, but I
haven't talked to anybody who thinks that that really means
anything but a brief respite, and nobody seriously expects that
the upward trend is going to end unless we do something to
address the upward trend. In fact, all the data indicates that
the upward trend has started again already.
Moreover, few believe that even a small part of the fraud
and abuse that is in in the system is caught. There are some
very poor mechanisms in place currently to try to ferret out
fraud and abuse. But under the current system with 1.4 million
people a year filing bankruptcy, it is simply impossible for
judges to try to locate the fraud and abuse that is going on in
the system without some sort of procedural mechanisms of the
type that are provided for in this bill.
As a result, the efforts that have been attempted to try to
hit fraud and abuse are haphazard. They are applied unequally,
unfairly. They really mock the rule of law and there is really
no sense in which the Bankruptcy Code is being applied
consistently, fairly, or equally throughout the country.
Moreover, the fact that there really is abuse going on has
created a widespread perception in the public that the
bankruptcy system is really just a place where you go to scheme
your creditors. The public really thinks of the bankruptcy
system as a big game these days, and I think in the long run
that is really detrimental in that it will undermine faith in
the bankruptcy system generally. So I think it is important to
get a hold of the fraud and abuse, both to ferret out fraud and
abuse, but also to reinstill faith in the public that the
bankruptcy system is working the way it is supposed to.
This bill does that. This bill is an incremental, common-
sense, experienced-based attempt to come to grips with the
fraud and abuse that is in the system, and to rebalance the
bankruptcy system to try to get a rein on some of the things
that have really manifested themselves increasingly in recent
years.
It preserves the fresh start. It doesn't deny anybody the
right to file bankruptcy, but it targets the abuses that we see
in the system, whether it is high-income people shirking debts
they can repay, whether it is the scheme of fractional
interests that are used to prevent banks from exercising their
legitimate foreclose rights, whether it is hiding assets, all
the different sorts of things that are going on.
I think the bill shows a striking amount of common sense
and grounding and experience of what is going on everyday in
the bankruptcy courts, while at the same time preserving the
integrity of the bankruptcy system for those who need it.
I think it is important to recognize that being pro-debtor
in bankruptcy is not the same thing as being pro-consumer. Most
consumers pay their bills, so that taking it easy on debtors
who don't pay their bills, for instance, doesn't help consumers
who do pay their bills. Being pro-debtor is not the same thing
as being pro-consumer.
Bankruptcy losses for a business are a business expense.
They are the same thing as paying the electric bill, paying
salaries, paying rent, paying taxes. To the extent that they
have bills that they can't collect, that is a cost of business,
and just like rental payments, electricity payments, all these
other expenses, get passed on to consumers.
It is inevitable that some bankruptcy losses get passed on
to consumers, and they get passed on in a variety of ways. It
is not just interest rates. It is also higher down payments,
say, on a car because creditors are unwilling to extend as much
credit and risk.
There was a story on bankruptcy in Fortune magazine,
bankruptcy in Memphis, Tennessee, which is the bankruptcy
capital of America. The story reports that in Memphis, where
the bankruptcy filing rate is 4.5 percent of the families every
year file bankruptcy in Memphis, the down payment on a used car
in Memphis is the wholesale price of the car. Why? Because
nobody is willing to extend any credit that they could be left
hanging out on, so the down payment allows them to recover what
they have to pay.
Creditors suffer, and in particular small creditors suffer.
What has been striking about this bill is from the very
beginning, it is small businesses, it is credit unions like we
heard from today, it is small department stores like Boscov's
who are trying to run credit operations. It is small furniture
companies who are trying to sell furniture on credit.
Throughout the entire process, these small creditors are
the ones who have supported it. Why? Because they have the most
difficulty passing these losses on to other consumers because
they simply don't have the revenue base to spread it in the way
that other people might.
Finally, I think this sends an important moral message that
people should pay their debts if they can pay their debts. And
it doesn't expect the impossible; it doesn't expect people to
pay what they can't pay. It says if you can pay 50 percent or
60 percent or 70 percent of your debts, if you can do that and
you can pay a substantial portion of your debts and you make
above the median income, you should do that as a condition for
discharge. You will not be denied the right to file bankruptcy.
It simply places a condition on your ability to file bankruptcy
to keep your promises to the extent that you can.
I have identified about 7 to 10 percent of filers who would
be affected by the means test. There is one study that purports
to find otherwise, but it is methodologically flawed. I could
talk about that more. It claims to only find 3 percent, but it
is a fundamentally flawed study. We are talking about
recovering $3 billion, roughly, that would otherwise be
discharged.
I see that I am out of time. I would be happy to address
some of the other things that have come out in the testimony,
but I want to add one last message, which is this has been
going on for a few years. When the bankruptcy bar starts
attacking the bankruptcy bill and that sort of thing, it seems
like they get you in the catch-22.
When the economy is good and filings are falling off a
little bit, they say, look, we don't need bankruptcy reform,
filings are tapering off on their own. When there is a
recession on the horizon, they say, well, bankruptcies are
going to rise and now is not the time to tighten up the
bankruptcy laws.
Is there ever a time? If you can't tighten them in good
times and you can't tighten them in bad times, when is the time
to think about reforming the bankruptcy system? I think now is
the time to do it, and it is the time to do it in a balanced,
common-sense, experienced-based kind of situation like we have
here, which is it does not deny people the right to file
bankruptcy, but targets the fraud and abuse in the system.
Thank you.
[The prepared statement of Mr. Zywicki follows:]
Statement of Todd J. Zywicki, George Mason University School of Law,
Arlington, Virginia
Distinguished Senators, it is a privilege to appear before you
today to speak on the subject of ``Bankruptcy Reform.'' At the end of
the last congressional session this body passed by an overwhelming
majority a bankruptcy reform bill that would bring balance and sanity
to a bankruptcy system that is threatening to spiral out of control. It
has been reintroduced this session as S. 220 (the ``Bill''). Recent
reports indicate that bankruptcy filing rates have begun to rise again
after a brief respite in recent years. Clearly the time is right to
address some of the problems with the bankruptcy system. Recognizing
this, I am pleased to see that this Committee has acted promptly to
introduce a bankruptcy reform Bill and to hold hearings on the issue. I
am pleased to provide my views on the matter. I hold both a J.D. and a
Master's Degree in Economics. I was also a John M. Olin Fellow in Law &
Economics at the University of Virginia and am a tenured member of the
faculty at George Mason University School of Law, one of the premier
centers for the study of economic analysis of law. In addition to my
publications in law reviews, I have also published several articles in
peer-reviewed economics journals. As such, I believe that I am in a
sound position to discuss both [Lc legal and economic aspects of the
current bankruptcy system as well as the probably effects of the
bankruptcy reform Bill.
This Bill represents a thoughtful and well-considered effort to
address many of the problems that are manifest in the bankruptcy system
today. The Bill makes incremental reforms to the consumer bankruptcy
system to address many of the loopholes and technicalities that
opportunistic debtors have found to evade their financial and personal
responsibilities. The reforms provided for by this Bill are grounded in
commonsense and experience derived from the observation of the day-to-
day operation of the bankruptcy system in practice.
The current system has been little-changed since its enactment in
1978. Since that time the number of personal bankruptcies is roughly
five times larger than when the Code was enacted. Today, some 1.4
million Americans troop through the bankruptcy courtrooms every year.
This growth in numbers has been matched by a growing sophistication
among lawyers and the public about the opportunities for fraud and
abuse-both legal and illegal-in the bankruptcy system. Few reasonable
observers believe that even a small fraction of the fraud and abuse
present in the system is caught. As a result, similarly-situated
debtors and creditors throughout the country suffer from dissimilar and
unpredictable treatment on the basis of accident of geography or
judicial whim. By guaranteeing unequal treatment for similarly-situated
individuals, the system mocks the rule of law. In turn, this undermines
public confidence that the bankruptcy system is operating fairly and
efficiently. Instead, it is increasingly viewed as a system prone to
cynicism and manipulation, and a free-ride for debtors lacking in
conscience and personal responsibility.
Thus, the current system suffers from a crisis of both real and
perceived abuse. This Bill addresses both of these problems. This Bill
rebalances the bankruptcy system, by taking sensible steps to address
many of the most prominent abuses by both debtors and creditors that
have been manifested in recent years. At the same time, it preserves
the commitment to the fre;'i start for all debtors who need it. By
preserving the fresh start but also addressing abusive behavior, this
Bill will restore fairness and efficiency to the bankruptcy system and
thereby restore public confidence in the system. A failure to act in a
sensible and rational way today will lead to continuing abuse and
continuing public frustration. Acting sensibly today will head-off more
drastic and ill-considered action later.
Being pro-debtor is not the same as being pro-consumer. When some
people get a free-ride in bankruptcy, the rest of us are forced to pick
up the slack. The overwhelming majority of Americans pay their Bills
and live up to their financial responsibilities. But it should not be
forgotten that those who pay their Bills inevitably have to pay more to
make up for those who do not. Bankruptcy losses are a cost of business.
Like all other business expenses, when creditors are unable to collect
debts because of bankruptcy, some of those losses are inevitably passed
on to responsible Americans who live up to their financial obligations.
Every phone bill, electric bill, mortgage, furniture purchase, medical
bill, and car loan contains an implicit bankruptcy ``tax'' that the
rest of us pay to subsidize those who do not pay their bills. We all
pay for bankruptcy abuse in higher down payments, higher interest
rates, and higher costs for goods and services. I can see no good
reason why a schoolteacher earning $30,000 a year should have to pay
more for a mortgage or more for a new couch because some other guy
making $100,000 a year finds it inconvenient to pay his debts. I can
see no good reason why a nurse earning $40,000 a year should have to
pay more for a car loan because some doctor earning $250,000 doesn't
want to pay for his Mercedes.
This bankruptcy ``tax'' takes many forms. It is obviously reflected
in higher interest rates. But it is also reflected in higher down-
payment requirements, as creditors desire greater up-front payments to
reduce the risk of nonpayment. It is reflected in shorter grace-periods
for paying bills and higher penalty fees and late-charges for those who
miss payments. Finally, it is reflected in fewer benefits to consumers,
whether the co-branding benefits offered by credit cards today or such
things as greater customer service or extended business hours.
Retailers raise their prices or close their credit operations.
Regardless of which of these forms it takes, it is evident that the
rest of us suffer when some people choose not to pay their bills.
Moreover, it is lower-income and fixed-income Americans who suffer
the most, as it is they who have the fewest credit choices and the
least ability to absorb increased credit and other costs. When
furniture stores are forced to close their credit operations because of
bankruptcy losses, this further restricts the options of low-income
creditors. When credit card issuers find it infeasible to issue credit
to low-income borrowers, those borrowers are not made better-off by
having their choices reduced. Instead, if they need a new transmission
or new suit, they are forced to turn to pawn shops and high-interest
``payday'' lenders who offer terms far more abusive than any credit
card issuer. See Todd J. Zywicki, The Economics of Credit Cards, 3
CHAPMAN L. REv. 79 (2000). Consumers as a whole, and especially low-
income consumers, are not made better-off when bankruptcy losses
increase prices and decrease service.
Creditors also lose from a runaway bankruptcy system. Smaller
businesses and small creditors suffer the most from a runaway
bankruptcy system, as they tend to have the narrowest margins and the
least ability to spree those losses among their customers. The small-
town furniture store selling couches and end tables on credit suffers a
lot when his customers don't pay up. As do independent car salesmen,
jewelers, contractors, and other small businesses who extend credit to
their customers. Thus, it is not surprising that support for bankruptcy
reform comes from across the full spectrum of creditors, but small
creditors, such as small retailers and credit unions, are among the
strongest supporters of bankruptcy reform.
The Bill will also reinforce the lesson that bankruptcy is a moral
as well as an economic decision. Filing bankruptcy reflects a decision
to break a promise made to reciprocate a benefit bestowed upon you. The
moral element of bankruptcy is reflected in the observation that the
English word ``credit'' comes from the Latin word for ``trust.''
Parents seek to teach their children values of personal and financial
responsibility, and promise-keeping and reciprocity provide the
foundation of a free economy and healthy civil society. Regrettably,
the personal shame and social stigma that once restrained opportunistic
bankruptcy filings has declined substantially in recent years. We have
``defined bankruptcy deviancy downward'' such that it has become a
convenient financial planning tool, rather than a decision freighted
with moral and social significance. Requiring those who can to repay
some of their debts as a condition for bankruptcy relief sends an
important signal that bankruptcy is a serious act that has moral as
well as economic consequences. Moreover, reducing the number of
strategic bankruptcies will reduce the bankruptcy tax paid by every
American family on goods and services, giving them more money for
groceries, vacations, and educational expenses.
The Bill establishes a much-needed system of means-testing to force
high-income debtors who can repay a substantial portion of their debts
without significant hardship to do so. Under current law, there are few
checks on high-income debtors seeking to walk away from their debts and
few safeguards to prevent bankruptcy fraud. Current law requires a
case-by-case investigation that turns on little more than the personal
predilections of the judge. The Bill narrows the judge's discretion by
establishing a presumption of abuse where a high-income debtor has the
ability to repay a substantial portion of his debts, as measured by an
objective standard. At the same time, the judge will retain discretion
to override this presumption in cases of hardship. Means-testing is not
a panacea for all of the ills of the bankruptcy system. But by focusing
judicial discretion on the existence of real hardship and reducing
procedural hurdles to challenging abuse, the Bill's reforms will
vindicate the rule of law and reduce abuse.
By targeting high-income bankrupts with substantial repayment
capacity, it is estimated that means-testing will recover roughly $3
million of the $40 million discharged in bankruptcy every year.
Although means-testing will affect only 7-10% of bankruptcy filers, but
focusing scrutiny on those high-income debtors who can repay a
substantial portion of their debts without significant hardship, the
Bill makes possible the recovery of substantial losses with minimal
administrative cost. Equally important, means-testing will have no
efect on those making less than the minimum income threshold provided.
Thus, for the 80% of filers whose income lies beneath the state median,
means-testing will have no effect whatsoever.
It should also be stressed that means-testing will not prevent
anyone from filing bankruptcy and receiving a bankruptcy discharge.
Instead, it will simply condition the discharge for affected filers to
pursuing a chapter 13 repayment plan rather than going into chapter 7.
In fact, the means-testing rules will simply govern eligibility for
chapter 7 relief; it has no impact on the confirmation of the debtor's
chapter 13 plan. In approving the debtor's plan the court will still
apply the budgetary processes provided for under current law without
any consideration of the means-testing eligibility rules.
The means-testing provisions also provide an excellent example of
the incremental and balanced approach to this issue. Under current law,
it is already the case that the primary factor for courts to consider
in deciding whether to dismiss a debtor's case for substantial abuse
under Sec. 707(b) is whether the debtor can repay a substantial portion
of his debts without significant hardship. Overwhelmed by the number of
cases they confront and lacking the will to enforce its provisions
consistently, however, it has been observed by one scholar that many
perceive Sec. 707(b) to be a ``dismal failure.'' Jack F. Williams,
Distrust: The Rhetoric and Reality of Means-Testing, 7 AM. BANKR. INST.
L. REv. 105 (1998). The Bill simply creates a more formal and reliable
mechanism for implementing the goals that bankruptcy courts are already
seeking to apply, but will do so in a way that more efficient and fair
than the current system. See Edith H. Jones and Todd J. Zywicki, Its
Time for Means-Testing, 1999 BRIGHAM YOUNG UNIVERSITY L. REV. 177.
The Bill also targets a whole range of other abuses of the
bankruptcy system, including such things as the use of ``fractional
interests'' to prevent legitimate foreclosures and abuse of the
cramdown provisions of the Code by filing bankruptcy simply to strip
down the value of a secured creditor's claim. It creates new
protections from bankruptcy ``mills'' and ensures that bankruptcy
filers undergo credit counseling to try to workout a consensual
solution to their financial problems. The Bill also eliminates abuse of
unlimited homestead exemptions, a reform advocated by even. the Bill's
critics. In short, it reflects practical solutions grounded in common-
sense experience regarding the problems in the bankruptcy system.
Contrary to the selective outrage of its critics, however, the Bill
does not limit itself to reducing abuse of the homestead exemption but
takes a comprehensive approach to rooting out all forms of bankruptcy
abuse.
It has been claimed by some that the Bill would negatively impact
the ability of divorced spouses to collect spousal and child support.
This claim is based on vague, speculative, and inaccurate accusations
about how the nondischargeability of certain debts will impact post-
petition efforts to collect these obligations. In contrast to these
speculative accusations, the Bill offers concrete assistance to non-
intact families in several ways. Among its numerous provisions
protecting the rights of former spouses and children are the following
protections: (1) Extends the scope of nondischargeability of spousal
support obligations to make nondischargeable certain property
settlements, (2) excepts state child support collection authorities
from the reach of the automatic stay, (3) elevates the priority level
of child support to first priority, (4) makes exempt property available
for the enforcement of domestic and child support obligations. These
speculative claims about the negative effects of the Bill appear to be
simply a concerted effort by the Bill's opponents to distract attention
from the real reforms and protections included in the Bill.
Moreover, the Bill's provisions on credit card nondischargeability
merely rationalizes some exceptions to discharge and closes loopholes
in the current law relating to the misuse of credit cards. Given this
modest aim of simply closing loopholes in the already-existing
exception to discharge for credit card fraud, it is difficult to see
how `his reform could have more than a trivial effect on collection of
spousal support payments. Nor have the Bill's opponents supplied any
details about the size of this purported effect. Assuming the effect is
non-trivial, it is also not unique to make certain debts
nondischargeable on the basis of public policy. Current law already
makes a multitude of exceptions to discharge, including such things as
tax obligations, fraudulently incurred debts, student loans, and
victims of drunk drivers. As a result, the Bill would no more ``pit''
postpetition child support obligations against credit card issuers than
current law ``pits'' child support obligations against the victims of
drunk drivers, the victims of fraud, student loan obligations, or tax
obligations. Indeed, the burden on a debtor from nondischargeable
credit card debts will be substantially smaller than the financial
burden on a debtor from the inability to discharge fraud liabilities,
tax liabilities, student loan debts, and drunk-driving judgments. That
opponents of the Bill have instead singled-out credit card issuers for
criticism says more about their desire to demonize the credit card
industry and less about their commitment to protecting women and
children or to real bankruptcy reform.
In contrast to the broad-based support for the Bill, opposition
primarily has come from one isolated comer--lawyers. Certainly the
opposition of some lawyers is based on sincere, albeit mistaken,
beliefs about the content and impact of the legislation. But it is
ironic that bankruptcy lawyers have been quick to question the motives
of creditors in seeking reform, while remaining slow to acknowledge
their own stake in opposing reform. James Shepard, a member of the
National Bankruptcy Review Commission, estimates that bankruptcy is now
a $5 billion a year industry for lawyers and others. By reducing
filings among high-income filers and reducing the cost of bankruptcy
cases by making them more predictable and less expensive, means-testing
will reduce both the volume and expense of bankruptcy cases. By closing
loopholes, the Bill reduces the need for lawyers to find those
loopholes. The Bill also will reduce bankruptcy filings by requiring
bankruptcy lawyers to inform their clients of availability of non-
bankruptcy alternatives, such as credit counseling, and by cracking
down on bankruptcy ``mills'' that mass-produce bankruptcy petitions
with little regard to the welfare of their clients. Put simply, more
bankruptcies means more money for bankruptcy lawyers, and fewer
bankruptcies means less money for bankruptcy lawyers. Also to the
dismay of bankruptcy lawyers, the Bill elevates child support
obligations to the first administrative priority--a position currently
occupied by attorneys' fees obligations. Efforts in the bankruptcy bar
to downplay the importance of this protection for divorced mothers
appear to be little more than a cynical effort to hide the self-
interest of bankruptcy lawyers behind the skirts of divorced mothers.
Balanced bankruptcy reform preserves the protection of the
bankruptcy system for those who need it, while limiting abuse by those
who are preying on that generosity simply to evade their financial
responsibilities. This Bill brings balance to a consumer bankruptcy
system that has become a tool for rich and savvy debtors to evade their
financial responsibilities. America has one of the most charitable and
forgiving bankruptcy systems in the world and many of those who file
bankruptcy truly need it as a consequence of personal trouble. But too
many people today are preying on our charity and using the bankruptcy
system not because they need it, but simply to evade their
responsibilities or to maintain an unrealistic and extravagant
lifestyle at the expense of those who live responsibly. Ignoring
rampant abuse undermines public support for the bankruptcy system
generally, which will eventually hurt those who legitimately need
bankruptcy relief.
There has been much talk in the media and elsewhere about the surge
in consumer bankruptcies in recent decades. It should be noted that
this discussion is largely beside the point in the current context.
This Bill does not deny anyone the right to file bankruptcy, nor does
it apportion blame for bankruptcy filings. It simply provides pragmatic
solutions to identifiable problems in the current bankruptcy system. To
the extent that larger bankruptcy issues are implicated, however, it is
evident that this Bill is an appropriate response to the problem. Two
identifiable factors present themselves as explaining the rise in
consumer bankruptcy filings in recent decades. First is a change in the
relative costs and benefits associated with filing bankruptcy. Second
is a general decline in the personal shame and social stigma associated
with bankruptcy.
It has been estimated that almost half of Americans would benefit
financially from filing bankruptcy after engaging in some basic pre-
bankruptcy planning. Moreover, because of the structure of property
exemptions under bankruptcy and state law, wealthier individuals gain
the greatest benefits from filing bankruptcy because they can protect
larger amounts of property in bankruptcy. Given the financial benefits
created by the enactment of the 1978 Code, it is little wonder that
consumers have increasingly recognized and acted on the financial
benefits of filing bankruptcy.
At the same time, the costs of learning about and filing bankruptcy
have decreased dramatically. Daytime television and the Yellow Pages
are awash in bankruptcy advertisements. The mass production of
bankruptcy petitions by bankruptcy lawyers have driven down prices for
bankruptcy services. In fact, scholars have reported that one of the
most difficult tasks confronting lawyers is persuading their clients
that there really is no catch to filing bankruptcy, because clients
routinely object that the whole things sounds ``too good to be true.''
There is also little question that the social stigma associated
with filing bankruptcy has declined over time. Singer Toni Braxton
filed bankruptcy, despite having recorded two albums that had earned
$170 million in sales at the time, and despite owning a baby grand
piano, a Porsche, and Lexus. She later appeared on Oprah Winfrey, who
questioned Toni on her purchase of $1,000 in Gucci silverware shortly
before filing bankruptcy. Toni's response: ``I only spent about $1,000
on it. If that made me broke, then I was truly in bad shape. It's
Gucci-I love it. I'd buy it again. And now that I get a huge discount
because I've given them so much pub, I can really shop.'' This
attitude, of course, is not limited to pop music stars, as evidenced by
the comments of one individual to CNNfn, ``When I found out-this was
watching it on the news, in the newspapers--that more and more people
are doing it [filing bankruptcy], and . . . it's not just a middle
class you know, upper class too-rich people--everybody's doing it. And.
. . I said: Why not me? You know, I'm just one more of them.''
By contrast, there is no evidence that factors such as credit cards
have contributed to the bankruptcy problem. It is evident that the
growth in credit cards has largely been a substitution away from other
even less-attractive forms of credit, such as pawn shops, loan sharks,
personal finance companies, layaway plans, and retail store credit. As
shown in the attached chart, since 1995 it is housing debt, not
consumer debt that has been rising most rapidly for American
households. In fact, credit card debt represents only some 3% of
American household debt. Moreover, defaults on credit card loans have
risen in tandem with defaults on other forms of consumer credit. This
rebuts the claim that credit card lenders have contributed to the
bankruptcy crisis by lending to noncreditworthy borrowers. It is true
that consumers have increased their use of credit cards, but this has
been offset by a reduction in the use of other forms of consumer
credit. If credit card issuers were acting irresponsibly, then defaults
on credit cards would be rising much faster than on other forms of
consumer credit. Instead, they are rising at the same rate. Empirical
studies have demonstrated that increasing bankruptcies have not
resulted from increased lending to higher-risk borrowers. Instead, what
has happened is that all borrowers have become more likely to file
bankruptcy, holding financial risk characteristics constant. What has
changed is not the structure of consumer borrowing; what has changed is
the willingness of individuals to file bankruptcy as the preferred
means of dealing with their financial obligations.
There has also been substantial confusion about the competitiveness
of the credit card market. Critics have argued that credit card
interest rates have remained ``high'' and stable despite changes in
other interest rates. This criticism is profoundly confused. First, it
is meaningless to decry ``high'' interest rates without asking ``As
compared to what?'' What is the ``correct'' interest rate on an
unsecured line of credit that an individual can draw upon at his
discretion? Unsecured credit lines at banks have much higher interest
rates and much higher initiation fees than do credit cards. It is not
clear what ``high'' interest rates means.
Credit card interest rates are also much less responsive to changes
in cost of funds rates than other forms of credit. This is because the
cost of funds comprises a relatively small percentage of the cost of
credit card interest rates. The administrative costs of processing a
large volume of relatively small transactions is enormous, and this is
completely unresponsive to changes in the cost of funds. Consider the
following two graphs, reproduced from my article The Economics of
Credit Cards:
Chart 1: U.S. Consumer Commercial Bank Rates, 1972-1989
[GRAPHIC] [TIFF OMITTED] T6343.001
Chart 2: Federal Funds Interest Rate, 1970-1989
[GRAPHIC] [TIFF OMITTED] T6343.002
As these two Charts demonstrate, during the 1970s and 1980s the
Federal Funds rate rose and fell dramatically over time. Moreover, the
rates on mortgages and car loans rose and fell accordingly.
Nonetheless, credit card interest rates remained relatively constant.
The reason was not because of any collusion or improper behavior by
credit card issuers, but simply because the cost of funds comprises
only 25% of the cost of credit card interest rates, whereas it
comprises 80-90% of the cost of a mortgage or car loan.
Nonetheless, credit card interest rates have fallen dramatically in
recent years:
Chart 3: Credit Card Interest Rates, 1981-1998
[GRAPHIC] [TIFF OMITTED] T6343.003
As this Chart indicates, from 1992 to 1998, credit card interest
rates fell approximately 15% and have remained relatively stable since
that time. Nor do we know how much credit card interest rates wou14
have fallen had bankruptcy filing rates not risen so precipitously
during this same time.
Finally a fixation on credit card interest rates ignores the fact
that the majority of credit card users use credit cards for
transactional convenience and pay off their bills in full every month,
rather than revolving balances. For those users, interest rates are
irrelevant. They instead prefer a credit card that provides tangible
benefits, such as frequent flyer miles or car rental insurance. They
also prefer a card without an annual fee. Unsurprisingly, the market
has responded by providing substantial consumer benefits and by
eliminating annual fees on basic credit cards. To the extent that this
is the course preferred by credit card users, this is a triumph of
competition in the credit card industry, not a failure. In amending the
bankruptcy code, this body should act very cautiously to make sure that
it does not interfere with the operation of consumer and commercial
lending markets.
Now is the time to act to reform the bankruptcy laws. This Bill is
a sensible, balanced, incremental, and well-considered attempt to deal
with these problems before they become intractable.
[GRAPHIC] [TIFF OMITTED] T6343.004
[GRAPHIC] [TIFF OMITTED] T6343.005
[GRAPHIC] [TIFF OMITTED] T6343.006
Chairman Hatch. We will each have 5 minutes.
Let me turn to you, Mr. Strauss. What does bankruptcy today
do to women heading single-parent families who rely on regular
support payments, and does the proposed legislation improve
that situation, and if so, how?
Mr. Strauss. Well, the first thing that happens frequently,
inevitably, is when somebody files a Chapter 13 bankruptcy, one
of the most useful means of collecting support is a wage
assignment or an earnings withholding order. It is called many
things. That stops, and all the debtor has to do is serve that
on the employer and mom, who may be depending on that next
check for rent or Christmas presents or shoes or whatever,
doesn't get the money.
When that is passed through our office, because we collect
on cases in which women are not receiving public assistance--
they are just struggling and we are enforcing their divorce
order--we have to tell them it has stopped and we will go do
our best to start it again.
I am in a wonderful district; the judges are very
supportive of child support. But I talk to people all over the
country whose judges are not the same and they say, look, you
know, you want to get the support started again, seek relief
from the automatic stay. It is expensive if you don't have a
public agency helping you out, and it is time-consuming.
Senator Biden. It is an automatic stay?
Mr. Strauss. Pardon me?
Senator Biden. Now, it is an automatic stay?
Mr. Strauss. Well, the automatic stay goes into effect in
all bankruptcies and one of the things that stops is that
collection.
Another thing that happens is that is fine for people who
have wages, but what about the people who are self-employed
individuals? This bankruptcy bill, whereas it doesn't have the
immediacy of the last provision, will tell anybody who is
filing a Chapter 13 that if you want to stay in there and you
want to succeed in the Chapter 13, we have set up checkpoints.
One of them is you are not going to get your plan confirmed
unless you have paid all of your post-petition ongoing support
obligations. Another checkpoint is you are not going to get
your discharge unless you have done that.
Last year, there was, I think, an amendment added by
Senator Torricelli which I thought complemented both of those,
and that is during this period if you are not paying it between
confirmation and discharge, if you stop paying it we can
dismiss your case. So these are the kinds of remedies, among
many others, that women who really--and I say mostly women
because there are men who are custodial parents who are in the
same financial difficulties. These are the kinds of things that
would help them out of it, I think, immensely.
Chairman Hatch. Overall, could you indicate your view on
how well this bill protects women and children, particularly
those who are dependent upon regular child support payments?
Mr. Strauss. Well, this bill would, first of all, create
exceptions to the automatic stay for many things, but the most
important one is it would put in an exception which means that
the automatic stay would not stop a wage assignment, which is
incidentally what Congress has mandated us to do anyway. Every
single support order that is issued in any State in the United
States is supposed to have a wage assignment.
Senator Sessions. Just so we are all on the same page, let
me ask you--a wage assignment means that the employer must send
the money directly to the mother or the child, right?
Mr. Strauss. Or to an agency like ours. We have done it and
it is a system by which we collect about 56 percent of the
child support. That is how important this is to make sure that
is not stopped.
Chairman Hatch. Thank you.
Mr. Zywicki, I only have a few more minutes left, but let
me just ask you this. Will means-testing mitigate the problem
of bankruptcy abuse by high-income filers?
Mr. Zywicki. Mr. Chairman, I believe it does. In
particular, what it does is it shifts the presumption in cases
involving high-income filers. Under the current system, you
have to actually kind of go out and find these people, bring
motions to dismiss their case and that sort of thing.
What this does here is gives a nice gatekeeping approach.
There is a safe harbor provision for those who make less than
the median income. But above that, what it does is it just
identifies those who make the above the median income, who have
substantial repayment capacity without significant hardship.
And it gives the presumption that they would have to repay some
of their debts.
The court would still have the discretion to look at every
single case to determine whether or not there is some
significant hardship present in that case that means they
should not repay their debts. But by creating predictability
and fairness, it will mitigate the problem of high-income
filers.
Chairman Hatch. Mr. Newsome, just a question for you. Do
you believe that there are cases in the system which would
qualify as, quote, ``substantial abuse,'' unquote, of the
Bankruptcy Code?
I understand you have been a bankruptcy judge for now,
what, 15 years or thereabouts?
Judge Newsome. It is going to be 19 in October.
Chairman Hatch. Nineteen years. In all those years, how
many cases have you dismissed for substantial abuse?
Judge Newsome. Of the motions that are filed, I am probably
running 50 to 60 percent.
Chairman Hatch. You have dismissed about 50 percent for
substantial abuse?
Judge Newsome. That is right.
Chairman Hatch. OK. Now, how can you blame Congress for
wanting to bring more accountability to the system?
Judge Newsome. I don't blame Congress at all, Senator, for
wanting to bring more accountability to the system. Nobody
hates bankruptcy abuse more than the judges who see it all the
time. All I am saying is I think that the unintended effects of
your bill are going to be very, very harmful to people who
don't deserve this kind of treatment.
Chairman Hatch. My time is up.
Senator Biden?
Senator Biden. Thank you very much. You know, there is an
irony here. The bill has been stopped from passage basically
based on four arguments against the bill.
By the way, I want to thank all of you, every one of you
for your testimony because you have all been very helpful. But
let me try to narrow this down, as I see it.
There have been four basic reasons why the bankruptcy bill
has not been able to be passed. One is the argument by my
friends on my side of the aisle that women receiving support
and alimony will be damaged by this legislation. They will be
put at a disadvantage, which you have put to rest here. I want
anybody to tell me how that would be the case here.
Number 2, we are told that the second argument is that the
homestead provision is not sufficiently strong. The third thing
we are told is that the poor generally will be disadvantaged by
this bill. And the fourth thing is that those who engage in
clinic violence will be able to get out from under their
obligations somehow.
Now, the irony I find here is two of those four provisions
that the critics have are positions held by those who support
the bill, including the creditors. I don't know a single
creditor who wants somehow to be able to get out of paying a
debt because they buy a $2 million home. I don't know a single
creditor who has come forward who has suggested that anyone who
bombs an abortion clinic, violates a stay-away order at a
clinic, et cetera, should be able to discharge in bankruptcy.
There is a real irony here. The creditors support the two
provisions that some of us want to change.
I think we should have the stronger language of the FACE
legislation in the bill. I support that. I also think that we
should have a flat limit nationwide on how much you can protect
your home. I think the limit should be around $100,000, maybe
$250,000, I don't know, but not where it is now, although as
the Senator said, we have tightened this up a lot. He and I
both think we could go much further. So there is an irony here.
I am going to focus on the two things where creditors and
debtors disagree, or at least those purporting to represent
debtors disagree. The first one is the argument that the poor
and disadvantaged or the women receiving alimony or support
payments are disadvantaged.
The only legitimate criticism I have heard based on any
fact is what you have put forward, Judge Newsome, and that is
the real problem is the burdensomeness of getting out from
under this legislation, making safe harbor work.
Does anyone on this panel think that any truly poor person
is, on the face of the legislation, subject to a more onerous
test than they are now? Anyone?
Judge Newsome. Yes.
Senator Biden. I don't mean burdensome. I mean just on the
face of the legislation.
Judge Newsome. Not burdensome, but the fact that you have
eliminated the ability to get rid of debts under certain
provisions of 523--you have eliminated the ability to do that
in Chapter 13--yes, I think that that could impact very
negatively upon people of very modest means.
Senator Biden. Well, how about people on the--
Judge Newsome. Senator, if I could just interrupt you for a
second, that is also the argument about child support. What you
have done by way of amendment to Chapter 13 is that you have
made it possible for credit card companies and others who might
allegedly hold, not necessarily, but allegedly hold a non-
dischargeable debt based upon 523(a)(2) to--
Senator Biden. Explain what 523(as)(2) is.
Judge Newsome. 523(a)(2) deals with fraud, and at this
point at least it requires a creditor to bring a complaint
against the debtor alleging that he committed fraud when he ran
up his credit cards. It is not just credit cards; it is any
kind of secured debt.
Senator Biden. So if there is fraud proven, your point is
that creditor goes to the head of the line, above alimony?
Judge Newsome. No, sir. What it does is it does two things.
By making it impossible to wipe out credit card debts, unless
you pay a hundred percent in a Chapter 13 the debtor comes to
the other end of the line, comes out of bankruptcy still owing
those credit card debts to the extent he didn't pay them in the
13. That is going to compete with child support.
Senator Biden. But under the law, child support has to be
paid.
Judge Newsome. That is right, but you can't get blood out
of a turnip. If a guy gets garnished too much or if he gets too
many payroll orders, his employer is going to fire him. It is
very easy to do that in some States; Georgia, for example, I
understand from my friends in Georgia.
Senator Biden. Mr. Strauss, you look like you wanted to
comment.
Mr. Strauss. Well, I hate to disagree with a judge before
whom I may have to appear sometime, but the bottom line is that
if it was an even playing field and the credit card companies
and the child support creditors had the same remedies, I would
say, yes, the child support creditors may have a problem
because of the resources of these credit card agencies, but the
playing field is not level at all. For example, if you are
collecting from wages--and we have discussed these wage
assignments--it has to be served on the employer and it takes
precedence no matter when served and it collects the debt
first.
Also, the consumer credit protection law says that when you
are collecting from a person's wages, only 25 percent of it can
go to non-child support stuff. But if it is a child support
thing, it can take as much as 50 to 65 percent, wiping out the
ability of the other people to collect at all.
Senator Biden. That is right. Really, what you are saying,
isn't it, Judge, is that it may cost them their job, it may
cost them other things, but if they are wage-earner it is not
going to get in front of collecting the child support?
Judge Newsome. No, but then the possibility is nobody gets
anything.
Senator Biden. Whoa, whoa, whoa, not true. If the wage is
garnished, the child support gets it first. You are saying if
it causes them to end up being fired, then no one gets
anything.
Judge Newsome. Or if they just give up and run away.
Senator Biden. Right, which happens all the time now.
Judge Newsome. All the time now.
Senator Biden. That happens all the time now.
Judge Newsome. And you wouldn't want to encourage that,
would you?
Senator Biden. No, you wouldn't want to encourage that, but
I find it a real stretch to figure out how this increases the
very mentality that already exists in there.
