To impose certain sanctions on foreign persons who transfer items contributing to Iran's efforts to acquire, develop, or produce ballistic missiles, and to implement the obligations of the United States under the Chemical Weapons Convention.
To amend title 11 of the United States Code, and for other purposes.
The Gekas-Moran Bankruptcy Reform Act Of 1998
Title I -- Consumer Bankruptcy Provisions
Subtitle A -- Needs-Based Bankruptcy
Sec. 101. Needs-Based Bankruptcy.
This section of the Bill requires those who have a current monthly total income of at least seventy-five percent (75%) of the national median family income for a family of equal size (or, in the case of a household of one person, at least seventy-five percent (75%) of the national median household income for one earner) plus a monthly net income greater than fifty dollars ($50) and the ability to pay at least twenty percent (20%) of their unsecured, non-priority debts over five (5) years to enter into a repayment plan under Chapter 13.
Sec. 102. Adequate Income Shall be Committed to a Plan that Pays Unsecured Creditors.
This section amends the Code to substitute for "disposable income" a new concept, "monthly net income," which is determined based upon expenditure levels now set by the Internal Revenue Service and used extensively throughout the country to make similar determinations. Provision is also made in a new Code section 111 for the adjustment of monthly net income in extraordinary cases, for example when the debtor experiences loss of income or when the debtor has unusual expenses.
Sec. 103. Definitions of Inappropriate Use.
The Bill amends Code section 707(b) to permit any party in interest to move to dismiss a Chapter 7 bankruptcy case on the basis that the granting of relief would be an inappropriate use of the Bankruptcy Code. A court shall find that the granting of relief would be an inappropriate use of the Bankruptcy Code. A court shall find that the granting of relief would constitute an inappropriate use where the debtor is ineligible for Chapter 7 under the needs-based provisions of the Bill or where the totality of the circumstances demonstrates inappropriate use.
Subtitle B - Adequate Protections for Consumers
Sec. 111. Notice of Alternatives.
This section assures that, before filing for bankruptcy, debtors receive information about debt counseling services and different options under bankruptcy. Specifically, this section requires that each consumer debtor receive a notice containing a brief description of services that may be available from independent non-profit debt counseling services.
Sec. 112. Debtor Financial Management Training Test Program.
This section would require the Executive Officer for U.S. Trustees (EOUST) to develop and test a financial management training curriculum and materials that can be used to educate debtors on how to better manage their finances. The EOUST would be required to select three (3) judicial districts in which to test the effectiveness of the training program.
Subtitle C -- Adequate Protections for Secured Lenders
Sec. 121. Discouraging Bad Faith Repeat Filings.
The section provides that the automatic stay will terminate in a consumer bankruptcy case on the 30th day after the filing if, in the previous year, the same debtor filed a bankruptcy case that was dismissed. The Bill provides an exception to this provision in the event the subsequent filing is made in good faith.
Sec. 122. Definition of Household Goods and Antiques.
The Bill defines "household goods" by using the definition already used in a similar context by the Federal Trade Commission in the Trade Regulation Rule on Credit Practices, 16 C.F.R. Sec. 444.1(I).
Sec. 123. Debtor Retention of Personal Property Security.
The Bill would add a new subsection to Code section 521 to provide that a Chapter 7 individual debtor may not retain possession of personal property securing an allowed claim for the purchase price unless the debtor either (a) reaffirms the debt or (b) redeems the property within thirty (30) days after the first meeting of creditors.
Sec. 124. Relief From Stay When the Debtor Does Not Complete Intended Surrender of Consumer Debt Collateral.
This section amends Code section 362 to provide that if an individual debtor does not file a timely statement of intention with respect to property securing the creditors claim or act in accordance with that statement of intention, a secured creditor may seek relief from the stay.
Sec. 125. Giving Secured Creditors Fair Treatment in Chapter 13.
The Bill amends Code section 1325(a)(5)(B)(1) to provide that the holder of an allowed secured claim shall retain the lien securing the claim until payment of the underlying debt or the debtor receives a discharge, whichever occurs earlier.
Sec. 126. Prompt Relief From Stay in Individual Cases.
This section amends Code section 362(e) to provide that the stay shall automatically terminate sixty (60) days after a request for relief from it is made, unless the court decides the relief from stay request during the sixty-day period, the parties agree to take a longer time, or thecourt orders additional time.
Sec. 127. Stopping Abusive Conversions from Chapter 13.
This section provides that when a debtor converts from Chapter 13 to Chapter 7, the cram down is not retained except for the limited purpose of redemption under Code section 722.
Sec. 129. Fair Valuation of Collateral.
The Bill amends Code section 506(a) to set the value of personal property securing an individual debtor’s personal property as the replacement value of the property on the petition date (without deductions for marketing or sales costs). The provision also clarifies that "replacement value" means the price a retail merchant would charge for property of that kind, considering its age and condition.
Subtitle D -- Adequate Protection for Unsecured Lenders
Sec. 142. Credit Extensions on the Eve of a Bankruptcy Presumed Nondischargeable.
The Bill amends Bankruptcy Code section 523(a)(2)(C) to create a presumption that consumer debts incurred within ninety (90) days of bankruptcy are nondischargeable.
Sec. 144. Applying the Co-Debtor Stay Only When it Protects the Debtor.
The Bill amends section 1301 so that the co-debtor stay would continue to be available when the debtor who borrowed the money sought Chapter 13 relief, but if a guarantor or other co-debtor who did not receive the consideration for the creditor’s claim filed for relief, the debtor who borrowed the money would not be protected by a stay unless he or she also filed for bankruptcy protection.
Sec. 145. Credit Extensions Without a Reasonable Expectation of Repayment Made Nondischargeable.
This section amends the Bankruptcy Code to provide that debts incurred when the debtor had no reasonable expectation or ability to repay are nondischargeable.
Subtitle E -- Adequate Protections for Lessors
Sec. 161. Giving Debtors the Ability to Keep Leased Personal Property by Assumption.
If the debtor then notifies the lessor that the debtor wants to assume the lease, the lease remains enforceable according to its terms.
Sec. 163. Adequate Protection for Lessors.
This provision extends Code section 362(b)(10) to residential leases, clarifying that the automatic stay does not bar a property owner from recovering rental property due to the filing by a resident for bankruptcy.
Subtitle F -- Bankruptcy Relief Less Frequently Available for Repeat Filers
Sec. 171. Extend Period Between Bankruptcy Discharges.
The Bill would expand the amount of time that must pass before a debtor may receive another discharge. The time period would expand to ten (10) years for Chapter 7 individual cases and five (5) years for Chapter 13 cases.
Subtitle G -- Exemptions
Sec. 181. Exemptions.
The Bill amends section 522(b)(2)(A) of the Bankruptcy Code to require a debtor to be domiciled in a state for 365 days, or the majority of 365 days, before filing a petition in order for that state’s exemptions to apply. Currently, a debtor must be domiciled in a state only for 180 days, or the majority of 180 days, for a state’s exemptions to apply.
Title II -- Business Bankruptcy Provisions
Subtitle A -- General Provisions
Sec. 201. Limitation Relating to the Use of Fee Examiners.
This provision explicitly precludes the appointment of so-called "fee-examiners."
Sec. 203. Chapter 12 Made Permanent Law.
This provision makes Chapter 12, Adjustments of Debts of a Family Farmer With Regular Annual Income, permanent law.
Sec. 204. Meetings of Creditors and Equity Security Holders.
This section would give the court the discretion not to convene a meeting of creditors if there is a prepackaged plan of reorganization.
Sec. 205. Creditors’ and Equity Security Holders’ Committees.
The Bill gives the court the discretion to change the membership of any committee to assure that it adequately represents its constituency.
Sec. 207. Preferences.
This provision helps enable small creditors to mount effective defenses against preference actions. Proposed Code section 547(c)(9) increases the minimum aggregate transfer that must be sought in a case against a creditor to $5000. This section also clarifies the ordinary course of business exception for preferential transfers by disallowing a creditor from being sued for receipt of a preferential transfer if it has received a payment in the ordinary course of the debtor’s business or made according to ordinary business terms.
Sec. 208. Venue of Certain Proceedings.
This provision mandates that a preference recovery action against a noninsider seeking less than $10,000 must be brought in the bankruptcy court in the district where the creditor resides.
Sec. 209. Setting a Date Certain for Trustees to Accept or Reject Unexpired Leases on Nonresidential Property.
The Bill amends Code section 365(d)(4) to eliminate the current 60-day period for assumption or rejection of a lease of nonresidential real property and replaces it with a 120-day initial time period following the date of the order for relief.
Subtitle B -- Specific Provisions
Chapter 1 -- Small Business Bankruptcy
Sec. 231. Definition.
The section establishes a "bright line" definition to identify those cases that merit special rules which enhance the efficient use of judicial resources and which streamline the reorganization process for debtors with meritorious cases by fixing the threshold at the $5,000,000 debt level.
Sec. 234 & 235. Uniform National Reporting Requirements.
This section amends the Bankruptcy Code and Rules to expressly require the periodic filing of financial and other reports, such as monthly operating reports, and the filing of schedules and statements within thirty days postpetition.
Sec. 236. Debtor’s Duties in Small Business Cases.
This section requires all small business debtors to establish segregated bank accounts for timely deposit of tax funds withheld or collected from third parties after the commencement of the case to stop the abusive practice of debtors, suffering from cash shortages, using government money for unauthorized business loans by financing their day-to-day operations with cash withheld from employee paychecks or sales-tax revenues, or other like "trust fund" taxes.
Sec. 237, 238 & 239. Plan Filing and Confirmation Deadlines.
This section addresses the need to move small business Chapter 11 cases at a pace appropriate for those cases by (1) establishing presumptive plan-filing and plan-confirmation deadlines specially tailored to fit small business cases and, (2) directing bankruptcy judges to use modern case-management techniques in all small business cases to further reduce cost and delay.
Sec. 240. Duties of the United States Trustee.
This section directs the U.S. Trustee to play a more active role throughout the Chapter 11 proceeding and provides the necessary tools to effectively manage Chapter 11 cases, including the ability to recommend conversion or dismissal in appropriate cases.
Sec. 241. Scheduling Conferences.
To quicken the pace for disposition of a Chapter 11 plan, the Bill requires that judges promptly hold at least one on-the-record status conference, unless the debtor and U.S. Trustee file an agreed scheduling order with the court prior to the judicial scheduling conference.
Sec. 243. Expanded Grounds for Dismissal or Conversion and Appointment of Trustee.
To maintain the legitimacy and continued public acceptance of Chapter 11 by limiting its exceptional protections to those cases in which the public derives a benefit therefrom, this section establishes statutory indicia of cases which are likely to fail, those cases in which there is no real likelihood of rehabilitation, and provides a mechanism for moving such cases expeditiously through Chapter 11.
Chapter 2 -- Single Asset Real Estate
Sec. 251. Single Asset Real Estate Defined.
This section eliminates the dollar cap from the definition of a "single asset real estate" (SARE) debtor and defines the SARE debtor to include real estate investors and to exclude debtors who use real estate in an active business, viewed in terms of economic substance rather than the form of ownership, and eliminates several ambiguities found in the current definition.
Sec. 252. Plan Confirmation.
This section establishes a clear, objective standard for new-value plans in SARE cases -the exception would be satisfied only if the secured portion of the loan was paid down to 80 percent of the value of the property, permitting the debtor to "strip off" liens to the extent that they exceed the current value of the property, while providing the secured creditors conventional terms on the remaining portion of the lien. This section allows the debtor to reorganize overencumbered property in Chapter 11, over the objection of its secured creditor, by reducing the mortgage debt to the current value of the property and retaining the property through a new-value contribution.
Sec. 253. Payment of Interest.
Section 362(d)(3), which prescribes the conditions required to impose the stay in SARE cases, requires the SARE debtor, within 90 days after the order for relief, to: (1) file a confirmable plan; (2) commence postpetition mortgage payments; or (3) obtain an extension of the 90-day plan-or-payment deadline. If the SARE debtor fails to perform any of these three options, secured creditors are entitled to relief from the automatic stay.
Title IV -- Bankruptcy Administration
Subtitle A -- General Provisions
Sec. 402. Creditor Representation at First Meeting of Creditors.
This sections amends Code section 341(c) to provide that non-attorney representatives can attend and participate in the first meeting of creditors.
Sec. 404. Audit Procedures.
This section amends title 28 to delegate to the Attorney General the responsibility for establishing random audits of the accuracy and completeness of information filed in individual bankruptcy cases under title 11.
Sec. 405 Giving Creditors Fair Notice in Chapter 7 and 13 Cases.
This section provides that the debtor include in any notice to the creditor the debtor’s account number if it is reasonably available, and to send any notices to an address which the creditor has previously specified.
Sec. 410. Chapter 13 Plans to Have a 5-Year Duration in Certain Cases.
The Bill would amend Code sections 1322(d) and 1329(c) to allow confirmation of plans with a life span of five (5) years if the debtor’s current monthly income is at least seventy-five percent (75%) of the national median family income for a family of equal size (or at least seventy-five percent (75%) of the national median household income for one earner) or more on the date of confirmation. In such cases, it would also permit the court to approve a plan longer than five (5) years up to a maximum of seven (7) years.
Sec. 412. Jurisdiction of Appeals Relating to Bankruptcy.
This proposal would streamline and expedite the appeals process by eliminating the first step and allowing appeals to be taken directly to the U.S. Court of Appeals.
Subtitle B -- Data Provisions
Sec. 441. Improved Bankruptcy Statistics.
The Bill would create a new 28 U.S.C. Sec. 159 that would require the EOUST to compile statistics on bankruptcy cases involving individual debtors, and report these statistics annually to Congress.
Sec. 442. Bankruptcy Data.
This provision requires the Attorney General to establish uniform national reporting forms for final reports in Chapter 7, 11 and 13 cases.
Sec. 443. Sense of the Congress Regarding Availability of Bankruptcy Data.
This provision expresses the Sense of the Congress that all non-confidential data held in electronic form by clerks of bankruptcy courts should be released to the public on the Internet on demand.
Title V -- Tax Provisions
Sec. 501. Treatment of Certain Liens.
This section provides that ad valorem taxes protected by liens are paid ahead of other expenses, except wage claims and claims for contributions to employee benefit plans, increasing the likelihood that local jurisdictions receive revenues which they would have received absent the operation of the Code.
Sec. 508. Chapter 13 Discharge of Fraudulent and Other Taxes.
This section provides that tax obligations arising from fraudulent returns, willful attempts to evade, and late and unfiled returns shall be nondischargeable in Chapter 13 cases.
Sec. 517. Requirement to File Tax Returns to Confirm Chapter 13 Plans.
In a Chapter 13 plan, the debtor is required to provide for the full payment of all claims entitled to priority, including taxes which have not been assessed but are still assessable.
Sec. 519. Setoff of Tax Refunds.
After a consumer files a petition in bankruptcy, a taxing authority is required to seek relief from the automatic stay on a case-by-case basis if it wants to offset a refund of prepetition taxes against a claim for prepetition taxes, even if the claim is not disputed. The cost to the government of prosecuting often uncontested and routine motions as a prerequisite to enforcing an undisputed, mutual obligation is substantial. Thus this section grants taxing authorities theability to set off an income tax refund that arose prepetition against an undisputed income tax liability which similarly arose prepetition.
Sec. 602. Effective Date; Application of Amendments.
This section ensures that nothing in this Act will not have an effect on pending bankruptcy cases.
To amend title 11 of the United States Code, and for other purposes.
To amend title 11 of the United States Code, and for other purposes.
An Analysis of the Consumer Bankruptcy Provisions of H.R. 3150
Proposed Bankruptcy Reform Legislation
Written by:
Hon. Eugene R. Wedoff
United States Bankruptcy Court
Northern District of Illinois
Chicago, Illinois
Prepared for the American Bankruptcy Institute
Web posted and Copyright © July 16,
1998, American Bankruptcy Institute.
H.R. 3150, passed on June 10, 1998 by the House of Representatives, proposes major
changes to the consumer provisions of the Bankruptcy Code (Title 11, U.S.C.). An analysis of the consumer provisions of the
bill, as originally proposed in February, 1998, has previously been published by ABI.
On May 18, 1998, the bill was amended by the House Judiciary Committee, and, as amended,
favorably reported. The bill was further amended prior to its passage by the House. In
order to allow an understanding of the bill as passed, the original analysis has been
completely revised. However, the current analysis continues to follow the format of the
original paper: first, identifying each of the changes that the bill would make in
the current consumer law; second, assessing the impact that these changes would
have in the operation of the law; and third, suggesting alternative approaches,
where appropriate, to achieving the goals of the legislation.
A similar bill, S. 1301, has been favorably reported by the Senate Judiciary Committee.
Where a section of H.R. 3150 covers the same subject matter as a section of S. 1301, a
reference to S. 1301 is included in the current analysis.
Introduction to current consumer bankruptcy law.
A description of the operation of current consumer bankruptcy law—which may be
helpful in understanding the changes proposed in H.R. 3150—is available through the
following link: Introduction to
Proposed Bankruptcy Reform.
Summary: major effects of the consumer bankruptcy provisions of H.R. 3150.
As discussed in the section-by-section analysis that follows, H.R. 3150 appears
designed to reduce bankruptcy filings and increase payments to creditors in bankruptcy.
However, the bill contains a number of provisions that may impair the overall
effectiveness of the consumer bankruptcy system. The major changes in consumer bankruptcy
law that would be effected by H.R. 3150 include the following:
1. Debts for family support obligations would be accorded the first priority in
distribution, ahead of the administrative expenses of the bankruptcy case. In Chapter 13,
each plan would have to provide for the payment of family support obligations before all
other unsecured claims, including expenses of administration. §145. Property settlements
not required for support would be made nondischargeable debts in both Chapter 7 and
Chapter 13 cases. §146.
2. Debtors would generally be ineligible for bankruptcy relief until they had first
attempted to negotiate a voluntary repayment plan through a consumer credit counseling
service approved by the United States trustee for the district in which the bankruptcy
case would be filed. §104. After a debtor received a bankruptcy discharge, the debtor
would be ineligible for any bankruptcy relief for a period of five years, and ineligible
for Chapter 7 relief for a period of 10 years, without consideration of good faith or
economic situation. §171.
3. Chapter 7 relief would be denied to a class of debtors, based on ability to pay a
specified portion of their debt. Debtors with relatively large debt would remain eligible
for Chapter 7 relief, while those with smaller debt would be ineligible. Testing for
eligibility—incorporating IRS collection standards of difficult
applicability—would be required for all debtors whose household income was at least
equal to a national median, and Chapter 7 trustees would be required to investigate and
file a report on eligibility in each case. §101. Charitable contributions would be
allowed to offset income available to pay debts, and trustees would generally not be able
to recover charitable contributions as fraudulent conveyances. §118. Any party in
interest would be allowed to challenge the debtor’s eligibility. §103.
4. For debtors whose household income was at least equal to a national median, Chapter
13 would be changed by increasing the minimum plan term to 5 years. The superdischarge in
Chapter 13 would largely be eliminated. §§102, 146, 409, 508. Debtors in Chapter 13
would be allowed during their bankruptcy cases to pay up to 15% of their gross annual
income to charities. §118.
5. Debtors would be notified about alternatives to bankruptcy, and of their obligations
in filing bankruptcy. These obligations would include submission of tax returns to the
United States trustee (with mandatory disclosure to any interested party), and filing of
detailed information regarding income, expenses, and assets, subject to formal audit.
Failure to file this information would result in automatic dismissal. §§111, 404, 406,
407.
6. In both Chapter 7 and Chapter 13 cases, secured creditors would receive secured
claims in an amount no less than the retail value of the collateral that secures the
claim, and, in some circumstances, the full amount of the claim, regardless of collateral
value. §§ 128, 129, 130, 162. Relief from stay would be granted in circumstances of
repeated bankruptcy filings without regard to equity available for distribution to
creditors generally. § 121. Condominium associations would be given a nondischargeable
debt for fees that accrue after bankruptcy regardless of whether the debtor was occupying
the premises. §148.
7. All debts incurred by a debtor within 90 days of the bankruptcy filing would be
presumed to have been incurred by fraud, and all fraudulently incurred debts would be
nondischargeable in both Chapter 7 and Chapter 13 cases. §§142, 143.
8. Bankruptcy court decisions would be appealable directly to the circuit courts of
appeals. §412.
9. Detailed provisions are set out regarding centralized collection and dissemination
of bankruptcy data. §§441-43.
10. An unlimited exemption would be provided for tax-exempt retirement funds. §119.
Debtors who changed their state of domicile within one year of bankruptcy would apparently
be required to employ federal exemptions, rather than the exemptions of either state of
domicile, and certain prepetition exchanges of nonexempt for exempt property would be
disallowed. §§181, 182.
The consumer bankruptcy provisions of H.R. 3150: specific proposals.
More than fifty of the sections of H.R. 3150 affect consumer bankruptcy cases. These
provisions are included in three of the bill’s titles. Title I ("Consumer
Bankruptcy Provisions"), Title IV ("Bankruptcy Administration"), and Title
V ("Tax Provisions"). This analysis deals with each of these sections in the
order of presentation; cross-references indicate areas in which one proposal affects
another. An indication is also given where the substance of the proposal is similar to a
provision of S. 1301. Sections that have been added, or substantially changed from the
original version of the bill, are marked by an asterisk.
Title I ("Consumer bankruptcy provisions")
Subtitle A ("Needs-Based Bankruptcy")
*§101 ("Needs based bankruptcy") (see S. 1301, §102)
Changes. This section of the bill would institute "means-testing" for
Chapter 7 relief, eliminating the choice of Chapter 7 bankruptcy for debtors who can pay a
defined portion of their future income to general unsecured creditors. Subsection 101(3)
of the bill would add a new provision to §109(b) of the Code. The new provision would
prohibit an individual from being a debtor under Chapter 7 if the individual had
"income available to pay creditors." The remainder of §101 sets up a procedure
for determining "income available to pay creditors" and a mechanism for
implementing the denial of Chapter 7 relief to debtors who have such income.
Means-testing. Whether a debtor has "income available to pay
creditors," and thus is ineligible for Chapter 7 relief, involves a three-step
determination. The first step is to compute the debtor’s "current monthly total
income." This consists of the debtor’s pretax (gross) income, from all sources,
averaged over the six months preceding the bankruptcy filing. It is to include "any
amount paid by anyone other than the debtor . . . on a regular basis to the household
expenses of the debtor and the debtor’s dependents."
In the second step, the debtor’s total monthly income is reduced by three
"automatic" categories of payments to obtain "projected monthly net
income," i.e., the amount available to pay general unsecured claims. The three
payment categories are: (1) general living expenses for the debtor and the debtor’s
dependents—excluding repayment of debt—according to standards established by the
Internal Revenue Service for purposes of collecting unpaid tax obligations; (2) all of the
payments on secured debt that will come due during the five years after filing, divided by
60 (to obtain a monthly average); and (3) all of the priority debt owed by the debtor,
again divided by 60.
Finally, in the third step, projected monthly net income may be further reduced by a
"personalized" category of "extraordinary circumstances," involving
either loss of income or additional expenses exceeding the "automatic"
categories. Such extraordinary circumstances must be itemized in a detailed sworn
statement, attested to by the debtor and the debtor’s counsel.
A debtor will be found to have "income available to pay creditors"—and
hence be ineligible for Chapter 7 relief— if three tests are met. First, the
debtor’s "current monthly total income" must be at least as much as the
national median for a household of the same size as the debtor’s household and any
smaller household, as established by the Census Bureau. Second, the debtor’s
"projected monthly net income" must be greater than $50. Third, the projected
monthly net income must be "sufficient to repay twenty per cent or more of unsecured
non-priority claims during a five-year repayment plan."
Implementation. Section 101 of the bill contains two mechanisms for implementing
means testing. First, Chapter 7 trustees are given the additional duty of investigating
and verifying the debtor’s projected monthly net income and filing a report with the
court as to whether the debtor is disqualified for Chapter 7 relief under the "income
available" standard. If the report finds that the debtor is not eligible for relief,
the trustee is required "to provide a copy of such report to the parties in
interest."
Second, if the debtor asserts extraordinary expenses, any party may object to the
statement within 60 days after the debtor makes the disclosures required by § 521 of the
Code (as expanded by §407 of the bill, discussed below), and if such an objection is
made, the bankruptcy court is to determine the matter, with the debtor having the burden
of proof.
A third implementation of means-testing is contained in §103 of H.R. 3150. As
discussed below, this provision would amend §707(b) of the Code to allow creditors to
seek dismissal or conversion of Chapter 7 cases that they believe fail the means test.
Chapter 13. Finally, §101(6) of H.R. 3150 sets out a provision unrelated to
means-testing. This final change would impose on Chapter 13 trustees the additional
responsibility of investigating and verifying the debtor’s monthly net income, and
filing annual reports with the court as to whether the amounts paid under the
debtor’s plan should be modified because of changes in the debtor’s net income.
Impact. Means-testing in general.The means-testing incorporated in §101
of H.R. 3150 would effect a major change in bankruptcy policy. That policy has
traditionally allowed debtors in financial difficulty to obtain an immediate fresh start
in exchange for surrendering their nonexempt assets. Accordingly, current § 707(b) denies
Chapter 7 relief only where this relief would be a "substantial abuse" of the
provisions of Chapter 7, and it provides that there is a presumption in favor of granting
the relief sought by the debtor. The means-testing provisions of H.R. 3150 would change
this, denying an immediate fresh start to a category of debtors in genuine financial
difficulty—unable to pay their current bills from available income—because their
future income is sufficient to pay 20 percent of their debt over five years. Thus, at a
given income level, those who have accumulated relatively small amounts of debt would be
denied Chapter 7 relief, while those who have accumulated relatively large amounts would
remain eligible. It can be anticipated that this change would decrease the number of
Chapter 7 bankruptcies, with a corresponding increase in cases under Chapters 11 or 13 or
in nonbankruptcy resolutions of consumer debts. In this way, means-testing may lead to
greater payments to creditors. But it may also have unintended consequences. For example,
at the present time, many debtors are able to avoid bankruptcy by working out voluntary
arrangements with creditors through credit counseling services. The willingness of
creditors to cooperate in such voluntary arrangements may be influenced by the fact that
the debtors otherwise have the option of Chapter 7 bankruptcy. If that option is removed,
the creditors may be less willing to enter into the voluntary arrangements. Means-testing
may also increase home foreclosure rates, since debtors now able to remove other debt in
Chapter 7 would be denied that option, and may be ineligible for Chapter 13 or unable to
complete a Chapter 13 plan.
However, regardless of the general desirability of means testing for Chapter 7 relief,
the means testing prescribed in §101 of H.R. 3150 presents substantial difficulties, both
in terms of reasonableness and practicality. Indeed, some of the practical
difficulties—involving the application of the IRS collection standards—would
make this testing difficult, if not impossible, to apply in many situations.
Determining "current monthly total income." The formula established by
H.R. 3150 for determining a debtor’s "current monthly total income" would
present substantial difficulty whenever income is earned by another member of the
debtor’s household, such as a nondebtor spouse or an adult child. The bill states
that any amount "paid by anyone other than the debtor . . . on a regular basis to the
household expenses of the debtor or the debtor’s dependents" should be counted
as part of the debtor’s income. Under this standard, it might be thought that all of
the income of a nondebtor household member should be counted, since all of that
person’s income, in some sense, supports the household. However, if the nondebtor
does not make "regular payments," attributable to identifiable expenses, it may
be that the standard does not apply. For example, a spouse’s payments into a savings
account or investment plan might well be found not to be amounts "paid to household
expenses." Interpreted in this way, the means test would require a detailed analysis
of the income and expenditures of each member of the debtor’s household.
The threshold for means-testing.Median household income, varying with size of
the household, is used in the proposal to establish a threshold below which there is no
need to examine income on an individualized basis: an individual whose total household
income is less than the median income, as determined by the Census Bureau, for a household
of the same or smaller size, would not be disqualified from Chapter 7 relief regardless of
the household expenses. However, there are two difficulties with the use of Census Bureau
medians. First, the information may be outdated. For any given year, the proposal states
that household income is based on the most recent Census Bureau figures available as of
January 1. As of January 1 of any year, the Census Bureau only has information available
for the second year before that date. Thus, 1996 income figures are presently the most
recent. In this way, the threshold under the proposal compares a debtor’s current
income to the median income that existed up to two years earlier. In times of high
inflation, this would substantially increase the number of cases subject to individual
scrutiny. (Similarly, the six-month average used to determine the debtor’s current
income will result in an artificially high income figure whenever the debtor’s income
has declined shortly before the bankruptcy filing.)
The second problem has to do with household size. The proposal employs median household
income, varying with the size of the household, with the apparent intent of allowing a
higher threshold income for larger households. In reality, however, median household
income changes erratically with household size. The median income for a single individual
(in 1996, the last year for which Census Bureau figures are currently available) was
$18,426, less than twice the federal poverty level of $9,260. But median income for a
household of two was $39,039, more than three times the poverty level of $12,480. The
median income continues to increase with household size for households of three and four
persons, but household income decreases for families of five and six persons. The
median family income for a household of seven persons was $45,241 in 1996—less than
the median income for a family of three, and again less than twice the poverty
level—and there are no increases in median income for households greater than seven.
The bill attempts to address this anomalous situation by setting the threshold for means
testing at the highest median income for households equal to or smaller than the
debtor’s household. Even under this standard, however, the threshold does not
increase as family size increases above four. Thus, for single individuals and individuals
in large households, the bill is much more likely to require individualized scrutiny than
for individuals in households of two to four persons, and the threshold has no consistent
relationship to the economic need of the individuals filing for bankruptcy relief. (Income
figures are drawn from U.S. Bureau of the Census, P60-197, Money Income in the United
States: 1996, Table 1 (1997). Poverty figures are from the Annual Update of the HHS
Poverty Guidelines, 63 Fed.Reg. 9235, 9236 (1998).)
The means-testing process—IRS collection standards. For those debtors whose
income is above the threshold, §101 of H.R. 3150 prescribes a two-part means test for
determining how much of the debtors’ projected monthly income during the five-year
period after the bankruptcy filing is "net income," available to pay general
unsecured debt. In the first part of the means-testing process, a debtor’s projected
total monthly income is reduced by a set of "automatic" deductions: (1) monthly
expenses allowances defined by Internal Revenue Service collection standards, (2) monthly
payments on secured debt, and (3) monthly payments on priority debt. To avoid double
deductions, §101 specifies that payment of debt should be excluded from the IRS
allowances. In the second part of the process, further deductions are allowed where the
debtor can establish extraordinary expenses. The balance that remains after the two sets
of deductions is the "projected monthly net income" available to pay general
unsecured debt.
There are several problems with this process—resulting primarily from the
incorporation of the IRS standards—that render it unworkable or inequitable. The IRS
collection standards are set out in Volume 2 of the Internal Revenue Manual
("Manual") §5323 (CCH 1995), and incorporate a number of exhibits also set out
in the Manual (Exhibits 5300-45 to 5300-51). More recent versions of some of the exhibits
may be found at the IRS website. As reflected in §101, the expense allowances under the
IRS collection standards fall into three categories: national standards, covering
food, housekeeping supplies, clothing, services, personal care products, and miscellaneous
expenses (Manual §5323.432); local standards, covering housing and transportation
(Manual §5323.433); and other necessary expenses, covering taxes, health care,
court-ordered payments, involuntary wage deductions, accounting and legal fees, and
secured debt, with provision for other necessary expenses (Manual, §5323.434).
The difficulties in applying the IRS standards within the procedures of §101 include
the following:
•The IRS standards are not automatic. The Manual defines the "other
necessary expenses" category as including any expense necessary to "provide for
a taxpayer’s and his or her family’s health and welfare and/or the production of
income." Manual § 5323.12. The "other necessary expense" category thus
includes all necessary expenses (such as costs of health care) that do not fall within the
national and local standards. Id.For all such expenses, the Manual requires a
discretionary determination of reasonable amounts for the expense: "Since there are
no nationally or locally established standards for determining reasonable amounts, the
[Internal Revenue] Service employee responsible for the case must determine whether the
expense is necessary and the amount is reasonable." Id.Thus, review of a
debtor’s schedules—presumably by the Chapter 7 trustee—will be necessary
whenever a debtor lists "other necessary expenses" under the IRS standards.
•There is no way to distinguish between the"other necessary expenses"
category of the IRS standards and the category of "extraordinary circumstances that
require allowance for additional expenses" established by §101 of H.R. 3150. Section
101 makes a substantial distinction between expenses covered by the IRS standards and
those arising from "extraordinary circumstances." If an expense is within the
IRS category, §101 simply provides for its deduction from the debtor’s income. But
if an expense arises from "extraordinary circumstances," then the debtor must
provide detailed explanations of the expense, subscribed to by counsel, and subject to
challenge by the trustee and creditors. However, as noted above, the IRS category includes
any necessary expense not otherwise treated by the Manual, specifically including health
care, and hence would appear to cover many expenses that could be considered
"extraordinary."
•There is no way to determine what portion of the IRS allowances reflect
payment of secured debt.The means-testing proposed in §101 deducts from the
debtor’s household income all monthly payments made on account of secured and
priority claims, and so, to the extent that the IRS standards allow deduction for debt
payments, §101 provides that payments for debt should be excluded from the IRS
allowances. In many situations, however, this exclusion will be impossible. The IRS local
standards specify a single monthly allowance for all housing expenses, including mortgage
or rent, property taxes, interest, parking, maintenance and repair, insurance, condominium
fees and all utilities—including heating and cooking fuel, electricity, and
telephone. Manual, Exhibit 5300-46. Thus, for example, the current IRS local standard for
the District of Columbia allows total monthly housing expenses, for a family of four or
more, in the amount of $1397, while a household of two in rural Illinois is allowed less
than $500. (See web listings at
<www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-dc.html> and
<www.irs.ustreas.gov/prod/ind_ info/col _stds/cfs-il.html >.) This single housing
allowance is intended to include any mortgage and property tax payments—which would
be payments of secured claims—but there is no way to separate an allowance for those
claims from the total housing allowance.
Similarly, the IRS’s local standard provides a single monthly allowance covering
all transportation expenses, including payment for vehicles (either by purchase or lease),
insurance, maintenance, fuel, registration, vehicle inspection, parking fees, tolls,
drivers’ licenses, and public transportation costs. The current monthly
transportation expense allowed for the District of Columbia, for a debtor with two cars,
is $357, while a debtor with one car in Buffalo is allowed $179. (See website listings at
<www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-trans.html>.) Again, for a debtor
with auto loans, some part of these totals would be attributable to payments on the loan,
but it is not possible to determine what part.
For both housing and transportation expenses, it might be thought that there could
simply be an exclusion from the IRS standard in the amount of whatever mortgage or car
loan payments are actually being made by the debtor. That approach, however, cannot be
used in any situation where the debtor’s secured debt payments approach or exceed the
IRS allowance, since excluding the secured debt payment would leave insufficient allowance
for the other expenses included in the category.
•The means-testing process would impose burdens disproportionately on debtors
without secured debt.The means-testing of §101 excludes secured debt payment from
projected monthly net income, and so mortgage and auto loan payments are automatically
deducted from income available to pay creditors, even if they are much higher than average
for the community in which the debtor resides. However, rental payments are not secured
debt, and so would only be excluded to the extent that they were part of the standard
levels of expense established by the IRS. Housing expenses in particular vary widely from
community to community within a metropolitan area, yet the IRS allowances are based on
county wide figures. Thus, the proposal would require all debtors in higher than average
rental communities to declare and prove "extraordinary" expenses, with the
potential for litigation concerning the extent to which bankruptcy courts should allow as
"extraordinary expenses" rental payments at a level higher than that determined
by the IRS.
Similarly, a debtor could buy a new car on credit without affecting the means-testing
of §101, but if the debtor leased a car with payments that caused the IRS transportation
allowance to be exceeded, there would again be a need to declare an extraordinary expense
in order to retain the car.
Finally, costs of rental housing may rise very quickly in a given area, but, as with
Census Bureau data, the IRS standards will necessarily lag. Thus, debtors in rental
housing may be required to establish "extraordinary circumstances" simply to
continue to rent an average apartment for their area.
• The means-test leaves unresolved recurring questions regarding the
appropriateness of various categories of expense.Currently, questions about the
reasonableness and necessity of expenses claimed by a debtor arise under §1325(b) of the
Code, which requires that Chapter 13 debtors contribute to their repayment plans any
income not "reasonably necessary" for their support and the support of their
dependents. In applying this standard, the courts have struggled to determine whether
debtors should be allowed to claim expenses for private school tuition, religious and
other charitable contributions, and care of elderly relatives or others whom the debtor
may not be legally obligated to support. See 2 Keith M. Lundin, Chapter 13
Bankruptcy §§5.36-5.37 (1994 & Supp. 1997). The IRS collection standards make clear
that private school tuition and charitable contributions are generally not allowed
as "other necessary expenses," and that care for the elderly, invalid, or
handicapped only "is necessary if there is no recourse except for a taxpayer to pay
the expense." Manual, Exhibit 5300-46. Section 118 of H.R. 3150, discussed below,
deals with the issue of charitable contributions, and generally provides that tax
deductible contributions that the debtor "has made, or continues to make" cannot
be used by the court as a factor in dismissing a Chapter 7 case under §707(b) of the
Code. Nevertheless, the debtor would presumably have to list all planned charitable
contributions as extraordinary expenses, and whether the expense should be allowed might
depend on whether the proposed contributions were a "continuation" of the
debtor’s prior practice. Questions regarding private school tuition and the costs of
caring for relatives would continue to be open. Thus, a debtor seeking to make any of
these payments would be required to list them as extraordinary expenses, with the
potential for litigation.
Costs of the proposed means-testing.Largely because of the difficulties outlined
above, the means-testing proposed by §101 can be expected to generate substantial
additional cost:
(1) A substantial burden would be placed on the Internal Revenue Service to maintain
current expense standards, for each distinct economic area in the country. These
determinations by the IRS may well require formal rulemaking procedures. While the
Internal Revenue Manual, under current law, is simply an intra-agency document giving
direction to IRS employees, §101 would transform the collection standards into an
administrative rule. (The definition of "rule" in the Administrative Procedure
Act, 5 U.S.C. § 551(5), includes "an agency statement of general . . . applicability
and future effect designed to implement . . . law or policy.")
(2) An increased burden would be placed on bankruptcy professionals.
• The proposal requires Chapter 7 trustees to investigate and report on the
debtor’s net income in each Chapter 7 case. The vast majority of Chapter 7 cases
involve no assets for distribution to creditors, and hence only a nominal fee for the
trustee. The new investigation and report will substantially add to the work required of
trustees in no-asset cases, with no provision for additional compensation. The trustees
will also have to review the appropriateness of any expenses claimed by the debtor under
the IRS’s "other necessary expenses" category.
• The investigation and reporting requirements for Chapter 13 would increase the
costs of the Chapter 13 trustee, reducing the portion of plan contributions available to
creditors.
• The bill would require debtors’ counsel to swear to the accuracy of any
extraordinary expenses claimed by a Chapter 7 debtor. Unless this oath is simply based on
the statement of the debtor (in which case it would add nothing to the debtor’s
oath), this requirement would impose on debtors’ counsel the obligation of
independently verifying all of the extraordinary expenses claimed by the debtor, thus
increasing the cost of the bankruptcy and the time required to file the case.
(3) The proposal would lead to increased "bankruptcy planning." The formula
employed for determining net monthly income is subject to manipulation by debtors. Most
obviously, because secured debt is excluded from projected monthly net income, a debtor
can reduce the income available to pay debts simply by taking on additional secured debt.
For example, assume that a debtor with $30,000 in unsecured, nonpriority debt owns a
three-year old car with no outstanding car loan, and that the debtor has $300 in monthly
net income as defined in the proposed bill. Over five years, that income would total
$18,000, well over 20% of the unsecured debt. However, if the debtor trades in the
three-year old car for a new one, and finances $12,000 for three years at 5% interest, the
debtor will need to make payments on the secured car loan of about $13,000, reducing the
total "net income" over the five years after filing to about $5000, less than
20% of the unsecured debt. Similarly, a debtor with projected income that is slightly over
20% of outstanding unsecured debt could increase the amount of that debt to arrive at a
point where disposable income is less than 20%. Debtors may be able to manipulate income,
by terminating second jobs, reducing hours, or changing employment. Finally, debtors may
be able to eliminate "excess" income by proposing to make substantial charitable
contributions.
(4) The proposal would lead to greater court involvement in Chapter 7 cases. The court
will be required to hear any disputes regarding "other necessary expenses," or
extraordinary income, as well as any questions of good faith arising out of the kind of
bankruptcy planning discussed above. These hearings will generate additional expense for
the courts and the parties involved in them.
Alternative.(1) The Bankruptcy Code has limited the availability of Chapter 7
relief in situations of improperly incurred debt by creating exceptions to discharge in
Chapter 7. To obtain relief from the improperly incurred debt, the debtor is then required
to complete a Chapter 13 plan. Rather than making Chapter 7 relief unavailable to a large
class of debtors (many of whom will have incurred their debt in good faith), it may be
preferable to define the type of debt (such as excessive credit card debt) that is
improper, and make that debt nondischargeable in Chapter 7, regardless of the disposable
income currently available to the debtor.
(2) Alternatively, if there are to be thresholds for denial of Chapter 7 relief based
on household income, those thresholds should be based on some formula (such as a multiple
of poverty level) that is not tied to median household income.
(3) Any denial of relief in Chapter 7 should be based on the presence of substantial
income that is not needed to meet current expenses, regardless of the level of debt to be
repaid, thus eliminating the incentive for manipulation of indebtedness.
§102 ("Adequate income shall be committed to a plan that pays unsecured
creditors")
Changes. Section 102 of H.R. 3150 proposes essentially two major changes in the
operation of Chapter 13.
Plan length. First, §102 imposes an increased minimum plan length for many
debtors. Instead of the current three-year minimum, §102 imposes a five-year minimum plan
length on all debtors whose "current total monthly income" exceeds the threshold
established in §101—that is, monthly income equal to or greater than the highest
national median for a household of the same size as the debtor’s household or any
smaller household, as established by the Census Bureau. If the debtor’s total income
is less than the applicable national median, the three year minimum is retained. (These
provisions are elaborated in §409 of the bill, which sets out maximum plan lengths of two
years in addition to the minimum plan length set forth here.)
