A better balance in bankruptcy law - includes related articles on how to avoid bankruptcy & keeping a small business afloat

Nation's Business, April, 1985 by Mary-Margaret Wantuck

A Better Balance In Bankruptcy Law

MEET CHARLIE, a computer executive making $75,000 a year in 1979. He owned a beautifully furnished $175,000 country home with a $150,000 mortgage and commuted daily into New York City. He and his wife, Sylvia, enjoyed Broadway shows and exclusive Manhattan restaurants.

Charlie loved credit and lived on it--a stockpile of charge cards, a credit union revolving loan and overdraft checking. In early 1980 he reached his credit limit and had to start paying cash for entertainment. But with so much of his monthly income committed to debt service, there was just not that much cash left over to play with, and that annoyed Charlie and Sylvia.

Enter the Bankruptcy Reform Act of 1978, which went into effect in October, 1979.

It was an answer to the couple's prayer. They declared bankruptcy under Chapter 7, which erased all their debts. They were able to keep their house and continue to enjoy all of Charlie's $75,000 salary. They resumed their lives without any obligation to repay any of their creditors.

Charlie and Sylvia are not a particularly extreme example of the new kind of debtor encouraged by the looseness of the 1978 law. During the law's first full year of operation, between October, 1979, and October, 1980, U.S. bankruptcy cases rose 59 percent. The next year personal bankruptcies climbed another 43 percent, to 515,355.

Sears, Roebuck & Company, for example, found that its bankruptcy losses jumped more than 120 percent from 1979 to 1980.

Lenders discovered there were many Charlies and Sylvias--people who were current on their required monthly payments, had little or no previous history of delinquency and may have even had additional credit available at the time their creditors received the bankruptcy notice--but who decided to cash in on the bonanza, get rid of all their unsecured debts and keep their real estate and personal property.

A study conducted by Purdue University's Credit Research Center in 1981 found that 4 out of 10 people who filed for Chapter 7 bankruptcy relief could have paid 50 percent or more of their nonmortgage obligations over the following five years; 29 percent could have repaid all of them.

Montgomery Ward discovered that nearly 13 percent of the accounts it was writing off as losses due to bankruptcy were up-to-date at the time the bankruptcy notice was received. And while Federated Department Stores experienced consumer bankruptcy losses of only $2.3 million in 1979, the figure nearly doubled to $4.6 million in 1980 and reached $5.3 million in 1981.

TRYING TO STEM the tide of losses after the 1978 law went into effect, lenders like the credit union at the National Aeronautics and Space Administration altered traditional lending practices.

The NASA Federal Credit Union raised its interest rates. Borrowers were encouraged to choose its home equity lending plan over the more generally used open-ended loans because "real estate collateral offered greater protection to the credit union should things go wrong,' says the organization's president, Donald Beall. (The home equity loan program, which carries a preferred rate, still exists. Because of the greater degree of risk, the credit union continues to charge higher rates for unsecurred loans.)

Creditor uproar over bankruptcy losses finally hit home on Capitol Hill. Last June, Congress passed the Bankruptcy Amendments Act of 1984. Among many changes are tighter consumer provisions, which took effect in October. "The law has been improved to everyone's benefit--from the debtor who needs relief to the creditor who was being importuned,' Beall says.

Most lenders call the new law better balanced between creditors and debtors. "What it represents is a livable compromise,' says Laurence P. King, who was a member of a group at New York University that studied bankruptcy law problems. "The old law was a farce.'

Bankruptcy judges can now consider a debtor's current income and expenditures in determining whether his financial situation dictates a Chapter 7 filing or a plan for debt repayment under Chapter 13. Under the old law, only assets and liabilities could be weighed.

Chapter 13 filings have also been modified. An unsecured creditor can object to a Chapter 13 repayment plan that does not include repayment of the entire debt and use all of the debtor's projected disposable income (beyond the basic necessities) over a three-year period for repayment. Before, a nominal payback was acceptable as long as the debtor's plan showed an effort to pay back something to the creditors.

Consumers may no longer "load up' just before declaring bankruptcy. Any debts of $500 or more for "luxury goods and services,' owed to a single creditor and incurred within 40 days of filing, must be paid. So must cash advances of more than $1,000 that are extended under an open-ended credit plan obtained by the debtor within 20 days before filing.

Federal exemptions have also undergone a facelift. In a Chapter 7 bankruptcy, a debtor's personal assets are converted to cash to remburse creditors as much as possible. However, before a liquidation occurs, the debtor can exempt specified personal items.