By the way, Ms. Vullo, I compliment you on your work.
Ms. Vullo. Thank you.
Senator Biden. One question. How would the new amendment
prevent the abuse of process that exists now? There is not a
single court in America that has ruled that a violation of any
order relating to a bankruptcy that relates to doing anything
at an abortion clinic is dischargeable. Not one has ever done
that, correct?
Ms. Vullo. To my knowledge, that is correct. There are just
five cases.
Senator Biden. I understand that, but there is not one that
has done that yet. Notwithstanding what my friend from New York
tells me every once in a while, there is not one that has done
it yet.
Now, you make a very valid point. You say the ability to
abuse the existing law as to contesting what willful means
allows this process to go on. It is costly, and thereby delays
your clients and people who should be recompensed from being
paid, and it costs them to stay in the game, right?
Ms. Vullo. Yes.
Senator Biden. How would the new legislation--I am not
arguing with you, but it is a serious question--how would that
prevent the same abuse of process?
Ms. Vullo. The new legislation focuses on the existence of
an action or a judgment under a particular type of statute. So,
for example, in my case I have a judgment under the FACE
statute.
Senator Biden. Correct.
Ms. Vullo. The new legislation says that judgment is non-
dischargeable. We don't get into the question of what willful
means, what malicious means. It is an automatic non-
dischargeable, and I would submit that a bankruptcy lawyer
would have a very, very difficult time signing on to any
document in bankruptcy court with that statute, whereas now,
because of the case law that is out there under the willful and
malicious injury exception, there are hundreds of cases going
different ways with a lot of different nuances.
With that, as I have seen in my case, lawyers are arguing
what those words mean. Despite the fact that there are cases
out there on our side on the willful and malicious injury
question, it does not mean that the risk of inconsistent
results is not real. It is real.
Senator Biden. The way things are going, the likelihood is
you are building case law. I support what you want to do, but
the likelihood is, for example, the very cases you have taken
in the various district courts, and now circuit courts probably
in those--have you gotten there yet?
Ms. Vullo. I haven't gotten there. I am still in bankruptcy
court. I have got several levels of appeal.
Senator Biden. They are, at a minimum, building the case
law that suggests that these do not fall under that exception.
In other words, I am not suggesting it shouldn't be cauterized
now. I agree with you. I just want to make we don't put
ourselves in a position of hyping this beyond what is real.
What is real is it is a costly process to have to appeal,
to fight an appeal against a judgment that was warranted in the
first instance. That is really the problem, right?
Ms. Vullo. There is more than that, Senator. With all due
respect, there is much more than that because in my case I had
specific findings from a trial judge that said specific intent
and malice, and even then I was in court because I didn't have
a statute that simply said judgment under FACE, non-
dischargeable. So they litigated the issue.
In many, many other cases which will happen in the future--
the FACE statute is not very old and in many cases that will
happen in the future. I suspect all there will be will be a
judgment without specific findings, and you are going to have
judges all across the country interpreting what the elements of
the statute are against willful and malicious injury, and they
may interpret it differently, Senator.
Senator Biden. My time is up. Maybe I can come back to you
later or personally talk to you about this. I am not suggesting
you are wrong. I don't know. I find it hard to see how a
judgment under the FACE Act, not in bankruptcy now--you
litigate under the FACE Act. I find it hard to figure how a
court would render a judgment on behalf of the client without
specifying what, in fact, was the conduct. I don't know how you
get there.
Ms. Vullo. It will happen, and I can give an example. The
current law says willful and malicious injury requires
intention to commit the injury, not simply intention to do the
act. If I bomb an abortion clinic and as a result of that
bombing someone dies, the intention was to do the act of the
bombing, not to commit the killing.
And I would submit--and I think this would be absurd, but
the current law logically would say that that debt to the
victim, the dead person, as opposed to the bombed building,
would be dischargeable in bankruptcy. I don't think we should
debate over whether or not--
Senator Biden. That is an absurd reading and it would take
absurd judges. We don't have that many absurd judges, except
the ones that the other guys appoint, but I don't know.
[Laughter.]
Senator Biden. That is a joke, that is a joke. That was a
bad joke. I would like to ask unanimous consent to strike that
from the record because I will have 731 judges calling me and
wondering if I am talking about them.
I thank my colleagues for their indulgence. Thank you very
much.
Senator Sessions [presiding]. Thank you, Senator Biden.
I really want to get off this subject, and you have had a
good day in the sun. If the Schumer amendment is made law,
someone still would be able to file bankruptcy and delay paying
your debt until such time as you went to that bankruptcy court
and overcame their objection still, even though it would be
easier to overcome the objection. Am I wrong about that?
Ms. Vullo. An abuser will again abuse the system
potentially, but it makes--
Senator Sessions. But the ultimate remedy for a court is
sanctions for contempt or things of that nature, it seems to
me.
Senator Schumer. Frivolous--
Senator Sessions. Yes, frivolous or that sort of thing.
Senator Schumer. It could be a frivolous suit and subject
them to sanctions and would be dismissed right away, which
happened in none of these cases, as I understand it.
Ms. Vullo. That is correct. A lawyer would be hard-pressed
to sign that bankruptcy petition if this amendment were in the
Code.
Senator Sessions. Well, I would just say this about this
subject, which has never been lost and is not a critical matter
in the world of commercial bankruptcy: If there are other
similar problems, such as extreme environmental violence that
results in spikes being put in trees or union attacks on small
businesses, it seems to me that we ought to consider the same
type rule as is being urged upon us with regard to abortion
clinics. That is all I am saying.
It does strike me that you represent abortion clinics and,
as such, you want to protect those clinics from violence. But
others may sue people who roll back odometers and they would
like to have their cases proceed, too. So there are a lot of
different issues here, and I think quality and fairness of
treatment across the board is what I would favor as opposed to
just targeting one issue.
Senator Biden. Mr. Chairman, can I ask a question?
Senator Schumer. Would the Chairman yield?
Senator Sessions. No. You will have your time.
Ms. Vullo. May I respond?
Senator Sessions. I am using my time up right now.
Senator Biden. I apologize.
Senator Sessions. You and I have talked about it, Senator
Schumer, and I respect your concern over this issue. There are
a lot of abuses in the bankruptcy court, unfortunately, such as
debtors delaying just adjudication and trying to frustrate
payment of debts, and that is what this reform effort is trying
to correct. Sadly, this is just one example of what is going on
daily in bankruptcy courts across America.
Senator Schumer. But I would say--
Senator Sessions. Thank you Senator, but I am claiming my
time.
Ms. Vullo. Senator, may I respond to that, please?
Senator Sessions. No. I am just having my say.
Senator Schumer. Give her the courtesy of a response, Mr.
Chairman.
Senator Sessions. She has had a chance to respond.
Senator Schumer. I would ask unanimous consent it not be
taken from my good friend from Alabama's time and let Ms. Vullo
respond.
Senator Sessions. On what subject?
Ms. Vullo. Can I grant that consent?
[Laughter.]
Senator Schumer. No, unfortunately you can't. It is up to
him.
Senator Sessions. I will not object. If it doesn't cause me
to lose my time, I would be glad to hear you.
Ms. Vullo. All I would want to say, Senator, is that there
is documented abuse here in a particular area. All pieces of
legislation deal with particular items when this committee
determines and learns of some element of abuse.
Senator Sessions. I understand that is your view.
Ms. Vullo. The fact that there might be other abuse does
not mean that documented abuse should go unremedied, and that
is all we are asking with respect to this piece of legislation.
It is documented and it is a group of people who do not believe
they have to follow the laws of this country. People who don't
believe they have to follow the laws of this country should not
have the benefits of the Bankruptcy Code when they have
demonstrated that abuse.
Senator Schumer. And I would say to my friend, just to have
an analogous example, some animal rights people started
shooting scientists who were experimenting on animals and then
somehow claimed bankruptcy as a shield. I would support an
amendment to do that.
Senator Sessions. Well, I think there are other problems
that we could deal with and I certainly do not object. I think
you make the best point, which is if you have got a documented
case of abuse, you are more justified in asking for relief.
Judge Newsome, you mentioned that you granted discharges in
bankruptcy for abuse.
Judge Newsome. No, no, I didn't grant discharges in
bankruptcy for abuse.
Senator Sessions. Excuse me, dismissals of bankruptcies.
Judge Newsome. Right.
Senator Sessions. How many, in terms of actual numbers,
have you granted throughout your career?
Judge Newsome. Senator, I don't know.
Senator Sessions. You said 50 to 60 percent of the motions.
Judge Newsome. And I can't tell you--
Senator Sessions. Less than ten?
Judge Newsome. Oh, no. It has been more than ten.
Senator Sessions. Less than a hundred?
Judge Newsome. Less than a hundred.
Senator Sessions. So it is not many. It would probably be
less than 1 percent of the cases you have presided over.
Judge Newsome. Oh, much less.
Senator Sessions. In my view, the abuse procedure has
failed.
Judge Newsome. I agree.
Senator Sessions. It is not an effective mechanism.
Judge Newsome. Not as written.
Senator Sessions. That is why we think, instead of having
it filed in every court, having judges determining from their
own feelings what ought to be granted and what not granted,
that it would be preferable to have a fair, objective statutory
scheme including bright-line rules based on size of family and
median income. That would be an improved approach to the
current problems.
Judge Newsome. May I respond?
Senator Sessions. Yes, sir.
Judge Newsome. The rule you have proposed is anything but
bright line. There are as many ways of interpreting the means
test as there are people looking at it. And if you think that
there has been inconsistency interpreting substantial abuse,
wait until the judges get a hold of this one.
Senator Sessions. Well, let me ask you this.
Judge Newsome. And let me just also say this. The problem
with the test that is in the statute right now is that the only
person who can file a motion is the U.S. trustee. The creditors
can't even bring it to the trustee's attention.
So if you opened this up, if you opened the test and you
got rid of the word ``substantial'' and just said if you commit
an abuse of the Bankruptcy Code, a creditor can bring a motion
to have the case dismissed for an abuse--contrary, I think, to
popular belief, there is an objective set of standards under
the substantial abuse test for when you should dismiss a case
for substantial abuse. It has been developed in the case law
and it basically is can the debtor afford to pay something in
Chapter 13.
Senator Sessions. Well, it strikes me that it is not very
difficult. If, for example, a family of four's median income is
about $50,000, and that same family of four seeks to file for
bankruptcy with an income of $40,000 they still get to go in
Chapter 7 and would not, under S. 220 or current law, be put in
Chapter 13. That is not a very difficult concept for a judge,
in my view, to understand.
Now, let me ask you a question, Mr. Strauss. If a person is
moved from chapter 7 to 13 because they have income above the
median, and have been found to be capable of paying some of
their debts they are required to repay those debts over a 5-
year period, isn't that correct?
Mr. Strauss. Yes.
Senator Sessions. And during that 5-year period, you have
got a Federal bankruptcy judge basically ensuring that they pay
the child support first out of every single debt that is paid.
Mr. Strauss. Exactly.
Senator Sessions. Isn't that a great protection for a
mother with children?
Mr. Strauss. Yes. We obviously prefer debtors in Chapter 13
for those reasons, especially if these other provisions are
enacted.
Senator Sessions. Senator Feingold?
Senator Feingold. Thank you, Mr. Chairman. I am pleased
that we are having a hearing in committee this year. We didn't
do that at the beginning of the 106th Congress, in 1999, and I
thought that was a mistake. I certainly want to thank all the
panelists.
In fact, the process we followed in the last Congress and
in the Congress before that led to a bill that the President
wouldn't sign and that a majority of the Democratic caucus
wouldn't support. I am afraid we are heading down that exact
same road again this year.
Of course, we have a new President, and most observers
expect that he would sign the bill that the Chairman and
Senators Grassley and Sessions have introduced if it gets to
his desk. But, my colleagues, that doesn't make the bill any
better or more fair or more balanced, or worthy of this
committee or this Congress, than the one we passed last year.
Amending the Bankruptcy Code, as my friend Brady Williamson
indicated, used to be a non-partisan exercise, where the
Congress listened to experts, practitioners, law professors,
judges and trustees, and made careful, considered judgments
about how the law would work. Now, it seems we ignore the
experts and, instead, do what the credit industry wants us to
do. And we use parliamentary tactics to avoid reasoned
consideration that harm the bill and I think actually discredit
the Senate.
We all know how the procedures of the Senate were abused to
pass the bankruptcy bill last year. This year, the bill has
been sent right to the calendar for floor action. We have a new
Judiciary Committee this year with four new members and a 50/50
split in party affiliation. I strongly believe this committee
should have the opportunity to fully consider and amend the
bill.
I just want to say for the record that our Leaders'
agreement to have evenly divided committees is really pretty
much meaningless if major legislation like bankruptcy reform
doesn't really go through committee, and so there is agreement
to have equal budget for staffs if major legislation is marked
up in this committee before that agreement is implemented. This
is a new Senate with an unprecedented power-sharing
arrangement, and I think this committee should start operating
on that basis, in fact, not someday, but now.
Mr. Chairman, I have a longer statement for the record that
spells out my concerns about S. 220. I would like to note here
that this committee should be cognizant of the extent to which
bankruptcy reform has come to be seen across the country as a
gift to special interests.
In that regard, I would like to ask unanimous consent that
recent studies by Common Cause and the Center for Responsive
Politics concerning the campaign contributions made by
supporters of bankruptcy reform legislation be included in the
record of this hearing.
Mr. Chairman, I am asking unanimous consent.
Senator Sessions. Without objection.
Senator Feingold. In light of the appearance that these
free-spending industries have created, we have a very heavy
burden to make sure that we are serving the public interest
with this kind of far-reaching legislation. We cannot meet that
burden unless we slow down and open our minds to the kinds of
criticisms expressed by witnesses at this hearing and by non-
partisan experts in this field. For two straight Congresses, we
have ignored the experts. We need to step back and take another
look.
Mr. Chairman, I want to welcome in particular the two
witnesses from Wisconsin, Brady Williamson and Mr. Beine, who
hail from my State. Senator Kohl very much wanted to be here
and extends his apologies. He is doing what we in Wisconsin
consider the Lord's work. He is with Agriculture Secretary
Venemen talking about the dairy industry.
We are glad you are here to provide a little Wisconsin
common sense to this debate. I will hopefully be able to ask
more questions in another round, but let me just use the time
here remaining in my round to ask Mr. Williamson to comment
briefly on whether the efforts of the National Bankruptcy
Reform Commission that he chaired are reflected in the bill
that passed the Senate last year and that is before the Senate
again.
Brady, if you could start by recounting how the Commission
went about its work and attempted to study and accommodate all
the competing views and tried to come up with a balanced bill
with regard to this law.
Mr. Williamson. Thank you, Senator. The Commission was
created by the Congress in 1994. It had 9 members, 3 appointed
by the President, 4 appointed by Congress, the House and the
Senate, and 2 by the Supreme Court. It conducted hearings
across the country, more than 25 hearings, heard from more than
300 witnesses, received more than 3,000 submissions, and
attempted to come up with a balanced set of recommendations.
The Commission submitted its report to the Congress and the
Supreme Court on October 20, 1997. It had 172 recommendations
and a 1,300-page analysis of the bankruptcy law which remains
available today on the Net and I still think is the single most
comprehensive assessment as of 1997 of American bankruptcy law.
This legislation includes some of the Commission's
recommendations. I would single out the Sessions-Kohl provision
on homestead as an example of that. I would also single out
direct appeals as an example of that. I would note that the
Commission found no need for a needs test, as such. The
Commission addressed the question of abuse in a variety of
ways, we think with a little more precision and sophistication
than the legislation does.
The Commission endorsed the notion of flexibility for
judges. We have heard a discussion this morning about a family.
I believe, Senator Sessions, you mentioned a family of four
with $50,000 of income, and shouldn't it be easy to tell
whether they get to go in Chapter 7 or Chapter 13. The answer
is, yes, it should be if it were a normal family. But if the
family had an autistic child, if the family had economic
consequences, circumstances that didn't fit readily into IRS
guidelines, then you have a different story. And then I think
you need the flexibility and the discretion that the Code today
affords bankruptcy judges.
Senator, if I could just take a minute to respond to the
Senator from Delaware's friendly challenge on his four issues,
first, Senator Biden, I would note that the people in the
credit industry who support this legislation have been
remarkably silent on the importance of the Sessions-Kohl
amendment.
Senator Biden. That is not true, by the way. That is simply
not true. That is simply not true.
Mr. Williamson. Well, Senator, then I would like to see the
evidence of that.
Senator Biden. I will give you the evidence.
Mr. Williamson. Thank you.
Senator Biden. It is simply not true.
Mr. Williamson. Second, with respect to the question of the
impact of this legislation--
Senator Biden. You mean homesteading, right?
Mr. Williamson. Yes, sir.
Senator Biden. OK.
Mr. Williamson. With respect to the Senator's comments
about women and children, bankruptcy law is fundamentally about
values, and this country and this Congress long ago decided
that taxes, child support and student loan obligations should
be non-dischargeable, and the reason was because we as a
society place a value on that.
One of the disturbing things about the bill in the
aggregate, Senator, is that it increases the categories of non-
dischargeable debt. And by doing that, it places that new non-
dischargeable debt in competition, inevitably, with the other
non-dischargeable debt.
Senator Biden. You are good, Brady.
[Laughter.]
Senator Biden. I forgot how much I liked working with you
over the years. You are so good.
Mr. Williamson. Senator, Chapter 7's only last a brief
amount of time and during that period, of course, a bankruptcy
judge can insist that child support be paid. Chapter 13's may
last 3 years or 4 years, but one thing we haven't talked about,
a dark secret here, is that 3 out of every 4 Chapter 13's fail.
And when they fail and when the debtor is sent out of the
courtroom into the world, each of that debtor's creditors with
a non-dischargeable debt--it is passed through bankruptcy
whether it is 7 or 13--is on the same footing.
They can go to the single mother or single father with
children and say we want you to pass. And during the bankruptcy
process, they can go to that same single mother and say, look,
we will let you keep your credit card, you just have to
reaffirm the debt.
Now, we haven't talked about reaffirmations here, and I
think we are all aware of the instances in the last 3 years
where major credit institutions have abused the reaffirmation
system. This legislation needs to pay more attention to that
issue.
The system is about balance, Senator, and it has to be
balanced and it has to prevent abuse. Bankruptcy judges can
provide balance if they have the discretion. I associate myself
with Judge Newsome's remarks because we need to give bankruptcy
judges flexibility, not put them in straightjackets, and that
applies as well to the means test.
Senator Sessions. Senator Schumer?
STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR FROM THE
STATE OF NEW YORK
Senator Schumer. Thank you, Mr. Chairman. I thank everyone
here. I think this is an excellent hearing, no matter what side
of the issue you are on, because we are really discussing the
issues. This is our committee, I think, at its best and I
appreciate everybody being here.
We were not allowed to make opening statements. I am going
to make part of my opening statement now and then ask that the
rest be put in the record, and then I will ask a few questions
if I have time. Otherwise, I will wait for the second round.
First, I want to thank everybody, all the witnesses for
being here, and especially Maria Vullo, who is an attorney from
New York. As we know now, she litigated the Nuremberg Files
cases.
Ms. Vullo, I can say to you that in the ante room there,
two of my colleagues were talking and one said to the other I
wouldn't want to be litigating against her--the ultimate
compliment to a litigator.
Mr. Chairman, bankruptcy law and bankruptcy legislation is
complicated. It is sometimes archaic, and I can safely say that
when I walk into, say, O'Halloran's Pub on Clinton Road and see
my constituents, they are not saying what is new with the
homestead exemption, the means test and safe harbors, Charlie.
The fundamental idea behind bankruptcy law and bankruptcy
reform is actually a fundamental and very simple one. Good
bankruptcy reform means strengthening the protections for the
neediest debtors by giving them a safety valve to deal with
misfortunes that may befall them, while at the same time
shoring up the system to prevent abusive filings by debtors who
do not need bankruptcy protections. It is that simple, Mr.
Chairman, balance the need to protect vulnerable Americans with
the need to prevent abuses.
Last year, I opposed the bill that ended up emerging from
the shadow conference because I think the bill got the wrong
balance. I am hopeful that this year we will work to achieve
truly balanced bankruptcy reform, something that is going to
cure abuses but doesn't throw out the baby with the bath water.
I hope we are not going to try to jam the same bill through
that came out of the shadow conference. That bill, which had
been unilaterally stripped of the FACE amendment, the so-called
now Schumer-Leahy amendment, had passed 80 to 17.
By now, I think everyone involved in bankruptcy knows that
the FACE amendment prevents those who engage in violence and
intimidation at abortion clinics from hiding behind the
Bankruptcy Code to escape their court-imposed debt. This
provision makes clear to those who would harm women and doctors
that bankruptcy is no escape from accountability for their
heinous acts. They have tried to use the bankruptcy courts for
that.
Now, what could be wrong with that purpose, as my good
colleague and friend from Delaware said? Probably everyone on
this panel agrees with that, and the issue frankly is not pro-
choice or pro-life; it is pro-law. That is why Harry Reid, who
is pro-life, joined as a cosponsor immediately. That is why
when I first passed the FACE law in the House we had a
coalition of pro-choice and pro-life Congress members
supporting it.
That is why last year Senators Jeffords, Snowe, Collins and
Specter made this a wholly bipartisan effort. And that is why,
when they heard bankruptcy was bring brought up again this
year, Senators Reid and Jeffords quickly approached me to
stress their support and desire to cosponsor the amendment.
And that is why our new Attorney General was so outspoken
both publicly and privately at his confirmation hearings about
his support for the FACE amendment. In the last Congress, the
Justice Department was a strong supporter of FACE. In fact, I
would like to ask unanimous consent that the DOJ letter I
received last year showing DOJ's position which outlines why
this law is so important be placed in the record.
Senator Sessions. Without objection.
Senator Schumer. Given Attorney General Ashcroft's pledge
to enforce FACE and his explicit support of the FACE amendment,
I hope that this year it will be included in the bankruptcy
bill.
Let's not kid ourselves. Attacks on clinics and clinic
workers are often planned by sophisticated individuals and
organizations. Violent activists who hide their assets to avoid
financial repercussions are quite capable of working bankruptcy
into their schemes to commit violence without accountability if
they believe it will work.
Ms. Vullo testified about the Nuremberg Files case. It is
not fiction. Your testimony was riveting. What happened there
was appalling and offensive. What is happening now in the
bankruptcy courts is equally appalling and offensive. We need
to shut it down. If we don't, there is a substantial risk that
others will pervert the Bankruptcy Code and it will become a
widespread tactic used by those who believe that their message
is more important than our American law and the Bankruptcy Code
will be perverted.
Can any of us really doubt that the groups that Ms. Vullo
has litigated against, if given the chance, will not continue
to force clinics and doctors, and relitigate and relitigate and
relitigate? That is my dispute with my good colleague from
Delaware. He is right that if these little clinics had free
lawyers--they don't even have to be as good as Ms. Vullo--they
would win. But they don't. The opponents have huge amounts of
money and go to court after court after court. And we all know
in practical effect what the consequence will be. It will be
that bankruptcy will be a shield from judgment.
Now, some have argued--we hear this argument a lot--about
the willful and malicious standard. They say FACE debts would
be covered. First, I have never argued that FACE debts would
never be covered. Certainly, some would be if they were proven
to fall under the willful and malicious injury exception. But
this in no way means that all FACE debts are covered by that
exception.
In the Nuremberg case, the judge made explicit findings of
maliciousness and intentionality that made it easier in the
bankruptcy cases to argue that the willful and malicious injury
exception applies. But even in these cases which should be slam
dunks, Ms. Vullo and the plaintiffs have spent more than a year
litigating in bankruptcy court.
What about cases where there are settlements and part of
the stipulation of the settlement is we are not going to find
willful and malicious and there is a judgment? Then what do we
do? Many, many, many cases end in settlement, probably more
than actually end in judgment. So it is vital that we make
perfectly clear that FACE debts are non-dischargeable. If we
don't, the individuals and organizations seeking to shut down
clinics will continue to force clinics, doctors and other
victims of clinic violence into a world of perpetual
litigation. By doing so, they may well deter victims of clinic
violence from ever bringing a case in the first instance.
Mr. Chairman, I have a lot more to say on this subject, but
I am going to ask unanimous consent that my entire statement be
put into the record.
Senator Sessions. We would be glad to. Once again, ably
delivered.
Mr. Zywicki, would you respond to Judge Newsome's
suggestion or statement that judges would find it difficult to
interpret the means test language in this bill? How hard and
complex would that be?
Mr. Zywicki. It is much less complex than under current
law. Basically, what happens under current law is judges just
kind of make it up as they go along, just sort of an open-ended
inquiry. If you read the cases, you see cases all over the
place. He says it is being refined by case law. That is simply
not the case. The cases are all over the place, and what this
does is brings order to it.
Senator Sessions. Cases on abuse?
Mr. Zywicki. Yes, cases on abuse. There is no consistency.
Senator Sessions. But under the proposed language of this
bill, to what extent is that ambiguous or unclear?
Mr. Zywicki. This is much less ambiguous or unclear. It
identifies things very clearly, and most importantly it
provides a list of expenses and that sort of things. And then
what it does is cabins at the end a judge's discretion and
says, look, here is your discretion, here is a simple list to
follow and here is your discretion; apply your discretion, but
subject to guidance, not just according to willy nilly
preferences. So I don't think there is any problem with
applying the means test as it is drafted.
Senator Sessions. With regard to the legislation, I think
it has previously been noted, but this bill passed the House in
June 1998, 306 to 118, essentially this bill with the means
test in it. In the Senate, it passed in 1998, 97 to 1. In the
House, it passed again in May 1999, 313 to 108. In the Senate,
it passed February 2, 2000, 83 to 14. In the House, it passed
again on voice vote virtually unanimously, I suppose, without
even a roll call vote. It passed 70 to 28 in the Senate.
There have been six different times this bill has been up
and passed by overwhelming majorities. We don't want to not
have hearings and let everybody talk, but sometimes it is time
to stand up and vote and I think we are about at that point
now.
Senator Biden, I will let you go now and if I have any
follow-ups, I will follow you.
Senator Biden. One of the reasons I think this hearing is
important is that there has been so much misinformation that
has been out there across the board. I would argue initially
the misinformation was on the part of the creditors 4 years
ago. Now, I would argue the misinformation is on the part of
those opposing this legislation.
I start off with sort of just a common-sense notion here.
Why are there so many more bankruptcies? Why has that happened?
Part of what our ethic was was that bankruptcy was something
that was an absolute last resort and was something that you
really tried to avoid because it had a social stigma related to
it, beyond a financial stigma related to it. That isn't the
case anymore. It is not working that way anymore. People still
need bankruptcy protection. That is why we got rid of debtor
prisons.
The irony here is I have been for my 28 years in the Senate
characterized by the business community as too much of a pro-
consumer Senator. I have found it kind of ironic that one of
the things that has been argued here today is that--and I might
add, Mr. Manning, without any data to support it; I have seen
no hard data. I read your entire report. I have no hard data
where you support the idea that you state that you have a
direct connection between bankruptcy and credit card debt. I
have not seen that data that you have supported here.
One of the things I heard today was the autistic child;
what about the person with the autistic child? Doesn't the
judge need discretion for that? Well, that is a medical
expense. Under this legislation, that is set aside. Where the
heck does that come in? I don't get that. Obviously, I don't
want to hurt people who have autistic children, but you all
make it seem like the autistic child is in trouble, you know,
the parent with the autistic child.
Brady, I don't think we have been on the opposite of an
issue, except this one. I can't think of it. How long have we
known each other, 25 years?
Mr. Williamson. Twenty-8 years.
Senator Biden. As a matter of fact, I tried very hard to
hire you to be my main guy. You were making too much money to
come work for me.
Mr. Williamson. Senator, it was your first day in the
Senate that we met.
Senator Biden. Well, that is 28 years, and I really have
overwhelming respect for you and you know that. We have been
old friends. You have supported me.
Now, reaffirmation. Are you alleging that for a creditor to
insist on reaffirmation is easier under the new proposal we are
making than it is under the old?
Mr. Williamson. I would not suggest, Senator, that the
legislation you are holding in your right hand is a model of
good draftsmanship.
Senator Biden. I didn't say that. Brady, stop playing games
with me. Is reaffirmation, as poorly drafted as your brilliant
drafting capability may discern--is it tighter or looser than
the existing bankruptcy law? Remember, your legal reputation is
part of this.
[Laughter.]
Senator Schumer. But if he demolishes it, you could always
get a job with him.
Senator Biden. I want him any time he is willing to come.
Mr. Williamson. Senator, I would say that the intent of the
folks who put that together was to make it slightly tougher.
Senator Biden. Not intent. Does it make it tougher, Brady,
or not?
Mr. Williamson. Senator, I don't think so.
Senator Biden. I will get back to you on that. The second
thing I want to ask you about is what new non-dischargeable
category of debt do we have in this legislation?
Mr. Williamson. The category of unsecured debt that can be
non-dischargeable is increased significantly.
Senator Biden. How?
Mr. Williamson. The time limits.
Senator Biden. Right, but no new category, right?
Mr. Williamson. Well, if you--
Senator Biden. That is what you said. You said new category
of debt.
Mr. Williamson. If you expand the category of non-
dischargeable unsecured debt incurred within 30 days--
Senator Biden. Let's go like when we were in grade school,
you know, file them. Do you mean category in that if you put
more of a debt within a category subjected to non-
dischargeability--if you increase the number or lower the
number, that is a new category. Is that what you are saying?
Mr. Williamson. It is certainly an expanded category.
Senator Biden. OK, then that may be more accurate, wouldn't
it be, because there is no new category?
Mr. Williamson. Actually, there are.
Senator Biden. Name me one.
Mr. Williamson. I believe the drunk driving penalty
exception is a new category of non-dischargeable debt.
Senator Biden. You are right. That is a good one. You agree
with that, don't you?
Senator Sessions. Abortion clinics. How about that?
Senator Biden. We want to make abortion clinics non-
dischargeable, too. But there is no new category of debt that
the creditors are seeking, is there, that you are aware of?
Mr. Williamson. Senator, I don't want to be involved in
semantics with you because of your caution about games. But if
you expand from 30 days to 90 days--
Senator Biden. OK, but it is not a new category. It is a
time limit. You argue that that makes somebody more
susceptible, but it is not a new category. I mean, that is the
part I am trying to get at here. I wish you would all be a
little straightforward with this. You are opposed to this flat
out.
Mr. Williamson. That is not correct, sir.
Senator Biden. Oh, give me a break.
Mr. Williamson. Senator, whether it is a category or not,
it is whale of a lot of new debt.
Senator Biden. OK, that I buy. Just try to be straight with
me. If you were staffing me and you did that to me, then I
would fire you because you would not be telling me the straight
stuff. Just give the straight scoop. That is all I want to
know, that is all I am trying to figure out. I really mean
this. That is all I am trying to figure out because a lot of
games are being playing here, not by you, but everybody out
here is playing games with this stuff.
What gets communicated to the press--there was a Time
magazine article--I think it was Time magazine, wasn't it, that
was riddled with absolute, total, complete fabrications, not
because I think the guy writing the article was, in fact,
somebody who tried to fabricate it, but because he heard things
like new categories. He heard things like the autistic child,
he heard things like be able to escape from debt on the
abortion clinic. No one has escaped yet.
Ms. Vullo makes an incredible case, I think. I hope the
credit card industry and I hope the creditors out there are
listening because she is making a very strong point. Now is the
time to put pressure on my conservative friends to accept her
position.
Senator Schumer. Hear, hear.
Senator Biden. But the point is she said it straight, she
said it straight. It may be someday that somebody will be
discharged in bankruptcy. It may be that someone is convicted
under FACE and, in fact, gets discharged, but none of that has
happened yet. But what has happened is it is costly. I am just
trying to get my arms around this a little bit here.
Your statement, Brady--any reasonable person listening to
what you said earlier would walk away thinking that
reaffirmation is easier to do under this legislation than
exists today. I doubt whether any honest person would conclude
that that wouldn't be the conclusion. Maybe that is not what
you intended, but the way you state it, it makes it sound that
way.
Creditors are not people I am crazy about because I am
listed as--I am not, but I am listed as the poorest Member of
Congress, literally. I mean, I am not.
Senator Schumer. Wait a minute.
Senator Biden. No, no. Seriously, the Washington Post four
or 5 years ago listed me as the poorest Member of Congress
because I refinanced my home to pay for Yale, Penn and
Georgetown. That is what happened. And I am not because the guy
who does my financial disclosure didn't list the equity in my
home, because under our stupid rules in order to list the
equity in your home you have to have a current assessment. It
costs $500 to get one done. I didn't want to spend $500. I
would rather pay it to Georgetown than do that.
To make a long story short, I am not the poorest, but I am
not a debt-free guy. I am not like a lot of our colleagues here
who the last thing they have ever seen is having to take that
lazy susan and spin it around and decide who gets paid this
month. Some of us still do that who have this job. So I don't
come at this like we are going to go out there and squeeze
every penny out of folks out there.
But I start off with the proposition that something is
rotten in Denmark, as the old expression used to be. An awful
lot of people are discharging debt who shouldn't. This
voluminous increase in filings--it is exponential what has
happened. Something is up, and that happened when the economy
was booming, absolutely booming.
Now, I am not a real smart fellow maybe, but there is
something wrong. Something is going on here, and it says to me
it has got to be tightened, for a simple reason, and the
gentleman on the end made the comment, as did Mr. Sheaffer.
Guess what? People who come from my economic class where I grew
up pay more now; they pay more. They pay more in the cost of
the product at Boscov's and other places where we shop, not
where a lot of the people who are getting out of the big
bankruptcies shop. Nobody who has a big bankruptcy shops at
Boscov's.
[Laughter.]
Senator Biden. I am not joking. I am not trying to be funny
here. This is serious, this is serious.
So what happens? I ask my colleagues, try to think back to
the time when you were just starting. You just got out of law
school, you just got out of college and you are trying to buy
the car and you are trying to get the first bit of credit. All
that is going on here is the people it is hurting is not the
wealthy people. As bankruptcies increase astronomically like
this and in geometric proportion, it is hurting people where I
come from.
So I am so sick of this self-righteous sheen put on anybody
who wants to tighten up bankruptcy is really anti-debtor.
People are getting hurt, people are getting hurt. Again, I very
much want to work out the two big provisions relating to
Chuck's initiative--and I give him great credit for that--and
also on your initiative, which is homesteading. We ought to be
able to force this issue.
So my message to the creditors out there who want this
tightened up is get on the team, join the band wagon, put as
much pressure on the folks who won't do that as you put on
people who are opposed to any change. I hope that message goes
out clearly.
The second piece of this is there has got to be a way--
Brady, if you are right, and if you are right, Judge, that on
the extreme, at the end of the day, even though we put women
and children first, like in sinking ships--even if they are
first, there ought to be a way where we can make them the first
among equals.
And we are not putting any new categories of debt in here,
but maybe as we expand categories, and marginally, I might add,
marginally--as we expand those categories, maybe we can still
come up with a provision that says women and children cannot,
even after they fail in 13, be subject to it, or even after
they lose their job.
I find that one a hard one, Judge. I was a family court
lawyer. I did these things. I wasn't a big-time lawyer. I was
just a plain old trial lawyer, and I spent a lot of time as a
public defender and a lot of time in family court going after
those support payments and going after that stuff.
I didn't know anybody I ever ran across in my experience
who would quit their job, because this legislation exists, in
order to spite their circumstances than would do it now. I
mean, I find that a real leap. But I hope there is a good-faith
way we can try to fine-tune this, if you still think you have
got to fine-tune it.
But something is wrong with a system that allows guys like
me getting out of law school discharging our law school debt
front-end, guys like me getting out of medical school
discharging their medical school debt.
Judge Newsome. You would never be able to do that.
Senator Biden. Like heck you can't.
Judge Newsome. Not under this system you can't, not the one
we have got right now. You can't get out of a medical debt. It
is a HEELS loan most of the time, and you can't get out of
those for love or money.
Senator Biden. By the way, that is not the only debt people
acquire going through school.
Judge Newsome. And as to the law school debt, if those are
educational loans, those are presumed non-dischargeable.
Senator Biden. No, no, they are not educational loans. I
graduated $100,000 in debt and they were commercial loans. I
didn't get one of those. I didn't qualify. My sons still have
$120,000 they are paying off. You are full of malarkey, Judge.
Judge Newsome. They probably still would be under the
statute.
Senator Biden. Well, then I had better let my sons know
that. Maybe they can get moving before this gets changed.
[Laughter.]
Senator Biden. Anyway, I just think this is--
Judge Newsome. By the way, there is a new category of debt.
It is 523(a(19) and it deals with loans that you take from your
pension plan.
Senator Biden. Protected?
Judge Newsome. No, non-dischargeable.
Senator Biden. Non-dischargeable. That is what I mean.
Judge Newsome. OK.
Senator Biden. And that wasn't pushed by creditors, by the
way.
Judge Newsome. I think it is a good provision.
Senator Biden. I do, too, and the other one, drunk driving,
is too, and this one is, too. Anyway, I just hope we get a
little bit of sanity into this debate here and stop the games.
