Reform bankruptcy laws before Covid debt comes due
Handmade signs litter the floor after an anti-eviction protest outside an apartment complex in Mount Rainier, Md., August 10, 2020.
Lea Millis | Reuters
Even with the latest coronavirus relief bill, economic tensions related to the pandemic will continue to escalate. An assortment of federal, state and local moratoriums on foreclosures, evictions and debt collections have kept creditors at bay, and UI has helped many families stay afloat.
But neither collection moratoria nor unemployment insurance will last forever, and they risk expiring as Covid-19 weakens. This is when the invoice will fall due.
Collection moratoriums only stop collection actions; they don’t write off debts. Unemployment insurance typically only replaces a fraction of consumers’ income, so the bills pile up when a consumer is unemployed. When the moratoriums expire, consumers will still owe months of rent or mortgage arrears, not to mention accrued interest and late fees.
These debts will not go away as the economy recovers. Many families were coping just before Covid. They have no financial safety net, and little or no ability to make up overdue bills from their future income. And for some families, there will be not only the usual bills, but also crushing medical bills related to Covid.
The magnitude of the problem is difficult to quantify, but there is no doubt that it is huge. When the moratoriums on collection end, there will be a tsunami of foreclosures, evictions and collection actions.
Bankruptcy has long been the economy’s safety valve in times of financial distress. When consumers are overburdened with debt, bankruptcy gives them the opportunity for a fresh start and serves as a type of social insurance by spreading losses among creditors. Unfortunately, however, the bankruptcy system poses too many barriers for consumers to get the immediate help they need.
Under current bankruptcy law, a consumer can choose between filing for Chapter 7 bankruptcy or Chapter 13 bankruptcy. In Chapter 7, the consumer gives away his or her assets (other than certain minimum necessities), but keeps all of them. future income and gets immediate “discharge” of its debts.
In Chapter 13, the consumer retains his assets, but commits to a repayment plan under which creditors get all of his disposable income for the next three to five years. In chapter 13, the consumer only obtains a discharge at the end of the reimbursement plan, something that most debtors fail to achieve. Those consumers who fail to complete their plans have lived in onerous conditions during the life of the plan, with little interest.
High-income consumers are required to file for Chapter 13, but many low-income consumers do so out of necessity: there is no provision for consumer counsel payment in Chapter 7, so unless the debtor can “save up to bankruptcy“, the only choice to pay the lawyer is under a Chapter 13 repayment plan, and Chapter 13 attorney fees are more than double that of Chapter 7. In other words, because bankrupt consumers are broke, they are forced to file for bankruptcy that is too complex and costly for their needs and often offers them no real debt relief.
Paying for a lawyer is just the start, however. Current bankruptcy law is obsessed with capturing the complicit debtor who uses bankruptcy to get rid of debts he can afford to pay. Yet this kind of abuse is rare because bankruptcy is not a free ride.
Honest and unhappy debtors – like Americans whose financial lives have been destroyed by Covid – have to file tons of unnecessary documents even though their bankruptcy cases are evidently meritorious. These requirements increase the cost of filing for bankruptcy and function as trips and traps that can prevent even deserving debtors from getting the relief they need.
Moreover, even when consumers are able to obtain discharge from their debts in bankruptcy, there are exceptions to discharge. Most notably, student loan debt is generally non-dischargeable. Additionally, if a debtor wants to keep their house or car in bankruptcy, they must repay the loan on their original terms. It doesn’t matter whether the car or the house is only worth a fraction of the amount owed on the loan.
Renters aren’t doing any better either. If a tenant wishes to keep their lease, bankruptcy law requires that they immediately catch up on any rent arrears. This is a hopeless proposition for most debtors; if the debtor had the money, she wouldn’t be behind on the rent in the first place.
Recently introduced legislation co-sponsored by Senator Elizabeth Warren, D-Mass. – the country’s leading expert on consumer bankruptcy law in her former position as a law professor – would correct these shortcomings with a major reform of the consumer bankruptcy system.
I have been happy to advise and help with the bill as drafted because reform is so needed. The proposed legislation would give consumers the tools to meet all of their financial obligations – mortgages, car loans, student loans, medical debt, etc. This would allow tenants to keep their lease without making up for months of rent arrears. And that would allow consumers to afford to file for bankruptcy.
The debt collection moratoria allowed Congress to act before the debt collection tsunami hit. Congress should take action to reform consumer bankruptcy law so that it can function as an effective safety valve for the economic fallout from Covid to consumers.
Adam J. Levitin is Professor of Law at Georgetown University.