129 posts categorized "2005 Bankruptcy Amendments (BAPCPA)"

Crashing the Credit Industry's Party

posted by Bob Lawless

Mr. Lawless has come back from Washington. Yesterday, I was a witness at the Senate hearing on the first year's experience with the 2005 bankruptcy law. My written testimony is here. To get to Capitol Hill, I took the Metro to Union Station, and browsed the shops to kill a little time. As I walked out the front doors, it was a perfect duplicate of that scene from Mr. Smith Goes to Washington, the same spot where Jimmy Stewart stands in awe of the Capitol dome. That movie served as a metaphor for the rest of the afternoon.

Make no mistake about it. This hearing was a party for the credit-card industry. It was the industry's chance to crow about how great the 2005 bankruptcy law is working, at least while their congressional friends still control the committee hearings. Along with Hank Hildebrand, a chapter 13 trustee, and the Hon. Randall Newsome, chief bankruptcy judge for the U.S. Bankruptcy Court for the Northern District of California, I had been invited to testify by Senator Schumer's office. We were clearly crashing the party.

Continue reading "Crashing the Credit Industry's Party" »

Scheduled Senate Hearing on Bankruptcy Law

posted by Bob Lawless

Tomorrow (December 6), the Subcommittee on Administrative Oversight and the Courts of the Senate Judiciary Committee is holding hearings on "Oversight of the Implementation of the Bankruptcy Abuse Prevent and Consumer Protection Act." I will be one of the witnesses along with Cliff White (acting director, Executive Office of U.S. Trustees), Todd Zywicki (George Mason law school), Steve Bartlett (Financial Services Roundtable), David Jones (Ass'n of Independent Consumer Credit Counseling Agencies), Judge Randall Newsome (U.S. Bankruptcy Court for the Northern District of California), and Henry Hillebrand, III (chapter 13 standing trustee in Nashville, Tennessee). More information about the hearing appears here: http://judiciary.senate.gov/hearing.cfm?id=2442.

Having never testified before Congress, it should be an interesting experience for me. Obviously, the Republicans are still in charge of Congress, and they were the ones who decided to hold the hearing. I'll post something on Credit Slips (probably Thursday morning) about what happened.

Congress Says Debtors' Thumbs May Be Amputated!

posted by John Pottow

Strictly speaking, this may not be true.  (The reason this may be so is because the statement is a complete lie of my own fabrication.)

Yet as we visit my parents where many old Canadians flee for the winter (Florida), I was struck by a radio adverstisement.  My dad has something called XM radio in his car, which I think is satellite, so I don't know if the adverstisers are local or national.  The ad was one of those super-hyped, manicly-overlapping succession of rapid rhetorical questions: "Trouble with credit?  Did you know you can consolidate your loans at a lower rate?" Etc., etc.

Here's the question that stuck out to me: "Did you know what new laws require you to pay back twice as much debt?"  (Or it may have been "Did you know new laws require you to pay back half of your debt?")

I wonder to readers who may have heard this or similar ads: Is this how credit consolidators and others are framing BAPCPA?  (In fairness, maybe it was some quirky state-specific law in Florida, or maybe I misheard, distracted by the challenge of driving with octogenarians.)  If this really is BAPCPA-puffing, then I think it is a strong illustration that perception may be more important than reality for new bankruptcy laws.  (Indeed, could ads like these literally be scaring people away from filing for bankruptcy?)  Worrisome, at least to me.

Why Hang Just the Paragraph?

posted by Bob Lawless

Among the many fine drafting points--where "fine" means "disastrous"--of the 2005 bankruptcy amendments was the so-called hanging paragraph in section 1325 where the law lists the requirements for a court to approve a consumer's chapter 13 plan. Wacky bankruptcy types like myself refer to this provision as the "hanging paragraph" because Congress did not bother to number it and just threw it in at the end of a section. Today, we have news on the hanging paragraph.

Continue reading "Why Hang Just the Paragraph?" »

Legislating Confusion

posted by Angie Littwin

Consumer bankruptcy attorneys just can’t win.  Among the most controversial changes the Bankruptcy Abuse Prevention and Consumer Protection Act made to the Bankruptcy Code are the provisions regulating the relationship between consumer debtor attorneys and their clients.  Collectively, sections 526, 527, and 528 of 11 U.S.C. impose a number requirements on consumer debtor attorneys, restricting the advice they can give, compelling them to make disclosures not required of other attorneys, and requiring them to advertise themselves as “debt relief agencies.”  The statute refers to consumer bankruptcy attorneys as “debt relief agencies” throughout. See, e.g., 11 U.S.C. § 101 (12A).  Debtor attorneys are not exactly overjoyed about the changes and have been challenging these provisions since they went into effect, arguing, among other things, that “they restrict attorney advertising in a manner inconsistent with the First Amendment.