Senator Sessions. I thank the Senator.
Senator Biden. Thank you.
Senator Sessions. The Senator from New York.
Senator Schumer. Thank you, Mr. Chairman. First, I want to
thank my colleague from Delaware not only for the passion which
he brings to this--we disagree on some of the issues--but
particularly for his understanding of why the amendment I am
proposing is so important, which you brought out, Ms. Vullo.
I certainly would hope that we could get people to accept
at this time his call for the creditor community to use their
suasion with people who have opposed this amendment. It would
be very helpful because we do have majority support. It is
simply that we couldn't get it through because a few people
didn't want it to be part of it.
Coming from New York, of course, I get lots of calls from
people who want this bill, heads of big financial institutions,
and they say can't you withdraw your amendment? I say, well, if
you get your wife to call me, I might consider that. Not a
single wife has called me because they know that our amendment
is the right amendment.
I just wanted to clarify a couple of things with Ms. Vullo.
Let's just go over the sense of time that it has taken you to
do this. First, how long did it take you to litigate the
Nuremberg Files case, start to finish?
Ms. Vullo. From October 1995--the jury verdict was February
2, 1999, so 3\1/2\ years before trial and verdict.
Senator Schumer. OK, and now how many more years has it
taken with bankruptcy?
Ms. Vullo. It is now 2 years, last week.
Senator Schumer. Have your plaintiffs collected a nickel?
Ms. Vullo. A little bit more than that, a couple of
thousand dollars by a garnishment of a corporate entity, not
from any of the individuals because the individuals filed for
bankruptcy when the--
Senator Schumer. So in none of the individual cases have
they gotten any money yet?
Ms. Vullo. That is correct.
Senator Schumer. And if this group whom you represented--if
the plaintiffs didn't have a top-notch pro bono lawyer, what do
you think would have happened?
Ms. Vullo. I don't think the case would have been brought
in the first instance, which is another reason, Senator, for
why the amendment to the Bankruptcy Code relates very directly
to the importance of the FACE statute itself, because you won't
bring the FACE claim if you know that they are just going to,
after the verdict, file for bankruptcy.
Senator Schumer. Right, and the amount of money in most of
the settlements and judgments so far--yours is a particularly
notorious case--would not compensate a lawyer even on a
contingency fee basis in general. Is that right?
Ms. Vullo. That is correct.
Senator Schumer. Thank you, Mr. Chairman.
Senator Sessions. On the question of reaffirmations, I was
asked to meet, Mr. Williamson, with Senator Reid, the White
House and the Department of Justice. We hammered out
reaffirmation language that did have some political give-and-
take in it. It is not perhaps law review style, but it
satisfied the Department of Justice and the Clinton White
House, and it provided more protections, as Senator Biden said,
clearly than were in existence before the law.
Senator Biden. Would you yield for a question? Didn't the
White House push this?
Senator Sessions. Yes, they pushed this kind of language
and we agreed to it.
Senator Biden. Brady has always been to the left of Clinton
anyway, so it doesn't matter.
Senator Sessions. But more than that, reaffirmation is
nothing but one of these arguments, in my view, that has
nothing to do with it of importance here fundamentally. A
person can go out and buy a room full of furniture or a washing
machine and he or she signs a note at whatever interest rate
the parties agree to. There is no lawyer present most of the
time under those circumstances. Instead they sign it, and that
is it.
But under bankruptcy law, they do have lawyers and the
lawyer signs off on the reaffirmation. So at least they have
had legal counsel. But that is not enough. They want to have
the judge approve it. So we provided a method in which the
information is provided to the judge and some standards that
would say that if it was unfair or abusive to the debtor who is
reaffirming the debt so they could keep the washing machine,
there would be less problems. I think we made a good stop
without creating a hearing for every doggone reaffirmation that
goes on.
Mr. Williamson, the Bankruptcy Commission never formally
voted on a means test, is that correct?
Mr. Williamson. That is correct, Senator.
Senator Sessions. And they didn't take a formal position on
it one way or the other?
Mr. Williamson. That is correct, Senator.
Senator Sessions. With regard to homestead, it is an area
of abuse, in my view, and I believe that bankruptcy law is
Federal law. It is provided for in the U.S. Constitution and
bankruptcy court judges are Federal judges.
Now, I am a States'-righter, and sometimes Senator Biden is
a fierce States'-righter, too. This is a Federal law that is
litigated in Federal court, but somewhere along the line
Congress decided it couldn't reach an agreement on what the
homestead limitations ought to be, so they punted it to the
States and let the States decide what homestead limits would
be. Some said none, and as a result people have the ability of
abusing the system, while other States have set varying limits.
I don't think it violates States' rights to do so, but our
Senators from Kansas and Texas and Florida and some other
States have even agreed to the homestead fix contained in this
bill--note that these laws override their States' laws, even
their constitutions. Despite that's though, we were able to
work out a solution that they were amendable to and that was
fairer to everyone involved. So we have made substantial
progress in eliminating abuses. If somebody ran from Mobile to
Pensacola, and filed bankruptcy within 2 years, they could not
protect but $100,000 of equity in their home.
Also, we provided that you could go back 7 years if you
could establish an abuse scheme--and it is not always
impossible to establish an abusive scheme--and then take that
equity, except for $100,000.
Senator Biden. Mr. Chairman, I wonder how many people plan
2 years ahead of time they are going to declare bankruptcy
before they declare it and that is why they buy the home. I
mean, that is a lot of foresight. That is pretty good.
Senator Sessions. But if they did it by calculation and
deviousness and delayed it for 2 years, then you could still go
back under the fraud exception. So I think we made real
progress in homestead.
I think the benefits for children and alimony are clearly
superior, and I believe that justice in America must hold that
a person who is making an average income in America and who can
pay at least a part of his or her debts ought to pay them. Some
say, well, we don't want to pay medical debts, but hospitals
are people, too, in a sense. They serve people, they have
needs.
Why should somebody who is capable of paying a part of
their hospital bill, pay nothing? Other people work very hard
to pay their hospital bills and sacrifice to maintain good
insurance. Oftentimes, it is an irresponsible person who wants
to ride on the responsible person.
I think bankruptcy, at its core, has the potential to be
unfair to the responsible American citizen. That is who we most
should affirm, the one who does right. We do allow, however,
historically--and there will be no problem in this quarter--to
maintain the right of a person in need who cannot pay his or
her debts to wipe them out completely. That is not being
changed. The needs-based issue is important for justice, basic
morality and fairness. If a person can pay, they should pay.
Senator Biden. Mr. Chairman, would you yield me 60 seconds?
Senator Sessions. Yes.
Senator Biden. I want to make two points. With regard to
the safe harbor provisions in here, just to set the record
straight, I didn't draft this bill. This is not my
subcommittee. I did not get involved in this. But when it was
pointed out to me over a year ago that there was concern about
poor people being subject and women and children being at the
end of the line, I asked for a meeting with some of the largest
creditors out there.
I told them that I wouldn't support this legislation unless
there was a safe harbor provision put in and women and children
went to the head of the line, expecting there to be an
argument. Not one single bit of opposition; total, immediate
support; zero opposition, none. One of them representing a
large non-Delaware credit card company made the following
comment: we don't want to be put in the position where we are
going after so little money for so high a public relations
cost, we don't want any part of that. So I just hope people
understand that piece.
The second piece is I want to make the point I was for
States' rights in Bush v. Gore and I don't know what happened.
Thank you.
Senator Sessions. Let me say this. Thank you all. It was an
excellent discussion. As you can tell, we have discussed many
of these issues before. They have been wrestled with, and
sometime in the sausage-making process of laws being passed,
certain compromises get made.
I must say, finally, Dr. Manning, on credit cards, that is
really a banking issue. What kind of regulations should be
placed on a credit card company offering credit to a poor
person is really, I think, not part of creating a Federal
system of bankruptcy law. I think we should be cautious about
what we do in that regard.
In fact, the Chairman of the Banking Committee has asserted
aggressively his belief that this is outside of our
jurisdiction. So I think fundamentally concerns about credit
cards should be directed to that committee. I would not want to
pass a law that made it more difficult for a poor person to be
able to get a credit card, because if they don't have ready
cash and they are on the margin--anytime they have a flat tire,
for example, and can't afford to fix their care without credit,
that would be a bad thing. Credit cards are not evil things,
per se. They have great advantages in many circumstances for
poor people, and I would just caution everyone to remember
that.
Senators Grassley and Kennedy have submitted written
statements which we will include in the record.
[The prepared statements of Senators Grassley and Kennedy
follow:]
Statement of Hon. Charles E. Grassley, a U.S. Senator from the State of
Iowa
Senator Sessions, thank you for chairing this hearing on bankruptcy
reform, which we all consider to be unfinished business from the 106
th Congress. As you know, the issue of bankruptcy reform is
familiar to all of us here in the Senate. For the past 4 years, we've
debated the fundamental rights of both borrowers and creditors, for the
greater good of individuals, society, and the economy. We've looked at
this issue at great length an in excruciating detail. The Judiciary
Subcommittee on Administrative Oversight and the Courts held, I
believe, eleven hearings over the past two Congresses, and heard
testimony from almost 90 witnesses on all aspects of bankruptcy. We
debated bankruptcy reform extensively on the floor in both the 105
th and 106 th Congresses, and last December we
passed a bipartisan, compromise bill by a vote of 70 to 28. That piece
of legislation received overwhelming support of Senators on both sides
of the aisle.
Unfortunately, President Clinton pocket-vetoed that good
legislation, and we here in the Senate did not have the opportunity to
override it. We had the votes to do so. That was too bad, because we
need bankruptcy reform. But I'm hopeful that we'll be able to move
swiftly in this Congress and get the job done. That is why Senators
Hatch, Sessions and Johnson joined me in reintroducing the exact same
conference report that was approved by the Senate with overwhelming
bipartisan support. I know many other members on both sides of the
aisle support this bill and want to see it passed into law.
I repeat, this bill is unfinished business. This is not new stuff.
We are not covering new ground. In fact, we don't even need to be in
Committee. But in the interest of addressing Senator Leahy's concerns
that new Senators on the Committee have a chance to familiarize
themselves with this issue, we're holding this hearing today with the
hope of proceeding quickly to this bill on the floor.
The current bankruptcy system needs to be reformed. Presently, when
individuals file for bankruptcy under Chapter 7, a court proceeding
takes place, and their debts are simply erased. We must realize that
every time a debt is wiped away through bankruptcy, someone loses
money. When someone loses money in this way, he or she has to decide to
either assume the loss as a cost of business, or raise prices for other
customers to make up that loss.
When bankruptcy losses are infrequent, lenders can just swallow the
loss. But when they are frequent, lenders need to raise prices to other
consumers to offset their losses. These higher prices translate into
higher interest rates for future borrowers. You'll recall that former
Treasury Secretary Larry Summers--a liberal Democrat--testified before
the Senate Finance Committee that bankruptcies tend to drive up
interest rates. With the possibility of the economy slowing down, we
need to fix a bankruptcy system that inflates interest rates and
threatens to make a slowdown even worse. Bankruptcy reform will help
the economy.
So, the result of the bankruptcy crisis is that hardworking, law
abiding Americans have to pay higher prices for goods and services. S.
220 would make it harder for individuals who can repay their debts from
filing bankruptcy under Chapter 7, thus lessening the upward pressure
on interest rates and higher prices. It's only fair to require people
who can repay their debts to pull their own weight. But under current
bankruptcy law, one can get full debt cancellation in Chapter 7 with no
questions asked. Our bill asks the question of whether repayment is
possible by an individual, and if it is, then he or she will be
channeled into Chapter 13 of the Bankruptcy Code, which requires people
to repay a portion of their debt as a pre-condition for limited debt
cancellation.
Let me be clear, people who don't have the ability to repay their
debt can still use the bankruptcy system as they would have before. S.
220 specifically provides that people of limited income can still file
under Chapter 7. But the bill makes it so that people who have higher
incomes and who can repay their debts, their free ride is over.
Personal responsibility has been one of the main themes of the
bankruptcy reform bill. I say this because since 1993, in the midst of
prosperity and with a booming economy, the numbers of Americans who
declared bankruptcy has increased over 100 percent. While no one knows
all the reasons underlying the bankruptcy crisis, the data shows that
bankruptcies increased dramatically during the same time frame when
unemployment was low and real wages were at an all-time high. I believe
that the bankruptcy crisis is a moral crisis. We need to stop people
from looking at bankruptcy as a convenient financial planning tool
where honest Americans will have to foot the bill.
So, it is clear to me that our lax bankruptcy system must bear some
of the blame for the bankruptcy crisis. A system where people are not
even asked whether they can pay off their debts obviously contributes
to the fraying of the moral fiber of our nation. Why should people pay
their bills when the system allows you to walk away with no questions
asked? Why should people honor their obligations when they can take the
easy way out through bankruptcy? I think the system needs to be
reformed because this is fundamentally unfair. Our bankruptcy reform
bill will promote personal responsibility among borrowers and create a
deterrence for those hoping to cheat the system.
Our bill does more than just provide for a flexible meanstest that
gives judges discretion to consider the individual circumstances of
each debtor to determine whether they truly belong in Chapter 7. It
also contains tough new consumer protections, like new procedures to
prevent companies from using threats to coerce debtors into paying
debts which could be wiped away once they are in bankruptcy. The bill
requires the Justice Department to concentrate law enforcement
resources on enforcing consumer protection laws against abusive debt
collection practices. The bill contains significant new disclosures for
consumers by mandating that credit card companies provide key
information about how much they owe and how long it will take to pay
off their credit card debt by only making a minimum payment. Consumers
will also be given a toll-free number to call where they can get
information about how long it will take to pay off their own credit
card balances if they make only the minimum payments. This will educate
consumers and improve consumers' understanding of their financial
situation. And credit card companies that offer credit cards over the
internet will be required for the first time to fully comply with the
Truth in Lending Act.
Moreover, our bill makes changes which will help particularly
vulnerable segments of our society. Child support claimants are given
the highest priority when the assets of a bankruptcy estate are
distributed to creditors. Bankruptcy trustees and creditors of
bankrupts will be required to give information about the location of
deadbeat parents who owe child support.
I also want to touch on another important section of the bill. S.
220 makes Chapter 12 of the Bankruptcy Code permanent. This means that
America's family farms are guaranteed the ability to reorganize. But
the bill goes further. It makes improvements to Chapter 12 so it will
be more accessible and helpful for farmers. For example, the definition
of the family farmer is widened so more farmers can qualify for Chapter
12 bankruptcy protection. S. 220 also reduces the priority of capital
gains tax liabilities for farm assets sold as a part of a
reorganization plan, which will allow cash-strapped farmers to sell
livestock, grain, and other farm assets to generate cash flow when
liquidity is essential to maintaining a family farm operation. These
reforms will make Chapter 12 even more effective in protecting
America's family farms during difficult times. I think it's a crying
shame that the opponents of bankruptcy reform have prevented Chapter 12
from being reauthorized and modernized. It was an outrage that
President Clinton pocket-vetoed the bankruptcy bill and denied the
farmers in my state of Iowa and across the country the bankruptcy
protections they really need.
Over the last ten years our economy has enjoyed unprecedented
success. But as we have seen, economic stagnation can occur just as
quickly as an upswing. On a macro-economic level, enacting bankruptcy
reform will help stimulate the economy by lessening upward pressure on
interest rates. So, by passing meaningful bankruptcy reform, we can
help our economy and simultaneously contribute to rebuilding our
nation's moral foundations. I look forward to hearing from our
witnesses this morning.
Statement of Hon. Edward M. Kennedy, a U.S. Senator from the State of
Massachusetts
I welcome this hearing to consider this important issue once again.
In the past four years, supporters and opponents of bankruptcy
legislation have disagreed many times about this legislation. Many of
us feel strongly that Congress should not pass sweetheart legislation
for the credit card industry. We do need to pass a bill to reduce fraud
and abuse--but it should also maintain the long-standing safety net for
vulnerable Americans who deserve it. Scores of bankruptcy scholars,
advocates for women and children, labor unions, consumer advocates, and
civil rights organizations agree with our position.
For weeks, President Bush has warned the nation about the potential
problems of the current economic downturn. Pointing to layoffs and
rising unemployment, decreasing consumer confidence, and low economic
growth, President Bush is urging Congress to pass legislation to
strengthen the economy. But punitive bankruptcy reform legislation
doesn't fall in that category. Now more than ever, we need to ensure
that Americans losing their jobs or struggling with medical debt have
the second chance for economic security that bankruptcy laws are
intended to provide. This is especially no time to pull the rug out
from under them.
We know the circumstances and market forces that often push middle
class Americans into bankruptcy.
A rising unemployment rate and company layoffs are a major part of
the problem. The slowing economy led to an unemployment rate of 4.2% in
January--the highest level in 16 months--and every week brings reports
of new layoffs that may well lead to bankruptcy for many families in
coming months.
Divorce is another major cause of bankruptcy. Divorce rates have
soared in recent decades--and the financial consequences are
particularly devastating for women. Divorced women are four times more
likely to file for bankruptcy than married women or single men. In
1999, 540,000 women--540,000--who head their own households filed for
bankruptcy to try to stabilize their lives. 200,000 of them were also
creditors trying to collect child support or alimony. The rest were
debtors struggling to make ends meet.
Another major factor in bankruptcy is the high cost 43 million
Americans have no health insurance, and many more are under-insured.
Each year, millions of families spend more than 20 percent of their
income on medical care. Older Americans are hit particularly hard. A
1998 CRS Report states that even though Medicare provides generally
good health coverage for older Americans, half of this age group spend
14 percent or more of their after-tax income on out-of pocket health
costs, including insurance premiums, co-payments and prescription
drugs.
These Americans are not cheats and frauds--but they do constitute
the vast number of Americans in bankruptcy. Two out of every three
bankruptcy filers have an employment problem. Two out of every five
bankruptcy filers have a health care problem. Divorced or separated
people are three more likely than married couples to file for
bankruptcy. Yet, the credit card industry and the Republican Congress
determined to deny them the bankruptcy safety. net in order to ensure
larger and larger profits for itself.
This legislation is an undeserved windfall for one of the most
profitable industries in America. Credit card companies are engaged in
massive and unseemly nation wide campaigns to hook unsuspecting
citizens on credit card debt. They sent out 2.87 billion--2.87
billion--credit card solicitations in 1999. In recent years, the
industry has even begun to offer new lines of credit targeted
specifically at people with low income--even though the industry knows
full well that these persons cannot afford to pile up such debt.
Supporters of the bill argue that it is not a credit card industry
bill. But, to deal effectively and comprehensively with the problem of
bankruptcy, we have to deal with the problem of debt. We must see that
the credit card industry does not abandon fair lending policies to
fatten its bottom line, or ask Congress to become the collector for its
unpaid credit card bills.
Proponents of the bill also say that it ensures that alimony and
child support will be the number one priority in bankruptcy. That
rhetoric hides the complexity of the bankruptcy system--but it doesn't
hide the fact that women and children will be the losers if this bill
becomes law.
Under current law, an ex-wife trying to collect support has special
protection. But under the pending bill, credit card companies are given
a new right to compete with women and children for the husband's
limited income after bankruptcy.
It is true that the bill moves support payments to the first
priority position in the bankruptcy code. But that only matters in the
limited number of cases where the debtor actually has assets to
distribute to a creditor. In most bankruptcy cases--over 95 percent--
there are no assets, and the list of priorities has no effect.
As 116 professors of bankruptcy and commercial law have stated,
``Granting `first priority' to alimony and support claims is not the
magic solution the consumer credit industry claims, because `priority'
is relevant only for distributions made to creditors in the bankruptcy
case itself. Such distributions are made in only a negligible
percentage of cases. More than 95% of bankruptcy cases make NO
distributions to any creditors because there are no assets to
distribute. Granting women and children first priority for bankruptcy
distributions permits them to stand first in line to collect nothing.''
Similarly, thirty-one organizations that support women and children
have stated, ``Some improvements were made in the domestic support
provisions . . . however, even the revised provisions fail to solve the
problems created by the rest of the bill, which gives many other
creditors greater claims--both during and after bankruptcy--than they
have under current law.''
This legislation unfairly targets middle class and poor families--
and it leaves flagrant abuses in place. Any credible bankruptcy reform
bill must include two important provisions--a homestead provision
without loopholes for the wealthy, and a provision that requires
accountability and responsibility from those who unlawfully--and often
violently--bar access to legal health services. The current bill
includes neither provision.
The bill does include a half-hearted loophole-filled homestead
provision that will do little to eliminate fraud. With a little
planning--or in some cases, no planning at all--wealthy debtors will be
able to hide millions of dollars in assets from their creditors.
Last year, the Senate passed a worthwhile amendment to eliminate
this inequity. But that provision was stripped from the conference
report. Surely, a bill designed to end fraud and abuse should include a
loophole-free homestead provision.
I urge my colleagues to stop peddling legislation to increase the
profits of the credit card industry--already one of the most profitable
industries in the country--at the expense of working families. It's
time to pass true bankruptcy reform legislation that fairly balances
the needs of both creditors and debtors.
I look forward to the testimony of today's witnesses.
Senator Sessions. We also have several letters and
statements which have been submitted and we will include those
in the record at this point.
The record will be open for further statements until
Friday.
[The prepared statement and attachments of Senator Durbin
and the prepared statement of Senator Thurmond follow:]
Statement of Hon. Richard J. Durbin, a U.S. Senator from the State of
Illinois
Mr. Chairman, thank you for holding today's hearing on bankruptcy
reform. Although we have debated bankruptcy legislation for several
years, the last time I participated in hearings on the subject was in
the 105 th Congress, when I first served on this Committee.
That was approximately three years ago. A lot has changed in three
years.
Three years ago, bankruptcy filings were not only up, they had
reached record setting levels. According to the Administrative Office
of the U.S. Courts, there were 1,436,964 bankruptcy filings in fiscal
year 1998, of which 1,389,839 (96.7%) were consumer bankruptcies. Now,
three years later, bankruptcy filings are down.
In fact, the 1998 numbers seemed to be the peak. Bankruptcy
filings--especially personal filings--dropped significantly in 1999--
down to 1,315,751 personal bankruptcies--and dropped again in 2000,
when the figure fell even further to 1, 226,037. That's 163,000 fewer
personal bankruptcy filings in 2000 than in the peak year, 1998. This
represents a 12% reduction in just two years.
Chapter 7 bankruptcies--``fresh start'' filings--are coming down at
an even faster pace, from 1,026,134 in 1998 to just under a million--
959,292--in 1999, with a further decrease to 870,805 in fiscal year
2000--a 15% reduction in only two years.
Three years ago, I worked with Senator Grassley to develop a
bipartisan balanced bankruptcy bill that addressed both irresponsible
debtors and irresponsible creditors.
Ninety-seven Senators supported this bill and agreed to legislation
that would have eliminated both debtor and creditor abuses while
ensuring the availability of information that permits consumers to make
informed financial decisions. Unfortunately, the bill was decimated in
conference and I could not support it in the end.
This year, we have before us last year's bankruptcy bill. It is the
same bill that, as written last year, failed to meet the basic test of
fairness and balance. I opposed this unbalanced bill last year.
President Clinton recognized the lack of balance and wisely pocket
vetoed the bill last Congress.
Our bill in the 105 th Congress included debtor specific
information that would enable cardholders to examine their current
credit card debt in tangible terms, driving home the seriousness of
their financial situation.
The bill before us today permits banks with less than $250 million
in assets to have the Federal Reserve provide its customers with a
tollfree phone number to review their credit card balances for the next
two years. It is unclear whether the banks would be required to provide
the service themselves after the two years are complete.
This exemption would cover 4,000 banks holding about $3 billion in
consumer credit card debt. This is a departure from a balanced
approach.
The bill also fails to close the homestead loophole. Under this
bill, a renter or someone with less wealth will get to keep nothing,
but a homeowner who has equity in her home that existed prior to the
two year cut off can keep all the equity. By failing to include a hard
cap, this provision only benefits the rich.
The current bankruptcy bill also fails to include an amendment
sponsored by the senior Senator from New York, Senator Schumer, which
would prevent documented abuse of the bankruptcy system by those who
violate the Freedom of Access to Clinic Entrances Act (FACE) or an
equivalent state law. In most cases where a defendant is held liable
under the FACE Act, there is no finding that the action was ``willful
and malicious'' and the FACE Act often includes acts which may not be
classified as ``acts of violence'' (e.g., an act of intimidation or
verbal harassment). Without Senator Schumer's amendment, this bill
would continue to allow many perpetrators of clinic violence to seek
shelter in the nation's bankruptcy courts.
For these reasons, although I am all for bankruptcy reform, I
cannot support the bankruptcy bill in its current form. It is
unbalanced.
One hundred and sixteen nonpartisan law professors also recognized
this in their letter to Congress last year. In their letter, the law
professors noted how ``deeply flawed'' the bankruptcy bill is and its
adverse affect on women and children.
Mr. Chairman, I ask for unanimous consent that the letter from the
116 nonpartisan law professors be entered into the record.
Mr. Chairman, I just received a letter from the American Academy of
Matrimonial Lawyers, also expressing their ``deep concern'' about the
reintroduction of this bankruptcy bill. In it they say, ``We believe
that children should come before credit card companies.'' I ask
unanimous consent that this letter also be entered into the record.
``Balance'' is certainly the order of the day. We're in a new
Congress, with a balanced, 50/50 Senate. We also have a new President,
faced with the challenge of uniting an evenly-divided electorate. And
we have a new and real opportunity to work together and pass balanced
and meaningful bankruptcy reform.
While there are some positive aspects to this bill, we could, and
we should, do much better. I look forward to working with my colleagues
both here in this Committee and on the Senate floor to improve this
bill and give all American people and businesses balanced meaningful
bankruptcy reform.
HARVARD LAW
October 25, 2000
Re: The Bankruptcy Reform Act Conference Report (H.R. 2415)
Dear Senators:
We are professors of bankruptcy and commercial law. We have been
following the bankruptcy reform process with keen interest. The 75
undersigned professors come to every region of the country and from all
major political parties. We are not a partisan, organized group, and we
have no agenda. Our exclusive interest is to seek the enactment of a
fair and just bankruptcy law, with appropriate regard given to the
interests of debtors and creditors alike, Many of us have written
before to express our concerns about the bankruptcy legislation, and we
write again as yet another version of the bill comes before you- This
bill is deeply flawed, and we hope the Senate will not act on it in the
closing minutes of this session.
In a letter to you dated September 7, 1999, 82 professors of
bankruptcy law from across the country expressed their gave concerns
about some of the provisions of S. 625, particularly the effects of the
bill on worsen clad children. We wrote again on November 2, 1999, to
reiterate our concerns. We write yet again to bring the same message:
the problems with the bankruptcy bill have not been resolved,
particularly those provisions that adversely affect women end children.
Notwithstanding tire unsupported claims of the bill's proponents,
H.R. 2415 does not help women and children. Thirty-one organizations
devotee! exclusively to promoting the best interests of Women; and
children continue to oppose the pending bankruptcy bill. The concerns
expressed in our earlier letters showing how S. 625 would hurt woman
and children have not been resolved. Indeed, they have not event been
addressed.
First, one of the biggest problems the bill presents for worsen and
children was stated in tile September 7, 1999, letter:
``Women and children as creditors will have to compete with powerful
creditors to collect their claims after bankruptcy,''
This increased competition for women and children will come from
many quarters: from powerful credit card issuers, whose credit card
claims increasingly will be excepted from discharge and remain legal
obligations of the debtor after bankruptcy; from large retailers, who
will have an easier tinge obtaining reactions of debt that legally
could be discharged; and from creditors claiming they bold security,
even when the alleged collateral is virtually worthless. Atone of the
changes made to S. 625 and none being proposed in H.R. 2415 addresses
these problems. The truth remains: if H.R. 2415 is enacted in its
current form, women, and children will face increased competition in
collecting their alimony and support claims after the bankruptcy case
is over. We have pointed out this difficulty repeatedly, but no charge
has been made in the bill to address it.
Second., it is a distraction to argue- as do advocates of the
bill--that the bill will ``help'' women and children--and that it will
``make child support and alimony payments the top priority--no
exceptions.'' As the law professors pointed out in the September 7,
1999, letter:
``Giving `first priority' to domestic support obligations does not
address the problem.''
Granting ``first priority'' to alimony and support claims is not
the magic solution the consumer credit industry claims because
`priority'' is--relevant only for distributions made to creditors in
the bankruptcy case itself. Such distributions are made in only a
negligible percentage of cases. More than 95% of bankruptcy cases make
NO distributions to airy creditors because there are no assets to
distribute. Granting women and children a first priority for bankruptcy
distributions permits them to stand first in line to collect nothing.
Woman's hard-fought battle is. over reaching the ex-husband's
income after bankruptcy. Under current law, child support and alimony
share a protected post-bankruptcy position with only two other
recurrent collectors of debt-taxes and student loans. The credit
industry asks that credit card debt and other consumer credit share
that position, thereby elbowing aside tile women trying to collect on
their own behalf. The credit industry carefully avoids discussing the
increased post-bankruptcy competition facing women if H.R. 2415 becomes
law. As a matter of public policy, this country should riot elevate
credit card debt to the preferred position of taxes and child support.
Once again, we have pointed out this problem repeatedly, and nothing
has been changed in the pending legislation to address it.
In addition to the concerns raised on behalf of the thousands of
women who are straggling now to collect alimony and child support after
their ex-husband's bankruptcies, we also express our concerns on behalf
of the more than half a million women heads of household who will file
for bankruptcy this year alone. As the heads of the economically most
vulnerable families, they have a. special stake in the pending
legislation. Women heads of households are now the largest demographic
group in bankruptcy, and according to the credit industry's owndata,
they are the poorest. The provisions in this bill, particularly the
many provisions that apply without regard to income, will fall hardest
on them. Under this bill, a single mother with dependent children who
is hopelessly insolvent and whose income is far below the national
median income would have her bankruptcy case dismissed if she does not
present copies of income tax returns for the past three years--even if
those returns are in the possession of her ex-husband. A single mother
who hoped to work through a chapter 13 payment plan would be forced to
pay every penny of the entire debt owed on almost worthless items of
collateral, such as used furniture or children's clothes, even if it
meant that successful completion of a repayment plan was impossible.
Finally, when the Senate passed S. 625, we were hopeful that the
final bankruptcy legislation would include a meaningful homestead
provision to address flagrant abuse in the bankruptcy system. Instead
the conference report retreats from the concept underlying the Senate-
passed homestead amendment.
The homestead provision in the conference report will allow wealthy
debtors to hide assets from their creditors.
Current bankruptcy law yields to state law to determine what
property shall remain exempt from creditor attachment and levy.
Homestead exemptions are highly variable by state, and six states
(Florida, Iowa, Kansas, South Dakota, Texas, Oklahoma) have literally
unlimited exemptions while twenty-two states have exemptions of $10,000
or loss. The variation among states leads to two problems--basic
inequality and strategic bankruptcy planning- The only solution is a
dollar cap on the homestead exemption. Although variation among states
would remain, the most outrageous abuses--those in the multi-million
dollar category--would be eliminated.
The homestead provision in the conference report does little to
address the problem. The legislation only requires a debtor to wait two
years after the purchase of the homestead before filing a bankruptcy
case. Well-counseled debtors will have no problem timing their
bankruptcies or tying-up the courts in litigation to skirt the intent
of this provision. The proposed change will remind debtors to buy their
property early, but it will not deny anyone with substantial assets a
chance to protect property from. their creditors. Furthermore, debtors
who are long-time residents of states like Texas and Florida will
continue to enjoy a homestead exemption that can shield literally
millions of dollars in Value.
These facts are unassailable: H.R. 2415 forces women. to compete
with sophisticated creditors to collect alimony and child support after
bankruptcy. H.R. 241.5 makes it harder for women to declare bankruptcy
when they are in financial trouble. H.R. 2415 fails to close the
glaring homestead loophole and permits wealthy debtors to hide assets
from their creditors. We implore you to look beyond the distorted
``facts'' peddled by the credit industry. Please do not pass a bill
that will hurt vulnerable Americans, including women and children.
Thank you for your consideration.
Peter A Alces
Professor of Law
College of William and Mary
Williamsburg, Virginia
Peter C. Alexander
The Dickinson School of Law
Penn State University
Carlisle, Pennsylvania
Thomas B. Allington
Professor and Associate Dean for Technology
Indiana University School of Law
Indianapolis, Indiana
Allan Axelrod
William J. Brennan Professor Emeritus Of Law
Rutgers Law School
Newark, New Jersey
Douglas G. Baird
Harry A. Bigelow Distinguished Service Professor
University of Chicago Law School
Chicago, Illinois
Laura B. Batten
Associate Professor of Law
Wayne Sate University Law School
Andrea Coles Bjerre
Visiting Assistant Professor of Law
University of Oregon School of Law
Eugene, Oregon
Susan Block-Lieb
Professor of Law
Fordham University School of Law
New York, New York
Amelia H. Boss
Charles Klein. Professor of Law
Temple University School of Law
Philadelphia, PA
William W. Bratton
Samuel Tyler Research Professor of Law
The George Washington University Law School
Washington, D.C.
Jean Braucher
Roger Henderson Professor of Law
University of Arizona
Ralph Brubaker
Associate Professor of Laws
Emory University School of Law
Atlanta, Georgia
Mark B. Budnitz
Professor of Law
Georgia State University
Atlanta, Georgia
Daniel J. Bussel
Professor of Law
UCLA School of Lawn
Los Angeles, California
Marianne B. Culhane
Creighton Law School
Omaha, Nebraska
Jeffrey Davis
Professor and Louis G. Sohn Research Scholar
University of Florida Law School
Gainesville, Florida
Susan DeJarnatt
Assistant Professor of Law
Temple University School of Law
Philadelphia, Pennsylvania
Paulette J. Delk
Professor of Law
Cecil C. Humphreys School of Law
The University of Memphis
Memphis, Tennessee
A. Mechele Dickerson
Professor of Law
William & Mary Law School
Williamsburg, Virginia
Thomas L. Eovaldi
Professor of Law
Northwestern University School of Law
David G. Epstein
Professor of Law
University of Alabama Law School
Tuscaloosa, Alabama
Christopher W. Frost
Brown, Todd & Heyburn Professor of Law
University of Kentucky
College of Law
Lexington, Kentucky
Nicholas Georgakopoulos
Professor of Law
University of Connecticut School of Law
visiting Indiana University School Of Law
Indianapolis, Indiana
Michael A. Gerber
Professor of Law
Brooklyn Law School
Brooklyn, New York
Marjorie L. Girth
Professor of Law
Georgia State University College of Law
Ronald C. Griffin
Professor of Lain
Washburn University School of Law
Topeka, Kansas
Professor Karen Gross
New York Law School
New York, New York
Matthew P. Harrington
Professor of Law
Roger William University
Bristol, Rhode Island
Joann Henderson
Professor of Law
University of Idaho College of Law
Moscow, Idaho
Adam Hirsch
Professor of Law
Florida State University
Margaret Howard
Professor of Law
Vanderbilt University Law School
Nashville, Tennessee
Sarah Jane Hughes
University Scholar arid Fellow in Commercial Law
Indiana University School of Law
Bloomington, Indiana
Kenneth N. Klee
Acting Professor of Law
University of California at Los Angeles School of Law
Los Angeles, California
Don Korobkin
Professor of Law
Rutgers-Camden School of Law
Camden, New Jersey
Edward J. Jangar
Associate Professor
Brooklyn Law School
Brooklyn, New York
Lawrence Kalevitch
Professor of Law
Shepard Broad Law Canter
Nova Southeastern University
Fort Lauderdale, Florida
Allen Kemp
Professor of Law
John Marshall Law School
Professor Lawrence King
Charles Seligson Professor of Law
New York University School of Law
New York, New York
John W. Larson
Associate Professor of Law
Florida State University
Tallahassee, Florida
Robert M. Lawless
Professor of Law
University of Missouri-Columbia
Columbia, Missouri
Leonard J. Long
Professor of Law
Quinnipiac University School of Law
Hamden, Connecticut
Lois R. Lupica
Associate Professor of Law
University of Maine School of Law
Portland, Maine
William H. Lyons
Richard H. Larson Professor of Tax Law
College of Law
University of Nebraska
Lincoln, Nebraska
Bruce A. Markell
Professor of Law
William S. Boyd School of Law, UNLV
Nathalie Martin
Assistant Professor of Law
University of New Mexico School of Law
Judith L. Maute
Professor of Law
University of Oklahoma Law Center
Juliet Moringiello
Associate Professor
Widener University School of Law
Harrisburg, Pennsylvania
Jeffrey W. Morns
Professor of Law
University of Dayton School of Law
Spencer Neth
Professor of Law
Case Western Reserve University
Cleveland, Ohio
Gary Neustadter
Professor of Law
Santa Clara University School of Law
Santa Clara, California
Nathaniel C. Nichols
Assoc. Professor of Law
Widener at Delaware
Scott F. Norberg
Visiting Professor of Law
University of California
Hastings College of the Law
San Francisco, California
Dean Pawlowic
Professor of Law
Texas Tech University School of Law
Lubbock, Texas
Lawrence Ponoroff
Vice Dean and Mitchell Franklin Professor of Law
Tulane Law School
New Orleans, Louisiana
Doug Rendleman
Huntley Professor
Washington and Lee Law School
Lexington, Virginia
Alan N. Resnick
Benjamin Weintraub Professor of Law
Hofstra University School of Law
Hempstead, New York
Alan Schwartz
Professor of Law
Yale University
New Haven, Connecticut
Steven L. Schwartz
Professor of Law
Duke Law School
Durham, North Carolina
Charles J. Senger
Professor of Law
Thomas M. Cooley Law School
Stephen L. Sepinuck
Professor of Law
Gonzaga University School of Law
Spokane, Washington
Charles Shafer
Professor of Law
University of Baltimore Law School
Baltimore, Maryland
Melvin G. Shimm
Professor of Law Emeritus
Duke University Law School
Durham, North Carolina
Charles J. Tabb
Professor of Law
University of Illinois
Walter Taggert
Professor of Law
Villanova University Law School
Villanova, Pennsylvania
Marshall Tracht
Professor of Law
Hofstra Law School
Hampstead, New York
Bernard Trujillo
Assistant Professor
U. Wisconsin Law School
Madison, Wisconsin
William T--Vukowich
Professor of Law
Georgetown University Law Center
Washington, D.C.