Minimum payments to unsecured creditors. The second major change proposed by
§102 replaces the current "disposable income test" of Chapter 13 with a
two-part formula requiring minimum payments on unsecured nonpriority debt. Under the first
part of the formula, the plan must provide for payments of at least $50 per month to
unsecured nonpriority creditors who are not insiders. The second part of the formula
defines "monthly net income" for purposes of a Chapter 13 plan, and creates a
mechanism for requiring that "the total amount of monthly net income" is paid to
unsecured nonpriority creditors during the minimum plan period, less only expenses of
administering the case.
The definition of "monthly net income" created by §102 is similar to
"projected monthly net income" established under §101—it starts with
"current total monthly income" and deducts expense allowances pursuant to
Internal Revenue Service collection standards, with the potential for adjustment if the
debtor has extraordinary expenses or loss of income.
To assure that all monthly net income is paid through a plan to unsecured nonpriority
creditors (and administrative claimants), §102 requires that the debtor itemize
extraordinary expenses or loss of income in a statement sworn to by the debtor and the
debtor’s attorney. The debtor’s statement of extraordinary expenses would be
subject to objection by the trustee or any party in interest, and the prevailing party in
a hearing on the objection could be awarded fees and costs. If the debtor files such a
statement, the statement would have to be refiled, to reflect current conditions, no less
than annually during the duration of the plan. All Chapter 13 plans would also be required
to provide that future net monthly income will be paid as reasonably determined by the
Chapter 13 trustee, with at least annual reviews to determine whether net income has
increased or decreased.
Impact. Three substantial impacts that can be anticipated as a result of the
changes made in §102 of the bill:
Plan length. The new five-year minimum plan length would be arbitrarily imposed,
depending on household size. As discussed above, in connection with §101, median income
varies erratically with the number of persons in the household. Single individuals would
be required, using currently available census figures, to propose a five-year minimum plan
whenever their gross annual income was at least $18,426, but the trigger point for a
married couple would be $39,039. Individuals in a household of four would not face the
five-year minimum until their household income reached $53,704; but that threshold would
continue to apply to all households of greater size. For example, a five-year minimum plan
would be required of a couple with three children of their own and four foster children,
even though their income exceeded the $53,704 threshold only because of payments received
on account of the foster children.
Where the five-year minimum plan length is imposed, it may increase payments to general
unsecured creditors; however, the longer length can be expected to increase the number of
cases that fail for default in payment. A five-year minimum term may also have the effect
of discouraging any Chapter 13 filing, giving debtors additional incentive for
prebankruptcy planning to meet the proposed new filing requirements for Chapter 7. As
discussed above in connection with §101, these limitations may be met by increasing debt
and decreasing income prior to filing, and by proposing to make large charitable
contributions.
The substitution of "net income" for "disposable" income.Current
law requires Chapter 13 debtors to contribute all of their disposable income to the
Chapter 13 plan, and, after payment of secured and priority claims, this income would be
used to pay general unsecured creditors. Disposable income is defined very generally in
the Code (§1325(b)(2)), and courts have varied in their interpretation of the term. The
proposed change would require that all of a debtor’s "net" income be used
to pay general unsecured creditors. Because secured priority claims are deducted from the
calculation of net income, the principal difference introduced by the proposed legislation
is that standard expense allowances would be determined, in the first instance, by the
IRS—rather than by the courts—subject to individualized exceptions, reviewed
annually. This process could reduce the arbitrariness associated with the disposable
income test; for this reason, some use of general guidelines for determining appropriate
levels of Chapter 13 plan contributions has been recommended by the National Bankruptcy
Review Commission. National Bankr. Review Comm’n, Bankruptcy: The Next Twenty Years
262-73 (1997) ("Final Report"). However, the application of the IRS standards is
very uncertain (if not impossible) in many situations, for the reasons listed in the
discussion of §101, above, and can be expected to generate substantial cost and
litigation.
Minimum monthly payments of $50 to general unsecured claims of noninsiders. The
$50 minimum payment to general unsecured creditors, proposed by §102, applies to all
Chapter 13 debtors, even those who have no net income, or less than $50 in net income.
This minimum payment may make Chapter 13 unavailable, or at least discourage its use, by
lower income debtors.
The situation of low or nonexistent net income is common in Chapter 13—for
example, debtors emerging from a divorce may have very great difficulty in making both
required support payments and mortgage payments. In order to save their homes or
automobiles, Chapter 13 debtors are often willing to attempt to live on substantially less
than what would be considered an appropriate level of expense for necessities. Plans
proposing food budgets of $100 for a family of four are not uncommon, with all or almost
all of the plan payments going to secured or priority creditors. The $50 minimum for
unsecured debt may render such marginal plans completely impossible.
A second problem exists for lower income debtors who owe unsecured debts both to family
members and others. Section 102 would require that the first $50 of every monthly payment
go to the nonfamily members (since family members are insiders). The $50 minimum thus
provides substantial incentive for debtors with low net income to choose Chapter 7, where
all of their debts will be discharged, so that they can repay debts owing to family
members voluntarily.
Alternative. As suggested by the National Bankruptcy Review Commission, the
objective of obtaining payment for general unsecured creditors might be advanced by
requiring that payments proposed for general unsecured claims in a Chapter 13 plan be made
in equal installments throughout the plan, rather than paid only after secured and
priority claims. See Final Report at 262.
*§103 ("Definition of inappropriate use") (see S. 1301, §102)
Changes. This section makes seven changes to §707(b) of the Bankruptcy Code.
Section 707(b) currently provides for dismissal of Chapter 7 cases that constitute a
"substantial abuse" of the provisions of Chapter 7, only on motion of the court
or the United States trustee. Section 103 of H.R. 3150 would—
(1) change the operative term from "substantial abuse" to "inappropriate
use";
(2) require a finding of "inappropriate use" if the debtor is disqualified
from Chapter 7 filing by the "ability to pay" provisions of §101, discussed
above, or if "the totality of circumstances of the debtor’s financial situation
demonstrates such inappropriate use";
(3) allow creditors and Chapter 7 trustees to bring motions to dismiss Chapter 7 cases
based on substantial abuse;
(4) allow conversion to Chapter 13, with the debtor’s consent, as an alternative
to dismissal of the bankruptcy case;
(5) require the court to award fees and costs against a creditor who brought a motion
seeking dismissal for inappropriate use, if the court found that the allegations of the
motion were not substantially justified, unless special circumstances would make the award
unjust;
(6) require the court to award fees and costs against the debtor if the United States
trustee or the Chapter 7 trustee prevailed in a §707(b) motion, unless awarding such fees
and costs would impose an unreasonable hardship on the debtor;
(7) restate, in the Bankruptcy Code itself, the requirement of reasonable
investigation, currently contained in Fed.R.Bankr.P. 9011, applying to court filings
signed by an attorney; the statutory restatement would apply only to debtors’
attorneys and would be extended to cover schedules and statements of financial affairs; if
the court found a violation of the requirement, the court would be required to impose a
civil penalty on the debtor’s counsel, payable to the Chapter 7 trustee or the United
States trustee.
Impact. Most of the proposed changes simply provide a means of enforcing the
limitation on Chapter 7 relief proposed in §101 of the proposed bill. Current law limits
the right to bring §707(b) motions, based on the understanding that debtors should
generally be able to choose to obtain an immediate fresh start when they are in financial
difficulty, and this understanding would be changed by §101, as discussed above. If
creditors are allowed to bring motions for substantial abuse, the fee shifting provision
may help to reduce creditor motions brought merely to exert leverage on debtors. Just as
current law does not define "substantial abuse," the proposed change would
retain a large degree of discretion by allowing courts to grant relief based on the
"totality of circumstances." The option of conversion to Chapter 13 would
usually exist under present law, pursuant to §706(a), which generally gives a Chapter 7
debtor the option of converting the case to Chapter 13 "at any time" (however,
it is not clear why an option of conversion to Chapter 11 is not also noted).
The remaining provisions of §103, however, would create unbalanced burdens on debtors
and their counsel. In any "inappropriate use" motion brought by a trustee (or
the United States trustee) there would be a presumptive award of fees to the movant if the
motion was granted, but no award of fees to the debtor if the motion was denied. This
would create a powerful incentive on the debtor not to litigate any trustee motion, an
impact aggravated by the provision of §116, discussed below, that would deny fees to the
debtor’s attorney in any case in which a §707(b) motion was granted. Similarly,
mandatory penalties are imposed only on debtor’s counsel in connection with court
filings that are not properly investigated. If there is to be such a statutory "Rule
11" provision, there is no apparent reason why it should not apply to creditors’
counsel as well as to counsel for debtors. The impact of the proposal is to require
debtors’ counsel to verify all of the financial information submitted by their
clients, which can be expected to increase the cost of bankruptcy filings. See §410,
below, which suggests (contrary to the statutory amendment made here) that Fed.R. 9011 be
amended to impose additional duties on debtors’ counsel).
Alternative. Any fee shifting provisions in connection with trustee motions
under this section should apply equally to both parties; any statutory enactment of the
investigation requirements of Rule 9011 should apply to all parties. The option of
conversion to Chapter 11 should be specified in connection with successful motions for
inappropriate use. (See §105, below, indicating that debtors ineligible for Chapter 7
under the means-testing of § 101 should be allowed to file Chapter 11 cases.)
*§104 ("Debtor participation in credit counseling program") (see S. 1301,
§321)
Changes.This section would impose a new eligibility requirement, under §109 of
the Bankruptcy Code, on all individual debtors—as a condition of eligibility for
bankruptcy, the debtor would have to make a good-faith attempt to create a debt repayment
plan through a credit counseling service. The service would have to be registered with the
district court (as provided for in §111 of the bill, discussed below), and would have to
be approved by the United States trustee for the district in which the petition is filed,
with approval withheld from any service that did not offer its program either without
charge or at reduced charges in situations of hardship. The requirement of a good-faith
attempt to create a debt repayment plan would be inapplicable (1) if the United States
trustee found that there was no suitable credit counseling service available in the
debtor’s geographical area, or (2) if the debtor was made subject to a debt
collection proceeding, involving a potential loss of property, "before the debtor
could complete" the good-faith attempt. The debtor would be required to file with the
court a certificate of the credit counseling service which the debtor contacted, or a
verified statement as to why the debtor was not required to attempt to create a debt
repayment plan through such a service. If the debtor entered into a debt repayment plan,
the plan would also have to be filed. If the debtor filed the bankruptcy without an effort
at repayment because of pending debt collection activity, the debtor would be required to
attempt to negotiate a voluntary repayment, after the bankruptcy filing, outside of the
judicial process. Only the United States trustee would be allowed to bring a motion for
dismissal of the bankruptcy case on the ground that the debtor failed to meet these new
eligibility and filing requirements.
Impact. To understand the effect of the changes proposed in this section, it is
necessary to understand how consumer credit counseling service (CCCS) interacts with
bankruptcy under the existing law. There is currently a network of 1,300 local non-profit
CCCS organizations, joined under the National Foundation for Consumer Credit (NFCC). As
described in the NFCC’s website, these
organizations are funded by creditors, and generally attempt to negotiate 100% repayment
plans with creditors. The benefit to the debtors under these plans is a voluntary
reduction or elimination of finance charges during the repayment term, coupled with the
potential for reinstatement of credit. The organizations generally charge no fee or a
small fee to the debtors. Under existing law, NFCC members have been successful in
attracting debtor interest; according to the "In Trouble?" page of its website,
NFCC members received inquiries from over 1.8 million consumers in 1997 (a substantially
greater number than the filings of consumer bankruptcy cases). However, NFCC members are
not the only CCCS providers. In any given area, there may be a substantial number of debt
consolidators, financial advisors, and "credit repairers," providing a variety
of services with a range of charges. (The 1998-99 Ameritech Chicago Consumer Yellow Pages
lists over 30 such organizations under the heading "Credit & Debt
Counseling," including "Emma’s Accounting & Credit Counseling
Services" and "Lawyers United for Debt Relief.")
The impact of the change in law proposed by this section would fall first on the United
States trustees. They would be required to engage in a program of approving debt
counsellors from a list maintained by the clerk’s office. Apart from requiring that
the organization be "nonprofit" (pursuant to §111 of the bill) and that its
charges are limited, the bill provides no standards for trustee approval. Thus, the United
States trustee would be required to engage in rule making to set such standards, and then
engage in an ongoing approval process. Finally, the United States trustee would bear the
entire responsibility for enforcing the new debtor’s obligations, including
monitoring of files, investigations of good faith, and presentation of motions in
appropriate circumstances. The cost of such a multi-level program on the United States
trustees would be very large.
The second impact of the change would be on debtors and the CCCS industry. Debtors
would be required to consult with a CCCS organization in many circumstances, and to submit
additional court filings verifying their compliance. This would impose additional costs on
debtors (at least in terms of time expended), but might result in the completion of a
larger number of 100% debt repayment plans effected through NFCC members or similar CCCS
organizations—the apparent intent of the legislation. However, there may be a number
of other, unintended consequences. First, NFCC members could have many debtors consult
with them, on advice of counsel, even though the debtors had no ability to effect
repayment plans of the sort administered by these organizations. This could substantially
increase the operating expenses of NFCC members. Second, it can be expected that new
nonprofit CCCS organizations would be formed that were allied with providers of bankruptcy
services. These organizations would propose repayment plans of less than 100%, and if
creditors did not accept the proposed terms, the organizations would provide the
certificate of good faith required by the statute.
The third impact would be on the courts, which would be required to adjudicate any
disputes regarding (1) the approval of a CCCS organization, (2) the availability of a
suitable CCCS organization to a particular debtor, (3) the good faith of a debtor in
proposing a repayment plan, (4) the existence of debt collection activity excusing
prebankruptcy attempts at voluntary repayment, and (5) the sufficiency of any postpetition
attempts at voluntary repayment.
Alternative. Instead of mandating CCCS as a condition for bankruptcy filing,
incentives might be given to the debtor to voluntarily consult with CCCS providers. For
example, §202 of S. 1301 provides debtors with a defense to certain nondischargeability
complaints based on the plaintiff’s refusal to negotiate a voluntary repayment plan.
*§105 ("Who may be a debtor under Chapter 11")
Changes. This section would amend the eligibility requirements for Chapter 11.
Currently, Chapter 11 is only available to individuals who meet the requirements for a
Chapter 7 filing. As amended, the eligibility requirements for Chapter 11 would extend to
individuals who are disqualified from Chapter 7 by reason of the means-testing proposed in
§101, discussed above.
Impact. This section would accomplish its apparent intent—debtors whose
income and debt level disqualified them from Chapter 7 under the means-testing of §101
would remain eligible to file a Chapter 11 case.
Subtitle B ("Adequate Protections for Consumers")
§111 ("Notice of alternatives") (see S. 1301, §301)
Changes. The major change involved in §111 is to assure that each consumer
bankruptcy debtor is given a written notice that both discusses the option of consumer
credit counseling and lists credit counseling services with offices in the district in
which the bankruptcy is filed or with toll-free telephone numbers serving the district.
The list would be prescribed by the United States trustee and questions about whether a
particular counseling service should be included in the list would be determined by the
court.
Impact. This proposal can result in relevant information being made available to
debtors, although it is likely that debtors consulting an attorney will place more weight
on the attorney’s advice than on the information in a form given to them by the
attorney. The proposal would probably have the greatest impact on pro se filers.
Difficulties may exist in describing the services available from credit counselors, at
least if the description includes any comparison of credit counseling and bankruptcy in
satisfying debt or in maintaining or reestablishing credit. The need to administer the
list of credit counselors will involve additional cost to the United States trustee, as
discussed in connection with §104, above.
§112 ("Debtor Financial Management Training Test Program") (see S. 1301,
§321)
Changes. This section of H.R. 3150 would require the Executive Office of the
United States Trustee (1) to develop a program to educate debtors on the management of
their finances, (2) to test the program for one year in three judicial districts, (3) to
evaluate the effectiveness of the program during that period, and (4) to submit a report
of the evaluation to Congress within three months of the conclusion of the evaluation. The
test program is to be made available, on request, to both Chapter 7 and 13 debtors, and,
in the test districts, bankruptcy courts could require financial management training as a
condition to discharge.
Impact. Debtor financial education was a recommendation of the National
Bankruptcy Review Commission, but the Commission did not recommend any methodology for
implementing it. See Final Report at 114-16. There are two potential problems with
the methodology suggested here. First, one year may not be a long enough time to assess
the effectiveness of any program. Success in financial management would be indicated by
such factors as completion of a Chapter 13 plan, ability to reestablish high quality
credit, and (most importantly) avoidance of further financial overspending. None of these
bench marks can be assessed after one year. Second, the power to compel debtor education
as a condition for discharge is accorded without specifying the circumstances in which it
should be exercised, with the potential for widely varying application. Some judges might
require debtor education in all consumer cases, while others never require it. Compulsory
education in pilot districts also would be subject to constitutional challenge, as
nonuniform bankruptcy legislation. See Railway Labor Executives' Assn. v. Gibbons,
455 U.S. 457, 469-71 (1982) (invalidating bankruptcy legislation that applied to a single
railroad).
Alternative. A study could be conducted of the effectiveness of the existing
debtor education programs, based on their past experience. Compulsory education should be
imposed only after an education program is available nationwide, and should be imposed
only in situations defined by law.
§113 ("Definitions")
§114 ("Disclosures")
§115 ("Debtor’s Bill of Rights")
§116 ("Enforcement")
Changes. These four sections of H.R. 3150 set up a new system for regulating the
providers of consumer bankruptcy services. Section 113 defines the term "debt relief
counseling agency" to include both lawyers and non-lawyer providers of consumer
bankruptcy goods or services, and the remaining sections establish regulations bearing on
these providers. Section 114 would place a new §526 in the Bankruptcy Code, imposing a
set of disclosure obligations on consumer bankruptcy providers. The disclosure would
include (1) the availability of consumer credit counseling services, (2) the need for a
truthful listing of assets and income in bankruptcy, subject to audit and criminal
sanctions, (3) the obligation of the provider to issue a contract specifying the services
that will be provided and their cost, together with a specification of the services that
might be needed, and (4) directions on how to complete bankruptcy schedules. Copies of the
first two of these notices would be required to be maintained by the provider for two
years after the notice is given. [Note: originally the bill provided that the notice would
have to be maintained for two years after a discharge is received whenever that was longer
than the time from which the notice was given. The current version of §114 is garbled in
this respect, containing the phrase "after the later of the date on which the
notice is given," but no longer containing the discharge date as a point from which
the two year retention period should be measured.]
Section 115 would add a new §527 to the Code, with further regulation of consumer
bankruptcy providers. It would require a written contract for bankruptcy-related services,
with a copy for the client, and specify that the advertising of consumer bankruptcy
providers include a conspicuous disclosure that they are engaged in bankruptcy filing.
Finally the section would prohibit consumer bankruptcy providers from (1) failing to
perform promised services, (2) negligently making or counseling to be made any false
statement in a bankruptcy filing, (3) misrepresenting the services to be provided, or the
benefits or detriments of bankruptcy, and (4) advising the incurring of debt to pay for
bankruptcy related services.
Section 116 would enforce the new regulations on consumer bankruptcy providers. It
provides debtors may not waive the provisions of new §§ 526 and 527. The section would
further impose sanctions on consumer bankruptcy providers who engage in prohibited
conduct. There is a mandatory sanction of loss of all fees previously paid by the debtor,
and a potential sanction of being required to continue the representation of the debtor
without further fees. The prohibited activities include intentional or negligent failure
to comply with any applicable requirement of the Code or the Federal Rules of Bankruptcy
Procedure applicable to consumer bankruptcy providers, and providing assistance to a
debtor whose case is dismissed or converted under §707(b), or dismissed for failure to
file bankruptcy papers. The section would allow enforcement of the provisions of §526
both by (1) officials of state government, in either federal or state court, with actual
damages awarded to the debtors affected, and with the consumer bankruptcy provider
required to pay the costs and fees of any successful enforcement action and (2) by the
bankruptcy court, on its own motion or the motion of the United States trustee, with
potential injunctive relief and civil penalties. Finally, the section specifies that its
provisions do not supersede any state regulation of consumer bankruptcy services except to
the extent of any inconsistency.
Impact. It is questionable whether the proposed regulation would have any
significant positive impact on the provision of bankruptcy services. The likely impact of
the new regulations imposed by H.R. 3150 on the providers of consumer bankruptcy services
can be divided into three classes.
First, some of the requirements merely reiterate existing obligations or good
practices. In this category are the obligations (1) to provide written contracts
specifying the services to be performed and their cost and (2) to perform the promised
services. (Fees and services of petition preparers and attorneys are presently regulated
by §§ 110, 329, and 330 of the Code.)
Second, some of the requirements appear to impose unnecessary costs on the providers.
For example, the requirement to retain copies of each notice provided to a client or
prospective client for at least two years involves substantial cost with no apparent
benefit. Similarly, the requirement of "conspicuous notices" in all
advertisements would impose unnecessary costs in connection with classified advertisements
and telephone directories.
Third, some of the regulations may have a chilling effect on the provision of consumer
bankruptcy services. For example, the automatic denial of fees in any case dismissed under
§707(b) can be expected to discourage attorneys from filing Chapter 7 cases in situations
where eligibility for Chapter 7 relief was questionable, particularly since, in any
successful motion brought by a trustee under §707(b) there is a presumptive award of
costs and fees to the trustee (see the discussion of §103, above). Similarly, automatic
denial of fees in cases dismissed for failure to file documents may discourage attorneys
from filing cases whenever the debtor’s obligation or ability to produce documents is
doubtful. Finally, the provision that a provider may never counsel borrowing to pay for
bankruptcy fees is overbroad, prohibiting appropriate advice necessary to permit a
bankruptcy filing. While a debtor should never be counseled to borrow money fraudulently,
with the intent of discharging the debt, it may be entirely appropriate to enter into a
secured loan for the purposes of financing a bankruptcy filing, and a loan from a friend
or relative (intended to be repaid despite the discharge) may also be proper.
Alternative. Where it is found that providers of consumer bankruptcy services
are engaged in specific misconduct that is not adequately addressed by existing law, the
current provisions of the Code can be amended to sanction that misconduct. For example, if
it is found that bankruptcy providers are misrepresenting their services as not involving
bankruptcy, that misconduct could be specified as a ground for refund of fees under §329
of the Code (with punitive damages, if appropriate).
*§117 ("Sense of the Congress") (see S. 1301, §321)
Changes. None. The section simply expresses the sense of Congress that the
states should develop courses in personal finance for grade school and high school. No
action is required.
*§118 ("Charitable contributions") (see S. 1244,
The Religious Liberty and Charitable Donation Protection Act of 1997, signed into law on
June 19, 1998)
Changes. This section, in substantially the same language as S. 1244, would make
three changes in bankruptcy law as it affects charitable contributions (for each of the
changes, "charitable contributions" are defined as cash or financial instrument
contributions to tax exempt organizations):
(1) Fraudulent transfer law. The section would amend §§548 and 544 of the
Bankruptcy Code so as to preclude avoidance of certain charitable contributions as
fraudulent transfers. Fraudulent transfer law generally operates against two distinct
types of transfers—those which the debtor makes with an "actual intent" to
hinder, delay or defraud creditors, and those which are found "constructively"
fraudulent because they are made without a return of reasonably equivalent value at a time
when the debtor was in defined financial difficulty. Section 548 of the Code gives the
trustee the power to avoid either type of transfer made within one year of the bankruptcy
filing. Section 118 of H.R. 3150 would continue to allow avoidance of charitable
contributions under §548 of the Code if the contribution was made with actual intent to
hinder, delay or defraud, but would prohibit recovery of constructively fraudulent
charitable contributions whenever the questioned contribution (1) together with the
debtor’s other charitable contributions did not exceed 15% of the debtor’s gross
annual income for the year in which the transfer was made, or (2) was "consistent
with the debtor’s practices in making charitable contributions."
Section 544 of the Code allows a trustee to pursue any remedy for fraudulent transfers
that a creditor of the estate would have under state law, and hence allows recovery of
transfers made prior to the one-year cut off of §548. Section 118 of H.R. 3150 would make
§544 inapplicable to any charitable contribution that would be excluded from the
constructive fraud provisions of §548.
(2) Section 707(b).As amended by §103 of H.R. 3150, §707(b) of the Code would
provide dismissal (or at the debtor’s option, conversion to Chapter 13) of any
Chapter 7 case found to be an "inappropriate use" of Chapter 7. In determining
inappropriate use, the court would be directed to consider whether the debtor was
disqualified by an ability to pay creditors—as defined under §101 of H.R.
3150—and to consider "the totality of the circumstances." However, § 118
would prohibit the court from considering, in any determination of inappropriate use, any
charitable contribution (as generally defined), without limitation as to amount or prior
practice of the debtor, that the debtor "has made or continues to make."
(3) "Monthly net income" in Chapter 13. Section 102 of H.R. 3150,
discussed above, would require Chapter 13 debtors to contribute all of their "monthly
net income," for the duration of their plans, to the payment of unsecured,
nonpriority claims. Monthly net income, in turn, would be determined according to Internal
Revenue Service collection standards, modified by a debtor’s showing of extraordinary
circumstances resulting in loss of income or additional expenses. Section 119 of H.R. 3150
would provide that charitable contributions not exceeding 15% of a debtor’s gross
income for the year of the contributions, would be considered "additional expenses of
the debtor required by extraordinary circumstances," and hence excluded from monthly
net income, irrespective of the debtor’s prior practice in charitable contributions.
Impact. The apparent intent of Section 118 is to protect good faith charitable
contributions from attack as fraudulent transfers, and to allow such contributions to be
made without affecting the application the debtor’s entitlement to relief under
either Chapter 7 or Chapter 13. The section would accomplish that intent, but would also
allow charitable contributions to be made in bad faith, simply as an alternative to paying
creditors. Specifically:
(1) A charitable contribution made by a debtor with actual intent to defraud creditors
would apparently be protected against avoidance by a trustee under §544 of the Code.
Although intentionally fraudulent as to creditors, such a transfer would still be excluded
from the constructive fraud provision of §548, and §544 would be made
inapplicable to all transfers so excluded. This appears to be a drafting error.
(2) Debtors anticipating a Chapter 7 filing would be able to liquidate nonexempt assets
and donate the proceeds to charities of their choice, rather than allow a Chapter 7
trustee to liquidate the assets for the benefit of creditors, without that conduct being a
basis for dismissal under §707(b) of the Code. Moreover, a debtor could commence a
practice of making large charitable contributions shortly before filing a Chapter 7 case,
and then announce an intent to "continue" making these contributions after the
filing. The contributions so declared could not be considered in determining that the
debtor had the ability to pay creditors or that the totality of circumstances merited
dismissal under §707(b). Accordingly, debtors with substantial income otherwise available
to pay creditors, and thus ineligible for Chapter 7 relief under the means-test of §101,
could render themselves eligible by declaring an intent to continue making large
charitable contributions. After obtaining a discharge in Chapter 7, such debtors would be
under no enforceable obligation to actually make the declared contributions.
(3) Chapter 13 debtors, regardless of their prior practice in charitable contributions,
would be given the option of donating up to 15% of their gross income to charities of
their choice, excluding that income from the monthly net income that would be payable to
creditors. Since monthly net income excludes payments on secured and priority debt (see
the discussion of §102, above), monthly net income for many Chapter 13 debtors would be
less than 15% of their gross annual income. Such debtors would be required to contribute
only $50 per month to creditors (the minimum payment under §102), with the balance of
their otherwise net income paid to charity. For example, a debtor with an annual income of
$120,000 ($10,000 per month), might have monthly tax, mortgage and car loan payments of
$6,000, other living expenses of $1000 (the IRS national standards allow $958), and
alimony payments of $1500—a total of $8500 in monthly expenses. Such a debtor would
be expected under §102 to contribute the remaining $1500 to payment of general unsecured
creditors for a five year period, allowing repayment of $90,000. However, the debtor would
be able to exclude $1500 per month from monthly net income under the 15% charitable
contribution allowance. Thus, the debtor would have the option of contributing all but $50
per month to any tax exempt charity, so that the amount of unsecured, nonpriority debt
repaid would be $3000.
Alternative. Charitable contributions made with actual intent to defraud
creditors should remain avoidable under § 544. Both prepetition and postpetition
charitable contributions should be considered under §707(b) if they are not in keeping
with a practice established by the debtor before the bankruptcy filing and not in
anticipation of the filing. Similarly, in Chapter 13, charitable contributions should be
deducted from "monthly net income" (or "disposable income" as defined
under current law) only where the contributions are in keeping with such a prebankruptcy
practice of the debtor.
*§119 ("Reinforce the fresh start") (see S. 1301, §414)
Changes. Section 119 makes three unrelated changes to the Bankruptcy Code:
(1) Section 523(a)(17).Section 523(a)(17) was added to the Code by the Prison
Litigation Reform Act of 1995, and creates an exception to discharge for "fees
imposed by a court for the filing of a case, motion, complaint, or appeal . . . regardless
of an assertion of poverty . . . or the debtor’s status as a prisoner." Section
119 of H.R. 3150 would limit the application of the exception to fees imposed on
prisoners.
(2) Exemption of retirement funds.Section 119 would provide a separate ground
for exemption, applicable in bankruptcy regardless of whether a state opted out of federal
exemptions, for all "retirement funds to the extent exempt from taxation under
section 401, 403, 408, 414, 457, or 501(a) of the Internal Revenue Code of 1986."
(3) Definition of utility under §366.Section 119 would define utility, for
purposes of §366 of the Code, as including "any provider of gas, electric,
telephone, telecommunication, cable television, satellite communication, water, or sewer
service," regardless of whether the service was a regulated monopoly.
Impact. (1) Section 523(a)(17), despite its origin in the Prison Litigation
Reform Act, was so broadly worded that it could arguably apply to any award of costs
imposed by a court. It appears that the few decisions considering the issue have given a
limited construction to the provision. See South Bend Community School Corp v.
Eggleston, 215 B.R. 1012, 1016-18 (N.D.Ind. 1997) (limiting the provision to awards
against prisoners). Nevertheless, the clarification proposed in this section of the bill
would be helpful in effectuating the original intent of the exception.
(2) Funds in retirement accounts may be excluded from distributions in a bankruptcy
case on several grounds. First, the funds may be excluded from the bankruptcy estate,
pursuant to §541(c)(2), which deals with restrictive trusts. In Patterson v. Shumate,
504 U.S. 753, 112 S.Ct. 2242 (1992), the Supreme Court applied §541(c)(2) to exclude
ERISA pension plans from the estate. Second, retirement funds might be exempted under
state law, applicable under §522(b)(2). Third, the funds might be exempted under the
federal exemption set forth in §522(d)(10)(E). However, as to all of these theories,
questions have been raised in the courts, particularly with respect to Individual
Retirement Accounts. See Andrew M. Campbell, Annotation, Individual Retirement Accounts
as Exempt Property in Bankruptcy, 133 A.L.R. Fed. 1 (1996). The apparent intent of
Section 119 is to generally render all IRAs and employer retirement plans fully
exemptible. However, there may be ambiguities in the language employed in the statute that
would limit its effectiveness. The phrase "to the extent exempt from taxation"
could mean (1) that the contributions were not taxable when made, (2) that current
earnings of the account are not subject to taxation, or (3) that distributions from the
account are not subject to taxation. An IRA, for example, may contain pretax contributions
that would be subject to taxation if withdrawn.
An unlimited exemption for tax-exempt retirement funds may provide an incentive for
debtors to transfer nonexempt assets into retirement accounts in preparation for
bankruptcy filing, preventing those funds from being paid to creditors. See the discussion
of such prebankruptcy exchanges of nonexempt for exempt property in connection with §182,
below.
(3) Section 366 of the Code requires utilities to provide service to debtors who have
filed bankruptcy, as long as the debtors provide adequate assurance of payment for the
postbankruptcy services. Part of the reason for the enactment of this section was that
utilities were usually monopolies in any given area, so that a debtor would not easily be
able to obtain an alternate source of service. (This is in contrast to other suppliers of
goods and services to whom the debtor might owe money, such as doctors or furniture
stores. These suppliers would not be required to do business with the debtor
postbankruptcy, because the debtor would be able to find other suppliers of the same goods
and services.) With the deregulation of many utilities, there is frequently the
possibility that more than one utility operates in a given area. In such circumstances, a
utility may argue that it should not be bound by §366—that it should be allowed to
cease doing business with the debtor, with the debtor obligated to deal with a competing
utility. Section 119 would preclude this argument, by expressly making §366 applicable to
traditional utilities regardless of their monopoly status.
*§119A ("Discharge of debts arising from tobacco-related debts")
Changes. Section 119A would provide that an exception to discharge in Chapter 11
cases for debts arising from legal proceedings related to a consumer’s purchase or
consumption of tobacco products, based on allegations of false pretenses, a false
representation or actual fraud.
Impact. This section has no application to consumer bankruptcy cases. Rather, it
would prevent tobacco companies from using Chapter 11 to deal with mass torts arising from
purchase and consumption of their products, since any liability arising from a legal
proceeding in which fraud was alleged could not be discharged as part of any plan.
(Chapter 11 has been used for similar product liability torts, notably by manufacturers of
asbestos, for which the Code now contains special provisions effectuating Chapter 11
discharges. See 11 U.S.C. §524(g) and (h).)
Subtitle C ("Adequate Protections for Secured Lenders").
*§121 ("Discouraging bad faith repeat filings") (see S. 1301,
§303).
Changes. This section provides:
(1) that the automatic stay would terminate after 30 days in situations where a
bankruptcy case is filed within one year of the closing of an earlier case filed by or
against the same debtor, which case was dismissed;
(2) that the automatic stay would never go into effect in situations where a bankruptcy
case is filed within one year of the closing of two or more cases filed by or against the
same debtor, which cases were dismissed, again, unless a party in interest demonstrates
that the filing of the last case was in good faith; and
(3) that bankruptcy courts would have discretion to enter orders granting relief from
the stay "in rem," providing that the automatic stay will not apply in
subsequent cases filed by the same debtor or in cases filed by other parties with
specified knowledge of the order, including constructive notice of orders recorded in the
applicable real property records.
Impact. The role of the automatic stay differs substantially in Chapter 7 and in
Chapter 13. In Chapter 7, the stay has the effect of allowing a trustee to determine
whether property of the debtor should be liquidated for the benefit of creditors. For
example, a home that is about to be sold in a foreclosure sale, might, in the
trustee’s judgment, be able to be sold by a broker for a higher price, sufficient to
pay the mortgage and have a surplus for distribution to unsecured creditors. The automatic
stay prevents a foreclosure from taking place in a situation like this, while allowing the
mortgagee to seek relief from the stay by showing that there is in fact no equity in the
property. In Chapter 13, the automatic stay has the effect of allowing a debtor to propose
and carry out a plan that deals with secured claims in such a way that the debtor is
allowed to retain the collateral, even if there is no equity. A debtor who has no ability
to deal with a secured claim properly in Chapter 13 may nevertheless file repeated
bankruptcy cases in order to prevent a foreclosure or repossession from going forward, by
invoking the automatic stay repeatedly. The proposal seeks to limit debtors’ ability
to use this tactic, and many of its features would be helpful. However, the proposed
changes do not reflect the different roles that the automatic stay plays in Chapter 7 and
Chapter 13, and thus may have unintended consequences.
In Chapter 7 cases, regardless of whether there were prior dismissed cases, the issue
involved in application of the automatic stay should be limited to the question of equity.
To allow the automatic stay to remain in effect, a Chapter 7 trustee should simply be
required to show that there is equity in the property at issue; the good faith of the
debtor in filing the case is not relevant. To see the problem with the proposal in this
connection, consider the following example: a debtor with limited income has taken out a
home equity loan on the family home, and cannot keep up with the payments. The lender
files a foreclosure action, and the debtor seeks to save the home in Chapter 13, but fails
to make plan payments, so that the bankruptcy case is dismissed and the foreclosure action
is recommenced. This time, again to stop the foreclosure, the debtor files a Chapter 7
case. There is considerable equity in the home. Under the proposal, there is a presumption
(since the debtor failed to make plan payments) that the second case is filed in bad
faith, and if the Chapter 7 trustee wants to keep the automatic stay in effect beyond 30
days, the proposal would require the trustee to establish, by clear and convincing
evidence, that the case was filed in good faith. If the trustee is unable to do so, the
foreclosure will go forward, and the estate will lose the higher value that could have
been obtained in a brokered sale.
On the other hand, the good faith standards set out in the proposal are reasonably
applicable to Chapter 13 cases, requiring that any party in interest establish the
debtor’s good faith for repeatedly invoking the automatic stay in Chapter 13.
The impact of the "in rem" provision is difficult to determine, because no
standards are set out for the entry of in rem orders. These orders would be most
appropriate as applied to property in which there was no equity, and as to which there had
been a pattern of bankruptcy filings. In such situations, the orders could help to prevent
debtor abuse. In other situations, the orders might again prevent sales by Chapter 7
trustees to the benefit of unsecured creditors. Also, the proposal does not state whether
the court would be authorized to vacate an in rem order in a subsequent case upon a
showing that the case was filed in good faith. Absent such specification, there may
substantial litigation to determine the issue.
Alternative. The automatic stay should remain in effect in Chapter 7 cases upon
a request by the trustee, within a reasonable time after the filing of the case, for a
hearing on the question of equity. In rem orders for relief from stay should be limited to
situations in which there is no equity in the property and in which the property has been
the subject of more than one bankruptcy filing.
*§122 ("Definition of household goods and antiques") (see S. 1301, §317)
Changes. Section 122 of H.R. 3150 would add a definition for "household
goods" to the definitions of §101 of the Code. "Household goods" are a
category of debtors’ assets that may be exempted under §522(d), and as to which
certain liens may be avoided under § 522(f). The proposal would define "household
goods" by incorporating the definition that appears in 16 C.F.R. §444.1(i). That
regulation of the Federal Trade Commission defines "household goods" as:
Clothing, furniture, appliances, one radio and one television, linens, china, crockery,
kitchenware, and personal effects (including wedding rings) of the consumer and his or her
dependents, provided that the following are not included within the scope of the term
"household goods": (1) Works of art; (2) Electronic entertainment equipment
(except one television and one radio); (3) Items acquired as antiques; and (4) Jewelry
(except wedding rings).
The definition would also include "any tangible personal property reasonably
necessary for the maintenance and support of a dependent child."
Impact. Section 522(f) allows the avoidance of nonpurchase money, nonpossessory
liens on certain items of exempt household property. The idea underlying this provision is
that when a lender extends credit on the basis of used household goods in the possession
of the debtor, it is unlikely that there would be any substantial resale value in the
collateral, and that the lender is primarily relying on the difficulty that the debtor
would face in replacing the items. The Bankruptcy Code made the determination that such
liens should not be enforced. Section 122 of H.R. 3150 apparently intends to limit the
type of household property as to which nonpossessory, nonpurchase money security interests
may be avoided. The Trade Commission definition of household goods would exclude such
common items as home computers, CD players, speaker systems, earrings, and framed prints.
If so, it would be unduly restrictive. To some extent, the limitations of the FTC
definition would not restrict § 522(f), because "household goods" is only one
of the categories of personal property as to which liens may be avoided under that
subsection. Other categories include "household furnishings," and
"jewelry." A major impact of the change may be to give rise to new litigation as
to whether particular items not within the FTC definition of "household goods"
constitute "household furnishings." It would similarly require litigation to
determine whether particular items of property (for example, a home computer) are
"reasonably necessary" for the support of a dependent child. Debtors in
bankruptcy are unlikely to have the resources to engage in such litigation, and there are
no provisions in H.R. 3150 for fee shifting in the event that the debtor prevails in a
dispute over the definition of household goods. Thus, creditors with nonpurchase money
security interests in personal property of the debtor would have substantial leverage if
they chose to object to a lien avoidance motion on the ground that the collateral was not
"household goods."
Alternative. In order to protect nonpurchase money lenders who genuinely rely on
the value of the debtor’s personal property in extending credit, Section 522(f) could
be amended to exclude from lien avoidance any items of personal property not within the
FTC definition whose resale value exceeds a specified amount (for example, $1000).
*§ 123 ("Debtor retention of personal property security")
Changes. Some courts have held that debtors in Chapter 7 may redeem personal
property in installments. The proposed change would require that redemption take place by
payment in full at the time of redemption. In addition, this section proposes that if the
debtor does not either redeem personal property that is collateral for a claim, or enter
into a reaffirmation agreement with respect to the property, then the property will be
deemed abandoned by the Chapter 7 trustee, so that the creditor may repossess the property
or take other action allowed by nonbankruptcy law. This abandonment would not take place
if the court determined, on motion of the trustee, and after notice and hearing, that the
property in question was of consequential value or benefit to the estate.
Impact. For property in which there is no equity for the estate, the impact of
the proposal would be to create an appropriate incentive in favor of Chapter 13 filings
whenever a debtor wished to retain property that could not be redeemed, and as to which a
reaffirmation agreement could not be negotiated. For property in which there is equity,
the proposal allows the trustee an opportunity to retain the property, so that it can be
sold for the benefit of the estate.
*§124 ("Relief from stay when the debtor does not complete intended surrender
of consumer debt collateral") (see S. 1301, §318)
Changes. Section 521(2) of the Bankruptcy Code currently requires Chapter 7
debtors to make an election as to their property which serves as collateral for consumer
debts: they must indicate that they intend to retain or surrender the property, and
"if applicable" state that the property is claimed exempt, that the debtor
intends to redeem the property, or that the debtor intends to reaffirm the debts secured
by the property. The law further indicates that the debtor is obligated to carry out the
specified choice within 45 days of filing its notice of the election as to the property
involved. Section 124 of H.R. 3150 would make a number of changes in the operation of this
provision:
(1) The section would be made applicable to all collateral, not merely collateral
securing consumer debts.
(2) The time for performing the election would be changed from 45 days after the filing
of the notice to 30 days after the first date set for the meeting of creditors under
section 341(a).
(3) The option for retaining the property and claiming it as exempt is eliminated, so
that the only options given the debtor for collateral are: (1) surrender, (2) redemption,
and (3) reaffirmation or lease assumption.
(4) A failure by the debtor to timely perform its election would result in termination
of the automatic stay as to the property involved unless (1) the debtor chose
reaffirmation and the creditor refused to reaffirm on the original contract terms, or (2)
the court determined, on motion of the trustee, and after notice and hearing, that the
property in question was of consequential value or benefit to the estate.
(5) If the automatic stay terminates pursuant to the above provisions, it is specified
that the creditor should be allowed to proceed with any state law remedies for default
based on the filing of the bankruptcy. Thus, the fact that the debtor was current in
payments would not be grounds to prohibit repossession or foreclosure if state law allowed
these remedies based on the filing of a bankruptcy. This provision would not be applicable
as to property for which a lien was avoided in the bankruptcy case.