So imagine my surprise when I came across the following warning on a Federal Trade Commission consumer-education web page: “BUYER BEWARE! ADS PROMISING ‘DEBT RELIEF’ ACTUALLY MAY BE OFFERING BANKRUPTCY.” 

Continue reading "Legislating Confusion" »

Anniversaries and Audits

posted by Melissa Jacoby

On a week of anniversaries relevant to bankruptcy reform and policy, it is worth noting that exactly 9 years ago, the National Bankruptcy Review Commission filed its final report.  The second proposal in this telephone-book-sized report was for random audits (proposal number 1.1.2) that, in a more detailed iteration, becomes operational today via section 603 of the 2005 bankruptcy amendments as Bob has noted.  Unlike other personal bankruptcy proposals discussed in the Commission Report, this one had widespread (indeed, possibly unanimous) support among the members of the Bankruptcy Commission who otherwise had fundamental descriptive and prescriptive disagreements about the personal bankruptcy system.   As Bob's 33% Solution post illustrates, however, Congress insisted on putting some consequential details in the statute that, if put into practice literally, undercut some of the justifications for the otherwise-popular audit proposal.   Now others are charged, within these constraints, to try to implement the concept in a cost-efficient and effective manner (for how the U.S. Trustee program is approaching this, see the press release here and 71 Fed. Reg. 58005 (Oct. 2, 2006)).

The 33% Solution

posted by Bob Lawless

Debtor audits begin today. In the 2005 bankruptcy amendments, Congress decreed that one of every 250 cases shall be randomly audited under procedures established by the Executive Office for U.S. Trustees. In addition, Congress declared there shall be an audit . . . and here is where it gets really fun . . . of every schedule "of income and expenses that reflect greater than average variances from the statistical norm of the district in which the schedules were filed." Greater than average variance from the statistical norm. How erudite. How brilliant. Who says Americans lag the world in math education?

Continue reading "The 33% Solution" »

One Year After

posted by Bob Lawless

Today is the one-year anniversary of the effective date of the 2005 bankruptcy amendments. I have refused to use the formal title--the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005--because the statute was most definitely not about consumer protection and prevented bankruptcy abuse in the same way that news talk shows fix political problems. We're not sure what the problem is, but if we talk about it a lot, we can claim credit for fixing it. Love it or hate it, we are now stuck with this law. What are the legacies of the 2005 amendments?

Continue reading "One Year After" »

Bankruptcy, Eviction and Patient Records

posted by Melissa Jacoby

The 2005 bankruptcy amendments added a provision to the Bankruptcy Code to help protect the privacy of patient records in the bankruptcy case of a "health care business."  The provision sets forth a process by which a trustee can notify patients about their records (broadly defined) and then ultimately destroy them if they are not claimed.  But reality may not always operate according to such plans.   According to this news story, a giant pile of patient financial records of a bankrupt doctor were found in a parking lot after an eviction overseen by the sheriff and the building manager in the doctor's absence (thanks to Rebecca Redwine for the tip).   

Stampeding Past the Self-Employed

posted by Bob Lawless

Will Congress just cut it out? Now, their inept drafting coupled with pandering to the religious right threatens the ability of the self-employed to fund chapter 13 plans. I thought we were supposed to like small business? As Melissa Jacoby reports, the Senate recently passed S. 4044 to protect charitable giving in bankruptcy. This bill comes on the heels of a bankruptcy court decision (In re Diagostino) where the bankruptcy court ruled that the 2005 bankruptcy amendments prevented above-median income chapter 13 debtors from making charitable contributions.

The need for congressional action is slim at best. It's a decision from one bankruptcy court that arguably misreads the statute (see a previous post). Bankruptcy court decisions don't create binding precedent, even for other judges in the same district. Senators Grassley, Hatch, and Sessions wrote a letter to the Executive of Office of U.S. Trustee's asking it to adopt a different rule as a matter of administrative enforcement. The political forces that have arrayed to attack this bankruptcy court decision are roughly the same coalition that sold a story about a bankruptcy system that was so rife with irresponsible debtors that it needed a major overhaul in 2005. Apparently, it's OK to stiff your creditors so long as you give that money to your church. In the stampede to pay obeisance to the religious right, the Senate has missed the fact that its actions could make it impossible for some self-employed debtors to fund chapter 13 plans.

Continue reading "Stampeding Past the Self-Employed" »

New Bankruptcy Legislation

posted by Melissa Jacoby

S. 4044, the Religious Liberty and Charitable Donation Clarification Act of 2006, was introduced on Sept. 29 and passed by unanimous consent on Sept. 30.  For the story that led up to this, see here and here.

