CHAMPAIGN, Ill. - Early signs of the effect of the new bankruptcy act on consumers and the courts are not encouraging, according to an expert on bankruptcy law at the University of Illinois.
The Bankruptcy Abuse Prevention and Consumer Protection Act, which went into effect eight months ago, is already proving to be "a huge hassle and waste of time and money," said Charles J. Tabb, the Alice Curtis Campbell Professor of Law.
"The bill was very poorly drafted, and the ambiguities in the act are causing the courts many difficulties in applying the law," he said.
The law stripped bankruptcy judges of discretion in determining the merits of debtors filing Chapter 7 bankruptcies - which clear most consumer debts - by establishing a "means test" for filers.
The means test is "a Byzantine gate-keeping provision that serves to bar consumer debtors from immediate discharge of debts in a Chapter 7 straight liquidation bankruptcy," Tabb said. "If debtors who earn more than their state's median income have the 'means' to pay a small amount of their debts to unsecured creditors, they are subject to procedures forcing them into Chapter 13 repayment plans.
"In addition, the new law embodies a long laundry list of amendments that almost uniformly work to the disadvantage of consumer debtors."
In a recently published paper, Tabb analyzed the means test and found it to be overly complex and ambiguous. "Bankruptcy lawyers are at sea wondering what in the world to do," he said. "This is causing widespread problems as judges and attorneys try to sort out the new requirements."
Between 1980 and 2000, individual bankruptcy filings went from 287,570 to 1,217,972 nationwide. "About 70 percent of the consumer cases were filed under Chapter 7," he noted. "Obviously, no one is happy about those numbers. But ascertaining the cause of this dramatic rise is not so easy."
Studies have shown that the vast majority of Chapter 7 bankruptcies were caused by medical problems, divorce or job layoffs. Furthermore, Tabb wrote, "the increase in the number of consumer bankruptcies is very closely correlated with the increase in the amount of outstanding consumer credit and with the rate of credit-card defaults."
Easy credit has flooded the nation in recent decades, with the average American between ages 18 and 64 receiving nearly 20 offers for credit cards per year. Many of these solicitations are made with little or no regard to a consumer's credit-worthiness.
"Credit-card issuers do this for a simple reason - they make a very large amount of money through high interest rates on debt run up by consumers," Tabb said. "Industry profits surged 44 percent from 1998 to 2000 alone. Yet, while inundating debtors with credit offers, credit issuers express consternation when some debtors are unable to pay the crushing debt load and file for personal bankruptcy. While debtors may not be blameless, neither are the creditors."
Already, figures coming from bankruptcy courts since the new law went into effect indicate that no more than 4 percent of Chapter 7 debtors can reasonably pay off their debt, while the overwhelming majority have no assets and few prospects for remunerative employment. This compares to the 15 to 30 percent of debtors who proponents of the new act said were able to repay their IOUs, but instead ducked responsibility by filing for bankruptcy.
"What we are finding is that abusive practices by consumer debtors are not a widespread problem. What's more, the assertion by the act's proponents that means testing will result in the collection of an additional $3 billion a year from debtors is looking very dubious," Tabb said. "Respected nonpartisan studies would put the figure - generously - at less than $1 billion, and some believe a more realistic figure would be around $450 million."
Chapter 13, where most consumer filings will wind up under the new act, "is not going to work very well," the Illinois scholar predicted. "The demands on consumer debtors who are above the income median are too onerous, and the debtor additionally is going to have to pay more for legal help.
Debtors' attorneys now report spending about double the time they used to spend in preparing cases to file under the new law."
Yet another provision requires all debtors to take a credit-counseling class before they file for bankruptcy. "There has been a myriad of problems sorting out this requirement," Tabb reported. "There is little indication that the counseling requirement is serving any useful purpose, and considerable evidence that it is a waste of money and time for everybody in the bankruptcy arena except creditors."
About 500,000 debtors filed for personal bankruptcy in the week before the new law became effective last October. In the first quarter of 2006, filings were off by 71 percent from the first quarter of 2005.
The numbers are likely to start increasing again as people are forced by circumstances, such as pending mortgage foreclosures or medical debts, to file. And the courts are liable to get increasingly clogged with cases stuck among the cumbersome new provisions, according to Tabb.
A member of the Illinois College of Law faculty since 1984, Tabb has published three books on bankruptcy law. They include "Bankruptcy Law: Principles, Policies and Practice," co-written with Ralph Brubaker, associate dean for academic affairs at the College of Law.
Tabb's analysis of the new law, "Consumer Bankruptcy After the Fall: U.S. Law Under S. 256," was published in the Canadian Business Law Journal.