LEXIS-NEXIS® Congressional Universe-Document

LEXIS-NEXIS® Congressional

March 17, 1999, Wednesday

SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 5235 words

HEADLINE: TESTIMONY March 17, 1999 AMERICAN FINANCIAL SERVICES ASSOCIATION HOUSE JUDICIARY COMMERCIAL AND ADMINISTRATIVE LAW BANKRUPTCY REVISION

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STATEMENT OF THE AMERICAN FINANCIAL SERVICES ASSOCIATION BEFORE THE SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW COMMITTEE ON THE JUDICIARY UNITED STATES HOUSE OF REPRESENTATIVES MARCH 17, 1999 The American Financial Services Association (AFSA) appreciates this opportunity to express our views on H.R. 833, the "Bankruptcy Reform Act of 1998". AFSA is the trade association for a wide variety of non-traditional, market-funded providers of financial services to consumers and small businesses. AFSA members include major providers of secured and unsecured credit. We look forward to working with the Subcommittee to pass H.R. 833 and to achieve a bankruptcy system that protects responsible borrowers through the provision of an appropriate needs based mechanism ensuring that those who can clearly repay a significant portion of their debts, do so. Before directly addressing some of the secured provisions in the bill, AFSA would like to comment on some of the issues that have continually come up when needs based bankruptcy reform is discussed. Summary of AFSA's Position Overview of H.R. 833 H.R. 833 is the exact text of the conference report on H.R. 3150 that was passed 300-125 by the House on October 9, 1998, during the final days of the 105th Congress. The bill represents a substantial compromise from the original House-passed version of H.R. 3150. 1 Nonetheless, while weakened from the original, H.R. 833 remains a balanced, comprehensive approach. H.R. 833 substantially restores the principles of fairness and personal responsibility to our bankruptcy system, while protecting, and in some places enhancing, the rights of the consumer. The heart of this legislation is a needs-based formula that would direct filers into Chapter 7 or Chapter 13 based on their ability to pay. The formula would move into Chapter 13 those filers who earn more than the national median income (roughly $51,000 for a family of four) and who can ultimately pay all secured debt and at least 25 percent of unsecured non-priority debt. Additionally, the legislation recognizes that creditors should take on additional responsibilities, and proposes new disclosures and other educational provisions. Key provisions of the bill are summarized below. Summary of Key Provisions in H.R. 833 NEEDS-BASED BANKRUPTCY H.R. 833 creates a fair, needs-based system that takes debtors' special circumstances into account while assuring that those who can afford to pay are required to do so. The legislation creates a presumption that a Chapter 7 proceeding should be dismissed or converted to Chapter 13 if the filer earns more than the national median income and can afford to pay back either $5,000 or 25 percent of his or her unsecured, non-priority debt over five years. The judge can then take any extraordinary circumstances into account, such as a decline in income or an unexpected medical expense, before making a decision to shift the debtor into Chapter 13 or dismiss the case. In certain cases where the debtor is subsequently moved into Chapter 13, and the debtor's attorney's actions in filing the case are not substantially justified, the attorney may be required to pay for all costs associated with challenging the "abusive" filing. 1 Attached is a chart detailing the differences between the H.R. 3150 as originally passed by the House and the Conference Report on H.R. 3150. For a Chapter 7 debtor whose income exceeds the national median, H.R. 833 also allows other interested parties, such as banks or creditors, to bring a motion to shift the debtor into Chapter 13 based on the debtor's ability to repay. If the third party, however, can be shown to have brought motion without substantial justification, the third party may be required to pay the debtor's attorney fees. The bill also includes new requirements to facilitate the administration of the needs-based system. Debtors, for example, will be required to include needs-based calculations in their statement of income and expenses, providing an easy "first-look" enforcement tool. The trustee or administrator must review the debtor's schedules and file a report at least 10 days before the first meeting of creditors as to whether the debtor's case is presumed to be one that should be dismissed. Each creditor is to receive that statement within five days. PRIORITIZING FAMILY SUPPORT OBLIGATIONS H.R. 833 recognizes that no obligation is more important than that of a parent to his or her children. A number of provisions designed to strengthen protections for child support and alimony payments are contained in the bill. For instance, the obligation to pay these vital family support obligations becomes the top priority when determining which debts are paid first in a bankruptcy case. This represents a substantial change from current law, in which child support and alimony payments are the seventh priority, behind such things as attorney's