UPDATE: My link to the bill isn't holding, so here's the substantive content of the bill: "Section 1325(b)(3) of title 11, United States Code, is amended by inserting `, other than subparagraph (A)(ii) of paragraph (2),' after `paragraph (2)'.

Taking Apart the Median Income Tables

posted by Bob Lawless

As bankruptcy specialists know, after the 2005 bankrutpcy amendments it matters a lot whether a debtor is above or below the state median income for a household of the size of the debtor's household. The statute directs that this calculation is to be taken from Census Bureau statistics. The Executive Office of U.S. Trustee ("EOUST") compiles the relevant figures and puts them on its web site. Recently, the EOUST updated these figures, and an analysis reveals some interesting patterns and changes.

Continue reading "Taking Apart the Median Income Tables" »

Slips Across the Blogosphere

posted by Bob Lawless

A few random items around the blogosphere that caught my eye and might be of interest to Credit Slips readers. Yes, this means I didn't have time to compose a lengthier post:

  • The Executive Office of U.S. Trustee ("EOUST") extended its waiver of the credit counseling and debtor education requirements for bankruptcy filers in areas struck by Hurricane Katrina. The waiver affects bankruptcy filers in the Eastern, Middle, and Western Districts of Louisiana and the Southern District of Mississippi. The press release is here. The 2005 bankruptcy amendments added these requirements and gives the EOUST power to waive requirements when they find the services are unavailable. Previous posts by Katie Porter and John Pottow discuss the increased power of the EOUST under the 2005 amendments, and this power to waive the counseling and education requirements is a good illustration of that increased power.
  • In the business bankruptcy area, the September 21 issue of The Economist had an article entitled "In the Shadows of Debt." The subtitle says it all: "Business is being reshaped by a massive borrowing binge, but much of it is unseen, unregulated and little understood." The article is available online here for subscribers or those willing to watch an ad.
  • An article in the N.Y. Times (reg. req'd) about skyrocketing housing costs and stagnating incomes. The second paragraph: "[M]any of the biggest jumps in the percentage of people paying a burdensome amount of their income for housing occurred in the Midwest and in suburbs nationwide, making it clear that the housing squeeze has reached deep into the middle class."

U.S. Trustee, Part II

posted by John Pottow

Following up on Professor Porter's excellent observations on the U.S. Trustee program, while she is interested in the normative power wielded by the UST, I am taken by the more tawdry matter of the expansion of institutional bureaucracy.  BAPCPA has mandated a hugely invasive role for the UST office (certifying decisions not to bring means test challenges, etc.), which means that my taxpaying dollars are going to subsidize a government-run debt collection agency for the benefit of for-profit creditors.  Yes, fees have been raised, but I'm not so sure how much they'll cover.  BAPCPA's proponents must have been fans of an active, involved, and well-funded federal government!  (I wrote about this in a piece for a Spanish commercial law journal, but I don't have the link to the journal and, for that matter, only take it on good faith that they translated the piece instead of just inserting gibberish -- at least random gibberish as opposed to my structured gibberish.)

Big (Bad?) US Trustee

posted by Katie Porter

A recent inquiry by Marc Stern to the Bankr-L list serv asked whether anyone had challenged the U.S. Trustee program’s calculations of the median income figures for use in the means test. He observes that the margin of error for the Census calculations can be substantial and that the U.S. Trustee has not incorporated the margin of error into the means test numbers that it promulgates.

The query reminded me of something that struck me last fall when I was teaching the new law for the first time. A central feature of the amended Bankruptcy Code is the tremendous power that it gives to the U.S. Trustee Office. Some of these powers are explicit, such as certifying credit counselors, supervising the audit program, providing more oversight in small business Chapter 11 cases, and waiving the counseling and education requirements (such as after Katrina). Other elements of the U.S. Trustee Office’s expanded influence are more subtle or arise implicitly. Any new law will raise interpretation issue, and the U.S. Trustee actively briefed key issues and intervened in cases. The U.S. Trustee has also promulgated "answers" that interpret BAPCPA. Panel trustees are told to contact the U.S. Trustee office if they do not agree with the interpretation. (There's some interesting stuff here if you haven't seen it).

The calculation of the median income figures identified in the Bankr-L list message is an excellent example of the U.S. Trustee's broader authority. These numbers are important, and the U.S. Trustee is effectively interpreting the law by promulgating these numbers. The law itself does not say that the U.S. Trustee should calculate these numbers. Should a court give deference to the U.S. Trustee’s interpretation of these numbers? Do the usual principles about agency rulemaking apply in this situation? Will courts feel free to interpret the law differently or to give equal weight to a litigant’s reading of the law? What are the advantages or the dangers of the new, more powerful U.S. Trustee?  One likely change seems to be more national uniformity in the bankruptcy system and a reduction in the "local legal culture" effect observed by Sullivan, Warren & Westbrook and Jean Braucher in early studies of the bankruptcy system.

