Volume 43 | Number 2 Spring 2008
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III. U.S. RESPONSE TO OVER-INDEBTEDNESS
A. The Consumer’s Right to a Fresh Start
Over-indebted U.S. consumers can seek formal financial relief by attempting to discharge some or all of their debts using the U.S. consumer bankruptcy laws.55 Unlike a number of countries (including Brazil), the United States has had a formal consumer insolvency regime since 1898 largely because of the recognition that it is virtually impossible for an individual consumer to reach a global debt renegotiation with all her creditors unless a federal law forces the creditors to accept a particular payment plan. Historically, U.S. consumer bankruptcy law have given over-indebted consumers a “fresh start” that allowed them to discharge their debts and become productive members of the market economy.56 Many have suggested that the best way to evaluate and respond to consumer over-indebtedness is to examine why consumers find themselves unable to repay their bills.57 Others argue that the causes of consumer over-indebtedness should be addressed outside of bankruptcy, that consumer bankruptcy laws generally should not be viewed as being part of the protections provided by the welfare state, and that bankruptcy laws should largely be unconcerned about why people found themselves unable to repay their debts.58 As we shall see in the following sections, a consumer insolvency scheme that ignores the causes of insolvency is unlikely to provide appropriate relief.
B. The Consumer’s Duty to Behave Responsibly: BAPCPA
The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), enacted by the U.S. Congress in 2005,59 significantly changed the U.S. Bankruptcy Code and moved U.S. consumer law policies closer philosophically to the European concept of an “earned” rather than “fresh” start.60 European consumer debt adjustment systems appear to be designed to give consumers an incentive to modify their spending habits and to make wiser spending choices, but also to force them to live with the economic consequences of unwise choices.61 Many in Congress seemed to believe that earlier versions of the U.S. consumer insolvency laws were too lax and allowed too many people to discharge debts they could afford to repay.62 BAPCPA was designed to make it harder for people to file for bankruptcy and to give consumers an incentive to avoid over-indebtedness. Rather than use bankruptcy laws to provide comprehensive relief to over-indebted consumers, the U.S. Congress wanted consumers to understand that they have a moral duty to make responsible spending decisions and to at least attempt to repay their debts.63
Before BAPCPA was enacted, consumers had almost complete control to decide whether they wanted to attempt to repay some of the debts over a three to five year period in a Chapter 13 debt repayment plan, or whether they wanted a quick discharge of their debts in a Chapter 7 proceeding and not even attempt to repay those debt.64 To reduce the overall number of bankruptcy filings and to force more consumers into Chapter 13 debt repayment plans, Congress made a number of changes to restrict virtually all consumers’ access to bankruptcy. Perhaps the biggest change in the new law is a means test, a complicated quantitative test consumers must “pass” before they are deemed to have “earned” the right to a quick discharge of their debts in a Chapter 7 liquidation proceeding.65 Until 2005, the U.S. approach had been to allow debtors a “quick” discharge if they had few assets they wanted to keep, or only had assets that they were allowed to keep statutorily (i.e., exempt) based on either applicable state or federal bankruptcy laws.66 Consumers who fail this new means test either must attempt to repay some of their debts through a Chapter 13 debt repayment plan or must attempt to renegotiate their debts outside of bankruptcy.67 Forcing consumers to prove that they are entitled to a particular type of debt relief moves the U.S. system a bit closer philosophically to the structure and substantive policies of debt adjustment systems in other countries.
The Code also requires all consumers to participate in mandatory credit counseling before they file their bankruptcy petition68 and mandates that Chapter 13 debtors receive financial management training from an approved financial education provider before they can receive a discharge.69 The number of documents consumers and their attorneys must provide to creditors before and during the bankruptcy case also increased under the new law.70 Finally, because of the additional time lawyers must now spend on each case and because of higher filing fees, it costs more for consumers to get relief from their over-indebtedness.71
Making it harder for over-indebted consumers to avoid repaying their debts is easily justifiable if purchases of iPods, plasma TVs, Hummers, or sable fur coats cause most consumer over-indebtedness. But empirical data collected by prominent U.S. academics show this is not the case; medical debts, a divorce, or a job interruption cause most consumer bankruptcies in the United States.72 Although these life circumstances, rather than profligate spending, appear to trigger most bankruptcy filings, the U.S. Congress nonetheless found that only two groups of over-indebted consumers should be viewed charitably and favorably and should be spared from BAPCPA’s harsh consequences.