fees. Additionally, the bill makes both confirmation and discharge of Chapter 13 plans conditional upon the debtor's complete payment of child support and alimony obligations. Among other things, H.R. 833 provides that the automatic stay does not apply to a state child support collection agency that seeks to impose or enforce a wage order for these obligations. NEW CREDITOR RESPONSIBILITIES - Credit Card Disclosures: H.R. 833 requires creditors to send information, both at the time a customer opens an account, and again annually thereafter, about incurring interest expense and the costs of paying only the minimum required amount. A worksheet must also be sent to credit card customers annually to help them understand their current credit and expense obligations and the impact of taking on more debt. Additionally, all credit card statements must explain that paying only the minimum will cost more over time. - Federal Reserve Board Study of Creditor Practices: H.R. 833 requires the Federal Reserve Board to study whether consumers have adequate information about borrowing activities which may result in financial problems, including information related to minimum payments. This study would also consider the impact that the availability of minimum payment options has on consumers experiencing financial difficulty. The Board is authorized to issue regulations requiring additional disclosures as necessary. - Study of Students and Credit Cards: H.R. 833 directs the General Accounting Office to study the impact that extending credit to college students has on the rate of bankruptcy cases filed. This study shall be presented to Congress within one year following enactment of the Act. - Convenience Users Restrictions: H.R. 833 amends the Truth in Lending Act to provide that an open-end creditor cannot terminate an account prior to its expiration date solely because the consumer has not incurred finance charges on the account. - Alternative Dispute Resolution: H.R. 833 allows the court to reduce an unsecured creditor's claim by up to 20 percent if a debtor can prove that any reasonable attempts to negotiate an alternative repayment schedule approved by a credit counseling agency were denied by the creditor. This provision could lead to fewer bankruptcy filings if more repayment agreements can be worked out as an alternative to bankruptcy. CONSUMER PROTECTIONS - Debtor's Bill of Rights: To ensure that consumers are not mistakenly steered into bankruptcy, H.R. 833 requires debt relief counseling agencies (popularly known as "bankruptcy mills") to provide detailed disclosures regarding the significance of bankruptcy and the nature of their services. Bankruptcy service providers also would be required to explain the alternatives to bankruptcy before the case is filed. - Consumer Education Provisions: H.R. 833 requires that, in order for a debtor to be eligible for bankruptcy relief, the debtor must receive credit counseling within the 90-day period prior to filing a bankruptcy petition. Additionally, the bill directs the Executive Office for U.S. Trustees to develop and test a pilot program on financial management for debtors, to help debtors avoid repeating their mistakes. - Protection of Post-secondary Education Savings: Under current law, savings earmarked for a child's college education could be liquidated in order to pay for debts claimed in bankruptcy. H.R. 833 protects such funds up to $50,000 per child, or $100,000 total, that have been placed in a qualified tuition program or in an education individual retirement account prior to one year before filing for bankruptcy. - Protection of Retirement Savings: H.R. 833 also protects qualified tax-sheltered retirement plan assets from the claims of creditors in bankruptcy, regardless of whether the debtor has begun receiving payments from those funds. Current law only protects retirement fund distributions to the extent necessary for the support of the debtor and his or her dependents. - Reaffirmation Review: To further protect consumers in entering reaffirmation agreements, H.R. 833 gives debtors who choose to reaffirm unsecured debt the right to appear before a judge for a hearing on the agreement. A debtor who is represented by an attorney is free to waive the right to a hearing. - Educating Future Generations: The bill includes a Sense of the Congress Statement that personal finance curricula be developed for elementary and secondary education programs. BANKRUPTCY SYSTEM ACCOUNTABILITY - Nondischargeability of Debts Incurred on the Eve of Bankruptcy: To address abusive "loading up" on debt by consumers prior to filing bankruptcy, H.R. 833 provides that consumer debts incurred to purchase luxury goods or services (aggregating more than $250 to a single creditor), or cash advances of more than $250 total, become nondischargeable if incurred within 90 days of filing. This strengthens existing laws by lengthening the time period (currently 60 days) and lowering the dollar amounts for both luxury purchases and cash advances (currently $ 1,000 each). - Debt Incurred to Pay Nondischargeable Debts: H.R. 833 attempts to curb abuses by those incurring dischargeable debt to pay for nondischargeable debt (e.g., paying for a student loan with a credit card check). In the