Mix bankruptcy with scandal and fraud and you get a volatile cocktail of emotion and outrage that commands the national stage. The debate over how and when people and companies can resort to bankruptcy, fueled by the recent high-profile filings of Enron, WorldCom and Adelphia, has suddenly turned the spotlight on the rewriting the nation’s bankruptcy laws. And everyone, it seems, has a dog in this fight.
CONSUMERS AND BUSINESSES are shedding their debt in record numbers. Bankruptcy filings in the 12 month period ending March 31 are up 15 percent from the same period a year ago, according to data from the Administrative Office of the U.S. Courts. The first quarter of the year saw 379,012 bankruptcy filings, the highest number ever recorded for a first quarter and the second highest number for a three-month filing period ever. Of those 369,237 were consumers; 9,775 were business-related.
Stories of consumer and corporate cheats beating the system by abusing the bankruptcy laws are legion. There’s one-time corporate raider Paul Bilzerian who has filed for bankruptcy twice in Florida, the last time listing $140 million in debts. Yet Bilzerian is able to shield his $5 million home, which he once dubbed his “Taj Mahal,” thanks to a loophole in the bankruptcy laws that allow Florida residents an unlimited homestead exemption. That exemption is also permitted for residents of Iowa, Kansas, South Dakota and Texas.
And remember the headlines surrounding actor Burt Reynolds when he filed bankruptcy claiming $10 million in debt but was allowed to keep his $2.5 million home? Or the couple that brought home a combined $3,200 a month yet ran up $237,000 on some 30 credit cards before they wiped it all out in a bankruptcy proceeding?
And then there are the companies like Enron and WorldCom, where highly questionable, and possibly illegal, accounting methods pushed them to shroud themselves in bankruptcy, thus eliminating all shareholder equity while wrecking havoc with pensions and a myriad of smaller creditors, as major bondholders and banks jockey in court for the table scraps.
Under the glare of such white-hot national attention, the House and Senate are close to final passage of a sweeping bankruptcy bill. The legislation languishes in conference committee where differences in the House and Senate proposals must be worked out. The bill nearly emerged for a vote last week but stalled over a last-minute dispute on a provision that would prohibit people convicted of violence against abortion clinics from using the bankruptcy laws to avoid paying fines.
Supporters hope the bill will emerge from committee shortly after the summer recess. The White House has already said it would sign it into law.
But consumer advocates, economists and attorneys question whether the bill actually does what its supporters claim: Make the bankruptcy laws “more fair.”
Critics claim that the brunt of bankruptcy reform is born on the backs of those that can least afford it: Consumers in legitimate need of an economic safety net, and large corporations are largely untouched by the reforms while small businesses also end up with more burdens, bankruptcy-law experts say.
No surprise, the credit card and banking industry, which have lobbied for six years to overhaul the nation’s bankruptcy laws, support the bill.
The American Bankers Association says the U.S. economy loses $40 billion annually. And those losses are passed along to all consumers, the ABA says. “Responsible borrowers should not have to bear the cost of irresponsible people who can pay at least part of their debts, but choose to use the bankruptcy code to escape them,” the ABA says.
“The credit card industry funneled $45 million into the lobbying effort [of the bankruptcy reform bill],” David Goch, of the Commercial Law League, told The Hill newspaper. “I can’t think of legislation in the last decade that banks and credit card institutions have lobbied as hard and spent as much money on,” said Goch, whose organization represents creditors’ rights and bankruptcy professionals.
NO NATION OF DEADBEATS
Though bankruptcy filings are hitting records, they could actually be much worse, according to research done by Michelle White, an economics professor at the University of Michigan. White’s research shows that at least 15% of American families could benefit from a bankruptcy filing, yet fewer than two percent actually do.
Half of the 1.6 million households seen by the network of 1,500 Neighborhood Financial Care Centers last year found themselves in trouble because of an unexpected life change, such as divorce, medical emergency or layoff, the non-profit group said. Those households had an average of 10 credit cards and owed an average of 79 percent of next year’s gross income, which was $25,000.