First, consumers who can document that they are in debt because of medical bills relating to serious medical conditions are largely unaffected by BAPCPA’s additional requirements.73 However, consumers who chose to use their credit cards to make ends meet while they were injured and unable to work were not viewed as favorably. That is, if a consumer used credit cards to compensate for income a debtor lost while injured, such a person cannot easily avoid BAPCPA’s additional requirements (i.e., means-testing, mandatory credit counseling, additional reporting) since the credit card debt would not technically be medical debt. To a lesser extent, BAPCPA also favors certain members of the armed forces (current and retired) who can avoid having to comply with some of BAPCPA’s additional requirements.74 The decision to favor members of the armed forces was, of course, an unabashedly political decision: no member of the U.S. Congress wanted to be viewed as penalizing consumers who are in debt solely because they had been deployed to fight in one of the many U.S.-led wars.75
C. BAPCPA’s Success?
While BAPCPA has changed how and when people file for bankruptcy, it has also had unintended consequences and imposed additional administrative burdens and costs on consumers. The number of consumers who filed for bankruptcy relief plummeted after BAPCPA became fully effective: there were over 1.5 million filings in 2004,76 over two million in 2005,77 but fewer than 600,000 in 2006.78 Given this dramatic drop, BAPCPA arguably succeeded in both making it harder for people to file for bankruptcy and also making people understand that they have a moral duty to repay their debts. However, many recognize that filing levels after October 18, 2005 remained low through mid-2006 because so many people rushed to file their bankruptcy petition before the effective date.79 Indeed, of the over two million people that filed for bankruptcy in 2005, approximately 600,000 (or, stated differently, an amount equal to the total number of filings in 2006) filed in the weeks before BAPCPA’s October 17 effective date.80 While consumer filings remained low for much of 2006, the numbers already have started to increase as there was a forty percent increase in consumer filings in 2007.81 While no one expects filings to return to the pre-BAPCPA apogee, filings appear to be headed toward the one million mark and total consumer filings likely will continue to increase for the next few years in large part because of the massive amount of consumer debt.82 Perhaps more importantly, while the number of consumers who filed Chapter 13 petitions increased after the new changes went into effect, fewer consumers are now filing Chapter 13 petitions relative to Chapter 7 petitions.83 So, despite Congressional attempts to decrease bankruptcy filings, over-indebted consumers are still filing for bankruptcy and more of them are now seeking to discharge their debts rather than attempt to repay them.
One other post-BAPCPA development suggests that the revised consumer insolvency laws and the additional requirements BAPCPA imposes on consumers have not had their intended results. The evidence has shown that the credit counseling requirement to be an administrative obstacle to debtors, rather than a financially beneficial exercise.84 The requirement that all consumers receive credit counseling before seeking formal debt relief is not, by itself, particularly objectionable or unusual. Indeed, debt counseling is common outside the United States and professional debt counselors in Europe historically have been very active in helping consumers restructure their debts and navigate formal debt adjustment procedures.85 In imposing the new credit counseling requirement, however, members of the U.S. Congress assumed consumers would consult with an impartial counselor before they filed a bankruptcy petition and would then realize that they actually had the ability to repay their debts outside of bankruptcy in a private debt management plan.86 Thus, the basic normative goal of the new credit counseling requirement is to make consumers understand that they have the responsibility to control and manage their financial affairs in a responsible manner. The specific goal of the counseling was to help potential debtors “make an informed choice about bankruptcy, its alternatives, and [the] consequences” of filing for bankruptcy.87
Despite these admirable goals, commentators uniformly have concluded that pre-filing credit counseling is of little value to most consumers because, by the time most people are contemplating a bankruptcy filing, their financial situation is so dire that they have no realistic alternative but to file for bankruptcy.88 For example, empirical studies conducted during the last two years have found that the overwhelming majority (approximately ninety-seven percent) of debtors who participated in pre-bankruptcy counseling simply did not have enough money to pay their bills, or do anything else except attempt to get relief for their over-indebtedness by filing for bankruptcy.89 The futility of credit counseling is especially pronounced for Chapter 13 debtors since many of them are facing imminent foreclosures on their homes and can stall the foreclosure only by filing a bankruptcy petition.90
Thus, the mandatory pre-filing counseling requirement has failed everyone involved: it has not helped consumers and it is not financially beneficial for credit counseling agencies either. Credit counseling agencies are not benefiting because Congress mandated that the counseling services be provided at a reasonable cost and that fees be waived for the poorest consumers (typically based on an amount that is well below the U.S. poverty line).91 Because of this, most agencies provide counseling on the Internet (the cheapest way) and many have eliminated face-to-face counseling (the most expensive way) even though counseling experts argue that the most effective way to counsel consumers is face-to-face.92 Because most credit counseling agencies charge consumers only fifty dollars, most are finding that even using the cheapest way to provide these services is not profitable.93
The credit counseling requirement would have been profitable for these agencies if more consumers could afford to repay their debts in a debt management plan (DMP). Consumers who participate in DMPs are required to repay some of their unsecured debts over an extended period of time outside of a bankruptcy proceeding. DMPs are profitable because credit card companies typically give credit counseling agencies a percentage of the amount consumers pay to their creditors. However, there is virtually uncontroverted evidence that in just two years the pre-filing counseling requirement has diverted few potential debtors into private DMPs.94 Thus, in addition to placing additional administrative burdens and unnecessary costs on consumers, the credit counseling requirement has failed to be a financially profitable venture for the credit counseling agencies who provide these services for the simple reason that most consumers are too over-indebted to benefit from anything other than discharging their debts in a bankruptcy proceeding.95