Thomas M. Ward
Professor of Law
University of Maine School of Law
Portland, Maine
Elizabeth Warren
Leo Gottlieb Professor of Law
Harvard Law School
Cambridge, Massachusetts
John Weistart
Professor of Law
Duke University School of Law
Durham, North Carolina
Elaine A. Welle
Winston S. Howard Distinguished Professor of Law
University of Wyoming
College of Law
Laramie, Wyoming
Jay L. Westbrook
Benno Schmidt Chair of Business Law
University of Texas School of Law
Austin, Texas
William C. Whitford
Emeritus Professor of Law
Wisconsin Law School
Madison, Wisconsin
Mary Jo Wiggins
Professor of Law
University of San Diego Law School
San Diego, California
Peter Winship
Professor of Law
SMU School of Law
Dallas, Texas
William. J. Woodward, Jr.
I. Herman Stein Professor of Law
Temple University
Philadelphia, Pennsylvania
American Academy of
Matrimonial Lawyers
Chicago, Illinois 60601
February 7, 2001
Senator Edward M. Kennedy
315 Russell Senate Office Building
United States Senate
Washington, DC 20510
Representative Jerald Nadler
B336 Rayburn House Office Building
United States House of Representatives
Washington, DC 20515
Dear Senator Kennedy and Representative Nadler;
As president of the American Academy of Matrimonial Lawyers (AAML),
I am writing to express the deep concern of the Academy over the re-
introduction and fast-tracking of the bankruptcy ``reform'' legislation
5.220 and H.R.333 and it's adverse effect on children and families
receiving child support payments.
The Academy believes credit card debts should retain their
unsecured status, because their nondischargeability will affect the
debtor's ability to pay child support, alimony and property
settlements.
The bill as written will change existing law in a way that is
extremely harmful to women and children. While at first reading it
appears that.support payments have ``priority,'' the reality is that
protection exists only for a limited amount of time.
In a Chapter 7 case the non-dischargeability of the credit card
debt will mean that the debtor does not truly have a ``fresh start' and
will be unable to pay all his remaining obligations; most specifically
support obligations and potentially a property settlement payment.
In a Chapter 13 case the credit card debts are treated equally with
support obligations when devising a payment plan, .thus the support
obligationreceives.a pro-rata payment only while under existing law
they have a priority.
We believe that children should come before credit card companies.
We urge the defeat of this legislation.
Respectfully yours,
Charles C. Shainberg
Statement of Hon. Strom Thurmond, a U.S. Senator from the State of
South Carolina
Mr. Chairman:
I am pleased that we are holding this hearing today on bankruptcy
reform.
There is a great need to reform our Bankruptcy Code to address the
abuse of the system that is widespread today. At one time in America,
the vast majority of people were determined to pay their debts and
there was a stigma attached to filing for bankruptcy. However, today,
filing for bankruptcy is much more accepted in society, and it has
become much more routine, even in the booming economy of recent years.
In 1999 alone, about 1.4 million Americans filed for bankruptcy.
These numbers represent more than a four-fold increase in the past
twenty years. The huge number of filings is a serious, national problem
that effects all Americans. We cannot allow bankruptcy to be used as a
tool for financial planning.
The Bankruptcy Reform Act, which passed the Congress last year and
has already been reintroduced, would target the abuses. The bill would
require people to reorganize their debts when they can afford to repay
them. It would prevent the much too common practice today of people
choosing to discharge their debts in bankruptcy rather than repay what
they can over time.
In addition, the bill contains special provisions to protect women
who depend on child support to provide for their families. It would
make child support payments the top priority for payment in bankruptcy.
Finally, the bill would reauthorize many important bankruptcy
judgeships, including one in my home state of South Carolina, and make
special bankruptcy protections for farmers permanent in the law.
The problems in bankruptcy are not new, and neither are our efforts
to solve them. In recent years, this Committee has held numerous
hearings and has extensively debated legislation to provide
comprehensive, needed changes to the current outdated system. The
Bankruptcy Reform Act that we passed late in the last Congress was a
good, compromise bill. It passed both houses of the Congress by wide
margins with bipartisan support. Unfortunately, President Clinton chose
not to sign the bill. However, I am confident that the current
Administration will be more receptive to the Congress's bankruptcy
reform agenda.
I hope the new Congress can act quickly on this critical
legislation. It is a serious problem that must be addressed without
further delay.
We are adjourned.
[Whereupon, at 12:46 p.m., the committee was adjourned.]
[Questions and answers, and submissions for the record
follow:]
[Additional material is being retained in the Committee
files.]
QUESTIONS AND ANSWERS
Responses of Philip L. Strauss to Questions from Senator Biden
Department of Child Support Services
San Francisco, CA 94105
Hon. Joseph R. Biden, Jr.
Senate Judiciary Committee
U.S. Senate
Dirksen Senate
Building, Room 224
Washington, D.C. 20510
ATTN: Kristen A. Cabral, Esq.
Re: Response to Memorandum of the National Bankruptcy Conference:
Erosion of the Discharge and the Myth of ``Special Protection'' for
Domestic Support Obligations
Dear Senator Biden:
On February 21, 2001 a facsimile transmission was received by my
office requesting a response to a memorandum of the National Bankruptcy
Conference entitled ``Erosion of the Discharge and the. Myth of Special
Protection'' for Domestic Support Obligations. I was attending a
conference the week this request was received so I am submitting the
answers somewhat late. I apologize for the delay.
In three and one-half single spaced pages the memorandum made two
points. One, that giving first priority status to domestic support
obligations will have little effect on collecting support. The argument
made is that to have an effect the estate must have assets and the vast
majority of cases filed are no asset Chapter 7 cases. The second point
was that support creditors would be severely hampered in their efforts
to collect support after bankruptcy because of the existence of debt
which was previously dischargeable
In answer to the first issue I make three points:
1. The ``vast majority of cases'' in general appears not to reflect
the profile of domestic support cases. It has been said that 95% of
bankruptcy petitions filed are no asset Chapter 7. cases. I ask whether
anyone has attempted to profile the typical domestic relations debtor
to determine what percentage of this population files Chapter 13 cases
(which, by definition, have assets) as opposed to Chapter 7 cases?
This morning I had our office run a report of all bankruptcy cases
in the San Francisco Department of Child Support Services. The results
indicated that 530 of the bankruptcy cases on our system are Chapter 13
cases. Thus, among child support debtors, 53% of the cases have assets.
I cannot believe that San Francisco differs that much statistically
from the general support-debtor population which files bankruptcies.
This result is not surprising to me since I see every bankruptcy
case coming into my office and know that a very high percentage are
Chapter 13 filings. Since support debtors have already been found to
have the ability to pay support by a domestic relations court, it is
not unreasonable to conclude such debtors have assets to protect and
therefore file under Chapter 13 more frequently than the population at
large. And, lest we forget, S. 220 will require a greater percentage of
bankruptcy debtors to file Chapter 13 cases, thus substantially
increasing the use of support enforcement enhancements of S. 220 to
collect support.
2. Priority for all child support debts is enormously important in
Chapter 13 cases. Since a debtor in a Chapter 13 case must repay all
arrears during the term of the Chapter 13 plan, unless the creditor
agrees otherwise, the priority status will insure that, to the extent
feasible, all debts in the nature of support will be paid. Thus, the
distribution of assets to priority creditors is not illusory at all.
In addition S. 220 makes all support debts enforceable against the
debtor's exempt property. Thus, support creditors may be able to
satisfy their support obligations even in no asset cases when the
debtor has exempted property from the estate.\1\
---------------------------------------------------------------------------
\1\ See the amendment to 11 U.S.C. Sec. 522(c)(1) contained in
section 216 of the bill.
---------------------------------------------------------------------------
3. Enormous benefits for support creditors, other than receiving
first priority are contained in the bill. The National Bankruptcy
Conference memorandum did not address the various and considerable
benefits support creditors receive in other sections of the bill.
Section 212 deals with priorities, but other provisions do a great deal
more good than section 212.
a. Section 213 prevents confirmation of plans and discharge of
debts when postpetition support is not paid in full.
b. Section 214 excepts numerous support collection devices from
the reach of the automatic stay, thus allowing support
collection to proceed without interruption from the bankruptcy
stay.
c. Section 215 prevents the discharge of non-support divorce
debts, which in far too many cases are necessary for the
maintenance and well-being of an exspouse.
d. Section 216 prevents the debtor from removing liens securing
support from his property and subjects the debtor's exempt
property to the enforcement of support debts.
e. Section 217 prevents the recovery by the trustee of support
payments actually paid by the debtor to the support creditor
before the bankruptcy was filed.
f. Section 219 requires the trustee to provide important notice
to support creditors in order to insure that their debts will
be collected.
All in all, criticizing this bill because the priority provision in
section 212 in not helpful is like burning down a house because the
chimney doesn't work. But the chimney does work here. While the
priority status in Chapter 7 cases may not provide wide spread
benefits, it certainly will in Chapter 13 cases.
The second issue raised by the memorandum is that, with all
this'newly nondischargeable-debt, support will be harder to collect. No
professional support collector sees the existence of newly
nondischargeable debt as an impediment to support collection! The
argument advanced is that credit card companies ``are institutionally
well suited to use the courts to collect their claims'' while the ex-
spouse is ``not institutionally established to collect these debts.''
One wonders, of course, how cost effective it will be for a credit card
company to use the courts in the first place to commence the collection
process.
I submit, however, that if a support creditor wants the debt
collected, this creditor will have to take some action to get the debt
collected, unless the creditor wishes to rely on the good faith of the
debtor to pay the debt voluntarily. In my experience this collection
technique is nearly worthless.
The federal child support enforcement program \2\ provides an easy
solution to this problem for generally needy and dependent mothers. It
is an institutionally established means to collect support debts after
bankruptcy. It exists in every jurisdiction of every state in this
country. It is provided free or for a nominal fee. And information
regarding this service must, under section 219 of the bill, be provided
to every support creditor by the bankruptcy trustee.
---------------------------------------------------------------------------
\2\ Social Security Act, Title IV-D, Sec. Sec. 451-469 (42 U.S.C.
99651-669).
---------------------------------------------------------------------------
Once the support creditor obtains either private or government
provided support collection assistance, the competitive advantages
available to the support collector over financial institutions are
staggering. For this reason I do not believe that credit card debt,
either before or after bankruptcy, stands in the same. position as
support debt with respect to its collectibility. Support collection
advantages outside of (or after) bankruptcy competitively overwhelm
financial institutions. For example the following post-bankruptcy
collection advantages are available to support creditors, and not to
credit card or other financial institutions:
a. Priority wage withholding to collect support. This advantage
is stunning. It means that whenever a wage garnishment is filed
by a support creditor, it will assume immediate priority over
any other garnishment, no matter when filed. And since the S.
220 allows wage withholding to continue or be implemented after
the bankruptcy has been filed, the collection of support in the
normal case will never be held hostage to bankruptcy, before,
during, or after the case is completed.
b. Interception of state and federal tax refunds to pay child
support arrears.
c. Garnishment or interception of Workers' Compensation or
Unemployment Insurance Benefits.
d. Free or low cost collection services, provided by the
government.
e. Use of interstate processes to collect support arrearage,
including interstate earnings withholding orders and interstate
real estate liens.
f. Revocation or suspension of driver's, professional and
recreational licenses of support delinquents.
g. Criminal prosecution and contempt procedures for failing to
pay support debts.
h. Federal prosecution for nonpayment of support and federal
collection of support debts.
i. Denial of passports to support debtors.
j. Automatic treatment of support debts as judgments which are
collectible under state judgment laws, including garnishment,
execution, and real and personal property liens.
k. Collection of support debts from exempt assets.
While this list is not exhaustive, it is certainly illustrative of
the vastly superior advantages of support creditors over commercial
creditors. For these reasons I do not consider S. 220 as a mechanism
for aggravating the problem of collecting post-bankruptcy support
debts.
Agencies, such as mine, operating the federal child support
enforcement program are funded in part by incentives based on
collections. We would hardly be advocating a bill which had the
potential of reducing post-bankruptcy collections and consequently
funding incentives. It is for this reason that the following national
organizations, whose membership consists mostly of persons employed in
or funded by the federal support enforcement program, support this
bill.
a. The National Child Support Enforcement Association
b. The National District Attorneys Association
c. The National Association of Attorneys General
d. The Western Interstate Child Support Enforcement Council
The National Child Support Enforcement Association, alone,
represents over 60,000 child support professionals in this country. I
attach their letter of support asking the President to sign last year's
version this bill.
One final note. The National Bankruptcy Conference contrasts the
96% success rate in collection by credit card companies with the rather
dismal support collection rate for women. On its face this statistic is
absurd because it deals with two distinct populations. To be fair we
would have to ask what the credit card company collection rate is for
persons already in economic trouble and not paying support. What
percentage of people owing child support even have credit cards. And
since support agencies must report support delinquents to credit
reporting agencies, persons with significant support debt will not be
issued credit cards in the first place. What's more, even as to those
``deadbeats'' who could, but are not, paying support but who are paying
credit card debt to retain their cards, I have the strongest doubts
that they would commence paying their support debts simply because
their credit card debt was extinguished. If history has any
significance, those credit cards would simply be reloaded with consumer
debt.
Therefore I am not at all impressed by the significance that the
general credit card population pays its bills. I am more concerned that
this comparison makes tacit assumptions which are just illogical, if
not, in fact, dead wrong. The most ill advised assumption being the
supposition that the payment characteristics of the general credit card
population have any relevance to the general support debtor population.
I hope this letter answers the issues raised by the National
Bankruptcy Conference. If you have any other questions please do not
hesitate to contact me.
Yours very truly,
Philip L. Strausss
Principal Attorney
Department of Child Support Services
cc. Hon. Orrin Hatch, Chairman, Senate Judiciary Committee
Responses of K.H. Beine to Questions submitted by Senator Feingold
Shoreline Credit Union
Two Rivers, WI 54241-0233
Jane Butterfield, Committee Liaison
US Senate Judiciary Committee
FROM: K H Beine
Re: Written Questions from Senator Russ Feingold, Bankruptcy Abuse
Prevention Legislation
Question 1: Testimony focused on means test, reaffirmations and
mandatory credit counseling. Reaction to other provisions of S. 220.
While my testimony focused on three specific issues as CUNA's
priorities in S. 220, we recognize that the bill is the product of many
years of debate and compromise. Because it is balanced between many
interests, it is not perfect for any particular group. And because of
that balance, CUNA is reluctant to pick apart individual parts of the
bill at this stage of the legislative process.
I assume your question regarding the nondischargeability of credit
cards refers to section 310 of the bill. This is a fairness issue. We
are unusually careful with respect to granting credit including credit
card limits. In addition we bend over backwards to assist members in
trouble. Yet despite those efforts we often times loose along with
everyone else when someone decides that it is no longer convenient to
repay their debts. A debt is a debt. If the person has the ability to
repay, then whether something was purchased on time payments or viii a
check that bounces or via a credit card, the debt should be repaid.
Regarding your question on section 311 of the bill, credit unions
are sympathetic to the needs of housing for people. There are practical
difficulties, however, with this issue. Experience has shown that some
people, as a planning tool, file bankruptcy just to stop eviction
proceedings. Somehow this doesn't seem fair.
With respect to the provision on cramdowns, if it does not remain
in the bill it would make auto credit terms for future borrowers that
much tougher.
Question 2: Testimony regards Shoreline Credit Unions banlauptcy
experience.
Before I answer your questions, I both have to commend you for your
astute observation and apologize for an incorrect number on the Pact
Sheet that accompanied the written testimony. Shoreline Credit Unions
losses due to bankruptcy for the 2000 calendar year were $64,186.
Shoreline's losses due to bankruptcy are very low and are not
material at the present time. However they have never the less doubled
each of the last three years. And yes, (and I thank you for your kind
comments) that is despite the fact that indeed we are careful lenders
and do evaluate our loan applicants with great care.
So, doubling or not, if below the national average, why am I
concerned? We can absorb one more doubling within our present operating
cost structure. However if losses double twice rnore we will be at
$250,000. That is hs1f our credit unions net earnings in recent years.
Game over.
We are a $50M credit union. Our deposit base on average grows about
10% per year. Credit unions, like banks, have minimum regulatory
capital requirements. However our earnings are our only source of
additions to capital. We cannot sell stock to bring in outside capital
as other financials. We therefore need to earn a ROA, Return on Assets,
of approx 1.00% per year to maintain a reasonable 8-12% capital ratio.
If losses reach the $250k mark as noted above, I will have no choice
but to increase general loan interest rates to recover this ``cost of
doing business''.
Who will pay those increased rates? Everyone to a certain extent,
which is not fair, but for the most part those members who can least
afford it. How will it be done? By applying ``risk: lending''
procedures, i.e. charging higher rates to those debtors who because of
past credit problems and already high debt ratios present a higher risk
and have a propensity to generate losses.
With respect to your position that perhaps the private sector could
fix the current ``bankruptcy crisis'' with more careful lending, T do
not believe that is possible. First of all the general ``tightening''
of credit across the country that would be necessary to accomplish that
would, in my opinion, be detrimental to the economy. (And in all
probability hurt many in the lower income areas who most need ready
access to credit.) And second the comfortable and repeated use of
bankruptcy as a financial management tool has become so pervasive that
I do not think drat the private sector can stem the tide on its own.
Question 3: Reaffirmation agreements.
While credit unions continue to enjoy a substantially higher
reaffirmation rate than other financial entities, the number of rations
is on the decrease. For example, in our case, prior to the mid 1990's
Shoreline enjoyed an almost 100% reaffirmation rate. Reaffirmations are
now running approx 50%. Why the drop? Often times the debtor's anorney
argues against reaffirmation or flat out refuses to sign the agreement.
And it takes a rare individual, regardless of what we may have done for
them; to voluntarily repay a debt that has been discharged.
CUNA has no objection to a standardized form that assures debtors
are getting full disclosure. And credit unions, like all other
creditors, will be required by the bill to provide a reaffirmation
disclosure to their members who agree to reaffirm a debt that would
otherwise be discharged in bankruptcy. This provision was added at the
insistence of the Clinton Administration to address concerns about
abusive and coercive reaffirmations.
But credit unions have not been found to be part of the problem, so
S. 220 recognizes the unique relationship between credit unions and
their members in negotiating reaffirmation agreements in good faith.
Therefore, a reaffmnation agreement filed with the court between a
member represented by counsel and the credit union will not have to
include a specific schedule of income and expenses, and will never
raise a presumption of an undue hardship for a credit union member
reaffirming a credit union debt, which would be subject to review by
the bankruptcy court. This exception for credit union reaffirmations is
appropriate because credit unions don't seek reaffirmation agreements
unless they feel the member is able to repay the loan and the member
will benefit by receiving future financial services from the credit
union, rather than have to seek them elsewhere at a steep premium.
Regarding the inquiry of whether abusive reaffirmation agreements
would put credit unions at a disadvantage, we are confident that with
the changes in this bill and with the numerous laws already on the
books, there is ample protection for the consumer in this area. There
are legal firms as well as the various consumer watchdog groups that
stand ready, willing and able to make any transgressor pay an onerous
price for noncompliance.
1 thank you for the opportunity to be able to assist you with
respect to your position on this important legislation. Please contact
me if you have any additional questions.
[Note: Revised Fact Sheet attached.]
FACT SHEET [Revised 2-19-2001]
Total Assets: $50.5 million (data as of December 2000)
Members: 11,700
Total Loans: 38.0 million
Losses Due to Bankruptcy:
2000 522,375 s/b $64,186 [khb 2/19/01]
1999 534,577
1998 15,309
1997 9,883
1996 1,875
Number of
Filings: Chapter 7 Chapter 13 Total
2000 10 0 10
1999 7 1 8
1998 5 0 5
1997 3 0 3
1996 1 0 1
Responses of Randall J. Newsome to Questions submitted by Senator
Feingold
United States Bankruptcy Court
Northern District of California
Oakland, California 94612
Senator Russ Feingold
506 Hart Senate Office Building
Washington, DC 20510-4904
Dear Senator Feingold,
This letter will serve as my response to the written questions you
submitted to me on February 20, 2001. Your first question asks whether
S. 220 ``will essentially destroy Chapter 13 as an option for debtors
who wish to keep their cars. . . '' As I stated in both my written
and oral testimony, I believe that the ``anti-cramdown'' provision in
Sec. 306(b) of the bill will destroy the incentive for many debtors to
file a chapter 13 case. When Sec. 306(b) is combined with Sec. 314(b),
which eliminates the enhanced discharge presently afforded by chapter
13, only those debtors seeking to save a home from foreclosure will
find chapter 13 a reasonable option.
A hypothetical will illustrate why Sec. 306(b) will hurt both
debtors and creditors. Suppose in 1998 Mr. Jones, who is single and
lives in an apartment, purchased a 1994 Dodge for $15,000 on credit. At
the time he bought the car, its fair rnarket value was only $12,000,
but because of his poor credit rating, he was forced to pay
substantially over market Because he can't afford the payments on the
Dodge along with his other monthly payments, he files a chapter 13 case
in 2001. At the time he files, he still owes $10,000 on the car, and he
has other unsecured debts totaling $4000. Without counting payments on
his debts, his monthly income exceeds his monthly expenses by $240 per
month. The real fair market value of the car at the time of filing is
$5000. Under present law Mr. Jones could write down the value of the
Dodge to $5000 in his chapter 13 plan. Assuming he proposes a plan to
pay $240 a month over 36 months, be would be able to pay $5000 plus
interest to the secured creditor, and repay a meaningful portion of his
unsecured debt over the life of the plan. But under Sec. 306(b) of S.
220, Mr. Jones would be forced to pay all $10,000 of the remaining
contract price on the car, because he bought it within five years of
filing his chapter 13 case. This is true even though the car is now 7
years old, and the creditor would get substantially less than its
present value of $5000 if the car were repossessed and sold. Depending
on the interest rate on the Dodge debt and the chapter 13 trustee's
commission, Mr. Jones might not even be able to propose a plan that
would pay off the car, pay nothing to his unsecured creditors, and be
completed within the 60-month time limit for chapter 13 plans. He would
be much better off allowing the secured creditor to repossess the
lodge, tile a chapter 7 case, and attempt to buy a newer car, even
though the interest rate undoubtedly would be exorbitant. 'thus,
neither the secured nor the unsecured creditors are paid what they're
owed, and the debtor is back in a debt trap. No one benefits.
Your second question concerns the problem of repeat filers. I view
this as one of the most serious abuses of the bankruptcy system. It has
been most severe in the Central District of California. Nonetheless, I
would urge cautioxl in attempting to correct it. No one would seriously
argue against amending the bankruptcy code to target those who file
repeatedly just to stop a foreclosure or an eviction. But many repeat
filers are forced to file a second petition because their first case
was dismissed for reasons beyond their control, such as the
incompetence of a bankruptcy petition preparer. I have read your
proposed amendment to S. 220, and believe it strikes the appropriate
balance. It protects the rights of imocent tenants, while preserving
the right of a landlord to rid themselves of a bad tenant without the
legal expense of seeking relief from the automatic stay in bankruptcy
court.
Please don't hesitate to contact me if I can be of further
assistance.
Very truly yours,
Randall J. Newsome
Responses of Philip L. Strauss to Questions submitted by Senator
Feingold
Department of Child Support Services
San Francisco, CA 94105
Honorable Orrin G. Hatch, Chairman
Senate Judiciary Committee
U. S. Senate
Dirkson Senate Building, Room 224
Washington, D.C. 20510
ATTN: Jane Butterfield
Re: Questions Submitted By Senator Russ Feingold For Phillip L. Strauss
Dear Senator Hatch:
A facsimile transmission was received by my office requesting
answers to three questions submitted by Senator Feingold February 22,
2001. I was attending a conference the week these questions were
submitted so I am submitting the answers somewhat late.
Question 1. Are you aware that in 95% of bankruptcy cases there are
no distributions to any creditors at all because there are no assets to
distribute?
Answer: That statistic is generally considered to be accurate for
Chapter 7 cases, which overall constitute about two thirds of all
bankruptcy filings. However, in Chapter 7 the debtor's earnings, after
he files bankruptcy, are not part of the distributions in the case. It
is from those earnings that the spouse or children will normally
receive their support payments. Therefore, that statistic is somewhat
irrelevant for support collection purposes in Chapter 7 cases. In
Chapter 13 cases, which comprise almost all of the remaining one third
of bankruptcy petitions, the filings do directly affect the debtor's
ongoing wages which are estate assets. The proposed amendments would
specifically require that the debtor provide for full payment of
ongoing support obligations and satisfaction of all arrears in order to
have a plan confirmed, unless the spouse agrees otherwise.
In San Francisco our actual experience is quite different from the
statistic you cite. This morning I had our office run a report of all
bankruptcy cases in the San Francisco Department of Child Support. The
results indicated that 530 of the bankruptcy cases our system are
Chapter 13 cases. Thus, among child support debtors, 53% of the cases
have assets. I cannot believe that San Francisco differs that much
statistically from the general support-debtor population which files
bankruptcies.
Chapter 13 cases give us the most trouble because of the severe
collection limitations placed even on support creditors during
bankruptcy. In Chapter 13 cases we truly are placed in unfavorable
competition with other creditors and must wait until secured. creditors
and administrative costs are paid before priority and then unsecured
debts are paid. Much child support consists of general unsecured debts
as of the petition date, and consequently it is the last paid, if paid
at all. S. 220 will insure that all child support is treated as a
priority debt, insuring its full payment during the term of a chapter
13 plan, as set forth above.
In addition, S. 200 would cause more debtors to file Chapter 13
cases and thus give support creditors the additional protections
afforded by many of the child support provisions of the bill.
Question 2. Do you understand that this bill will elevate some
unsecured credit card debt, namely a debt which is found to be
nondischargeable and debt that is reaffirmed, to the same position
after bankruptcy as child support and alimony?
Answer: I do not believe that credit card debt, either before or
after bankruptcy, stands in the same position as support debt. Also,
this bill does not change the relative position of support debt and
reaffirmed debt, since discharged debt can now be reaffirmed.
In trying to determine whether the existence of postbankruptcy
credit card debt will affect the collection of support debt adversely,
I can only say that no professional support collector believes this to
be a problem. Your question asserts that credit card debt will be
``elevated'' to the same position as support after bankruptcy. If by
this statement you mean that some limited additional amount of debt may
be held nondischargeable, in addition to the amounts that may already
be so held, then you are correct. But support collectors have enormous
advantages in collecting their debts, compared to other unsecured
creditors in the nonbankruptcy arena. Nonsupport debts will not,
however, be elevated to an equal collection status with support debts.
As I have said many times, professional support collectors are not
concerned with the existence of other debt. Support collection
advantages outside of (or after) bankruptcy competitively overwhelm
financial institutions. For example the following post-bankruptcy
collection advantages are available to support creditors, but not to
credit card or other financial institutions:
a. Priority wage withholding to collect support.
b. Interception of state and federal tax refunds to pay child
support arrears.
c. Garnishment or interception of Workers' Compensation or
Unemployment Insurance Benefits.
d. Free or low cost collection services provided by the
government.
e. Use of interstate processes to collect support arrearage,
including interstate earnings withholding orders and interstate
real estate liens.
f. Revocation or suspension of driver's, professional and
recreational licenses of support delinquents.
g. Criminal prosecution and contempt procedures for failing to
pay support debts.
h. Federal prosecution for nonpayment of support and federal
collection of support debts.
i. Denial of passports to support debtors.
j. Automatic treatment of support debts as judgments which are
collectible under state judgment laws, including garnishment,
execution, and real and personal property liens.
k. Collection of support debts from exempt assets.
while this list is not exhaustive, it is certainly illustrative of
the vastly superior advantages of support creditors over commercial
creditors. For these reasons I do not consider S. 220 as a mechanism
for ``elevating'' credit card debts to the position of support debts
after bankruptcy in any sense of the word. Moreover, absent passage of
the changes contained in S. 220, the government is currently precluded
from using many of these techniques while a bankruptcy case is
pending--a fact that currently makes bankruptcy a haven for
recalcitrant spouses and parents.
Question 3. Explain what is wrong with the position taken by 116
law professors who wrote the Senate last year, that the most important
issue for women and children raised by this bill is that it will make
is much more difficult for them to reach an ex-husband's income after
that ex-husband goes through bankruptcy?
The short answer is that nothing about 5.220 makes it more
difficult to reach the husband's income post-bankruptcy in that nothing
about the bill affects post-bankruptcy activities in that regard.
Rather, as described above in question 2, support creditors continue to
enjoy substantial advantages in being able to collect from the former
spouse's post-discharge income. Perhaps, a more salient question is how
many of these law professors have ever actually enforced a support
obligation? I, and thousands of my colleagues, do it every day and take
pride in obtaining that support, under difficult circumstances, for the
children who are entitled to it. We know where the problems lie and
would hardly be supporting legislation which would make the collection
of that support more difficult. The support provisions of this bill are
supported by:
a. The National Child Support Enforcement Association
b. The National District Attorneys Association
c. The National Association of Attorneys General
d. The Western Interstate Child Support Enforcement Council
With respect to the effect of this bill on support collection, if
we are just counting numbers of supporters and adversaries, one need
look no further than the National Child Support Enforcement Association
which urged the President to sign it last year. This organization
represents over 60,000 child support professionals in this country with
the daily hands-on experience to know where the problems lie and what
changes they would like to see made to address those problems. While no
bill is perfect, we believe the changes made to the domestic support
provisions of the Bankruptcy Code by this bill are an overwhelming
improvement over the current law.
If you have any other questions please do not hesitate to contact
me.
Yours very truly,
Philip L. Strauss
Principal Attorney
Department of Child Support Services
Responses of Todd I. Zywicki to Questions from Senator Feingold
Question 1: Concerning the proposed means test in S. 220, you
stated that ``we've identified about 7 to 10 percent of filers who
would be affected by the means test. . . .We're talking about
recovering $3 billion, roughly, that would otherwise be discharged [in
Chapter 7].''
(A) What is the source of your statement?
Answer: My statement is based on a composite assessment of the
various studies that have been done to try to estimate the impact of
means-testing generally. It is difficult to establish a precise figure,
as the various studies were conducted according to different versions
of means-testing that have been proposed over the past several years.
Nonetheless, the February 1998 Ernst & Young study using 1992-93 data
concluded that about 15% of filers would be affected by means-testing.
The March 1998 Ernst & Young study again concluded that about 15% of
filers would be affected. A study by the Credit Research Center in 1997
concluded that 5% of the filers in its study could have repaid 100% of
their debts over five years and that approximately 25% of filers could
have repaid 30% or more of their debts. A study by Marianne Culhanne
and Michaela White that was sponsored by the American Bankruptcy
Institute concluded that approximately 7% of the debtors in their
sample would have been affected by means-testing. It has been reported
that this last study found that only 3% of filers would be affected,
but that conclusion was based on a patent misunderstanding of the IRS
guidelines that will apply to means-testing. In particular, it is based
on the erroneous belief that the IRS guidelines would actually allow a
debtor to buy a new car while in bankruptcy, an interpretation of the
IRS guidelines that is simply incorrect. Once this error in the
interpretation of the automobile exception is corrected, the final
figure, as noted rises to approximately 7% of the sample. Also, the ABI
study was of substantially poorer quality than the other studies, as
that study was smaller in size, drawn from fewer districts, and based
on older data than the other studies. As a result, the results of the
ABI study are not as probative as the other studies. Nonetheless, its
conclusions are consistent with the findings of the other studies once
its erroneous assumptions are corrected. I chose the figure of ``about
7 to 10%'' as a conservative assessment to convey that the estimates
were tentative but that most of them fell within this range or above.
(B) What did you do to ``identify'' the 7 to 10 percent of Chapter
7 cases that would be ``affected by the means test''?
Answer As noted, I relied upon a composite of studies conducted by
researchers and did not conduct my own study.
(C) Particularly, with respect to the $3 billion that you say
would be recovered under the proposed means test, where can we find the
statistical evidence for that claim?
Answer: A 1998 study by the WEFA Group concluded that means-testing
would recover $3.6 billion to $7.4 billion that is currently discharged
in bankruptcy. The March 1998 Ernst & Young study concluded that the
WEFA, study likely underestimates the amount of debt discharged in
Chapter 7 and that is also underestimates the amount that would be
recovered by means-testing. Those studies were both based on assuming
that those. making 75% of the national median income would be eligible
for means-testing, rather than the current standard of 100% of state
median income. This adjustment might exclude a handful of filers with
some modest repayment capacity, but would not likely have a large
effect on the overall amounts recoverable. Given this, I chose the
figure of $3 billion as a conservative estimate of what these studies
suggest could be recovered in bankruptcy according to the current
version of the means-test.
Responses of Dean Sheaffer to Questions submitted by Senator Feingold
Dear Chairman Hatch:
I am in receipt of your February 20, 2001 correspondence forwarding
written questions submitted by Senator Feingold regarding my recent
testimony in support of S. 220. My responses follow.
Question 1: Your testimony on behalf of the National Retail
federation focuses exclusively on abuse of the bankruptcy system by
debtors and does not make any mention of the fact that quite a few
retailers have admitted to committing bankruptcy fraud on a widespread
basis.
Question 1 A: Has your company engaged in any postbankruptcy
collection acti vity without filing reaffirmation agreements?
Answer: Boscov's maintains policies that require compliance with
local, state and federal statutes and regulations, including federal
bankruptcy taw.
Question 1B: Do you think that the current laws suporvising
reaffirmation agreements have been adequate?
Answer: Yes. The sufficiency of the current supervision is
evidenced by the fact that retailers accused of reaffirmation
violations have been identified and fined up to approximately one-third
of a Billion dollars.
Question 1C: Do you have a problem with requiring court review of
all reaffirmation agreements, rather than only those that are made by
debtors who don't have counsel?
Answer: With over one million bankruptcy filings each year, we view
this is an unnecessary burden to the court system. Debtors' counsel
have a clear obligation to protect their chonts' interests.
Question 2: In your testimony you conclude that our current
bankruptcy laws cost the average American family hundreds of dollars
each year.
Question 2A: How do you arrive at that figure?
Answer: Total annual bankruptcy losses are more than $40 Billion.
There are approximately 100 million U.S. households; thereforc, the
average annual loss per household is approximately $400.
Question 2B: Assuming that it is simply based on the amount of debt
discharged in bankruptcy, do you agree that if the laws are changed and
fewer Americans file for bankruptcy and less debt is dischargoablc, the
cost the bankruptcy laws to the American consumer may not necessarily
drop? In other words, do you recognize that them are other costs and
effects of the laws that ought to be considered by policy makers?
Answer: We recognize that there are other factors that may effect
the ``net'' benefit of bankruptcy reform to American consumers. We
believe that these have been--fully considered by Congress over the
course of the last five years. S. 220 carefully balances these factors.
Question 3: You said in your testimony that ``over $40 billion was
written off in banlauptcy losses last year, which amounts to the
discharge of at least $110 million every single day.'' Please provide
us with the documentation or source for the statistics in your
statement.
Answer: It has been widely reported that annual bankruptcy losses
are between $40 Billion and $45 Billion. $42.5 Billion divided by 365
days is greater than $110 Million.
Question 4: Your testimony focuses on the importance of the means
test. As you know, S. 220 which you endorse in your testimony contains
many other provisions.
Question 4A: Are the bill's provisions that expand the
nondischargeability of credit card debt important to your support of
the bill?
Answer: Retailers see many cases where unnecessary purchases of
luxury goods are made in preparation for bankruptcy. The marginal
changes in the existing nondischargeability provisions will prevent the
costs of such abuse from being ``transferred'' to American consumers as
a whole.
Question 4B: Do you think that the bill's provision that deny the
bankruptcy stay to tenants who are facing eviction and would actually
be able to pay their rent during the bankruptcy are necessary to
address the retailers' concem with the bankruptcy system?