More on Filing Rates

posted by Ronald Mann

Following up on my post from Monday, Charles Tabb has posted a new paper on SSRN, Consumer Bankruptcy Filings: Trends and Indicators.  He uses A.O. data through the first half of 2006 and suggests, consistently with my post, that the long-run filing drop will not be as substantial as many seem to think.

He also looks at the Chapter 7/Chapter 13 mix and notes that the Chapter 13 filing rate is not as high as you would expect given the stated motivation of BAPCPA.  Bill Whitford's paper in the Illinois symposium offers some good reasons why you would expect the Chapter 13 filings to be low, and I think Charles's paper buttresses that.  Looking at the weekly Lundquist data to which I referred on Monday, I have a similar take on the Chapter 13 filings.  Although the share of filings has been quite high since BAPCPA, it has been steadily trending downward throughout 2006, getting closer and closer to the pre-BAPCPA filing share.  And the high filing share plainly is an artifact of the preternaturally low level of post-BAPCPA Chapter 7 filings, because the number of Chapter 13 filings after BAPCPA has been much below pre-BAPCPA levels.

Finally, the last part of Charles's paper provides a useful catalog that shows how bankruptcy filing rates correlate roughly with several indicators of consumer indebtedness, including such things as total borrowings and credit card delinquencies.  He clearly is on the right track there.  In Charging Ahead I present some detailed data on credit card borrowing and consumer credit, with some multivariate regressions finding that credit card borrowing is significantly related to bankruptcy filings, even when you account for broader borrowing trends.

Interesting paper worth the read!

Mann's Calls Study

posted by John Pottow

Professor Mann's proposed study is, as usual, interesting and thought-provoking.  (I confess to finding it somewhat exhibitionist to engage in a public dialogue with a colleague, awkwardly having to use the third person, but I guess that what a "blog" is all about.)  In any event, what I would counsel Professor Mann to consider as he pursues this project is the role of denial in the psychology of distressed debtors.  While his study is not designed to gather this sort of data specifically -- that is more the domain of co-blogger Professor Thorne -- it occurs that readers of this blog might have helpful anecdotal data to share with Professor Mann regarding his intuition that a bankruptcy filing comes in response to external legal prompting, and my related intuition that that passivity in turn stems from a denial of the seriousness of the debtor's affairs until objective forces conspire to make such denial no longer tenable.

Senators on Tithing in Bankruptcy

posted by Melissa Jacoby

Bob recently posted about a court decision refusing a deduction for tithing in a chapter 13 case.   That case has prompted Senators Grassley, Hatch, and Sessions to write a letter to the Attorney General asking the DOJ to direct chapter 13 trustees not to object to tithing that meets the requirements of the Religious Liberty and Charitable Donation Protection Act of 2005.   

On the Immovability of Bankruptcy Filings

posted by Ronald Mann

Count me in the group that is skeptical about the role of the legal system in influencing overall bankruptcy filing rates. Sure, I can see that the raw filing rates in the United States are a lot higher than they are in other countries. But when you account for factors like level of indebtedness, use of credit cards, and general economic conditions, the apparently large differences between the United States, on the one hand, and the UK and Japan, on the other, seem to disappear. The data suggest that the overwhelming majority of bankruptcy filings are inevitable, and that the principal effect of legal changes is to accelerate or defer the time of filing.

So I have been watching with interest the trends in filing rates since BAPCPA. The conventional view, of course, is that the filings are much lower than they were before BAPCPA and that the mid-2006 plateau in filings suggests that filings have stabilized at a level less than half of the pre-BAPCPA level.

But I’m not convinced. It is true, of course, that the filings for 2006 are much lower than they were in 2004 and 2005. Currently they are about 12,000 per week, as compared to 37,000 per week a year ago and 32,000 a week two years ago. It also is true that the 2006 filings seemed to plateau from around the beginning of April to the middle of August, a fact that might suggest stabilization. But neither of those facts tells us ANYTHING about filing trends. During 2004 and 2005, filings per week declined steadily for much of the middle of the year (weeks 10-28), the same period during which filings reached an apparent plateau in 2006. Thus, if we consider annualized filing trends, the mid-year plateau in 2006 in fact might reflect a push back towards the pre-BAPCPA filing level. To illustrate, the figure below shows the 2004 filings (not affected by the passage of BAPCPA), the 2006 filings, and the difference between 2006-2004.  {Apologies for my lack of graphics expertise.}  The trend line superimposed over the difference line suggests that in the first eight months of this year the relative increase in filings has eliminated about one third of the difference between pre-BACPCPA and post-BAPCPA filing levels.