Impact. Current law has no enforcement mechanism for § 521(2), and §124 of
H.R. 3150 provides the most reasonable enforcement mechanism—relief from the
automatic stay. Similarly, expressly allowing repossession based on the bankruptcy filing
(if permitted by state law) addresses the creditor’s concern that the collateral will
not be maintained once the debtor is no longer personally liable for any deficiency.
Moreover, the section allows a trustee to retain for the estate property that has equity
above the creditor’s lien.
However, the proposal would interfere with the debtor’s option to retain exempt
property without reaffirmation or redemption. Debtors are allowed by § 522(f) of the Code
to avoid liens on certain exempt personal property secured by nonpossessory, nonpurchase
money security interests. A requirement that the debtor surrender such property, redeem
it, or reaffirm debt as to the property would contradict this lien avoidance provision.
Under the proposal, the automatic stay would terminate as to property exempted under
§522(f) when the debtor failed to redeem the property or reaffirm the debt, even though
no discharge had yet been granted the debtor. The debtor would presumably have a defense
of lien avoidance if the creditor pursued state law remedies as to the property in
question, but there is no reason why the automatic stay should not remain in effect so as
to prohibit such actions from being brought.
Alternative. Debtors should retain the option of keeping property subject to
lien avoidance under § 522(f).
§125 ("Giving secured creditors fair treatment in Chapter 13") (see S.
1301, §302)
Changes. Current case law interpreting Chapter 13 is in disagreement about the
time at which a lien should be deemed released under a plan. This provision would resolve
the dispute by amending §1325 of the Code to state that a lien can only be released at
the time the debtor is discharged under section 1328, or until the claim secured by the
lien is fully paid, whichever is earlier. The provision also states that, in the event of
conversion or dismissal of a Chapter 13 case, the lien would remain to the extent
recognized under nonbankruptcy law.
Impact. This change would primarily affect automobile loans. Frequently an auto
loan in a Chapter 13 case is in an amount greater than the value of the automobile. In
such a case, the debtor is allowed to pay the value of the car in satisfaction of the
secured claim, with the balance of the claim treated as unsecured. The plan may provide
that as soon as the secured portion of the claim is satisfied, the creditor is required to
release its lien. Thereafter, the debtor may fail to complete the plan, so that the
creditor does not receive full payment of the unsecured portion of its claim. This
provision would allow the creditor to retain its lien to secure payment of that unsecured
portion.
The provision contradicts the bankruptcy policy requiring equal treatment of creditors.
To the extent that a secured creditor has a claim not supported by collateral value, the
Bankruptcy Code treats the creditor’s claim as unsecured, and entitled to the same
treatment as other unsecured claims. This provision would allow the unsecured portion of a
secured claim a preferential position—even though the value of its secured claim was
paid, the creditor would be able to take action against property of the debtor to enforce
its unsecured claim, a right that no other unsecured creditor would have.
The effect of conversion or dismissal of a Chapter 13 case is treated in separate
provisions of the Bankruptcy Code, §§348 and 349. See §127 of H.R. 3150, discussed
below. If changes are made regarding the effect of conversion or dismissal and not placed
in those sections, there will be a question as to which section controls.
Alternative. Payments on account of unsecured claims could be required to be
made in equal installments throughout a plan, so that the unsecured portion of a
bifurcated claim is paid during the same time that the secured portion is paid, and all
unsecured claims are treated in the same way. Changes in the effect of conversion or
dismissal should be made in §§348 and 349 of the Code.
§126 ("Prompt relief from stay in individual cases") (see S. 1301, §311)
Changes. This section would provide that in individual bankruptcy cases under
Chapters 7, 11, or 13, the automatic stay would terminate 60 days after a request for
relief from the stay, unless (1) the court denies the motion, or (2) all parties in
interest agree to a continuance of the stay beyond that time, or (3) the court makes a
finding that continuance of the stay is required by compelling circumstances.
Impact. This provision does not substantially change existing law, which
requires that all motions for relief from stay be heard initially within 30 days, and that
if the initial hearing is not final, the final hearing must commence within 30 days after
the conclusion of the preliminary hearing. This section would only apply in cases of
hearings lasting more than one day, which are very unusual in consumer cases. Both present
law and the proposal allow extensions by the court for compelling circumstances.
§127 ("Stopping abusive conversions from Chapter 13") (see S. 1301,
§310)
Changes. This section of the proposed legislation has two parts. First, under
§348(f) of the Bankruptcy Code, when a debtor converts a Chapter 13 case to a case under
Chapter 7, the valuation of allowed secured claims is carried over from the Chapter 13
case to Chapter 7, with the amount of the secured claim reduced by whatever payments were
made on account of that claim to the secured creditor. Section 127 of H.R. 3150 would
change this result, providing that to the extent any amount remains owing to the secured
creditor at the time of the conversion, the entire amount owed will be secured by the
collateral. Second, the section provides that, to the extent that any default in payments
is not fully cured, the default "shall have the effect given under applicable
nonbankruptcy law." [Note: This section of H.R. 3150 contains a drafting error.
Section 348(f) of the Bankruptcy Code applies to all cases converted from Chapter
13 to other chapters of the Code. Section 127 of H.R. 3150 is intended to leave the terms
of §348(f) in place as they apply to Chapter 13 cases converted to Chapter 11 or 12, and
then set out new terms, in a new subsection 348(f)(C), for cases converted from Chapter 13
to Chapter 7. Thus, the new subsection should have been introduced by the phrase
"with respect to cases converted to Chapter 7." Instead, the new subsection is
introduced by the redundant and confusing phrase "with respect to cases converted
from Chapter 13." There is also a typographical error in the enrolled text of the
bill, referring to the valuation of the claim made for purposes of the case "under
chapter of this title" instead of "under chapter 13 of this title."]
Impact. The first proposed change has a very narrow impact. In Chapter 7,
pursuant to the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410
(1992), a debtor cannot simply pay the secured portion of any secured creditor’s
claim and retain the collateral. Rather, a Chapter 7 debtor can only exercise this right
in the context of a redemption, pursuant to §722 of the Code. Section 722 allows a debtor
to pay the amount of the "allowed secured claim" in order to redeem
"tangible personal property intended primarily for personal, family or household use,
from a lien securing a dischargeable consumer debt, if the property is exempted . . . or
has been abandoned." When a case is converted from Chapter 13 to Chapter 7, a
question may arise as to how much is required to be paid by the debtor in order to redeem
tangible personal property, such as an automobile. Current law provides that the amount of
the secured claim, fixed during the Chapter 13 case at the value of the collateral,
continues to be the amount of the secured claim for purposes of the case on conversion to
Chapter 7, and that any payments made on account of the secured claim during the Chapter
13 case reduce the claim on conversion. For example, if the debtor owed $10,000 on a car
loan at the outset of a Chapter 13 case, and the car was valued by the court at $7,000,
the lender would have had a secured claim of $7,000 in the Chapter 13 case and an
unsecured claim of $3,000. If the debtor paid $2,000 on the secured claim through the
Chapter 13 plan, and then converted the case, current law would provide that, on
conversion, the lender had a secured claim of $5,000 (the original $7,000 claim reduced by
the $2,000 payment). Thus, if the debtor wished to redeem the automobile in Chapter 7, the
price for redemption would be $5,000, even if the car was worth more than that amount at
the time of redemption. Under the proposed change, the intent appears to be that the
creditor would have an $8,000 claim secured by the automobile (the total claim of $10,000
less the $2,000 paid during the Chapter 13 plan). In order to redeem, the debtor would
then have to pay the entire value of the automobile, up to $8,000. In this way, the
secured creditor could receive, as a price for redemption, a total compensation greater
than the value of the collateral at the time of the filing of the case.
The second provision of the section, dealing with the cure of default, is unclear.
Under nonbankruptcy law, a default gives secured creditors certain rights to the
collateral, which may include immediate repossession or commencement of a foreclosure
action. In a Chapter 7 bankruptcy, those rights are automatically stayed, subject to the
creditor’s right to seek relief from the stay. It may be that this provision is
intended to terminate the automatic stay in a case converted from Chapter 13 to Chapter 7
whenever there is an uncured default. If so, the provision would violate the principle
that the Chapter 7 trustees are allowed to sell property in which there is equity, for the
benefit of all creditors. This would not appear to be a reasonable provision, but no other
meaning is apparent.
Alternative. Bad faith conversion from Chapter 13 is currently penalized by
§348(f)(2), which provides that the Chapter 7 trustee in the converted case may liquidate
all of the nonexempt property in the possession of the debtor at the time of conversion.
This penalty could be made more effective by uniform exemption laws. Another alternative
would be to allow denial of conversion in situations of bad faith.
§128 ("Restraining abusive purchases on secured credit") (see S. 1301,
§302)
Changes. This section of the proposed bill would change the bifurcation of any
secured claim resulting from the debtor’s incurring secured credit within 180 days of
the bankruptcy filing. Instead of the secured creditor having a secured claim only to the
extent of the value of its collateral, with an unsecured claim for the difference, the
secured creditor would be given a secured claim in the amount of the entire indebtedness
outstanding at the time the bankruptcy was filed. If the creditor is also secured by other
property, purchased more than 180 days prior to the bankruptcy, the claim would be
bifurcated, but the resulting secured claim could not be less than the debt outstanding as
a result of the purchase made within the 180 day period.
Impact. The section is not limited to situations of bad faith purchases—it
applies in any case in which the debtor files bankruptcy after making a credit purchase.
For example, if a debtor purchased an automobile in January, was laid off in February, and
filed bankruptcy in May, this provision would result in a change in the operation of the
Bankruptcy Code with respect to the claim secured by the automobile. In Chapter 7, one
impact of this provision is to increase the cost of redemption. Instead of paying the
value of the collateral at the time of redemption, the debtor would be required to pay the
entire outstanding indebtedness. Another impact is to reduce the recovery of the secured
creditor in any Chapter 7 case where there is a distribution. Under existing law, any
secured creditor would be viewed as having a secured claim to the extent of the value of
the collateral, and an unsecured claim for the difference between the value of the
collateral and the total claim. Thus, in the example given above, if $25,000 was the
outstanding loan balance, and the car valued at $20,000, current law would allow the
creditor both to repossess the car and have a $5000 unsecured claim, payable through sale
of the debtor’s other assets. Under the proposal, the creditor’s claim would be
treated as fully secured, and repossession would be the sole recovery.
In Chapter 13 cases, the impact of this provision would be to prevent "strip
down" of the affected secured claim. As a result, a greater portion of the
debtors’ contributions to the Chapter 13 plan would go to pay the secured claim, and
a smaller amount would be paid to unsecured creditors. For example, an automobile
purchased six months before a bankruptcy may have substantially depreciated. If the
automobile was purchased at a high interest rate with a long amortization, the amount
owing on the car at the time of the bankruptcy may be close to the original purchase
price. If the debtor missed one or more payments, the debt may exceed the original
purchase price. The proposal would require that the debtor, in order to retain the
automobile, pay the total amount due, rather than what the car was worth. Assuming that
the debtor’s plan makes less than full payment of all claims, the effect is to
increase the amount paid on the auto loan and reduce the amount paid to other creditors.
Alternative. Current law allows both Chapter 7 and Chapter 13 cases to be
dismissed for lack of good faith. The Code could be amended to provide that a case shall
be dismissed for lack of good faith where a debtor is shown to have made a purchase on
secured credit with the intent of filing bankruptcy shortly thereafter.
§129 ("Fair valuation of collateral") (see S. 1301, §302)
Changes. This provision of the proposed bill would amend the claim bifurcation
provision of the Bankruptcy Code (§ 506(a)) to provide that collateral in Chapter 7 and
13 cases is always valued at the cost to replace the property, without deducting the costs
of sale or marketing, and that this replacement cost, for property "acquired for
personal, family, or household purpose" is "the price a retail merchant would
charge for property of that kind."
Impact. The impact of this proposal differs, depending on whether it is applied
in Chapter 7 or in Chapter 13. In Chapter 7, the most common reason for bifurcating a
claim is in redemption: a debtor is allowed, in Chapter 7, to retain personal property
that cannot be sold for the benefit of unsecured creditors (because there is no equity in
the property, or because it is exempt), by paying any creditors secured by the property
the amount of their allowed secured claims. In this way, instead of obtaining the
property, as they would by repossession, the secured creditors receive the value of the
property, which may be less than the total amount owed. To the extent that the creditors
receive less than the total amount they are owed, they are given an unsecured claim for
the difference. Under current law, there is no explicit direction as to how to value the
collateral being retained by the debtor. However, since redemption is a substitution for
return of the collateral, there is no apparent reason why secured creditors should
receive, in a redemption, any more than they would receive if they did repossess the
collateral. Valuing the collateral at the price it would cost the debtor to replace it
gives an arbitrary increase in collateral value to the secured creditor, with the amount
of the increase depending on how expensive it would be for the debtor to replace the
property involved. Using retail price as the measure for replacement cost exacerbates this
problem, since, as the Supreme Court noted in its recent Rash decision, retail
price may include "items such as warranties, inventory storage, and
reconditioning," that are in no sense part of the collateral that secures a
creditor’s claim. Associates Commercial Corp. v. Rash, 117 S.Ct. 1879, 1886
n.6 (1997). Finally, in the context of redemption, the creditor has no risk of nonpayment,
and so there is no reason for any increase in the amount of the secured claim to
compensate for risk of nonpayment.
In Chapter 13, the principal reason for bifurcation is in "stripping down"
liens to the value of the collateral and paying the reduced secured claim over the course
of the plan. Here, the impact of bifurcation is to divide the plan payments between
secured and unsecured creditors. The debtor must either pay all claims in full (including
the unsecured portion of a secured claim) or else must pay all disposable or
"net" income into the plan. To the extent that a secured claim is valued at a
higher level, less of the plan payments will go to unsecured creditors. So, in this
context, "fairness" requires a balancing of the rights of secured and unsecured
creditors. Again, the value of collateral to a secured creditor is best measured in terms
of what that creditor could get for the collateral. To the extent that the creditor could
only obtain part of what is owed from the collateral, the creditor is best seen as
unsecured, just like the other unsecured creditors, regardless of how much it might cost
the debtor to replace the property. In contrast to redemption, however, the secured
creditor in Chapter 13 does not receive immediate payment of its claim, and so the
creditor does have a risk of nonpayment. This can be addressed by amending the Code to
provide that payments of secured claims in Chapter 13 plans should carry an interest rate
sufficient to offset the risk of nonpayment.
In either Chapter 7 or Chapter 13, the interests of secured creditors would be harmed
by a requirement of retail valuation whenever the collateral is repossessed. In such
situations, where the value of the collateral is less than the amount of the
creditor’s claim, the creditor is given an unsecured claim for the deficiency. By
requiring retail valuation of collateral, even where the creditor cannot obtain retail
price, §129 of H.R. 3150 would artificially lower the creditor’s unsecured
deficiency claim.
A final difficulty with the proposal is that many items of collateral (unlike
automobiles) do not have an established retail market for used items. For example, a
creditor may be secured by a five year old washing machine. There are unlikely to be
readily ascertainable retail markets for such machines. The proposal would leave no
guidance as to the proper valuation method in this situation.
Alternative. To create a fair valuation of collateral, the Code could be amended
to provide that a secured creditor receive a secured claim in the amount that the creditor
could establish that it would receive using any method of sale available to the creditor.
If the claim is not paid immediately, the creditor should receive an interest rate on the
secured claim sufficient to offset the risk of nonpayment. A similar standard of valuation
has been proposed by the National Bankruptcy Review Commission. Final Report at 243-58.
§130 ("Protection of holders of claims secured by debtor’s principal
residence")
Changes. Section 130 of H.R. 3150 would (1) provide that a claim is not subject
to modification if it is secured "primarily" (rather than "only") by a
lien on property used as the debtor’s principal residence at any time during the 180
days prior to the bankruptcy, (2) define "debtor’s principal residence,"
and (3) exclude continuances of mortgage foreclosures from the operation of the automatic
stay.
Impact. These changes largely resolve conflicts in the case law respecting the
treatment of home mortgages in Chapter 13. Section 1322(b)(2) provides that, generally,
secured claims can be modified in Chapter 13. This allows the plan to pay, as a secured
claim, only the value of the collateral. To protect lenders of home mortgages, the right
to modify is denied when the lender is secured only by a mortgage on the debtor’s
principal residence. Some decisions have held that a multi-unit building would constitute
security other than the debtor’s principal residence, or that a mobile home would not
be a residence. The proposed change would include loans on such property within the scope
of the protection. Similarly, there have been reports of situations in which debtors have
vacated their homes shortly before filing Chapter 13 cases, so as to remove the protection
given to the mortgage lender. The proposal negates such a tactic by applying the
protection to homes used as the debtor’s principal residence during a 180 day period
prior to the bankruptcy.
A final issue regarding the application of the non-modification provision has to do
with other security issued in connection with a home mortgage. Current law applies
nonmodifiability where the claim is secured "only" by a lien on the
debtor’s principal residence. Questions have arisen as to whether security incident
to a mortgage (such as an assignment of rents) result in the loss of nonmodifiability. The
proposal deals with these questions by requiring only that the claim be primarily secured
by a homestead mortgage. This change may be overbroad. Debtors may give home mortgages as
additional security in connection with a business loan—clearly not the kind of loan
for which the special protection was found necessary—and the business lenders could
argue (particularly if the business fails) that the home mortgage was their
"primary" security.
The remaining change made by this section involves the automatic stay. Some decisions
have held that, in order to avoid violation of the automatic stay, a lender with a
foreclosure pending at the time of a bankruptcy filing would have to dismiss the
proceeding. Then, if the automatic stay were terminated, the lender would be required to
serve all required notices and otherwise recommence the proceeding. The proposal would
allow, instead, a simple continuance of the proceeding as of the time of the bankruptcy
filing, so as to allow immediate recommencement in the event of termination of the stay.
Alternative. Instead of providing for nonmodifiability whenever a homestead is
the "primary" security for a loan, the needs of mortgage lenders could be
addressed by a provision applying nonmodifiability to any loan secured only by a mortgage
and by interests associated with the mortgage.
*§131 ("Aircraft equipment and vessels")
Changes. This section deals with the application of the automatic stay to
certain aircraft equipment in Chapter 11 cases. It has no application to consumer cases,
and there is no apparent reason why the section was placed in Title I ("Consumer
Bankruptcy Provisions") of H.R. 3150.
Subtitle D ("Adequate Protections for Unsecured Lenders")
*§141 ("Debts incurred to pay nondischargeable debt") (see S. 1301,
§315)
Changes. Current § 523(a)(14) provides that debts incurred to pay
nondischargeable tax obligations are nondischargeable. Section 141 of H.R. 3150 would
create a new exception to discharge—523(a)(19)—applying the concept of §
523(a)(14) to all nondischargeable debt, with one exception: if the debtor was
either a "single custodial parent" at the time of the bankruptcy filing, or if
the debtor owed child support or alimony payments at the time of the bankruptcy filing,
then the debt incurred to pay a nondischargeable debt would remain dischargeable unless
the creditor was able "to demonstrate that the debtor intentionally incurred the debt
to pay the debt which is nondischargeable." Section 141 would further provide for a
new class of priority claims, consisting of the following: "remaining allowed
unsecured claims for debts that are nondischargeable under section 523(a)(19), but which
shall be payable under this paragraph in the higher order of priority (if any) as the
respective claims paid by incurring such debt."
Impact. The primary impact of this proposal would be an arbitrary imposition of
nondischargeability. The provision is not limited to debts incurred fraudulently, which
are already nondischargeable under § 523(a)(2). Thus, this proposal would apply to debts
incurred in good faith, and would render them nondischargeable based simply on how the
debtor chose to use the borrowed funds. For example, if the debtor used borrowed funds to
pay rent, and other funds to repay a student loan, the debtor would have no
nondischargeable debt. But if the debtor used the same borrowed funds to pay the student
loan, and the other funds to pay rent, the debt for the borrowed funds would be
nondischargeable.
The exception to the new ground for nondischargeability is highly ambiguous, and,
depending on its interpretation, will either be very broad or largely inapplicable. Single
parents, and any debtor owing support payments at the time of bankruptcy filing, would
only be liable under the new exception if the creditor could show that they
"intentionally incurred" the debt to pay the otherwise nondischargeable debt.
This intent requirement could be interpreted to mean simply that the debtor intended to
borrow the money used to pay the nondischargeable debt—that is, that the debt was not
incurred inadvertently, such as by automatic payment of a checking account overdraft.
Under this reading, the exception would rarely apply, since most debtors intend the
borrowing that they engage in. Another possible reading of the intent requirement would be
that the debtor was aware that the debt being paid was nondischargeable in bankruptcy.
Creditors would rarely be able to make such a showing. Regardless of the interpretation,
however, there appears to be little rationale for the exception. There is no apparent
reason why a single parent—as opposed to a married parent—should be accorded
special protection in repaying student loans. Nor should the status of owing support
payments at the time of bankruptcy be relevant. Indeed, a debtor with support obligations
is given an incentive to withhold those payments prior to filing bankruptcy in order to
take advantage of the exception.
Moreover, the provision presents substantial tracing problems. Section 523(a)(14) has
had little impact thus far, perhaps because of the difficulty in tracing the source of
cash used to pay taxes. It would similarly be difficult to trace the source of cash used
by a debtor to pay nondischargeable obligations, such as child support, whenever these
obligations were paid from an account into which the debtor deposited both borrowed funds
and funds received from other sources.
Finally, the new class of priority claims presents two distinct difficulties. First,
the language describing the new priority, as quoted above, is very difficult to
understand. The intent may be to allow a priority, at the lowest level, for claims
nondischargeable under the new §523(a)(19), but only if the claim satisfied through the
nondischargeable debt was itself a priority claim, and with multiple nondischargeable
priority claims arising under §523(a)(19) paid in the order of the priority of the
satisfied claims. However, the section is also capable of being read to apply to all
claims nondischargeable under §523(a)(19). Second, under either reading, the effect of
the new priority provision may be to make completion of Chapter 13 cases involving alimony
and support much more difficult. In Chapter 13, all priority debt must be paid, in full,
through the plan. Debts incurred to pay support obligations may well be nondischargeable
under the proposed §523(a)(19)—either because the debtor was current with support
obligations at the time of the bankruptcy filing, or because the debtor
"intended" to borrow the funds needed to make the support payments. If so, the
nondischargeable debt would be a priority claim, that the debtor would have to pay in
full, together with current support payments, during the pendency of the Chapter 13 case.
*§142 ("Credit extensions on the eve of bankruptcy presumed
nondischargeable") (see S. 1301, §316)
Changes. Current § 523(a)(2)(C) provides that if a debtor borrows more than
$1000 from a single creditor for items that are not needed for the support of the debtor
or the debtor’s dependents, or takes cash advances of more than $1000, within 60 days
of the filing of a bankruptcy, the debt is presumed to have been obtained by fraud. In
keeping with the consensus reflected in In re Anastas, 94 F.3d 1280, 1285 (9th Cir.
1996), this would mean that the debtor is presumed to have incurred the debt without
intending to repay it. The proposed change would expand this presumption to all consumer
debts incurred within 90 days preceding the bankruptcy, except for "debts incurred
for necessaries that do not exceed $250 in the aggregate" to a single creditor.
Impact. The impact of the presumption is to require debtors to carry the burden
of establishing, in a creditor complaint alleging fraud, that they did intend to repay
each debt incurred by them within three months of the bankruptcy filing. The expanded
presumption would have an impact far beyond the credit card matters to which the
presumption now applies, applying, for example to medical debts, grocery bills, and rent
obligations. The exception would result in arbitrary application of the presumption: if
the debtor used a single credit card to pay for "necessaries," the $250
aggregate would be quickly exceeded. On the other hand, the use of multiple credit cards
could extend the exception substantially.
The impact of the presumption of nondischargeability would be increased by §143, which
makes debts arising from fraud nondischargeable in Chapter 13.
Alternative. The present law could be amended to make clear that the misconduct
leading to nondischargeability is incurring debt with an intent not to repay the debt.
With this understanding, other circumstances might be set out in which debt incurred
shortly before bankruptcy is presumed to be nondischargeable: for example, debt incurred
to finance casino gambling, or debt incurred in excess of some percentage of the
debtor’s ordinary expenses.
*§143 ("Fraudulent debts are nondischargeable in Chapter 13 cases") (see
S. 1301, §314)
Changes. This section would limit the superdischarge available in Chapter 13,
excluding from the Chapter 13 discharge debts incurred (1) by fraud (as defined by §
523(a)(2) of the Code); (2) by fraud or defalcation while acting as a fiduciary,
embezzlement, or larceny (as defined by § 523(a)(4)); and (3) by willful and malicious
injury (as defined by §523(a)(6)). Also excluded from discharge in Chapter 13 would be
debts covered by § 523(a)(3)(B), which applies to debts nondischargeable under
§523(a)(2), (4), and (6), as to which notice was not given to the creditor in time to
file a timely complaint to determine dischargeability.
Impact. This provision would increase the recovery of certain creditors after
the completion of a Chapter 13 case. However, the provision would also largely eliminate
the superdischarge of Chapter 13, thus removing a major incentive for filing Chapter 13
cases, and would increase the need for court hearings.
The largest number of nondischargeability complaints brought before bankruptcy courts
in recent years has been on account of alleged fraud by debtors in the use of credit
cards. The courts have struggled with the application of the fraud provisions of §
523(a)(2) of the Code to credit card debt, but a consensus is emerging that the use of a
credit card is fraudulent if the debtor had an actual intent not to repay the credit card
charge at the time the card was used. See In re Anastas, 94 F.3d 1280, 1285 (9th
Cir. 1996). This, in turn, presents a question of fact that can require a trial. Rather
than incur the expense of such a trial, a debtor may, under current law, seek relief under
Chapter 13, and, if the plan is successfully completed, the debtor will be discharged from
the credit card debt regardless of the circumstances under which it was obtained. Under
the proposal, the question of the debtor’s intent (and the dischargeability of the
debt) would remain in Chapter 13, thus providing no incentive for the debtor to choose
that chapter, and presenting the courts with the potential for more hearings on the
dischargeability of credit card debt. Similar incentives to file Chapter 13 exist when the
debtor has engaged in conduct that might give rise to claims for breach of fiduciary duty
or intentional torts. All of these incentives to file Chapter 13 are removed by this
provision. It can thus be expected to increase the incentives to file Chapter
7—discharging all other debts without payment—leaving only the questionable debt
to be dealt with outside of bankruptcy.
*§144 ("Applying the codebtor stay only when it protects the debtor")
(see S. 1301, § 305).
Changes. Under present law, if a Chapter 13 debtor is liable with another party
on a particular debt, the creditor is automatically stayed from taking action against the
other party, but the creditor may obtain relief from this codebtor stay if the codebtor
received the consideration for the claim. Section 144 of H.R. 3150 would change this
situation by providing that the codebtor stay would never go into effect if the debtor did
not receive the consideration, so that the creditor, in that circumstance, could take
action against the codebtor or property not in the possession of the debtor. An exception
would be made for joint obligations arising out of a "separation agreement, divorce
decree, or other order of a court of record." For such obligations, when the debtor
is primarily liable, the creditor would still need to obtain relief from the codebtor stay
before proceeding against the codebtor. The section also provides for termination of the
codebtor stay as to any rented property that the debtor’s plan proposes to abandon or
surrender.
Impact. Contrary to the title of this section of the proposed bill, the codebtor
stay in Chapter 13 never protects the debtor. Actions against the debtor are stopped by
the automatic stay invoked in all chapters of the Code. Rather, the codebtor stay allows
the Chapter 13 debtors to pay, through the plan, debts for which they are primarily
responsible, and protects codebtors who did not receive the benefit of the debt (that is,
true accommodation parties) from collection actions. Under current law, if the creditor
believes that the nondebtor obligor was the one who really obtained the benefit of the
debt, the creditor may seek relief from the codebtor stay to allow action to be brought
against the codebtor (and property owned by the codebtor). The proposed change states that
the codebtor stay never goes into effect when the codebtor received the benefit of the
transaction. When the debtor and another party jointly incur a liability (like a joint
loan, or a cosigned loan), it may not be clear which of the parties received the benefit
of the transaction. Current law protects true accommodation parties by requiring that the
creditor seek court permission before acting against them on the belief that they were the
ones receiving the benefit of the transaction. The change would allow creditors to take
action without court permission, and require that debtors seek sanctions for violation of
the stay if the debtor was the actual beneficiary. The issue is not a common one, but
given the limited resources of debtors in Chapter 13, current law, requiring that
creditors move for relief from stay, is probably more efficient, since it allows a court
determination of any dispute prior to enforcement action.
The exception for debts affected by divorce decrees does not remove the right of the
creditor to pursue a nondebtor spouse on a joint obligation for which the spouse received
the original consideration. It merely requires that the creditor seek relief from the
codebtor stay on that basis, as under current law.
There is no apparent reason why a surrender of leased property should eliminate the
need for the codebtor stay. Where a nondebtor signed a personal property lease as an
accommodation to the debtor, the debtor would—under current law—retain the right
to pay whatever obligations arose from the lease in full through the plan, regardless of
whether the debtor kept the leased property. In such a situation, the party who signed the
lease as an accommodation should continue to be protected from collection actions while
the debtor was making plan payments.
*§145 ("Debts for alimony, maintenance, and support") (see S. 1301,
§§323-26)
Changes. Section 145 of H.R. 3150 would make nine distinct changes in bankruptcy
law as it bears on family support obligations:
(1) Section 523(a)(18) of the Code currently makes nondischargeable in Chapter 7
certain debts owed to states and municipalities on account of support obligations. This
ground for dischargeability would be broadened by making interest on the covered debts
nondischargeable and by allowing the states or municipalities to collect support
obligations that are not governed by federal law. Finally, the broadened
nondischargeability would apply in Chapter 13 as well as in Chapter 7.
(2) The automatic stay would be made inapplicable to (a) wage deduction orders entered
by a state, pursuant to federal law, to enforce debtors’ support obligations, and (b)
a state’s withholding, suspension, or restriction of debtors’ driver’s
licenses, professional and occupational licenses, or recreational and sporting licenses,
pursuant to federal law, to enforce overdue support. [Note: in connection with license
suspension, the bill makes reference to "section 466(a)(15) of the Social Security
Act," rather than the applicable §466(a)(16).]
(3) Exempt property of the debtor would continue to be liable for the debts to state
and local municipalities for support obligations that are nondischargeable under §
523(a)(18).
(4) A first priority in payment—ahead of administrative claims—would be
accorded to support obligations, as defined under current law, and renumbered by §151 of
H.R. 3150, discussed below.
(5) Debts nondischargeable under §523(a)(18) (support obligations owing to states and
municipalities) would be accorded priority status, at a lower (eighth) level of priority.
(6) Chapter 13 plans would be allowed to provide for the payment of support obligations
prior to the payment of any other priority claim. [Note: this provision apparently may be
intended to amend §1322(a)(1), which deals with mandatory plan provisions. However, the
provision, as it appears in §145(e) of H.R. 3150, states that it is amending §1322(b)(1)
of the Code, which deals with permissive plan provisions.]
(7) In order for any plan to be confirmed in Chapters 11, 12, and 13, a debtor
obligated to make support payments would be required to have paid all support obligations
that became due after the bankruptcy filing.
(8) A standard (nonhardship) discharge in Chapters 12 and 13 would only be granted to a
debtor obligated to make support payments if, at the time the debtor was otherwise
entitled to a discharge, the debtor certified that all support obligations that became due
after the bankruptcy filing had been paid.
(9) A provision of the Social Security Act dealing with the nondischargeability of
support obligations to states and municipalities would be amended to conform to the
amended version of §523(a)(18).
Impact. The provisions of this section would have a major impact on the
bankruptcies of debtors who owe support obligations, with the apparent intent of providing
greater assurance that obligations will be paid. Several of the provisions, however, may
impede payment of support obligations.
(1) By changing the scope of §523(a)(18) to include interest, the bill increases the
payments that a debtor is required to make to a party other than the supported spouse or
child. More significantly, by making these obligations to pay the government
nondischargeable in Chapter 13, this section extends the overall policy of H.R. 3150 in
eliminating the Chapter 13 superdischarge. As discussed above, in connection with §143,
this can be expected to create additional incentives for debtors to choose Chapter 7
instead of Chapter 13, and increase litigation regarding the debtor’s qualifications
for Chapter 7.
(2) In order to make payments to a Chapter 13 plan, debtors generally need to receive
their full paychecks, and be able to use their automobiles. By making the automatic stay
inapplicable to the enforcement of support obligations through wage deduction and license
suspension, H.R. 3150 would deprive certain debtors whose wages or licenses have been
withheld from obtaining automatic relief at the beginning of a bankruptcy case. Where a
state has withheld wages or suspended a license to enforce support obligations, the debtor
would have to file an adversary proceeding for injunctive relief in order to stop the
enforcement activity. Such a procedural requirement would add substantially to the cost of
Chapter 13 for the parties and the court, and provide little additional protection for the
debtor’s dependents, since the state can, under current law, seek relief from the
stay if it appeared that the bankruptcy was filed in bad faith.
(3) The provision regarding exemption would only apply in situations where federal law
provided a more extensive set of exemptions than the state law would provide to a debtor
who owed support obligations. In such situations, the impact of the change in exemption
law would be to substitute state exemption law for federal law whenever the state was
attempting to collect support obligations nondischargeable under §523(a)(18). Although
this situation is unlikely to be common, the change would have the effect of increasing
support collections where it did arise. (Note that states can accomplish the same result
under current law by opting out of the federal exemptions.)
(4) The reordering of support obligations to the first priority in bankruptcy violates
a core bankruptcy concept—that the costs of administration must be paid first. If
this is not done, there would be a powerful disincentive for any party to work in the
bankruptcy process. The change in priorities would apply most directly in Chapter 7 cases,
where a trustee is required to review the debtor’s filings (including, under H.R.
3150, an assessment of the debtor’s eligibility for Chapter 7 relief), conduct an
examination of the debtor, and reduce the debtor’s assets to cash for the benefit of
creditors. In any case involving unpaid support obligations, the trustee would face the
prospect of performing all of this work without compensation. Other professionals, such as
appraisers, brokers, and auctioneers, would be affected in the same way. The likely
result, if this provision were enacted, is that Chapter 7 cases involving support
obligations would not be properly administered, with the result that all
creditors—including support creditors—are paid less, rather than more, from the
debtors’ available assets.
(5) In Chapter 13, all priority debt must be paid, in full, during the term of the
Chapter 13 plan. Therefore, the greater the amount of priority debt, the more difficult it
is for a Chapter 13 debtor to complete a plan successfully. Section 145 of H.R. 3150
creates a new class of priority debt—support obligations to states and municipalities
that are nondischargeable under §523(a)(18)—and so requires that these governmental
obligations be repaid in full through any Chapter 13 plan. To the extent that this makes
it difficult for debtors to complete Chapter 13 successfully, it will result in increased
incentives for debtors to choose Chapter 7, with the potential for lower payments to
creditors as a whole.
(6) The provision that support obligations in Chapter 13 may be paid before any other
priority claims would have no substantial effect on current law. Section 1322(a)(2) of the
Code requires that a Chapter 13 plan "provide for the full payment, in deferred cash
payments" of all priority claims, unless the holder agrees to different treatment,
but there is no requirement that priority claims be paid in any particular order, or at
any particular time. See In re Ferguson, 134 B.R. 689, 696 (Bankr.S.D.Fla. 1991)
(the deferred payments required by Section 1322(a)(2) are not required to be equal monthly
payments over the life of the plan, but "may be paid in periodic intervals over the
life of the plan as determined by the individual debtor"). Thus, it appears current
law would allow a Chapter 13 plan to pay support obligations ahead of other unsecured
claims. It is possible that another priority creditor could assert that such a plan
involved unfair discrimination under §1322(b)(1), although there appear to be no reported
cases applying unfair discrimination analysis to competing priority claims. However, since
§145 of H.R. 3150 already provides that support payments should be given higher priority
(see point (4) above), discrimination in favor of support payments would plainly be
permissible. Thus, permissive payment of support obligations before other priority
claims would not require special authorization.
Any real impact would only occur, if, as suggested above, the priority payment of
support obligations was made mandatory. However, a requirement that support obligations in
Chapter 13 be paid before any other priority claims would have the effect of subordinating
administrative claims. This would contradict the general policy of paying administrative
claims first. The greatest impact of such a provision would be on debtors’ attorneys.
Under current law, these attorneys frequently agree to provide legal services without
advance payment to Chapter 13 debtors, looking to be paid their fees as an administrative
expense in the Chapter 13 case itself. If they are not allowed to be paid until after all
past due support payments are made, attorneys will likely be unwilling to represent
Chapter 13 debtors without full advance payment. This would cause Chapter 13 debtors with
support obligations to be delayed in filing their bankruptcy cases, and such delays can
have serious consequences, such as the loss of a home to foreclosure. Moreover, such a
provision might often delay prebankruptcy support payments, as debtors withhold their
support payments in order to accumulate legal fees for their attorneys.
(7) It is reasonable to require that debtors be current in their postpetition support
payments as a condition for confirmation of a plan. Support obligations are simply one of
a number of current payments (such as mortgage and utility bills) that a debtor must be
able to maintain while making plan payments. If a debtor falls behind in current support
obligations after filing the bankruptcy case, it is unlikely that the debtor would be able
to complete a plan.
(8) Withholding a discharge in Chapter 12 and 13 from a debtor who has fallen behind in
current support obligations will likely have the positive effect of discouraging debtors
from withholding support obligations in order to make plan payments. If a debtor is
unable, because of unanticipated difficulties to make both plan payments and support
obligations, it would be more appropriate for the debtor to seek to amend the plan to
provide for lower payments or to seek a hardship discharge than to fail to make the
current support payments.
(9) Federal law should certainly avoid having inconsistent statutes dealing with the
same subject matter, and so it is appropriate for any provision of the Social Security Act
dealing with dischargeability in bankruptcy to be consistent with the terms of the
Bankruptcy Code. However, rather than have identical provisions in the two statutes, it
would be preferable to place all of the exceptions to discharge in the Code itself,
avoiding the potential for inconsistency.
Alternative. The changes proposed by this section should be limited to (1)
requiring payment of postbankruptcy support payments as a condition of plan confirmation
and discharge, and (2) changing the dischargeability provision of the Social Security Act
to merely incorporate by reference, rather than restate, any applicable provision of the
Bankruptcy Code.
*§146 ("Nondischargeability of certain debts for alimony, maintenance, and
support") (see S. 1301, §327)
Changes. Current bankruptcy law makes a distinction between two types of awards
arising in cases of divorce and separation: support obligations—that is,
payments that are intended for the support of the debtor’s dependents—are always
nondischargeable, in both Chapter 7 and Chapter 13, pursuant to § 523(a)(5), regardless
of the manner in which the payments are described in a divorce or separation decree; on
the other hand, property settlements—that is, payments made to divide the
commonly owned assets of the parties to the divorce or separation, when these payments are
not intended as support—are nondischargeable only in Chapter 7 cases, pursuant to
§523(a)(15), and only if the relative financial positions of the parties make the payment
equitable (that is, where it would be more of a burden on the nondebtor spouse to be
deprived of the property settlement payment than it would be a burden on the debtor to
make the payment). Section 146 of H.R. 3150 would erase this distinction, making all
property settlements, as well as support payments, completely nondischargeable in Chapter
7 and Chapter 13, by including property settlements within the scope of §523(a)(5).
Impact. The proposal has the potential for requiring larger payments to
nondebtor spouses, but it would also create substantial unfairness to other creditors, and
further erode the superdischarge of Chapter 13.
Where a payment in a divorce or separation decree is not intended for support, the
nondebtor spouse who is entitled to the payment has no greater equitable claim than any
other creditor. Suppose that a debtor and the debtor’s former spouse jointly owned a
piece of investment property worth $50,000, which the debtor is allowed to keep in
exchange for a promise to pay $25,000 to the nondebtor spouse. At the same time, the
debtor is liable for negligently injuring a pedestrian in an auto accident, again owing
$25,000. There is no reason why the claim of the nondebtor spouse should be accorded any
greater right to payment in bankruptcy than the claim of the pedestrian. Only if the
property settlement is needed for support is the greater right to payment appropriate, but
current bankruptcy law recognizes the nondischargeability of nominal property settlements
actually needed for support.
Moreover, as discussed in connection with §151, below, the priority accorded support
obligations under H.R. 3150, is a continuation of present law—limited to actual
support, not including property settlements. Thus, it is quite possible that a Chapter 13
debtor would be precluded from paying property settlements in a Chapter 13 case at a
higher rate than other unsecured, nonpriority debt, pursuant to the unfair discrimination
provision of §1322(b)(1). See McCullough v. Brown, 162 B.R. 506 (N.D.Ill.
1993). This would result in a Chapter 13 debtor completing the plan and still owing
substantial amounts in nondischargeable property settlement obligations.
The impact of making genuine property settlements completely nondischargeable in
Chapter 13 is thus, once again, to provide a strong incentive for debtors to choose
Chapter 7 over Chapter 13, and, in this way, reduce the overall payments made to
creditors, and increase the likelihood of litigation over the debtor’s eligibility
for Chapter 7.
*§147 ("Other exceptions to discharge") (see S. 1301, §327)
Changes. Section 147 would eliminate from the Code current § 523(a)(15), which
deals with property settlements in divorce and separation proceedings. This elimination is
consistent with the placement of property settlements in §523(a)(5), as provided in §146
of H.R. 3150, discussed above.
One other change is made in § 147 of H.R. 3150—an expansion of the exception from
discharge set out in §523(a)(7). Currently, this exception applies to debts for "a
fine, penalty, or forfeiture" payable to a governmental entity, and not as
compensation for actual loss. This list would be supplemented by adding "an order of
disgorgement or restitution obtained by a governmental unit" to the other categories
of awards.
Impact. The impact of the proposed change in the dischargeability of property
settlements is discussed above, in connection with §146.
The proposed change to §523(a)(7) is somewhat problematic. Section 523(a)(7)
distinguishes between situations in which a governmental entity receives an award from the
debtor that is basically punitive—a fine or penalty for some misconduct—from
situations in which there is an award of compensation. To the extent that a governmental
body is simply owed money by a debtor (for example, the debt resulting from a
contractor’s negligent construction work), there is no reason why the debt should be
treated differently than debts owing to other creditors. "Disgorgement " and,
more particularly, "restitution" may imply some sort of compensation, and, to
that extent, should not be included in §523(a)(7). However, the proposed language retains
the limitation presently included in § 523(a)(7) that the debt in question must not be
"compensation for actual pecuniary loss." Accordingly, with the change limited
to noncompensatory "disgorgement" and "restitution" awards, the
proposal would be an appropriate extension of the present law.