Answer: Retailers have not advocated in favor or against this
provision. We understand that there are strongly felt, and well
founded, views on both sides. The current provision is part of a
heavily negotiated and carefully balanced bill which attempts to
address the interests of debtors, creditors, and the public at large.
The NRF supports swift passage of S. 220 without additional amendment.
Question 4C: To get your support, does the bankruptcy reform bill
have to contain the provisions of S. 220 that inflate the value of
secured debt by denying cramdown or stripdown of car loans taken out
within 5 years of a bankruptcy filing?
Answer: This provision is part of a heavily negotiated and
carefully balanced bill which attempts to weigh not only the interests
of both debtors and creditors, but the competing interests among
creditors as well. The NRF supports swift passage of S. 220 without
additional amendment.
Question 4D: Could you support a bankruptcy bill that includes a
means test and reaffirmation provisions, even if it didn't contain all
of these provisions mentioned above, about which consumer advocates and
law professors have been so concerned?
Answer: The provisions mentioned above address genuine misuses of
the current law in a reasonable and balanced fashion. While some
individuals believe that the final product does not go as far as they
would like, others believe it goes too far. Retailers believe that
whatever the bill's alleged shortcomings, it is a significant
improvement over the present abuse-prone system.
Responses of Brady C. Williamson to Written Questions
Question 1: How would the means test in the bill affect families
with extraordinary medical expenses?
Answer: The means test in the bill does not provide any flexibility
in its application to take into account extraordinary medical expenses.
The bill, in section 102, establishes a means test that applies
regardless of the reason for a family's financial difficulty. It
applies with equal force, in this regard, to the honest but unfortunate
debtor and to the debtor determined to defraud creditors. The bill
should be amended to provide an exemption from the means test for
families forced into bankruptcy by extraordinary medical expenses.
Question 2: What is your view of the reaffirmation provisions in S.
220? Are there improvements to be made to these provisions that will
make them more effective in combating creditor abuse?
Answer: While the bill makes slight improvements in the
reaffirmation process, it does not address the more fundamental,
problems, problems that became painfully evident with the criminal and
civil penalties imposed on several of the country's leading retailers
for reaffirmation abuse. Some creditors use the ``carrot'' of
additional credit to turn dischargeable debt into nondischargeable debt
whether or not the debtor can afford to continue to make payments.
Others use the ``stick'' by threatening to ask the court to declare the
debt nondisehargeable, litigation the debtor cannot afford to defend.
The reaffirmation process does not involve parties with equal
bargaining power or equal sophistication. The 1975 bankruptcy
commission recognized this when it recommended the abolition of
reaffirmation agreements. The 1997 commission essentially reiterated
this recommendation.
Some of the provisions in the bill actually increase the need .for
stronger reaffirmation protection. With more debt nondischargeable
under the bill than under current law, the post-bankruptcy burdens of a
debtor will be greater. That decreases the debtor's ability to make
post-bankruptcy payments on debt that has been. reaffirmed,
jeopardizing the prospects for a successful Chapter 13 proceeding. New
provisions in the bill provide additional opportunities For aggressive
creditors to threaten actions against debtors, which they can
``settle'' by taking reaffirmation agreements. The bill's reaffirmation
provisions, as written, do not curb abuses. Rather, they only
standardize reporting and procedures.
Yes, improvements can and should be made in the bill. The
bankruptcy courts should have to evaluate reaffirmation agreements, as
they did from the enactment of the bankruptcy code in 1978 through
1984, asking whether the debtor has the capacity to meet his/her
obligations and still give preferential treatment to one creditor in a
reaffirmation agreement. The law should require the court particularly
to determine if the debtor can make reaffirmation payments and still
satisfy his or her obligations to a current or former spouse and their
children. In addition, other creditors who are entitled to depend on
the debtor's income for payment in a Chapter 13 or after a Chapter 7
bankruptcy also should be protected.
At the very least, the bill should be amended to require court
approval for reaffirmation agreements with any debtor who has spousal
or child support or other family obligations. While this would not
restore the reaffirmation provisions of the code to their 1978 status,
it would protect those most vulnerable to an improvident reaffirmation
agreement and their other creditors.
Responses of the Administrative Office of the Courts to Questions
submitted by Senator Leahy
Question 1: I recall last year the Congressional Budget Office
estimated that it would cost $218 million over the 2000-2004 period to
implement the new bankruptcy--provisions of S. 625. Have you or the
Administrative Office of the Courts made any estimates about how many
millions of taxpayer dollars would be required to meet the mandates of
this year's bill, S. 220?
Answer: The Congressional Budget Office (CBO) estimate of $218
million to implement the provisions of S. 625 is a government-wide cost
estimate. We defer to CBO with regard to the estimate of government-
wide costs to meet the mandates of S. 220. Extrapolating from the
analysis of S. 625 by the Congressional Budget Office, the
Administrative Office has estimated that implementation of S. 220 would
cost the judiciary approximately $104 during the five-year period
following enactment of the bill, and in some instances, following a
delayed effective date. This figure is obtained as follows:
Data collection.................... ............... $30 million
Maintaining income tax returns..... ............... 9 million \1\
New judgeships--...................
discretionary costs............ $51 million.....
(administrative costs).......
mandatory costs................ $14 million.....
(salaries and expenses)......
.................................. ............... 65 million \2\
------------------------------------
Increased cost..................... ............... $104 million
Although your question does not specifically raise the issue of
lost revenue, the bill as introduced would revise filing fees in
chapter 7 and chapter 13 cases and re-allocate a portion of the
revenues derived from those fees from the judiciary to the United
States Trustee program. We estimate this loss in revenue to exceed $25
million over the next five years. This is as ``real'' a cost as a
required increase in outlays, When this figure is added to the direct
cost imposed by the bill, our total cost approaches $130 million, all
of which will require an increase of judiciary appropriations.
---------------------------------------------------------------------------
\1\ The provision in S. 625 regarding the maintenance of tax
returns would have required all chapter 7 and chapter 13 debtors to
file three-years tax returns with the bankruptcy court. CBO estimated
this cost to the judiciary to be approximately $34 million over five
years. The analogous provision of S. 220 requires a debtor to file tax
returns only upon request of a creditor. CBO estimates that.this
provision, when compared to its predecessor, could result in savings of
as much as $25 million, depending upon the number of cases in which
creditors seek access to the returns. Thus, assuming a best case
scenario, the pending bill would impose a cost of approximately $9
million upon the judiciary.
\2\ Analyzing the judgeship provision of S. 625, CBO determined
that the creation of 18 new bankruptcy judgeships would cost $40
million in discretionary spending and $11 million in mandatory spending
over the next five years. Extrapolating these figures to determine the
cost of 23 new judgeships, as would be created by S. 220, yields $51
million in discretionary spending and $14 million in mandatory
spending, for a total of $65 million.
Question 2: Do you have any other legislative proposals to improve
provisions in the current bankruptcy reform legislation besides the
direct appeal provision?
The bill as introduced would create 23 new temporary judgeships and
extend the terms of four existing temporary judgeships. The Judicial
Conference recommends creation of the 23 judgeships currently in the
bill as well as two others--one in the district of Maryland and one in
the district of South Carolina. It further recommends that 13 of these
judgeships be created on a permanent basis and the other 12 on a
temporary basis; that the existing temporary judgeships in the district
of Delaware, district of Puerto Rico and northern district of Alabama
be converted to permanent positions; and, that the temporary judgeship
in the eastern district of Tennessee be extended for a period of five
years.
Reason: Creating temporary judgeships where permanent judgeships
are clearly needed detracts from the most efficient administration of
the bankruptcy code. Extending temporary judgeships for very short
periods of time is also bad policy. The fact that South Carolina lost a
judgeship in January 2000 although that judgeship is needed points up
this problem. Congress has not created a new bankruptcy judgeship since
1992. Future Congresses should not be ``forced'' to frequently pass
``temporary judgeship extension'' bills, particularly when the failure
to act is not in the public interest.
We recommend deletion of the provision that would revise filing
fees (which were revised only 14 months ago) and re-allocate revenues
derived from those fees from the judiciary to the United States Trustee
program. This provision would have the effect of depriving the
judiciary of approximately $25 million over the next five years.
Reason: The judiciary expends significant funds administering the
bankruptcy code. In recognition of this fact, in 1999, Congress, acting
on the decision of the Senate and House Appropriations Committees,
increased certain bankruptcy filing fees and allocated the revenues
derived from those fees with due regard to the costs of both the
judiciary and the United States Trustee program. S. 220 re-opens that
decision by again revising fees, reducing judiciary revenues, and
significantly increasing income to the United States Trustee program.
The decision to reduce judiciary revenues disregards the rationale
underlying current law and ignores the $104 million five-year cost
increase that the enactment of S. 220 will levy upon the judiciary.
We recommend re-assigning the responsibility for collection of
financial data on debtors from the judiciary to the United States
Trustee program as an adjunct to its responsibility to conduct audits
under the bill.
Reason: Having financial data collected by United States Trustees
would have two significant benefits. First, it would yield audited, and
thus accurate, data. By contrast, having bankruptcy clerks collect the
data from schedules and statements filed by debtors at the outset of
cases will result in unreliable data. Data filed by debtors, in many
instances without the assistance of a lawyer, frequently inaccurately
values assets and liabilities; further, some debt simply cannot be
valued definitively at the outset of a case because it is unliquidated,
contingent or disputed. Second, since data would be collected by
Trustees as part of its audit system, it would be collected at a
fraction of the cost of C5tab11tshlng a new system for this purpose in
each clerk's office.
We recommend re-assigning the responsibility to maintain income tax
returns from the bankruptcy clerks to the United States Trustees.
Reason: In order for the courts to meet this new responsibility, it
will be necessary to establish a new filing system in each clerk's
office, separate and apart from public case files, in order to
safeguard the security of the records and control access to them as
required by the bill. Since the Trustees' files, unlike court files,
are not publicly available, the Trustees would be able to meet this
responsibility without the costs and administrative burdens associated
with establishing and maintaining new filing systems.
We recommend extending the date for initiating collection and
reporting of case event statistics.
Reason: Docket sheet information in bankruptcy cases is reported to
the Administrative Office through the electronic case management
systems of the courts. The current systems are nearing the end of their
useful lives and are an a schedule to be replaced. These systems cannot
collect additional information of the sort required by this bill
without costly upgrades that would divert resources from the new
replacement system that is in the process of being deployed in the
bankruptcy courts. Since the new system will not be deployed in every
court for three and a half years, this provision should be revised to
take effect 48 months after enactment of the legislation.
Finally, we recommend deletion of provisions regarding revision of
bankruptcy rules.
Reason: Two provisions of the bill, sections 102 and 319,
inappropriately impact Bankruptcy Rule 9011 and, if enacted, would
cause confusion and needless satellite litigation. Six other provisions
require the Supreme Court or the Judicial Conference or the Advisory
Committee on Bankruptcy Rules to promulgate a rule or official form.
Directing the Judicial Conference or one of its committees to amend a
particular rule or form bypasses the Rules Enabling Act process and
needlessly undercuts the proper role of the Judicial Conference and its
committees, the bench and bar, the public, and the Supreme Court in
that process. Furthermore, these provisions are unnecessary because the
Advisory Committee on Bankruptcy Rules automatically reviews any
legislation amending the bankruptcy code to identify and prescribe
necessary amendments to rules and forms.
Responses of Robert D. Manning to Questions submitted by Senator Leahy
As per your request, the following is my response to your questions
regarding recent trends in consumer bankruptcy. This information is a
follow-up to my testimony before the Serrate Judiciary Committee on
February 8, 2001. I respectfully request that these questions and
answers be added as an addendum to my testimony.
Question 1, Part A: ``Over the last 15 years, how have the
marketing and lending practices of the credit card industry changed in
regard to college students?''
Question Part B: ``Have these policies contributed to greater
student credit card debt? ''
Answer: Due to the onset of banking deregulation (beginning in
1980, e.g. elimination of Regulation Q) and massive loan losses of the
major money center banks due to questionable underwriting policies with
`third World countries as well as U.S. commercial/residential loan
losses during the 1989-91 recession, the banking industry found that
credit cards were one of their most profitable lending activities after
doubledigit inflation subsided following the 1981-82 recession. As
banks began expanding the marketing focus of revolving credit cards
after the recession, such as soliciting lower income, blue-collar
households that were coping with un- and underemployment during the
restructuring of manufacturing industries, they realized that the most
neglected and potentially profitable market niche was middle-class
college students.
Until the late 1980s, the standard industry practice required that
students had to have their parents or guardians co-sign the credit
cardholder agreement, unless the student demonstrated sufficient income
to pay for the modest line of credit. At the same time, the first
exclusive marketing agreements were being negotiated for modest sums
with college administrators, beginning with MBNA and its agreement with
Georgetown University in the early 198Os, but this was solely for
employed alumni.
As credit card and retail companies sought to expand from college
alumni into the college student market, they began soliciting to
college seniors who were 21 years old and soon to enter the job market.
That is, the lending risk was relatively low with the assumption that
college seniors had one foot in school and the other foot looking for a
job. Typically, these student ``kiddie'' cards offered credit in the
$200-$500 range, most were around $300. Hence, the industry was
concerned about lending money to unemployed students based on the
uncertainty of--the student cardholders' ability to repay. By ensuring
repayment through parental co-signature, the industry faced the trade-
off of low risk in its underwriting standards and limited profits since
students' consumption would be monitored by their parents and thus
their behavior would still be influenced by ``family values'' and
parental authority.
By the late 1980s and especially during the 1989-91 recession, the
credit card industry discontinued its requirement of parental co-
signature anal aggressively marketed credit cards on campus. In 1990,
Citibank was nearly insolvent (low Tier 1 capital reserve levels) due
to its unperforming.Third World and commercial/residential lending
loans and end of cheap capital due to the phase-out of Reg Q. However,
credit cards in general and college students in particular were
yielding sharply rising profits. As a result, students were directly
solicited through the mail, campus bulletin boards, inserts in book
store bags, and the growing presence of direct marketers such as
application booths or on-campus fundraisers such as fraternity and
sorority programs. Significantly, my research shows that few students
graduated in the early 1990s with high credit card debts; rare was a
student with $5,000 in debt and most in the $500 to $2,000 range. These
students were far more likely to accumulate their credit card debt
after graduation while they encountered difficulty finding employment
in a tight job market. So, the seeds of mounting credit card debt were
planted during college but harvested after graduation.
During the early 1990s, as credit card companies raised credit card
lines of credit--due to rising debt levels--of students rather than hi
student incomes, credit card companies sought to reduce their risk by a
policy of having debt collectors contact parents and demand payment and
even pursue legal suits for debt collection against parents of college
students--even if they were not co-signatories of the cardholder
agreement. The success of this policy emboldened credit card companies
to continue to increase the lines of credit to students as parents and
family members found themselves unexpectedly paying off student credit
card debts. Also, as the cost of college education rose with the sharp
decline in public financial support, student loans routinely replaced
federal grants axed family loans in the 1990s.
The increasingly common strategy of financing one's college
education with borrowed money contributed to the credit card industry's
realization that its risk was further reduced by students paying their
credit card debts with student loans. This trend also minimized the
perception of the growing problem of student credit card debt since
reports focused on current credit card balances rather than total,
accumulated credit card debt that was amassed through private bank
lows, family loans, and shifting credit card debt into student loans.
As a result, students that charged up to their limits on their credit
cards were actually rewarded with higher lines of credit or even
additional credit cards. This policy continued even after the credit
card industry lost its law suits in the early 1990s in an effort to
force parents to repay their children's credit card debts even though
they were not co-signers of the credit card agreement. The credit card
industry's response, which continues today, is to have debt collectors
pressure the parents of college students to repay the credit card debts
of their children. The punitive threat is that the failure to pay
delinquent credit card debts will lead to serious consequences for
their children in the future: bad credit reports/scores, much higher
interest rates and insurance premiums, loan denials such as auto and
mortgages, and even job rejection.
By the mid-1990s, credit card companies began to double their
marketing budgets, including more aggressive campaigns on college
campuses. This was because the risk of defaults diminished for banks
(due to student loans, family loans, greater available of part--time
jobs during economic expansion) while the demand for credit cards on
campus soared due to escalating consumption pressures on campus and the
rising cost of college matriculation which led to greater reliance on
borrowed money to finance college expenses. With the optimism of the
economic expansion of the 1990s spurring the consumer-driven economy,
the highly profitable student credit card portfolios led banks to an
intensifying competition over prize college accounts. Indeed, banks
began to realize that credit cards provided entire to middle class
households during their most formative years and thus offered future
additional, lending/proft opportunities: auto, home mortgage,
investment, insurance, and even college loans. With the end of the
recession, the consolidation of the credit card. industry began to
accelerate which. led to more lucrative exclusive marketing agreements
with universities and their alumni associations (especially the largest
250 universities). In, addition, this expanded marketing campaign
resulted in a larger on-campus presence through sponsored events
(spring fairs, athletic events, spring break activities, campus
newspaper advertisements) and subcontracted solicitors who boldly
established tables and booths in student centers, outside cafeterias,
in dormitory ``commons'' areas, and along classroom walkways. Not
incidentally, the increasing use of subcontracted marketing companies
led to increased pressure tactics and illegal policies such as
submitting applications with forged signatures and altering the age of
applicants (e.g. high school students visiting college campuses or
underage freshmen). Daily fees paid to colleges in order to ``rent''
on-campus booths or tables typically range from $50 to $250. However,
an increasingly common practice is to solicit without authorization or
simply to ``crash'' a campus. Robert Bugai, President of College
Marketing Intelligence and an investigative journalist, has documented
hundreds of cases of marketing abuses on college campuses in the 1990s.
The more aggressive marketing of credit cards on campus, together
with the implicit assent of university administrators who saw greater
access to credit as a revenue generator by enabling students to pay for
the higher cost of educational expenses plus million dollar marketing
agreements, led to marketing not just to alumni and upper classmen but
then to freshmen and sophomores. Not only had solicitations become
commonplace in book bags but they had become an accepted feature of
freshman orientation. More importantly, the lines of credit offered to
student soared. From an initial $300 to $500 lime of credit, students,
found that they could request or were automatically offered lines of
credit of from $2500 to $5000 within a year, Furthermore, students were
now offered multiple credit cards; if they exhausted their credit on
one card then they could receive two or three others. As the
underwriting standards eroded, students became a distinct market niche
for banks. In only a decade, the required co-signature with parents was
replaced with only some proof of enrollment in college.
By the mid-1990s, some students were amassing $5,000 to $15,000 in
credit card debt and parents were finding themselves in the dilemma of
``loaning'' their children the money to pay off their debts or teaching
them a lesson in financial responsibility. With the booming economy,
students could easily find part-time jobs and/or their parents were
more likely to have savings or access to lower interest loans to payoff
these debts. Increasingly, students in public schools used larger
portions of their student loans to pay down their credit cards while
private school students began resorting to private bank loans or
college credit union loans; at Georgetown University, I was informed
that the most common use of the $10,000 loan available to students at
the university credit union is to pay for their credit cards.
Increasingly, students that ``mixed-out'' their credit cards were
rewarded with higher hues of credit or other credit card applications.
By the end of the decade, college campuses have become filled with
anxiety ridden students whose request for holiday gifts were often
``please pay may credit card debt.'' More importantly, credit card
debts of the most indebted, mixed out students jumped from $10,000
$15,000 range to $20,000-$25,000. In a few cases, financial aid offers
have communicated to me that they have had students from disadvantaged
backgrounds report that they have accumulated over $30,000 in credit
card debt. More recently, attention has focussed on the medical,
educational, employment, and financial impacts (even suicides)
associated with escalating student credit card debt.
Today, the most striking feature of credit card marketing is how
young students are when then receive their first credit card. In 2000,
an industry sponsored survey reported that 25% of college seniors
reported receiving credit cards before starting college compared to 55%
of college freshmen. In some cases, students have simply applied for
bank credit cards while in high school while others have been solicited
due to their use of retail credit cards or are secondary account
members of their parents' credit cards. In fact, the new VISA BUXX
credit card program, which requires parental co-signature, is designed
for teenagers. Most importantly, as the marketing of credit cards has
shifted from employed alumni and then college seniors to college
freshmen arid now high school students, there has not been a
corresponding increase in financial education as credit increasingly is
being allocated to consumers before they begin full-time employment.
Unlike driving a car, young people are being given the ``keys'' to the
consumer lifestyle but not required to learn the necessary defensive
``driving'' skills.
Lastly, the interest rates and penalty fees are among the highest
levels in the college student market. More importantly, credit card
companies recognize that college students are mobile and have crisis
periods which commonly lead to cash advances and penalty fees that
quickly lead to sharp increases in credit card finance charges: from
22.8% to 27.9% APR. For instance, a student that forgets to pay his/her
credit card bill during final exam week may then wait until the
forwarded mail arrives at parents' home or summer job. Often, the
student is now two (2) payments late which invokes the ``escalator''
clause and thus requires the student to pay the highest finance charge
rate.
In sum, the last decade has seen a dramatic rise in the extension
of credit to increasingly younger students without any accompanying
financial educational programs. As the cost of higher education has
risen and the cost of the student lifestyle has escalated, it is not
surprising that the highest credit card debt levels of students have
jumped sharply over the last 10-12 years: from less than $5,000 to over
$25,000. And, the proportion of students with credit cards is now
between 75 and 80 percent.
Question Part C: ``Are these policies different for young adults of
the same age that are not college students? ''
Answer: The different status and underwriting standards of college
students is revealed by the policies of the credit card industry as
they apply to .non-students in the 18-23 year-old age range. For this
age group, proof of employment and total income are required as well as
a consumer credit investigation. Young adults that report typical
student incomes of $3,000 to $8,000 per year are routinely rejected for
bank credit cards or offered ``subprime'' credit cards with low credit
limits and high mandatory fees. For instance, a typical subprime credit
card offers from $300 to $900 in credit with the highest interest rates
(19.9%-36% APR) as well as requires membership fees ($20-$50),
processing fees ($10-$25), and educational materials ($75-$199). In
addition, they may be offered more costly ``secured'' cards that
require a bank deposit that determines the amount of credit offered.
For example, a $100 deposit will result in a credit line of from $100
to $250 and often a high membership fee. Even more instructive is the
experience of students after graduation that do not get credit cards in
college or accept only low credit limits. Commonly, recent graduates
with relatively low-wage, entry-level jobs (and typically high student
debt levels) are offered low credit limits and even rejected for new
credit cards. In sum, there is clearly a ``double standard'' in
offering unsecured consumer loans via credit cards to students versus
non-students of the same age. Ironically, young adults with relatively
low-wage, full-time jobs ate more likely to be rejected for bank credit
cards and/or offered low credit limits than their peers who are
unemployed and may have never had a fell-time job.
Question 2, Part A: ``Are young adults the fastest growing
bankruptcy filers today? ''
Answer: Yes, young adults 25 years-old and younger have experienced
a dramatic rise in their bankruptcy rates. In 1995, with the number of
bankruptcies at a near record of almost 900,000, less than 1 percent or
under 9,000 bankruptcy filers were 25 years old oar younger. When U.S.
personal bankruptcies peaked at 1.4 million in 1998, this included
about 68,000 young adults or approximately 4.9 percent of the total. In
2000, it appears that the proportion of bankruptcy filers 25 years old
or younger has jumped to over 10 percent of the total--over 100,000
people. According to bankruptcy expert Professor Elizabeth Warren
(Harvard Law School), who is the director of a national survey of
bankruptcy filers and co-author of The Fragile Middle Class (Yale,
2000), bankruptcies among young adults are continuing to increase
today.
Question Part B: ``What are the primary factors responsible for
this new trend of the late 1990s? ''
Answer: As the cost of a college education has soared over tine
last two decades, the average debt levels of college graduates has
similarly increased; federal grants have been increasingly replaced
with federal loans. At the end of the 1990s, student loans of public
school graduates averaged over $13,000 and student loans of private
school graduates averaged over $16,000. With shorter deferment periods
(typically 6 months), higher finance: rates plus increasing amounts of
unsubsidized loans, and the end of income tax averaging as well as
deductibility of interest on student loans (interest deductibility was
re-instituted in 1998-to a maximum of $2,000), recent graduates with
modest incomes from their entry level jobs found themselves squeezed by
their substantial education and credit card debts.
Furthermore, the consumption-oriented lifestyle that is being
promoted on college campuses bias been viewed by students as an
entitlement that is expected to be continued after graduating anal
obtaining a full-time job. Indeed, this is a generation that has not
experienced a recession and has been encouraged to accept debt as a
middle-class entitlement rather than `saving for a rainy day.'
Unfortunately, this short-sighted attitude has been reinforced in
college by encouraging the use of `plastic money,' the CitibankSony
Visa--`the currency of fun,' and the self-deprecating reference to
credit cards as `yuppie food stamps.' In addition, the recent
employment volatility of hi-tech sector companies has pushed more young
adults into debt-counseling/debt refinance programs. Since they are the
least likely to have accumulated equity through homeownership, unlike
their parents, a larger proportion of heavily indebted young adults are
funding few financial ``life lines'' and thus no other recourse but to
file for bankruptcy.
Question Part C: ``How will the proposed bankruptcy reform
legislation affect them? ''
Answer: In many ways, as the fastest growing group of bankruptcy
filers, young adults are the most disadvantaged by the proposed
bankruptcy legislation. This could have serious long-term consequences
to the nation since these age cohorts currently have the lowest
(negative) savings rate.
First, for many of these bankruptcy filers, their college debts are
the first or second largest debts. Since student loans normally can not
be discharged, many young filers will find relatively little relief
from the bankruptcy process-especially with the difficulty in obtaining
future credit when they are so early in their consumer lifecycle. This
situation is especially difficult for those with student loans that did
not graduate from. college or whose vocational training did not offer
marketable job skills.
Second, the much higher finance rates of consumer credit card debts
encourages students to pay for them with low-interest college education
loans. For many young adults that file for bankruptcy, this decision
means that they are required to pay for past credit card bills since
these debts have been shifted into student loans. As the credit card
industry demands that a larger proportion of credit card debt be
repaid, they fail to acknowledge that a substantial portion is not
dischargeable and must be repaid after it has been ``revoted'' into
student loan debt. Since this was not an option for undergraduate
students a decade ago, the deleterious impact is primarily assumed by
young adults under 30 and especially under 25 years old.
Third, this age group is least likely to own their residences and
thus have the ability to protect personal assets through home
ownership. Proposed changes in consumer bankruptcy law that help
households protect some of their accumulated assets via home ownership
do not affect most young adults filing for bankruptcy.
Fourth, the most common form of start-up capital/financing for
small businesses especially young entrepreneurs-is bank credit cards.
Since these young adults are the least likely to have accumulated much
equity through home ownership and thus have the option of ``home
equity'' loans, business failure could push them into personal
bankruptcy since they have few opportunities to secure small business
loans.
Fifth, with a slowdown in the economy and the accompanying rise in
employment disruptions, the inability to discharge any student loan
debts may lead to a greater likelihood of multiple bankruptcies by the
youngest age cohorts of bankruptcy filers whose only option will be to
increase the length of time of their loan repayment period.
Question 3. Part A.: ``How do the lending and underwriting policies
of small banks and regional retailers compare with the major credit
card companies.''
Answer: One of the most striking trends of banking deregulation is
the increase in providing consumer loans in the form of ``evolving'' or
unsecured credit cards rather than the traditional ``installment'' loan
that dictates a fixed term of repayment at a specified monthly payment
and interest rate. At the conclusion of the contract, the consumer has
accumulated equity in the purchased item (auto, furniture, appliance)
and the merchant or bank rewarded responsible consumers with more
credit in the future.
Small banks and regional retailers require a more extensive
application process for consumer loans and tend to be more cautious in
their underwriting criteria. Also, they have the option of repossessing
the defaulted consumer goods (computers, stereos, autos) whereas
unsecured credit cards are more likely to be used for purchases on
consumer services that can not be repossessed. Unfortunately, credit
cards have turned upside down the logic of financial lending: the most
profitable loans are those that are not repaid. As a result, the most
desired clients of the credit card companies are consumers that
dutifully remit payments on their loans (especially late!) bust do not
pay in full. In fact, in some cases, credit card companies may cancel
the accounts of clients that payoff all of their charges each month
arid disdainfully refer to them as ``dead beats.'' The result is that
small banks and retailers tend to have more stringent lending criteria,
encourage installment loans, and offer consumers lower lines of credit.
Question 3. Part B: ``Do consumer defaults on loan contracts affect
retailers the salve as large credit card companies? ''
Answer: One of the major problems with the dramatic increase in the
amount of consumer lending through bank credit cards is that it has
shifted more financial risk to retailers and smaller banks. For
example, a regional furniture store company that carefully limits the
size of its consumer installment loans has no control over the
additional amount of debt that its clients may obtain through bank or
other retail credit cards. 'this is important because a default on a
consumer loan means that the furniture company and/or its bank partner
lose the amount of the consumer's financial delinquency. For the
furniture company, this means that it has to absorb some portion of the
defaulted consumer loan or it may lose its banking partner and thus
financing source for future sales. For the consumer, the loss of modest
cost financing may mean higher costs by obtaining a loan through a
dance company.
The link between. prudent installment credit by small banks and
retailers and the weak underwriting criteria of major credit card
companies (top ten credit card companies control \3/4\ of the market)
merits greater attention. That is, ``good'' installment loans may end
up in bankruptcy court because of future ``bad'' credit card debts.
And, because of this relatively new shift in the relative allocation of
consumer credit through ``installment'' loans versus unsecured
``revolving'' credit cards, both types of loans are treated equally
whereas the risk to retailers has increased substantially. This is
because major credit card companies sell much of their credit card debt
in secondary markets (U. S., Europe, and Asia) as ``securitized''
financial instruments. Higher default rates on credit cards often
simply means that the ``bundle'' of credit card debt sells at a lower
premium rather than producing a direct loss such as a default on a loan
for the purchase of a stereo system.
In sum, requiring bankruptcy petitioners to repay a portion of
unsecured credit card debt could encourage banks to increase high
interest consumer loans to financially insecure or distressed
households that have the greatest likelihood of not being able to repay
the loans. This, of course, would create a greater financial burden on
low-income households and especially single, female-headed households
with children. This impact has been previously discussed and
documented. What has been generally neglected is how this proposed
change in the bankruptcy law could seriously hurt retailers in general
and smaller companies in particular. That is, these most recent trends
suggest that a more effective change in consumer bankruptcy law should
require more prudent lending policies by major credit card companies in
the marketing of relatively large amounts of credit to low and middle-
income households.
Please contact me if you require any additional information.
Responses of Todd Zywicki to Questions submitted by Senator Leahy
Question 1: You testified that the current bankruptcy system is
``threatening to spiral out of control'' and ``suffers from a crisis of
both real and perceived abuse.'' But over the last two years, Chapter 7
filings have dropped 15 percent and personal bankruptcy filings overall
have declined by 12 percent across the nation. How can the current
system be out of control and in crisis when personal bankruptcy filings
have declined so dramatically in the last two years?
Answer: After a brief respite in bankruptcy filing rates,
bankruptcy filings have begun to rise again this year. I am not aware
of any bankruptcy analyst who believed at the time that the two-year
decline in bankruptcies presaged a permanent, rather than a temporary
drop. Moreover, despite these slight reversals, the fact remains that
despite a decade of unprecedented economic prosperity, consumer
bankruptcies are almost twice as high as 1990, and are five times
greater than in 1980. Most analysts expect at least a 15% increase in
bankruptcy filings this year. Moreover, recent history suggests that
bankruptcies tend to rise during a recession. Thus, if it is true that
an economic slowdown portends, then this augurs a continuing rising
tide of bankruptcy filings and threatens to cause the bankruptcy system
to ``spiral out of control.''
Question 2.: You testified that S. 220 should be enacted into law
to stop the ``bankruptcy tax'' caused by bankruptcy abuses, which ``is
reflected in shorter grace periods for paying bills, and higher penalty
fees and late-charges for those who miss payments.'' What guarantee is
in S. 220 that any savings to the credit industry from the passage of
the bill will be passed down to consumers in longer grace periods for
paying bills, and lower penalty fees and late charges for those who
miss payments?
Answer: As I testified, bankruptcy losses are a cost of doing
business for firms that extend credit. As such, they are no different
from other business expenses, whether rent, employee salaries, taxes,
electricity bills, theft, or gas prices. The government provides a
system of courts to enforce contracts in the belief that making valid
contracts enforceable decreases the costs of doing business, which in
turn favors all buyers and sellers, including consumers. Does anyone
believe that eliminating the enforceability of contracts would not
cause prices to rise? By limiting opportunistic use of the bankruptcy
system, the bankruptcy reform bill similarly reinforces the
enforceability of contractual promises; after all, no one doubts that
there is actually a contractual obligation involved. As such, it will
have the same effect as increasing the enforceability of contracts
generally. Most people believe that making contracts more easily
enforceable tends to benefit all parties, including consumers. Thus, if
one believes that greater enforcement of valid contracts generally
reduces costs and benefits consumers, then it is equally obvious that
consumers as a whole will benefit from greater enforcement of consumer
credit contracts through restrictions on opportunistic bankruptcy use.
In a competitive market, consumer prices reflect changes in
business costs. Consumer creditors unquestionably operate in
competitive industries, thus changes in their costs will be reflected
in changes in the bundle of price and non-price terms that they offer
to consumers. See Todd J. Zywicki, ``The Economics of Credit Cards,'' 3
Chapman L. Rev. 79 (2000). For instance, when interest rates were
capped in the pre-Marquette era, issuers of consumer credit responded
in a number of ways, including the imposition of substantial annual
fees on consumers. These annual fees amounted to a redistribution from
convenience users who paid their bills in full every month to those who
revolved balances at below-market interest rates. Retailers who ran
credit operations, such as large department stores, imposed the costs
through charging higher prices for the goods they sold, sometimes
offering ``cash discounts'' to those who did not buy the item on
credit. In short, changes in the cost structure of credit issuers are
reflected in the price and nonprice terms they charge.
Question 3: Should Congress include a trigger mechanism in S. 220
to make sure that consumers will benefit from lower credit costs as a
result of bankruptcy reform legislation that will clearly benefit the
credit industry by lowering its costs of doing business?
Answer: No. It would be impossible to predict how the consumer
credit industry will respond to reductions in its bankruptcy losses and
it would be unwise to force them to respond in a way calculated to
satisfy political pressures rather than consumer preferences.
Attempting to draft such a trigger would throw a blanket of uniformity
over a market characterized by dynamic competition and strong consumer
choice. Recent history indicates, for instance, that market competition
has been driven by consumer demand for greater benefits, rather than
reductions in credit prices. In the credit card industry alone, these
benefits have included such a diverse array of services as cobranding
benefits, frequent flyer miles, 24-hour customer service, anti-fraud
protection, and car rental insurance. It is evident that these services
are being supplied in response to customer demand, and that consumers
have demanded these benefits in lieu of reductions in price terms. To
paraphrase a recent observation from an article I with Judge Edith H.
Jones, ``Using [cost savings] as the only proxy for vigorous
competition is tantamount to saying that the automotive industry is
noncompetitive because car manufacturers increase quality through
improved safety, comfort, or gas milage, rather than simply cutting
prices.'' Edith H. Jones and Todd J. Zywicki, ``It's Time for Means-
Testing,'' 1999 Brigham Young University L. Rev. 177.
Question 6: You testified that there is a ``growing sophistication
among lawyers and the public about the opportunities for fraud and
abuse--both legal and illegal--in the bankruptcy system.'' Please
provide specific examples of these opportunities for, fraud and abuse--
both legal and illegal.
Answer: It is generally understood by bankruptcy analysts that
there is a substantial degree of abuse in the system. Many of the
reforms included by the legislation are responsive to concerns
identified by the National Bankruptcy Review Commission in its Report.
This includes such abuses as improper serial filings and such things as
the use of so-called ``fractional interests'' to frustrate the
legitimate exercise of creditors' rights (see NBRC Recommendation
1.5.6). NBRC Recommendation 1.1.2 reflects the widespread concern about
the inaccurate and misleading information provided by debtors on their
schedules. Recommendation 1.1.4 expresses the concern that lawyers are
not providing adequate oversight as to their clients behavior.
Recommendation 1.4.4 evidences the Commission's concern that bankruptcy
was being used improperly to avoid performance of spousal and child-
support obligation. Even though many of the Recommendations of the
National Bankruptcy Review Commission were quite contentious, there has
been a broad consensus that these particular Recommendations are rooted
in real-world concerns about fraud and abuse in the bankruptcy system.
I am not aware of anyone who has questioned the NBRC's concerns about
inaccurate schedules, fractional interests, and the like.
Moreover, it is evident that there are at least some individuals
filing bankruptcy and receiving a discharge in chapter 7 that could
repay some of their debts. Even if the figure is as low as 3%, this
number is still greater than the current number of filers who have
their cases dismissed for substantial abuse. For instance, Judge
Newsome testified during the hearing that he has dismissed for
substantial abuse less than 1% of the cases he has seen, which is
substantially smaller than even the most modest estimates of what
meanstesting would do. Professor Jack F. Williams, for instance, has
observed that many perceive the anti-abuse provisions of Sec. 707(b) to
be a ``dismal failure.'' See Jack F. Williams, ``Distrust: The Rhetoric
and Reality of Means-Testing,'' 7 Am. Bankr. Inst. L. Rev. 105 (1998).