For me, the hot issue in the consumer credit literature right now is learning what motivates individuals to file at the TIMES that they file. So the passage of BAPCPA provides a natural experiment to see how the statute affects filing dates. There are two obvious filing trends connected with the passage of the statute. First, the “early filing” effect: a LOT of people filed before BAPCPA who otherwise would have filed later. That effect should depress filing rates after BAPCPA until that effect plays out. Second, the “deferral” effect: the provisions that make filing more costly, more bureaucratic, and more humiliating should defer filings until people are deeper in distress. That effect should depress filings initially but ultimately fade away as well.

What is most provocative about the data is the long period over which those effects have played out. I would not have expected pre-BAPCPA early filers to have filed a full ten months early. But if we discard that explanation, we have to think that the deferral effect operates over a similarly extended period, so that the steady upward trend in filing rates reflects the period during which  the deferred filings are slowly rising to their “normal” level. If we have not yet reached that level, BAPCPA is deferring some filings more than ten months.

Tithing Overheats

posted by Bob Lawless

There has been a heated press release and news coverage (Wash. Times, Salt Lake Tribune, Albany Times-Union) about a case called In re Diagostino. The bankruptcy court in Albany, New York, ruled that the Diagostinos could not make a charitable contribution of $100/month but instead had to pay that money to their creditors in chapter 13. This case has been cited as yet another example of the problems with the 2005 bankruptcy amendments. Your creditors now come before your church! No more tithing in chapter 13! What's next? Didn't the Republicans know they were taking money from churches and giving it to the credit card companies? For shame, Doc.

The hype on the Diagostino case seems a little overblown. I'm no fan of the 2005 bankruptcy amendments. Never have so many been bought by so few for so much. That act could be the poster child for campaign finance reform. On this one, however, I'll give the 2005 amendments a pass.

First, the facts of the case do not support the rhetoric. The Statement of Financial Affairs, which is filed in every bankruptcy case, asks the debtor to list all charitable contributions made in the year before filing. The Diagostinos responded "None," making them not the first set of debtors to discover a sudden interest in charitable giving after filing bankruptcy. Also, the Diagostinos proposed to give $100/month in charitable contributions. There is no indication in the judicial opinion that the contributions were intended for a church. Indeed, the words "tithe" or "church" do not appear in the opinion, although the reasoning in the opinion would apply to tithes and church contributions. This is simply not a case of a couple with a long history of making charitable contributions to a church suddenly being deprived of this right in bankruptcy.

Second, I am not known for my sympathy toward unpaid consumer lenders, but when one donates to a church or charity at the expense of creditors, one is not giving. The ethic of charity is to give of oneself. One of my favorite law review pieces is an essay by Dan Keating about the ethics of charitable giving in bankruptcy. As he writes:

What has always puzzled me . . . is why debtors do not view their insistence on tithing while insolvent as simply trading one sin for another. I realize there is no "standard" Christian doctrine, but most Christian churches consider the Bible to be at least a primary source of moral and spiritual guidance. And just as the Bible supports the notion that its adherents ought to tithe, it also makes clear that repaying one's legal debts is a significant moral obligation.

Daniel Keating, Bankruptcy, Tithing, and Pocket-Picking Paradigm of Free Exercise, 1996 U. Ill. L. Rev. 1041.

Third, on the doctrine, the judicial opinion is a plausible reading of the bankruptcy statute. It certainly is a literal reading of the statute. This is not the place to get into whether section 707(b)(2)(A)(ii)(I) incorporates section 707(b)(1) or what parts of section 1325(b)(2)(A)(ii) are covered by the income test in 1325(b)(3)(A). There are a lot of cross-referenced sections, and we have had a few posts suggesting the 2005 bankruptcy amendments were not the most artfully drafted provisions in the history of Western legal thought. (OK, there have been more than a few such posts.) For present purposes, suffice it to say that a reading of the statute that considered the Bankruptcy Code as a whole might have come to a different conclusion. For example, if the Diagostino opinion is correct, then high-income chapter 13 debtors no longer can pay the expenses of their business. That cannot possibly be what Congress intended as it would remove the ability of self-employed persons to fund a chapter 13 plan.

If you want to read the Diagostino opinion for yourself, I have made a copy through the Credit Slips site. I could not find the opinion posted on the New York bankruptcy court's web site. Click below

Download diagostino.pdf

UPDATE (9/22): For some reason, I am having trouble downloading the file with Mozilla Firefox, but I have no problems with Internet Explorer (sigh). Try Internet Explorer if you have trouble with the download.