*§148 ("Fees arising from certain ownership interests")
Changes. Section 523(a)(16) provides for the nondischargeability of certain
debts arising from postbankruptcy condominium assessments and similar charges. Section 148
of H.R. 3150 would expand the scope of § 523(a)(16) by removing two of its limitations.
First, the section would no longer be restricted to dwelling units, but would also apply
to fees arising from shares in a cooperative corporation or a "lot in a homeowners
association." Second, fees would be nondischargeable not only for the postbankruptcy
periods in which the debtor or a renter occupied the property, but for any postpetition
period during which the debtor or trustee had any interest in the dwelling unit, corporate
share, or lot. Finally, §148 would amend §365 of the Code to provide that the debts made
nondischargeable under §523(a)(16) could not be considered executory contracts.
Impact. The impact of § 148 of H.R. 3150 is to increase the recovery of fees
that become due to condominiums, cooperatives, or similar membership associations after
the filing of a bankruptcy petition in Chapter 7. Current law limits the
nondischargeability of such fees to those incurred while a dwelling unit is occupied by
the debtor or a renter of the debtor, on the theory that the debtors should pay for the
use of the property that provides them with a benefit. The proposed change would create a
nondischargeable debt for all postbankruptcy fees incurred until the membership
association gained full control and ownership of the property involved, regardless of
whether it was occupied by the debtor or a renter of the debtor, and would assure that
payment of the postbankruptcy fees could not be limited by rejecting the contract giving
rise to the fees as an executory contract. The argument in favor of this change is that
membership associations incur costs (for insurance and maintenance) regardless of the
debtor’s use of the property, and that the debtor should be responsible for these
costs. On the other hand, mortgage holders also incur costs for insurance and maintenance
of property securing their claims in bankruptcy, but they are generally required to look
to the property to satisfy their costs. The current law is a compromise between the view
that condominium fees are a fully dischargeable prepetition debt (like personal liability
on a mortgage) and the position advanced by the current bill, which fully advances the
position of membership associations. To the extent that the associations are able to
assert claims against a debtor after discharge in Chapter 7, they will be competing with
other nondischargeable debt, including support obligations.
*§149 ("Protection of child support and alimony")
Changes. Section 149 of H.R. 3150 would add a new §529 to the Code, directing
the manner in which state law should provide for collection of debts that are excepted
from discharge in bankruptcy, and imposing obligations on the holders of certain
nondischargeable claims to transfer to others any funds that they collect on account of
these claims. The section appears to contain a drafting error. The specific changes are as
follows:
(1) Priority claims for support, as defined by current law, would be given a priority
in state collection proceedings over claims that were excepted from a debtor’s
discharge under paragraphs (2), (4) or (19) of §523.
(2) This priority would not apply to security interests supporting the creditor’s
nondischargeable claim unless the interest arose after the date of the filing of the
petition.
(3) If, despite the required priority of state collection proceedings, a creditor
holding a claim excepted from discharge under paragraphs (2), (4), or (19) nevertheless
receives some payment on account of its claim prior to payment of the debtor’s
outstanding support obligations, the creditor must "not later than 20 days after
receiving such payment . . . distribute such payment . . . ratably to individuals who then
hold debts [for support] entitled to priority." [Note: there is an apparent drafting
error in the text at this point, referring to § 523(a)(14) instead of (19). It is
presumably the new nondischargeability provisions of §523(a)(19)—discussed in
connection with §141, above—that this section intends to subordinate to support
obligations, rather than the existing provisions of §523(a)(14).]
(4) In an apparent contradiction of the twenty day limit previously stated, the new
section would also provide that "[n]ot later than 2 years after receiving such
payment. . . such creditor shall make the distribution required by this section to all
individuals whose identity is known to such creditor at the time of the
distribution."
Impact. This new section is likely to be ineffective in assuring collection of
support obligations prior to other nondischargeable debt following a debtor’s
discharge, for several reasons.
First, only formal state collection proceedings would be regulated. Informal collection
procedures—such as letters and telephone calls from collection agencies—would
not be regulated, and can be expected to continue.
Second, even in formal state collection proceedings only certain types of
nondischargeable debt would be subordinated to a debtor’s support obligations. Tax
liabilities (§523(a)(1)), debts arising from failure to provide notice (§523(a)(3)(B)),
debts from willful and malicious injury (§523(a)(6)), student loan debts (§523(a)(8)),
and the expanded set of debts arising from condominium ownership (§523(a)(16), see §148,
above), would all be allowed to have whatever priority of collection a state wished to
accord them, and if creditors holding these claims obtained payment through informal
means, they would have no obligation under the new section to transfer that payment to
support claimants.
Third, even those creditors who would be bound by the new section might be able to
receive payment ahead of support claimants, as long as the support claimants were not owed
money at the time of the payment to the creditor, although the statute is ambiguous on
this point. An alternative reading might be that the creditor would be required to turn
over any funds collected from the debtor, for a period of up to two years after the
collection, to support claimants who, at any point during that two year period, were owed
support payments from the debtor. But even under this reading, the support claimants would
(1) have to discover the payment to the creditor on account of the nondischargeable debt
(and distinguish it from payments on debts incurred after the discharge), (2) be aware of
the right that would be accorded by the new law, (3) make demand upon the creditor
obligated to turn over the collected proceeds, and (4) pursue the creditor in state
court—with no right to collect fees in the event of a successful recovery. Few
support claimants can be expected to engage in this process.
. *§150 ("Adequate protection for investors")
Changes. This section would modify the provisions of the automatic stay to allow
for regulatory activity by self-regulatory bodies of stock exchanges to continue after the
commencement of a bankruptcy case. This section would have no application in consumer
cases, and would generally apply in the bankruptcies of members of stock exchanges whose
activities were under investigation.
*§151 ("Higher priority for debts for alimony, maintenance, and support")
Changes. This section would merely renumber the existing provision for priority
of support obligations from §507(a)(7) to §507(a)(3). The actual change in priority
effected by H.R. 3150 is set forth in §145, discussed above. That change—to first
priority—could have been accomplished with no change in numbering, making §151
unnecessary.
Subtitle E ("Adequate Protections for Lessors")
§161 ("Giving debtors the ability to keep leased personal property by
assumption")
Changes. This section would make two principal changes to the Bankruptcy Code.
First, it would remove from the estate (i.e., abandon) all leased personal property as to
which the lease is not assumed. In Chapter 7, this abandonment would occur when the lease
is rejected by the trustee (which occurs automatically, under existing law, if the trustee
does not assume the lease within 60 days of the filing of a voluntary case). [Note: the
section states that "the leased property is no longer property of the estate and the
stay under section 362(a) of this title is automatically terminated." This language
is redundant, since § 362(c)(1) already provides that the stay terminates as to property
of the estate when the property is no longer property of the estate. By including the
extra language terminating the stay, this provision might lead to confusion, for example,
the erroneous belief that the stay was terminated as to personal actions against the
debtor arising out of the lease.] In Chapters 11 and 13, the rejection and abandonment
would occur if the lease was not assumed in the plan, and in Chapter 13 the codebtor stay
would terminate.
The second effect of the section is to permit the equivalent of reaffirmations with
respect to leased property through assumption of the leases, and to eliminate the
automatic stay as it would apply to discussions regarding such assumptions. Under the
procedure set out by the section, the debtor would have to initiate discussions regarding
assumption of a lease through a written notification.
Impact. The provisions regarding abandonment of leased property make explicit
the implication that leased property as to which the lease is rejected is no longer part
of the bankruptcy estate.
The provisions regarding assumption of leases by the debtor in Chapter 7 may require
additional safeguards. Reaffirmations of debt have been a sensitive subject under the
Bankruptcy Code, since they involve debtors repaying debts that otherwise would be
discharged. To prevent overreaching by creditors in this regard, the Code presently
contains a number of safeguards applicable to reaffirmation, including information that
must be given to the debtor, determinations by debtor’s counsel that the
reaffirmation is in the debtor’s best interest, and court authorization of
reaffirmations for unrepresented debtors. Unless similar protections were enacted in
connection with assumed leases (with cure of past due indebtedness), creditor overreaching
could be a similar problem.
§162 ("Adequate protection of lessors and purchase money secured
lenders") (see S. 1301, §319)
Changes. This section of the proposed bill would create a new provision in
Chapter 13, requiring payments to secured creditors and lessors of personal property.
These payments would be in the amounts and frequency specified by the applicable contract
unless the debtor sought a court order reducing the amounts and frequency. However, the
court would be required to order payments no less than monthly in an amount no less than
the depreciation of the property involved. These payments would be required to continue
until the creditor began receiving "actual payments" under the Chapter 13 plan.
The section would also clarify the right of creditors to retain possession of the
debtor’s property, if it was properly obtained before the bankruptcy was filed, until
the creditor receives the first adequate protection payment required by the section.
Finally, the section requires that debtors in Chapter 13 must provide proof of
insurance of leased property and collateral within 60 days of the filing of the
bankruptcy.
Impact. Secured creditors are entitled to seek adequate protection, pending plan
confirmation, under existing law, and are entitled to relief from the automatic stay if
adequate protection is not provided. This provision would give secured creditors a
presumptive right to more than adequate protection payments, because the underlying
contract (for example, a mortgage or an auto note or lease) generally provides for
payments at a level greater than necessary to offset depreciation. The debtor would be
required to present a motion to reduce the presumptive payments to the actual level of
depreciation (if any). That will involve significant additional cost in most Chapter 13
cases.
Under existing law, it may be unclear whether a creditor in rightful possession of a
debtor’s property at the outset of a bankruptcy case must return the property in the
absence of adequate protection. The proposal would make it clear that adequate protection
is required.
The requirement for periodic proof of insurance is an unnecessary burden on debtors,
since creditors are generally informed by insurers as to any lapse in coverage. Moreover,
if the creditor does not receive this information, the creditor would have to take action
to ascertain the status of the insurance within the first 60 days of the bankruptcy case.
Proof of insurance by the debtor at the conclusion of the 60-day period would add no
protection to the creditor.
§163 ("Adequate Protection for Lessors") (see S. 1301, § 409)
Changes. Despite its caption, this section deals with an exception to the
automatic stay. Under current law, lessors of nonresidential real estate (for example,
shopping center lessors) may proceed with eviction proceedings after the lessee files a
bankruptcy case, without violating the automatic stay, once the lease has terminated by
expiration of its stated term. Section 163 of H.R. 3150 would expand the exception to
cover all rented real estate. Thus, landlords would be allowed to evict Chapter 13 debtors
from their apartments, without obtaining relief from the automatic stay, as soon as the
leases terminate.
Impact. There is no reason for the automatic stay to apply to an residential
lease that has genuinely expired according to its stated term. A lease can only be assumed
by a debtor in Chapter 13 if it is unexpired, pursuant to §§ 365(a) and 1322(b)(7).
However, a debtor and landlord may well be in dispute about whether a lease has expired.
Many leases have automatic renewal terms, contingent on notice being given or the lease
not being in default. If there is a dispute about lease expiration, then, under current
law, the landlord would be required to obtain relief from the automatic stay before going
forward with an eviction proceeding in state court. See, e.g., Robinson v.
Chicago Housing Authority, 54 F.3d 316 (7th Cir. 1995) (affirming an order granting
relief from the stay to pursue eviction). Under the proposed change, the landlord, in the
event of such a dispute, would be able to go forward with the eviction, requiring the
Chapter 13 debtor—believing that the lease was still in effect—both to defend
the eviction proceeding and to bring a proceeding in bankruptcy court to have the landlord
found in violation of the automatic stay. If the debtor prevailed, fees and costs would be
awarded, pursuant to §362(h), but the problem for the debtor is in obtaining the funds to
pursue proceedings in both courts. Although this situation may not arise frequently, it
may be preferable to continue to require that evictions in situations of residential
leases be subject to the automatic stay.
On the other hand, the proposed exception could be applied in Chapter 7 cases without
harm to the rights of the debtor, since Chapter 7 debtors have no right to assume
defaulted leases.
Alternative. The expanded exception could be applied in Chapter 7 cases only.
Subtitle F ("Bankruptcy Relief Less Frequently Available for Repeat
Filers")
§171 ("Extended period between bankruptcy discharge")
Changes. Current law allows a Chapter 7 discharge to be entered only once in six
years. The proposal would change this to a 10 year interval. Current law imposes no limit
on Chapter 13 discharges, although the discharge can only be entered at the completion of
a plan, and most plans require a three to five year period to complete under current law.
The proposal would require that a Chapter 13 discharge not be granted if the debtor
received any bankruptcy discharge within the five-year period prior to filing the Chapter
13 case.
Impact. These proposals would render large numbers of debtors unable to obtain
any bankruptcy relief for an extended period of time, and would substantially reduce the
incentives for using Chapter 13.
It is entirely possible for individuals to require bankruptcy relief on more than one
occasion within a span of a few years. Job loss, medical problems, and divorce can each
cause financial difficulties that an individual cannot overcome. Under current law, the
individual can obtain a Chapter 7 discharge to address these problems only once in six
years, but could submit to a Chapter 13 repayment plan and obtain relief within the six
year period. The availability of such a discharge is one of the major incentives for the
use of Chapter 13. That possibility is removed under present law, leaving the individual
with no means of requiring creditors to accept pro rata payment of the debtor’s
available funds. The result would be the "race to the courthouse" that
bankruptcy was intended to avoid, with the more aggressive creditors getting the larger
share of wage garnishments and judgment lien foreclosures. The incentive for creditors to
cooperate with consumer counseling services in these situations would also be greatly
reduced, since the debtor would not have the option of bankruptcy in the event of
noncooperation, and other noncooperating creditors will have an advantage over those who
did cooperate.
Alternative. The required period between Chapter 7 discharges could be extended
without imposing limits on Chapter 13 discharges.
Subtitle G ("Exemptions")
*§181 ("Exemptions")
Changes. This section impacts the perceived problem of debtors changing their
residence in order to obtain more favorable homestead exemptions. Current law applies the
homestead exemption law of the place where the debtor’s domicile was located for the
"longer portion" of the 180 days preceding the bankruptcy. Thus, a debtor could
obtain a homestead exemption by establishing a domicile in a new state 91 days prior to
filing a bankruptcy. The change would increase the 180 day period to 365 days, and remove
the provision regarding the "longer portion."
Impact. The problem dealt with by this section is a minor one—only a few,
wealthy debtors are likely to change state of domicile in order to obtain larger
exemptions. Nevertheless, it is ironic that the impact of the new section may be to
encourage changes of domicile to obtain larger exemptions. Under the proposed law, if a
debtor changes his or her state of domicile during the year before the bankruptcy filing,
no state would have been the debtor’s domicile for that 365-day period, and hence,
apparently, the debtor would be required to use the federal exemptions. Since federal
exemptions are higher than those of many states, and since a change of domicile only
shortly before the bankruptcy would be effective to avoid state exemption law, debtors in
low-exemption states would be encouraged to move to a neighboring state just prior to
filing bankruptcy, so as to obtain the higher federal exemptions.
Alternative. The fundamental issue regarding exemptions is whether they should
be more uniform, so that debtors do not receive significantly differing treatment in
bankruptcy depending on their state of domicile. Greater uniformity would reduce the
incentive for debtors to change domicile before filing bankruptcy petitions, and such a
change in exemption law has been proposed by the National Bankruptcy Review Commission.
Final Report at 117-44. H.R. 2500 proposes a new commission to study the question.
*§182 ("Limitation")
Changes. This section addresses another potential abuse of exemptions—the
conversion of nonexempt property to exempt property prior to filing bankruptcy. The
section provides, in effect, that if the debtor uses the proceeds of any disposition of
nonexempt property to obtain value in an exempt residence or burial plot, within one year
of the bankruptcy, then that portion of the value of the residence or burial plot
attributable to the disposition of the nonexempt property may not be exempted. This
limitation on the value of residence and burial plot exemptions is only made applicable to
state exemption law, not to the federal exemptions.
Impact. This section would likely affect only those ignorant of its terms, and
may have a negative effect in undoing conversions of nonexempt property into exempt
property. Debtors who wish to engage in such conversions will not likely be deterred by
the new section, because of the many forms of exempt property that are not affected,
including insurance policies, and, most significantly, the unlimited exemption for
retirement accounts created by §119, discussed above. On the other hand, debtors ignorant
of this provision might engage in home improvements in complete good faith, and have the
value of the improvements deducted from their homestead exemptions. Finally, by specifying
limited circumstances in which conversions from nonexempt to exempt property will be
disallowed, this section may imply that all other such conversions are permissible.
Alternative. If the issue is to be addressed, there should be a generally
applicable rule distinguishing permissible from impermissible "bankruptcy
planning." Such a rule might be based on activity outside the debtor’s usual
practice (such as a large, lump sum contribution to a retirement account) within a year of
the bankruptcy filing.
Title II ("Business Bankruptcy Provisions")
Title III ("Municipal Bankruptcy Provisions")
These titles do not involve consumer bankruptcy issues and are therefore not treated in
this analysis.
Title IV ("Bankruptcy Administration")
Subtitle A ("General Provisions")
§401 ("Adequate preparation time for creditors before the first meeting of
creditors in individual cases")
Changes. This section would amend the Bankruptcy Code to provide that first
meetings of creditors must take place between 60 and 90 days after the filing of voluntary
individual bankruptcy cases, unless the court orders an earlier meeting.
Impact. Under current law, set out in Fed.R.Bankr.P. 2003(a), the first meeting
of creditors must take place between 20 and 40 days after case filing in voluntary Chapter
7 and 11 cases, and between 20 and 50 days in a Chapter 13 case. The proposal would delay
these times by more than a month. This may allow greater creditor involvement in consumer
bankruptcy cases, but it would have the drawback, particularly in Chapter 13 cases, of
delaying payouts to creditors.
§402 ("Creditor representation at first meeting of creditors") (see S.
1301, §308)
Changes. This provision would allow nonattorneys to represent creditors at
creditor meetings.
Impact. This proposal would have the potential for increasing creditor
involvement in any jurisdictions where appearances by nonattorneys are currently
prohibited.
§403 ("Filing proofs of claim")
Changes. This section changes the law that currently requires the filing of a
proof of claim in order for a creditor to share in the distribution of payments in Chapter
7 and 13 cases. Under this provision, a proof of claim would be deemed filed as to all
debts scheduled by the debtor as other than disputed, contingent, or unliquidated.
Impact. Frequently, consumer debtors have poor records of what they owe.
Accordingly, the debtors often schedule debts that either are not owed, or are owed in
smaller amounts than scheduled. The requirement of a proof of claim by the creditor
assures that an actual debt is paid in an appropriate amount. Treating all scheduled debts
as proofs of claim may result in overpayments of claims, or payment of claims that are not
owing, reducing the payments to creditors with actual, accurate claims.
The requirements for filing proofs of claims, as well as the results of untimely
filing, were extensively treated in the 1994 Bankruptcy Reform Act. This provision would
undo what has only recently become settled law.
*§404 ("Audit procedures") (see S. 1301, §307)
Changes. This section of the proposed bill would establish a system for random
audits of the accuracy and completeness of schedules and other information required to be
provided by debtors in bankruptcy. The proposal would require that at least 1% of all
cases be audited "in accordance with generally accepted auditing standards . . . by
independent certified public accountants or independent licensed public accountants."
The proposal requires the Attorney General to establish procedures for fully funding the
audits, but does not specify a source of funding. The report of each audit is to be filed
with the court, the Attorney General, and the United States Attorney, and if the audit
report discloses any material misstatement of income, expenses, or assets, notice of the
misstatement is required to be given to creditors and to the United States Attorney for
possible criminal investigation. [Note: the sentence of the proposal dealing with material
misstatements requires rewriting to correct syntactical errors.]
Impact. This proposal reflects a recommendation of the National Bankruptcy
Review Commission (Final Report at 107-110), and would provide an incentive for debtors
and their counsel to provide accurate and complete information. However, formal audits by
licensed accountants would also generate substantial costs. With bankruptcy filings
exceeding 1 million per annum, an audit cost of only $500 per case would impose an
additional cost of at least $5 million per annum; at $1000 per case, a more likely figure
given the poor record-keeping of many consumer debtors, the 1.4 million bankruptcies filed
last year would generate an audit cost of $14 million. Since the proposal does not
identify a source for funding the audits, the impact of the cost is uncertain. If the cost
were treated as an administrative expense, creditors would pay for the audits in the form
of reduced payments on their claims. A fairer way to pay for audits would be through the
fees currently collected from debtors (at the time of filing) and creditors (seeking
relief from the automatic stay), but in order to allow payment from these current fees,
the cost of the audits would have to be restrained.
Additionally, the requirement that audit reports be filed will impose additional costs
for document retention on clerk’s offices, and, depending on the detail of the
reports, involve unnecessary intrusions on the debtors’ privacy.
Alternative. In order to reduce costs, audits could be conducted by trained
employees of the United States trustees, rather than by licensed accountants, according to
regulations established by the Executive Office of the United States Trustee, rather than
generally accepted auditing standards. With costs controlled, the source of funding for
the audits can be specified as the existing fees collected in bankruptcy cases, without an
increase in those fees.
§405 ("Giving creditors fair notice in Chapter 7 and 13 cases") (see S.
1301, §309)
Changes. The primary change made by this section is a requirement that creditors
be given notice of a bankruptcy filing at their preferred addresses. Under current law,
creditors who actually receive notice of a bankruptcy case may be liable for sanctions for
willful violation of the automatic stay if they thereafter take action to enforce their
rights against collateral or otherwise attempt to collect a debt owed by the debtor. This
provision would eliminate sanctions for violation of the stay (or failure to turn over
property of the estate) in situations where notice of the bankruptcy was sent to an
address of a creditor other than the last address the creditor provided to the debtor for
correspondence regarding the debtor’s account. This elimination of liability would
only apply if (1) the creditor had a designated person or department for receiving
bankruptcy notices, (2) the creditor had a reasonable procedure for directing bankruptcy
notices to that person or department, and (3) despite the reasonable procedures, the
creditor’s designated person or department did not receive the notice in time to
prevent the collection activity from taking place.
Impact. This proposal would eliminate sanctions for violation of the automatic
stay in situations where notice of a bankruptcy was received by personnel of the creditor
who were unable to prevent subsequent collection action. However, it would also greatly
complicate litigation regarding violations of the automatic stay. If a creditor took
collection action after the bankruptcy case was filed, there would be questions subject to
litigation concerning (1) the last address specified by the creditor in a communication,
(2) whether the creditor had reasonable procedures in place for directing the
communication to a particular person or department, and (3) whether that person or
department received the notice in time to prevent the collection activity from taking
place. Most of the information relating to these matters would be exclusively in the
possession of the creditor, making it difficult for debtor’s counsel to determine
whether an intentional violation of the automatic stay had occurred without substantial
discovery. Lacking the resources to pursue such discovery, debtors might be unableo pursue
enforcement action.
§406 ("Debtor to provide tax returns and other information") (see S.
1301, §301)
Changes. This section would add several items to the information that individual
Chapter 7 and 13 debtors are required to provide in connection with a bankruptcy case,
unless ordered otherwise by the court. These items include (but are not limited to) the
following: (1) copies of any federal tax returns, including schedules and attachments,
filed by the debtor during the three years prior to the bankruptcy filing; (2) copies of
any tax returns and schedules filed during the pendency of the bankruptcy case, either for
current tax years, or for the three years preceding the bankrutpcy filing; (3) any
amendments of the returns set out above; (4) evidence of payments made by any employer of
the debtor during the 60 days prior to the filing of the case; and (5) a certificate
regarding the debtor’s receipt of the proposed required notice regarding consumer
counseling services. In addition, a Chapter 13 debtor would be required to file annually a
statement of the debtor’s income and expenditures in the preceding year and the
debtor’s monthly net income during that year, showing the method of calculation,
disclosing the amount and sources of income, the identity of the persons responsible with
the debtor for the support of any dependents, and any persons who contributed (and the
amounts contributed) to the debtor’s household. Also, debtors would have the
obligation to provide copies of their petition, schedules, statement of affairs, and any
plan and plan amendments to any creditor on request of the creditor, and any copies of
such filings made subsequent to the request. Tax returns would be filed with the United
States trustee; the other information would be filed with the court. All of these filings,
including the tax returns and amendments, would be available to any party in interest for
inspection and copying, subject to court order.
Impact. This section has the potential for making information available to
trustees and creditors that may be significant in the administration of the debtor’s
case. However, Fed.R.Bankr.P. 2004 currently allows information regarding the
debtor’s financial condition—including tax returns—to be obtained, as
required, with disclosure limited to the parties who need the information, and with the
potential for court orders limiting further disclosure. The general disclosures required
by the changes proposed here would impose two significant burdens not part of current law:
(1) There would be a potentially difficult and expensive provision of information in
every case, regardless of the need for the information. Since debtors in financial
distress often fail to retain financial documentation, it is likely that they will not
have ready access to their tax returns for the three years preceding the bankruptcy, or to
their pay stubs for two months preceding bankruptcy. Similarly, during a bankruptcy,
debtors are likely to have difficulty maintaining detailed records regarding their
expenditures and sources of income.
(2) The changes would involve a significant intrusion into the privacy of the debtors.
Tax returns are not public documents, and are ordinarily disclosed in litigation only when
they are particularly relevant to a dispute, and only to the parties with a need to review
them. This provision would require debtors to make several years of their tax returns
available for review by any creditor, and the creditors would be free to make whatever use
they wished of the information contained in the returns, including compiling and
disseminating it. Both the difficulty and cost of assembling the required information and
the intrusion on privacy would act as substantial barriers to good faith bankruptcy
filings.
The requirement that debtors provide copies of petitions, schedules and plans to all
creditors on request may encourage routine requests for such documents by creditors who do
not require these documents for their participation in the bankruptcy case (current law
requires notice to creditors of the essential events in the case), imposing additional
expense on debtors and their counsel.
The provision that the required information need not be supplied if the court orders to
the contrary creates the potential for substantial variations in practice from court to
court. Some judges may determine that certain of the information (or all of it) is not
required unless requested by a creditor with cause; other judges may routinely deny any
request by debtors to limit the information. No standards are supplied.
Finally, the need to file all of the additional documents in each consumer case would
impose a substantial additional cost on the clerks’ offices and the offices of the
United States trustees.
§407 ("Dismissal for failure to file schedules timely or provide required
information") (see S. 1301, §312)
Changes. This section creates a new ground for dismissal of Chapter 7 and 11
cases—failure to provide the information required by §406. Failure to file initial
documents (including past tax returns and pay stubs) results in mandatory, automatic
dismissal on the 46th day after filing, subject only to a timely request by the debtor for
an extension of up to 15 days. The court is required to enter an order confirming the
dismissal if requested by any party. Failure to file (or supply to creditors on their
request) any subsequently required documents is also subject to mandatory dismissal, upon
request of any party in interest. The deadline for compliance with a creditor request is
to be set by the court within 10 days of the request, and may not exceed 30 days.
Impact. The difficulty of complying with the proposed initial disclosures (of
tax returns and pay stubs) is noted in the commentary on §406, above. Section 407 would
impose automatic dismissal as a penalty for failure to comply with these disclosure
requirements, without providing notice to the debtor of any deficiency in the filing.
Although the debtor is given an opportunity to seek an additional 15 days to comply, no
further extensions are authorized. Given that it may take more than 60 days to obtain
copies of tax returns from the Internal Revenue Service, these provisions may result in
unavoidable dismissal of cases filed in good faith. In connection with enforcing the
requirements for postpetition copies and tax information, the court is also given no
discretion. It must order the information produced and dismiss the case if the order is
not complied with. These provisions would discourage good faith filings at the outset, and
may result in dismissal of cases that are filed and prosecuted in good faith.
Rather than making debtors subject to such dismissal, some courts may generally order
that the documents need not be filed, but, as noted above, in the discussion of §406, no
standards are provided for orders of nonproduction, and practice among courts can be
expected to vary widely.
Alternative. The failure of a debtor to provide information ordered by a court
to be produced to a creditor in connection with an examination pursuant to Fed.R.Bankr.P.
2004 could be specified as a ground for dismissal of both Chapter 7 and Chapter 13 cases.
§408 ("Adequate time to prepare for hearing on confirmation of the plan")
(see S. 1301, §§304, 313)
Changes. This section provides that the hearing on confirmation of a Chapter 13
plan must take place no sooner than 20 days and no later than 45 days after the first
meeting of creditors.
Impact. Under Section 401 of H.R. 3150, discussed above, creditors’
meetings must be convened between 60 and 90 days after case filing. Section 408 requires
that the confirmation hearing take place between 20 and 45 days after the creditors’
meeting, thus placing confirmation between 80 and 135 days after case filing. Present law
(Fed.R.Bankr.P. 2003(a)) requires creditor meetings between 20 and 50 days after case
filing, with no defined waiting period for the confirmation hearing, and so permits
quicker confirmation of plans and payouts to creditors, but also allows much longer time
to elapse before confirmation. Although the different times provided for by the proposed
bill would delay plan confirmation in many cases, they do move toward uniformity.
Alternative. The more uniform time for confirmation hearings specified by this
section could be combined with the shorter time for creditor meetings currently specified
by Fed.R.Bankr.P. 2003(a).
*§409 ("Chapter 13 plans to have a 5-year duration in certain cases")
Changes. This section would increase the term of Chapter 13 plans from the
present range of three to five years to a new range of five to seven years, for all
debtors with total monthly income equal to at least the national median for their
household size or a smaller household. The proposal would retain the three-to-five year
range for those earning less than the applicable medians. In each situation, plans lasting
longer than the minimum plan term would require court approval. These provisions should be
read in conjunction with §102 of the proposed bill, discussed above, which requires that
all net income of the debtors be paid to general unsecured creditors for the minimum plan
term.
The section also amends §1329 of the Code, which governs modified plans. Although an
original plan is allowed, with court approval, to have a duration two years beyond the
minimum term, the amendment would prohibit this extension for modified plans.
Impact. Consistent with §102 of H.R. 3150, this section would have the effect
of lengthening the minimum Chapter 13 plan term from 3 to 5 years for many Chapter 13
debtors. This increase in minimum plan length may result in increased payments to
creditors, but only if the plans are completed. Increased plan length may discourage use
of Chapter 13 by debtors who have the choice of Chapter 7, and may decrease successful
plan completion by those who do choose Chapter 13.
Extending plans beyond the minimum term is sometimes in the debtor’s
interest—in order to cure large mortgage arrearages or retire nondischargeable debt.
There is no apparent reason why this extension should be prohibited in modified plans.
§410 ("Sense of the Congress regarding expansion of Rule 9011 of the Federal
Rules of Bankruptcy Procedure")
Changes. Fed.R.Bankr.P. 9011 is the bankruptcy analog to Rule 11 of the Federal
Rules of Civil Procedure. It requires the signature of the attorney (for a represented
party) or of the party (if unrepresented) on documents filed with the court, and provides
that this signature constitutes a certificate that the document is, among other things,
well grounded in fact—based on the signer’s knowledge, information, and belief,
formed after reasonable inquiry. Currently, Rule 9011 does not apply to schedules,
apparently with the understanding that debtor’s attorneys are not economically able
to independently verify the accuracy of the information supplied by their clients. This
section suggests that the Rule be modified to apply to all filings, specifically including
schedules.
Impact. Section 103 of H.R. 3150, discussed above, imposes by statute the change
suggested in this section for Fed.R.Bankr.P. 9011. This section, apart from suggesting an
investigatory obligation on pro se debtors, is therefore unnecessary. As discussed in
connection with §103, requiring independent verification by debtors’ attorneys of
all of the schedule information required of their clients would delay bankruptcy filings
and increase the cost of legal services, thus discouraging good faith filings. In light of
the auditing requirement proposed both by this bill and by the National Bankruptcy Review
Commission, it is questionable that attorney verification of schedules is needed to assure
accuracy.
§411 ("Jurisdiction of Courts of Appeals") (new)
Changes. Under present law, appeals of decisions of bankruptcy courts are heard
by the district courts or by Bankruptcy Appellate Panels, composed of bankruptcy judges.
This section would grant jurisdiction over such appeals to the Circuit Courts of Appeals.
Impact. The current system of appeals generates appellate decisions that are
largely without binding precedential impact. Decisions of the Courts of Appeals would be
binding on all courts within the circuit, promoting intercircuit uniformity. Direct
appeals would also eliminate one stage of adjudication in arriving at a decision from the
Courts of Appeal, thus reducing costs for litigants who would appeal to those courts in
any event.
*§412 ("Establishment of official forms") (new)
Changes. This section would require the Judicial Conference of the United States
to establish official forms to facilitate compliance with the means-testing and other
provisions of §§101 and 102, discussed above.
Impact. The Judicial Conference regularly promulgates Official Bankruptcy Forms
to reflect changes in law and technology, and hence a statutory directive is probably
unnecessary
*§413 ("Elimination of certain fees payable in Chapter 11 bankruptcy
cases")
Changes. Under current law, fees payable to the United States trustee are
assessed in Chapter 11 cases, based on the level of funds disbursed, until the case is
closed or converted. This section would reduce the time for fee payment by terminating
payments upon confirmation. The change would be effective on October 1, 1999.
Impact. The proposed change would reduce costs for Chapter 11 debtors and remove
an incentive to prematurely close Chapter 11 cases in order to save fees.
*§414 ("Study of bankruptcy impact of credit extended to dependent
students")
Changes. This section directs the Comptroller General to conduct a study and to
submit a report, within one year of the bill’s enactment, of the impact of credit
extension to dependent students in post-secondary educational institutions on the rate of
bankruptcy filings.
Impact. This study may have significance in determining the causes for the
increase in bankruptcy filings experienced over the past several years. Other empirical
studies, including an ABI-sponsored study on the extent of income available to pay
creditors in Chapter 7 cases, are currently in progress. The results of such studies would
be most helpful if they could be reviewed prior to the enactment of major bankruptcy
legislation.
Subtitle B ("Data Provisions")
§441 ("Improved bankruptcy statistics") (see S. 1301, §306)
Changes. This section would require the Director of the Executive Office for
United States Trustees to compile bankruptcy data in specified categories and require the
Administrative Office of the United States Courts to specify the form of the data and make
it public.
Impact. Although this provision would be costly to implement, it has the
potential for making useful information available to those interested in the functioning
of the bankruptcy system. The National Bankruptcy Review Commission (Final Report at
921-43) recommended that a similar program of data collection and reporting be
implemented. One potential problem in the proposed legislation is in its specification of
matters for data collection and reporting. The Review Commission suggested a pilot program
to develop effective programs, and this might be preferable to establishing categories for
data collection by legislation. As an example of the problem with legislative
specification, the proposal includes a requirement that data be collected and reported as
to "the number of [Chapter 13] cases in which a final order was entered determining
the value of property securing a claim less than the claim." Such a report would
likely yield little useful information, since in many situations of the cramdown of
secured claims the parties negotiate an appropriate bifurcation, with no court order
entered.
Alternative. It may be preferable to implement the Review Commission’s
recommendation of a pilot program to determine effective categories and methods of data
collection and reporting.
§442 ("Bankruptcy data") (see S. 1301, §306)
Changes. This proposal would require the Attorney General to issue regulations
for uniform reporting of bankruptcy cases on standard forms, designed to facilitate both
physical and electronic access to the information contained in the reports. Detailed
contents of the reports are specified.
Impact. A consistent reporting system would provide many benefits, and has been
recommended by the National Bankruptcy Review Commission as part of a national bankruptcy
filing system (Final Report at 105-07). As with the prior provision of the proposed bill,
there may be some difficulty with the details it sets out.
Alternative. It may be preferable to allow the details of any reporting system
to be developed by the office administering the system.
§443 ("Sense of the Congress regarding availability of bankruptcy data")
Changes. This proposal effectively recommends that Congress establish a national
bankruptcy filing system.
Impact. A nationwide reporting system would provide many benefits, and has been
recommended by the National Bankruptcy Review Commission (Final Report at 105-07).
Title V ("Tax Provisions")
Most of the sections of Title V do not involve consumer bankruptcy issues and are
therefore not treated in this analysis.
*§502 ("Enforcement of child and spousal support") (see S. 1301, §328)
Changes. This section adds additional language to §522(c)(1) of the Code to
confirm the rule in In re Davis, 105 F.3d 1017, 1022 (5th Cir.1997) (allowing
enforcement of child support against property exempt under state law).
Impact. The proposed language should serve to clarify the meaning of the
statutory provision.
§503 ("Effective notice to government")
Changes. This section specifies that all notices from a debtor to a governmental
agency (as well as the original scheduling of the agency as a creditor) contain detailed
information regarding the nature of the agency and its claim. For example, a real estate
tax claim is required to be identified by real estate parcel number. The clerk of court is
required to maintain a register of "safe harbor" mailing addresses that may be
used by debtors. The Advisory Committee on Bankruptcy Rules of the Judicial Conference is
required to propose "enhanced rules" for providing notice to governmental
agencies, incorporating the provisions set out earlier in the section. Notices not in
compliance with the proposed requirements would have no effect unless, among other things,
the debtor showed either that notice was sent to the safe harbor address, or both that no
safe harbor address had been specified and that there was actual notice to a responsible
officer of the appropriate agency. In particular, governmental violations of the automatic
stay and turnover provisions of the Code could not result in any sanction if notice of the
commencement of the case was not given in compliance with the requirements of the section.
Impact. The provision would provide surer notice to governmental agencies. Some
of the detail required, however, may unnecessarily increase the cost of case filing, and
litigation can be anticipated on issues of whether notices were in compliance with the
requirements. See the discussion in connection with §405, above.
§508 ("Chapter 13 discharge of fraudulent and other taxes")
Changes. This section would make the tax obligations that are defined by
§523(a)(1) of the Code nondischargeable in Chapter 13 cases as well as in Chapter 7
cases.
Impact. Together with §143, this section of H.R. 3150 has the effect of largely
eliminating the superdischarge of Chapter 13. See the discussion of this issue in
connection with §143, above.
§517 ("Requirement to file tax returns to confirm Chapter 13 plans")
Changes. This section would impose on Chapter 13 debtors the obligation to file
both past due and current tax returns, as a condition for confirmation. Deadlines are
specified for the filing of the returns (at least 120 days from the filing of the
bankruptcy case), and failure to comply is specified as a ground for conversion or
dismissal of the case. The taxing body is given 60 days after the filing of a return to
submit a timely claim for the tax involved in the return. Finally, it is suggested that
the Federal Rules of Bankruptcy Procedure be amended to allow objections to confirmation
to be made by a taxing body "on or before 60 days after" the debtor files all of
the required tax returns.
Impact. These provisions are largely reasonable, and will assist the debtor and
the taxing bodies in resolving past due tax obligations. However, the suggested change in
the bankruptcy rules further complicates the issue of when a confirmation hearing is
supposed to take place under the provisions of H.R. 3150. See the discussion in connection
with §408, above. In order to allow the suggested objection based on the filing of a tax
return 120 days after the bankruptcy filing, confirmation hearings would have to be
scheduled 180 days after the filing of the case, rather than the maximum of 135 days
specified by §408.
Title VI ("Miscellaneous")
This title does not involve consumer bankruptcy issues and is therefore not treated in
this analysis.
To amend title 11 of the United States Code, and for other purposes.
Analysis of Tax Proposals in H.R. 3150
Testimony before the House Judiciary Committee
March 18, 1998
Written by:
Grant W. Newton
Chair, ABI Bankruptcy Taxation Committee
Web prepared, posted and
Copyright © March 18,
1998, American Bankruptcy Institute.
H.R. 3150 contains several tax proposals that involve
modifications of the Bankruptcy Code. Most of the proposals were
recommendations made by the National Bankruptcy Review Commission
("NBRC"). However, several of the proposals contradict the
recommendations of both the NBRC and the Tax Advisory Committee
appointed by the Chairman of the NBRC. The objective of this analysis
is to explain the tax provisions that are in H.R. 3150 and identify
some of the issues that need to be addressed before these provisions
become law. H.R. 3150 contains no recommended changes to the Internal
Revenue Code because these provisions must originate in the House
Ways and Means Committee rather than the Judiciary Committee to which
H.R. 3150 has been referred. The proposed changes recommended by the
NBRC to the Bankruptcy Code that were not addressed by H.R. 3150 are
described in the final section.
The views expressed here are my own and not necessarily those of
the American Bankruptcy Institute.
Listed below is a summary of the recommended changes to H.R. 3150.
|
Section and Topic |
|
|
Sec. 501(a)(1). Exempting ad valorem tax from |
No change recommended. |
|
Sec. 501(a)(2). Subordination of tax liens to chapter 7 |
Delete this provision. It will limit the recovery of |
|
Sec. 501(a)(3). Trustee exhaust unencumbered assets, |
No change recommended. |
|
Sec. 501(b). Precludes determination of taxes where |
Modify to provide that bankruptcy court can determine the |
|
Sec. 502. Section 522(c)(1) is modified to provide that |
The meaning of this section is not clear. Since the |
|
Sec. 503. Provides for effective notice to Governmental |
Modify to provide that Rules Committee issues notice |
|
Sec. 504. Requires proper notice before taxes determined |
No change recommended. |
|
Sec. 505. Provides for use of the interest rate in IRS |
Modify to provided that it is the rate without reference |
|
Sec 506. (1) Provides for tolling of priority of tax |
Agree with general provision, but suggest that to be |
|
(2) Extends the tolling to installment agreements. |
Delete this provision. During the time period prior to or |
|
Sec. 507. Assessment defined. |
No change recommended. |
|
Sec. 508. Section 1328 would be modified to make chapter |
Delete this provision. Chapter 13 facilitates the workout |
|
Sec. 509. Section 1141(d) the confirmation of a plan does |
Delete this provision. Management of the company that was |
|
Sec. 510. (1) The stay under section 362(a)(8) would be |
Modify provision to apply to only prepetition taxes. |
|
(2) Provides that the stay does not apply to the appeal |
No change recommended. |
|
Sec. 511. (1) Establishes required payments of at least |
Modify to follow the recommendation of the NBRC and the |
|
(2) Require secured claims to follow requirements of |
No change recommended provided above suggestion is |
|
Sec. 512. Overrule cases that penalize the government due |
No comments on this proposed change. |
|
Sec. 513. Payment of postpetition taxes is required when |
No change recommended. However, the writer is concerned |
|
Sec. 514 Provides that taxing authority must file a claim |
No change recommended. |
|
Sec. 515. Modifies section 523(a)(1)(B) to include tax |
Delete last section of proposed law and follow both NBRC |
|
Sec. 516. Includes the word "estate" for purposes of tax |
No change recommended. However, section 505(b) should |
|
Sec. 517. Requires tax returns for six years in chapter |
Modify to provide that a return filed under IRC section |
|
Sec. 518. Requires tax disclosure. |
No change recommended. |
|
Sec. 519. Setoff of tax liability against tax refund. |
No comments on this proposal. |
Section 724 of the Bankruptcy Code provides for the subordination
of tax liens to administrative expenses and other priority taxes.