In addition to this abuse, it appears that illegal activity has
also increased in the bankruptcy system. In the past two years there
has been large-scale criminal prosecutions in certain areas of the
country that have demonstrated the presence of substantial illegal
activity that is present in the consumer bankruptcy system. Consider
some recent stories from the past year or so that have been reported in
Bankruptcy Court Decisions:
``Sixteen Charged in Bankruptcy Abuse Cases,'' Volume 35,
Issue 8 (Jan. 11, 2000). ``In the fourth bankruptcy fraud sweep
in four years, 16 individuals from across Southern California
have been charged with a variety of criminal violations arising
form alleged misdeeds in bankruptcy cases.''
``Bankruptcy Fraud a Growing Problem Nationwide-In Maryland,''
Volume 36, Issue 2 (June 6, 2000). ``Maryland U.S. Attorney
Lynne A. Battaglia said her office is pursuing an increasing
number of criminal bankruptcy fraud cases because this crime is
a growing problem nationwide-and in Maryland.''
``L.A. Landlord Convicted on Three Counts of Bankruptcy
Fraud,'' Volume 35, Issue 20 (April 4, 2000). ``Bernard Gross
of Los Angeles was convicted Feb. 16, after a two-week jury
trial, on three counts of bankruptcy fraud for making false
statements in his bankruptcy papers. `Gross' false statements
prevented the bankruptcy court from learning about other
potentially related bankruptcy cases, and about properties and
businesses that may have been connected with other bankruptcy
filings,' said U.S. Trustee Maureen Tighe.''
``New Mexico Man Pleads Guilty to Wire Fraud in Connection
with His Chapter 7,'' Volume 35, Issue 16 (March 7, 2000).
``Gaylen Hindeldey, currently residing in Palm Sptings, Calif.,
pleaded guilgy Feb. 22 in district court in New Mexico to one
count of wire fraud in connection with his 1992 Chapter 7.
`Hinkeldey attempted to use wire communications to hide more
than $55,000 from his creditors,' said U.S. Trustee Brenda
Moody Whinery.''
``Administrative Law Judge Convicted of Bankruptcy Fraud,''
Volume 35, Issue 15 (February 29, 2000). ``Simona Flores
Rosales, an administrative law judge for the California State
Unemployment Insurance Appeals Board, was convicted Feb. 4 by a
Federal District Court jury of five felony criminal counts,
three counts of bankruptcy fraud, one count of money laundering
and one count of filing a false income tax return. The jury
found Rosales guilty of concealing assets and making false
statements under oath during her bankruptcy proceedings.''
These stories are merely illustrative and chosen at random, but are
suggestive of the concerns over fraud and illegality in the system.
Question 5: Which provisions, if any, should be improved in S. 220?
If there are provisions in S. 220 that should be improved, do you have
any proposals, including legislative language, for the Committee?
Answer: The only possible improvement to the bill that I can
identify would be an elimination of the broad safe harbor provisions of
the means-test provisions of the legislation. This provision could
potentially allow high-income debtors with substantial repayment
capacity to escape the means-test.
Question 6: You testified that: ``means-testing will have no effect
on those making less than the minimum income threshold provided. Thus,
for the 80% of filers whose income lies beneath the state median,
means-testing will have no effect whatsoever.'' Is it not true that the
new paperwork requirements in S. 220 that are intended to implement the
bill's means-test apply to all personal bankruptcy filings?
Answer: Read in context, I believe it is clear that my testimony
refers to the substantive elements of means-testing, not the procedural
elements. Substantively, means-testing does not affect those who make
less than the state median income. As for the question of whether
increased paperwork will be required, I am not sure what specific
paperwork the question refers to, nor am I aware of specific new
paperwork that is supposedly the result of administering the means-
test, as opposed to preventing other forms of fraud and abuse. Current
bankruptcy schedules I and J already require the information on the
debtor's income and expenditures that are required by the means-test.
Thus, it is not clear what additional paperwork would be required to
administer the means-test.
SUBMISSIONS FOR THE RECORD
American Bar Association
Governmental Affairs Office
Washington, DC 20005-1022
The Honorable Orrin G. Hatch
Chairman
Committee on the Judiciary
United States Senate
Washington, D.C. 20510
Re: Bankruptcy Appellate Structure
Dear Mr. Chairman:
On behalf of the American Bar Association (``ABA ''), I would like
to thank you for the opportunity to submit the ABA's views regarding
the bankruptcy appellate reform provisions contained in Section 1235 of
S. 220, the ``Bankruptcy Reform Act of 2001,'' and we request that the
following comments be included in the record of the Committee's hearing
scheduled for February 8, 2001.
The ABA, which has over 400,000 members throughout the country,
strongly supports legislative provisions like Section 1235 that would
allow direct appeals from orders of bankruptcy judges to the existing
circuit courts of appeals. This is a non-partisan proposal which would
significantly improve the bankruptcy system. As Chair of the Business
Bankruptcy Committee of the ABA Section of Business Law, I have been
authorized to express the ABA's views to you on this important matter
in an effort to improve the administration of the bankruptcy laws.
Direct appeal of bankruptcy matters to the regional circuit courts
of appeals has also been recommended by the National Bankruptcy Review
Commission (``Commission''), which studied the matter in depth. The
Commission was composed of three members appointed by the President
(then President Clinton), two members appointed by the Senate, two
members appointed by the House of Representatives, and two members
appointed by the Chief Justice.
Although the Commission was split on a number of the bankruptcy
issues addressed in its Report, the recommendation for direct appeals
of bankruptcy matters received the unanimous support of all of the
Commission's members.
Under the current system of bankruptcy appeals, a bankruptcy order
(unlike other federal trial court orders) is subject to an additional
level of review: an appeal must go first to either a district court or
a bankruptcy appellate panel (``BAP '') before the appeal may go to a
circuit court. The two-level bankruptcy appellate process is extremely
unusual. The ABA believes that this multi-tiered bankruptcy appellate
structure works poorly. It imposes unnecessary delays and costs on all
parties. In addition, as stated in the Judicial Conference's 1995 Long
Range Plan for the Federal Courts: ``Under current practice, district
courts and BAY decisions are not treated as stare decisis in other
cases--resulting in a `patchwork' of differing legal interpretations
that encourage forum shopping and undermine the national system of [a
uniform] bankruptcy law.'' (p.48)
The ABA believes that a direct appeals system, designed to closely
parallel the track of nonbankruptcy civil appeals, will result in:
Faster final decisions;
Greater certainty, uniform interpretation and decisions of
precedential value with respect to key bankruptcy issues; and
Reduction in unnecessary bankruptcy litigation.
The ABA believes that direct appeals will aid in achieving the
important goal of reducing the time and costs associated with the
bankruptcy process and will also assist in harmonizing bankruptcy laws
and nonbankruptcy commercial laws generally.
When members of the National Bankruptcy Review Commission appeared
before Congress on November 13, 1997, after submitting its Final
Report, the Honorable Edith H. Jones of the U.S. Court of Appeals for
the Fifth Circuit testified that: ``Congress should adopt the
Commission's unanimous recommendation that appeals from bankruptcy
courts should be routed directly to the U.S. Court of Appeals, rather
than through an intermediary such as the district courts or bankruptcy
appellate panels. . .(and) the importance of this measure cannot be
overstated.'' (emphasis in original).\1\
---------------------------------------------------------------------------
\1\ ``The current system which provides two appeals, the first
either to a district court or a bankruptcy appellate panel and the
second to the U.S. Court of Appeals, as of right from final orders in
bankruptcy cases, should be changed to eliminate the first layer of
review.'' National Bankruptcy Review Commission, Final Report,
Recommendation 3.1.3 at 752-53 (1997).
---------------------------------------------------------------------------
As noted in its commentary on the Recommendation: ``The
Constitution authorizes Congress to establish a uniform law of
bankruptcies. Despite this clear constitutional mandate, the current
bankruptcy appellate structure has yielded results which are far from
uniform.* * *Concerns over costs and efficiency also support the
Recommendation. Under the current system, every bankruptcy appeal is an
expensive excursion for both debtor and creditor who must work through
two layers of appeal for a final resolution of their disputes. Final
Report at 753-54.
Both the ABA and the National Bankruptcy Review Commission
recognize, and are sensitive to, the possibility of increased workload
for the circuit court judges. After examining and analyzing the issue,
however, the Commission concluded that, while direct appeals may
temporarily increase the workload by approximately 9%, ``over time. .
.this number should decrease as more issues are settled within the
circuit and fewer uncertainties linger, necessitating fewer appeals.''
(A copy of the relevant portions of the Commission's Final Report to
Congress is enclosed for your convenience.) The Commission concluded
that the substantial long-term benefits of a direct appeals system
significantly outweigh any modest short-term burdens, and the ABA
agrees with this conclusion.\2\
---------------------------------------------------------------------------
\2\ In its 1995 Long Range Plan for the Federal Courts, the
Judicial Conference stated that the appellate review of orders of
bankruptcy judges should be studied to ``ensure prompt, inexpensive
resolution. . .and foster coherent, consistent development of
bankruptcy precedents.'' Recommendation 21 at 47. It was recommend that
statutory change ``should await the [National Bankruptcy Review
Commission's] report in that respect. Id at 48. As noted above, the
Commission unanimously recommended direct appeals.
---------------------------------------------------------------------------
Section 1235 of S. 220 would allow for direct appeals in most
bankruptcy cases. Under this provision (which is identical to the
corresponding provision in H.R. 2415, the bill approved by Congress
last year but vetoed by President Clinton), bankruptcy appeals
initially would be routed to the district courts for a 30-day period.
After the 30-day period, the appeals would automatically proceed to the
regional court of appeals if the district court had not ruled or
entered an order extending such 30-day period or if the parties had not
consented to the retention of the appeal in the district court beyond
the 30-day period.
Section 1235 was designed to address concerns that some litigants
may prefer to keep the appeal in the district court and that the
district court should be given some latitude to keep the appeal.
Although the ABA prefers a pure direct appeal system for the bankruptcy
courts that is the same as the system used in the other federal trial
courts, the proposed alternative is acceptable to the ABA and we view
it as a clear improvement over current law. In essence, this
alternative would permit direct appeals to the circuit courts in most
cases, except where the district court ruled during the 30-day period,
the parties otherwise consented, or the district court extended the 30-
day period.\3\
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\3\ Several other provisions of the present Judicial Code relating
to bankruptcy jurisdiction already hinge on the consent of the
litigants or orders entered for cause. For example, if a circuit has
established a bankruptcy appellate panel, appeals can go to the BAP
only with consent of the parties. 28 U.S.C. Sec. 158(c)(1). A jury
trial can be conducted by a bankruptcy judge only with the consent of
the parties. 28 U.S.C.
Question 1157(e). Also, a district court may withdraw the reference
to a bankruptcy judge for cause. 28 U.S.C. Sec. 157(d).
The bankruptcy system affects the lives of many Americans, whether
as debtors or as creditors or as employees of companies undergoing
reorganization. The ABA believes that direct appeals to the regional
circuit courts of appeals is an important component of bankruptcy
reform. It is fair and beneficial to all parties; it will help achieve
uniformity; and it will help harmonize bankruptcy and nonbankruptcy
commercial law. For these reasons, the ABA urges the Committee to
support Section 1235 of S. 220.
Thank you for your consideration, and if you would like to discuss
the ABA's views on the bankruptcy appellate structure in greater
detail, please feel free to contact me at (212) 4557140 or Larson
Frisby in the ABA Governmental Affairs Office at (202) 662-1098.
Sincerely,
M. O. Sigal, Jr.
cc: Members, Committee on the Judiciary
Statement of Hon. Richard S. Arnold, U. S. Circuit Judge for the Eighth
Circuit
Mr. Chairman and Members of the Committee:
I make this statement at the request of your staff, who got in
touch with me by telephone on the afternoon of Monday, February 5. I
understand that the Committee is holding hearings on pending bankruptcy
legislation, including a provision that would allow for direct appeal
from bankruptcy courts to the courts of appeals, instead of the current
appellate structure, which is three-tiered, including bankruptcy
courts, either district courts or bankruptcy appellate panels, and
courts of appeals.
I understand that the Judicial Conference of the United States is
not in favor of the direct-appeal proposal. It is with some reluctance
that I voice a different view, the more so as the position of the
Judicial Conference is to be stated by Chief Judge Becker of the Third
Circuit, whom I respect and admire as much as any judge in the country.
Nevertheless, you have asked my opinion, and I believe that, as a
citizen and an officer of the United States, I should respond to such a
request from Congress.
Some time ago, during the deliberations of the National Bankruptcy
Review Commission, I was asked to appear before the Commission and give
my views on certain subjects. Among other things, I expressed the
opinion that the current complicated appeal process should be replaced
by a simple system of direct appeals from bankruptcy courts to the
courts of appeals, with further discretionary review by the Supreme
Court, of course. I have not changed my opinion since that time, and
desire to state briefly the reasons why. The statement will be very
brief indeed, as I have not had much time to prepare it.
For a litigant to have two appeals as of right is very unusual in,
the federal system. It has always seemed odd to me that such a
provision should obtain in bankruptcy cases, of all places, where, by
hypothesis, assets are limited. Most litigants in bankruptcy fall into
one of two broad categories: people who cannot pay their debts, and
creditors who are destined to receive less than full payment. Every
dollar that goes into litigation is a dollar that the creditors will
not receive. For this reason, it seems to me that, in bankruptcy above
all other areas, simplicity and reduction of expense should be the
order of the day. Yet, largely for historical reasons, this is not the
case.
The best solution to any problem is usually the simplest one. In
this instance, the simplest solution is to provide for appeals from
bankruptcy courts directly to the courts of appeals. Under the current
system, appeals from bankruptcy courts go either to the district courts
or to bankruptcy appellate panels. Thereafter, unhappy litigants are
given a second appeal, as of right, to the courts of appeals. Cases are
prolonged, and expense is multiplied. I suggest that a direct appeal to
the court of appeals is the best solution to this problem, because the
courts of appeals, after all, are in the appellate business all the
time. If there is anything we know how to do, this is it.
I do not for a moment depreciate the work done by the district
courts and the bankruptcy appellate panels in bankruptcy appeals. I
have no criticism of the quality of their work. I have never
understood, however, why bankruptcy appeals should be so much more
complicated than appeals in other kinds of cases. If the Congress is
not inclined to create a single system of direct appeals to the courts
of appeals, perhaps it could leave in place the existing appellate
system, but make the second step discretionary. Under such a system,
the courts of appeals would have discretion, akin to that exercised now
by the supreme Court on petitions for certiorari, to hear, or not,
appeals in bankruptcy cases that have already received one appeal as of
right.
The downside of the direct-appeal idea, of course, is that it would
load more cases into the courts of appeals, which are already
overloaded. The solution, I suggest, is more judgeships. If more judges
are needed to do the appellate work in an orderly and thorough fashion,
and I believe they are, then Congress should create them. The addition
of direct bankruptcy appeals to the work load of the courts of appeals
would furnish one more reason for the creation of these new judgeships.
Mr. Chairman, I appreciate your allowing me to submit this
statement in writing. If there is any way in which I can be of further
service to you or to the Committee, please don't fail to let me know.
Richard S. Arnold
Statement of Association of Financial Guaranty Insurors
Mr. Chairman, the Association of Financial Guaranty Insurors
(AFGI), a trade association of financial guaranty insurors \1\,
appreciates the opportunity to submit testimony to the Committee on
suggested revisions to the United States Bankruptcy Code related to
asset-backed securities. AFGI fully supports H.R. 220, but we would
like to limit our remarks to the provisions included in Title IX,
Section 912 that relate specifically to asset-backed securities.
---------------------------------------------------------------------------
\1\ The members of AFGI are AMBAC Indemnity Corporation, AXA Re
Finance S.A., Capital Reinsurance Company, Enhance Reinsurance Company,
Financial Guaranty Insurance Company, Financial Security Assurance,
Inc, and MBIA Insurance Corporation.
---------------------------------------------------------------------------
AFGI has supported the revisions incorporated in Title IX, Section
912 of S. 220 for several years. Through outside counsel, our
Association submitted recommendations to the National Bankruptcy
Commission in 1997; submitted testimony for the hearing record when the
House Committee on the Judiciary's Subcommittee on Commercial and
Administrative Law held hearings in the 105 th and 106
th Sessions of Congress; and testified before this
Committee's Subcommittee on Administrative Oversight and the Courts in
1998.
Purpose of the Proposed Change to the Bankruptcy Code
AFGI believes that the suggested revisions incorporated in Title IX
of S. 220 relating to asset-backed securities reduces uncertainty under
the Bankruptcy Code as it applies to the almost $200 billion per year
of asset-backed securities issued in the United States. By reducing
uncertainty, the proposed amendment will increase stability in the
capital markets and thereby facilitate asset-backed financings and
eliminate certain risks which otherwise indirectly increase interest
rates for millions of consumers, small business and others seeking
financing from the capital markets. The proposed revision is
constructed to achieve these benefits without impairing any of the
reorganization and fairness policies underlying the Bankruptcy Code.
Application of the Proposed Change
The proliferation of asset-backed securities in the United States
over the past two decades has dramatically increased both the number of
lenders and the lending capacity of existing financial institutions.
This increased capacity has, in turn, created intense competition for
borrowers.
Today, consumers and small businesses have more choices when
looking for a home, auto loan, a new credit card, or financing for a
small business. More significantly, consumers and small businesses
whose credit posed too great a risk to qualify for financing are now,
in many cases, able to do so. This is because, in an asset
securitization, loans and other receivables are sold by lenders to a
company formed to sell securities in a structure which takes into
account the credit risks posed by these receivables. The sale proceeds
paid to the lender enable it to fund the ``securitized assets'' to make
additional loans to consumers and small businesses.
The company to which lenders sell their loans or other receivables
(the ``Securitized Assets ''), will typically be a ``bankruptcy remote
entity.'' The company's activities are restricted to the purchase and
ownership of the Securitized Assets and issuance of the securities.
Following its acquisition of the loan assets or other receivables, the
bankruptcy remote entity will typically issue debt or other
securities--the asset-backed securities--backed by Securitized Assets.
By bankruptcy-remote, we simply mean that the company is required to
maintain an existence that is completely separate from its affiliate
companies such that it will not be affected by the bankruptcy of an
affiliate.
Generally, the cash flow or other proceeds generated by the
Securitized Assets are sufficient to pay the amounts due on the asset-
backed securities. In certain instances credit enhancement is provided
by third parties, including members of AFGI, guaranteeing the timely
payment of amounts due to the holders of the asset-backed securities.
Under current law, uncertainty can arise when the transfer of the
Securitized Assets by the lender or its operating company to the
bankruptcy remote entity is deemed to be something other than a sale.
If the transfer is not a sale and if the seller of the loan assets
seeks relief under Chapter 11 of the Bankruptcy Code, the Securitized
Assets purported to have been transferred to the bankruptcy remote
entity may be included in the seller's bankruptcy estate. In that
event, the cash flow or other proceeds generated by the Securtized
Assets (i) would be subject to the automatic stay provision of the
Bankruptcy Code and would not be available to pay the holders of the
asset-backed securities until relief was obtained from the automatic
stay, and (ii) could be subject to cramdown or collateral substitution
that would further impair the bankruptcy remote entity's ability to pay
amounts due on the asset-backed securities.
Any interruption or impairment of the cash flow or proceeds
resulting from the application of the automatic stay, cramdown or
collateral substitution, impairs the market value of the asset-backed
securities and, in the case of insured asset-backed securities,
requires the insurer of these securities to pay the amounts due the
holders thereof which would otherwise have been paid by the bankruptcy-
remote entity.
A ``true sale'' opinion is a fundamental requirement of every asset
securitization. It is a ``reasoned'' opinion of legal counsel to the
effect that the assets ``sold'' by an originator to the issuer of
asset-backed securities will not be impaired in the event of the
subsequent bankruptcy of the originator. The current Bankruptcy Code
injects uncertainty into this opinion because it does not provide any
clear guidance on what constitutes a ``true sale.'' Attached is a copy
of a letter and an exhibit of a ``true sale'' opinion that was rendered
in a recent asset-backed transaction rated by two rating agencies that
the Association delivered to Senator Grassley following the 1998 Senate
hearing (Appendix 1). Both our letter to Senator Grassley and the
``true sale'' opinion more fully describe and illustrate the pressing
need for the asset-backed security provision set out in Section 912 of
S. 220.
The Proposed Revision
In order to address the situation, in which the seller of loans or
other receivables commences a Chapter 11 case under the Bankruptcy
Code, the proposed change in Title IX, Section 912 of S. 220 prevents
the Securitized Assets transferred to the bankruptcy remote entity from
being included in the seller's bankruptcy estate. This enables the
bankruptcy remote entity to continue using the cash flow or other
proceeds from the Securitized Assets to make payments to the holders of
the asset-backed securities. To the extent, if any, that the bankruptcy
remote entity owes any amount to the seller, that obligation remains
valid and the seller can obtain payment of that amount in accordance
with its original terms.
The revision to Section 541 of the Bankruptcy Code contained in
Title IX, Section 912 of S. 220 is limited in its application to
preventing the Securitized Assets conveyed by the seller to the
bankruptcy remote entity from being included in the seller's bankruptcy
estate. Thus, the proposed amendment simply confirms that the transfer
intended by the parties as a sale will not be unwound and the
reorganization of the bankrupt seller will not be otherwise impaired.
Furthermore, the proposed amendment is limited to transactions
involving the issuance of investment-grade, asset-backed securities,
since a primary purpose of Section 912 is to protect the legitimate
expectations of investors in asset-backed securities sold in the
capital markets. In addition, as explained in greater detail in the
commentary at Appendix 2, limiting the application of the proposed
amendment to securitized transactions in which one class or tranche of
securities are rated investment grade substantially reduces the
possibility that a lender or its operating company could transfer some
or all of its loan assets or other receivables to a bankruptcy remote
entity in an effort to defraud creditors of the company. In addition,
Section 912 provides that securitized assets may be included in a
debtor's bankruptcy estate to the extent such assets may be recoverable
by the bankruptcy trustee under Section 550 of the Bankruptcy Code by
virtue of evidence as a fraudulent conveyance under Section 548 (a).
AFGI strongly supports the revisions to Section 541 of the
Bankruptcy Code contained in Section 912 of H.R. S. 220 relating to
asset-backed securities. We believe the proposal will provide increased
certainty to investors and other participants in the asset-backed
securities market which, in turn, will create further stability in the
capital markets, and facilitate future asset-backed financings. All of
this will help maintain and foster an efficient funding source for
mortgage loans, credit card receivables, automobile loans, and other
loans available to citizens in small rural communities as well as our
nation's cities. Section 912 will ensure that consumers small
businesses and others have the opportunity to access the least
expensive source of financing, the capital markets.
Fordham University
New York, NY
The Honorable Orrin G. Hatch
Chairman
Committee on the Judiciary
United States Senate
224 Dirksen Building
Washington, D.C. 20510
Dear Mr. Chairman,
Thank you for the opportunity to state my views regarding the
bankruptcy appellate reform provisions contained in Section 1235 of S.
220, the ``Bankruptcy Reform Act of 2001.'' I respectfully request that
these remarks be included in the record of the Committee's hearing
scheduled for February 8, 2001.
Section 1235 would enlarge the jurisdiction of the courts of
appeals to permit direct review of certain bankruptcy court orders.
Providing a route for parties directly to appeal the final judgments,
decisions, orders, and decrees of bankruptcy courts will improve
substantially the expeditious administration of bankruptcy cases and
the ability of the bankruptcy appellate system to develop binding
precedent.
Bankruptcy appeals should be resolved as quickly as
administratively feasible since delay in the resolution of a bankruptcy
case invariably reduces distributions to creditors.\1\ The opportunity
for a direct appeal to the court of appeals provided under section 1235
would enable litigants who would in any event desire circuit court
review to avoid the needless delay and expense attendant to a dual
appeal system.\1\
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\1\ As early as 1845, the Supreme Court indicated that the
``manifest object'' of the federal bankruptcy laws was to provide
speedy proceedings, and the ascertainment and adjustment of all claims
and rights in favor of or against the bankrupt's estate, in the most
expeditious manner. Ex pane Christy, 44 U.S. (3 How.) 292, 314-15
(1845); see also Bailey v. Glover, 88 U.S. (21 Wall.) 342, 346 (1874)
(``It is obviously one of the purposes of the Bankrupt law [of 1867]
that there should be a speedy disposition of the bankrupt's estate '').
\2\ A recent study conducted by the Federal Judicial Center
concluded that, [f]or cases that continue on through the court of
appeals, the time spent at the district covet or BAP adds substantially
to the total time on appeal--for cases terminated on the merits by the
courts of appeals in fiscal 1998, the average time spent in the total
appellate process was more than 27 months (826 days), and the median
time was more than 22 months (663 days). Judith A. McKenna & Elizabeth
C. Wiggins, ALTERNATIVE STRUCTURES FOR BANKRUPTCY APPEALS at 3 (Federal
Judicial Center 2000).
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The existing two-tiered bankruptcy appellate system undermines the
development of stare decisis--binding precedent--in the bankruptcy
context.\3\ While it is clear that the decision of a court of appeals
binds every federal court within the circuit, courts are irreconcilably
divided as to whether the appellate decisions of federal district
courts or bankruptcy appellate panels are binding precedent for the
circuit. The inability to create binding precedent undoubtedly creates
a substantial reduction in the benefits of appellate review. If lawyers
and others cannot predict the state of the law on important bankruptcy-
related topics, they may be unable to advise clients in structuring
transactions or settling litigation. Enabling parties the ability to
appeal certain bankruptcy court orders directly to the courts of
appeals would improve significantly this lack-of binding-precedent
problem in the bankruptcy system.\4\
---------------------------------------------------------------------------
\3\ [Dan Bussel]
\4\ (may not be the only method but probably the most politically
feasible method] ASBA at 7-8.
---------------------------------------------------------------------------
Two criticisms of proposals to enable direct review of bankruptcy
appeals in courts of appeals have exaggerated the possible detrimental
effects of this bankruptcy appellate reform.
First, some argue that enactment of section 1235 would inundate
courts of appeals with direct bankruptcy appeals. Careful studies of
the likely effect of bankruptcy appellate reform on appellate filings
predict relatively mild increases in the workload of courts of appeals,
however. Specifically, the Federal Judicial Center, in its recent
report on ALTERNATIVE STRUCTURES FOR BANKRUPTCY APPEALS, projected that
proposals to eliminate intermediate level appellate review of
bankruptcy court decisions (namely, the proposal made by the National
Bankruptcy Review Commission) would affect total appellate filings by
between 6.9 and 4.5 percent, with their ``best estimate'' at the low
end of this range.\5\ These figures compare favorably to 9 percent
increase in appellate filings estimated by the National Bankruptcy
Review Commission in their Report to Congress.\6\
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\5\ Judith A. McKenna & Elizabeth C. Wiggins, ALTERNATIVE
STRUCTURES FOR BANKRUPTCY APPEALS at 55-59 (Federal Judicial Center
2000).
\6\ National Bankruptcy Review Commission, Final Report at 753-54
(1997).
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It is important to emphasize, moreover, that both the projections
of the National Bankruptcy Review Commission and the Federal Judicial
Center attempt to assess the effect on courts of appeals of eliminating
intermediate levels of review for all bankruptcy appeals, a result that
section 1235 of S. 220 does not seek to obtain. Section 1235 instead
would permit direct review by court of appeals only of bankruptcy court
orders as to which the district court has not, within a 30-day period,
rendered an appellate decision or entered an order extending this
period for cause. In addition, both of these projections estimate the
immediate affects of bankruptcy appellate reform on the workload of
courts of appeals. In the long term, however, direct filings should
diminish as courts of appeals develop a clearer and more predictable
body of stare decisis in bankruptcy.
Second, some have argued that bankruptcy appellate reforms
proposing to permit direct bankruptcy appeals to courts of appeals
would subject bankruptcy courts' current exercise of jurisdiction to
the claim that it is unconstitutional.\7\ Of course, any change to the
complex balance of interests found in the existing bankruptcy
jurisdictional provisions might invite spurious constitutional
challenge, but I believe that section 1235 easily would withstand
constitutional scrutiny.\8\ Supreme Court precedent clearly identifies
de novo review, rather than ordinary appellate review, as critically
important to the conclusion that an adjunct court's exercise of
authority complies with constitutional requirements. For example, in
U.S. v. Raddatz,\9\ the Supreme Court upheld the delegation of
authority to untenured magistrates under 28 U.S.C. Sec. 636(c)(1) as
constitutional and, in so doing, emphasized that ``Congress has
provided that the magistrate's proposed findings and recommendations
shall be subjected to de novo determinations `by the judge who. .
.then exercise[s] the ultimate authority to issue an appropriate
order.'' Similarly, in Thomas v. Am,\10\ the Court rejected the
argument that a rule viewing a failure timely to object to a magistrate
judge's decision as a waiver of appellate review would violate Article
III on these terms, emphasizing that
---------------------------------------------------------------------------
\7\ During the 105th Congress, for example, the
Department of Justice voiced its objection to section 411 of H.R. 3150
(which would have eliminated all intermediate levels of review of
bankruptcy court orders), urging Congress ``not to lessen district
court review and remove this potentially significant basis for the
constitutionality of the bankruptcy court's exercise of judicial
power'' Letter from Ann N. Harkins, Acting Assistant Attorney General,
to Rep. Henry J. Hyde (May 7, 1998). Section 411 did not survive the
conference on H.R. 3150. See also John P. Hennignan, Jr., The Appellate
Structure Regularized: The NBRC's Proposal, 102 DICK. L. REV. 839
(1998) (``There is a plausible argument that the constitutionality of
the present system depends upon classifying bankruptcy judges as
adjuncts to the district courts and bypassing those courts on appeal
obviates that classification.'').
\8\ For a more detailed discussion of these constitutional issues,
see Susan Block-Lieb, Assessing the Constitutionality of Proposed
Reforms to the Bankruptcy Appellate Process, Appendix C to Judith A.
McKenna & Elizabeth C. Wiggins, ALTERNATIVE STRUCTURES FOR BANKRUPTCY
APPEALS at 93-107 (Federal Judicial Center 2000).
\9\ 447 U.S. 667 (1980).
\10\ 474 U.S. 140 (1985).
---------------------------------------------------------------------------
[t]he waiver of appellate review does not implicate Article III,
because it is the district court, not the court of appeals, that must
exercise supervision over the magistrate.\11\
---------------------------------------------------------------------------
\11\ Id. at 153-54. See also Briney v. Burley, 738 F.2d 981, 986
(9th Cir. 1984) (``Because there is no constitutional right
to an appeal,. . .a fortiori there is no constitutional right to two
levels of appeal. . .by an Article III judge.'').
---------------------------------------------------------------------------
Moreover, it is important to re-emphasize that section 1235 would
not altogether eliminate intermediate appellate review of bankruptcy
orders. It would provide for direct review by courts of appeals only in
the event that a district court did not enter, within a 30-day period,
either a decision on the appeal or an order extending such period for
cause. Presumably, a significant percentage of district courts will be
able to render their appellate decisions within this 30-day period. In
addition, section 1235 would require all parties to the appeal to
consent to direct review by the court of appeals. The Supreme Court
repeatedly has emphasized the significance of litigant consent in this
context in that, much like other constitutionally protected individual
rights, an individual's interest in a fair and independent judiciary is
subject to waiver.\12\
---------------------------------------------------------------------------
\12\ See, e.g, Commodity Futures Trading Comm'n v. Schor, 478 U.S.
833, 850 (1986).
---------------------------------------------------------------------------
The process by which bankruptcy appeals are resolved is critically
important to the administration of bankruptcy cases. Section 1235 of S.
220 represents a cautious improvement over the existing arcane
bankruptcy appellate provisions in that it would, under limited
circumstances, permit courts of appeals directly to review certain
bankruptcy court orders. Direct review would expedite resolution of
bankruptcy appeals and strengthen both the quality and quantity of
binding bankruptcy precedent. Direct review would not deluge courts of
appeals with bankruptcy appeals and would not render the bankruptcy
court system unconstitutional.
Thank you for your consideration. Should you have further questions
on my views regarding these or other bankruptcy appellate reforms,
please feel free to contact me at (212) 636-6782.
Sincerely,
Susan Block-Lieb
Statement of the Bond Market Association
The Bond Market Association appreciates the opportunity to comment
on proposed reforms to the bankruptcy laws. The Bankruptcy Reform Act
of 2001 (S. 220) includes several provisions that would help insulate
the financial system from systemic risk-the risk that the failure of
one market participant could ripple through the capital markets and
bring down other participants. The Bond Market Association represents
securities firms and banks that underwrite, trade, and sell debt
securities both domestically and internationally. The Association's
membership collectively accounts for approximately 97 percent of the
nation's bond underwriting activity.
We commend Senator Hatch for calling this hearing and for his
commitment to comprehensive bankruptcy reform early in the current
congressional session. Last year's bankruptcy bill passed both houses
of Congress by wide margins, and we are hopeful that this year's bill
will be enacted quickly.
In this statement, the Bond Market Association focuses on
provisions in S. 220 concerning cross-product netting, closeout rights
and asset-backed securities (ABS).
I. Introduction
Certain financial transactions involve ongoing economic
relationships or commitments to be fulfilled in the future. For
example, risk management tools such as forward contracts and swaps are
based on contractual agreements between parties to transfer assets or
payments at some future time. Repurchase agreements, which are
important sources of liquidity in the debt markets and, to an
increasing degree, in the equity markets, involve financial commitments
that must be fulfilled at a later date. In these important market
activities which can involve huge sums and concentrated exposures, the
inability of one party to exercise its contractual ``self-help'' rights
in the event of the insolvency of the other party could cause ripple
effects by undermining the financial condition of the nonbankrupt party
(and its counterparties) and the markets more generally.
Recognizing the important role of these transactions in capital
formation and market liquidity and the potential for a chain reaction
of insolvencies should non-bankrupt parties' contractual self-help
rights be impaired, Congress has included provisions in the Bankruptcy
Code and the bank insolvency laws that expressly protect the exercise
of such rights in the event of bankruptcy or insolvency. However, it
has been almost ten years since the last legislative update to the
safe-harbor provisions. The financial markets have evolved during that
time in ways that leave various transactions and parties subject to
legal uncertainty. As more types of market participants have engaged in
a broader range of transactions, statutory inconsistencies have
surfaced that make it difficult to conclude that Congress's goal of
minimizing systemic risk has been fully achieved through the existing
market safe harbors. Important technical corrections are needed to
minimize systemic risk in light of market developments.
The Bankruptcy Code should also be amended to protect and enhance
the important role of the asset-backed securitization process. Asset
securitizations, which provide a secondary market for mortgage,
consumer, commercial and industrial loans and other debt obligations,
are multi-stage transactions where the integrity of securities payment
commitments rests on the finality of earlier transfers of underlying
assets. An efficient secondary market for debt obligations lowers the
cost and increases the availability of capital. This translates into
more jobs for Americans. Amendments to increase market efficiency and
provide comfort for investors will not only enhance the development of
future asset-backed securitizations, they will provide a safeguard
against market turmoil should a seller of financial assets become the
subject of proceedings under the Bankruptcy Code and attempt to disrupt
the cash flow on assets that were securitized.
The comprehensive bankruptcy bills currently pending in Congress
would substantially improve the statutory regime that governs financial
transactions when a party fails to meet its payment obligations. The
Bankruptcy Reform Act of 2001 (S. 220) and the Bankruptcy Abuse
Prevention and Consumer Protection Act (H.R. 333) are identical to the
bankruptcy conference report that was approved by a wide bipartisan
majority in the House and Senate last year.
This legislation would harmonize the Bankruptcy Code and bank
insolvency laws governing swaps, repurchase agreements, securities
contacts, forward contracts, and commodity contracts. They would also
provide a safe-harbor in the Bankruptcy Code for ABS transactions. The
Bond Market Association urges Congress to enact the full set of
bankruptcy and insolvency law changes that are needed to protect modern
financial markets. These proposed changes are entirely consistent with
many statutory provisions that have already been enacted, and are in
the nature of technical corrections.
II. The Current Safe Harbors Need to be Updated
a. swap agreements
Swap agreements are privately negotiated contracts between parties
to exchange payments under specified conditions. The parties'
obligations are linked to some index, commodity price, interest rate,
currency or other indication of economic value. In an interest rate
swap, for example, two parties agree to exchange payments based on some
agreed upon notional principal amount. However, principal does not
typically change
hands in a swap contract. It merely serves as the reference for the
calculation of the payments to be made.
The primary purpose of swaps is risk management. The universe of
parties actively engaged in swaps is expansive and growing: banks,
securities firms, mutual funds, pension funds both public and private,
manufacturing firms, and state and local governments, just to name a
few. Virtually all significant commercial enterprises face certain
risks that can be managed through the use of swaps. In the example that
follows, Party B attempts to manage its exposure to changes in interest
rates through the use of an interest rate swap:
Example 1. Two parties to an interest rate swap agree to exchange
payments based on a $1 million notional amount. Party A agrees
to pay a fixed rate of seven percent, and Party B agrees to
make floating payments based on some market index. If payments
are exchanged once per year, Party A would pay Party B $70,000
(seven percent of $1 million) and Party B would pay Party A
$40,000 in the first year (four percent of $1 million),
assuming that the floating rate index were four percent at the
time of calculation. In practice, the payments are netted so
that Party A simply pays Party B $30,000, or $70,000--$40,000.
