As a Matter of Fact: Clarifying a Few Hot Button Issues in Consumer Bankruptcy

For many years, consumer bankruptcy has been beset by controversies and misconceptions. Some stakeholder groups continue to wage war against the Bankruptcy Abuse Prevention and Consumer Protect Act of 2005 (BAPCPA) which changed consumer practice in fundamental ways. Perhaps the debate could be a bit more constructive and less vitriolic if there was a common understanding of basic facts. This is the first in an occasional series of short analyses AIS will post on some of the controversies that have received the most attention. We will start with the Means Test, which is probably the hottest of the hot-button issues in the consumer bankruptcy world.

The cornerstone of the 2005 consumer bankruptcy amendments was the Means Test, that was designed to limit bankruptcy relief to debtors with modest or no disposable income after deducting for allowable expenses set by the Internal Revenue Service. The Means Test applies to individual chapter 7 debtors with primarily consumer debt. It also applies to chapter 13 wage-earners in calculating the amount of income that must be devoted to a repayment plan. The major criticism of the Means Test is that the numerical expense limitations would disqualify many needy debtors. Guess, what? It didn’t happen. So now the debate has shifted to whether the extra financial information required under the Means Test and other provisions of the law have added unnecessary costs to filing.

Let’s look at the facts (using round numbers that hold true year after year): only about 10 percent of all chapter 7 (liquidation) debtors earn more than their state’s median income. The rest are exempt from the Means Test. Of those debtors with above-median income, less than 10 percent have excess disposal income that exceeds the statutory maximum of about $250 per month. That shows that the overwhelming majority of debtors who seek to wipe out their debts are truly in financial crisis and not simply taking advantage of their creditors. Not only that, but the U.S. Trustee Program (USTP) has found that more than 60 percent of all chapter 7 cases with excess income are not abusive because of recent job loss or ongoing medical expenses for which the Means Test formula cannot take into account. Congress gave the USTP the discretion not to file motions to dismiss in cases of debtors with exceptional circumstances, and it prudently exercises that discretion. The bottom line is that less than one percent of chapter 7 filers are dismissed because they "fail” the Means Test.

Not only do these facts speak for themselves, but everybody who practiced or observed the consumer bankruptcy system before BAPCPA knows that there was a gross disparity in judicial decisions on what constituted "substantial abuse” justifying dismissal. The old (and universally known) joke was that a lawyer knew her client’s case was in trouble if the debtor drove a better car than the judge. Inherent in the notion of justice is equality – the fundamental principle that like cases should be decided alike regardless of the court where the cases were filed.

With the argument that the Mean Test disqualifies needy debtors laid to rest, opponents of BAPCPA say, with some justification, that the costs of filing bankruptcy are too high. This is a legitimate point. By far the most significant cost increase has been in debtor attorney fees. Over the nearly 20 years since the enactment of the 2005 amendments, debtor attorney fees have skyrocketed by a multiple of the less than $1000 that used to be charged for a simple chapter 7 case. It is true that the Means Test paperwork is substantial, but about 90 percent of chapter 7 debtors do not even have to fill out most of the paperwork because their income is below their state’s median for a family of their size. Yet, even the simplest cases cost significantly more. Even though the 2005 law also imposed some additional non-Means Test documentation (e.g., proof of income), how can that alone justify legal fee increases that dwarf inflation? The problem is even more acute when considering that the debtors who pay the fees are in dire financial straits.

It is absolutely true that debtor lawyers have been in rough economic times. With filings so relatively low, it is hard for firms to realize economies of scale without sacrificing the quality of work.¹ By law, unpaid chapter 7 legal fees are discharged in the bankruptcy case. So chapter 7 lawyers have to be paid upfront before the case is filed. (Chapter 13 debtor attorney fees can be paid over the life of the repayment plan.) Some attorneys have turned to "bifurcated” fee arrangements whereby the scope of the pre-petition engagement is limited, and so are the upfront fees. Others argue for changing the law so that chapter 7 legal fees are not discharged. These solutions all have significant drawbacks worthy of a separate analysis.

Perhaps the best solution may lie in technology improvements. For example, new software might allow debtors to complete more paperwork themselves if they have few or no assets subject to liquidation under bankruptcy law. A few pioneers in this area, such as Law Professor Lois Lopica at the University of Denver, have made some progress. But talk of innovative solutions has largely been drowned out by a cacophony of political rhetoric and self-interested arguments designed to justify higher legal fees. There is also some serious academic and legislative debate on rethinking the bankruptcy system. But, for any of the flaws of some of those ideas, at least they represent a non-self-interested effort at improving access to bankruptcy relief.

All in all, blaming the Means Test for burgeoning attorney fees may be a bit exaggerated. The solution to the legal fee dilemma may reside outside of any changes to the Means Test.

As with many political debates, the controversy over bankruptcy policy and practice is fraught with misconceptions. But the debates also raise many legitimate issues worthy of consideration. That debate will best flourish, and contribute to better public policy, only when we work from the same set of facts.

¹The significant increases in the number of consumer bankruptcy filings in recent months may provide some compensation relief to debtors’ attorneys.

Commentary provided by Clifford J. White, Senior Advisor - Bankruptcy Compliance for AIS.