Dana Redux: Bank Power!

posted by John Pottow

When Sen. Edward Kennedy (D-MA) got 503(c) into the new bankruptcy bill, I am sure he thought he was protecting rank-and-file employees from the perceived ravages of excessive corporate executive compensation.  And maybe he was.  But as someone who doesn't think KERPs are inherently evil, I was struck by Floyd Norris' insightful reporting in today's New York Times -- which I just saw Co-Blogger Lawless has posted a link to -- regarding the denial of the Dana executive compensation package under 503(c).  I will not repeat Professor Lawless's thoughtful comments, but I will add another, which may buttress his, that troubled me with the ruling.  I don't mind purposive statutory interpretation, but one must acknowledge that it can sometimes open a can of worms.  And one of the worms that has crawled out in this case is the well placed criticism that Dana's exec comp package doesn't look all that different from Calpine's, which recently got the judicial OK.  At pains to distinguish Calpine, Judge Lifland noted that the creditors there logrolled with the plan, whereas with Dana, they did not.  (For that matter, neither did Dana's shareholders, employees, nor even the US Trustee.)  But was that the basis of distinction that Congress truly wanted, if we are searching for legislative purpose -- whether the creditors said it quacked too much like a KERP?  Was according creditors another veto right in the debtor's magement affairs what Sen. Kennedy had in mind when pushing 503(c)?  I am doubtful.

Lifland Rules

posted by Bob Lawless

Judge Lifland ruled against Dana Corporation yesterday. Floyd Norris continues his good reporting on this story in today's N.Y. Times. According to Mr. Norris, Judge Lifland said, "This compensation scheme walks like, talks like, and is a KERP." A "KERP" is a key employee retention plan, and if you are unfamiliar with this case, see my previous postings here and here.

If I ran the world, Judge Lifland would be right, but I am not sure the statute Congress passed supports his reasoning. The statute does not reach things that walk like, talk like, and look like KERPs. Rather, it reaches payments "for the purpose of inducing [a corporate insider] to remain with the debtor's business." Here, the payments were made for the purpose of inducing the corporate insider to reach certain performance benchmarks. They may have been easily met benchmarks, but they were still performance benchmarks. Yeah, one might say the benchmarks were so low that they were essentially done for the purpose of inducing the insider to remain with the company. That argument proves too much, however, as every bit of salary and benefit paid to an employee is done to induce the person to remain with the company. There is no indication that Congress intended courts to apply the new rules to all forms of compensation to corporate insiders.

In the end, this case comes down to the question of whether we apply the statute the way it was written or the way we think Congress wanted to write. (This is a pervasive question in statutory interpretation as I previously discussed.) I wish Congress had written the statute the way Judge Lifland interprets it, but I am not sure it did.

All of my comments on this case are based on Mr. Norris's reporting in the N.Y. Times. It will be interesting to see if a written opinion emerges to explain Judge Lifland's reasoning more fully. Until we can assess how broad this ruling might be, I wonder what it will mean for Manhattan as a venue choice for publicly traded companies filing bankruptcy.

Will Dana Be the New K-Mart?

posted by Bob Lawless

Floyd Norris continues his reporting (N.Y. Times) on the battle over executive pay for bankrupt Dana Corporation, an auto parts maker. Restrictions passed in 2005 limit the ability to pay executives of bankrupt companies a bonus merely to stay with the company. I previously posted on another of Mr. Norris's columns noting that corporate bankruptcy attorneys expected this provision to have little substantive effect. It is easy to structure a bonus plan so the payment is for some easily attainable goal, such as having the company emerge from bankruptcy, rather for staying with the company.

Today, however, Mr. Norris notes that the U.S. Trustee has filed a brief opposing Dana's bonus plan. That ups the ante. The U.S. Trustee has joined Dana's creditors in arguing that the company's compensation plan should be recharacterized as a retention plan. Dana would pay its executives a  large bonus if the company emerges from bankruptcy and another large bonus if the company's securities hit certain targets six months after bankruptcy. The U.S. Trustee and the creditors argue that the targets are so low and likely to be met that the bonuses are not true incentives and thus are better characterized as retention bonuses.

What will happen if the bankruptcy court rules against Dana? Will such a ruling cause bankrupt companies to avoid filing in Manhattan, much as a ruling in the K-Mart case caused bankrupt companies to avoid filing in Chicago? Is Dana's compensation plan out of line with what other companies in chapter 11 are doing?

