Untangling the proposed bankruptcy reforms
By David A. Skeel Jr.

A friend of mine likes to compare the bankruptcy legislation that's been winding its way through Congress for the past six years to a vampire. The legislation never seems fully alive but it isn't dead either. It reappears every year and comes very close to enactment before failing at the last moment.

Attempts at bankruptcy reform began back in early 1997, when a National Bankruptcy Review Commission that had been appointed three years earlier was poised to submit its final report to Congress. Credit card companies and other consumer creditors were unhappy with the report because they considered it too soft on debtors. They persuaded several lawmakers to introduce proposed reforms that were more to their liking.

The proposals have had a great deal of support from the beginning but have been stymied by a shifting series of obstacles. The legislation made it to President Clinton's desk in 2000, but he refused to sign, reportedly due in part to Hillary Clinton's opposition. President Bush is less hostile to the legislation than President Clinton was, and the legislation seemed certain to pass in fall 2002.

But once again the legislation failed, this time because a group of House Republicans rebelled against a provision that would have prohibited debtors from using bankruptcy to wipe out judgments for protesting at abortion clinics.

But don't think that the bankruptcy legislation is gone. It's a new year, and the legislation is back once again.

In February, the House passed this year's version without the controversial abortion provision by an overwhelming majority (315-113). The Senate hasn't yet taken up the bill, but there are reports that Senate Judiciary Committee Chairman, Orrin Hatch, R-Utah, plans to bypass committee consideration and send it directly to the Senate floor. This means that the bankruptcy debate will be heating back up at any moment now.

There are two key provisions in the proposed legislation.

The first is "means testing." Consumers who file for bankruptcy have two choices, Chapter 7 or Chapter 13. If a consumer files for Chapter 7, any property that is not exempt (exempt property is property that debtors are entitled to keep) must be turned over. In return, the debtor receives a prompt discharge of his or her debts. With Chapter 13, debtors are required to repay some or all of their debts over a three-to-five-year period.

The means test is an effort to force more debtors to choose Chapter 13. Currently, roughly 70 percent choose Chapter 7. Any debtor who is capable of repaying either $10,000 or 25 percent of what they owe to ordinary creditors, whichever is less, would be prohibited from filing for Chapter 7. If a debtor has the means (hence the term means test) to repay a significant portion of his or her obligations within the next five years, the reasoning goes, he or she should be required to do so.

I am often asked how many debtors the means test would force into Chapter 13. The answer: not very many. As it turns out, the means test applies only to debtors who make more than the median income and not surprisingly, the vast majority of debtors earn less than the median.

The real effect of the test would be to increase the cost and bureaucracy of bankruptcy. Even debtors who did not meet the means test would be forced to fill out the forms to prove this, which would make filing for bankruptcy much more costly than it currently is.

The second key provision is a new consumer counseling requirement. The goal is to teach debtors about financial management, and reduce the likelihood they will wind up in bankruptcy again. Every debtor who files for bankruptcy would be required to obtain counseling from a court-approved counseling center before filing for bankruptcy and continue to be counseled after filing.

This provision may further increase the cost of bankruptcy and certainly will increase the hassle. Credit card companies provide most of the current consumer counseling services. These are often offered free of charge, but there is no guarantee that a debtor will have access to a free counseling service. The proposed reform requires that approved services operate on a nonprofit basis but permits them to charge for their services. There also is no guarantee that the services will be easy to get to. The counseling requirement would only be waived if local counseling services "are not reasonably able to provide adequate services."

In short, the legislation would add new hurdles -- new costs and inconveniences -- to the bankruptcy process.

So what does this mean for a consumer who has crushing debts?

It is still quite unclear whether the legislation will pass. If the legislation makes its way toward the president's desk in the coming months, consumers who need to file for bankruptcy may wish to consider filing before it gets there. Bankruptcy should always be a last resort, but it is a less burdensome last resort under existing law.

David Skeel Jr., a professor of Law at the University of Pennsylvania, is an internationally known expert on corporate and bankruptcy law. He is the author of "Debt's Dominion: A History of Bankruptcy Law in America." Professor Skeel has also written commentaries for the New York Times, Financial Times, Los Angeles Times, Philadelphia Inquirer, and other publications; he has appeared on "Nightline," "Hardball with Chris Matthews," CNBC, CNN Book TV, Marketplace, NPR and elsewhere; and he has been quoted in the Wall Street Journal, New York Times, Washington Post, U.S. News & World Report, The American Prospect, The Weekly Standard and many other newspapers and magazines.