H.R. 3150 would modify the subordination provision by not
subordinating perfected, unavoidable tax lien arising in connection
with an ad valorem tax on real or personal property, as recommended
by the NBRC. Additionally, administrative expense incurred after the
petition is filed is restricted to chapter 7 expenses unless the
claim is for wages, salaries or commissions. The subordination only
to chapter 7 expenses was not included in the recommendation of the
NBRC.
H.R. 3150, as recommended by the NBRC, would also add a subsection
(e) to section 724, providing that before a tax lien may be
subordinated, the trustee shall (1) exhaust the unencumbered assets
of the estate, and (2) in a manner consistent with section 506(c)
recover from property securing an allowed secured claim the
reasonable, necessary costs and expenses of preserving or disposing
of that property.
Subsection (f) provides that notwithstanding the exclusion of ad
valorem tax liens claims for wages, salaries, and commissions that
are entitled to a section 507(a)(3) priority and claims for
contributions to an employee benefit plan entitled to a 507(a)(4)
priority may be paid from property of the estate which secures a tax
lien, or the proceeds of such property.
Comment: The proposals to not subordinate property taxes,
to use unencumbered assets, and to subordinate property tax claims to
wage holders, appears fair.
However, the provision to limit the subordination to chapter 7
expenses will limit the recovery of assets for unsecured creditors. A
trustee appointed in a chapter 11 case, where there is a tax lien on
all assets, has no incentive to go after known or potential
recoveries because any costs that are incurred will not be allowed
unless the tax claims are paid in full. Trustees are often better
equipped to recover assets than the taxing authorities. Removing the
incentive for the chapter 11 trustee may in fact result in less
recovery to both the taxing authorities and to other creditors.
Studies have shown that state and local governments have suffered
losses because of the subordination of ad valorem tax liens. However
that generalization should not be applied to the IRS and other state
income taxing authorities by not allowing the tax lien to be
subordinated to chapter 11 administrative expenses. Abuses have
occurred where administrative expenses have been in excess of what
they should have been, resulting in less return to taxing
authorities. In most cases, the U.S. trustee appoints chapter 7 and
11 trustees. The activities of trustees are monitored by the U.S.
trustees and their involvement should help control the actions of the
appointed trustee. No doubt a much greater abuse occurs when a
chapter 11 case with no prospects of successful reorganization is
allowed to continue until all of the free assets are consumed by
professionals and then the case is converted to chapter 7. The change
to section 724 that limits subordination to chapter 7 administrative
expenses does nothing to deal with this abuse, however.
H.R. 3150 modifies section 505(a)(2) to provide that the court may
not determine an ad valorem tax if the applicable period for
contesting or redetermining the amount under any law other than
bankruptcy law has expired. Some bankruptcy courts have redetermined
the tax because the bankruptcy court may determine all claims. The
NBRC did not recommend this change.
H.R. 3150 also provides that the debtor-in-possession or trustee
may request a determination of the tax at the time the tax return is
filed. Upon payment of the amount shown on the return, the trustee,
debtor, and any successor to the debtor is discharged unless the
governmental unit notifies the trustee or debtor-in-possession within
60 days that the return has been selected for examination and
completes the examination within180 days after the request was made.
Note that the wording in section 505(b) does not discharge the
estate. Courts have held that the IRS may assess additional taxes
against the estate but not against the trustee or debtor. Thus, even
though the estate received the letter stating that the taxes were
accepted as filed, additional taxes may be assessed against the
assets that remain in the estate. To correct this problem H.R. 3150
follows the recommendation of the NBRC and the Tax Advisory Committee
and proposes to amend section 505(b) of the Bankruptcy Code by
inserting "the estate."
Section 505(b) of the Bankruptcy Code would be amended by
providing that the request for tax determination must be made in the
manner designated by the governmental unit (see notice section
below). This was recommended by the NBRC.
Comment: By not allowing the bankruptcy court to determine
the ad valorem tax claim, the proposed change would allow a
governmental unit to collect a tax that is greater than the amount
allowed. If the tax were properly determined, the state will receive
its priority payment. For example, in one case where a chapter 11
trustee was appointed, the debtor allegedly borrowed millions of
dollars of debt under false pretense. The debtor did not file
business tax forms and the taxing unit determined the tax based on
values that were greater than the actual values of the assets. Under
this proposal, since the time for redetermining the tax expired, the
business tax would remain, even though all parties know the tax was
incorrectly calculated. Taxes already have a priority over all other
general unsecured claim holders and this change will allow the taxing
authority to collect or retain taxes for amounts that are greater
than the amount that should be allowed.
The inclusion of the "estate" in section 505(b) is a change that
is needed.
The modification to section 505(b) requiring notice be made
according to the manner designed by the governmental units seems
reasonable; however, the section should also be modified to provide
that a partnership and S corporation in bankruptcy and chapter 13
debtors are within the provisions of section 505(b). The IRS has
issued a policy statement stating that section 505(b) does not apply
to partnership and S corporations and has refused to apply section
505(b) to chapter 13 cases.
Section 522(c)(1) of title 11 is amended by inserting at the end
of the paragraph: "except that, notwithstanding any other Federal law
or State law relating to exempted property, exempt property shall be
liable for debts of a kind specified in section 523(a)(1) or (5) of
this title." This proposed change was not recommended by the NBRC.
Comment: The meaning of this section is not clear. Since
the impact this change will have is not known, it is difficult to
comment on the proposed change.
Effective Notice to Governmental Units (H.R. 3150, Section
503)
Section 342 of the Bankruptcy Code under H.R. 3150 would be
modified to establish standards for effective notice and provide
information about the taxpayer such as taxpayer identification
number, loan, account or contract number, or real estate parcel
number. H.R. 3150 also provides that the clerk shall keep and update
quarterly, in the form and manner as the Director of the
Administrative Office for the United States Courts prescribes, and
makes available to debtors, the register in which a governmental unit
may designate a safe harbor mailing address for service of notice in
bankruptcy cases.
H.R. 3150 directs the Advisory Committee on Bankruptcy Rules of
the Judicial Conference to adopt rules that provide notice to state,
federal and local governmental units that have regulatory authority
over the debtor and suggests selected items that should be included.
H.R. 3150 also provides that no sanction under section 362(h) of
the Bankruptcy Code or any other sanction that a court may impose on
account of violations of the stay under section 362(a) of this title
or failure to comply with section 542 or 543 of this title may be
imposed unless the action takes place after notice of the
commencement of the case has been received as required by section
342.
Comment: The NBRC adopted the Tax Advisory Committee's
recommendation that all issues affecting governmental unit notice be
in the form of proposed changes to the Bankruptcy Rules. H.R. 3150
codifies part of the notice provisions and includes the revision to
section 362(a) that was not part of the NBRC recommendations. This
provision is intended to somewhat codify for the benefit of taxing
authorities, In re Bloom, 875 F.2d 224 (9th Cir.
1989), which held that "the statute provides for damages upon a
finding that the defendant knew of the automatic stay and that the
defendant's actions which violated the stay were intentional."
Section 342(g) is troublesome in that it appears that this section
would require the debtor to notify a governmental entity of a
potential trust fund tax (100 percent penalty) even though the debtor
was not aware of the potential liability.
Taxing authorities need to be notified of bankruptcy filings;
however, the requirements for such notice including content, timing
of notice, sanctions for non-compliance, etc. should be covered by
the Rules Committee.
H R. 3150 would add a new section 511 to the Bankruptcy Code that
would provide for interest on claims existing before the order of
relief to be applied at the rate provided in section 6621(a)(2) of
the Internal Revenue Code of 1986. Section 6621(a)(2) provides that
the rate should be the federal-short-term rate determined under
subsection (b) plus 3 percentage points. Subsection (b) provides that
the Secretary shall determine the Federal short-term rate for the
first month in each calendar quarter. Subsection (c) provides that
the rate for large corporations should be increased by 2 percentage
points. It is assumed that subsection (c) would not apply.
Comment: The Bankruptcy Code does not specify the interest
rate that is to be used for tax claims that are entitled to interest.
Judicial consensus is that a market rate of interest should be used
and that the federal statutory rate is relevant in determining the
appropriate rate. To avoid the wasting of both judicial and debtor
resources by litigating the rate, the NBRC followed the
recommendation of the Tax Advisory Committee that the rate be fixed
at the statutory rate under section 6621(a)(2), without reference to
section 6621(c) and it should be the rate in effect as of the
confirmation date. H.R. 3150 ignores the comment of the NBRC that the
rate should not consider 6621(c) and that it should be set as of the
confirmation date of the plan. If the rate in section 6621(a)(2) is
allowed, it should be determined as of the confirmation date and
should not be allowed to fluctuate from quarter to quarter. Since all
other creditors generally must assume the risk of changes in the
market rate of interest, the same consideration should also apply to
the IRS. Regarding the rate under section 6621(c), since only the
rate in section 6621(a) is mentioned, it is not clear if the section
6621(c) rate would also apply. These changes are needed, if for no
other reason than to avoid the litigation necessary to clarify the
point.
The first changes would provide that the period of three years
before the filing of the petition under section 507(a)(8)(A)(i) would
be modified to provide for any time, plus 6 months, during which the
stay of proceedings was in effect under a prior case.
The second change would provide a revised section
507(a)(8)(A)(ii): "(ii) assessed within 240 days before the date of
the filing of the petition, exclusive of- (I) any time plus 30 days
during which an offer in compromise or installment agreement with
respect of such tax, was pending or in effect during such 240-day
period, and (II) any time plus 6 months during which a stay of
proceedings against collections was in effect in a prior case under
this title during such 240-day period."
Comment: The majority of courts (justifiably) have allowed
for tolling of priority time periods during prior bankruptcies
because the stay was in effect and the IRS was limited as to the type
of action it could take. This provision codifies the impact of the
tolling. The added time allows the IRS time to respond once the stay
has been removed. Thus, rather than extending the time period by six
months or 30 days (in case of an offer in compromise), the extension
should be the greater of any time during which the stay of
proceedings was in effect in a prior case (or offer in compromise
pending) or six months (or 30 days for an offer in compromise).
H.R. 3150 would extend the tolling to installment agreements.
During the time period prior to or at the time the IRS enters into an
installment agreement, the IRS has the right to place liens on the
debtor's property. Even during the installment period, the IRS may
reserve the right to place liens on the debtor's property and take
other actions to protect its interest. Some tax practitioners have
indicated that they will recommend a larger number of their clients
file bankruptcy rather than apply for an installment agreement if
this change goes into effect. This change penalizes those individuals
that in good faith extend the time period for payment of their
claims, and a major illness, loss of job or other unfortunate events
force them to file a bankruptcy petition. Prior years' taxes for this
individual would be a priority claim because of the tolling
provision, but if this individual had no interest in paying the taxes
and had not contacted the IRS to work out an installment payment
plan, the taxes may be discharged.
The IRS seeks this change because it has seen numerous cases where
a taxpayer entered into a minimal installment agreement to buy time
until the 240-day measuring period passed thereby making the tax
nondischargeable.
The NBRC stated in its report that the proposal for tolling during
the period of compromise did not extend to installment agreements.
There has been some conflict with state law as to the meaning of
the term "assessment." Section 101 of the Bankruptcy Code is amended
by inserting a definition for assessment: "(3) 'assessment'- (A) for
purposes of State and local taxes, means that action which is
sufficiently final so that thereafter a taxing authority may commence
an action to collect the tax, and (B) for Federal tax purposes has
the meaning given such term in the Internal Revenue Code of 1986; and
'assessed' and 'assessable' shall be interpreted in light of the
definition of assessment in this paragraph."
Comment: Assessment was defined in accordance with the
recommendations of the NBRC.
Section 1328(a)(2) of the Bankruptcy Code is amended by expanding
the dischargeability of taxes to cover those taxes that are
nondischargeable in chapter 7. Thus, the provisions for chapter 13
regarding tax discharge for fraudulent and unfiled tax returns under
this proposal would be equivalent to those in chapter 7.
Comment: In general, it can be argued that there should be
no difference between the dischargeability of taxes under chapter 7
and chapter 13. Chapter 13 facilitates the workout of tax claims and
is consistent with other provisions of H.R. 3150 that require
taxpayers to pay some of their claims over the plan period. Taxing
authorities collect substantial taxes because chapter 13 requires
that all priority taxes be paid during the plan period and it places
on the tax rolls individuals that have not paid taxes in several
years. On the other hand, in chapter 7, taxing authorities receive a
very small percent of the taxes due and probably less than would have
been received in chapter 13. This proposed change was debated by the
NBRC, but the Commission was unable to obtain enough votes to pass
the proposal. To assist the taxing authorities in determining the
tax, especially the priority taxes, the Tax Advisory Committee
recommended that tax returns for six years be filed as described
below. This author supported the six-year requirement on the
assumption that the discharge provisions in chapter 13 would not be
repealed.
Section 1141(d) of the Bankruptcy Code is amended by adding the
following provision: "(4) Notwithstanding the provisions of paragraph
(1), the confirmation of a plan does not discharge a debtor which is
a corporation from any debt for a tax or customs duty with respect to
which the debtor made a fraudulent return or willfully attempted in
any manner to evade or defeat such tax."
Comment: The NBRC recommended that section 1141(d) be
modified to deny a discharge to a corporation for which a fraudulent
return was filed. There is considerable opposition to this
recommendation on the basis that the management of the company that
was involved with the fraud is often replaced and a provision that
prohibits a nonpriority tax from being discharged limits the ability
of the creditors to reorganize the debtor. Because of the inability
to restructure the troubled business due to the inability to obtain a
discharge of nonpriority taxes, the Service may even collect less.
The Service should file criminal action against the corporate officer
that filed a fraudulent return, but the creditors should not be
punished because of the errors of prior management. It should,
however, be recognized that there is a significant difference between
what constitutes civil fraud and what constitutes criminal fraud.
The stay under section 362(a)(8) would be revised to apply only to
a tax liability for a taxable period ending before the order for
relief. H.R. 3150 would revise section 362(b)(9) to provide that the
stay does not apply to the appeal of a decision by a court or
administrative tribunal that determines a tax liability of the
debtor.
Comment: Although designed to apply to postpetition taxes,
the stay as restricted in section 362(a)(8) would also apply to some
prepetition taxes. For example, the Eight and Ninth Circuits, In
re L.J. O'Neill Shoe Co., 64 F. 3d 1146 (8th Cir.
1995) and In re Pac-Alt. Trading Co., 64 F.3d 1292
(9th Cir. 1995), have held that the taxes of a corporation
can be bifurcated into two parts&2151;the part prior to the
filing of the petition (a prepetition tax with eighth priority) and
the tax incurred after the filing (an administrative expense). This
change would allow the taxing authorities to collect the prepetition
tax even before the plan is developed because the stay does not cover
these taxes. While it can be argued that both the O'Neill and
Pac-Alt. Trading Co. decisions are judge-made law and do not
follow the provisions of tax law, it is necessary for the bifurcation
issues to be settled before the proposed change becomes law.
Additionally, based on the provisions in section 507(a)(8) it has
become a common practice for employers' taxes and trust fund tax
withholdings that were made prior to the filing of the petition to be
classified as prepetition taxes even though the tax period may end
after the petition is filed. While this type of tax is not actually a
quarterly or yearly tax, but an each-pay-day- tax, it is important
that the proposed change is clear that it only applies to
postpetition taxes.
Thus, before this provision becomes effective, it needs to, at
least, be revised to provide that it only applies to postpetition
taxes.
Both the NBRC and the Tax Advisory Committee recommended that the
relevant event for triggering the application of section 362(a)
limitation is the filing of the petition and not the entry of the
order for relief as advocated by H.R. 3150 and recommended the
application of the stay to tax appeals as proposed in H.R. 3150.
H.R. 3150 proposes to amend the Bankruptcy Code to provide that
the payments under section 1129(a)(9) must be periodic and must be
"in at least quarterly installments designed to pay at least 15
percent of the claim in each of the first 5 years of the plan and no
more than 20 percent of the claim in the final year of the plan."
H.R. 3150 follows the recommendation of both the NBRC and the Tax
Advisory Committee in proposing that the requirements of section
1129(a)(9) should also apply to secured taxes that would be entitled
to priority absent their secured status.
Comment: Both the NBRC and the Tax Advisory Committee
suggested that the payments should be periodic, but did not define
periodic other than to suggest that the payments should be monthly or
quarterly and that balloon payments be prohibited. Because of the
difficulty of establishing the time of assessment, both the NBRC and
the Tax Advisory Committee recommend that the six-year period begin
with the date of the order for relief. H.R. 3150 only deals with the
issue of periodic and balloon payments. For some debtors, it is
difficult for large payments to be made in the first year or two
after emerging from bankruptcy. To facilitate that process, some
creditors agree to limit the payments the first year or two to
interest only or interest and limited principal payments. It seems
reasonable that under these conditions the tax authorities should
also receive less in the first year or two than is paid in the latter
years. Thus, the recommendation of the NBRC provides, under these
conditions, an opportunity for the court to approve payments that are
less than equal payments, but would not allow plans to be approved
that provide for one balloon payment at the end of the sixth year.
The 15 percent and 20 percent rule will not work. For example,
assume that the taxes were assessed one year before the petition was
filed and that the company was in chapter 11 for two years. Payments
under the plan would be made over three years.
However, payments could not be evenly distributed because only 20
percent of the claim could be paid in the third year. Another
problem, in using the word "claim", does it include interest that
begins to accrue on the allowed claim as of the effective date of the
plan? If not, would the service allocate the first part of the
payment as interest and the balance as payment on the claim? If so,
then the payments in the first year would involve interest on the
full amount of the claim plus a payment of 15 percent of the
principal (claim). Thus, payments spread over six years may be
required to be larger in the first year than in any other year. This
proposal in its current conditions will create more problems than
solutions and should not become law.
H.R. 3150 amends section 545(2), as recommended by the NBRC and
the Tax Advisory Committee, to overrule cases that penalize the
government due to certain benefits for purchasers provided for in the
lien provision of the IRC or similar provisions of state or local
law.
Payment of postpetition taxes is required when taxes are due in
the course of such business unless the tax is a property tax secured
by a lien against property that is abandoned by the trustee under
section 554 of the Bankruptcy Code within a reasonable time after the
lien attaches as provided for in H.R. 3150. Also H.R. 3150 modifies
section 503 to provide that property taxes are to be paid as an
administrative expense and that it is unnecessary for a governmental
unit to make a request to the debtor to pay taxes that are entitled
to payment as administrative expenses.
Comment. These provisions were recommendations by both the
NBRC and the Tax Advisory Committee.
H.R. 3150 provides, as recommended by both the NBRC and the Tax
Advisory Committee, that a taxing authority must file a claim for
priority tax before the final order approving the trustee's report is
entered by the court.
Comment: It is important that the claim be filed before the
final order approving the trustee's report is entered to avoid
requiring the trustee to recalculate the amount paid to creditors and
equity holders, to rewrite the report, and to reschedule the hearings
to approve the report. Filing a claim after the report is filed
clearly impacts the efficient court administration of the case. See
Pioneer Investment Servs. Co. v. New Brunswick Assocs. Ltd.
113 S. Ct. 1489 (1993).
H.R. 3150 amends section 523(a)(1)(B) by providing a definition of
a tax return for purposes of dischargeability as follows:
(iii) for purposes of this subsection, a return-
(I) must satisfy the requirements of applicable nonbankruptcy law,
and includes a return prepared pursuant to section 6020(a) of the
Internal Revenue Code of 1986, or similar State or local law, or a
written stipulation to a judgment entered by a nonbankruptcy
tribunal, but does not include a return made pursuant to section
6020(b) of the Internal Revenue Code of 1986, or similar State or
local law, and
(II) must have been filed in a manner permitted by applicable
nonbankruptcy law.
The last provision "(II) must have been filed in a manner
permitted by applicable nonbankruptcy law" is confusing; it muddles a
provision that was clarified in (I) above.
Comment: Both the Tax Advisory Committee and the NBRC
recommended that a return filed under IRC section 6020(b) or similar
federal, state, or local law provisions, should constitute a filed
return for Bankruptcy Code dischargeability purposes where the
taxpayer has taken reasonable steps to sign and file the return, even
though the taxing authorities fail to accept such return for filing.
Section 1325 of the Bankruptcy Code is amended by H.R. 3150 to
provide that one of the requirements for plan confirmation is the
filing of income tax returns required under section 1308 of the
Bankruptcy Code. The proposed section 1308 is as follows:
11308. Filing of prepetition tax returns
(a) On or before the day prior to the day on which the first
meeting of the creditors is convened under section 341(a) of this
title, the debtor shall have filed with appropriate tax authorities
all tax returns for all taxable periods ending in the 6-year period
ending on the date of filing of the petition.
(b) If the tax returns required by subsection (a) have not been
filed by the date on which the first meeting of creditors is convened
under section 341(a) of this title, the trustee may continue such
meeting for a reasonable period of time, to allow the debtor
additional time to file any unfiled returns, but such additional time
shall be no more than-
(1) for returns that are past due as of the date of the filing of
the petition, 120 days from such date, and
(2) for returns which are not past due as of the date of the
filing of the petition, the later of 120 days from such date or the
due date for such returns under the last automatic extension of time
for filing such returns to which the debtor is entitled, and for
which request has been timely made, according to applicable
nonbankruptcy law,
(3) upon notice and hearing, and order entered before the lapse of
any deadline fixed according to this subsection, where the debtor
demonstrates, by clear and convincing evidence, that the failure to
file the returns as required is because of circumstances beyond the
control of the debtor, the court may extend the deadlines set by the
trustee as provided in this subsection for-
(A) a period of no more than 30 days for returns described in
paragraph (1) of this subsection, and
(B) for no more than the period of time ending on the applicable
extended due date for the returns described in paragraph (2).
(c) For purposes of this section, a return-
(1) must satisfy the requirements of applicable nonbankruptcy law,
and includes a return prepared pursuant to section 6020(a) of the
Internal Revenue Code of 1986, or similar State or local law, or a
written stipulation to a judgment entered by a nonbankruptcy
tribunal, but does not include a return made pursuant to section
6020(b) of the Internal Revenue Code of 1986, or similar State or
local law, and
(2) must have been filed in a manner permitted by applicable
nonbankruptcy law.".
Section 1307 of the Bankruptcy Code would be amended under H.R.
3150 to provide that upon the failure of the debtor to file the
returns required under section 1308, on request of a party in
interest or the U.S. trustee and after and a hearing, the court shall
dismiss or convert the chapter 13 case to chapter 7, whichever is in
the best interest of the estate.
H.R. 3150 proposes to amend section 502(b)(9) to provide that an
objection to the confirmation of a plan is considered to be timely if
it is filed within 60 days after the debtors' tax returns were filed
under section 1308. Additionally, H.R. 3150 proposes that Congress
direct the Advisory Committee on Bankruptcy Rules of the Judicial
Conference to propose rules that provide for an opportunity for
governmental units to object to (1) the confirmation of a plan on or
before 60 days after the debtor files all tax returns required under
sections 1308 and 1325(a)(7) of the Bankruptcy Code and (2) that no
objection can be filed in reference to a tax of a return required to
be filed under section 1308 until such return has been filed as
required.
Comment: The Tax Advisory Committee concluded that this
provision would help reestablish the chapter 13 debtor as a
"taxpayer" and would determine the priority tax that must be paid for
a debtor to qualify for the chapter 13 super discharge. The Tax
Advisory Committee concluded, after discussion with federal and local
taxing authorities and with attorneys and accountants that render
services for chapter 13 debtors, that requiring the chapter 13 debtor
to file tax returns for six years, pay through the chapter 13 plan
all of the priority taxes, and provide for some payment of the
nonpriority taxes (realizing that some courts approve a zero plan for
unsecured claim holders) along with other general unsecured claim
holders will most likely result in the taxing authorities collecting
more taxes now and in the future than would be collected with the
filing of a chapter 7 petition. With the proposed repeal of the
chapter 13 tax discharge provisions, tax professionals generally will
not recommend that clients file chapter 13. As a result, this
provision will not have the impact that was intended. This writer
would not have supported the six-year chapter 13 filing requirement
on the Tax Advisory Committee with a repeal of the chapter 13
discharge provisions.
As noted above, both the Tax Advisory Committee and the NBRC
recommended that a return filed under IRC section 6020(b) or similar
federal, state, or local law provisions, should constitute a filed
return for Bankruptcy Code dischargeability purposes. H.R. 3150 would
not treat a return filed under section 6020(b) as a filed return for
tax discharge purposes.
Section 1125(a) of the Bankruptcy Code dealing with the disclosure
requirements is expanded by requiring the proponent of the plan to
include full discussion of the potential material Federal and State
tax consequences of the plan to the debtor, any successor to the
debtor, and a hypothetical investor typical of the holders of claims
or interests in the case.
Comment: In general, the disclosure requirements for income
tax impact of the plan has not generated the desired results. Often,
interested parties have been told to talk with their tax specialists
to find out the income tax impact of the plan. Time will only tell if
this requirement, if enacted, would result in the tax impact of the
plan being explained in such a manner that readers of the disclosure
statement would understand tax consequences. The purpose of the
amendment is not to change existing law, but to make plan proponents
adhere to the original intent of the law to effectively disclose the
tax ramifications of the plan on the debtor.
Setoff of Tax Liability against Tax Refund (H.R. 3150, Section
519)
Section 362(b) of the Bankruptcy Code would be amended to provide
that the setoff of an undisputed prepetition tax liability against an
income tax refund does not violate the automatic stay. Setoff could
not be taken if, prior to the setoff, an action was commenced under
section 505(a) to determine the amount or the legality of the tax.
However, if the setoff is tolled during the 505(a) hearing, the
taxing authority may hold the refund.
Comment: The writer supported the recommendation of the Tax
Advisory Committee. However, it has been pointed out by some writers
that the impact of Seminole Tribe of Florida, 116 S. Ct. 1114
(1996), suggests that no change should be made regarding the tax
setoff be considered because the debtor may be unable to recover tax
refunds that were setoff improperly by a state taxing authority.
Listed below are some of the changes that were recommended by the
NBRC that were not a part of H.R. 3150 that should be considered.
Conform State and Local Tax Issues to Federal Laws
Conform section 346 of the Bankruptcy Code to the 1398(d)(2)
election and conform state and local tax attributes that are
transferred to the estate to those transferred for federal income tax
purposes. Conform treatment of state and local claims to that
provided for federal tax claims, including confirming state and local
tax attributes to the federal list. Considerable conflicts exist
between state and local taxes and federal taxes. Congress indicated
at the time the Bankruptcy Reform Act of 1978 became law that the
state and local tax issues would be changed when the Congress passed
the federal bankruptcy tax laws. A few years later Congress passed
the Bankruptcy Tax Act of 1980 and no action has been taken to
eliminate the tax problems that arise because of the differences
between the two federal laws. To correct these problems, changes need
to be made only in the Bankruptcy Code, which means that these
changes should be a part of the Bankruptcy Bill and not a Tax Bill.
(NBRC Proposals 4.2.4, 4.2.16-4.2.17)
The NBRC recommended that corporations have the same right as
individuals to elect to have taxes incurred prior to the filing for
tax years that straddle the petition date to be considered a
prepetition tax and tax incurred for the balance of the tax year
after the petition is filed to be classified as an administrative
expense. The Eighth and Ninth Circuits allow the debtor to bifurcate
the taxes.
Currently, section 1146(d) of the Bankruptcy Code gives the
bankruptcy court the power to determine the tax impact of a plan for
state and local tax purposes. The NBRC recommended that this power
also be extended to cover federal income taxes as well. Section
1146(d) should be modified by removing the "state or local."
The NBRC recommended that the payment of prepetition tax penalties
in chapters 11, 12 and 13 be subordinated to payment of general
unsecured claims the payment is in chapter 7 cases. The NBRC noted
that granting a priority to penalties works unfairness on general
unsecured creditors by, in effect, punishing them for the debtor's
misconduct. This is, according to NBRC, inequitable, especially where
creditors have limited access and ability to monitor a taxpayer's
compliance with tax reporting requirements.
To amend title 11 of the United States Code, and for other purposes.
An Analysis of the Consumer Bankruptcy Provisions of H.R. 3150
Proposed Bankruptcy Reform Legislation (Revised)
Written by:
Hon. Eugene R. Wedoff
United States Bankruptcy Court
Northern District of Illinois
Chair, Consumer Bankruptcy Committee
Prepared for the American Bankruptcy Institute
Web prepared, posted and Copyright ©
April 6, 1998, American Bankruptcy Institute.
Revised critique points out problems with the means-testing procedure of H.R. 3150.
H.R. 3150, presently pending before the the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee, would add "means-testing" as a prerequisite for Chapter 7 relief, denying that relief to individuals who can pay a defined portion of their future income to general unsecured creditors. The procedure for means-testing in H.R. 3150 adopts standards used by the Internal Revenue Service in collecting unpaid taxes. According to a revised critique of H.R. 3150, written by Bankruptcy Judge Eugene R. Wedoff, these IRS standards do not operate effectively in the context of H.R. 3150, and hence the means-testing procedure of the proposed legislation may be unworkable. The critique discusses the means-testing procedure in connection with §101 of H.R. 3150.
Introduction: The general operation of consumer bankruptcy.
H.R. 3150, currently pending before the 105th Congress, proposes major changes to the consumer provisions of the Bankruptcy Code (Title 11, U.S.C.). Similar changes have been proposed by two other bills, H.R. 2500 and S. 1301, that are the subject of an earlier analysis published by the American Bankruptcy Institute. Like the earlier analysis, this paper reviews the proposed legislation with three aims: first, identifying each of the changes that the bill would make in current consumer bankruptcy law; second, assessing the impact that these changes would have in the operation of the law; and third, suggesting alternative approaches, as appropriate, to achieving the goals of the bill. Where the provisions of H.R. 3150 are substantially the same as those of H.R. 2500 or S. 1301, the comments from the earlier analysis are reproduced here, to avoid the need for cross-reference.
In order to discuss the proposed changes and their impact, it is necessary first to have an understanding of how consumer bankruptcy operates under the present law. It is helpful to look at the law as a two-part system, that (1) determines the assets that are available to consumer debtors and (2) divides the assets, allowing the debtor to retain some of those assets, and using other assets to pay the debtor’s creditors.
The assets available. The Bankruptcy Code views consumer debtors as having two basic types of assets: present assets and future assets. The present assets are what a debtor owns at the time a bankruptcy is filed. These include tangible assets like a home, a car, clothing, furniture, and cash, as well as intangible assets, like savings and retirement accounts and lawsuits for personal injury. Future assets are those to which a debtor first becomes entitled after a bankruptcy is filed. The principal future assets of most debtors are the personal earnings to which they become entitled after the bankruptcy filing; other future assets include gifts received or lawsuits accruing after the filing.
The classes of claims. In a bankruptcy case, the assets available to the debtor are divided between the debtor and the debtor’s creditors. The share of each creditor depends on the type of claim the creditor holds. The Bankruptcy Code sets out several different classes of claims.
(a) Secured claims. Debts that are supported by liens on property owned by the debtor (like a home mortgage, or a lien on an automobile), are known as "secured claims." The Bankruptcy Code generally provides that secured claims must be paid at least the value of the collateral that supports them before that collateral can be used by the debtor or paid to other creditors. In other words, the debtor and other creditors are only entitled to the "equity" that exists in the property above the amount of the claim for which the property is collateral. In this way, secured claims are generally first in the distribution of a debtor’s assets. Claims that are not supported by a lien on property of the debtor are known as "unsecured" claims.
(b) Priority claims. Certain claims are viewed by the Bankruptcy Code as being especially entitled to payment. Examples include certain tax obligations, expenses of administering a case in bankruptcy, and family support obligations of the debtor. Although these claims against the debtor may not be secured, the Bankruptcy Code provides that when a debtor’s assets are distributed, these claims should be paid ahead of other unsecured claims, and so they are known as "priority unsecured" or simply "priority" claims, in contrast to ordinary ( "general") unsecured claims against the debtor.
(c) General unsecured claims. Unsecured claims that do not have priority status—"general unsecured" claims—are involved in nearly every consumer bankruptcy case. Examples include most credit card debt and medical bills. However, even a creditor secured by a home mortgage or automobile lien may hold a general unsecured claim. An important concept in the Bankruptcy Code is that, whenever the value of collateral is insufficient to cover the entire amount owed on the creditor’s claim, the creditor holding the lien has both a secured claim (to the extent of the collateral value) and an unsecured claim (in the amount of the deficiency in the value of the collateral). Thus, a creditor with a $10,000 claim, secured by an automobile worth only $7,000, is treated as having a secured claim of $7,000 and a general unsecured claim of $3,000.
(d) Nondischargeable claims. Ordinarily, when the distribution of a debtor’s assets under the Bankruptcy Code has been concluded, the debtor is given a discharge, wiping out the debts that the debtor owed at the time the bankruptcy was filed. Thus, all of the debtor’s future assets, after the distribution, are allowed to be retained by the debtor. However, there is an exception to the discharge for certain types of debt. Some of this debt is of the same nature as priority debt (taxes and family support obligations), but the Bankruptcy Code also excepts from discharge certain debts that were incurred through misconduct of the debtor, such as debts arising from fraud and intentional injuries. These "nondischargeable" claims—to the extent they have not been paid from the assets that are distributed during a bankruptcy case—remain payable from the future assets of the debtor.
Chapter 7: distributing present assets to creditors. Since the enactment of the Bankruptcy Act of 1898, the standard process of a bankruptcy case has been for a trustee to collect the debtors’ present assets, liquidate them, and divide the proceeds among the debtors’ creditors, with the debtors, in exchange, being discharged from their debts, so that they retain the right to their future assets, free of claims of creditors. This process, set out in Chapter 7 of the current Bankruptcy Code, is known as "liquidation" or "straight bankruptcy." Allowing the debtors to use future assets free of creditor claims is known as the "fresh start."
There are, however, two features of Chapter 7 that vary the general plan of liquidating present assets for distribution to creditors and leaving future assets for the debtor. First, debtors are allowed to retain some of their present assets. The Bankruptcy Code sets forth a list of "exempt" property, deemed necessary for debtors’ maintenance. States may provide an alternative to this list, and then either allow the debtors to choose between the two lists of exempt property (state and federal) or else provide that the state exemptions are the only ones available. In any event, debtors are allowed to keep some of their current assets as exempt, excluding them from distribution in Chapter 7. Where debtors have no substantial assets beyond those that are exempt, there will be no distribution to creditors. Cases such as these are known as "no asset" Chapter 7 cases.
Second, debtors in Chapter 7 are not always discharged from all of their debts. As noted above, some debts are nondischargeable, and these remain, after bankruptcy, so that the creditors holding these claims may seek payment from future assets of the debtor. Moreover, under certain circumstances (generally involving misconduct by the debtor in the course of the bankruptcy itself), a Chapter 7 debtor may be denied a discharge altogether.
Taking all of this into consideration, Chapter 7 generally divides a debtor’s assets as follows:
(1) Secured creditors are given the value of their liens in the debtor’s present assets.
(2) The debtor’s exemptions are deducted from the present assets.
(3) Any remaining present assets are liquidated and distributed, first to priority claims, and then to general unsecured claims.
(4) The debtor is given a discharge, allowing the debtor to have future assets free of creditor claims, subject to nondischargeable claims.
(5) Nondischargeable claims remain payable in full from the future assets.
Chapter 13: distributing future assets to creditors. Chapter 13 is presented in the Bankruptcy Code as an alternative to the standard Chapter 7 liquidation. The basic idea of Chapter 13 is to allow debtors to retain all of their present assets, in exchange for paying to creditors, out of future assets, at least as much as the creditors would have received if there had been a Chapter 7 liquidation. To accomplish this, the debtor must propose a plan, administered by a trustee, to pay creditors through periodic contributions from the debtor’s regular income. Chapter 13 recognizes that debtors cannot pay all of their income into the plan, since some income will be necessary for the support of the debtors and their dependents. However, all income not necessary for that support is defined as "disposable" income, and a Chapter 13 plan must either pay creditors in full, or devote all disposable income to the plan. A plan that does not provide for full payment of debts must have a duration of at least three years, and five years is the maximum length of the plan. Because of the disposable income requirement, Chapter 13 plans may be required to pay much more to creditors than they would have received in a Chapter 7 bankruptcy.
Under current law, Chapter 13 is entirely voluntary. Only a debtor can propose a Chapter 13 plan; a debtor has an absolute right to dismiss a case that was originally filed under Chapter 13; and a debtor can convert a Chapter 13 case to Chapter 7 at any time. To encourage debtors to choose Chapter 13 over Chapter 7 (and thus provide greater payment to creditors), the Bankruptcy Code has two distinct types of incentives. First, at the conclusion of a Chapter 13 plan, the debtor is given a broader discharge than is available in Chapter 7. This "superdischarge" results in the discharge of several types of debt (including those for fraud and intentional injuries) that are not discharged in Chapter 7. Second, debtors are allowed to keep property that is encumbered by liens, even though they are in default on the underlying obligations. A debtor with a home in foreclosure or a car subject to repossession may be able to retain the home or car by making payments to the secured creditors through a Chapter 13 plan. Moreover, except for certain home mortgages, the debtor in Chapter 13 may pay to a secured creditor the value of the collateral, even though it is less than the full amount owing, and obtain a release of the lien. Chapter 13 contains detailed provisions as to the type of payments required on secured claims.
Plans in Chapter 13 are required to pay priority claims in full, over the course of the plan, and not to discriminate unfairly among general unsecured creditors. Considering all of its provisions, Chapter 13 generally divides a debtor’s assets as follows:
(1) The debtor retains all present assets.
(2) The debtor contributes disposable future assets to a plan for a period of three to five years, or for a shorter period sufficient to pay the debts in full. The payments to be received by creditors must be at least as much as they would have received in a Chapter 7 case. Secured creditors must receive at least the value of their liens. Priority claims must be paid in full.
(3) The debtor retains all nondisposable future assets during the time of the plan.
(4) After the completion of the plan, the debtor is given a discharge, allowing the debtor to retain all future assets, free of dischargeable creditor claims.
(5) Nondischargeable claims remain payable in full from the future assets. However, many debts that are nondischargeable in Chapter 7 are able to be discharged in Chapter 13.
Choice of Chapter 7 or Chapter 13. Under current law, consumers have a largely free choice between Chapter 7 and Chapter 13 as a form of relief. However, there are some limitations, the most significant of which are the following: First, a debtor cannot file any bankruptcy case within 180 days after a prior case was dismissed under specified circumstances. Second, Chapter 13 is unavailable to individuals with large amounts of debt (over $250,000 in unsecured debt or $750,000 in secured debt). Third, a Chapter 7 case may be dismissed on motion of the court or the United States trustee if granting Chapter 7 relief would be a "substantial abuse." Fourth, a debtor cannot receive a discharge in a Chapter 7 case if that case was filed within six years of an earlier filing in which the debtor received a Chapter 7 discharge. However, a debtor may receive a discharge in a Chapter 13 case regardless of whether or when a discharge was granted in any prior bankruptcy case. The absence of such limits on Chapter 13 discharge is a third incentive encouraging debtors to choose Chapter 13 over Chapter 7.
The automatic stay. In either Chapter 7 or Chapter 13, an automatic stay goes into effect at the time the case is filed, which generally operates to prohibit any collection activity—including foreclosure and repossession—on debts that were in existence at the time of the filing. In order to obtain the right to proceed with collection activity, a creditor must obtain relief from the automatic stay. In either Chapter 7 or Chapter 13, a creditor is entitled to relief if the value of its lien is declining or at risk of declining, and no action (known as "adequate protection") is taken to make up for the decline. In Chapter 7, the creditor is also entitled to relief if there is no equity in the property that might be obtained for the benefit of creditors. In Chapter 13, relief is granted if there is no equity and the property is not needed for the debtor’s plan to be effective.
Summary: major effects of the consumer bankruptcy provisions of H.R. 3150.
As discussed in the section-by-section analysis that follows, H.R. 3150 appears designed to reduce bankruptcy filings and increase payments to creditors in bankruptcy. A number of features would increase the cost of bankruptcy filing and administration. Among the significant changes proposed in H.R. 3150 include the following:
1. The ability of a debtor to obtain successive discharges would be substantially limited. After a debtor received a bankruptcy discharge, the debtor would be ineligible for any bankruptcy relief for a period of five years, and ineligible for Chapter 7 relief for a period of 10 years. §171.
2. Chapter 7 relief would be denied to certain debtors, based on their ability to pay a specified portion of their debt. Debtors with relatively large debt would remain eligible for Chapter 7 relief, but those with smaller debt would be ineligible. Testing for eligibility would be required for most debtors. §§101, 103.
3. Chapter 13 would be changed by increasing minimum plan terms and eliminating the superdischarge. §§102, 410, 508.
4. Debtors would be notified about alternatives to bankruptcy, and of their obligations in filing bankruptcy. These obligations would include submission of tax returns to the United States trustee (with disclosure to any interested party), and the filing of detailed information regarding income, expenses, and assets, subject to formal audit. §§111, 404, 407.
5. In both Chapter 7 and Chapter 13 cases, secured creditors would receive payment of their claims in an amount no less than the retail value of the collateral that secures the claim, and, in some circumstances, the full amount of the claim, regardless of collateral value. §§128, 129, 130, 162. Relief from stay would be granted in certain circumstances without regard to equity available for distribution to creditors generally. §§121, 124.
6. Credit card debt would be nondischargeable, on the ground of fraud, if the debtor did not have a reasonable ability to repay the debt at the time it was incurred, regardless of the debtor’s subjective intent to repay. Such debts would be nondischargeable in both Chapter 7 and Chapter 13 cases. All debts incurred by a debtor within 90 days of a bankruptcy would be presumed to have been incurred fraudulently. §§141, 142, 143, 145.
7. New deadlines would be established for important events in consumer bankruptcy cases, but there are conflicting provisions regarding the time for confirmation of a Chapter 13 plan. §§401, 405, 406, 409.