bill, debts incurred within 90 days prior to filing for bankruptcy to pay nondischargeable debts themselves become nondischargeable. Debts incurred prior to the 90-day period to pay for nondischargeable debts become nondischargeable if it can be shown that this was done in order to discharge the debt in bankruptcy. - Homestead Exemption: H.R. 833 imposes a two-year residency requirement before a debtor can claim the homestead exemption available in a particular state. The bill strengthens current law by discouraging some debtors from moving to a state with "softer" homestead laws for the purpose of keeping an expensive home after declaring bankruptcy. Plan Length: H.R. 833 sets Chapter 13 repayment plans at a maximum of five years for those filers making more than the national median income. This improves current standards, which frequently set Chapter 13 plans at 3 years. - Tax Return Disclosure: The bill requires debtors to file three years of tax returns when filing for bankruptcy. If the debtor fails to file this information within set time frames, his or her case will be dismissed. Current law does not require filers to provide any tax return information, thus making it difficult to assess a debtor's finances as part of the bankruptcy case. - Valuation of Secured Claims: Under current law, inconsistent valuation methods are used throughout the country to value items that secure a loan. H.R. 833 values secured personal property at replacement value. - Improved Data Collection: The bill requires the clerk in each district to collect certain bankruptcy data and requires that those statistics be made publicly available. Additionally, an annual report of this data will be made to Congress so bankruptcy trends can be tracked. - Creditor Representation at First Meeting of Creditors: H.R. 833 allows non-attorney representatives of any creditor holding a claim in a Chapter 7 or 13 case to be present at the first meeting of creditors. Notice to Creditors: The bill requires debtors filing for Chapter 7 or 13 to send any correspondence regarding the bankruptcy to the address specified in his or her credit agreement, and must include the debtor's account number. All notices served on the creditor will not be effective unless these stipulations are followed. Upon request, the court shall provide to creditors key income information filed by the debtor in the case, such as the petition and schedules. - New audit Provisions: H.R. 833 directs the Attorney General to establish procedures to determine the accuracy and completeness of petitions, schedules, and other information that the debtor is required to provide. Audits shall be performed on at least 0.4% of individual Chapter 7 and 13 cases, as well as schedules reflecting "greater than average variances from the statistical norm of the district in which the schedules were filed." Such audits shall be in accordance with generally accepted auditing standards and performed by independent certified public accountants or independent licensed public accountants. DISCUSSION OF SELECTED ISSUES CAUSATION -- IS IT AS SIMPLE AS TOO MANY CREDIT CARDS AND TOO MUCH CREDIT? Opponents of bankruptcy reform claim that the industry has created the problem by indiscriminately extending too much credit in the form of credit cards and simply wants to "turn the government into a bill collector". Nothing is further from the truth on a both a statistical and qualitative basis. First of all, if bankruptcy were simply a matter of too much credit, bankruptcy rates would be uniform across the country. In fact, they are not -- they show wild variations across the nation and within the individual states. For example, Shelby County, Tennessee has a bankruptcy rate that is 32 times the national average -- does Shelby County get 32 times the amount of credit that the rest of the country does? No, of course not. Well, then, if not too much credit, what does cause bankruptcy? The causes are very complex and frequently a number of factors are present. Some of the main causative correlations include divorce, lack of health insurance, lack of mandatory automobile insurance laws (7 states) and so on. Unemployment in and of itself is not a big factor. Urban areas have the highest bankruptcy rates -- they also have the highest divorce rates. Young adults between the ages of 21 and 25 have low rates of bankruptcy filing, as do adults over the age of 41. The age group most likely to file are those in their early 30s, particularly age 32. Poor people and minorities have relatively low rates of overall filing while filings take off as you approach a total annual household income of between $32-36,000 and remain high thereafter. There is no way to really screen for most of these types of events and characteristics during the underwriting process. Should we not lend to 32 year olds? Should we ask applicants if they are happily married? 