Small Business or Consumer?

posted by Bob Lawless

Leslie Eaton of the N.Y. Times today reports on the state of small business in New Orleans, one year after Hurricane Katrina. It is a great article, exploring the relationship of small business both to the social fabric and economic health of a community. In the article are stories about the financial decisions small-business owners have made in recovering from Katrina's devastation. A restaurateur expresses hope that he has not made a "foolish decision" by using all of his savings to reopen his restaurant. To cover losses stemming from months when her store was closed and slow sales since reopening, a shopkeeper has "mortgaged her house to the hilt" and borrowed from in-laws.

Whether these are reasonable risks or foolish decisions, these stories illustrate that "consumer" credit policy presents subtle and highly textured issues. First, I highlight "consumer" because one wonders how to classify the financial decisions of these business owners. Are these consumer debts or business debts? If the restaurateur now begins to rack up credit card debts for his daily living expenses because his savings are sunk into the business, how do we count that? Is the shopkeeper's home mortgage a business debt? For a significant segment of the public, their financial affairs are in a gray area between consumer and business. About one out of every seven bankruptcies, for example, is someone that is or recently was self-employed. Most every small-business owner's personal and business affairs are intertwined and interdependent.

One might wonder why these small-business do not incorporate or form a limited liability company, to separate business and personal affairs. The answer is that they may have done do so, but why does it matter if they have put their personal credit at risk to finance the business? Even if they have not, that can be a rational decision. With the press of all the other demands of a small business, the time and expense it takes to incorporate may not seem worth it if you have put your personal credit on the line anyway. Regardless of the fiction of legal separateness, small-business owners cannot financially walk away from a failed business.

When we think about "consumer" credit policy, we are thinking about different groups, and small-business owners comprise one of these groups. Often, however, consumer credit policy thinks about consumers monolithically. The monolithic image that often results is the irresponsible, overspending, unsophisticated consumer, and we end up with rules that are unsuitable for large portions of the public. An example is the new bankruptcy requirement that all individual filers undergo consumer credit counseling. If the New Orleans business owners mentioned in the N.Y. Times article later end up in bankruptcy court, query what credit counseling would tell them. Don't take business risks? The credit counseling requirement is just one example. Last year, I taught a seminar where looked at a host rules that looked great for consumers or looked great for big businesses but did not work well for small business owners.

Credit and bankruptcy laws directed at consumers will sweep in small-business owners. At that point, another law may come into play--the law of unintended consequences.

Column on Bankruptcy Reform in Houston Chronicle

posted by Bob Lawless

Loren Steffy, a columnist with the Houston Chronicle had a column in Sunday's paper about the 2005 bankruptcy amendments. He writes, "After almost a year under the so-called bankruptcy reform that Congress enacted at their behest, the law has proved to be what it appeared: a love letter to lenders." (Thanks to Professor Tim Zinnecker for bringing this to our attention.)

On Absurdity

posted by Bob Lawless

A few days ago, I discussed the sloppy drafting in the 2005 bankruptcy amendments, focusing on one particular piece of drafting that could be construed to eliminate involuntary bankruptcy petitions. Tom Perkins made a good point in the comments. A venerated legal maxim holds that courts are to apply the plain meaning of a statute unless the results would be absurd, but "[c]ourts are now faced with having to define absurdity much more frequently in light of many of the curiously drafted or pasted together provisions of BAPCPA."

In January, Judge Bruce Markell published a thoughtful opinion exploring what it means for a result to be absurd such that a court should not follow the literal words of the statute. Judge Markell was dealing with a part of the 2005 amendments related to homestead exemptions. He uses Justice Scalia's legisprudential writings as a point of departure: "Justice Antonin Scalia is one of the strictest, if not the strictest, textualists active today. . . .  If the methods used by Justice Scalia would lead to the reformation of the statute, then the statute probably should be reformed, and little time need be spent in discerning the proper or ultimate test for all federal statutes." This opinion has been called the WWSD or "What Would Scalia Do" approach. The legal citation is In re Kane, 336 B.R. 477 (Bankr. D. Nev. 2006) and is well worth a read by anyone grappling with applying the 2005 bankruptcy amendments.

Floyd Norris Asks a Good Question

posted by Bob Lawless

In today's N.Y. Times ($), columnist Floyd Norris asks a good question. Were parts of the 2005 bankruptcy amendments meaningless? Specifically, Mr. Norris writes about a section of the new law that appears to put limits on retention bonuses for executives of bankrupt firms. Mr. Norris details the dispute between the reorganizing Dana Corporation and its creditors. Dana wants to pay its CEO a $3 million bonus for staying with the company until it emerges from bankruptcy.