8. Bankruptcy court decisions would be appealable directly to the Circuit Courts of Appeals. §412.
9. A detailed program would be established for the centralized collection and dissemination of bankruptcy data. §§441-43.
10. Only minor changes would be made in the exemption provisions of the Code. §§181, 502.
The consumer bankruptcy provisions of H.R. 3150: specific proposals.
More than 40 of the sections of H.R. 3150 affect consumer bankruptcy cases. These provisions are included in three of the bill’s titles. Title I ( "Consumer Bankruptcy Provisions"), Title IV ( "Bankruptcy Administration"), and Title V ( "Tax Provisions"). This analysis deals with each of these sections in the order of presentation; cross-references indicate areas in which one proposal affects another. An indication is also given where the substance of the proposal is similar to a provision of H.R. 2500 or of S. 1301.
Title I ( "Consumer bankruptcy provisions")
Subtitle A ( "Needs-Based Bankruptcy")
§101 ("Needs based bankruptcy") (see H.R. 2500, §101; S. 1301, §102).
The changes. This section of the bill would institute "means-testing" for Chapter 7 relief, eliminating the choice of Chapter 7 bankruptcy for debtors who can pay a defined portion of their future income to general unsecured creditors. Subsection 101(3) of the bill would add a new provision to §109(b) of the Code. The new provision would prohibit an individual from being a debtor under Chapter 7 if the individual had "income available to pay creditors." The remainder of §101 sets up a procedure for determining "income available to pay creditors" and a mechanism for implementing the denial of Chapter 7 relief to debtors who have such income.
Means-testing. Whether a debtor has "income available to pay creditors," and thus is ineligible for Chapter 7 relief, involves a three-step determination. The first step compares the debtor’s "current monthly total income" (all of the debtor’s income from any sources, averaged over the six months preceding bankruptcy) against a national median income established by the Census Bureau. The debtor’s income must be at least 75% of the national median, based on household size, in order to be subject to exclusion from Chapter 7 relief. Because the Census Bureau’s reports deal with pre-tax income, rather than "take-home pay," this provision of the bill presumably deals with pre-tax income as well.
In the second step, the debtor’s total monthly income is reduced by three "automatic" categories of payments to obtain "projected monthly net income," i.e., the amount available to pay general unsecured claims. The three payment categories are: (1) general living expenses for the debtor and the debtor’s dependents, according to standards established by the Internal Revenue Service for purposes of collecting unpaid tax obligations; (2) all of the payments on secured debt that will come due during the five years after filing, divided by 60 (to obtain a monthly average); and (3) all of the priority debt owed by the debtor, again divided by 60.
Finally, in the third step, projected monthly net income may be further reduced by a "personalized" category of expenses, resulting from "extraordinary circumstances" established by the debtor.
A debtor will be found to have "income available to pay creditors"—and hence be ineligible for Chapter 7 relief— if, in addition to meeting the total income test, the debtor’s "projected monthly net income" is both greater than $50, and is "sufficient to repay twenty per cent or more of unsecured non-priority claims during a five-year repayment plan."
Implementation. Section 101 of the bill contains two mechanisms for implementing means testing. First, Chapter 7 trustees are given the additional duty of investigating and verifying the debtor’s projected monthly net income and filing a report with the court as to whether the debtor is disqualified for Chapter 7 relief under the "income available" standard.
Second, if the debtor asserts extraordinary expenses, a statement to that effect is required to be included with the debtor’s bankruptcy petition, together with an itemization and detailed description of each expense, and a sworn statement by the debtor and the debtor’s attorney that the statement is true. Any party may object to the statement within 60 days after the debtor makes the disclosures required by § 521 of the Code (as expanded by §407 of the bill, discussed below), and if such an objection is made, the bankruptcy court is to determine the matter, with the debtor having the burden of proof.
A third implementation of means-testing is contained in §103 of H.R. 3150. As discussed below, this provision would amend §707(b) of the Code to allow creditors to seek dismissal or conversion of Chapter 7 cases that they believe fail the means test.
Chapter 13. Finally, Subsection 101(6) of the bill sets out a provision unrelated to means-testing. This final change would impose on Chapter 13 trustees the additional responsibility of investigating and verifying the debtor’s monthly net income, and filing annual reports with the court as to whether the debtor’s plan should be modified because of changes in the debtor’s net income.
The impact. Means-testing in general. The means-testing incorporated in Section 101 of H.R. 3150 would effect a major change in bankruptcy policy. That policy has traditionally allowed debtors in financial difficulty to obtain an immediate fresh start in exchange for surrendering their nonexempt assets. Accordingly, current § 707(b) denies Chapter 7 relief only where this relief would be a "substantial abuse" of the provisions of Chapter 7, and it provides that there is a presumption in favor of granting the relief sought by the debtor. The means-testing provisions of H.R. 3150 would change this, denying an immediate fresh start to a significant category of debtors in genuine financial difficulty—unable to pay their current bills from available income—because their future income is sufficient to pay 20 percent of their debt over five years. Thus, at a given income level, those who have accumulated relatively small amounts of debt would be denied Chapter 7 relief, while those who have accumulated relatively large amounts would remain eligible. It can be anticipated that this change would decrease the number of Chapter 7 bankruptcies, with a corresponding increase in Chapter 13 cases or in nonbankruptcy resolutions of consumer debts. In this way, means-testing may lead to greater payments to creditors. But it may also have unintended consequences. For example, at the present time, many debtors are able to avoid bankruptcy by working out voluntary arrangements with creditors through credit counseling services. The willingness of creditors to cooperate in such voluntary arrangements may be influenced by the fact that the debtors otherwise have the option of Chapter 7 bankruptcy. If that option is removed, the creditors may be less willing to enter into the voluntary arrangements. Means-testing may also increase home foreclosure rates, since debtors now able to remove other debt in Chapter 7 would be denied that option, and may be ineligible for Chapter 13 or unable to complete a Chapter 13 plan.
The threshold for means-testing. Median household income, varying with size of the household, is used in the proposal to establish a threshold below which there is no need to examine income on an individualized basis: an individual whose total household income is less than 75% of the median income, as determined by the Census Bureau for a household of the same size, would not be disqualified from Chapter 7 relief regardless of the household expenses. However, there are two difficulties with the use of Census Bureau medians. First, the information may be outdated. For any given year, the proposal states that household income is based on the most recent Census Bureau figures available as of January 1. As of January 1 of any year, the Census only has information available for the second year before that date. Thus, 1996 income figures are presently the most recent. In this way, the threshold under the proposal compares a debtor’s current income to the median income that existed up to two years earlier. In times of high inflation, this would greatly increase the number of cases subject to individual scrutiny. (Similarly, the six-month average used to determine the debtor’s current income will result in an artificially high income figure whenever the debtor’s income has declined shortly before the bankruptcy filing.)
A second problem has to do with household size. The proposal employs median household income, varying with the size of the household, with the apparent intent of allowing a higher threshold income for larger households. In reality, however, median household income changes erratically with household size. The median income for a single individual (in 1996, the last year for which Census Bureau figures are currently available) was $18,426, so that any single individual earning over $13,819.50 would be subject to individualized scrutiny under the proposal. This is only about $4,500 more than the federal poverty level of $9,260. But median income for a household of two was $39,039, producing a threshold for scrutiny, under the proposed bill, of $29,279.25, more than twice the poverty level of $12,480. The median income continues to increase with household size for households of three and four persons, but household income decreases for families of five and six persons. The median family income for a household of six persons was $44,782 in 1996—less than the median income for a family of three—which would result in a threshold for scrutiny, under the proposed bill, of $33,586.50, compared to a poverty level of $25,360. Thus, for single individuals and individuals in large households, the bill is much more likely to require individualized scrutiny than for individuals in households of two to four persons. (Income figures are drawn from U.S. Bureau of the Census, P60-197, Money Income in the United States: 1996, Table 1 (1997). Poverty figures are from the Annual Update of the HHS Poverty Guidelines, 63 Fed.Reg. 9235, 9236 (1998).)
The means-testing process—IRS collection standards. For those debtors whose income is above the threshold, §101 of H.R. 3150 prescribes a two-part means test for determining how much of the debtors’ projected monthly income during the five-year period after the bankruptcy filing is "net income," available to pay general unsecured debt. In the first part of the means-testing process, a debtor’s projected total monthly income is reduced by a set of "automatic" deductions: (1) monthly expenses allowances defined by Internal Revenue Service collection standards, (2) monthly payments on secured debt, and (3) monthly payments on priority debt. To avoid double deductions, §101 specifies that payment of debt should be excluded from the IRS allowances. In the second part of the process, further deductions are allowed where the debtor can establish extraordinary expenses. The balance that remains after the two sets of deductions is the "projected monthly net income" available to pay general unsecured debt.
There are several problems with this process—resulting primarily from the incorporation of the IRS standards—that render it unworkable or inequitable. The IRS collection standards are set out in the Internal Revenue Manual ("Manual") §5323 (CCH 1995), and incorporate a number of exhibits also set out in the Manual (Exhibits 5300-45 to 5300-51). More recent versions of some of the exhibits may be found at the IRS website, e.g.:
http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-other.html
As reflected in §101, the expense allowances under the IRS collection standards fall into three categories: national standards, covering food, housekeeping supplies, clothing, services, personal care products, and miscellaneous expenses (Manual §5323.432); local standards, covering housing and transportation (Manual §5323.433); and other necessary expenses, covering taxes, health care, court-ordered payments, involuntary wage deductions, accounting and legal fees, and secured debt, with provision for other necessary expenses (Manual, §5323.434).
The difficulties in applying the IRS standards within the procedures of §101 include the following:
•The IRS standards are not automatic. The Manual defines the "necessary expenses" category as including any expense necessary to "provide for a taxpayer’s and his or her family’s health and welfare and/or the production of income." Manual § 5323.12. The "other necessary expense" category thus includes all necessary expenses (such as costs of health care) that do not fall within the national and local standards. Id. For all such expenses, the Manual requires a discretionary determination of reasonable amounts for the expense: "Since there are no nationally or locally established standards for determining reasonable amounts, the [Internal Revenue] Service employee responsible for the case must determine whether the expense is necessary and the amount is reasonable." Id. Thus, review of a debtor’s schedules—presumably by the Chapter 7 trustee—will be necessary whenever a debtor lists "other necessary expenses" under the IRS standards.
•There is no way to distinguish between the"other necessary expenses" category of the IRS standards and the category of "extraordinary circumstances that require allowance for additional expenses" established by §101 of H.R. 3150. Section 101 makes a substantial distinction between expenses covered by the IRS standards and those arising from "extraordinary circumstances." If an expense is within the IRS category, §101 simply provides for its deduction from the debtor’s income. But if an expense arises from "extraordinary circumstances," then the debtor must provide detailed explanations of the expense, subscribed to by counsel, and subject to challenge by the trustee and creditors. However, as noted above, the IRS category includes any necessary expense not otherwise treated by the Manual, specifically including health care, and hence would appear to cover many expenses that could be considered "extraordinary."
•There is no way to determine what portion of the IRS allowances reflect payment of secured debt. The means-testing proposed in §101 deducts from the debtor’s household income all monthly payments made on account of secured and priority claims, and so, to the extent that the IRS standards allow deduction for debt payments, §101 provides that payments for debt should be excluded from the IRS allowances. In many situations, however, this exclusion will be impossible. The IRS local standards specify a single monthly allowance for all housing expenses, including mortgage or rent, property taxes, interest, parking, maintenance and repair, insurance, condominium fees and all utilities—including heating and cooking fuel, electricity, and telephone. Manual, Exhibit 5300-46. Thus, for example, the current IRS local standard for the District of Columbia allows total monthly housing expenses, for a family of four or more, in the amount of $1397, while a household of two in rural Illinois is allowed less than $500. (See website listings at http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-dc.html and http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-il.html.) This single housing allowance is intended to include any mortgage and property tax payments—which would be payments of secured claims—but there is no way to separate an allowance for those claims from the total housing allowance.
Similarly, the IRS’s local standard provides a single monthly allowance covering all transportation expenses, including payment for vehicles (either by purchase or lease), insurance, maintenance, fuel, registration, vehicle inspection, parking fees, tolls, drivers’ licenses, and public transportation costs. The current monthly transportation expense allowed for the District of Columbia, for a debtor with two cars, is $357, while a debtor with one car in Buffalo is allowed $179. (See website listings at http://www.irs.ustreas.gov/prod/ind_info/coll_stds/cfs-trans.html.) Again, for a debtor with auto loans, some part of these totals would be attributable to payments on the loan, but it is not possible to determine what part.
For both housing and transportation expenses, it might be thought that there could simply be an exclusion from the IRS standard in the amount of whatever mortgage or car loan payments are actually being made by the debtor. That approach, however, cannot be used in any situation where the debtor’s secured debt payments approach or exceed the IRS allowance, since excluding the secured debt payment would leave insufficient allowance for the other expenses included in the category.
•The means-testing process would impose burdens disproportionately on debtors without secured debt. The means-testing of §101 excludes secured debt payment from projected monthly net income, and so mortgage and auto loan payments are automatically deducted from income available to pay creditors, even if they are much higher than average for the community in which the debtor resides. However, rental payments are not secured debt, and so would only be excluded to the extent that they were part of the standard levels of expense established by the IRS. Housing expenses in particular vary widely from community to community within a metropolitan area, yet the IRS allowances are based on county wide figures. Thus, the proposal would require all debtors in higher than average rental communities to declare and prove "extraordinary" expenses, with the potential for litigation concerning the extent to which bankruptcy courts should allow as "extraordinary expenses" rental payments at a level higher than that determined by the IRS.
Similarly, a debtor could buy a new car on credit without affecting the means-testing of §101, but if the debtor leased a car with payments that caused the IRS transportation allowance to be exceeded, there would again be a need to declare an extraordinary expense in order to retain the car.
Finally, costs of rental housing may rise very quickly in a given area, but, as with Census Bureau data, the IRS standards will necessarily lag. Thus, debtors in rental housing may be required to establish "extraordinary circumstances" simply to continue to rent an average apartment for their area.
• The means-test leaves unresolved recurring questions regarding the appropriateness of various categories of expense. Currently, questions about the reasonableness and necessity of expenses claimed by a debtor arise under §1325(b) of the Code, which requires that Chapter 13 debtors contribute to their repayment plans any income not "reasonably necessary" for their support and the support of their dependents. In applying this standard, the courts have struggled to determine whether debtors should be allowed to claim expenses for private school tuition, religious and other charitable contributions, and care of elderly relatives or others whom the debtor may not be legally obligated to support. See 2 Keith M. Lundin, Chapter 13 Bankruptcy §§ 5.36-5.37 (1994 & Supp. 1997). None of these questions are resolved by the means-testing proposed in §101 of H.R. 3150. To the contrary, the IRS collection standards make clear that private school tuition and charitable contributions are generally not allowed as "other necessary expenses," and that care for the elderly, invalid, or handicapped only "is necessary if there is no recourse except for a taxpayer to pay the expense." Manual, Exhibit 5300-46. Thus, a debtor seeking to make any of these payments would be required to list them as extraordinary expenses, with the potential for litigation.
Costs of the proposed means-testing. Largely because of the difficulties outlined above, the means-testing proposed by §101 can be expected to generate substantial additional cost:
(1) A substantial burden would be placed on the Internal Revenue Service to maintain current expense standards, for each distinct economic area in the country, These determinations by the IRS may well require formal rulemaking procedures. While the Internal Revenue Manual, under current law, is simply an intra-agency document giving direction to IRS employees, §101 would transform the collection standards into an administrative rule. (The definition of "rule" in the Administrative Procedure Act, 5 U.S.C. § 551(5), includes "an agency statement of general . . . applicability and future effect designed to implement . . . law or policy.")
(2) An increased burden would be placed on bankruptcy professionals. The proposal requires Chapter 7 trustees to investigate and report on the debtor’s net income in each Chapter 7 case. The vast majority of Chapter 7 cases involve no assets for distribution to creditors, and hence only a nominal fee for the trustee. The new investigation and report will substantially add to the work required of trustees in no-asset cases, with no provision for additional compensation. The trustees will also have to review the appropriateness of any expenses claimed by the debtor under the IRS’s "other necessary expenses" category. (The investigation and reporting requirements for Chapter 13 would increase the costs of the Chapter 13 trustee, reducing the portion of plan contributions available to creditors.) Similarly, the proposal requires debtors’ counsel to swear to the accuracy of any extraordinary expenses claimed by a Chapter 7 debtor. Unless this oath is simply based on the statement of the debtor (in which case it would add nothing to the debtor’s oath), this requirement would impose on debtors’ counsel the obligation of independently verifying all of the extraordinary expenses claimed by the debtor, thus increasing the cost of the bankruptcy and the time required to file the case.
(3) The proposal would lead to increased "bankruptcy planning." The formula employed for determining net monthly income is subject to manipulation by debtors. Most obviously, because secured debt is excluded from projected monthly net income, a debtor can reduce the income available to pay debts simply by taking on additional secured debt. For example, assume that a debtor with $30,000 in unsecured, nonpriority debt owns a three-year old car with no outstanding car loan, and that the debtor has $300 in monthly net income as defined in the proposed bill. Over five years, that income would total $18,000, well over 20% of the unsecured debt. However, if the debtor trades in the three-year old car for a new one, and finances $12,000 for three years at 5% interest, the debtor will need to make payments on the secured car loan of about $13,000, reducing the total "net income" over the five years after filing to about $5000, less than 20% of the unsecured debt. Similarly, a debtor with projected income that is slightly over 20% of outstanding unsecured debt could increase the amount of that debt to arrive at a point where disposable income is less than 20%. Finally, debtors may be able to manipulate income, by terminating second jobs, reducing hours, or changing employment.
(4) The proposal would lead to greater court involvement in Chapter 7 cases. The court will be required to hear any disputes regarding "other necessary expenses," or extraordinary income, as well as any questions of good faith arising out of the kind of bankruptcy planning discussed above. These hearings will generate additional expense for the courts and the parties involved in them.
Alternatives. The Bankruptcy Code has limited the availability of Chapter 7 relief in situations of improperly incurred debt by creating exceptions to discharge in Chapter 7. To obtain relief from the improperly incurred debt, the debtor is then required to complete a Chapter 13 plan. Rather than making Chapter 7 relief unavailable to a large class of debtors (many of whom will have incurred their debt in good faith), it may be preferable to define the type of debt (such as excessive credit card debt) that is improper, and make that debt nondischargeable in Chapter 7, regardless of the disposable income currently available to the debtor. Alternatively, if there are to be thresholds for denial of Chapter 7 relief based on household income, those thresholds should be based on some formula (such as a multiple of poverty level) that is not tied to median household income.
§102 ("Adequate income shall be committed to a plan that pays unsecured creditors") (see H.R. 2500, § 102).
The changes. Section 102 of H.R. 2500 proposes essentially two major changes in the operation of Chapter 13.
Plan length. First, §102 imposes an increased minimum plan length for most debtors. Instead of the current three-year minimum, the proposed legislation provides that, if the debtor’s total income is 75% or more of the national median income, based on household size, the debtor’s plan must have a duration of at least five years. If the debtor’s total income is less than 75% of the national median income, the three year minimum is retained. (These provisions are elaborated in §410 of the proposed bill which sets out maximum plan lengths of two years in addition to the minimum plan length set forth here.)
Minimum payments to unsecured creditors. The second major change proposed by §102 replaces the current "disposable income test" of Chapter 13 with a two-part formula requiring minimum payments on unsecured nonpriority debt. Under the first part of the formula, the plan must provide for payments of at least $50 per month to unsecured nonpriority creditors who are not insiders. The second part of the formula defines "monthly net income" for purposes of a Chapter 13 plan, and creates a mechanism for requiring that "the total amount of monthly net income" is paid to unsecured nonpriority creditors during the minimum plan period, less only expenses of administering the case.
The definition of "monthly net income" created by §102 is similar to "projected monthly net income" established under §101—it starts with total monthly income and deducts expense allowances pursuant to Internal Revenue Service collection standards, with the potential for adjustment if the debtor has extraordinary expenses or loss of income. In contrast to §102 of H.R. 2500, secured debt and priority debt are also deducted from net income.
To assure that all monthly net income is paid through a plan to unsecured nonpriority creditors (and administrative claimants), §102 requires that the debtor itemize extraordinary expenses or loss of income in a statement sworn to by the debtor and the debtor’s attorney. The debtor’s statement of extraordinary expenses could be challenged by objection, and the prevailing party in a hearing on the objection could be awarded fees and costs. If the debtor files such a statement, the statement must be refiled, to reflect current conditions, no less than annually during the duration of the plan. All Chapter 13 plans would also be required to provide that future net monthly income will be paid as reasonably determined by the Chapter 13 trustee, with at least annual reviews to determine whether net income has increased or decreased. [This last provision is inconsistent with §101 of the proposed bill. As noted above, §101 imposes a duty of the Chapter 13 trustee to report annually to the court as to whether any increases or decreases in the debtor’s net income should result in modification of the debtor’s plan. Under the terms of §102, increases or decreases in the debtor’s net income, as determined by the trustee, would automatically result in changes in payments to creditors, without plan modification.]
The impact. Three substantial impacts that can be anticipated as a result of the changes made in §102 of the bill:
Plan length. The new five-year minimum plan length would be arbitrarily imposed, depending on size of household. This new plan length is required whenever the debtor’s household income is at least 75% of the median household income determined by the Census Bureau, according to the number of persons in the debtor’s household. As discussed above, in connection with §101, median income varies erratically with the number of persons in the household. Single individuals would be required, using currently available census figures, to propose a five-year minimum plan whenever their gross annual income was at least $13,819.50, but the trigger point for a married couple would be $29,279.25. Individuals in a household of four would not face the five-year minimum until their household income reached $40,278; but in a household of six, the five-year minimum would be triggered by income of $33,586.50.
Where the five-year minimum plan length is imposed, it may increase payments to general unsecured creditors; however, the longer length can be expected to increase the number of cases that fail for default in payment. A five-year minimum term may also have the effect of discouraging any Chapter 13 filing, giving debtors additional incentive for prebankruptcy planning to meet the proposed new filing requirements for Chapter 7. As discussed above in connection with §101, these limitations may be met by increasing debt and decreasing income prior to filing.
The substitution of "net income" for "disposable" income. Current law requires Chapter 13 debtors to contribute all of their disposable income to the Chapter 13 plan, and, after payment of secured and priority claims, this income would be used to pay general unsecured creditors. Disposable income is very generally defined in the Code (§1325(b)(2)), and courts have varied in their interpretation. The proposed change would require that all of a debtor’s "net" income be used to pay general unsecured creditors. Because secured priority claims are deducted from the calculation of net income, the principal difference introduced by the proposed legislation is that standard expense allowances would be determined, in the first instance, by the IRS—rather than by the courts—subject to individualized exceptions, reviewed annually. This process could reduce the arbitrariness associated with the disposable income test; for this reason, some use of general guidelines for determining appropriate levels of Chapter 13 plan contributions has been recommended by the National Bankruptcy Review Commission. National Bankr. Review Comm’n, Bankruptcy: The Next Twenty Years 262-73 (1997) ("Final Report"). However, the application of the IRS standards is very uncertain, for the reasons listed in the discussion of §101, above, and can be expected to generate substantial cost and litigation.
Minimum monthly payments of $50 to general unsecured claims of noninsiders. The $50 minimum payment to general unsecured creditors, proposed by §102, applies to all Chapter 13 debtors, even those who have no net income, or less than $50 in net income. This minimum payment may make Chapter 13 unavailable, or at least discourage its use, by lower income debtors.
The situation of low or nonexistent net income is common in Chapter 13—for example, debtors emerging from a divorce may have very great difficulty in making both required support payments and mortgage payments. In order to save their homes or automobiles, Chapter 13 debtors are often willing to attempt to live on substantially less than what would be considered an appropriate level of expense for necessities. Plans proposing food budgets of $100 for a family of four are not uncommon, with all or almost all of the plan payments going to secured or priority creditors. The $50 minimum for unsecured debt may render such marginal plans completely impossible.
A second problem exists for lower income debtors who owe unsecured debts both to family members and others. Section 102 would require that the first $50 of every monthly payment go to the nonfamily members (since family members are insiders). The $50 minimum thus provides substantial incentive for debtors with low net income to choose Chapter 7, where all of their debts will be discharged, so that they can repay debts owing to family members voluntarily.
Alternative. As suggested by the National Bankruptcy Review Commission, the objective of obtaining payment for general unsecured creditors might be advanced by requiring that payments proposed for general unsecured claims in a Chapter 13 plan be made in equal installments throughout the plan, rather than paid only after secured and priority claims. See Final Report at 262.
§103 ( "Definition of inappropriate use") (see H.R. 2500, §115; S. 1301, §102)
The changes. This section makes five changes to §707(b) of the Bankruptcy Code. Section 707(b) currently allows for dismissal of Chapter 7 cases that are a "substantial abuse" of the provisions of Chapter 7. Section 103 of H.R. 3150 would change the operative term from "substantial abuse" to "inappropriate use." Next, the section would require a finding of "inappropriate use" if the debtor is disqualified from Chapter 7 filing by the "ability to pay" provisions of §101, discussed above, or if "the totality of circumstances of the debtor’s financial situation demonstrates such inappropriate use." The third change made by this section would allow creditors and Chapter 7 trustees to bring motions under §707(b). Currently, such motions may only be initiated by the United States trustee or the court. Fourth, the section would allow conversion to Chapter 13, with the debtor’s consent, as an alternative to dismissal of the bankruptcy case. Finally, the section would allow the court to award fees and costs against a creditor who brought a motion seeking dismissal for substantial abuse, upon a finding by the court that the allegations of the motion were unsubstantiated.
The impact. The proposed changes principally provide a means of enforcing the limitation on Chapter 7 relief proposed in §101 of the proposed bill. Current law limits the right to bring §707(b) motions based on the understanding that debtors should generally be able to choose to obtain an immediate fresh start when they are in financial difficulty, and this understanding would be changed by §101, as discussed above. If creditors are allowed to bring motions for substantial abuse, the fee shifting provision may help to reduce creditor motions brought merely to exert leverage on debtors. Just as current law does not define "substantial abuse," the proposed change would retain a large degree of judicial discretion by allowing courts to grant relief based on the "totality of circumstances." The option of conversion to Chapter 13 would usually exist under present law, pursuant to §706(a), which generally gives a Chapter 7 debtor the option of converting the case to Chapter 13 "at any time."
Subtitle B ( "Adequate Protections for Consumers")
§111 ( "Notice of alternatives") (see H.R. 2500, §103; S. 1301, §301).
The changes. The major change involved in §111 is to assure that each consumer bankruptcy debtor is given a written notice that both discusses the option of consumer credit counseling and lists credit counseling services with offices in the district in which the bankruptcy is filed. The list would be prescribed by the United States trustee and questions about whether a particular counseling service should be included in the list would be determined by the court.
The impact. This proposal can result in relevant information being made available to debtors, although it is likely that debtors consulting an attorney will place more weight on the attorney’s advice than on the information in a form given to them by the attorney. The proposal will probably have the greatest impact on pro se filers. Difficulties may exist in describing the services available from credit counselors, at least if the description includes any comparison of credit counseling and bankruptcy in satisfying debt or in maintaining or reestablishing credit. The need to administer the list of credit counselors will involve some additional cost to the United States trustee.
§112 ( "Debtor Financial Management Training Test Program") (new)
The changes. This section of H.R. 3150 would require the Executive Office of the United States Trustee (1) to develop a program to educate debtors on the management of their finances, (2) to test the program for one year in three judicial districts, (3) to evaluate the effectiveness of the program during that period, and (4) to submit a report of the evaluation to Congress within three months of the conclusion of the evaluation. The test program is to be made available, on request, to both Chapter 7 and 13 debtors, and, in the test districts, bankruptcy courts could require financial management training as a condition to discharge.
The impact. Debtor financial education was a recommendation of the National Bankruptcy Review Commission, but the Commission did not recommend any methodology for implementing it. See Final Report at 114-16. There are two potential problems with the methodology suggested here. First, one year may not be a long enough time to assess the effectiveness of any program. Success in financial management would be indicated by such factors as completion of a Chapter 13 plan, ability to reestablish high quality credit, and (most importantly) avoidance of further financial difficulty. None of these bench marks can be assessed after one year. Second, the power to compel debtor education as a condition for discharge is accorded without specifying the circumstances in which it should be exercised, with the potential for widely varying application. Some judges might require debtor education in all consumer cases, while others never require it. Compulsory education in pilot districts also would be subject to constitutional challenge, as nonuniform bankruptcy legislation. See Railway Labor Executives' Assn. v. Gibbons, 455 U.S. 457, 469-71 (1982) (invalidating bankruptcy legislation that applied to a single railroad).
Alternatives. A study could be conducted of the effectiveness of the existing debtor education programs, based on their past experience. Compulsory education should be imposed only after an education program is available nationwide, and should be imposed only in situations defined by law.
§113 ( "Definitions") (new)
§114 ( "Disclosures") (new)
§115 ( "Debtor’s Bill of Rights") (new)
§116 ( "Enforcement") (new)
The changes. These four sections of H.R. 3150 set up a new system for regulating the providers of consumer bankruptcy services. Section 113 defines the term "debt relief counselling agency" to include both lawyers and non-lawyer providers of consumer bankruptcy goods or services, and the remaining sections establish regulations bearing on these providers. Section 114 would place a new §526 in the Bankruptcy Code, imposing a set of disclosure obligations on consumer bankruptcy providers. The disclosure would include (1) the availability of consumer credit counseling services, (2) the need for a truthful listing of assets and income in bankruptcy, subject to audit and criminal sanctions, (3) the obligation of the provider to issue a contract specifying the services that will be provided and their cost, together with a list of the services that might be needed, and (4) directions on how to complete bankruptcy schedules. Copies of the first two of these notices would be required to be maintained by the provider for two years after the notice is given, or two years after a discharge is received, whichever is longer.
Section 115 would add a new §527 to the Code, with further regulation of consumer bankruptcy providers. It would require a written contract for bankruptcy-related services, with a copy for the client, and specify that the advertising of consumer bankruptcy providers include a conspicuous disclosure that they are engaged in bankruptcy filing. Finally the section would prohibit consumer bankruptcy providers from (1) failing to perform promised services, (2) negligently making or counseling to be made any false statement in a bankruptcy filing, (3) misrepresenting the services to be provided, or the benefits or detriments of bankruptcy, and (4) advising the incurring of debt to pay for bankruptcy related services.
Section 116 would enforce the new regulations on consumer bankruptcy providers. It provides debtors may not waive the provisions of "section 526" and that contracts not complying with "section 526" are void. [This is apparently a drafting error, since proposed §526 governs notices, while proposed §527 governs the content of contracts and the performance of services on behalf of debtors.] The section would further impose sanctions on consumer bankruptcy providers who engage in prohibited conduct. There is a mandatory sanction of loss of all fees previously paid by the debtor, and a potential sanction of being required to continue the representation of the debtor without further fees. The prohibited activities include intentional or negligent failure to comply with any applicable requirement of the Code or the Federal Rules of Bankruptcy Procedure applicable to consumer bankruptcy providers, and providing assistance to a debtor whose case is dismissed or converted under §707(b), or dismissed for failure to file bankruptcy papers. The section would allow enforcement of the provisions of §526 by officials of state government, in either federal or state court, with actual damages awarded to the debtors affected, and with the consumer bankruptcy provider required to pay the costs and fees of any successful enforcement action. Finally, the section specifies that its provisions do not supersede any state regulation of consumer bankruptcy services except to the extent of any inconsistency.
The impact. The likely impact of the new regulations imposed by H.R. 3150 on the providers of consumer bankruptcy services can be divided into three classes.
First, some of the requirements reiterate existing obligations or good practices. In this category are the obligations (1) to provide written contracts specifying the services to be performed and their cost and (2) to perform the promised services. (Fees and services of petition preparers and attorneys are presently regulated by §§110, 329, and 330 of the Code.) The restatement of these obligations may be helpful, particularly as coupled with defined sanctions.
Second, some of the requirements may impose unnecessary costs on the providers. For example, the requirement to retain copies of each notice provided to a client or prospective client for at least two years involves substantial cost with no apparent benefit. Similarly, the requirement of "conspicuous notices" in all advertisements could impose unnecessary costs in connection with advertisements in newspaper classifieds and in telephone directories.
Third, some of the regulations may have a chilling effect on the provision of consumer bankruptcy services. For example, the automatic denial of fees in any case dismissed under §707(b) can be expected to discourage attorneys from filing Chapter 7 cases in situations where eligibility for Chapter 7 relief was questionable. Similarly, automatic denial of fees in cases dismissed for failure to file documents may discourage attorneys from filing cases whenever the debtor’s ability to produce documents is doubtful. Finally, the provision that a provider may never counsel borrowing to pay for bankruptcy fees may be overbroad, prohibiting appropriate advice necessary to permit a bankruptcy filing. While a debtor should never be counseled to borrow money fraudulently, with the intent of discharging the debt, it may be entirely appropriate to enter into a secured loan for the purposes of financing a bankruptcy filing, and a loan from a friend or relative (intended to be repaid despite the discharge) may also be proper.
Alternative. This provision might be limited to addressing specific misconduct by providers of consumer bankruptcy services that is not adequately addressed by existing law. For example, if it is found that bankruptcy providers are misrepresenting their services as not involving bankruptcy, that misconduct could be specified as a ground for mandatory sanctions.
Subtitle C ( "Adequate Protections for Secured Lenders").
§121 ( "Discouraging bad faith repeat filings") (see H.R. 2500, §109; S. 1301, §303).
The changes. This section provides (1) that the automatic stay will terminate after 30 days in cases of repeated bankruptcy filings within one year, unless a party in interest demonstrates that the filing of the later case was in good faith, and (2) that the bankruptcy court have discretion to enter orders granting relief from the stay "in rem," providing that the automatic stay will not apply in subsequent cases filed by the same debtor or in cases filed by other parties with specified knowledge of the order.
The impact. The role of the automatic stay differs substantially in Chapter 7 and in Chapter 13. In Chapter 7, the stay has the effect of allowing a trustee to determine whether property of the debtor should be liquidated for the benefit of creditors. For example, a home that is about to be sold in a foreclosure sale, might, in the trustee’s judgment, be able to be sold by a broker for a higher price, sufficient to pay the mortgage and generate a surplus for distribution to unsecured creditors. The automatic stay prevents a foreclosure from taking place in a situation like this, while allowing the mortgagee to seek relief from the stay by showing that there is in fact no equity in the property. In Chapter 13, the automatic stay has the effect of allowing a debtor to propose and carry out a plan that deals with secured claims in such a way that the debtor is allowed to retain the collateral, even if there is no equity. A debtor who has no ability to deal with a secured claim properly in Chapter 13 may nevertheless file repeated bankruptcy cases in order to prevent a foreclosure or repossession from going forward, by invoking the automatic stay repeatedly. The proposal seeks to limit debtors’ ability to use this tactic, and many of its features would be helpful. However, the proposed changes do not reflect the different roles that the automatic stay plays in Chapter 7 and Chapter 13, and thus may have unintended consequences.
In Chapter 7 cases, regardless of whether there was a prior case, the issue involved in application of the automatic stay should be limited to the question of equity. To allow the automatic stay to remain in effect, a Chapter 7 trustee should simply be required to show that there is equity in the property at issue; the good faith of the debtor in filing the case is not relevant. To see the problem with the proposal in this connection, consider the following example: a debtor with limited income has taken out a home equity loan on the family home, and cannot keep up with the payments. The lender files a foreclosure action, and the debtor seeks to save the home in Chapter 13, but fails to make plan payments, so that the bankruptcy case is dismissed and the foreclosure action is recommenced. This time, again to stop the foreclosure, the debtor files a Chapter 7 case. There is considerable equity in the home. Under the proposal, there is a presumption (since the debtor failed to make plan payments) that the second case is filed in bad faith, and if the Chapter 7 trustee wants to keep the automatic stay in effect beyond 30 days, the proposal would require the trustee to establish, by clear and convincing evidence, that the case was filed in good faith. If the trustee is unable to do so, the foreclosure will go forward, and the estate will lose the higher value that could have been obtained in a conventional sale, outside of foreclosure.
On the other hand, the good faith standards set out in the proposal are reasonably applicable to Chapter 13 cases, requiring that the debtor establish good faith for repeatedly invoking the automatic stay.
The impact of the "in rem" provision is difficult to determine, because no standards are set out for the entry of in rem orders. These orders would be most appropriate as applied to property in which there was no equity, and as to which there had been a pattern of bankruptcy filings. In such situations, the orders could help to prevent debtor abuse. In other situations, the orders might again prevent sales by Chapter 7 trustees to the benefit of unsecured creditors. Also, the proposal does not state whether the court would be authorized to vacate an in rem order in a subsequent case upon a showing that the case was filed in good faith. Absent such specification, there may substantial litigation to determine the issue.
Alternatives. The 30-day termination of the automatic stay should be postponed in Chapter 7 cases upon a request by the trustee for a hearing on the question of equity. In rem orders for relief from stay should be limited to situations in which there is no equity in the property and in which the property has been the subject of more than one bankruptcy filing.
§122 ( "Definition of household goods and antiques") (see H.R. 2500, §119).
The changes. The proposed legislation would add a definition for "household goods" to the definitions of §101 of the Code. "Household goods" are a category of debtors’ assets that may be exempted under §522(d), and as to which certain liens may be avoided under §522(f). The proposal would define "household goods" by incorporating the definition that appears in 16 C.F.R. §444.1(i). That regulation of the Federal Trade Commission defines "household goods" as:
Clothing, furniture, appliances, one radio and one television, linens, china, crockery, kitchenware, and personal effects (including wedding rings) of the consumer and his or her dependents, provided that the following are not included within the scope of the term "household goods": (1) Works of art; (2) Electronic entertainment equipment (except one television and one radio); (3) Items acquired as antiques; and (4) Jewelry (except wedding rings).
[Although the heading of the proposed section mentions antiques, no definition of "antiques" is given in the text.]
The impact. Section 522(f) allows the avoidance of nonpurchase money, nonpossessory liens on certain items of exempt household property. The policy underlying this provision is that when a lender extends credit on the basis of used household goods in the possession of the debtor, it is unlikely that there would be any substantial resale value in the collateral, and that the lender is primarily relying on the difficulty that the debtor would face in replacing the items. The Bankruptcy Code made the determination that such liens should not be enforced. It appears to be the intent of the proposed legislation to strictly limit the type of property that may be excluded from nonpossessory, nonpurchase money security interests. The FTC definition of household goods would exclude such common items as home computers, CD players, speaker systems, earrings, and framed prints. If so, it would be unduly restrictive. To some extent, the limitations of the FTC definition would not restrict §522(f), "because household goods" is only one of the categories of personal property as to which liens may be avoided under that subsection. Other categories include "household furnishings," and "jewelry." The major impact of the change may be to give rise to new litigation as to whether particular items not within the FTC definition of "household goods" constitute "household furnishings."
Alternative. In order to protect nonpurchase money lenders who genuinely rely on the value of the debtor’s personal property in extending credit, Section 522(f) could be amended to exclude from lien avoidance any items of personal property not within the FTC definition whose resale value exceeds a specified amount (for example, $1000).
§123 ( "Debtor retention of personal property security") (see H.R. 2500, §112).
The changes. Some courts have held that debtors in Chapter 7 may redeem personal property in installments. The proposed change would require that redemption take place by payment in full at the time of redemption. In addition, this section proposes that if the debtor does not redeem personal property that is collateral for a claim, or enter into a reaffirmation agreement with respect to the property, that the property will be deemed abandoned by the Chapter 7 trustee, so that the creditor may repossess the property or take other action allowed by nonbankruptcy law.
The impact. Although debtors rarely have equity in personal property that is collateral for debt, there can be situations where equity does exist, as in jewelry or luxury cars. This proposal, perhaps unintentionally, would remove property from the estate even if there was equity in the property. As applied to property in which there is no equity, the impact of the proposal would be to create an appropriate incentive in favor of Chapter 13 filings whenever a debtor wished to retain property that could not be redeemed, and as to which a reaffirmation agreement could not be negotiated.
Alternative. The proposal should be amended to allow a trustee to require that abandonment take place only after notice to the Chapter 7 trustee, with an opportunity for the trustee to be heard on the question of whether there is equity in the property.
§124 ( "Relief from stay when the debtor does not complete intended surrender of consumer debt collateral") (see H.R. 2500, §208).
The changes. Section 521(2) of the Bankruptcy Code currently requires Chapter 7 debtors to make an election as to their property which serves as collateral for consumer debts: they must indicate that they intend to retain or surrender the property, and "if applicable" state that the property is claimed exempt, that the debtor intends to redeem the property, or that the debtor intends to reaffirm the debts secured by the property. The law further indicates that the debtor is obligated to carry out the specified choice within 45 days of filing its notice of the election as to the property involved. Section 124 of the H.R. 3150 would make a number of changes in the operation of this provision:
(1) The section would be made applicable to all collateral, not merely collateral securing consumer debts.
(2) The time for performing the election would be changed from 45 days after the filing of the notice to "30 days after the first meeting of creditors under section 341(a)."
(3) The option for retaining the property and claiming it as exempt is eliminated, so that the only options given the debtor for collateral are: (1) surrender, (2) redemption, and (3) reaffirmation or lease assumption.
(4) A failure by the debtor to timely perform its election would result in termination of the automatic stay as to the property involved unless the debtor chose reaffirmation and the creditor refused to reaffirm on the original contract terms.
(5) If the automatic stay terminates pursuant to the above provisions, it is specified that the creditor should be allowed to proceed with any state law remedies for default based on the filing of the bankruptcy. Thus, the fact that the debtor was current in payments would not be grounds to prohibit repossession or foreclosure if state law allowed these remedies based on the filing of a bankruptcy. This provision would not be applicable as to property for which a lien was avoided in the bankruptcy case. [In this connection, there appears to be drafting error—including §553 of the Code in a list of sections under which a lien might be avoided. Section 553 terminates certain setoffs, which can function like liens in some circumstances, but the provisions of §521(2), sought to be enforced by this proposal, have nothing to do with setoffs.]
The impact. Current law has no enforcement mechanism for §521(2), and this section provides the most reasonable enforcement mechanism—relief from the automatic stay. Similarly, expressly allowing repossession based on the bankruptcy filing (if permitted by state law) addresses creditor concern that the collateral will not be maintained once the debtor is no longer personally liable for any deficiency. However, the proposal does not deal with the situation in which there may be equity in the property. Thus, in the situation of a home mortgage where there is equity in the property, the failure of the debtor to comply with the requirements of §521 results in relief from the automatic stay with no opportunity for the trustee to oppose that relief.