2 What about credit cards? Bank credit cards account for approximately between 5 and 6 percent of total consumer debt. If you include other types of credit cards, you might get to 9 percent, depending on how you account for convenience users who pay off their balance every month. Is this 9 percent of consumer debt causing all of the problems while the other 91 percent maintains a benign budgetary impact? This is counterintuitive --, as all of us know, our big obligations are our housing, car, student loansetc. Do credit cards play any role in bankruptcy? Of course, but they are in no way the principal cause. In general, the role that credit cards play is that they are the last form of credit available for use before filing for bankruptcy. When a debt or gets into financial trouble for whatever reason, they will frequently try to float themselves using their credit cards, or if a debtor is planning to file a bankruptcy of convenience, they will frequently use their cards to acquire certain goods or make certain payments prior to filing. The industry has learned to identify some of this behavior and can sometimes reduce losses, but particularly in case of planned or non-insolvent bankruptcies, this is virtually impossible. College Students and Credit Cards Recent assertions and "Projections" in the media about college students filing for bankruptcy because of credit card debt require careful review. As of 1996, the 18 to 25 year old age group accounted for about 8.7% of all filings 3 ; the 21 to 25 year old portion of that age group had a filing rate less than half of the national median 4 . A national survey on student credit card use conducted by the Education Resources Institute and the Institute for Higher Education Policy makes findings substantially contrary to these recent assertions and unsurprisingly paints a much more complex picture of students and how they use credit: "The majority of students use credit cards responsibly and do not accumulate large amounts of credit card debt." Where students do encounter credit problems, one of the three characteristics frequently present in combination is the use of the credit card to charge tuition and fees. It is worth noting that the federal government has huge student loan programs involving large extensions of credit to students for college tuition and fees with no more than the hope that these students will find adequate employment after college. Federally insured student loans are nondischargeable in bankruptcy. Another finding of the survey is that 29 percent of all college students are so- called "nontraditional" students. These students tend to be older, part-time, financially independent, and often are married with children. These older, working students more frequently have some of the risk factors mentioned above. 2 Last Congress the Subcommittee heard testimony from Stuart Feldstein who examined many of these issues in depth. 3 Consumer Bankruptcy: Annual Bankruptcy Debtor Survey. Visa Consumer Bankruptcy Reports, August 1997. 4 The Personal Bankruptcy Crisis, 1997. SMR Research Corporation, 1997. Like all bankruptcy causation issues, college students and credit cards is not susceptible to a simple explanation and many of the anecdotes bandied about have little value in a policy discussion. There is no serious evidence of a problem. The Needs Based Provisions Much of the controversy around H.R. 833 centers around the needs based provisions of the bill designed to make sure that those debtors with meaningful ability to pay actually do so. Below is a more detailed discussion of the provisions that illustrate that they achieve this goal in a fair, straightforward and flexible manner. In brief, the test takes the debtors current monthly income, if it is above the national Household Median income, subtracts expenses and secured and priority debt payments, and determines whether the remaining income is high enough for the debtor to pay his unsecured creditors $5,000 or 25% over five years: a). The Debtor's Current Monthly Income - (Must equal 100% of Median National Income for Household size 651,000 for a family of four) or the means test does not apply b.) Minus: Monthly expenses determined by IRS standards c.) Minus: Average monthly secured debt payments d.) Minus: Average monthly priority debt payments e.) Equals: Monthly income available to pay unsecured debts. A determination is then made to see if the debtor has enough income left over to pay 25 percent of unsecured debts or $5,000 over five years. f. Take into account "extraordinary circumstances." - Loss of a job, divorce, high medical bills or other circumstances can be taken into account by the judge, giving him or her the discretion to reduce income or increase expenses under the means test. Thus the test is designed to establish an extremely high threshold that must be met before any debtor would be impacted at all. Specifically, the means test would affect the debtor only if they made above the National Median Income and if after paying all the debtor's expenses, all the of the debtor's monthly secured debt payments, all of the debtor's monthly priority debt payments and any special circumstances, does the debtor has sufficient income to pay 25 percent or $5,000 of their unsecured debts to their creditors. The Elements of the Needs Based Provisions: a.) Current Monthly Income The first step in applying the means test is to determine the debtor's current monthly income. For purposes of the means test, the debtor would estimate current monthly income by taking his or her average monthly income over the six months preceding the bankruptcy filing. H.R. 