Progress on Bankruptcy Reform

Washington veterans will tell you that bankruptcy reform is always a long and tedious process. The latest experience is no exception. In the fall of 1997, bankruptcy reform legislation was introduced in the U.S. Congress. Since then, both the House and Senate have passed (several times) similar versions of a reform bill. One version emerged from the House-Senate conference committee and was approved by Congress, only to die for lack of President Clinton's signature. But, in the last two weeks of April this year, another House-Senate conference committee quietly resolved nearly all of the substantive differences between the latest House and Senate versions of a reform bill. Bankruptcy reform may actually happen this year.

Interestingly, the collapse of Enron may have influenced the personal bankruptcy language in the latest version of the bankruptcy bill. According to Ruth Simon's recent article in the Wall Street Journal, the conference committee has already accepted about 50 revisions to the bill, some of which reflect the Enron case. Most notably, the highly publicized fallout from the Enron case has focused legislators' attention on provisions in the laws of Texas and Florida, the two largest states that allow consumers filing for bankruptcy to shield their residences from creditors. In the case of the Enron executives living in Texas, the shield applies to multimillion-dollar estates. However, in his article in the New York Times, Philip Shay reports that lawyers and spokespersons for former Enron executives say that they have "no plans to invoke the homestead exemption." Shay notes that at least two exclusives have sold properties elsewhere, but were retaining properties in Florida and Texas. For example, he notes that Kenneth L. Lay, the former chairman, and his wife will keep their "$7.1 million 13,000-square foot condominium in what is considered the finest apartment building in Houston." Andrew S. Fastow, the former chief financial officer of Enron, "is building a multimillion-dollar Tudor home on a plot of land in Houston that he bought for $1.1 million."

The homestead exemption had been a major obstacle to compromise between House and Senate versions of the reform bill, as the Texas delegation steadfastly refused to accept a cap on the homestead exemption. Apparently, the collapse of Enron has created sufficient political liability for such a stance that the conference committee was able to broker a compromise. Senate and House negotiators agreed to limit the homestead exemption to $125,000 for convicted felons or for anyone who owes a debt under federal or state securities law. The negotiators also barred use of the unlimited homestead exemption to anyone who has not lived in the state for at least 40 months.

Prominent features of the current bill include a requirement that debtors seeking to file for bankruptcy should first have to go through a credit-counseling course before filing. The proposal also imposes a "means test" for eligibility for Chapter 7 bankruptcy relief. This provision marks a significant shift in U.S. bankruptcy law because it sets up a formal mechanism to determine whether debtors have the capacity to fund a meaningful repayment plan (under Chapter 13) out of their expected future income. Under current law, debtors are free to choose between a Chapter 13 repayment plan or a Chapter 7 "liquidation" plan. About 70 percent of all filings are under Chapter 7. The means-test feature seeks to eliminate the opportunity for debtors with substantial incomes to abuse the bankruptcy system by ignoring the Chapter 13 repayment option. It is estimated that about five or six percent of consumers who file for bankruptcy each year under Chapter 7 would be shifted to Chapter 13.

Treatment of secured debts would also change under the new bankruptcy proposal. Currently, a consumer filing for Chapter 13 who owes $10,000 on an automobile worth only $6,000 would be liable only for $6,000 plus interest, with the remaining $4,000 treated as an unsecured debt. Both House and Senate bills would require that a consumer repay the full $10,000 under Chapter 13. Another interesting proposal would require an audit of one of every 250 filings to ascertain the accuracy of the data provided. Attorneys who submit the forms could be sanctions if the data proved to be significantly inaccurate.