Moreover, the proposal would interfere with the debtor’s option to retain exempt property without reaffirmation or redemption. Debtors are allowed by §522(f) of the Code to avoid liens on certain exempt personal property secured by nonpossessory, nonpurchase money security interests. A requirement that the debtor surrender, redeem, or reaffirm debt as to this property would contradict this lien avoidance provision. Under the proposal, the automatic stay would terminate as to property exempted under §522(f) when the debtor failed to redeem or reaffirm the debt, even though no discharge had yet been granted the debtor. The debtor would presumably have a defense of lien avoidance if the creditor pursued state law remedies as to the property in question, but there is no reason why the automatic stay should not remain in effect in this situation.
A final difficulty with the proposal is its ambiguity in establishing the date by which a debtor must make the §521(2) election. The language "30 days after the first meeting of creditors under section 341(a)" might mean (1) 30 days after the first date set for the meeting (see Fed.R.Bankr.P. 3002(c)), (2) 30 days after the date on which the meeting is actually commenced, or (3) 30 days after the meeting is concluded (see Fed.R.Bankr.P. 4003(b)). This ambiguity, if uncorrected, can be expected to generate litigation.
Alternative. Failure by debtors to exercise their obligations under §521 could be made grounds for relief from the automatic stay, but relief awarded only on notice to the trustee. Relief would not be awarded where there is equity in the property and the trustee wishes to sell the property. The provision should also include as an option the retention of property with lien avoidance under §522(f), and should specify that the debtor must make the election within 30 days from the first date set for the creditors’ meeting.
§125 ( "Giving secured creditors fair treatment in Chapter 13") (see H.R. 2500, §105; S. 1301, §302).
The changes. Current case law interpreting Chapter 13 is in disagreement about the time at which a lien should be deemed released under a plan. This provision would resolve the dispute by amending §1325 of the Code to state that a lien can only be released at the time the debtor is discharged under §1328, or until the claim secured by the lien is fully paid, whichever is earlier. The provision also states that, in the event of conversion or dismissal of a Chapter 13 case, the lien would remain to the extent recognized under nonbankruptcy law.
The impact. This change would primarily affect automobile loans. Frequently an auto loan in a Chapter 13 case is in an amount greater than the value of the automobile. In such a case, the debtor is allowed to pay the value of the car in satisfaction of the secured claim, with the balance of the claim treated as unsecured. The plan may provide that as soon as the secured portion of the claim is satisfied, the creditor is required to release its lien. Thereafter, the debtor may fail to complete the plan, so that the creditor does not receive full payment of the unsecured portion of its claim. This provision would allow the creditor to retain its lien to secure payment of that unsecured portion.
The provision contradicts the bankruptcy policy requiring equal treatment of creditors. To the extent that a secured creditor has a claim not supported by collateral value, the Bankruptcy Code treats the creditor’s claim as unsecured, and entitled to the same treatment as other unsecured claims. This provision would allow the unsecured portion of a secured claim a preferential position—even though the value of its secured claim was paid, the creditor would be able to take action against property of the debtor to enforce its unsecured claim, a right that no other unsecured creditor would have.
The effect of conversion or dismissal of a Chapter 13 case is treated in separate provisions of the Bankruptcy Code, §§348 and 349. See §127 of H.R. 3150, discussed below. If changes are made regarding the effect of conversion or dismissal and not placed in those sections, questions may arise as to which section controls.
Alternative. Payments on account of unsecured claims can be required to be made in equal installments throughout a plan, so that the unsecured portion of a bifurcated claim is paid during the same time that the secured portion is paid, and all unsecured claims are treated in the same way. Changes in the effect of conversion or dismissal should be made in §§348 and 349 of the Code.
§126 ( "Prompt relief from stay in individual cases") (see H.R. 2500, §207; S. 1301, §311).
The changes. This section would provide that in individual bankruptcy cases under Chapters 7, 11, or 13, the automatic stay would terminate 60 days after a request for relief from the stay, unless (1) the court denies the motion, or (2) all parties in interest agree to a continuance of the stay beyond that time, or (3) the court makes a finding that continuance of the stay is required by compelling circumstances.
The impact. This provision does not substantially change existing law, which requires that all motions for relief from stay must be heard initially within 30 days, and that if the initial hearing is not final, the final hearing must commence within 30 days after the conclusion of the preliminary hearing. Both present law and the proposal allow extensions by the court for compelling circumstances.
§127 ( "Stopping abusive conversions from Chapter 13") (see H.R. 2500, §108; S. 1301, §310).
The changes. This section of the proposed legislation has two parts. First, under §348(f) of the Bankruptcy Code, when a debtor converts a Chapter 13 case to a case under Chapter 7, the valuation of allowed secured claims is carried over from the Chapter 13 case to Chapter 7, with the amount of the secured claim reduced by whatever payments were made on account of that claim to the secured creditor. The proposed bill would change this result, providing that to the extent any amount remains owing to the secured creditor at the time of the conversion, the entire amount owed will be secured by the collateral. Second, the section provides that, to the extent that any default in payments is not fully cured, the default "shall have the effect given under applicable nonbankruptcy law." [Note: This section of the proposed bill contains a drafting error. Section 348(f) of the Bankruptcy Code applies to all cases converted from Chapter 13 to other chapters of the Code. Section 108 is intended to leave the terms of §348(f) in place as they apply to Chapter 13 cases converted to Chapter 11 or 12, and then set out new terms, in a new subsection 348(f)(C), for cases converted from Chapter 13 to Chapter 7. Thus, the new subsection should have been introduced by the phrase "with respect to cases converted to Chapter 7." Instead, the new subsection is introduced by the redundant and confusing phrase "with respect to cases converted from Chapter 13."]
The impact. The first proposed change has a very narrow impact. In Chapter 7, pursuant to the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992), a debtor cannot simply pay the secured portion of any secured creditor’s claim and retain the collateral. Rather, a Chapter 7 debtor can only exercise this right in the context of a redemption, pursuant to §722 of the Code. This section allows a debtor to pay the amount of the "allowed secured claim" in order to redeem "tangible personal property intended primarily for personal, family or household use, from a lien securing a dischargeable consumer debt, if the property is exempted . . . or has been abandoned." When a case is converted from Chapter 13 to Chapter 7, a question may arise as to how much is required to be paid by the debtor in order to redeem tangible personal property, such as an automobile. Current law provides that the amount of the secured claim, fixed during the Chapter 13 case at the value of the collateral, continues to be the amount of the secured claim for purposes of the case on conversion to Chapter 7, and that any payments made on account of the secured claim during the Chapter 13 case reduce the claim on conversion. For example, if the debtor owed $10,000 on a car loan at the outset of a Chapter 13 case, and the car was valued by the court at $7,000, the lender would have had a secured claim of $7,000 in the Chapter 13 case and an unsecured claim of $3,000. If the debtor paid $2,000 on the secured claim through the Chapter 13 plan, and then converted the case, current law would provide that, on conversion, the lender had a secured claim of $5,000 (the original $7,000 claim reduced by the $2,000 payment). Thus, if the debtor wished to redeem the automobile in Chapter 7, the price for redemption would be $5,000, even if the car was worth more than that amount at the time of redemption. Under the proposed change, the intent appears to be that the creditor would have an $8,000 claim secured by the automobile (the total claim of $10,000 less the $2,000 paid during the Chapter 13 plan). In order to redeem, the debtor would then have to pay the entire value of the automobile, up to $8,000. In this way, the secured creditor could receive, as a price for redemption, a total compensation greater than the value of the collateral at the time of the filing of the case.
The second provision of the section, dealing with the cure of default, is unclear. Under nonbankruptcy law, a default gives secured creditors certain rights to the collateral, which may include immediate repossession or commencement of a foreclosure action. In a Chapter 7 bankruptcy, those rights are stayed. It may be that this provision is intended to terminate the automatic stay in a case converted from Chapter 13 to Chapter 7 whenever there is an uncured default. If so, the provision would violate the principle that the Chapter 7 trustees are allowed to sell property in which there is equity, for the benefit of all creditors.
Alternatives. Bad faith conversion from Chapter 13 is currently penalized by §348(f)(2), which provides that the Chapter 7 trustee in the converted case may liquidate all of the nonexempt property in the possession of the debtor at the time of conversion. This penalty could be made more effective by uniform exemption laws. Another alternative would be to allow denial of conversion in situations of bad faith.
§128 ( "Restraining abusive purchases on secured credit") (see H.R. 2500, §110).
The changes. This section of the proposed bill would change the bifurcation of any secured claim resulting from the debtor’s incurring secured credit within 180 days of the bankruptcy filing. Instead of the secured creditor having a secured claim only to the extent of the value of its collateral, with an unsecured claim for the difference, the secured creditor would be given a secured claim in the amount of the entire indebtedness outstanding at the time the bankruptcy was filed. If the creditor is also secured by other property, purchased more than 180 days prior to the bankruptcy, the claim would be bifurcated, but the resulting secured claim could not be less than the debt outstanding as a result of the purchase made within the 180 day period.
The impact. The section is not limited to situations of bad faith purchases—it applies in any case in which the debtor files bankruptcy after making a credit purchase. For example, if a debtor purchased an automobile in January, was laid off in February, and filed bankruptcy in May, this provision would result in a change in the operation of the Bankruptcy Code with respect to the claim secured by the automobile. In Chapter 7, one impact of this provision is to increase the cost of redemption. Instead of paying the value of the collateral at the time of redemption, the debtor would be required to pay the entire outstanding indebtedness. Another impact may be to reduce the recovery of the secured creditor in any Chapter 7 case where there is a distribution. Under existing law, any secured creditor would be viewed as having a secured claim to the extent of the value of the collateral, and an unsecured claim for the difference between the value of the collateral and the total claim. Thus, in the example given above, if $25,000 was the outstanding loan balance, and the car was valued at $20,000, current law would allow the creditor both to repossess the car and have a $5000 unsecured claim, payable through sale of the debtor’s other assets. Under the proposal, the creditor’s claim would be treated as fully secured, and repossession would be the sole recovery.
In Chapter 13 cases, the impact of this provision would be to prevent "strip down" of the affected secured claim. As a result, a greater portion of the debtors’ contributions to the Chapter 13 plan would go to pay the secured claim, and a smaller amount would be paid to unsecured creditors. For example, an automobile purchased six months before a bankruptcy may have substantially depreciated. If the automobile was purchased at a high interest rate with a long amortization, the amount owing on the car at the time of the bankruptcy may be close to the original purchase price. If the debtor missed one or more payments, the debt may exceed the original purchase price. The proposal would require that the debtor, in order to retain the automobile, pay the total amount due, rather than what the car was worth. Assuming that the debtor plan makes less than full payment of all claims, the effect is to increase the amount paid on the auto loan and reduce the amount paid to other creditors.
Alternatives. Current law allows both Chapter 7 and Chapter 13 cases to be dismissed for lack of good faith. The Code could be amended to provide that a case shall be dismissed for lack of good faith where a debtor is shown to have made a purchase on secured credit with the intent of filing bankruptcy shortly thereafter.
§129 ( "Fair valuation of collateral") (see H.R. 2500, §111).
The changes. This provision of the proposed bill would amend the claim bifurcation provision of the Bankruptcy Code (§506(a)) to provide that collateral in Chapter 7 and 13 cases is always valued at the cost to replace the property, without deducting the costs of sale or marketing, and that this replacement cost, for property "acquired for personal, family, or household purpose" is "the price a retail merchant would charge for property of that kind."
The impact. The impact of this proposal differs, depending on whether it is applied in Chapter 7 or in Chapter 13. In Chapter 7, the most common reason for bifurcating a claim is in redemption: a debtor is allowed, in Chapter 7, to retain personal property that cannot be sold for the benefit of unsecured creditors (because there is no equity in the property, or because it is exempt), by paying any creditors secured by the property the amount of their allowed secured claims. In this way, instead of obtaining the property, as they would by repossession, the secured creditors receive the value of the property, which may be less than the total amount owed. To the extent that the creditors receive less than the total amount they are owed, they are given an unsecured claim for the difference. Under current law, there is no explicit direction as to how to value the collateral being retained by the debtor. However, since redemption is a substitution for return of the collateral, there is no apparent reason why secured creditors should receive, in a redemption, any more than they would receive if they did repossess the collateral. Valuing the collateral at the price it would cost the debtor to replace it gives an arbitrary increase in collateral value to the secured creditor, with the amount of the increase depending on how expensive it would be for the debtor to replace the property involved. Using retail price as the measure for replacement cost exacerbates this problem, since, as the Supreme Court noted in its recent Rash decision, retail price may include "items such as warranties, inventory storage, and reconditioning," that are in no sense part of the collateral that secures a creditor’s claim. Associates Commercial Corp. v. Rash, 117 S.Ct. 1879, 1886 n.6 (1997). Finally, in the context of redemption, the creditor has no risk of nonpayment, and so there is no reason for any increase in the amount of the secured claim to compensate for risk of nonpayment. Chapter 7 cases involving a distribution
In Chapter 13, the principal reason for bifurcation is in "stripping down" liens to the value of the collateral and paying the reduced secured claim over the course of the plan. Here, the impact of bifurcation is to divide the plan payments between secured and unsecured creditors. The debtor must either pay all claims in full (including the unsecured portion of a secured claim) or else must pay all disposable or "net" income into the plan. To the extent that a secured claim is valued at a higher level, less of the plan payments will go to unsecured creditors. So, in this context, "fairness" requires a balancing of the rights of secured and unsecured creditors. Again, the value of collateral to a secured creditor is best measured in terms of what that creditor could get for the collateral. To the extent that the creditor could only obtain part of what is owed from the collateral, the creditor is best seen as unsecured, just like the other unsecured creditors, regardless of how much it might cost the debtor to replace the property. In contrast to redemption, however, the secured creditor in Chapter 13 does not receive immediate payment of its claim, and so the creditor does have a risk of nonpayment. This can be addressed by amending the Code to provide that payments of secured claims in Chapter 13 plans should carry an interest rate sufficient to offset the risk of nonpayment.
On the other hand, in both Chapter 7 and Chapter 13 cases, this provision may have the effect of reducing secured creditor recovery in situations where the collateral is repossessed. A creditor who repossesses collateral after the case is filed would be given a secured claim for the retail value of the collateral, even though the creditor could not obtain retail value in disposing of the collateral. The artificially high secured claim would, in turn, reduce the unsecured claim for the creditor would receive a distribution.
A final difficulty with the proposal is that many items of collateral (unlike automobiles) do not have an established retail market as used items. For example, a creditor may be secured by a five year old washing machine. There are unlikely to be readily ascertainable retail markets for such machines. The proposal would leave no guidance as to the proper valuation method in this situation.
Alternative. To create a fair valuation of collateral, the Code could be amended to provide that a secured creditor receive a secured claim in the amount that the creditor could establish that it would receive using any method of sale available to the creditor. If the claim is not paid immediately, the creditor should receive an interest rate on the secured claim sufficient to offset the risk of nonpayment. A similar standard of valuation has been proposed by the National Bankruptcy Review Commission. Final Report at 243-58.
§130 ( "Protection of holders of claims secured by debtor’s principal residence") (see H.R. 2500, §120).
The changes. Section 130 of H.R. 3150 would (1) provide that a claim is not subject to modification if it is secured "primarily" (rather than "only") by a lien on property used as the debtor’s principal residence at any time during the 180 days prior to the bankruptcy, (2) define "debtor’s principal residence," and (3) exclude continuances of mortgage foreclosures from the operation of the automatic stay.
The impact. These changes largely resolve conflicts in the case law respecting the treatment of home mortgages in Chapter 13. Section 1322(b)(2) provides that, generally, secured claims can be modified in Chapter 13. This allows the plan to pay, as a secured claim, only the value of the collateral. To protect lenders of home mortgages, the right to modify is denied when the lender is secured only by a mortgage on the debtor’s principal residence. Some decisions have held that a multi-unit building would constitute security other than the debtor’s principal residence, or that a mobile home would not be a residence. The proposed change would include loans on such property within the scope of the protection. Similarly, there have been reports of situations in which debtors have vacated their homes shortly before filing Chapter 13 cases, so as to remove the protection given to the mortgage lender. The proposal negates such a tactic by applying the protection to homes used as the debtor’s principal residence during a 180 day period prior to the bankruptcy.
A final issue regarding the application of the non-modification provision has to do with other security issued in connection with a home mortgage. Current law applies nonmodifiability where the claim is secured "only" by a lien on the debtor’s principal residence. Questions have arisen as to whether security incident to a mortgage (such as an assignment of rents) results in the loss of nonmodifiability. The proposal deals with these questions by requiring only that the claim be primarily secured by a homestead mortgage. This change may be overbroad. Debtors sometimes give home mortgages as additional security in connection with a business loan—clearly not the kind of loan for which the special protection was found necessary—and the business lenders could argue (particularly if the business fails) that the home mortgage was their "primary" security.
The remaining change made by this section involves the automatic stay. Some decisions have held that, in order to avoid violation of the automatic stay, a lender with a foreclosure pending at the time of a bankruptcy filing would have to dismiss the proceeding. Then, if the automatic stay were terminated, the lender would be required to serve all required notices and otherwise recommence the proceeding. The proposal would allow, instead, a simple continuance of the proceeding as of the time of the bankruptcy filing, so as to allow immediate recommencement in the event of termination of the stay.
Alternative. Instead of providing for nonmodifiability whenever a homestead is the "primary" security for a loan, the needs of mortgage lenders could be addressed by a provision applying nonmodifiability to any loan secured only by a mortgage and by interests associated with the mortgage.
Subtitle C ( "Adequate Protections for Secured Lenders")
§141 ( "Debts incurred to pay nondischargeable debt") (see H.R. 2500, §106).
The changes. Current §523(a)(14) provides that debts incurred to pay nondischargeable tax obligations are nondischargeable. This provision would expand §523(a)(14) to apply to all nondischargeable debt and would further provide that the debt to pay nondischargeable debt would have the same priority as the debt it was incurred to pay.
The impact. The impact of this proposal could be an arbitrary imposition of nondischargeability. The provision is not limited to debts incurred fraudulently, which are already nondischargeable under §523(a)(2). Thus, this proposal would apply to debts incurred in good faith, and would render them nondischargeable based simply on how the debtor chose to use the borrowed funds. If the debtor used borrowed funds to pay rent, and other funds to pay child support, the debtor would have no nondischargeable debt. But if the debtor used the same borrowed funds to pay child support, and the other funds to pay rent, the borrowed funds would be a nondischargeable debt, required to be paid as a priority.
Moreover, the provision presents substantial tracing problems. Section 523(a)(14) has had little impact thus far, perhaps because of the difficulty in tracing the source of cash used to pay taxes. It would similarly be difficult to trace the source of cash used by a debtor to pay nondischargeable obligations, such as child support, whenever these obligations were paid from an account into which the debtor deposited both borrowed funds and funds received from other sources.
§142 ( "Credit extensions on the eve of bankruptcy presumed nondischargeable") (see H.R. 2500, §107).
The changes. Current §523(a)(2)(C) provides that if a debtor borrows more than $1000 from a single creditor for items that are not needed for the support of the debtor or the debtor’s dependents, or takes cash advances of more than $1000, within 60 days of the filing of a bankruptcy, the debt is presumed to have been obtained by fraud. In keeping with the consensus reflected in In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996), this would mean that the debtor is presumed to have incurred the debt without intending to repay it. The proposed change would expand this presumption to all consumer debts incurred within 90 days preceding the bankruptcy. [Note: the proposed language continues to include the phrase "consumer debts owed to a single creditor." In view of the fact that there is no longer a minimum borrowing requirement for invoking the exception, this phrase serves no purpose and may be confusing—e.g., creating the impression that only one creditor could assert the presumption.]
The impact. The impact of the presumption, under current law, would be to require debtors to carry the burden of establishing, in response to a creditor complaint alleging fraud, that they did intend to repay each debt incurred by them within three months of the bankruptcy filing. The expanded presumption would have an impact far beyond the credit card matters to which the presumption now applies, applying, for example to medical debts, grocery bills, and rent obligations. The impact of this provision would be increased by §143, which makes debts arising from fraud nondischargeable in Chapter 13. Finally, §145, discussed below, would change the standard for fraud in the use of credit cards, significantly increasing the burden of the debtor under §142.
Alternatives. The present law could be amended to make clear that the misconduct leading to nondischargeability is incurring debt with an intent not to repay the debt. With this understanding, other circumstances might be set out in which debt incurred shortly before bankruptcy is presumed to be nondischargeable: for example, debt incurred to finance casino gambling, or debt incurred in excess of some percentage of the debtor’s ordinary expenses.
§143 ( "Fraudulent debts are nondischargeable in Chapter 13 cases") (see H.R. 2500, §104).
The changes. This section would limit the superdischarge available in Chapter 13 by excluding from that discharge debts incurred by fraud (as defined by §523(a)(2) of the Code); by fraud or defalcation while acting as a fiduciary, embezzlement, or larceny (as defined by §523(a)(4)); and intentional torts (as defined by §523(a)(6)). [Note: the rationale of this section would require that debts covered by §523(a)(3)(B) also be nondischargeable in Chapter 13. Subparagraph (a)(3)(B) governs debts nondischargeable under §523(a)(2), (4), and (6), as to which notice was not given to the creditor in time to file a timely complaint to determine dischargeability.]
The impact. This provision would increase the recovery of certain creditors after the completion of a Chapter 13 case. However, the provision would also largely eliminate the superdischarge of Chapter 13, thus removing a major incentive for filing Chapter 13 cases, and increasing the need for court hearings.
The largest number of nondischargeability complaints brought before bankruptcy courts in recent years has been on account of alleged fraud by debtors in the use of credit cards. The courts have struggled with the application of the fraud provisions of §523(a)(2) of the Code to credit card debt, but a consensus has emerged that the use of a credit card is fraudulent if the debtor had an actual intent not to repay the credit card charge at the time the card was used. See In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996). This, in turn, presents a question of fact that can require a trial. Rather than incur the expense of such a trial, a debtor may, under current law, seek relief under Chapter 13, and, if the plan is successfully completed, the debtor will be discharged from the credit card debt regardless of the circumstances under which it was obtained. Under the proposal, the question of the debtor’s intent (and the dischargeability of the debt) would remain in Chapter 13, thus providing no incentive for the debtor to choose that chapter, and presenting the courts with the potential for more hearings on the dischargeability of credit card debt. Similar incentives to file Chapter 13 exist when the debtor has engaged in conduct that might give rise to claims for breach of fiduciary duty or intentional torts. All of these incentives to file Chapter 13 are removed by this provision. It can thus be expected to increase the incentives to file Chapter 7—discharging all other debts without payment—leaving only the questionable debt to be dealt with outside of bankruptcy.
§144 ( "Applying the codebtor stay only when it protects the debtor") (see H.R. 2500, §118; S. 1301, §305).
The changes. Under present law, if a Chapter 13 debtor is liable with another party on a particular debt, the creditor is automatically stayed from taking action against the other party, but the creditor may obtain relief from this codebtor stay if the codebtor received the consideration for the claim. Section 144 of H.R. 3150 would change this situation by providing that the codebtor stay would never go into effect if the debtor did not receive the consideration, so that the creditor, in that circumstance, could take action against the codebtor or property not in the possession of the debtor. The section also provides for termination of the codebtor stay as to any rented property that the debtor’s plan proposes to abandon or surrender.
The impact. Contrary to the title of this section of the proposed bill, the codebtor stay in Chapter 13 never protects the debtor. Actions against the debtor are stopped by the automatic stay invoked in all chapters of the Code. Rather, the codebtor stay allows the Chapter 13 debtors to pay, through the plan, debts for which they are primarily responsible, and protects codebtors who did not receive the benefit of the debt (that is, true accommodation parties) from collection actions. Under current law, if the creditor believes that the nondebtor obligor was the one who really obtained the benefit of the debt, the creditor may seek relief from the codebtor stay to allow action to be brought against the codebtor (and property owned by the codebtor). The proposed change states that the codebtor stay never goes into effect when the codebtor received the benefit of the transaction. When the debtor and another party jointly incur a liability (like a joint loan, or a cosigned loan), it may not be clear which of the parties received the benefit of the transaction. Current law protects true accommodation parties by requiring that the creditor seek court permission before acting against them on the belief that they were the ones receiving the benefit of the transaction. The change would allow creditors to take action without court permission, and require that debtors seek sanctions for violation of the stay if the debtor was the actual beneficiary. It is not clear which approach is most efficient. The issue is not a common one.
There is no apparent reason why a surrender of leased property should eliminate the need for the codebtor stay. Where a nondebtor signed a personal property lease as an accommodation to the debtor, the debtor would—under current law—retain the right to pay whatever obligations arose from the lease in full through the plan, regardless of whether the debtor kept the leased property. In such a situation, the party who signed the lease as an accommodation should continue to be protected from collection actions while the debtor was making plan payments.
§145 ( "Credit extensions without a reasonable expectation of repayment made nondischargeable") (new)
The changes. Current law deals with misuse of credit cards as a type of fraud, and, accordingly, the courts have generally held that misuse of a credit card is only nondischargeable if the debtor did not intend to repay the charges made before filing bankruptcy. Thus, a debtor who uses a credit card foolishly, but in good faith, is able to obtain a discharge of the resulting debt. See In re Anastas, 94 F.3d 1280, 1285 (9th Cir. 1996) (applying this interpretation). Section 145 of H.R. 3150 would change this rule to provide that if the debtor used a credit card "without a reasonable expectation or ability to repay," the resulting debt is nondischargeable. In this way, the debtor’s financial situation would be reviewed as of the time the credit card was used, and, if a reasonable person would have concluded that the debtor was unlikely to be able to repay the debt, the debt would be nondischargeable.
The section makes a second change not related to its title, dealing with false written statements about the debtor’s financial condition. Current law makes such statements the basis for nondischargeability only when, among other things, the debtor intends to deceive the creditor. The proposal would change this standard of intent to one of negligence, allowing a finding of nondischargeability if the debtor did not take reasonable steps to assure that the statement was accurate.
The impact. This proposal would make a major change in dischargeability law. In general, debts have been held nondischargeable under the Bankruptcy Code in only two situations: (1) where the debt is one that must be repaid for the good of society, such as taxes and family support, and (2) where the debtor has engaged in intentional wrongful conduct. Negligence, except in situations involving fiduciary duties, has not been a ground for nondischargeability. This proposal would institute a negligence standard for fraud, both in the use of credit cards and in the completion of financial statements.
The change with respect to credit card debt is the most significant, because so many of the nondischargeability cases now before the courts involve this issue. The impact of the change is to render nondischargeable all use of credit cards beyond the reasonable ability of the debtors to repay.
The impact of the proposed change is magnified by two of the other changes proposed by H.R. 3150: the presumption of nondischargeability that would be created by §142, and the extension of nondischargeability to Chapter 13, proposed by §143. The combined effect of these provisions is to render all use of credit cards within 90 days of bankruptcy nondischargeable, in both Chapter 7 and Chapter 13, unless the debtor can prove that there was a reasonable prospect for repaying the charges.
Subtitle E ( "Adequate Protections for Lessors")
§161 ( "Giving debtors the ability to keep leased personal property by assumption") (see H.R. 2500, §116).
The changes. This section would make two principal changes to the Bankruptcy Code. First, it would remove from the estate (i.e., abandon) all leased personal property as to which the lease is not assumed. In Chapter 7, this abandonment would occur when the lease is rejected by the trustee (which occurs automatically, under existing law, if the trustee does not assume the lease within 60 days of the filing of a voluntary case). [Note: the section states that "the leased property is no longer property of the estate and the stay under section 362(a) of this title is automatically terminated." This language is redundant, since §362(c)(1) already provides that the stay terminates as to property of the estate when the property is no longer property of the estate. By including the extra language terminating the stay, this provision might lead to confusion, for example, the erroneous belief that the stay was terminated as to personal actions against the debtor arising out of the lease.] In Chapter 13, the abandonment would occur if the lease was not assumed in the plan and the codebtor stay would also terminate on lease rejection.
The second effect of the section is to permit the equivalent of reaffirmations with respect to leased property through assumption of the leases, and to eliminate the automatic stay as it would apply to discussions regarding such assumptions. Under the procedure set out by the section, the debtor would have to initiate discussions regarding assumption of a lease through a written notification.
The impact. The provisions regarding abandonment of leased property make explicit the implication that leased property as to which the lease is rejected is no longer part of the bankruptcy estate.
The provisions regarding assumption of leases by the debtor in Chapter 7 may require additional safeguards. Reaffirmations of debt have been a sensitive subject under the Bankruptcy Code, since they involve debtors repaying debts that otherwise would be discharged. To prevent overreaching by creditors in this regard, the Code presently contains a number of safeguards applicable to reaffirmation, including information that must be given to the debtor, determinations by debtor’s counsel that the reaffirmation is in the debtor’s best interest, and court authorization of reaffirmations for unrepresented debtors. Unless similar protections were enacted in connection with assumed leases (with cure of past due indebtedness) creditor overreaching could be a similar problem.
§162 ( "Adequate protection of lessors and purchase money secured lenders";) (see H.R. 2500, §212).
The changes. This section of the proposed bill would create a new provision in Chapter 13, requiring payments to secured creditors and lessors of personal property. These payments would be in the amounts and frequency specified by the applicable contract unless the debtor sought a court order reducing the amounts and frequency. However, the court would be required to order payments no less than monthly in an amount no less than the depreciation of the property involved. These payments would be required to continue until the creditor began receiving "actual payments" under the Chapter 13 plan.
The section would also clarify the right of creditors to retain possession of the debtor’s property, if it was properly obtained before the bankruptcy was filed, until the creditor receives the first adequate protection payment required by the section.
Finally, the section requires that debtors in Chapter 13 must provide proof of insurance of leased property and collateral within 60 days of the filing of the bankruptcy.
The impact. Secured creditors are entitled to seek adequate protection, pending plan confirmation, under existing law, and are entitled to relief from the automatic stay if adequate protection is not provided. This provision would give secured creditors a presumptive right to more than adequate protection payments, because the underlying contract (for example, a mortgage or an auto note or lease) generally provides for payments at a level greater than necessary to offset depreciation. The debtor would be required to present a motion to reduce the presumptive payments to the actual level of depreciation (if any). That would involve significant additional cost in most Chapter 13 cases.
Under existing law, it may be unclear whether a creditor in rightful possession of a debtor’s property at the outset of a bankruptcy case must return the property in the absence of adequate protection. The proposal would make it clear that adequate protection is required.
The requirement for periodic proof of insurance may be an unnecessary burden on debtors, since creditors are generally informed by insurers as to any lapse in coverage. Moreover, if the creditor is not assured of such notice, the creditor would have to take action to ascertain the status of the insurance before 60 days had elapsed from the date of the bankruptcy filing. Proof of insurance by the debtor at the conclusion of the 60 day period would add little protection to the creditor.
§163 ( "Adequate Protection for Lessors") (new).
The changes. Despite its caption, this section deals with an exception to the automatic stay. Under current law, lessors of nonresidential real estate (for example, shopping center lessors) may proceed with eviction proceedings after the lessee files a bankruptcy case, without violating the automatic stay, if the lease has terminated by expiration of its stated term prior to the bankruptcy filing. Section 163 of H.R. 3150 would expand this exception to cover all rented real estate. Thus, landlords would be allowed to evict Chapter 13 debtors from their apartments, without obtaining relief from the automatic stay, if the leases expired prior to the bankruptcy filing.
The impact. There is no reason for the automatic stay to apply to an expired residential lease. A lease can only be assumed by a debtor in Chapter 13 if it is unexpired, pursuant to §§365(a) and 1322(b)(7). However, a debtor and landlord may well be in dispute about whether a lease has expired. Many leases have automatic renewal terms, contingent on notice being given or the lease not being in default. If there is a dispute about lease expiration, then, under current law, the landlord would be required to obtain relief from the automatic stay before going forward with an eviction proceeding in state court. See, e.g., Robinson v. Chicago Housing Authority, 54 F.3d 316 (7th Cir. 1995) (affirming an order granting relief from the stay to pursue eviction). Under the proposed change, the landlord, in the event of such a dispute, would be able to go forward with the eviction, requiring the Chapter 13 debtor—believing that the lease was still in effect—both to defend the eviction proceeding and to bring a proceeding in bankruptcy court to have the landlord found in violation of the automatic stay. If the debtor prevailed, fees and costs would be awarded, pursuant to §362(h), but the debtor may have difficulty in the first instance in obtaining the funds to pursue proceedings in both courts. Although this is not a situation that arises frequently, it may be preferable to continue to require that evictions in situations of residential leases be subject to the automatic stay.
On the other hand, the proposed exception could be applied in Chapter 7 cases without harm to the rights of the debtor, since Chapter 7 debtors have no right to assume defaulted leases.
Alternative. The expanded exception could be applied in Chapter 7 cases only.
Subtitle F ( "Bankruptcy Relief Less Frequently Available for Repeat Filers")
§171 ( "Extended period between bankruptcy discharge") (see H.R. 2500, §121).
The changes. Current law allows a Chapter 7 discharge to be entered only once in six years. The proposal would change this to a 10 year interval. Current law imposes no limit on Chapter 13 discharges, although the discharge can only be entered at the completion of a plan, and most plans require a three to five year period to complete under current law. The proposal would require that a Chapter 13 discharge not be granted if the debtor received any bankruptcy discharge within the five year period prior to filing the Chapter 13 case.
The impact. These proposals would render large numbers of debtors unable to obtain any bankruptcy relief for an extended period of time, and would substantially reduce the incentives for using Chapter 13.
It is entirely possible for individuals to require bankruptcy relief on more than one occasion with a span of a few years. Job loss, medical problems, and divorce can each cause financial difficulties that an individual cannot overcome. Under current law, the individual can obtain a Chapter 7 discharge to address these problems only once in six years, but could submit to a Chapter 13 repayment plan and obtain relief within the six year period. The availability of such a discharge is one of the major incentives for the use of Chapter 13. That possibility is removed by the proposed provision, leaving the individual with no means of requiring creditors to accept pro rata payment of the debtor’s available funds. The result would be the "race to the courthouse" that bankruptcy was intended to avoid, with the more aggressive creditors getting the larger share of wage garnishments and judgment lien foreclosures. The incentive for creditors to cooperate with consumer counseling services in these situations would also be greatly reduced, since the debtor would not have the option of bankruptcy in the event of noncooperation, and noncooperating creditors would have an advantage over those who did cooperate.
Alternative. The required period between Chapter 7 discharges could be extended without imposing limits on Chapter 13 discharges.
Subtitle G ( "Exemptions")
§181 ( "Exemptions") (see H.R. 2500, §113).
The changes. This section impacts the perceived problem of debtors changing their residence in order to obtain more favorable homestead exemptions. Current law applies the exemption law of the place where the debtor’s domicile was located for the largest part of the 180 days preceding the bankruptcy. Thus, a debtor could obtain a homestead exemption by establishing a domicile in a new state 91 days prior to filing a bankruptcy. The change would increase the 180 day period to 365 days, requiring that a debtor, seeking a homestead exemption in a new state, must establish a new domicile 183 days before filing bankruptcy.
The impact. This proposal will likely have very little impact. Only a few, wealthy debtors are likely to change state of domicile in order to obtain larger exemptions, and those debtors are likely to be able to wait for six months before filing bankruptcy.
Alternatives. The fundamental issue regarding exemptions is whether they should be more uniform, so that debtors do not receive significantly differing treatment in bankruptcy depending on their state of domicile. Greater uniformity would reduce the incentive for debtors to change domicile before filing bankruptcy petitions. Such a change in exemption law has been proposed by the National Bankruptcy Review Commission. Final Report at 117-44. H.R. 2500 proposes a new commission to study the question.
Title II ( "Business Bankruptcy Provisions")
Title III ( "Municipal Bankruptcy Provisions")
These titles do not involve consumer bankruptcy issues and are therefore not treated in this analysis.
Title IV ( "Bankruptcy Administration")
Subtitle A ( "General Provisions")
§401 ( "Adequate preparation time for creditors before the first meeting of creditors in individual cases") (see H.R. 2500, §204).
The changes. This section would amend the Bankruptcy Code to provide that first meetings of creditors take place between 60 and 90 days after the filing of voluntary individual bankruptcy cases, unless the court orders an earlier meeting.
The impact. Under current law, set out in Fed.R.Bankr.P. 2003(a), the first meeting of creditors must take place between 20 and 40 days after case filing in voluntary Chapter 7 and 11 cases, and between 20 and 50 days in a Chapter 13 case. The proposal would delay these times by more than a month. This may allow greater creditor involvement in consumer bankruptcy cases, but it would have the drawback, particularly in Chapter 13 cases, of delaying payouts to creditors.
§402 ( "Creditor representation at first meeting of creditors") (see H.R. 2500, §205; S. 1301, §308).
The changes. This provision would allow nonattorneys to represent creditors at creditor meetings.
The impact. This proposal would have the potential for increasing creditor involvement in any areas where appearances by nonattorneys are currently prohibited.
§403 ( "Filing proofs of claim") (see H.R. 2500, §209).
The changes. This section changes the law that currently requires the filing of a proof of claim in order for a creditor to share in the distribution of payments in Chapter 7 and 13 cases. Under this provision, a proof of claim would be deemed filed as to all debts scheduled by the debtor as other than disputed, contingent, or unliquidated.
The impact. Frequently, consumer debtors have poor records of what they owe. Accordingly, the debtors often schedule debts that either are not owed, or are owed in smaller amounts than scheduled. The requirement of a proof of claim by the creditor assures that an actual debt is paid in an appropriate amount. Treating all scheduled debts as proofs of claim may result in overpayments of claims, or payment of claims that are not owing, reducing the payments to creditors with actual, accurate claims.
The requirements for filing proofs of claims, as well as the results of untimely filing, were extensively treated in the 1994 Bankruptcy Reform Act. This provision would undo what has only recently become settled law.
§404 ( "Audit procedures") (see H.R. 2500, §202; S. 1301, §307).
The changes. This section of the proposed bill would establish a system for random audits of the accuracy and completeness of schedules and other information required to be provided by debtors in bankruptcy. The proposal would require that at least 2% of all cases be audited "in accordance with generally accepted auditing standards . . . by independent certified public accountants or independent licensed public accountants." The proposal requires the Attorney General to establish procedures for fully funding the audits, but does not specify a source of funding. The report of each audit is to be filed with the court, the Attorney General, and the United States Attorney, and if the audit report discloses any material misstatement of income, expenses, or assets, notice of the misstatement is required to be given to creditors and to the United States Attorney for possible criminal investigation. [Note: the sentence of the proposal dealing with material misstatements requires rewriting to correct syntactical errors.]
The impact. This proposal reflects a recommendation of the National Bankruptcy Review Commission (Final Report at 107-110), and would provide an incentive for debtors and their counsel to provide accurate and complete information. However, formal audits by licensed accountants would also generate substantial costs. With bankruptcy filings exceeding 1 million per annum, an audit cost of only $500 per case would impose an additional cost of at least $10 million per annum; at $1000 per case, a more likely figure given the poor record-keeping of many consumer debtors, the 1.4 million bankruptcies filed last year would generate an audit cost of $28 million. Since the proposal does not identify a source for funding the audits, the impact of the cost is uncertain. If the cost were treated as an administrative expense, creditors would pay for the audits in the form of reduced payments on their claims. A fairer way to pay for audits would be through the fees currently collected from debtors (at the time of filing) and creditors (seeking relief from the automatic stay), but to allow payment from current fees, the cost of the audits would have to be restrained.
Additionally, the requirement that audit reports be filed in multiple locations will impose additional costs for document retention on offices inolved, and, depending on the detail of the reports, involve unnecessary intrusions on the debtors’ privacy.
Alternatives. In order to reduce costs, audits could be conducted by trained employees of the United States trustee, rather than by licensed accountants, according to regulations established by the Executive Office of the United States Trustee, rather than generally accepted auditing standards. With costs controlled, the source of funding for the audits can be specified as the existing fees collected in bankruptcy cases, without an increase in those fees.
§405 ( "Giving creditors fair notice in Chapter 7 and 13 cases") (see H.R. 2500, §206; S. 1301, §309).
The changes. The primary change made by this section is a requirement that creditors be given notice of a bankruptcy filing at their preferred addresses. Under current law, if a creditor actually receives notice of a bankruptcy case, it may be liable for sanctions for willful violation of the automatic stay if it thereafter takes action to enforce its rights against collateral or otherwise collect a debt owed by the debtor. This provision would eliminate sanctions for violation of the stay (or failure to turn over property of the estate) in situations where notice of the bankruptcy was sent to an address of the creditor other than the last address it provided to the debtor for correspondence regarding the debtor’s account. This elimination of liability would only apply if (1) the creditor had a designated person or department for receiving bankruptcy notices, (2) the creditor had a reasonable procedure for directing bankruptcy notices to that person or department, and (3) despite the reasonable procedures, the creditor’s designated person or department did not receive the notice in time to prevent the collection activity from taking place.
The impact. This proposal would eliminate sanctions for violation of the automatic stay in situations where notice of a bankruptcy was received by personnel of the creditor who were unable to prevent subsequent collection action. However, it would also complicate litigation regarding violations of the automatic stay. If a creditor took collection action after the bankruptcy case was filed, there would be questions subject to litigation concerning (1) the last address specified by the creditor in a communication, (2) whether the creditor had reasonable procedures in place for directing the communication to a particular person or department, and (3) whether that person or department received the notice in time to prevent the collection activity from taking place. Most of the information relating to these matters would be exclusively in the possession of the creditor, making it difficult for debtor’s counsel to determine whether an intentional violation of the automatic stay had occurred without substantial discovery. Lacking the resources to pursue such discovery, debtors might be unable or unwilling to pursue enforcement action.
§406 ( "Timely filing and confirmation of plans in Chapter 13") (see H.R. 2500, §114; S. 1301, §304).
The changes. This section would set a time limit for Chapter 13 debtors to file plans—30 days after the filing of the bankruptcy case. The section would also require that hearings on the confirmation of the plan take place within 45 days of the filing of the plan. In each situation, the court could order the deadline altered.