(In this example, Party B may have floating rate assets and
fixed rate liabilities, and it desires to hedge that mismatch.
In this example, the payment that Party B receives makes up for
the reduced return Party B receives on its floating rate
assets, allowing it to satisfy its fixed rate liabilities.
Party A may be a dealer, who hedges its position by taking an
offsetting position, either in the swaps market or in another
fixed income market.)
The fundamental contractual terms in a swap for the exercise of
remedies in the event of bankruptcy or insolvency provide for ``close-
out,'' ``netting'' and foreclosure. Close-out involves the termination
of future obligations between the parties and the calculation of gain
or loss. Netting involves offsetting the parties' gains and losses to
arrive at a net outstanding amount payable by one party to the other.
Foreclosure involves the use of pledged assets to satisfy the net
payment obligation. The ability to execute this process swiftly is key
to the financial markets and the solvency of its participants due to
the potential exposure a counterparty in such transactions has to
market risks and the possibility of changes in the values of financial
contracts and collateral due to market movements. The inability of a
financial market participant to exercise these remedies promptly could
impair its liquidity and solvency.
The following is a basic example of the close-out, netting and
foreclosure process:
Example 2. Party A and Party B enter into two interest rate swaps at
different times (Swap X and Swap Y). Both contracts contain
provisions that allow for close-out, netting and foreclosure
and are in effect when Party A becomes insolvent. At the time
of Party A's insolvency, Party A's mark-to-market loss under
the terms of Swap X is $30 million and its mark-to-market gain
under the terms of Swap Y is $20 million. Through the process
of close-out and netting, the swaps are terminated and Party A
owes Party B $10 million. If Party A had pledged $15 million of
collateral to Party B, Party B would foreclose on the
collateral, use $10 million to satisfy Party A's obligation,
and return $5 million to Party A.
If Party A became subject to a proceeding under the Bankruptcy
Code, Party B would be entitled under current law (Sections 362(b)(17)
and 560 of the Bankruptcy Code) to exercise its self-help close-out,
netting and foreclosure remedies as described above. If Party A were an
FDIC-insured bank that became subject to a receivership (and Swaps X
and Y were not transferred to a successor entity), Party B would be
entitled under the Federal Deposit Insurance Act to exercise its self-
help close-out, netting and foreclosure remedies as described above. In
either case, if Party B were unable to exercise such remedies, its
liquidity and solvency could be impaired, creating gridlock and posing
the risk of systemic problems.
The swaps market has evolved since the protections for interest
rate and other swaps were first put in place. Parties have learned to
apply the principles of risk management in many different ways that are
not expressly covered under the applicable definitions in the
Bankruptcy Code and the Federal Deposit Insurance Act. As a result, the
markets in some cases proceed under some degree of legal uncertainty
regarding the enforceability of certain contracts, even though they are
economically equivalent to other contracts that are expressly protected
and pose the same risks that Congress has sought in the past to avoid.
For example, if in the above hypothetical the two swaps were equity
swaps in which the payments were calculated on the basis of an equity
securities index, it is not entirely clear that the transactions would
fall within the market safe harbor in the Bankruptcy Code or the
Federal Deposit Insurance Act for ``swap agreements.'' If both of the
parties were ``financial institutions'' under the Federal Deposit
Insurance Corporation Improvement Act or the Federal Reserve Board's
Regulation EE and the swap agreement were a ``netting contract,'' then
Party B might (although it is not entirely clear) be able to exercise
close-out, netting and foreclosure rights in respect to the equity swap
transactions. If one of the parties were not a ``financial
institution'' or the contract did not constitute a ``netting contract''
(for example, because it was governed by the laws of the United
Kingdom), then Party B could be subject, among other things, to the
risk of ``cherry-picking''--the risk that Party A's trustee or receiver
would assume Swap Y and reject Swap X, leaving Party B with a $30
million claim (which would be undersecured because of the impairment of
netting) and to the risk that its foreclosure on the collateral would
be stayed indefinitely. This could impair Party B's creditworthiness,
which in turn could lead to its default to its counterparties. The
pending legislation would minimize these risks by making clear that an
equity swap is a ``swap agreement,'' entitled to the same market safe
harbors as interest swap agreements.
b. repurchase agreements
Repurchase agreements, also known as ``repos,'' are contracts
involving the sale and repurchase of securities or other financial
assets at predetermined prices and times. Although structured and
treated for legal purposes as purchases and sales, economically repos
resemble secured lending transactions. In economic terms, one
participant in the repo transaction (the ``seller'') is borrowing cash
at the same time that the other participant (the ``buyer'') is
receiving securities. The recipient of cash agrees to pay the cash-to
repurchase the securities-at a predetermined time and price, including
a price differential (the economic equivalent of interest). The buyer
agrees to purchase and later resell the securities.
According to published reports, on an average day in 2000, nearly
$1.4 trillion in repos were outstanding between dealers of U.S.
government and federal agency securities, up from a daily average of
$310 billion in 1988. Parties also routinely engage in repo
transactions involving non-agency mortgage-backed securities, whole
loans and other financial instruments. As a result of recent
legislative changes enacted as part of the National Securities Markets
Improvement Act and recent changes to federal margin regulations, repos
may now involve equity securities. Participants in the repo market are
diverse, including commercial banks, securities firms, thrifts, finance
companies, nonfinancial corporations, state and local governments,
mutual and money-market funds and the Federal Reserve Banks, among
others.
In 1984, Congress acted to protect certain types of repos from the
insolvency of market participants after the 1982 Lombard-Wall
bankruptcy court decision cast uncertainty on the ability of market
participants to close out their positions. According to the Senate
Judiciary Committee report on the 1984 legislation, that decision had a
distinct adverse effect on the financial markets. At that time,
Congress granted protection only to repos involving certificates of
deposit, eligible bankers' acceptances, and securities that are direct
obligations of, or that are fully guaranteed as to principal and
interest by, the federal government. In doing so, Congress expressly
stated that repos serve a vital role in reducing borrowing costs in the
markets for these securities and sought to encourage market
participants to use repos with confidence.
Unfortunately, the list of instruments protected by those 1984
amendments to the Bankruptcy Code has grown outdated as market
participants have entered into repos involving a wide range of
financial assets. Besides repurchase agreements on government and
federal agency securities, which are covered under the Bankruptcy Code
and Federal Deposit Insurance Act definitions of ``repurchase
agreement,'' firms now actively engage in repurchase agreements on the
foreign sovereign debt of OECD countries, whole mortgage loans, and
mortgage-backed securities of many types. Under H.R. 333 and S. 220,
each of these types of repurchase agreements would be covered by the
market safe harbors provided in the Bankruptcy Code (they are already
covered by the Federal Deposit Insurance Act and regulations
thereunder). Market participants could then enter into such
transactions with greater confidence that they will be easily
enforceable, improving the liquidity and cost of financing in the
markets for the underlying instruments, and minimizing systemic risk.
c. securities contracts, forward contracts and commodity contracts
Market participants enter into contractual arrangements for the
sale of securities and commodities where payment and delivery
obligations are fulfilled at some future date. Securities contracts,
forward contracts, and commodity contracts all can take many forms, but
they can also be similar from an economic perspective. ``Securities
contracts'' include forward purchases of securities, pursuant to which
the parties agree to exchange payments and securities at a fixed date
in the future. ``Forward contracts'' include privately negotiated
arrangements where one party agrees to sell a commodity to another
party at a fixed price for delivery at a future date. The terms of
forward contracts can closely resemble those of futures contracts
(which are ``commodity contracts''). However, forward contracts are not
traded on commodity exchanges under standardized terms and the parties
envision actual delivery of the underlying commodity. Despite the
economic similarities of securities contracts, forward contracts and
commodity contracts, the Bankruptcy Code and the Federal Deposit
Insurance Act are inconsistent in their treatment of these
transactions. Under the Federal Deposit Insurance Act, any counterparty
can close out and net obligations under all securities contracts,
forward contracts or commodity contracts it may have outstanding with
the FDIC-insured bank in a liquidating receivership. However, if the
failing counterparty is a debtor subject to the Bankruptcy Code, the
enforceability of close-out provisions depends on a number of factors,
including the type of counterparty, and the type of contract involved.
In order to close out and net ``securities contracts,'' the non-
bankrupt counterparty must be a ``stockbroker,'' ``financial
institution'' or ``securities clearing agency.'' In order to close out
and net ``forward contracts,'' the non-defaulting party must qualify as
a ``forward contract merchant.'' A few examples illustrate these
differences:
Example 3. Party A, a mutual fund, and Party B, a securities
dealer, have two outstanding contracts for the purchase of securities,
one that is in-the-money to Party A, one that is out-of-the-money to
Party A. If Party B becomes the subject of proceedings under the
Bankruptcy Code, Party A would not be able to close out the contracts
and net its obligations to Party B under the out-of-the-money contract
against Party B's obligations under the in-the-money contract (unless
it had acted through a bank agent). However, if it is Party A that
becomes the subject of proceedings under the Bankruptcy Code, Party B
would be able to close out the transactions and net its obligations.
This is because Section 555 of the Bankruptcy Code allows liquidation
of securities contracts only by stockbrokers, financial institutions
and securities clearing agencies, none of which includes the mutual
fund (unless it had acted through a bank agent).
Example 4. Now assume that in the above example Party B is an FDIC-
insured depository institution. If Party B becomes the subject of
receivership proceedings and the securities contracts with Party A are
not transferred to a successor institution, Party A will be able to
close out the transactions and net the obligations thereunder. This is
because the Federal Deposit Insurance Act, since 1989, contains no
counterparty restrictions.
Example 5. Party A, the mutual fund, and Party B, an affiliate of a
securities dealer, have two outstanding forward foreign exchange
contracts. If Party B becomes the subject of proceedings under the
Bankruptcy Code, Party A would be able to close out and net the foreign
exchange transactions. This is because Section 556 of the Bankruptcy
Code allows liquidation of ``forward contracts'' (the foreign exchange
transactions) by forward contract merchants, a classification that
includes the mutual fund. (Note that the forward foreign exchange
contracts would also be ``swap agreements,'' and the mutual fund, as a
``swap participant,'' could exercise its rights on that basis as well.
Other ``forward contracts'' would not qualify as ``swap agreements.'')
Thus, parties of similar size who enter the markets with equal
frequency and in the same manner enjoy different degrees of protection
under the Bankruptcy Code and the Federal Deposit Insurance Act. This
makes no sense from the point of view of the reduction of systemic
risk--the failure of these market players could trigger the same kind
of chain reaction that a bank, broker-dealer or clearing agency failure
could trigger. The pending legislation would improve the current
situation by making certain technical definitional changes under the
Bankruptcy Code (to bring it closer to the Federal Deposit Insurance
Act). The amendments would expand the universe of counterparties whose
contractual rights would be enforceable. In addition to stockbrokers,
financial institutions, registered investment companies and securities
clearing agencies, large and sophisticated market participants would be
able to close out their securities contracts, forward contracts and
commodity contracts against Bankruptcy Code debtors. Such
counterparties would be defined as ``financial participants'' under the
Bankruptcy Code through certain quantitative tests modeled on the
Federal Reserve Board's Regulation EE. Once amended, the counterparty
limitations under the Bankruptcy Code would have a more rational scope
than they do under current law.
d. cross-product netting
Financial market participants often have a wide range of
transactions outstanding with one another at any given time. Thus, a
given party's exposure to the risk of default by another party may be
understood only by considering the total value of the payments that
party expects to receive and pay under all of the various contracts.
The Federal Deposit Insurance Act reflects an understanding of this and
permits the netting of obligations stemming from one type of
``qualified financial contract'' against obligations stemming from
another type of ``qualified financial contract.'' This practice, known
as ``crossproduct'' netting, permits more rational risk management
practices and allows market participants to resolve whatever problems
arise from the insolvency of one of their counterparties in a more
orderly fashion. Cross-product netting also reduces the likelihood of
systemic risk, as it allows the non-bankrupt counterparty to
crystallize its exposure and not be treated as a secured creditor with
an interest in cash collateral subject to the automatic stay.
Cross-product netting is also permitted under the Bankruptcy Code,
but to a lesser degree. Parties can net their obligations under
securities contracts, forward contracts and commodity contracts against
one another. It is unclear whether cross-product netting is permitted,
however, when the contracts involved are swaps and repurchase
agreements.
Example. Party A, a securities dealer, and Party B, a large
corporation, have an outstanding securities contract that upon close-
out is profitable for Party A. The parties also have an outstanding
forward contract that upon close-out is profitable for Party B. When
Party B becomes the subject of a proceeding under the Bankruptcy Code,
Party A would be able to close out each of the contracts and offset its
obligation to pay Party B under the forward against Party B's
obligation to Party A under the securities contract.
Example 7. Party A and Party B have an outstanding swap that upon
close-out is profitable for Party A. The parties also have an
outstanding repurchase agreement under which Party A holds securities
purchased from Party B that upon close-out is profitable to Party B
(i.e., the value of the securities exceeds the repurchase price). If
Party B becomes the subject of proceedings under the Bankruptcy Code,
Party A would not clearly be able to offset the excess repo proceeds
against Party B's outstanding obligation under the swap. At worst,
Party A would be treated as a secured creditor with a security interest
in the repo proceeds. Its rights could, however, be subject to the
automatic stay, thereby impairing its liquidity and creating the
potential for systemic risk.
There is no plausible rationale for treating cross-product netting
between securities, forward and commodity contracts differently from
cross-product netting between those contracts, swap agreements and
repurchase agreements. These anomalies emerged over time, as various
protective provisions were added to the Bankruptcy Code to protect
various types of markets. (Because the ``qualified financial contract''
provisions of the Federal Deposit Insurance Act were enacted at the
same time, no such anomalies exist in those provisions.) However, the
capital markets have grown and matured to such an extent that various
types of market participants now engage in many types of transactions,
and it is time for the market safe harbors to be rationalized and made
consistent in their application to all financial products for all
participants. Wider and more certain cross-product netting in cases of
bankruptcy should allow parties to enter into additional types of
transactions with the same counterparty without necessarily increasing,
on a net basis, their overall credit exposure or risk to the markets as
a whole. Indeed, some cross-product transactions will serve to reduce a
counterparty's overall risk, facilitating better risk management and
reducing overall risk in the financial markets.
III. Mortgage- and Asset-backed Securities
The process of assembling pools of financial assets and selling
securities with payments derived from the assets' cash flows is known
as ``securitization.'' Almost any financial asset can be securitized.
The earliest examples were home mortgage loans, but today financial
services firms securitize car loans and leases, credit card
receivables, business loans and many other assets generating current or
future cash flows. The proceeds from sales of securities supported by
those assets make their way back into the capital markets and become
available for new lending to homeowners, car owners, consumers,
businesses and myriad other borrowers. A larger supply of lendable
capital means that home buyers, car buyers, consumers and companies can
all borrow at lower interest costs. A simple example demonstrates the
process of financial asset securitization:
Example 8. Party O originates mortgage loans with a total principal
amount of $100 million and sells the whole loans to a special-purpose
vehicle (an ``SPV ''). The SPV issues mortgage-backed securities (``MBS
''), the payments on which are supported by cash flows from the
mortgage loans. As borrowers make principal and interest payments on
their mortgage loans, these payments pass through a servicer and
eventually are distributed to the MBS investors. The proceeds of the
sale of the loans by Party O to the SPV are available for new loans to
home buyers.
Certain types of mortgage-backed and asset-backed transactions
raise issues under the Bankruptcy Code that make them more costly or
difficult to complete. The central issue in such situations is the risk
that securitized assets transferred to a special-purpose vehicle, which
then issues securities backed by such assets, will be considered part
of the bankruptcy estate of the party selling them into the pool if
that seller becomes insolvent. Such treatment could subject the cash
flows from the securitized assets to the automatic stay and inhibit the
timely distribution of principal and interest payments to investors in
the subsequently issued asset-backed securities. It could also subject
the pool of transferred assets to attack by a bankruptcy trustee who
might seek to reclaim them for the bankrupt's estate for the benefit of
general creditors, denying beneficial holders of asset-backed
securities the primary source of repayment that was intended to be
provided by these securitized assets. Consider the following
transaction:
Example 9. Party A originates mortgage loans with a total principal
amount of $100 million and sells the loans to Party B. Party B sells
two classes of asset-backed securities based on the pool. The Class A
securities, totaling $90 million, have a senior claim on the cash flows
generated by the mortgage loans and receive an investment-grade credit
rating. The Class B securities, totaling $10 million, are subordinated
to the Class A securities and not rated investment-grade. Assume Party
B obtained the mortgage loans from Party A in exchange for (i) the $90
million raised through the sale of the Class A securities and (ii) the
Class B certificates. If Party A becomes insolvent, Party A (as debtor-
in-possession) or its trustee could attempt to recharacterize the sale
of the mortgage loans as a pledge to secure a financing, based on Party
A's retention of the Class B securities. If it were successful,
notwithstanding that it had received fair value at the outset of the
transaction and the reasonable expectations of the investors in the
Class A securities, distribution of the principal and interest payments
on the loans to the investors would be subject to the automatic stay,
jeopardizing timely payment to the Class A investors. Such a result
would not only harm the particular investors in question, it could have
a material, negative effect on the mortgage-backed and asset-backed
securities markets more generally.
In order to obtain sales treatment under the relevant accounting
standards, participants in mortgage-backed and asset-backed
securitization transactions must obtain assurances from counsel that
the sale of assets will be final under applicable bankruptcy law. Such
legal advice is referred to as a ``true sale opinion.'' Unfortunately,
there is a lack of guiding judicial precedent regarding what
constitutes such a true sale of assets. The considerations in the
analysis are highly subjective and depend on a qualitative assessment
of a wide variety of facts and circumstances. For these and other
reasons, any true sale opinion will generally be a reasoned one, with
various assumptions as to factual matters and conclusions that
introduce an unnecessary degree of legal uncertainty in the asset-
backed market. As a result, for some types of transactions, true sale
opinions can be extremely difficult, costly, and in a few cases,
impossible to render.
The FDIC recently released for comment a proposed Policy Statement
that would clarify that, with respect to certain securitizations by
FDIC-insured institutions, the FDIC would not seek to reclaim assets
that were the subject of the securitization. In particular, the Policy
Statement ``provides that subject to certain conditions, the FDIC will
not attempt to reclaim, recover, or recharacterize as property of the
institution or the receivership estate. . .the financial assets
transferred. . .in connection with the securitization.'' 63 Fed. Reg.
71926 (December 30, 1998). Similar action is needed to cover transfers
by market participants who later become debtors under the Bankruptcy
Code. In an effort to clarify the rights of investors in asset-backed
securities and bring the benefits of securitization to a broader
spectrum of market activity, H.R. 333 and S. 220 include a series of
amendments to the Bankruptcy Code that would specifically exempt
certain transferred assets from a debtor's bankruptcy estate and
clarify whatever ``true sale'' confusion may exist. The amendments
would be narrowly tailored to apply only to eligible assets transferred
as part of a bona fide securitization involving the issuance of
securities rated investment grade by at least one nationally recognized
rating organization. Through a series of definitions, the proposed
amendments would exclude from a debtor's estate any asset ``to the
extent that such eligible asset was transferred by the debtor, before
the date of commencement of the case, to an eligible entity in
connection with an asset-backed securitization.''
These changes would not only reduce transaction costs for future
mortgage- and asset backed securitizations, they would minimize the
likelihood that an insolvent debtor could attempt to reclaim already--
securitized assets in a proceeding under the Bankruptcy Code,
notwithstanding the structural safeguards designed to avoid such a
result. Even if such a debtor were not successful, the possibility of
recharacterization could have a significant adverse impact on the
markets in mortgage- and asset-backed securities.
IV. Conclusion
The above examples illustrate the need for Congress to enact the
financial contract provisions of S. 220 and H.R. 333, which would make
important, but highly technical changes to the Bankruptcy Code and the
Federal Deposit Insurance Act. These changes are consistent with the
existing market safe harbors in the Bankruptcy Code and the Federal
Deposit Insurance Act and will encourage broader use of sound risk
management techniques and help to minimize overall systemic risk. We
urge Congress to act quickly on this important legislation.
Statement of Commercial Law League of America
The Honorable Orrin G. Hatch
Chairman of the Judiciary Committee
The United States Senate
131 Russell Senate Office Building
Washington, DC 20510
Dear Senator Hatch:
The Commercial Law League of America (the ``League ''), founded in
1895, is the nation's oldest organization of attorneys and other
experts in credit and finance actively engaged in the fields of
commercial law, bankruptcy and reorganization. Its membership exceeds
4,600 individuals. The League has long been associated with the
representation of creditor interests, while at the same time seeking
fair, equitable and efficient administration of bankruptcy cases for
all parties in interest.
The Bankruptcy Section of the League is made up of approximately
1,600 bankruptcy lawyers and bankruptcy judges from virtually every
state in the United States. Its members include practitioners with both
small and large practices, who represent divergent interests in
bankruptcy cases. The League has testified on numerous occasions before
Congress as experts in the bankruptcy and reorganization fields.
In the Senate and the House of Representatives, S. 220 and H.R. 333
have been respectively introduced to reform the nation's bankruptcy
laws. Each is virtually identical to H.R. 2415, which passed the
106th Congress, but did not become law due to a presidential
veto. Although the League has prepared a position paper addressing its
foremost substantive concerns with S. 220 and H.R. 333, we believe it
is necessary to address procedural and substantive concerns that have
arisen in that past and that, in all likelihood, will persist as S. 220
and H.R. 333 are considered.
Last session's H.R. 2415 reflected a compromise between H.R. 833
and S. 625, each of which passed its respective Congressional house but
with some significant substantive differences. Unfortunately, the
compromise that produced H.R. 2415 was not the product of reasoned
debate because the legislation was never considered by a conference
committee consisting of members of the Judiciary Committee.
The need for a full conference cannot be overemphasized. Bankruptcy
law and legislation is highly specialized and complex, requiring
intimate knowledge of the inner workings of the Bankruptcy Code and
Rules, and their interrelationship among the various parties in
interest. Further, to the League's knowledge, not a single bankruptcy
organization, judges group or academicians has endorsed the current
versions of the bills or their predecessors. Most disturbing is that
the recommendations of the Bankruptcy Review Commission have been all
but ignored in the current legislation.
While extensive attention has been given to the consumer aspects of
bankruptcy reform, the business bankruptcy provisions have varied from
bill to bill and have not been afforded the same deference. With an
economic downturn already occurring, business bankruptcies inevitably
will rise, making it more critical that any business bankruptcy reform
be well reasoned and fully considered.
The business provisions of H.R. 833 and S. 625 were fundamentally
flawed. As extensively addressed in the League's previous position
papers, both pieces of legislation created far more problems than they
remedied. These problems are carried forward in the recently re-
introduced versions of H.R. 833 and S. 625.
For example, the legislation creates an untested procedure for the
reorganization of small businesses. The problems begin with the
commencement of the bankruptcy case be case the definition of ``small
business,'' tied to the amount of debt, would include an overwhelming
majority of all business bankruptcies. Designed with a preference for
efficiency over practicality, the small business provisions completely
ignore the realities involved and will effectively eliminate the
possibility of an otherwise viable reorganization in a great number of
cases, causing creditors to go unpaid and workers to lose their jobs.
Retail bankruptcies are doomed to failure. The proposed legislation
grants lessors of commercial real estate virtual veto power over lease
assumption and rejection, rather than allowing the bankruptcy courts to
continue to exercise their discretion regarding the time necessary for
a debtor to make decisions about whether or not to retain leased
property. Lessors will, in all likelihood, use their extraordinary
power to exert concessions from debtors as the quid pro quo for the
requested extensions, to the detriment of all other parties in
interest. This protection is, of course, in addition to the already
preferential treatment that commercial real estate lessors currently
enjoy under the Bankruptcy Code, which requires debtors to timely remit
lease payments or risk eviction from the premises. Equally disturbing
is that lessors' administrative expense claims are proposed to be
expanded. This further enhances lessors' rights, correlatively
compounding the harm to all other creditors. Strenuous objection has
been raised to this provision and virtually no one, other than the
shopping center lobby, supports it.
Most critically, the legislation does not address the single
largest defect in the business bankruptcy process--venue. The corporate
chapter 11 has become an embarrassment to our system of law. Due
process considerations have been undermined and access to the courts by
creditors and parties in interest has effectively been eliminated,
based on a debtor's current ability to file in its state of
incorporation, rather than where its principal assets or principal
place of business is located. This has resulted in over 40%of the
business bankruptcy cases filed in 1999 having been filed in Delaware.
Delaware courts are now determining from a remote location, issues
which directly impact the community where the debtor is actually
located and conducts its business. The inequitable nature of this
process is heightened, as the largest bankruptcy cases are now being
filed in Delaware. Whole communities, which are dependent on these
mega-employers, are affected without having any local presence or real
access to the process. Taxing authorities, who do not routinely utilize
``local counsel'' are being railroaded in the claims process, to the
detriment of their citizens. Local community issues, such as hospital
bed availability, nursing home care and public services such as garbage
removal and utility service, are being determined by those who are
least affected by the bankruptcy courts. Public confidence in the
bankruptcy process is eroding, and justifiably so, when ``notice'' and
``an opportunity to be heard'' are nothing but hollow gestures.
These and a plethora of other troublesome provisions demonstrate
the inherent complications involved in the process of reforming the
Bankruptcy Code on the scale contemplated by the most recent bankruptcy
reform legislation. The please of those with an intimate understanding
of the bankruptcy system, including judges, practitioners, trustees,
and academics, to more carefully consider the effects of the reform
legislation have repeatedly fallen on deaf ears. Bankruptcy reform
generally has yet to be debated in an appropriate conference,
independent of other legislation, where its problematic aspects can be
considered, including proper analysis of the harmful, unintended
consequences that surely will befall debtors, creditors and the process
as a whole. Real bankruptcy reform need not be so disruptive and should
never depart so far from the longstanding and bedrock principle of
bankruptcy--fair and balanced treatment of all parties in interest.
The League appreciates the opportunity to set forth and discuss
these significant concerns regarding proposed bankruptcy reform and the
process by which such reform is being considered. We welcome the
invitation to work with you and the other members of Congress to
achieve effective, balanced and meaningful bankruptcy reform for all
parties in interest.
Respectfully submitted,
Jay L. Welford
Co-Chair, Legislative Committee
Judith Greenstone Miller
Co-Chair, Legislative Committee
Mark Shieriff
President
Commercial Law League of America
Position Paper on S. 178 and H.R. 188 Permanent Reenactment of Chapter
12 of Title 11, United States Code Submitted to the United
States House of Representatives and the United States Senate by
The Commercial Law League of America and Its Bankruptcy Section
The Commercial Law League of America (``League ''), founded in
1895, is the nation's oldest organization of attorneys and other
experts in credit and finance actively engaged in the field of
commercial law, bankruptcy and reorganization. Its membership exceeds
4,600 individuals. The League has long been associated with the
representation of creditor interests, while at the same time seeking
fair, equitable and efficient administration of bankruptcy cases for
all parties in interest.
The Bankruptcy Section of the League is made up of approximately
1,600 bankruptcy lawyers and bankruptcy judges from virtually every
state in the United States. Its members include practitioners with both
small and large practices, who represent divergent interests in
bankruptcy cases. The League has testified on numerous occasions before
Congress as experts in the bankruptcy and reorganization fields.
The League strongly supports H.R. 188 and S. 178, which would make
permanent Chapter 12 of the Bankruptcy Code (the ``Code ''), the
provisions authorizing family farmer reorganization. The League urges
prompt enactment of this legislation.
Since the 105th Congress, the existence of the family
farmer reorganization provisions have been tenuous, subject to a series
of sunset dates imposed by temporary extensions. During this time, the
intent of Congress to make Chapter 12 permanent has been clear.
Fulfilling this intent has been repeatedly stalled, however, because
the necessary provisions to make Chapter 12 permanent have been
included in controversial bills that sought extensive reform of the
Code generally.
By all accounts, Chapter 12 has proven successful, enabling family
farmers to reorganize within a specifically tailored bankruptcy
structure. Prior to the enactment of Chapter 12, many family farmer
bankruptcies failed simply because the existing Code provisions were
unworkable in the unique circumstances involved in farming operations.
No evidence has been presented that Chapter 12 is not accomplishing
the purpose for which it was designed. It appears to be a victim of the
ongoing discussions relative to much more comprehensive and more
controversial bankruptcy legislation.
Enacting the permanent extension of Chapter 12, as proposed in H.R.
188 and S. 178, will ensure that family farmers in need of
reorganization are not denied meaningful bankruptcy relief. Too much
uncertainty arises for existing Chapter 12 debtors from temporary
extensions when, as in the past, gap periods occur during which there
is no authority to utilize the chapter's provisions. A permanent
extension of Chapter 12 independent of any other reform of the Code is
the only means of protecting all parties involved, including current
and potential family farmer debtors, as well as their creditors.
The League appreciates the opportunity to comment on H.R. 188 and
S. 178. We would be happy to address the position taken by the League
and its Bankruptcy Section in this Position Paper or to respond to
questions or concerns raised by this analysis.
Statement of Consumer Mortgage Coalition
Mr. Chairman, the Consumer Mortgage Coalition (``CMC''), a trade
association of national mortgage lenders and servicers, appreciates the
opportunity to submit testimony to the Committee on S. 220, the
``Bankruptcy Reform Act of 2001.''
Impact of Bankruptcy In the Residential Mortgage Market
CMC acknowledges the potential societal benefit in providing relief
for borrowers who are unable to pay their debts because of legitimate,
unforeseen circumstances. At the same time, it must be recognized that
the effect of bankruptcy on home mortgage lenders (``bankruptcy
severity'') ultimately affects the cost of residential mortgage loans
or credit availability, or both. In making pricing and underwriting
decisions, mortgage lenders consider the frequency of bankruptcy
filings, the delays caused by such filings, the amount of debt
recovered in bankruptcy, and the legal fees and other transaction costs
involved. Delays are of particular concern to mortgage lenders because
they lead to deterioration of the secured residence, which is being
maintained by a debtor with little or no stake in the property. Too
often, by the time the automatic stay is lifted by the bankruptcy court
and the lender is permitted to foreclose upon and sell the residence,
the proceeds of the sale are insufficient to pay the mortgage loan in
full. Lenders who want to remain in business spread their mortgage loan
losses to other borrowers in the form of higher interest rates. Any
changes in the bankruptcy system that decrease bankruptcy severity will
ultimately reduce the cost of home mortgages to the general public and
will benefit creditworthy consumers who are seeking home mortgage
financing.
Abusive Filings
There are a number of abuses of the bankruptcy process that prevent
lenders from foreclosing, even when the debtor is clearly unable to pay
the mortgage debt. Attached to this testimony is a case history
(Appendix A) which illustrates the reason mortgage lenders are
concerned with abusive filings. In this case, the debtor was able to
delay foreclosure for more than a year through the simple technique of
repeatedly conveying a partial interest in the mortgaged property to a
third party, who then filed for bankruptcy relief under Chapter 7. The
filing by the third party triggered the automatic stay, delaying
foreclosure on the property by two to three months. When the judge
dismissed the Chapter 7 filed by the third party, the debtor simply
found another transferee to whom a partial interest was conveyed and
who filed under Chapter 7 following the conveyance again triggering the
application of the automatic stay to the mortgaged property.
In this case example, the debtor was able to obtain nine separate
delays of the foreclosure sale, using five different transferees. The
lender was finally able to obtain relief from the automatic stay by
presenting evidence demonstrating to the court that the addresses--and
even the existence--of the transferees could not be verified. Even
after the court granted the motion for relief, the debtor again
attempted the same technique, transferring a partial interest in the
mortgaged property to yet another third party who immediately filed
under Chapter 7. Unfortunately, the practice of transferring partial
interests in mortgaged property to third parties who in turn file a
bankruptcy petition to delay foreclosure has become more prevalent over
the last few years. CMC would be pleased to present additional case
histories to the Committee or its staff upon request.
In addition to the third party transferee abuse, a debtor may file
a Chapter 13 petition, never make a single mortgage payment under the
plan, voluntarily dismiss the case just before the hearing on the
lender's motion to lift the automatic stay--and then file another
petition just before the next foreclosure sale. Although these
practices should subject the debtor to sanctions, the penalties in the
current Bankruptcy Code are difficult to enforce.
S. 220, Mr. Chairman, addresses the above-described filing abuses.
Section 302 amends Section 362 of the Bankruptcy Code to provide that
if a case filed by a debtor under Chapters 7, 11 or 13 was dismissed
and if the same debtor files a second case within a year of the
dismissal, the automatic stay will terminate within 30 days of the
filing of the second case unless the court extends the stay upon a
finding that the second case was filed in good faith.
In addition, Section 303 of S. 220 addresses the situation in which
a debtor transfers undivided interest in secured property to third
party transferees by permitting the bankruptcy judge to grant in rem
relief from the automatic stay. Properly applied, the in rem relief
would prevent third party transferees who file a petition in bankruptcy
from delaying foreclosure on property covered by in rem relief because
the automatic stay would not apply to the covered property.
Cramdowns
Several recent decisions have held that a lien on a residence
securing a mortgage loan is subject to- cramdown in certain
circumstances. A cramdown can negatively impact the lender's secured
claim. In a cramdown, the secured claim--the amount due on the mortgage
loan--is reduced to the amount of the lien that does not exceed the
market value of the property. The remainder of the claim is considered
unsecured, which reduces or eliminates its value.
In addition, the lender's remaining lien under a cramdown is
subject to restructuring as a secured claim in the Chapter 13 plan,
which can dramatically reduce its value. There have been cases, for
example, in which a conventional mortgage loan with equal monthly
payments to maturity was converted into one with small monthly payments
and large balloon payment at maturity--which the borrower could not
realistically be expected to be able to pay.
The United States Supreme Court in Nobelman v. American Savings
Bank, 508 U.S. 324 (1993), disallowed cramdowns under a Chapter 13 on
residential mortgage loans that constituted the debtor's principal
residence. However, courts, such as the Third Circuit Court of Appeals
in Hammond v. Commonwealth Mortgage Corporation of America, 27 F.3d 52
(3d Cir. 1994), have subsequently narrowed the reach of the Nobelman
decision. Section 1322(b)(2) of the Bankruptcy Code provides that a
Chapter 13 plan may not cramdown a ``claim secured only by a security
interest in real property that is the debtor's principal residence.''
(Emphasis added). The Third Circuit in Hammond narrowly read the term
``only'' and held because the mortgage lien on the principal residence
contained language creating a security interest in fixtures, rents,
escrow balance and the like--in addition to the lien on the real
property--the mortgage lien was no longer entitled to protection from
cramdowns under Section 1322(b)(2) of the Bankruptcy Code. Almost all
residential real estate mortgages--including the standard Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac) mortgage forms--contain language
creating a security interest in fixtures, escrow balances, etc. The
practical effect of decisions, such as Hammond, is to nullify the
cramdown protections in the Bankruptcy Code as enacted by Congress and
interpreted by the U.S. Supreme Court in Nobelman for the overwhelming
majority of residential mortgages.
There are a number of reasons for according residential mortgage
loans protection from the cramdown provisions of Chapter 13.
Protecting residential mortgage loans against cramdown
encourages lenders to make higher loan-to-value loans and to
lend to borrowers to whom they might otherwise not lend at all.
This in turn makes possible wider home ownership consistent
with the national policy evidenced by tax benefits favoring
home ownership and government-sponsored mortgage insurance
programs.
Prohibiting cramdowns on residential mortgage loans protects
and supports the secondary market for home mortgages. A sizable
portion of Fannie Mae and Freddie Mac mortgage loans, together
with other residential mortgage loans, are sold into the
secondary market. The existence of the secondary market
encourages mortgage origination by providing greater access to
capital with which to fund residential mortgage loans.
If a debtor is permitted to cramdown a mortgage loan to the
current market value of the residence securing the mortgage
loan, he will be able to take advantage of a temporary decline
in the value of his home to reduce the mortgage lender's
secured claim. If the residence later increases in value
following a cramdown, the debtor rather than the lender will
obtain the benefit of the appreciation. This problem is not
particularly serious in the case of other consumer collateral
(such as automobiles or appliances) since those types of
collateral depreciate in value over time. It is a serious
problem (and a temptation to the debtor) in the case of a home
mortgage, since a residence often fluctuates in value over the
life of a mortgage loan.
Since the procedures provided by real estate law for
foreclosing on a residential mortgage loan are typically more
formal, more cumbersome and provide greater protection to
borrowers (e.g., through rights of redemption) than is the case
with other types of consumer collateral, the borrower's need
for the ability to cramdown a mortgage loan is less and the
prejudice to the mortgage lender of taking away the protection
from cramdown, when combined with the stricter limitations on
the lender's ability to foreclose is greater.
