CREDIT CHANGES: CHAPTER AND WORSE
Byline: Valerie Seckler / With contributions from Vicki M. Young
NEW YORK — Mass market retailers are riled up over proposed changes in the U.S. Bankruptcy Code that would make it easier to file personal bankruptcies; consumers’ filings this year are expected to top 1996’s record 1.1 million.
The proposal to streamline the bankruptcy code — recommended in a 1,300-page report issued by the National Bankruptcy Commission Oct. 20 — does “virtually nothing to prevent individuals from escaping obligations by the too-easy recourse of filing personal bankruptcy,” charged Morrison G. Cain, senior vice president of government affairs at the International Mass Retail Association.
About one in every 80 U.S. households will file personal bankruptcies in 1997, projected Mallory Duncan, general counsel and credit specialist at the National Retail Federation. “An overwhelming majority of them, around 70 percent, will be Chapter 7s, and 95 percent of those debts typically are not paid.”
According to the Georgetown Credit Research Center, about 25 percent of American consumers who file for Chapter 7 bankruptcy could afford to repay one-third or more of their obligations.
Under the NBC’s proposal, payment-exemption levels for debtors would be raised so that an individual could file Chapter 7, yet retain the equity in his or her home, plus personal exemptions of up to $40,000 for a husband and wife, or $20,000 for a single head of household.
“This means that someone who owns a house valued at $190,000 and owes $90,000 on their mortgage could keep up to $140,000 in net worth and never repay their bills,” Duncan pointed out. Such a net worth is higher than that of 75 percent of American households, observed NRF president Tracy Mullin.
“I would argue that at a time when Chapter 7 abuse is on the rise, the process should not be streamlined,” Duncan offered.
Some retailers, including Wal-Mart Stores, Kmart Corp., Kohl’s Corp. and the Target division of Dayton Hudson Corp., declined to comment on how to address the rising insolvency rate among their customers. Others, such as Sears, Roebuck & Co. and J.C. Penney Co., back the NRF’s position.
“We have worked closely with the National Retail Federation on this issue, and we have aligned with them,” said a Sears spokeswoman.
“Bankruptcies cost retailers more than $1 billion a year,” Mullin said. “The commission’s recommendations do nothing less than provide an incentive for debtors to walk away from their obligations and stick good customers with the bill.”
Instead, NRF advocate that if a consumer is able to pay off 10 to 20 percent of his or her debt, it should be mandatory that he or she file for Chapter 13 bankruptcy, the course consumers pursue when they intend to repay at least some of their bills.
Consumers have found some wiggle room lately in Chapter 13, however, Duncan noted.
“In an increasing number of Chapter 13s, we’re seeing lawyers finesse the cases so that consumers pay only a few percentage points, or even zero, of what they owe,” he said. “Some cases are almost like Chapter 7s.”
The remedy, according to the NRF, is for the federal government to establish tougher standards for filing Chapter 7, with the provision that such filings would bring the automatic discharge of a consumer’s debt.
“If someone is totally under water, without assets to repay obligations, why spend money and time to establish a payment plan?” Duncan asked.
The NRF repeatedly has asked the NBC to consider a person’s ability to repay before moving him or her through the bankruptcy system.
“The increase in consumer bankruptcy is being fueled by individuals who choose to walk away from their debts despite an ability to pay,” Mullin said. “The current system is bad; what the commission is proposing would make it a disaster.”
Roughly 88 percent of bankruptcy cases in the U.S. are filed by consumers, according to Duncan.
Retailers may find some relief in Congress, which historically has dragged its feet on bankruptcy reform. The federally funded NBC report was the subject of a Senate Judiciary Committee meeting Oct. 21, the day after the report was issued.
On that day, Sen. Charles E. Grassley (R., Iowa) and Sen. Richard J. Durbin (D., Ill.) introduced the Consumer Bankruptcy Reform Act, which is aimed at finding a middle ground between debtors and creditors. The bill, introduced in the Judiciary Committee, would require Americans with assets to pay at least some of their debts instead of declaring themselves insolvent.
“I think there is bipartisan recognition on Capitol Hill of a need to make it more difficult for individuals to file for personal bankruptcy,” said IMRA’s Cain. “With 1.1 million personal bankruptcies filed last year, clearly something is going on other than people pursuing the last resort of hard-scrapped debtors.
“The question is, what is going to be done about it, and how soon,” Cain asked.
“I think Congress realizes that if personal bankruptcies have quadrupled from 1980 levels during a stable economy, the situation only stands to worsen when the economy turns down,” Duncan said.
“Those who don’t want to take personal responsibility for their debts need to get the message that the free ride is over,” said Grassley, who chairs the Judiciary Committee, in filing the bill. The bankruptcy reform proposal would give judges the power to require partial repayment by some Chapter 7 petitioners. They could do so either by dismissing a Chapter 7 case outright or converting it to a Chapter 13, which sets the rules for a repayment schedule.
Grassley and Durbin also seek to rein in what they termed the “abusive collection techniques” of some retailers by raising fines for illegal creditor activities.
Sears, as noted, took an after-tax charge of $320 million in the second quarter this year in connection with the illegal collection of bills from bankrupt consumers through written agreements, or reaffirmations, to repay those debts. In some cases, Sears filed those documents incorrectly; in others, it failed to file them at all.
“We are certainly staying close to the situation, but we will continue to pursue reaffirmations with our customers,” the Sears spokeswoman said.
Striking the proper balance between creditors’ rights and protecting individual debtors promises to be the subject of extensive Congressional debate, forecast bankruptcy attorneys.
Kenneth Klee, acting professor of law at UCLA’s law school and counsel to the law firm of Stutman, Treister & Glatt, maintained that the marketing practices of lenders are too liberal. In Klee’s view, lenders should be forced to more closely monitor credit levels because evaluations of the borrowers’ ability to pay sometimes miss the mark.
“One big question is: ‘Why isn’t consumer credit being more closely regulated?”‘ Klee contended.
Prior to the recent tidal wave of personal bankruptcy filings, there was little incentive for retailers to do so, Klee explained, because the “costs of doing that homework exceeded the number of debtors who don’t pay.”
Retailers also need to take a closer look at the profitability of their credit card businesses, Klee advised.
Consumer abuses are being blamed for higher credit costs, which are being passed on to those who pay their credit card debts, Klee noted, adding, “I don’t buy this.”
Retail officials are speculating that Congress will be reluctant to implement the controversial streamlining suggested by the NBC, which was passed in a 5-to-4 vote.
“There’s a joke circulating in Washington,” said IMRA’s Cain, “that what we may be seeing in the National Bankruptcy Commission’s report is Chapter 20: the worst of Chapters 7 and 13, combined.”
U.S. Personal Bankruptcies
1,125,006 households filed in 1996.
Filings leaped 28 percent last year over 1995.
70 percent filed under Chapter 7 in 1996.
1.3 million households expected to file.
personal bankruptcy petitions this year.
Bankruptcy Losses of Creditors:
$32 billion overall in 1996.
$3.5 billion lost by retailers.
$300 per U.S. household in 1996.
Chapter 7 Debtors:
25 percent could pay at least 30 percent of their non-housing debt in 1996.
5 percent could pay all of their non-housing debt last year.
Debtors filing Chapter 7 in 1996.
could have repaid $5.1 billion.
Sources: National Retail Federation; Georgetown Credit Research Center