The impact. Under current law, Fed.R.Bankr.P. 3015(b), a plan is required to be filed either with a Chapter 13 petition or within 15 days thereafter, unless extended by the court for cause. The proposal would increase the time in which a debtor would be allowed to file a plan. This, in turn, would delay payments into the plan, which are required by §1326(a) of the Code to commence within 30 days after the plan is filed. There is no current time limit for the hearing on confirmation, but some courts have determined to delay confirmation until after the deadline for filing claims has passed. The proposed change would require that these courts enter orders extending the time for hearing if this practice were to be continued. This section conflicts with other provisions of H.R. 3150. See the discussion in connection with §409, below.
Alternatives. In order to effectuate timely confirmation of Chapter 13 plans, the 15 day time limit for plan filing might be enacted as part of the Code itself, rather than being part of the bankruptcy rules.
§407 ( "Debtor to provide tax returns and other information") (see H.R. 2500, §210; S. 1301, §301).
The changes. This section would add several items to the information that individual Chapter 7 and 13 debtors are required to provide in connection with a bankruptcy case, unless ordered otherwise by the court. These items include (but are not limited to) the following: (1) copies of any federal tax returns, including schedules and attachments, filed by the debtor during three years prior to the bankruptcy case; (2) copies of any tax returns and schedules filed during the pendency of the case, either for current tax years, or for the three years preceding the filing; (3) any amendments of the returns set out above; (4) evidence of payments made by any employer of the debtor during the 60 days prior to the filing of the case; and (5) a certificate regarding the debtor’s receipt of the proposed required notice regarding consumer credit counseling services. In addition, a Chapter 13 debtor would be required to file annually a statement of the debtor’s income and expenditures in the preceding year and the debtor’s monthly net income during that year, showing how calculated, disclosing the amount and sources of income, the identity of the persons responsible with the debtor for the support of any dependents, and any persons who contributed (and the amounts contributed) to the debtor’s household. Also, debtors would have the obligation to provide copies of their petition, schedules, statement of affairs, and any plan and plan amendments to any creditor on request of the creditor, and any copies of such filings made subsequent to the request. Tax returns would be filed with the United States trustee; the other information would be filed with the court. All of these filings, including the tax returns and amendments, would be available to any party in interest for inspection and copying.
The impact. This section has the potential for making information available to trustees and creditors that may be significant in the administration of the debtor’s case. However, Fed.R.Bankr.P. 2004 currently allows information regarding the debtor’s financial condition—including tax returns—to be obtained, as required, with disclosure limited to the parties who need the information, and with the potential for court orders limiting further disclosure. The general disclosures required by the changes proposed here would impose two significant burdens not part of current law: (1) There would be a potentially difficult and expensive provision of information in every case, regardless of the need for the information. Since debtors in financial distress often fail to retain financial documentation, it is likely that they will not have ready access to their tax returns for the three years preceding the bankruptcy, or to their pay stubs for two months preceding bankruptcy. Similarly, during a bankruptcy, debtors are likely to have difficulty maintaining detailed records regarding their expenditures and sources of income. (2) The changes would involve a significant intrusion into the privacy of the debtors. Tax returns are not public documents, and are ordinarily disclosed in litigation only when they are particularly relevant to a dispute, and only to the parties with a need to review them. This provision would require debtors to make several years of their tax returns available for review by any creditor, and the creditors would be free to make whatever use they wished of the information contained in the returns, including compiling and disseminating it. Both the difficulty and cost of assembling the required information and the intrusion on privacy would act as substantial barriers to good faith bankruptcy filings.
The requirement that debtors provide copies of petitions, schedules and plans to all creditors on request may encourage routine requests for such documents by creditors who do not require these documents for their participation in the bankruptcy case (current law requires notice to creditors of the essential events in the case), imposing additional expense on debtors and their counsel.
The provision that the required information need not be supplied if the court orders to the contrary creates the potential for substantial variations in practice from court to court. Some judges may determine that certain of the information (or all of it) is not required unless requested by a creditor with cause; other judges may routinely deny any request by debtors to limit the information. No standards are supplied.
Finally, the need to file all of the additional documents in each consumer case would impose a substantial additional cost on the clerks’ office and offices of the United States trustee.
§408 ( "Dismissal for failure to file schedules timely or provide required information") (see H.R. 2500, §211; S. 1301, §312).
The changes. This section creates a new ground for dismissal of Chapter 7 and 11 cases—failure to provide the information required by §407. Failure to file initial documents (including past tax returns and pay stubs) results in mandatory, automatic dismissal on the 46th day after filing, subject only to a timely request by the debtor for an extension of up to 15 days. The court is required to enter an order confirming the dismissal if requested by any party. Failure to file (or supply to creditors on their request) any subsequently required documents is also subject to mandatory dismissal, upon request of any party in interest. The deadline for compliance with a creditor request is to be set by the court within 10 days of the request, and may not exceed 30 days.
The impact. The difficulty of complying with the proposed initial disclosures (of tax returns and pay stubs) is noted in the discussion of §407, above. Section 408 would impose automatic dismissal as a penalty for failure to comply with these disclosure requirements, without providing notice to the debtor of any deficiency in the filing. Although the debtor is given an opportunity to seek an additional 15 days to comply, no further extensions are authorized. Given that it may take more than 60 days to obtain copies of tax returns from the Internal Revenue Service, these provisions may result in dismissal of cases filed in good faith. In connection with enforcing the requirements for postpetition copies and tax information, the court is also given no discretion. It must order the information produced and dismiss the case if the order is not complied with. These provisions would discourage good faith filings at the outset, and may result in dismissal of cases that are filed and prosecuted in good faith.
Rather than making debtors subject to such dismissal, some courts may generally order that the documents need not be filed, but, as noted above, in the discussion of §407, no standards are provided for orders of nonproduction, and practice among courts can be expected to vary widely.
Alternative. The failure of a debtor to provide information ordered by a court to be produced to a creditor in connection with an examination pursuant to Fed.R.Bankr.P. 2004 could be specified as a ground for dismissal of both Chapter 7 and Chapter 13 cases.
§409 ( "Adequate time to prepare for hearing on confirmation of the plan") (see H.R. 2500, §213; S. 1301, §313).
The changes. This section provides that the hearing on confirmation of a Chapter 13 plan must take place no sooner than 20 days and no later than 45 days after the first meeting of creditors.
The impact. H.R. 3150 is internally inconsistent in setting the time for the hearing on confirmation of a Chapter 13 plan. Section 406 requires that the hearing on confirmation take place within 45 days of plan filing, which may be no later than 30 days after the filing of the case. Thus, §406 requires that the confirmation hearing take place no later than 75 days after the bankruptcy filing. However, under Section 401, the earliest that the creditors’ meeting can take place is the 60th day after case filing, and §409 requires that the confirmation hearing take place no earlier than 20 days thereafter, or no earlier than the 80th day after filing. It is impossible to comply with both sets of provisions.
Present law, which requires prompt filing of plans (within 15 days of the filing of a Chapter 13 case), and prompt creditor meetings (between 20 and 50 days after case filing), with no deadline for the confirmation hearing, allows (1) the creditor meeting to take place after the plan is filed, and (2) the creditor meeting to take place prior to confirmation. There does not appear to be any need to change these time frames. The different times provided for by the proposed bill would delay plan confirmation in many cases, without assuring more time for creditor review of the plan.
Alternative. If a change is to be made in the time frames of current law, the various provisions now included in H.R. 3150 must be harmonized.
§410 ( "Chapter 13 plans to have a 5-year duration in certain cases") (see H.R. 2500, §117).
The changes. This section would increase the term of Chapter 13 plans from the present range of three to five years to a new range of five to seven years, for all debtors with total monthly income equal to at least 75% of the national median for their household size. The proposal would retain the three-to-five year range for those earning less than 75% of the applicable median. In each situation, plans lasting longer than the minimum plan term would require court approval. These provisions should be read in conjunction with §102 of the proposed bill, discussed above, which requires that all net income of the debtors be paid to general unsecured creditors for the minimum plan term.
The section also amends §1329 of the Code, which governs modified plans. Although an original plan is allowed, with court approval, to have a duration two years beyond the minimum term, the amendment would prohibit this extension for modified plans.
The impact. Consistent with §102 of H.R. 3150, this section would have the effect of lengthening the minimum Chapter 13 plan term from 3 to 5 years for most Chapter 13 debtors. This increase in minimum plan length may result in increased payments to creditors, but only if the plans are completed. Increased plan length may discourage use of Chapter 13 by debtors who have the choice of Chapter 7, and may decrease successful plan completion by those who do choose Chapter 13.
Extending plans beyond the minimum term is sometimes in the debtor’s interest—in order to cure large mortgage arrearages or retire nondischargeable debt. There is no apparent reason why this extension should be prohibited in modified plans.
§411 ( "Sense of the Congress regarding expansion of Rule 9011 of the Federal Rules of Bankruptcy Procedure") (new).
The changes. Fed.R.Bankr.P. 9011 is the bankruptcy analog to Rule 11 of the Federal Rules of Civil Procedure. It requires the signature of the attorney (for a represented party) or of the party (if unrepresented) on documents filed with the court, and provides that this signature constitutes a certificate that the document is, among other things, well grounded in fact—based on the signer’s knowledge, information, and belief, formed after reasonable inquiry. Currently, Rule 9011 does not apply to schedules, apparently with the understanding that debtors’ attorneys are not economically able to independently verify the accuracy of the information supplied by their clients. This section suggests that the Rule be modified to apply to all filings, specifically including schedules.
The impact. Requiring independent verification by debtors’ attorneys of all of the schedule information required of their clients would delay bankruptcy filings and increase the cost of legal services, thus discouraging good faith filings. In light of the auditing requirement proposed both by this bill and by the National Bankruptcy Review Commission, it is questionable that attorney verification of schedules is needed to assure accuracy. Any determination of the need for such a change in the law could be made after the initial results of the audits become available.
§412 ( "Jurisdiction of Courts of Appeals") (new)
The changes. Under present law, appeals of decisions of bankruptcy courts are heard by the district courts or by Bankruptcy Appellate Panels, composed of bankruptcy judges. This section would grant jurisdiction over such appeals to the Circuit Courts of Appeals.
The impact. The current system of appeals generates appellate decisions that are largely without binding precedential impact. Decisions of the Courts of Appeals would be binding on all courts within the circuit, promoting intercircuit uniformity.
Subtitle B ( "Data Provisions")
§441 ( "Improved bankruptcy statistics") (see H.R. 2500, §201: S. 1301, §306).
The changes. This section would require the Director of the Executive Office for United States Trustees to compile bankruptcy data in specified categories and require the Administrative Office of the United States Courts to specify the form of the data and make it public.
The impact. Although this provision would be costly to implement, it has the potential for making useful information available to those interested in the functioning of the bankruptcy system. The National Bankruptcy Review Commission (Final Report at 921-43) recommended that a similar program of data collection and reporting be implemented. One potential problem in the proposed legislation is in its specification of matters for data collection and reporting. The Review Commission suggested a pilot program to develop effective programs, and this might be preferable to establishing categories for data collection by legislation. As an example of the problem with legislative specification, the proposal includes a requirement that data be collected and reported as to "the number of [Chapter 13] cases in which a final order was entered determining the value of property securing a claim less than the claim." Such a report would likely yield little useful information, since in many situations of the cramdown of secured claims the parties negotiate an appropriate bifurcation, with no court order entered.
Alternatives. It may be preferable to implement the Review Commission’s recommendation of a pilot program to determine effective categories and methods of data collection and reporting.
§442 ( "Bankruptcy data") (see H.R. 2500, §203)
The changes. This proposal would require the Attorney General to issue regulations for uniform reporting of bankruptcy cases on standard forms, designed to facilitate both physical and electronic access to the information contained in the reports. Detailed contents of the reports are specified.
The impact. A consistent reporting system would provide many benefits, and has been recommended by the National Bankruptcy Review Commission as part of a national bankruptcy filing system (Final Report at 105-07).
Alternatives. It may be preferable to allow the details of any reporting system to be developed by the office administering the system, rather than specifying them in the statute.
§443 ( "Sense of the Congress regarding availability of bankruptcy data") (see H.R. 2500, §203).
The changes. This proposal effectively recommends that Congress establish a national bankruptcy filing system.
The impact. A nationwide reporting system would provide many benefits, and has been recommended by the National Bankruptcy Review Commission (Final Report at 105-07).
Title V ( "Tax Provisions")
Most of the sections of Title V do not involve consumer bankruptcy issues and are therefore not treated in this analysis.
§502 ( "Enforcement of child and spousal support") (new)
The changes. This section adds additional language to a provision of Section 522(c) that excepts certain tax and family support obligations from the general rule that exempt property is not liable for debts. See In re Davis, 105 F.3d 1017, 1022 (5th Cir.1997) (allowing enforcement of child support against property exempt under state law).
The impact. Although the proposed language is apparently intended to clarify the meaning of the statutory provision, it does so by creating an exception to the exception already in the statute, and may therefore engender additional confusion.
§503 ( "Effective notice to government") (new)
The changes. This section specifies that all notices from a debtor to a governmental agency (as well as the original scheduling of the agency as a creditor) must contain detailed information regarding the nature of the agency and its claim. For example, a real estate tax claim is required to be identified by real estate parcel number. The clerk of court is required to maintain a register of "safe harbor" mailing addresses that may be used by debtors. The Advisory Committee on Bankruptcy Rules of the Judicial Conference is required to propose "enhanced rules" for providing notice to governmental agencies, incorporating the provisions earlier set out in the section. Notices not in compliance with the proposed requirements would have no effect unless, among other things, the debtor showed either that notice was sent to the safe harbor address, or both that no safe harbor address had been specified and that there was actual notice to a responsible officer of the appropriate agency. If notice of the commencement of the case was not given in compliance with the requirements of the section, governmental violations of the automatic stay and turnover provisions of the Code would not result in any sanction.
The impact. The provision would provide surer notice to governmental agencies. Some of the detail required, however, may unnecessarily increase the cost of case filing, and litigation can be anticipated on issues of whether notices were in compliance with the requirements. See the discussion in connection with §405, above.
§508 ( "Chapter 13 discharge of fraudulent and other taxes") (new)
The changes. This section would make the tax obligations that are defined by §523(a)(1) of the Code nondischargeable in Chapter 13 cases as well as in Chapter 7 cases.
The impact. Together with §143, this section of H.R. 3150 has the effect of largely eliminating the superdischarge of Chapter 13. See the discussion of this issue in connection with §143, above.
§514 ( "Tardily filed priority tax claims") (new)
The changes. The Bankruptcy Code was amended in 1994 to provide that tardily filed tax claims are entitled to priority in Chapter 7 cases until the time that the trustee commences distribution. This section would provide, instead, that tardily filed tax claims are entitled to priority until the court approves the trustee’s final report and accounting.
The impact. This section would create severe problems of administration for trustees. The section would apply in situations where the trustee had already made payments to creditors in a Chapter 7 case, but before the trustee’s final report had been approved. In this situation, the section provides that a late-filed priority tax claim would retain its priority. As a result, the trustee would have to pay the tax claim ahead of other claims of lower priority, even though distributions were already made on account of those claims. Accordingly, the trustee would have to attempt recovery of the previously distributed funds, generating substantial additional administrative expense and consequently reducing the overall distribution. There is no apparent justification for this result.
§517 ( "Requirement to file tax returns to confirm Chapter 13 plans") (new).
The changes. This section would impose on Chapter 13 debtors the obligation to file, as a condition for confirmation, all prepetition tax returns. Deadlines are specified for the filing of the returns (at least 120 days from the filing of the bankruptcy case), and failure to comply is specified as a ground for conversion or dismissal of the case. The taxing body is given 60 days after the filing of a return to submit a timely claim for the tax involved in the return. Finally, it is suggested that the Federal Rules of Bankruptcy Procedure be amended to allow objections to confirmation to be made by a taxing body "on or before 60 days after" the debtor files all of the required tax returns.
The impact. These provisions are largely reasonable, and will assist the debtor and the taxing bodies in resolving past due tax obligations. However, the suggested change in the bankruptcy rules further complicates the already very confused issue of when a confirmation hearing is supposed to take place under the provisions of H.R. 3150. See the discussion in connection with §409, above. In order to allow the suggested objection based on the filing of a tax return 120 days after the bankruptcy filing, confirmation hearings would have to be scheduled six months after the filing of the case.
Title VI ( "Miscellaneous")
This title does not involve consumer bankruptcy issues and is therefore not treated in this analysis.
To amend title 11 of the United States Code, and for other purposes.
To amend title 11 of the United States Code, and for other purposes.
To amend title 11 of the United States Code, and for other purposes.
Conference Report on H.R. 3150—Major Consumer Provisions
Prepared for: the American Bankruptcy Institute Web posted and Copyright © October 9, 1998 |
Prepared by: Hon. Eugene R. Wedoff |
See Issue 4: Additional Content and Commentary have been inserted.
H.R. 3150 was passed by the House of Representatives on June 10, 1998; S. 1301 was passed by the
Senate (as an amendment to H.R. 3150) on September 23, 1998. Both bills provided for extensive—but
conflicting—changes in consumer bankruptcy law. ABI has published several analyses of the consumer
provisions of these bills, at various stages of their consideration. The most recent analysis of the House bill can
be found at http://www.abiworld.org/legis/bills/98julhr3150.html. The most recent analysis of the Senate bill
is at http://www.abiworld.org/legis/bills/98julnew1301a.html.
On October 7, a conference report on H.R. 3150 was released, modifying many of the provisions of the
two bills. To help assess the potential impact of these changes on consumer bankruptcy law, the following chart
lists several major issues covered by the legislation as passed by the House and Senate, and discusses the
treatment of these issues by the Conference Report.
| Issue | Senate bill | House bill |
| 1. Means testing | §§101-102 A Chapter 7 case would be subject to dismissal or conversion to Chapter 13 (on the debtor's request) if the debtor could pay 20% of general unsecured claims through a Chapter 13 plan.
Any party in interest would be allowed |
§101 A debtor would be ineligible for Chapter 7 relief where (1) the debtor's household income is above a national median for same size household, and (2) the income—after deduction of (a) expenses allowed according to IRS collection standards, (b) extraordinary expenses shown by the debtor, and (c) amounts necessary to pay secured and priority debts—is both greater than $50 per month and sufficient to pay 20% of general unsecured claims over a five-year period. Trustees would be required to report on ability to repay in all Chapter 7 cases. §103 Any party in interest would be
§105 Debtors ineligible for Chapter 7 |
Content: The mechanism for means-testing would be that of the Senate bill—motions under §707(b) would be changed to
allow dismissal or conversion (at the debtor's option) in cases of simple abuse (instead of "substantial" abuse) of Chapter
7—rather than the eligibility requirement of the House bill. However, the motions would be required to be filed in many cases,
and judicial discretion to deny the motions would be strictly limited.
Commentary: The impact of the Conference Report is largely to adopt the means-testing mechanism proposed by the House
bill, which relies principally on IRS collection standards to assess reasonable expense levels for debtors, and calculates
repayment ability over a 5-year period. However, the Conference Report introduces a feature substantially different from the
earlier test—rather than limiting Chapter 7 relief to debtors who have an inability to repay a certain amount of their debt, the
Conference Report would deny Chapter 7 relief to any debtor with $83.33 in disposable income per month, regardless of the
amount of outstanding debt. For example, a debtor with medical bills totalling $200,000, and disposable income (under the
formula) of $90 per month, would be found to have made an abusive Chapter 7 filing, even though less than 3% of the
unsecured debt could be paid in a 5-year Chapter 13 plan. Conversely, debtors with very small amounts of disposable income
could be denied Chapter 7 relief if their debts were also small. For example, a debtor with disposable income of only $20 per
month could be denied Chapter 7 relief unless the unsecured debts scheduled exceeded $7200.
Several problems with the use of the IRS standards are pointed out in the analysis of the House bill cited above: for
example, the IRS standards themselves include a category ("other necessary expenses") covering the sort of individualized
expenses that also be seen as arising from "extraordinary circumstances." The standards do not specify any particular
allowance for such expenses, and thus trustees would have to assess reasonableness on a case by case basis. If an expense
arose from "extraordinary circumstances," detailed scheduling (under oath from the debtor and the debtor's attorney) would be
required. Trustees would therefore have to determine how any given expense (such as for medical care) not covered by the
other IRS categories should be categorized.
Secured debt presents another serious problem under the formula adopted by the Conference Report. The House bill
provided that payments of secured debt should be excluded from the IRS allowances. This provision had a sensible basis—the
IRS expense allowances are intended to cover all housing and transportation expenses, including the cost of acquiring a dwelling
or automobile. Therefore, if a debtor was given a separate expense allowance for repaying a mortgage or car loan, there would
be double counting of the expense. However, it is not possible to deduct mortgage or car payments from the IRS allowances,
because IRS standards establish single allowances for all of the expenses connected with housing (such as insurance,
maintenance, and real estate taxes) and all of the expenses connected with transportation (such as parking and fuel). The
Conference Report accordingly allows separate deductions of the IRS allowance and of secured debt payments, but this creates
the problem of double expense allowances in all situations of secured debt. The Conference Report formula therefore
discriminates substantially against those who rent either their housing or their automobiles. Such renters will receive only the
expense allowance provided by the IRS standards (supplemented by any showing of extraordinary circumstances). Owners of
cars or houses, in contrast, would receive not only the IRS allowance, but the full amount of their mortgage and auto loan
payments as well, unlimited in amount.
The fact that allowed expenses can be increased by incurring secured debt provides a ready means of avoiding the
proposed means test. A debtor who would otherwise have disposable income of as much as $400 per month could trade in an
old car for a new one, and the resulting increase in secured indebtedness could easily reduce the disposable income to a number
that would not result in dismissal of the Chapter 7 case. An even easier method of avoiding the test would be for a debtor to
declare an intent to make charitable contributions. Section 4 of the Religious Liberty and Charitable Donation Protection Act
of 1998, enacted earlier this year, allows debtors to contribute up to 15% of their gross income to charity without those
contributions being considered in making a determination under §707(b). Thus, a debtor with an income of $60,000 could
remove $500 per month in disposable income by declaring an intent to make the maximum charitable contributions.
| Issue | Senate bill | House bill |
| 2. Abusive Chapter 7 petitions and §707(b) motions |
§102 Debtor's attorneys would be required to reimburse panel trustees for all costs of prosecuting a successful motion to dismiss or convert under §707(b) of the Code, wherever the court found the filing of the case "not substantially justified." If the court found a violation of Rule 9011, it would be required to impose a civil penalty against the debtor's attorney in favor of the United States trustee or the case trustee. Costs could be imposed against the proponent of a §707(b) motion only if (1) the motion was not substantially justified; or (2) the motion was brought "solely for the purpose of coercing the debtor into waiving a right guaranteed . . . under the Bankruptcy Code;" and (3) the moving party was not a panel trustee, the United States trustee, or a party in interest with an aggregate claim against the estate of less than $1000. |
§103 The debtor would be required to pay the fees and costs of the United States trustee or Chapter 7 trustee who prevailed in a motion to dismiss or convert under § 707(b), unless the award of such costs would be an unreasonable hardship on the debtor. If the court found a violation of Rule 9011, it would be required to impose a civil penalty against the debtor's attorney in favor of the United States trustee or the case trustee. A creditor who brought an unsuccessful motion under §707(b) would be required to pay the debtor's fees and costs if the court found that the motion was not substantially justified, absent special circumstances making such an award unjust.
|
Content: The provisions of the Senate bill were adopted.
Commentary: The potential for an award of sanctions against debtors' counsel may have a chilling effect on representation of
debtors. Creditors with claims of less than $1000 may bring entirely groundless §707(b) motions without being liable to pay
the costs of the debtor in responding. This immunization would allow major creditors to file §707(b) motions, without
potential liability, in any case where their claims were small.
| Issue | Senate bill | House bill |
| 3. Chapter 13 plan length |
No change is made in current law, which set out a minimum plan term of three years. |
§§102, 409 Where the debtor's household income is above the national median for the same size household, the minimum plan term would be five years. |
Content: For debtors whose income equals or exceeds a specified amount, generally based on national median household
income: (a) five years is the maximum term of the plan, (b) a plan cannot be amended to provide for payments extended
beyond "the applicable commitment period under section 1325(b)(1)(B)(ii)," and (c) the "duration period" would be five years.
For debtors whose income is below the specified amount, three years would be the maximum plan term unless the court found
cause to extend the term to no more than five years (the current law as to all Chapter 13 debtors), and the "duration period"
would be three years.
Commentary: The provisions of the Conference Report are confused. There is no §1325(b)(1)(B)(ii) under current law, and
the Conference Report does not appear to add such a section. There is also no provision of the Conference Report defining
"duration period" or specifying its relevance. The provision regarding "duration period" is placed at the end of §1329 of the
Code, which deals with plans modified after confirmation, and so would not appear to require a minimum five-year plan for
any debtor. If the Conference Report did require minimum five-year plans for certain, it would make the completion of
Chapter 13 plans more difficult for these debtors, increasing incidents of default, and giving the debtors an incentive to choose
Chapter 7 over Chapter 13.
| Issue | Senate bill | House bill |
| 4. Limitation of the Chapter 13 discharge |
§314 Debts covered by §523(a)(6) would be nondischargeable in Chapter 13 only if they involved injuries resulting in personal injury or death. Debts under §523(a)(2) and (4) would be nondischargeable in Chapter 13 as well as Chapter 7.
§327 The limitations on the
No change is made to current |
§143 All debts covered by §523(a)(6) (willful and malicious injury)—as well as §523(a)(2) and (4)— would be nondischargeable in Chapter 13 as well as in Chapter 7. §146 Property settlements in divorce
§508 All debts covered by §523(a)(1) |
Content: All debts covered by §523(a)(1) (certain tax obligations), (a)(2) (fraud), (a)(3)(B) (unlisted debts requiring dischargeability determinations in bankruptcy court), and (a)(4) (breach of fiduciary duty) would be nondischargeable in Chapter 13 as well as in
Chapter 7. All debts covered by §523(a)(15) would remain the same, but the provision would be clarified to apply only to claims of a spouse, former spouse or child of the debtor.)
Commentary: The "superdischarge" of Chapter 13 has the effect of encouraging debtors with debts that might be
nondischargeable in Chapter 7 to choose Chapter 13 as a means of discharging those debts and obtaining a fresh start. This has
the corollary result of reducing litigation over dischargeability. The Conference Report preserves more of the superdischarge
that either the House or Senate bill, and thus retains more of the positive effects of that discharge. However, the Conference Report would exclude from the Chapter 13 discharge debts arising from fraud—the most common ground for claims of nondischargeability, and the one involved in most claims of credit card nondischargeability. Under this change in the law, debtors subject to nondischargeability claims under §523(a)(2) would be encouraged to file Chapter 7 rather than Chapter 13, and litigation over dischargeability in Chapter 13 would increase substantially.
| Issue | Senate bill | House bill |
| 5. Presumption of fraud |
§316 Fraud would be presumed under §523(a)(2) as to all debts incurred within 90 days of the order for relief that are (1) in an aggregate amount of more than $400 to a single creditor, and (2) for goods and services not reasonably necessary for the support of the debtor or a dependent child of the debtor. |
§142 Fraud would be presumed for all debts incurred within 90 days of an order for relief, except for purchases of "necessaries" that do not exceed an aggregate of $250 to a single creditor. |
Content: All credit card debt aggregating more than $250 in cash advances or $250 in "luxury goods or services" during the 90
days preceding a voluntary bankruptcy filing would be presumed nondischargeable under §523(a)(2). "Luxury goods or
services" is not defined, but the section specifies that the phrase "does not include goods or services reasonably necessary for
the support or maintenance of the debtor or a dependent of the debtor."
Commentary: The presumption of fraud in the Conference Report is potentially much broader than the presumption in either
of the passed bills, since it aggregates all purchases and all cash advances. Thus, under either of the bills, a single, small
"luxury" purchase from an individual creditor (for example, the purchase of flowers for the debtor's spouse) would never be
presumed fraudulent. But if several of such small purchases were made from different creditors over a 90-day period, the
Conference Report would result in a presumption of fraud. However, this is only a potential result, due to the ambiguity in
the description of "luxury goods or services." Although the Conference Report clearly excludes "necessities" from the scope of
"luxury goods," it leaves open the possibility that some purchases (like flowers for a spouse), although not "necessary" for
support, would still be common enough, and inexpensive enough, not to be considered "luxuries." The absence of a definition
here could lead to substantial litigation.
| Issue | Senate bill | House bill |
| 6. Valuation of secured claims |
§302 Secured claims incurred within 90 days of bankruptcy would not be bifurcated.
No bifurcation of secured claims would
In situations where claims were still |
§128 Secured claims incurred within 180 days of bankruptcy would not be bifurcated No change would be made in current law
§129 All secured claims would be valued |
Content: Secured claims for the purchase of personal property acquired by an individual debtor within 5 years of the
bankruptcy filing would not be bifurcated in any chapter of the Code. Where bifurcation did occur in Chapter 7 and 13 cases,
the secured claim would be valued on basis of the debtor's cost of replacement, without deduction for costs of sale. For
household and personal goods, this would be retail price.
Commentary: The overall impact of the Conference Report is (1) to encourage debtors to surrender collateral in both Chapter
7 and 13, and (2) to allow secured creditors to obtain artificially high payments in Chapter 13, at the expense of unsecured
creditors.
Surrender of collateral would be encouraged, because, unless the debtor purchased the collateral more than five years
prior to the bankruptcy, the debtor would have to pay the full amount outstanding on the purchase in order to retain the
collateral, even if the collateral was worth much less that the outstanding balance. For example, the debtor may have purchased
a used car, or a new refrigerator, on credit, with a high rate of interest. If the debtor missed several payments before filing the
bankruptcy case, the amount owed on the car or refrigerator could greatly exceed its actual value. Nevertheless, in order to
redeem the property in Chapter 7 or to retain it in Chapter 13, §124 of the Conference Report would require the debtor to pay
the full outstanding balance. In such circumstances, it would often be in the debtor's best interest to return the collateral, and
attempt to purchase a replacement.
Where the debtor chose to retain the property in Chapter 13, unsecured creditors would be disadvantaged in any case
that did not have a 100% payout. This is because, in such a case, the payments made by the debtor in excess of the collateral
value would otherwise have gone to the unsecured creditors. Valuing collateral at its retail price involves payment to secured
creditors of more than they could obtain upon surrender or repossession of the collateral (since selling the property at retail
would ordinarily involve substantial costs of sale). This provision, then, would also have the effect of diverting funds from
unsecured to secured creditors in many Chapter 13 cases.
| Issue | Senate bill | House bill |
| 7. Adequate protection of secured claims pending Chapter 13 plan confirmation |
§319 Payments of adequate protection would be required, pending confirmation of a Chapter 13 plan, at times and in amounts determined by the court. |
§162 Payments of adequate protection would be required, pending confirmation of a Chapter 13 plan, at times and in amounts specified by the applicable contract, but the debtor would be allowed to seek a court order reducing the amounts and frequency. |
Content:
The provisions of the House bill were adopted.
Commentary: By requiring adequate protection payments to be made in addition to preconfirmation plan payments, this
provision would make Chapter 13 very difficult for many debtors. Plan payments are often intended to deal with secured
claims, and are often required to exhaust the debtor's disposable income (pursuant to §1325(b) of the Code). Thus, pending
confirmation it would often be impossible for debtors to make both plan payments (as required by §1326 of the Code) and
adequate protection payments. Furthermore, contract payments are often in an amount greater than the depreciation of
collateral withheld by the debtor, and so a presumption that adequate protection should be paid in the contract amount may be
unreasonable. Requiring the debtor to seek a lower payment would increase the debtor's costs of proceeding in Chapter 13.
| Issue | Senate bill | House bill |
| 8. Timing of events in Chapter 13 cases |
§304(a) Debtors would be required to file a plan within 90 days of the case filing. No change is made to the current law
§304(b) Confirmation hearings for
§313 If a creditor objects to |
No change is made to the current law (Fed.R.Bankr.P. 3015) which requires the debtor to file a Chapter 13 plan within 15 days of the case filing.
§401 Meetings of creditors pursuant to
§408 Confirmation hearings for Chapter |
Content: Debtors would be given 90 days after case filing to file a Chapter 13 plan; no change is made in the time for meetings
of creditors; confirmation hearings would be held between 20 and 45 days after the meeting of creditors.
Commentary:
The timing specified by the Conference Report would cause substantial difficulty. By delaying plan filing for| Issue | Senate bill | House bill |
| 9. Special treatment for support obligations |
§323 "Domestic support obligations"— entitled to a variety of protections— would include obligations arising both before and after the filing of the bankruptcy case, whether owed to a spouse, former spouse, child, or guardian of the child of the debtor, or to any governmental entity, as long as the obligation both was in the nature of support and arose from a specified agreement, decree, or process. The special treatments would include the following:
§324 A first priority of distribution
§325 "Domestic support obligations" §§326-27 The exceptions from the
§328 Exempted property would
§329 Payment of domestic support
No change would be made in the scope |
§§ 145(d), 151 The support obligations entitled to first priority of distribution would be limited to "claims" (prepetition obligations), owed to a spouse, former spouse, or child of the debtor, and would not include assigned debts and debts to governmental entities. Support obligations owing to governmental entities (nondischargeable under §523(a)(18)) would be given an eighth level priority.
§145 Support obligations would have to
§523(a)(18) would be broadened by
Exempt property of the debtor would A standard (nonhardship) discharge in
No change would be made in the |
Content: The provisions of the Senate bill were adopted.
Commentary: The provision according support obligations priority over administrative expenses would make it difficult for a
trustee to administer any case in which there may be support obligations, since any professional retained by the trustee would
be at risk of nonpayment, even though some funds are available to the estate.
| Issue | Senate bill | House bill |
| 10. Nondischarge- ability of property divisions |
§327 Debts arising from property divisions in divorce or separation proceedings would be nondischargeable only in Chapter 7 cases, pursuant to §523(a)(15), as under current law, but the property division debt would be nondischargeable regardless of the debtor's ability to pay or the nondebtor's need for the payment. Also, the dischargeability of debts under § 523(a)(15) would no longer require bankruptcy court determination. |
§§146, 147 Debts arising from property divisions in divorce or separation proceedings would be included in §523(a)(5), and §523(a)(15) would be eliminated. This would have the effect of making all property division debts completely nondischargeable in both Chapter 7 and Chapter 13, regardless of the debtor's ability to pay or the nondebtor's need for the debt to be paid. |
Content: The Conference Report contains conflicting provisions on this topic. Section 145 sets out the provision of the
Senate Bill, making all property settlements in family cases nondischargeable regardless of ability and need, and removing
exclusive bankruptcy jurisdiction. Section 1113 generally reaffirms the current language of §523(a)(15), and implicitly
continues exclusive bankruptcy jurisdiction over §523(a)(15) by providing that, if a creditor does not receive notice of the
bankruptcy in time to file a timely claim under §523(a)(15), the claim would be nondischargeable under §523(a)(3).
Commentary:
It would be difficult to determine which of the conflicting provisions should be enforced. There is no apparent| Issue | Senate bill | House bill |
| 11. Disclosure of tax return information |
§301 Several items—including copies of any federal tax returns, with schedules and attachments, filed by the debtor during three years prior to the bankruptcy case— would be added to the information that individual Chapter 7 and 13 debtors are required to provide, unless otherwise ordered by the court. These documents would be available for inspection and copying by any party in interest, but the Director of the Administrative Office of the United States Courts would be required to "establish procedures for safeguarding the confidentiality of any tax information."
§312 If this information was not filed |
§406 The same additional items would have to be filed by the debtor, but the filed documents would be available for inspection and copying by any party in interest, with no provision for procedures to safeguard confidentiality of tax information.
§407 Automatic dismissal for failure to |
Content: The provisions of the Senate bill were adopted, except that the maximum extension would be 45 days rather than 50.
Commentary: The Senate bill makes it less likely that a case would be automatically dismissed simply because the debtor did
not maintain copies of tax returns and the IRS was unable to furnish copies within 45 days of the case filing. However, several
problems with the provision remain: (1) the requirement to furnish tax returns (and the other required information) will impose
an additional cost on debtors who do not have tax return copies and financial records available; (2) the requirement to file tax
returns will impose an additional burden on the clerks of the bankruptcy courts; (3) automatic dismissal would take place even
in cases where the trustee finds assets to administer, such as preferences and fraudulent conveyances, that creditors might have
difficulty pursuing outside of bankruptcy; (4) it would be difficult for regulations to safeguard the confidentiality of tax returns
in a manner consistent with the general requirement that they be made available to any party in interest for inspection and
copying.
| Issue | Senate bill | House bill |
| 12. Audits | §307 At least 0.2% of individual Chapter 7 and 13 cases—and schedules reflecting "greater than average variances from the statistical norm of the district in which the schedules were filed"—would be required to be audited by "qualified persons" according to procedures established by the Attorney General. No provision is made for payments of the expenses of the audits. |
§404 At least 1% of all individual Chapter 7 and 13 cases—and schedules reflecting "greater than average variances from the statistical norm of the district in which the schedules were filed"— would be required to be audited "in accordance with generally accepted auditing standards . . . by independent certified public accountants or independent licensed public accountants." The proposal requires the Attorney General to establish procedures for fully funding the audits, but does not specify a source of funding. |
Content: Audits would be required in 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." The audits would be
required to be performed "in accordance with generally accepted auditing standards [GAAS] . . . by independent certified
public accountants or independent licensed public accountants." The U.S. trustee for each district would be authorized to
contract for the auditing services, but no funds are provided for this purpose.
Commentary: Audits by licensed professionals according to GAAS are likely to be extraordinarily expensive. Such formal
audits are likely unnecessary to determine significant misstatements in debtors' petitions and schedules. The Senate formula
would have been substantially less costly. The proposal is ambiguous in requiring audits of all schedules with "greater than
average variances from the statistical norm of the district in which the schedules were filed." If "statistical norm" means the
median, and the average variation is half the range from the high and low points to the median, then the proposal could require
audits of half of all filed schedules: the lowest 25% and the highest 25%.
| Issue | Senate bill | House bill |
| 13. Credit counseling | §321(a) Debtors would generally be ineligible for bankruptcy relief until they had first attempted to negotiate a voluntary repayment plan through a consumer credit counseling service approved by the United States trustee, with no limitations as to the type of counseling service that could be approved.
Exceptions would be made for situations
There would be no limitation on |
§104 Debtors would generally be ineligible for bankruptcy relief until they had first attempted to negotiate a voluntary repayment plan through a consumer credit counseling service approved by the United States trustee, with approval withheld from any service that did not offer its program either without charge or at reduced charges in situations of hardship.
Exception would be made (1) if the
Only the United States trustee would be |
Content: The provisions of the Senate bill were adopted, with provision for group briefings by the creditor counseling service,
but requiring an initial budget analysis by the counseling service.
Commentary: The requirements would add to the cost of bankruptcy relief, and the cost of existing credit counseling services.
New credit counseling services can be expected to be formed, associated with debtor attorneys. Regulating and approving
credit counselors would impose a substantial burden on the U.S. trustees.
| Issue | Senate bill | House bill |
| 14. Debtor education | §321 A new exception to discharge would be applicable in Chapter 7 cases, for situations in which the debtor failed to complete a course in personal financial management administered or approved by the U.S. trustee. The court would be directed not to grant a Chapter 13 discharge to any debtor who failed to complete such a course. An exception would be made for districts in which the U.S. trustee or bankruptcy administrator found that suitable courses were unavailable. |
§112 The Executive Office of the U.S. Trustee would be required (1) to develop a program to educate debtors on the management of their finances, (2) to test the program for one year in three judicial districts, (3) to evaluate the effectiveness of the program during that period, and (4) to submit a report of the evaluation to Congress within three months of the conclusion of the evaluation. The test program would be made available, on request, to both Chapter 7 and 13 debtors, and, in the test districts, bankruptcy courts could require financial management training as a condition to discharge. |
Content: The provisions of both bill were adopted.
Commentary: Requiring completion of an approved course of instruction in personal financial management as a condition for
discharge would present several problems: (1) it would apply to individuals who could not benefit from such a course, such as
financial professionals who had encountered financial problems (such as medical expenses) unconnected to failures in personal
budgeting or the mentally impaired; (2) there is no provision for payment for the courses, and Chapter 13 debtors would
ordinarily lack disposable income to pay for them; (3) substantial resources would have to be expended by the U.S. trustee in
order to administer a program for approving and regulating educational facilities; (4) it is difficult to see why a complete
educational program would be put into effect before the results of the pilot program are reported.
| Issue | Senate bill | House bill |
| 15. Homestead exemptions |
§§212, 320. A $100,000 cap would be placed on homestead exemptions and a finding made that such a cap is necessary for meaningful bankruptcy reform. No change would be made in the |
No cap would be placed on homestead exemptions.
§181 Debtors who changed their state of |
Content: The provisions of the House bill were adopted, amended to require that a debtor reside in a state for 730 days before
being allowed to claim the exemption law of that state.
Commentary: The proposal does nothing to address abuse of the bankruptcy system by existing residents of states with
unlimited homestead exemptions. Such individuals may amass substantial estates in homestead property, and obtain a
bankruptcy discharge without having to surrender any of that property. The proposal would discourage some debtors from
changing their state of domicile for the purpose of obtaining higher exemptions. However, it would encourage many others to
make such moves. Since no state's exemption law would apply until a debtor had resided in the state for two years, the
applicable exemption law would be the federal exemptions. These exemptions are more generous than the laws of many states,
and debtors from states with exemptions lower than the federal exemptions would be encouraged to move to any new state
prior to filing bankruptcy.
| Issue | Senate bill | House bill |
| 16. Bankruptcy appeals |
§602 Appeals of bankruptcy court decisions could be taken to the Circuit Courts of Appeals if the district court did not file a decision within 30 days of the filing of the appeal. |
§411 Bankruptcy court decisions would be directly appealable to the Circuit Courts of Appeals. |
Commentary: Although both bills contained provisions for expedited appeals from bankruptcy courts to the courts of
appeals, the Conference Report fails to address the issue. Direct appeal would have the benefit of reducing the cost of
obtaining binding precedent in bankruptcy cases.
| Issue | Senate bill | House bill |
| 17. Effective date | §408 The amendments contained in Title IV of the bill ("Financial instruments") would apply to cases commenced "or appointments made" after the date of enactment.
§734 The amendments contained in Title |
No effective date is specified |
Content: Unless otherwise specifically provided, the amendments would become effective 180 days after enactment, and
would not apply to cases pending on that date.
Commentary: Because of the many changes in the law, the delay in the effective date would be critical to allow for study and
preparation of forms and procedures necessary to comply with the new provisions.
To amend title 11 of the United States Code to modify the application of chapter 7 relating to liquidation cases. (Introduced in House)