Perhaps the best argument for protecting residential mortgage loans
from cramdown was advanced by the Fourth Circuit Court of Appeals in
its recent decision, Witt v. United Companies Lending Corp. 113 F.3d
508, (4th Cir. 1997) in which it noted that:
We recognize that the effect of our decision will require the
Witts to pay back the full amount of their home mortgage loan,
making it harder for them to get `a fresh start in life, after
they have made a good-faith attempt to pay what they can.'
Report at 32. As Justice Stevens recognized in Nobelman, `[a]t
first blush it seems somewhat strange that the Bankruptcy Code
should provide less protection to an individual's interest in
retaining possession of his or her home than of other assets.'
Nobelman, 508 U.S. at 332 (Stevens, J., concurring). Permitting
the bifurcation of home mortgage loans, however, could make
lenders more hesitant to make such loans in the first place.
Although a broader reading of [section] 1322(c)(2) might help
the Witts today, it could make it more difficult in the future
for those similarly situated to the Witts to obtain any
financing at all. Congress appears to have designed another
important section, [section] 1322(b)(2), with this result in
mind. See id. (stating that [section] 1322(b)(2)'s `legislative
history indicat[es] that favorable treatment of residential
mortgagees was intended to encourage the flow of capital into
the home lending market)'; Perry, 945 F2d at 64 (finding that
[section] 1322(b)(2) `was intended to make home mortgage money
on affordable terms more accessible to homeowners by assuring
lenders that their expectations would not be frustrated');
Grubbs v. Houston Am. Sav. Ass'n, 730 Fd 236 (5th Cir. 1984)
(noting that the exception for home mortgages in [section]
1322(b)(2) `was apparently in response to perceptions, or to
suggestions advanced in the legislative hearings. . .that
home mortgage lenders, performing a valuable social service
through their loans, needed special protections against
modification thereof (i.e., reducing installment payments,
secured valuations, etc.)'). Witt at page 514.
Recognizing the importance of protecting residential mortgage loans
from cramdown under a Chapter 13, Section 306(c) of S. 220 includes
definitions of ``debtor's principal residence'' and ``incidental
property'' clarifying that a lender's security interest in incidental
property that is commonly conveyed with a principal residence to secure
a mortgage loan will not remove the loan from the cramdown protections
afforded under Section 1322(b)(2).
One additional cramdown issue merits consideration of the
Committee. It relates to confusion that has arisen among various courts
in differing jurisdictions as to whether mortgage loans secured by
duplexes, triplexes and four-unit residences are entitled to protection
from cramdown under Section 1322(b)(2).
The definition of ``debtor's principal residence'' in Section
306(c)(1) of S. 220 reads as follows:
(13A) `debtor's principal residence'--
(A) means a residential structure, including incidental property,
without regard to whether that structure is attached to real
property; and
(B) includes an individual condominium or cooperative unit, a mobile
or manufactured home, or trailer;
Language should be added to subsection (A) of the definition of
``debtor's principal residence'' to make it clear that the definition
includes duplexes, triplexes and four-unit residences. The revised
subsection (A) would read as follows:
(A) means a residential structure containing 1 to 4 units, including
incidental property, without regard to whether that structure
is attached to real property; and
The ``1 to 4 units'' language would resolve a conflict in
jurisdictions. Courts have differed as to whether a duplex, triplex or
four-unit residence in which the debtor/owner lives in one of the units
and rents out the remaining units qualifies as a ``debtor's principal
residence'' protected from cramdown under Section 1322(b)(2). See Lomas
Mortgage, Inc. v. Louis, 82 F.3d 1 (1st Cir, 1996) in which the First
Circuit found that a triplex did not qualify as ``debtor's principal
residence'' under Section 1322(b)(2) and Brunson v. Wendover Funding
Inc., 201 B.R. 351 (Bankr. W.D.N.Y. 1996) in which the Bankruptcy Court
for the Western District of New York found that a duplex did qualify as
``debtor's principal residence''.
The First Circuit in Lomas noted that the Supreme Court in Nobelman
had determined that Congress enacted carmdown protection under Section
1322(b)(2) to encourage the flow of capital into the home lending
market and went on to state that:
If the antimodification provision [Section 1322(b)(2)] is meant to
encourage home lending, then excluding multifamily houses would
tend to harm (in revenue terms) those purchasing property in
urban neighborhoods, where owner-occupied multi-unit housing
would tend to be more common, and to favor those purchasing
single-family homes, more common in suburbia. The theory is
that lenders would face relatively more risk of modification
[cramdown] in the case of default in urban areas, and interest
rates on loans in those areas would rise accordingly. Lomas, 82
F.3d at 6.
The First Circuit noted that ``extending the antimodification
provision to multi-family houses would create a difficult line-drawing
problem. It is unlikely Congress intended the antimodification
provision to reach a 100-unit apartment complex simply because the
debtor lives in one of the units.'' Lomas, 82 F.3d at 6.
The First Circuit ended its decision by noting that ``If we are
wrong as to what Congress intended [in concluding that the
antimodification provisions of Section 1322(b)(2) did not protect a
triplex from cramdown], legislation can provide a correction.'' The
Burnson court shared the concern of the First Circuit in Lomas, noting
that the Lomas:
Court bemoaned a lack of `clear guidance' on the question [of whether a
multi-family residential property was subject to cramdown] from
either the language or contemporaneous legislative history of
Section 1322(b)(2). . .This Court shares the frustration of
numerous other courts in attempting to interpret this statute
which is impenetrable when sought to be applied to a single
parcel of land upon which the Debtor resides but which contains
two or more dwelling units. Brunson, 201 B.R. at 351.
As the First Circuit noted in Lomas, a number of residential
properties, particularly in the Northeast, are comprised of duplexes,
triplexes and four-unit residences. Clarifying that such properties
would qualify as ``debtor's principal residence'' for purposes of
Section 1322(b)(2) with the result that mortgage loans secured by
duplexes, triplexes and four-unit residences would not be subject to
cramdown--would provide certainty to residential mortgage lenders. Such
certainty would encourage the continued flow of capital into the 2 to 4
unit residential market.
The definition of ``debtor's principal residence'' at Section
306(c)(1) of S. 220 should be modified to include language making it
clear that that a ``debtor's principal residence'' for purposes of
Section 1322(b)(2) of the Bankruptcy Code includes a residential
``structure containing 1 to 4 units.''
Conclusion
Mr. Chairman, CMC is very appreciative of the opportunity to
present its views on issues of critical importance to the residential
mortgage industry and to all American homeowners. We look forward to
working with you and the other Members of the Committee and the staff
in finalizing legislation to implement necessary and long overdue
reforms to the Bankruptcy Code.
Statement of the International Council of Shopping Centers
Introduction
The International Council of Shopping Centers (ICSC) is pleased to
present this written statement for the record to the Senate Judiciary
Committee in conjunction with its February 8, 2001 hearing on the
Bankruptcy Reform Act of 2001 (S. 220).
ICSC is the global trade association of the shopping center
industry. Its 40,000 members in the United States, Canada and more than
70 other countries around the world include shopping center owners,
developers, managers, investors, lenders, retailers and other
professionals. The shopping center industry contributes significantly
to the U.S. economy. In 1999, shopping centers in the U.S. generated
over $1.2 trillion in retail sales and over $47 billion in state sales
tax revenue, and employed over 11 million people.
First and foremost, ICSC would like to commend Congress, and this
Committee in particular, for its efforts over the past few years to
enact meaningful bankruptcy reform legislation. We are hopeful that S.
220, introduced by Senator Charles Grassley (R-IA), will be swiftly
enacted so it can end existing abuses of the bankruptcy system.
Although all of ICSC's concerns are not addressed in S. 220, we believe
it is a well-balanced piece of legislation and should be approved and
signed into law as soon as possible.
Business Bankruptcy Abuses are a Growing Problem
As we all know, an increasing number of retailers and entertainment
establishments have been filing for bankruptcy protection over the last
several years, including Bradlees, Crown Books, Discovery Zone, Edison
Brothers, Garden Botanika, General Cinema, Montgomery Ward, Paul Harris
Stores, Planet Hollywood, Service Merchandise, and United Artists, just
to name a few. According to industry sources, included in the total
number of businesses filing Chapter 11 bankruptcies in 2000 are 176
companies with assets totaling $95 billion. It seems as if every week
another longstanding business is declaring bankruptcy. Furthermore, as
our nation's economy continues to soften, it is very likely that
additional businesses--both large and small alike--will be forced to
seek the protections of Chapter 7 and 11 of the Bankruptcy Code.
ICSC supports and respects an underlying goal of the bankruptcy
system that companies facing financial catastrophe should be able to
reorganize their businesses under Chapter 11. Unfortunately, more and
more solvent businesses are taking advantage of the system and filing
for bankruptcy protection in order to accomplish goals that would
otherwise not be permissible, such as shedding undesirable leases.
In addition, many U.S. bankruptcy judges and trustees are not
abiding by existing rules that were enacted by Congress to protect
shopping center owners. As a result, many shopping center owners are
losing control over their own properties, neighboring tenants are
losing business, retail employees are losing jobs or suffering reduced
working hours, and local economies are being threatened.
Shopping Centers Need Special Protection Under the Bankruptcy Code
Bankruptcies pose unique risks and hardships to shopping center
owners that are not faced by other creditors because such owners are
compelled creditors to their retail tenants. As a compelled creditor, a
shopping center owner must, under the Bankruptcy Code, continue to
provide leased space and services to its debtor tenants without any
real assurance of payment or knowledge as to whether or when its leases
will be assumed or rejected or whether its stores will be vacated.
On the other hand, trade creditors can decide for themselves
whether or not they want to continue providing credit to its bankrupt
customers for goods or services. Banks and other lenders are not
obliged to continue making loans to their clients once they file for
bankruptcy. Utility companies can demand security deposits before they
provide additional services to their customers. In fact, some judges
are granting ``critical vendor motions'' made by certain creditors that
allow them to receive their pre-petition claims (before all other
creditors) in exchange for agreeing to provide their goods or services
to the debtor during bankruptcy.
Another element unique to shopping center owners is the
interdependence and synergy that exists between a shopping center and
its tenants. Owners carefully design a ``tenant mix'' for each of its
shopping centers in order to maximize customer traffic from its market
area. The tenant mix includes tenants based on their nature or ``use'',
their quality, and their contribution to the overall shopping center,
and is enforced by lease clauses that describe the required uses,
conditions and terms of operation. Such clauses are designed to prevent
an owner from losing control over its own property and to maintain a
well-balanced shopping atmosphere for the local community.
For example, an owner and a retailer of upscale ladies' shoes may
enter into an agreement that restricts the tenant, or an assignee, from
selling low quality, discounted footwear or changing its line of
business to one that competes with another store in the same shopping
center. When a use clause is ignored during bankruptcy proceedings, the
delicate retail balance and synergy that has been painstakingly
achieved by an owner with its tenants is disturbed and can deal a
devastating blow to the entire shopping center, and to the community at
large.
Acknowledging that shopping center owners are in a truly unique
position once one of its tenants files for bankruptcy, Congress enacted
special protections in Section 365 of the Code in 1978 and 1984.
Unfortunately, many of these laws either have not been enforced or have
been liberally construed against shopping center owners beyond
Congress' original intent.
Leases Need to be Assumed or Rejected within a Reasonable, Fixed Time
Period
Under Section 365(d)(4), tenants have 60 days after filing for
bankruptcy to
assume or reject their leases. If additional time is needed, the
court may extend the time period ``for cause''. Unfortunately, in most
cases, the ``for cause'' exception has become the rule. As a matter of
practice, bankruptcy judges routinely extend the 60-day period for
several months or years. In many instances, debtors do not have to
decide what they plan on doing with their leases until their plans of
reorganization are confirmed. Some debtors are even permitted to make
such decisions after the date of confirmation.
As a result, the stores of these bankrupt retailers often remain
closed for long periods of time, casting a dark shadow on the entire
shopping center. Even if a shopping center owner receives rent from the
bankrupt tenant during this period, a vacant store usually creates a
negative impact on the other stores in the shopping center. Not only do
the neighboring stores suffer reduced traffic and sales, but the owner,
by virtue of percentage rent clauses that have been written into their
leases, suffers reduced percentage rent income from its other tenants.
To make matters worse, the owner is unable to make arrangements to
lease out the vacant space to another potential tenant since the
bankrupt retailer is not required to inform the owner whether it plans
to assume or reject the lease. It is this uncertainty that is most
frustrating to shopping center owners. They, and the rest of the
shopping center, are essentially kept in limbo until the debtor, or the
debtor's trustee, makes a decision to assume or reject its lease.
Owners are not attempting to pressure debtors to reject their leases.
Instead, they simply want a determinable period of time for their
bankrupt tenants to assume or reject their leases.
The current situation is clearly unfair to shopping center owners
and has to be remedied. While we realize that 60 days in most cases is
not enough time for a bankrupt retailer to decide which of its leases
it wants to assume or reject, we strongly believe that a reasonable,
fixed time period must be created so an owner, and the rest of the
tenants in the shopping center, have certainty as to when a lease of a
vacant store will be either assumed or rejected.
One must remember that, in most cases, a debtor can decide when it
files for bankruptcy protection. Retail chains do not suddenly decide
they will file for bankruptcy. They typically review their economic
situation well in advance of filing a bankruptcy petition. Retailers
and their advisors have a pretty good indication even before they file
for bankruptcy which leases they want to assume and which they want to
reject since it is often the very reason they are filing for
bankruptcy.
Section 404(a) of S. 220 would require a debtor tenant to assume or
reject its leases within 120 days after filing for bankruptcy. Prior to
the expiration of the 120 days, a judge could extend this time period
for an additional 90 days upon the motion of the trustee or owner ``for
cause''. Additional extensions could be granted only upon the prior
written consent of the owner.
By requiring an owner's consent for additional extensions after the
initial 120-day and court-extended 90-day periods, shopping center
owners would retain a certain degree of control of their property if a
tenant has not decided to assume or reject its leases within 210 days.
Owners would often be amenable to extending the time period for
assumption or rejection for a certain length of time if it appears to
be in the best interest of both parties.
While ICSC believes that a total of 120 days (including a court
extension ``for cause '') is ample time for retailers in bankruptcy to
make informed decisions as to which leases should be assumed and which
should be rejected, to the extent the other shopping center provisions
listed below are included in the final package, we would support this
provision of S. 220.
``Use'' Clauses Need to be Adhered to by Trustees Upon Assignment
As mentioned above, a well balanced ``tenant mix'' helps create the
character and synergy among the various tenants of a shopping center. A
lease's ``use'' clause is specifically designed to maintain this tenant
mix, and is supposed to be adhered to upon assumption or assignment.
Unfortunately, a growing number of judges are allowing trustees to
assign shopping center leases to outside retailers in clear violation
of existing use clauses and Code Sections 365(f)(2)(B) and 365(b)(3).
A recent notable case involves a children's educational retailer in
the Boston-area in which a judge allowed the trustee to assign two of
its unexpired leases to a jeweler and a candle shop, even though
another children's educational retailer offered bids, albeit lower
ones, on those leases.
Use clauses are mutually agreed-upon provisions that are intended
to direct the use of a particular property to a particular use. They do
not prevent the assignment of a property to another retailer; however,
the new tenant is supposed to adhere to the lease's use clause.
Congress has already recognized in the Bankruptcy Code that a
shopping center does not merely consist of land and buildings. It is
also a particular mix of retail uses which the owner has the right to
determine. Thus, Section 365(f)(2)(B) already requires that a trustee
has to obtain adequate assurance that a lease's use clause will be
respected before he or she can assign the lease to a third party.
Section 365(b)(3)(C), defining ``adequate assurance'', states that ``.
. .adequate assurance of future performance of a lease of real
property in a shopping center includes adequate assurance . . . that
assumption or assignment of such lease is subject to all the provisions
thereof, including (but not limited to) provisions such as radius,
location, use, or exclusivity provision . . . .''
Yet, a number of bankruptcy judges have ignored this requirement.
This abuse of the Bankruptcy Code must end. Section 404(b) of S. 220
would amend Section 365(f)(1) to make it crystal clear to all trustees
that the shopping center provisions contained in Section 365(b),
including that relating to adequate assurance that use clauses will be
respected, must be adhered to before they can assign leases to other
retailers.
Shopping Center Owners Need Greater Access to Creditors' Committees
Another growing concern of the shopping center industry is the lack
of appointments by many U.S. trustees of shopping center owners to
creditors' committees during bankruptcy proceedings. A creditors'
committee is the key decision-making body in a bankruptcy case as it
helps formulates how and when a debtor is going to reorganize its
business. In addition to having a vested interest in the outcome of a
bankruptcy case, a shopping center owner can provide valuable
knowledge, insight and perspective to a creditors' committee in order
to assist in the creation of a successful reorganization plan.
Under current law, U.S. trustees are authorized under Section
1102(a)(1) to appoint a committee of creditors holding unsecured
claims. Unfortunately, many trustees have excluded shopping center
owners from these committees, even if they qualify to serve under
Section 1102(b)(1). This section states that a creditors' committee ``.
. . shall ordinarily consist of the persons, willing to serve, that
hold the seven largest claims against the debtor of the kinds
represented on such committee . . .''.
Even in cases where an owner is not one of the seven largest pre-
petition creditors, it usually is one of the seven largest post-
petition creditors due to damage claims from rejected leases. A
retailer may have been making timely lease payments up to the time it
filed for bankruptcy; however, if it later defaults on payments (which
it is obligated to make) or decides to reject some or all of its
leases, the shopping center owner usually has very large potential
rejection claim damages. Certainly, such an owner should be entitled to
participate on these creditors' committees.
Although bankruptcy judges currently may order the appointment of
additional committees to assure adequate representation of creditors,
only the trustees are actually authorized to appoint such committees.
Therefore, the discretion to add shopping center owners to creditors'
committees is solely vested with the U.S. trustees. Section 405 of S.
220 would also give this discretion to bankruptcy judges as it would
permit them, after receiving a request from an interested party, to
order a change in the membership of a creditors' committee to ensure
the adequate representation of creditors.
Non-Monetary Defaults Need to be Cured before a Lease can be Assumed
Under Section 365(b)(1)(A) of the Bankruptcy Code, a trustee may
not assume an unexpired lease unless he or she cures, or provides
adequate assurance that he or she will promptly cure, all existing
monetary and non-monetary defaults. This provision was enacted by
Congress to ensure that existing leases are adhered to before they may
be assumed and later assigned to another tenant. Unfortunately, some
judges are allowing leases to be assumed and assigned despite the fact
that such leases remain in default.
Section 328 of S. 220 would amend existing law by providing that
non-monetary defaults of unexpired leases of real property that are
``impossible'' to cure would not prevent a trustee from assuming a
lease. Unlike monetary defaults, certain non-monetary defaults are
impossible to cure. For example, a vacant store can later be reopened;
however, the default (the vacating of the store) can never be fully
cured since it is impossible to reopen the store during the time it was
vacant.
However, Section 328 also provides that ``. . . if such default
arises from a failure to operate in accordance with a nonresidential
real property lease, then such default shall be cured by performance at
and after the time of assumption in accordance with such lease, and
pecuniary losses resulting from such default shall be compensated . .
.''. Therefore, a trustee would be able to assume the lease of a vacant
store so long as its nonmonetary defaults are cured (e.g., the store is
reopened) at and after the time of assumption. ICSC supports this
provision since it would require trustees to abide by the terms of a
commercial lease agreement upon its assumption.
A Reasonable Administrative Priority for Rents Should be Enacted
Under current law, post-petition rents are treated as an
administrative priority until a lease is assumed or rejected under
Section 365(d)(3). If a lease is rejected, postrejection rents are
treated as an unsecured claim under Section 502(b)(6), which usually
limits the claim to one year's rent. The Bankruptcy Code, however, does
not specifically address claims resulting from nonresidential real
property leases that are assumed and subsequently rejected.
However, in a 1996 U.S. Court of Appeals case, Klein Sleep
Products, the court held that all future rents due under an assumed
lease, regardless of whether it is subsequently rejected, should be
treated as an administrative priority and not limited by Section
502(b)(6). As a practical matter, shopping center owners prefer to
lease their property to operating retailers as soon as possible to
maintain a vibrant center and collect rent, rather than maintain a
vacant store whose unpaid rents are treated as an administrative
priority.
Section 445 of S. 220 would treat rents due under an assumed and
subsequently rejected lease as an administrative priority for two years
after the date of rejection or turnover of the premises, whichever is
later, ``without reduction or set off for any reason except for sums
actually received or to be received from a nondebtor''. Any remaining
rents due for the balance of the lease term would be treated as an
unsecured claim limited under Section 502(b)(6).
While ICSC prefers that rents due under an assumed and subsequently
rejected lease are treated as an administrative priority for three
years, and that any remaining rents due under the lease are treated as
an unsecured claim not limited under Section 502(b)(6), we accept this
provision as a reasonable compromise so long as the other shopping
center provisions listed above are included in the final package.
United States Court of Appeals
Fifth Circuit
Houston, Texas 77002-2655
Chairman Orrin Hatch
Senate Judiciary Committee
Washington, DC 20510
Re: Section 1235, Bankruptcy Reform Act of 2000, Expedited Appeals
of Bankruptcy Cases to Courts of Appeals
Dear Chairman Hatch:
Streamlining the bankruptcy appellate process is one of the most
important bankruptcy reform goals that Congress can achieve. As an
appellate court judge, a member of the National Bankruptcy Review
Commission, and a former bankruptcy lawyer, I write to issue my support
for expediting some bankruptcy appeals to the courts of appeals. By
keeping this type of provision in the Bankruptcy Reform bill, Congress
will: (1) eliminate excessive costs and delay; (2) promote efficiency,
fairness and stability; and (3) bring much needed uniformity to
bankruptcy and the American commercial law system. Contrary to the
position taken by some appellate judges, authorizing direct appeals
will not cause an undue burden on the federal courts of appeals.\1\
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\1\ I do not write in support of any particular form of direct
appeals, because there are a number of possibilities in addition to
Sec. 1235 as now structured that would accomplish the same basic
objective.
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Enthusiasm for expedited appeals exists throughout the bankruptcy
community. Its supporters include bankruptcy judges, lawyers,
academics, and debtor and creditor representatives. Indeed, in a rare
expression of unity, the National Bankruptcy Review Commission voted
unanimously to recommend direct appeals.\2\
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\2\ See 1 National Bankruptcy Review Commission, Final Report of
the National Bankruptcy Review Commission (Bankruptcy: The Next Twenty
Years) 752-67 (1997). Then-Chief Judge Richard Arnold of the Eighth
Circuit, who was at that time a member of the Executive Committee of
the Judicial Conference of the United States, endorsed the direct
appeal proposal when he attended the meeting where the Commission voted
to support it.
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The present two-tier appellate system directs bankruptcy appeals
first to the district courts and then to the courts of appeals. The
policy reasons supporting the elimination, as far as practical, of
federal district courts from the bankruptcy appellate process are
overwhelming. Bankruptcy cases, recently rising to over one million a
year, have immediate and far-reaching consequences for borrowers and
lenders nationwide. These cases are a significant federal court
responsibility. Not only do bankruptcy courts interpret the federal
Bankruptcy Code, but their decisions form the core body of cases in
American commercial law today. Despite the potential social
significance of the decisions, and despite the Constitution's provision
for uniform bankruptcy law, there is precious little uniformity in
bankruptcy.
The present system discourages final rulings and uniformity in
several ways. First, most participants in bankruptcy lack the resources
to finance legal fees through two full stages of appeal. Since most
bankruptcy claims are already heavily discounted, there is rarely
enough money at stake to justify undertaking duplicative appeals in
order to obtain binding precedent. Second, delay imposes high costs.
Adding to the inherent delay from duplication is the fact that some
federal district courts do not handle bankruptcy appeals expeditiously.
Neglect by these courts creates incentives to file appeals for the
purposes of delay, even as it discourages the pursuit of meritorious
appeals.
The excessive costs and delays mean that courts of appeals are
rarely called upon to issue bankruptcy precedents binding throughout
their circuit. Unfortunately, district court opinions rendered at the
first level of review are not considered binding on the bankruptcy
courts. Consequently, bankruptcy law is variable, non-uniform, and
lacking in stare decisis within individual judicial districts as well
as nationwide. Many issues that could have been settled by circuit
courts are subject to interminable and costly relitigation in case
after case, because the current appellate process stymies the
definitive resolution of issues by courts of appeals.
The current two-tier system is thus both legally inefficient and
unfair to the hapless participants in bankruptcy.
Against the manifest deficiencies of this system, and the national
impact of bankruptcy court and Bankruptcy Code decisions, some
appellate judges fear that eliminating the district court appellate
function will unbearably increase our workload. With due respect, I
believe this fear is exaggerated.
The courts of appeals, while busy, are currently not overburdened.
In fact, appellate filings for fiscal year 1999 fell 3%, after
excluding some newly-counted original proceedings.\3\
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\3\ See Administrative Office of the U.S. Courts, Judicial Business
of the United States Courts: 1999 Annual Report of the Director 15.
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The short-term impact of expediting bankruptcy appeals to the
courts of appeals is unknowable, but there are several reasons to
predict it will not be severe.\4\ First, many appeals now filed for
purposes of delay in the district courts would not be pursued to the
courts of appeals. Second, the Bankruptcy Appellate Panels (BAP's) will
remain available for bankruptcy appeals in several circuits or could be
created in other circuits where they become necessary. BAP's will be
selected by many litigants for strategic reasons that we cannot presume
to assess.\5\ Finally, devices such as appeals without oral argument
and the growing use of appellate conference attorneys could screen and
resolve many less consequential bankruptcy appeals.
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\4\ Even if each appeal filed in the district courts in fiscal year
1999 went to the courts of appeals, that would amount to about 3,000,
or at most, a 6t increase in the court of appeals docket. For the
reasons stated, I question whether anything close to one-to-one
equivalency would occur.
\5\ In addition, to some litigants, the relative unfamiliarity of
federal appellate court procedure might be a deterrent (albeit an
irrational one) to appeal.
---------------------------------------------------------------------------
The long-term forecast for direct bankruptcy appeals is more
optimistic. As unclear issues are resolved at the circuit level, there
will be more stability in the initial bankruptcy process and less need
for appeals.
As is the case with any changes in legal process, the courts of
appeals can expect a period of somewhat increased bankruptcy appeals,
followed by a leveling-off due to the growing effect of stare decisis.
To measure the desirability of the change, one must consider the impact
not only on the appellate courts but also on the bankruptcy system and
the American commercial system it serves. In view of the very large
benefits that will accrue from eliminating a wasteful and inefficient
extra layer of bankruptcy appeals and from instilling more appellate
certainty in bankruptcy, I think the complaints about an increased
appellate caseload are misplaced.
Thank you for allowing me to comment on this vital element of
bankruptcy reform.
Very truly yours,
Hon. Edith H. Jones
U.S. Department of Justice
Office of Legislative Affairs
Washington, DC 20530
Hon. Charles E. Schumer
United States Senate
Washington, DC 20510
Dear Senator Schumer:
The Administration is deeply concerned by the incidents of
violence, vandalism, and harassment committed against family planning
clinics: Some of these acts have resulted in the deaths and maiming of
innocent people. The Administration believes that these unlawful
activities must not be tolerated, and that when they are committed,
those found liable should be held accountable under the law.
The Administration has a strong record of supporting efforts to end
clinic violence. The Freedom of Access to Clinic Entrances (FACE) Act
of which you were the principal House sponsor, and which the President
signed into law, provides federal protection against unlawful and
violent actions while it protects the right to engage in peaceful
picketing and protest unaccompanied by force or physical obstruction.
Violators of FACE are subject to criminal penalties of imprisonment, a
fine or both. In addition, the court may also assess civil penalties
for a particularly egregious offense or against a repeat offender.
State clinic access laws and state and federal anti-racketeering laws
are additional tools used to prosecute clinic violence. Yet, if
offenders are able to escape the damages assessed under these laws,
then they will gradually lose their effectiveness.
Unfortunately, some defendants found liable for clinic violence are
abusing the bankruptcy system in an effort to shield themselves from
civil monetary penalties assessed under these laws. More specifically,
these defendants are filing for Chapter 7 to discharge their
obligations to the victims of their clinic violence and to escape
responsibility for their actions. In order to stem the tide of clinic-
related violence by ensuring that penalties for these acts are strictly
enforced, we support your amendment that would make court-ordered fines
and debts resulting from clinic violence nondischargeable.
The Administration's general position has been to oppose the
expansion of nondischargeable debt unless there is an overriding public
policy objective to be protected and no other way to achieve that
objective. Consistent with this position, we view your amendment as a
necessary tool in our current efforts to end illegal clinic violence
and intimidation.
Certainly, one could argue that damages awarded- for all
intentional torts should be nondischargeable. Indeed, this is largely
the case under the ``willful and malicious injury'' exception contained
in Section 536(x)(6) of the Bankruptcy Code. Some damages resulting
from clinic-related violence, however, are not protected under this
exception. This was made clear in the Supreme Court's recent decision
in Geiger v. Kawaauhau, 523 U.S. 57 (1998). In Geiger the Court held
that the word ``willful'' ``modifies the word `injuy' indicating that
nondischargeability takes a deliberate or intentional injury, not
merely a deliberate or intentional act that leads to injury. . .''
Although some clinic=related violence is not committed with the direct
intention to inflict injury, some such violence indirectly may result
in injury. Take for example a family planning clinic that is blockaded,
preventing all ingress and egress. Women who need essential medical
services--some unrelated to abortion--may be denied those services;
resulting in serious physical harm. Should damages awarded to victims
such as these be any less protected simply because the blockader did
not intentionally intend to injure these victims?
In addition, there is another compelling reason to create a
specific nondischargeability carve-out for clinic-related violence
damages. There are reports of-those who have been found liable for such
acts blatantly--even enthusiastically--announcing how they are going to
escape responsibility for their actions by filing for Chapter 7.
Indeed, such abuse of the bankruptcy system appears to be part of a
concerted plan on the pant of these individuals to perpetuate their
acts of violence and intimidation.
Parties on both sides of the issue of abortion agree that violence
against clinics should not be tolerated. This is why we have laws in
place designed to deter such activity. We must not permit those who
have committed odious acts of violence to escape responsibility for
their actions. Your amendment furthers our efforts toward achieving
this goal.
Sincerely,
Jon P. Jennings
Acting Assistant Attorney General
Statement of George J. Wallace, Eckert Seamans Cherin & Mellott LLC,
Washington, DC
Chairman Hatch, Senator Leahy and Members of the Committee, thank
you for this opportunity to express my views on consumer bankruptcy and
H.R. 333, The Bankruptcy Reform of 2001, and particularly the impact of
the bill upon low income women.
My name is George Wallace. I am a member of the law firm of Eckert
Seamans Cherin & Mellott LLC and am resident in the Washington, D.C.
office.
I represent the The Coalition for Responsible Bankruptcy Laws, a
broad coalition of consumer creditors, including banks, credit unions,
savings institutions, retailers, mortgage companies, sales finance
companies and diversified financial services providers.
The Coalition strongly supports S. 220 because it will take
significant steps toward reforming today's consumer bankruptcy laws
while at the same time preserving the basic bankruptcy discharge and
repayment plan remedies for debtors who use bankruptcy responsibly.
Despite being well-intentioned, it is increasingly clear that our
bankruptcy laws are susceptible of misuse. Everyone is by now familiar
with the ``means test'' and how it would require approximately 10% of
those who file chapter 7 who have the ability to repay a significant
part of what they owe to do so. But an equally important flaw in the
present bankruptcy system is that it can be used to significantly delay
or defeat the payment of child support and marital obligations. S. 220
stops that misuse of the bankruptcy system. It assures that those who
file for bankruptcy will continue to pay their child support
obligations throughout the bankruptcy. If S. 220 is enacted, filing
bankruptcy will no longer halt the payment of crucial child support
payments to low income single parent families.
The most important change the bill makes to child support
collection is to except child support collection orders from the
automatic stay, require a chapter 13 debtor to be current in post-
filing child support payments to confirm a plan, and stay current as
well as pay all arrears in order to get a discharge. With these
changes, the ability to use chapter 13 to delay payment of child
support for up to 5 years is stopped. The bill also changes current law
to place child support arrears in first priority (versus seventh under
present law) in a chapter 7, extremely important if there are assets to
be distributed. Other marital dissolution obligations, including
indemnification obligations, are made clearly nondischargeable (unlike
under present law which permits discharge under certain circumstances).
Post- filing support arrears owed to the single parent must be paid in
order to receive a discharge, unless waived by the custodial parent.
Some, however, have asserted that S. 220 would harm single-parent
families, and especially those headed by women. One claim is that
single parents trying to collect child support will lose out to credit
card companies collecting nondischargeable debt. This claim is
completely without foundation. In fact, the quite reforms in S. 220
extending in minor ways the provisions of present law on
nondischargeable debts are unlikely to have a significant impact on
collection of credit card debt. Moreover, the child support collection
system Congress has mandated outside bankruptcy already gives the child
support creditor extraordinary power to collect child support, both
current and in arrears, except when the debtor goes into bankruptcy.\1\
That is why it is recognized by child support collection professionals
that child support always wins over competing creditors like credit
card companies. Philip L. Strauss, Assistant District Attorney, City
and County of San Francisco. Testified in 1999 before the House
Committee on the Judiciary directly to this point:
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\1\ Child support obligations take precedence over all other debts,
and Congress has given extraordinary powers to assist in its collection
Today, a custodial parent owed child support can obtain free or at a
minimal cost (the maximum charge for collection is a one time fee of
$25, waived by many states) a child support collection lawyer employed
by the state or municipality whose only job is to collect child
support. That lawyer has the power to withhold child support from the
non-custodial parent's income of payment to the mother and children.
The child support creditor also has a blanket, automatic lien arising
upon nonpayment on all of the debtor's personal property. In addition,
failure to make child support payments will result in the loss of a
motor vehicle operators license, professional license (such as a
physician's license, law license, etc.), or even jail. Faced with loss
of the driver's license if he doesn't pay child support, the debtor
will always pay that first, if he can pay anything at all.
``Some criticism has been raised that the 1999 Bankruptcy Reform Act
would be detrimental to women and children because it would pit
them against banks and credit cared companies for collection of
nondischarged credit card debt. Although this argument has some
surface logic, no support collection professional that I know
deems this concern to be serious. . . .[N] onbankruptcy law
has so tilted the field in favor of support creditors that
competition with financial institutions for the collection of
postdischarge debts presents no problems for support
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creditors.''
Other have claimed that the means test will be excessively harsh on
poor, single parent families, and particularly those headed by women,
when they seek bankruptcy protection. Nothing could be further from the
truth. To be impacted by the ability to pay provisions in this
legislation as a practical matter, families would have to earn more
than the State median income adjusted for family size. To put this
inperspective, a family of four living in Alabama would have to earn
over $46,000 annually before the ``ability to pay'' test would even be
applied. In Connecticut, they would have to earn over $72,000. As you
know, the vast number of single parent families with children survive
on an income well below that amount.
Moreover, even when the ability to pay test comes into play, it
will only require dismissal from chapter 7 if the debtor's net income
shows that the debtor could pay more than $100 a month if the debtor
has debts over $24,000, or a minimum of $10,000 is his debts are
smaller. Poor families would not have such net income, and could remain
in chapter 7. Thus, no matter how you look at it, S. 200's ability to
pay test will have no impact on poor families. They will continue to
have, as they have under present law, the choice to either file in
chapter 7 or chapter 13.
Finally, vague claims have been made that in some fashion, other
provisions of the bill will somehow make bankruptcy less available or
less beneficial for low income families. When examined, these claims
always evaporate. For example, some have urged that the requirement of
pre-filing credit counseling burdens low income debtors who have a
great deal of difficulty paying for their bankruptcy attorney. Yet the
requirement is minor. You just have to go to a short (1 hour) training
session approved by the United States Trustee, which can be over the
phone or by internet. If there is an emergency, the debtor can file for
bankruptcy and obtain the counseling within the next 30 days.
Furthermore, obtaining credit counseling before filing bankruptcy
generally benefits debtors. First, they obtain more information about
their alternatives from a neutral source, not a bankruptcy professional
trying to earn money from their filing. Second, some of them may be
able to save themselves from bankruptcy through a credit repayment
plan. They will save their credit rating and be rehabilitated more
quickly. Finally, credit counseling teaches budgeting skills, crucial
for the very poor struggling to make ends meet. On examination, there
appears to be absolutely no basis to argue that these benefits somehow
will hurt low income families, whether they are headed by women or men.
In summary, S. 220 is legislation which benefits low income
families, particularly those headed by women. To the extent those
families are dependent on child support, it makes major changes to
bankruptcy law so that it can no longer be misused to delay or defeat
the collection of child support. Moreover, its provisions aimed at
those who would abuse the bankruptcy system in other ways will not
affect the honest, poor debtor needing relief from debts he has no hope
of repaying. Finally, the bill contains provisions such as the credit
counseling provisions, which will improve the assistance that the
bankruptcy system provides debtors who need debt relief and help in
reorganizing their finances.
Thank you for the opportunity to address the Committee, and I urge
your strong support for S. 220.