LV bankruptcy experts work to sway Congress

John Wilen

Tuesday, June 1, 1999 | 11:25 a.m.

The bankruptcy reform legislation working its way through Congress will create debtor's prisons and a debt-strapped underclass forced to roam from town to town and job to job to avoid creditors, says a group of Las Vegas bankruptcy trustees and bankruptcy attorneys.

But proponents of bankruptcy reform dispute that view, saying the legislation is necessary to prevent mounting abuses of the bankruptcy system.

The bankruptcy trustees and attorneys are seeking media attention because they say their concerns have largely been ignored by a Congress that has been swayed by an estimated $80 million banking industry lobbying campaign. The bankruptcy trustees are Tom Grimmett, Yvette Weinstein and Kathleen McDonald. The attorneys are Philip Goldstein and Shelley Krohn.

One version of bankruptcy reform legislation passed the House by a vote of 313 to 108. Another version is pending in the Senate and has cleared the Senate Judiciary Committee.

The two bills will have to be reconciled at some point. President Clinton's advisors have recommended that the president veto the measure. A Clinton veto threat helped kill similar bankruptcy reform legislation last year.

The legislation under consideration would change Chapter 7 of the Bankruptcy Code from what the local bankruptcy officials call a fresh-start approach to a means-test approach. Under current law, Chapter 7 allows debtors to immediately discharge most of their debts by agreeing to liquidate assets.

But each state provides exemptions to the liquidation requirements. In Nevada, Texas and Florida, debtors receive generous homestead exemptions to Chapter 7 liquidation, meaning most can keep their homes no matter how much they owe.

Depending on each debtor's assets and the exemption laws of the state in which they file bankruptcy, even people with enough income to repay substantial amounts of their debts can discharge those debts under a Chapter 7 filing, according to an analysis provided by the Consumer Bankruptcy Legislative Group. In cases where all of a person's assets are exempted from liquidation by state law, that person may obtain a Chapter 7 discharge of all their debts without liquidating or repaying anything.

Under Chapter 11 and Chapter 13 bankruptcy filings, debtors must present a plan to the court to pay off their debts. The court reviews a debtors' income statement and assets, determines an appropriate budget and allows the debtor to keep his or her possessions as long as the debtor pays the amount they agree to pay under the plan.

Under the bill that passed the House, Chapter 7 filings would only be available to debtors whose five-year income available to pay unsecured debt is $5,000, about $83.33 per month. Any who do not meet this means test would be forced into a Chapter 13 filing. Under the bill pending in the Senate, the five-year income means-test level would be $15,000, or about $250 per month.

Under both bills, any debtor who can pay at least 25 percent of their debts after allowable living expenses are deducted from their income would also be denied a Chapter 7 filing.

The local bankruptcy officials have problems with this plan, arguing that few debtors will meet the monthly income means tests, and that most will be forced into a Chapter 13 repayment plan. Debtors that do meet the test will be encouraged to run up more debt prior to filing for bankruptcy to ensure that they do not have the income to pay 25 percent of their debts, the officials say.

But their biggest complaint is with a provision of the bills that would use strict Internal Revenue Service collection standards to determine what are reasonable living expenses. The officials say the IRS criteria does not take into consideration expenses like health care and eldercare, or changes in circumstances like the loss of a job or a broken-down car.

Because the new bill would enforce stricter standards, fewer people would qualify for a Chapter 7, the officials say. They would instead be forced into a Chapter 13 repayment plan that will set a budget based on the unrealistic IRS collection standards.

The result, the officials say, will be many more debtors who find they cannot make they payments required under their Chapter 11 and Chapter 13 plans, and will simply "drop out" of the legal economy, moving frequently and working for cash to avoid creditors.

"We're going to have people in this town who are garnished to the point where it's better off to quit," said Goldstein, the attorney.