As the law that eventually emerged in 2005 wended its way through Congress in the early part of this decade, reports appeared about bankrupt corporations signing multimillion dollar contracts with corporate executives to ensure the executives stayed with the company through bankruptcy. If generals make the mistake of always fighting the last war, politicians make the mistake of always solving the last corporate crisis. Hence, the congressional solution was a new law banning payments to induce a corporate insider to remain with the bankrupt business. These payments are allowed only if the insider was essential to the business, the insider had a competing offer to go elsewhere, and the payment was no more than 10 times the amount paid to nonmanagement employees to induce them to stay with the company.

To answer Mr. Norris's question, this particular section is meaningless. The weakness lies in the way the section was drafted, a point I made yesterday about the 2005 law generally. The predicate for its application is that the payment has to be made for purposes of inducing the insider to stay with the business. It is a simple matter to structure a compensation package so the payment is made for other purposes. For example, a bonus payable upon confirmation of a chapter 11 plan or to meet certain performance goals is an incentive payments to meet those goals, not retention payments. I have yet to encounter an attorney doing chapter 11 work who thinks this new provision will have any substantial effect on compensation practices in chapter 11.

Whatever Else It Is, It Is Poorly Written

posted by Bob Lawless

Here is my entry for biggest understatement on the Credit Slips blog: the 2005 bankruptcy amendments have drawn some criticism. Regardless of one's views about the substance of the amendments, most everyone seems to agree that the legislative drafting left something to be desired. An example is with involuntary petitions. Because section 109(h) requires credit counseling for all consumer debtors in the 180 days preceding or (in some circumstances) the 30 days after the bankruptcy petition, a consumer debtor could defeat an involuntary petition by simply not getting credit counseling. Does that mean that the 2005 amendments eliminated involuntary bankruptcy petitions against consumer debtors?

A bankruptcy court in New Jersey has reached the sensible conclusion, "of course not." (In re Fagan, No. 06-14863 NLW (Bankr. D.N.J. Aug. 14, 2006). In amending the Bankruptcy Code, Congress left in place the section that authorizes involuntary petitions (section 303). If Congress had wanted to except consumer debtors from involuntary petitions, it simply could have amended the list of debtors ineligible for involuntary relief. Moreover, an "individual" must get consumer credit counseling before a bankruptcy petition "by such individual" (section 109(h)). Because an involuntary petition is filed by creditors and not "by such individual," the credit counseling requirements do not apply.

All of this hair-splitting could have been avoided if the credit counseling requirements had simply started with  "Except in the case of an involuntary petition," but is there a larger point here other than the hair splitting? I think so. The 2005 bankruptcy amendments were the most sweeping changes to the federal bankruptcy law since 1978 when congressional staffers worked closely with professional experts to draft the Bankruptcy Code. Since 1978, we have seen a steady erosion of congressional willingness to involve bankruptcy experts in legislative drafting. The result was that special interests and their paid lobbyists had a major role in drafting the 2005 amendments.

That's not surprising. Most legislation is drafted, at least initially, by lobbyists. In 1978, there were around 200,000 total bankruptcy filings, and in 2005, there were over 2,000,000. I don't expect to see a return to the days when Congress looked to bankruptcy experts for advice in how to draft the bankruptcy law. The stakes are higher than they were in 1978.

Parts of BAPCPA Unconstitutional

posted by Bob Lawless

Among the many changes in the 2005 amendments to the bankruptcy law (known as the Bankruptcy Abuse Prevention and Consumer Protection Act or "BAPCPA") were provisions designed to restrict what bankruptcy attorneys had to say to clients and what they could not say to clients. Yesterday, a federal judge in Dallas found one of these provisions unconstitutional but upheld other parts of the law. The case is Hersch v. United States, No. 3:05-CV-2330-N (N.D. Tex., July 26, 2006), and the plaintiff was represented by Howard Marc Spector. The opinion is available here.

BAPCPA lumps bankruptcy attorneys in with all debt relief agencies and then states that no debt relief agency can advise a debtor to incur more debt before filing bankrutpcy. Not surprisingly, Judge David Godbey ruled this provision unconstitutionally restricts speech. I'm no constitutional scholar, but one cannot imagine a more direct regulation of speech (maybe I just lack imagination). Other provisions of BAPCPA require bankruptcy attorneys to make lengthy disclosures to all clients. Despite cases holding the government cannot compel business to make speech, Judge Godbey found this provision constitutional. He analogized to compelled disclosures doctors had to make before performing abortions and that the Supreme Court upheld in the Casey decision.

There is a lot more I would like to say about this case, but I have to run. Blog readers can breathe a sigh of relief. As an experiment, I have turned on the comments for this posting. My fellow bloggers also may have more to add.


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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.