833 uses an average calculation because of the month to month income fluctuations: taking a 94 snapshot" of a person's monthly income in any particular month may result in an over or under estimation of a person's income. For example, a six month average may understate monthly income because it may exclude bonuses and other upward adjustments to income that may occur outside the six month period. However, the means test is this case simply gives the debtor the benefit of the doubt in order to implement a simple test that is simple to utilize. As a result, if the six-month calculation understates the debtor's typical monthly income, the debtor is under no obligation to correct the understatement. On the other hand, the test does address situations where the debtor's income has been overstated. Specifically, the "extraordinary circumstances" provisions of the test are designed to take a debtor's particular circumstances into account, including, for example, the loss of a job, a divorce, or high medical bills. In addition, even if the debtor's case is ultimately sent to Chapter 13, the debtor may decrease his or her payment at anytime if he or she experiences a decrease in income or an increase in expenses. If the debtor's income is below the median household income for a family of that size, $51,000 annually for a family of four, then the means test does not apply to the debtor. This is important to note, because it means that only high income households are impacted by the means test. b). IRS Expense Allowances Once the monthly income is determined, and it is higher than the median household income, the next steps are to subtract the debtor's expenses from his or her income. Considerable flexibility is built into the calculation of expenses for the debtor. Specifically, the calculation uses three broad categories of expenses which have been employed by the IRS: (I) National Standards; (II) Local Standards; and (III) Other Necessary Expenses. Generally, the debtor's actual expenses, rather than numbers specified by the IRS, are used. 1). National Standards. National Standards cover items such as apparel (e.g., shoes and clothing, laundry and dry cleaning), food, housekeeping supplies (e.g., postage and stationery, laundry and cleaning supplies, household products, paper goods and garden supplies), and personal care products and services (e.g. hair care products, shaving needs, cosmetics), as well as a miscellaneous category of expenses. For these expenses, the IRS has specified allowable dollar amounts which vary depending upon the debtor's income and household size. The dollar amounts specified by the IRS are based upon the consumer expenditure survey conducted by the Bureau Of Labor Statistics ("BLS"). 2.) Local Standards. The Local Standards cover residential and transportation expenses, such as rent, parking, maintenance and repairs, renter's insurance, utilities, the cost of leasing and operating a car, parking fees, tolls, public transportation and other similar expenses. The Local Standards are intended to take geographic price variations into account, and they are therefore based on the cost of housing and transportation in the county where the debtor lives. However, the Local Standards are also designed to use the debtor's actual expenses rather than the IRS standards. For instance, when the debtor owns a car or house, the debtor's actual average monthly mortgage and car loan payments are used. (See the discussion of Average Monthly Secured Payment, below.) 3). Other Necessary Expenses. Finally, the means test has broad allowances for expenses that fall into the "Other Necessary Expenses" category. These additional expenses include taxes, child support and alimony payments, and other court ordered payments, child care, expenses for the care of dependents, education for physically or mentally challenged dependents education expenses that are necessary as a condition of employment, health care, and other miscellaneous expenses. The IRS has not specified any dollar amounts applicable to those categories. Instead, for purposes of the means test, the debtor uses his or her own actual expenses for each of these categories, thus giving the debtor further flexibility in tailoring the means test to reflect his or her actual expenses. c). Average Monthly Secured Debt Payments The means test also takes into account the debtor's monthly payment due on secured loans, such as mortgages and car loans, and subtracts this from the debtor's current monthly income. By taking these payments into consideration, the means test allows the debtor to keep his or her house and car and other secured property. Thus, it represents yet another way in which the needs based calculation reflects personal, individualized circumstances of the debtor. Average monthly secured debt payments are calculated by taking debtor's monthly payment due to secured creditors in each month of a hypothetical five year Chapter 13 plan and dividing that total sixty months. d.) Average monthly Priority Debt Payments The means test also ensures that debtors have enough income to pay all of their priority debts, such as child support, unpaid wages, taxes and other important debts before it attempts to calculate whether or not there is