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Consumer Bankruptcy Overhaul Envisioned in New Bill: Explained

Oct. 17, 2022, 9:00 AM

Congressional Democrats have reintroduced a bicameral bill that would radically alter how individuals file bankruptcy, a response to criticism that the process is too complicated and disfavors people of color.

The Consumer Bankruptcy Act of 2022 was introduced in September by two Democrats—former bankruptcy professor Sen. Elizabeth Warren and chairman of the House Judiciary Committee Rep. Jerrold Nadler. The proposal is the lawmakers’ latest attempt to introduce sweeping reform after a prior version of the bill introduced in 2020 failed to gain traction.

Why Change Personal Bankruptcy?

Bankruptcy is supposed to give the “honest but unfortunate debtor” a means to get a “fresh start.” But critics, including consumer advocates and a group of 86 bankruptcy law professors who signed a letter in support of the bill, say there are numerous problems that limit the consumer debtor’s ability to win that fresh start.

Currently, typical consumers choose between filing under Chapter 7 or Chapter 13 of the US bankruptcy code. In Chapter 7—the far faster option—an independent trustee liquidates the debtor’s available assets and makes distributions to creditors. In Chapter 13, debtors contribute their income to a trustee who makes payments under a three- or five-year plan.

Studies over the years have shown that Black Americans have disproportionately been steered into Chapter 13, even when Chapter 7 would be a better option. Black households are about twice as likely to file Chapter 13 as compared to other races, according to the professors’ letter.

Chapter 13 cases are often unsuccessful, with fewer than half of filers getting their discharge, according to the law professors.

Ironically, those who would most benefit from a Chapter 7 filing are often precluded because it’s too expensive. Lawyers generally won’t file a Chapter 7 case without being paid in full in advance, driving many into Chapter 13 where attorneys can be paid over time.

What Does the Bill Do?

Under the proposed legislation, individuals with less than $7.5 million in debt would file under a newly-created Chapter 10. Chapter 13 would be eliminated.

Consumers would follow one of two paths in the new Chapter 10. One path would provide a simple discharge of debts. The other option would require individuals with a certain annual income level—above 135% of the median income for the state and household size—to make partial payments to creditors over a three-year plan.

The bill would allow debtors to pay attorneys after the filing, eliminating the requirement to pay upfront.

Debtors also would be allowed to wipe out certain government and criminal fines. Criminal and government fines disproportionately affect people of color, according to the National Consumer Law Center.

Discharging liability for violating civil rights would be banned.

The bill also would ease debtors’ ability to keep their homes and cars. Homeowners would have more options to sell their properties free of liens and facilitate mortgage modifications based on fair market value. Debtors who rent can stay without having to make lease default amounts, so long as they don’t exceed six months’ rent.

Car owners would be able to keep their vehicles by paying the lenders only their market value, not the full amount of the loan.

There would also be a federal $35,000 wildcard exemption that the debtor can use to protect any chosen asset.

The requirement to attend credit counseling—considered by many to be waste of money—will also be removed.

The measure also cracks down on predatory lending and debt collection practices. A newly created special ombudsman in the Consumer Financial Protection Bureau would handle bankruptcy complaints.

What About Student Loans?

Over the years, student loans have become increasingly difficult to wipe out in bankruptcy.

In most jurisdictions debtors have to satisfy an extremely difficult threshold establishing that the debt creates an “undue hardship” that would continue into the future.

The bill proposes to remove the rule that student loans aren’t dischargeable.

Debtors who can make debt payments under the newly proposed Chapter 10 would still make payments on student loans, the same as with other debts. But when the three-year payment timeframe ends, the remaining debt would be discharged.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bloomberglaw.com

To contact the editors responsible for this story: Maria Chutchian at mchutchian@bloombergindustry.com; Roger Yu at ryu@bloomberglaw.com