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Thursday, January 21, 2016

A Modest Proposal for Protecting Consumer Debtors in the Poorest Jurisdictions

I haven't posted in a while.  There is a lot of financial distress going on and a lot of other big issues as well, but I try not to post unless I can convince myself have something unique to contribute.  This is one of those topics, I think.

A couple of years ago I was in San Juan, P.R., for an ABI conference.  At the lunch break, I found myself at a table with a long-time professional colleague, a Judge from another district that I had appeared in front of a few times, and certain personnel from the local Bankruptcy Court, all of whom shall remain nameless.  One of the topics that came up, which can, without a doubt, be considered part of my continuing professional education, pertained to the local consumer bankruptcy practice, which, not surprisingly, is rather bustling in what is one of the poorest jurisdictions in the United States of America. Yet, in the course of the discussion, I learned a very curious fact about consumer bankruptcy practice in Puerto Rico: it is one of the few jurisdictions that has a significantly higher proportion of chapter 13 petitions than chapter 7 petitions for consumer debtors.  Statistics on the website of the U.S. Bankruptcy Court for the District of Puerto Rico show that, last year, the district had 5,744 chapter 13 filings and 4,477 chapter 7 cases, a number of which were likely not consumer cases but small business petitions.

Now that doesn't make a lot of sense.  Puerto Rico is, by a shockingly large margin, poorer than any State in the United States.  The Census Bureau estimates the median household income in Puerto Rico to be just $19,686.  For comparison purposes, data generated by the U.S. Census Bureau about median household income in different places in the US (specifically, the table "Income of Households by State Ranked from Highest to Lowest") reveal that the median household income in the US (in 2013 dollars) was $51,849.  And the 5 lowest ranked states are:

West Virginia$42,581
Kentucky41,707
Arkansas40,760
Louisiana40,462
Mississippi40,194

Thus, the median household income in Puerto Rico isn't even half that in the poorest States in the US.  Moreover, given the amount of its population receiving income assistance and other welfare support from the Federal government, their actual earned income is probably significantly less than even that sum.   So it's highly surprising that the sub-population that winds up seeking relief from consumer debts by filing bankruptcy tends to pursue the chapter that was generally designed for higher earners and therefore provides less of a write-down and burdens their subsequent earnings more.

Unfortunately, the anomaly is not limited to Puerto Rico. As a recent summary on the U.S. Trustee  website states:

"Chapter 13 filings vary greatly from state to state, ranging from 6 percent to 70 percent of filings. These extremes are even more pronounced at the district level, with some judicial districts having chapter 13 percentages as high as 80 percent. The top jurisdictions with a predominant concentration in chapter 13 filings, or more than half of total filings, are Louisiana, Puerto Rico, South Carolina, Tennessee, Texas, Georgia, Arkansas and Mississippi.  States with the fewest chapter 13 filings, or less than 10 percent of total filings, are Idaho, South Dakota, Iowa and New Mexico." 


With the exception of Texas, which ranks 25th, the jurisdictions with disproportionately high chapter 13 filings are all jurisdictions in the bottom third of the median national household income ranking:  Georgia [34], South Carolina [41], Tennessee [43], Arkansas [48] Louisiana [49], Mississippi [50], and of course, Puerto Rico [51].

I looked at filings last year in the three poorest states and confirmed the Executive Office of the U.S. Trustee's summary remained generally accurate:

Arkansas: In this State, in 2015, filing statistics bore a remarkable resemblance to Puerto Rico's:  5,296 chapter 13 filings vs. 4,560 chapter 7 cases. (Those figures are the sum of the filings in the State's two federal judicial districts.)

Louisiana:  Only the Eastern District published data on its website breaking down consumer bankruptcy filings by chapter for 2015.  The distribution of filings in their district is skewed toward chapter 13: 1,834 chapter 13 cases vs 1,469 chapter 7 cases

Mississippi:  In 2015, curiously, the two districts had significantly different balances of consumer bankruptcy filings.  In S.D. Miss., there were 2,913 chapter 13 filings and 3,339 chapter 7 filings.  Conversely, in N.D. Miss., they had 2,727 chapter 13 filings, vs, only 1,952 chapter 7 filings.