any income left to pay unsecured creditors. Thus it is also designed to take each debtor's personal circumstances into account. It is calculated by taking the debtor's expenses for payment of all priority (including priority child support and alimony support) and dividing the total by sixty months. e) 25% of Unsecured Debt or $5000 over Five Years The remaining income is then inspected to determine if the debtor has enough remaining income to, pay either 25% of their unsecured debt or $5000 over five years, which ever is less. If there is insufficient income remaining, then the debtor is not affected by the means test. f) "Extraordinary Circumstances" Even if the after the application of the test, the debtor still has an opportunity to highlight any extraordinary circumstances to the bankruptcy judge, which gives the bankruptcy judge an opportunity to exercise his or her discretion and make an adjustment to the debtor's income or expenses. For example, a bankruptcy judge could take into account a debtor's loss of a job, divorce or high medical bills, for example, and could reduce the debtor's income or increase their expenses under the test accordingly. Thus, the means test attempts to take a debtor's unique circumstances into account, and in effect represents an attempt to "weed out" from consideration those debtors who do not have the income to pay back their unsecured creditors. However, it seeks to ensure that those who can pay back a portion of their debts are required to do so by using a easy to apply, generous formula with judicial discretion to take special circumstances into consideration. RESTORING BALANCE BETWEEN DIFFERENT TYPES OF LENDING -- THE CRAMDOWN In 1978, during the last major overhaul of the bankruptcy code, one of the major changes that unbalanced the code between debtor and creditor and, in our view, has provided a substantial impetus to the increase in bankruptcies of convenience is the extraordinary device known as the "cram-down". This is a statutorily based mechanism, found in Section 506(a) of the Code, which provides that every claim filed which is secured by a lien on property is an "allowed secured claim" to the extent of the creditors interest in such property. To the extent that creditor's interest is less than the total amount of the claim, the claim is an allowed "unsecured claim." Under the present Code, a secured claim cannot be an allowed secured claim in an amount greater than the value of the collateral. As written in the National Consumer Law Center's Consumer Bankruptcy Law and Practice, the cram down power provided to the Bankruptcy Court in favor of the debtor by the 1978 Code represents a significant example of a statutorily-supported wealth transfer between a debtor and creditor: One of the greatest advances for consumers under the (1978) Bankruptcy Code came in the powers they were given with respect to secured debts. Under the prior Bankruptcy Act, relatively little could be done to protect consumer debtors from the holders of such claims. A straight bankruptcy did not generally affect the status of otherwise valid liens or security interests and, as a practical matter, few Chapter XIII plans could get very far with respect to secured claims unless the holders of those claims agreed to the plan or were not affected by it. Now, in contrast, almost every conceivable type of security interest can be altered in some way through bankruptcy, often to a tremendous degree and with very significant benefits for the debtor. Consumer Bankruptcy Law and Practice, 4th Ed., p. 203. The workings of the cram down with both real estate and non-real estate have created a large body of law on this mechanism alone. The most recent significant case on how to value collateral for the purposes of determining how to determine the value of the allowed secured claim was Associates Commercial Corporation v. Rash, which provided that the value of a creditor's collateral for cram down purposes should be what the debtor would have to pay for comparable property ("the replacement-value" standard). Secured credit is usually the only "deep pocket" in a consumer bankruptcy case. Since 1978, debtors' advocates have been moderately successful in "unlocking" the secured creditor's pocket through cram downs, "ride throughs", nonpayment while a plan is being confirmed, Chapter 13 conversions to Chapter 7 after cramdown or cure, and the like. These various developments erode the fundamental distinction between secured and unsecured credit. There are very definite reasons that a lender chooses to extend secured credit over unsecured credit and one of them is certainty of repayment. H.R. 833 addresses these issues to varying degrees and AFSA supports these provisions prior to filing Secured lenders for items such as vehicles, boats etc. suffer the greatest losses on cramdown in the early years of vehicle or vessel life when depreciation is the greatest. AFSA believes that this is an important fact in prebankruptcy planning. CONCLUSION Again, AFSA appreciates the opportunity to express its views. We strongly support the efforts of the Committee to develop a modern legal framework for bankruptcy and urge you to move forward with H.R. 833.

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