The idea that millions of Americans are running up credit cards and simply tossing in the towel when the payments or collection agencies start making life miserable isn’t an accurate picture of real life, said Gregory J. Revord, a Munising, Michigan-based bankruptcy attorney.
“I think that’s hype, honestly,” Revord said of the typical consumer bankruptcy characterization. Revord said he doesn’t see such abuse in his practice.
“In the entire time I’ve practiced, I’ve probably had one client come to me that I felt had improper motives and I refused to represent him,” Revord said. “Most of the people have fallen on hard times.”
Revord blames the “predatory practices” of the lending industry for making credit available to people that shouldn’t be getting credit in the first place, such as giving credit cards to 18-year-olds. But he doesn’t lay the blame solely at the feet of the lenders; however, their aggressive solicitations don’t help the situation, he said.
“I’m not an advocate of unfettered spending on the part of consumers,” Revord said. “I do believe there is a culture of reckless spending on the part of consumers, I think that’s bred through all kinds of sources,” he said. “But the banks certainly lend to that culture, literally.”
Indeed, the reform bill does nothing to reign in the relentless direct mail marketing habits of credit card companies; some five billion credit-card solicitations were made in 2001. The Consumer Federation of America calls that practice a “reckless effort” by those companies to increase their profits.
Credit-card companies incredulously bombard recent bankruptcy filers with offers for new cards, Revord said. “I hear such stories from almost every single one of my clients,” he said.
THE SQUEEZE PLAY
The most nefarious aspect of the pending bankruptcy reform bill is it’s mainly aimed at ordinary families, making bankruptcy less appealing as a means of financial relief while preserving loopholes for the wealthy, said Elizabeth Warren, a Harvard Law professor and expert in bankruptcy issues.
For example, the new bill is aimed at pushing more people into the so-called Chapter 13 bankruptcy filing — which puts the debtor under a court ordered repayment plan-rather than Chapter 7, which wipes out most debt not secured by a home or loan of some kind.
And there is a “means test” provision in the new bill, Warren says, that disadvantages lower- and middle-income earners. In general, the means-test process is more expensive and more of a hassle, creating more obstacles to bankruptcy for those with less money, she said.
“Every consumer that files for bankruptcy has to put up past tax records, file additional forms, go off to a credit counseling school, and pay more to their attorneys because attorneys are obligated to fill out more forms,” Warren said. This drives up the cost of bankruptcy by a few hundred dollars, “which may not sound like a lot to you or me but if you’re only making $19,000 a year and you’re in big financial trouble it may be enough to squeeze some people out,” she said.
Now contrast that with a corporate executive that is being sued for fraud has been shorting some stock or makes a bad real-estate deal and now owes millions. Such people aren’t caught in the means test provision of the new bill because “their debt is principally business debt,” Warren said, which she said is exempt to means testing.
The bill also makes it harder for small businesses to reorganize under the protection of bankruptcy. Businesses with less than $3 million in debt will have less access to bankruptcy protection and reorganization and are pushed more to liquidate under the new law, Warren said, “but for businesses with more than $3 million in debt, it’s business as usual.”
The current bankruptcy system “was never written for times like this,” Warren said, noting that scenarios brought to light by the collapse of Enron and WorldCom were never anticipated. Corporate bankruptcy “was written for companies like Braniff Airlines that expanded too fast and ended up having to liquidate all of its assets to pay off its creditors,” Warren said.
Bankruptcy law doesn’t have “good tools” to recover money from the corporate cheats the loot a companies coffers and exit with lucrative severance packages, Warren said.
“Meanwhile, WorldCom has filed for bankruptcy and drastically cut its severance packages,” said Frank Torres, legislative counsel for Consumers Union. So while WorldCom employees are stripped of their health insurance and left with a retirement plan worth next to nothing, those people “may find it impossible to file for bankruptcy” under the new law, while the company “is free to file for bankruptcy after it cooked the books and cheated investors.”