The idea behind the existing bankruptcy laws was to give people in trouble a fresh start, said McDonald, the trustee. If that idea is abandoned, she said, the laws will create a sub-class of "Gypsies" running from city to city to throw off their creditors for a while.

The fresh-start idea, "may be offensive to some people ... but the alternative is debtors' prisons," said McDonald.

Grimmett, also a trustee, said the system that would be created by the bills in Congress would be more like the welfare system. Debtors will apply for relief and "you'll be told" by a bureaucrat using a formula what kind of bankruptcy you can file for, said Grimmett.

The officials said the bills under consideration would do little to end the high-profile bankruptcy cases and examples of abuse cited by the bills' proponents and the banking industry. First, the test requiring debtors who can pay more than 25 percent of their debts to file under Chapter 13, as opposed to Chapter 7, would encourage debtors to run up more debts prior to filing. That way, they would ensure they don't meet the means test and would be allowed to take advantage of the beneficial debt discharges of a Chapter 7. That provision in and of itself encourages abuse, say bill opponents.

Second, the language of the bills require that the means-test of monthly income available to pay debts -- the $83.33 per month in the House bill and the $250 per month in the Senate bill -- be based on the income the debtor received in the six months prior to their bankruptcy filing. Rich people can meet this test easily by living off their savings for the six months prior to filing for bankruptcy, and then reporting zero income, said Goldstein.

Thus, the high-profile abusers bankruptcy reform is intended to catch -- the billionaire who declares bankruptcy to evade millions in bad debts but gets to continue living in his mansion -- will continue to abuse the system, said Goldstein. Meanwhile, the working class mother whose kids get sick or whose car breaks down will be strapped with an unrealistic repayment plan based on IRS collection standards that was devised under an Chapter 13 filing, and will have no choice but to default on the plan, said Goldstein.

"It's going to penalize and crush the hourly worker who does fall on hard times," said Goldstein.

The attorneys and trustees admit that there is abuse of the current system, and concede that some reform is needed. But the current bill goes too far, they say.

During debate of the House bill, reform opponents got some support from an unlikely source: Rep. Henry Hyde of Illinois, Republican chairman of the House Judiciary Committee.

The New York Times reported Hyde offered an amendment that would have changed the bill to give judges more discretion to decide reasonable living expenses for debtors in bankruptcy.

"For goodness sakes, let us give some flexibility to the debtor," said Hyde, as reported by the Times. "I'm as capitalist as anybody and I'm as conservative as anybody. But it doesn't seem to me that giving some flexibility to someone in bankruptcy is a renunciation of one's conservative standards."

Hyde also criticized the creditor lobby.

"Let me also pay my respects to the creditor lobby," the Times reported Hyde saying sarcastically when his amendment was defeated. "They are awesome."

Nevada Sen. Richard Bryan said he will carefully consider the means-test and living standards provisions of the Senate bill, and cited Hyde's attempts to change the House bill as a sign it may be too extreme.

"Prima-facie, you have to wonder, has this thing really gone too far if the Judiciary Committee chairman is trying to mitigate the income and earnings tests?" said Bryan in an interview.

Bryan does not serve on the Senate Judiciary Committee, and has not had a chance to read either the Senate or House bills. He said bankruptcy reform is needed, but said it is too early to tell whether the current bills are the proper mechanism for reform.

"It could well be that the criticism that it goes too far may be valid," said Bryan.

The local bankruptcy officials do not believe the reform bills will hurt their livelihood. For attorneys, the workload will shift from numerous small Chapter 7 cases to a few large Chapter 13 cases. Litigation will increase as the less-defined parts of the new laws are hammered out, and bankruptcy attorney billings could actually increase, officials said.

Bankruptcy trustees -- charged with collecting debts -- will likely end up with more work and greater collection responsibilities, but little in the way of extra compensation, officials said.

"We're going to have people in this town who are garnished to the point where it's better off to quit."Philip GoldsteinATTORNEY

Bryan

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