SmartMoney.com Column: “Look Out Debtors”

My look into the bankruptcy “reform” legislation has been revealing, to say the least. The more I learn, the more I’m convinced that this bill should not become law.

SmartMoney.com has looked into it too (bolds within main points are mine), and like me, has come to conclusions about the bill’s effects that are vastly different from the stated claims of its proponents:

1. More people forced into Chapter 13.
Once the law is in place, however, most people will be forced into Chapter 13 even if they can’t afford it……because of the new Means test, which will require a filer’s income to be lower than the median for the state (as determined by the IRS) in order to qualify for Chapter 7 filing. This will affect many middle-income individuals or families who earn above their state’s median, but are forced into bankruptcy after accruing large debts, often because of divorce or medical emergencies. (Ed. Note: State median income figures will come from the Census Bureau, not the IRS.)

2. Chapter 13 repayment schedules become unaffordable for many.
……Under the new law — and by applying the Means test — the courts will determine the amount to be repaid to creditors based on the basic living expenses in your state or county as determined by the IRS. The catch here is that your actual expenses are often higher than what the IRS says they should be in its Collection Financial Standards.
(Ed. note: In its collection efforts, The IRS’s Collection Financial Standards “home page” says that it uses uniform National Standards for basic living expenses that are based on the nationwide Bureau of Labor Statistics [BLS] Consumer Expenditure Survey, and BLS data for specific Metropolitan Statistical Areas [MSAs] for other items, specifically utilities and transportation. So the new bankruptcy law will use the BLS’s national and MSA-specific standards just as the IRS does. The bill also mentions “Other Necessary Expenses,” which I can’t find a definition of. I am still investigating and will try to nail this down.)

Note: It therefore appears that the new law’s allowances for basic living expenses and other items will be the same regardless of income AND, in most cases, regardless of where you live. The uniform treatment based on income may seem intuitively appealing at first, but doesn’t square with reality. The geographic uniformity is simply absurd on its face. All of this appears to be deliberately restrictive and designed to tie the hands of bankruptcy trustees in favor of the bill’s lending industry underwriters (I am soooooo surprised).

As an example, I don’t see where assuming that a professional person making $80,000 in a New York city spends the same on clothing as a blue-collar person earnings $40,000 in the middle of Kansas is even remotely equitable (or true, even after a measly 5% increase in the allowance permitted by law). It would obviously be inequitable even if these two people were in the same town. And I don’t see where effectively forcing that higher-income person into a Chapter 13 with a calculated monthly payment that essentially mandates reduced spending on clothing (and probably other items, unless all the other allowances are somehow miraculously correct) serves a public-policy purpose, unless hurting a person professionally is one of the goals (it does make you wonder).

Plus, despite the new law’s alleged flexibility in adjusting these allowances, I would be concerned that trustees will feel very reluctant, either due to extra paperwork or fear of second-guessing by beancounting auditors, to try to adjust these allowances to reflect a person’s or family’s real living situation. And all of this of course assumes that the person or family is astute enough and comptetent enough to complete all the documents needed to prove different expenditures. Otherwise, they will need professional help to do so, which gets to the next point.

Back to SmartMoney.com:

3. The cost of filing bankruptcy increases.
The new law will also make the disclosure of the debtor’s assets a lot more detailed…. Think of it as a court audit of every bankruptcy filing: If any mistakes or omissions are found, the case will be dismissed and the attorney will be held legally responsible for all costs, fees and sanctions. That doesn’t come out of the debtor’s pocket directly … but the overall costs of filing would still go up as a necessity. That’s because rather than risk being sanctioned and fined by the court, attorneys will start requiring their clients to obtain full professional appraisals of all of their household’s goods and furnishings. By initial estimates, that may cost as much as an additional $500 to $1,500.
……The lawyers themselves may also increase their fees because of the additional workload……

The first two paragraphs in this final point essentially tell us that bankruptcy lawyers are going to have to practice “defensive lawyering” to avoid sanctions and maybe even jail. They may have to hire accountants just to satisfy themselves that a given filing will be sufficiently accurate before it takes place.

Those who saw this post earlier on Saturday, March 19 saw a paragraph from the article about a mandatory 180 days of credit counseling before filing. I have learned from an experienced bankruptcy attorney who responded to my request for e-mail clarification that the article is incorrect (unrestricted and unconditional THANKS!). A “briefing” with a credit counselor has to take place before filing, but there apparently is no waiting period after the briefing takes place. I would think there would be a good possibility of a bottleneck if swamped credit counselors (which I expect) build up lengthy backlogs of unseen clients. Perhaps that’s why the bill allows phone and Internet briefings, as ineffective as they are likely to be. The mandatory financial training takes place between the time of filing and discharge.

In sum, add SmartMoney.com to the list of reviewers of this bill who are telling financially troubled consumers that there’s a high chance they’ll be forced into Chapter 13; when they are, they will be forced to pay workout amounts that are unrealistic; and that the whole thing will cost a lot more in legal, asset appraisal, and other professional fees. In other words: “You are so screwed.”