For comparison's sake, I looked at the filing patterns in the other States, West Virginia and Kentucky, in the bottom decile of the Census Bureau's rankings:

West Virginia: In 2015, West Virginia saw 1,095 chapter 7 filings and only 189 chapter 13 filings, making it quite a standout vs its economic peers in delivering the benefit of the federal bankruptcy law.

Kentucky:  Its Western District saw 4,883 chapter 7 filings and 2,261 chapter 13 filings. The Eastern District's bankruptcy court website does not seem to present statistics on the chapter 7 / chapter 13 breakdown.

As further comparison, I looked at filing patterns in a couple of the highest ranked states.

Maryland: In Maryland, the State said to have the highest median household income, in 2015, there were 5137 chapter 13 filings vs 12,583 chapter 7 filings, some of which again were probably business filings and thus not comparable

New Hampshire:  In New Hampshire, the second highest ranked State, in 2015, there were 503 chapter 13 filings vs 1,367 chapter 7 filings, some of which again were probably business filings and thus not comparable. 

New Jersey:  In New Jersey, the 5th highest ranked State, in 2015, there were 17,983 consumer chapter 7 cases and 7,473 chapter 13 cases. 

So, in all of these higher-income States, chapter 13 filings consistently comprise between 25% and 30% of total consumer bankruptcies, a dramatic contrast to the collection of poor states where such filings are more than half of total consumer bankruptcies.

Do Fee Practices Cause the Anomaly?

Initially, when I was in San Juan, I thought that the explanation for its radical departure from national norms might lie in the fact that the District has a pre-approved, "no-look" fee for attorneys for chapter 13 debtors of $3,000, which, I thought at the time, might be serving to incentivize said attorneys to channel their clients into chapter 13 cases for personal enrichment.  That may be the case  -- in these poor jurisdictions, I imagine, a steady diet of $3,000 fees would give an attorney a much higher lifestyle than the $600 or so they might be able to charge for preparing "no asset" chapter 7 filings.

But, when I researched the "no-look" practices of a number of other jurisdictions, I found no correlation between such fees and a preference for chapter 13 vs. chapter 7.  In part, I relied on an article by Bruce M. Price, "'No Look' Attorneys' Fees and the Attorneys Who Are Looking: An Empirical Analysis of Presumptively Approved Attorneys' Fees in Chapter 13 Bankruptcies and a Proposal for Reform", from Spring 2012, and in part I did my own research on bankruptcy court websites.  I found the States with low proportions of chapter 13 filings have similar fee schedules to those with high proportions. 

For example, in Maryland, the chapter 13 debtor's attorney has a menu of fixed fee arrangements to select from (Local Rules, App. F): $2,000 for plan confirmation alone; $3,000 for all matters in main case, right reserved to apply for more; or $4,500 for all matters in main case, no right to seek more.
In New Hampshire, there is a simple $2,500 fixed fee pre-confirmation and $1,000 for post-confirmation representation (Admin Order 2016-1).  In New Jersey, it's $3,500  (Local Bankruptcy Rule 2016-5).  Looking at the poorer States with a low proportion of chapter 13, West Virginia and Kentucky, they too have similar fee arrangements.  In West Virginia, according to the Price article, it's  $3,000, and in Kentucky, the Western District offers a sliding scale from $1,625 to $3,000 depending on the amount of post-confirmation earnings and other assets available for distribution to unsecured creditors.   Finally and most tellingly, the two Districts of Mississippi have an identical standing order providing chapter 13 attorneys a no-look fee of $3,200, yet have contrasting filing patterns.   So, the existence of a no-look fee in the prevailing range (generally $3,500 and below), in and of itself, cannot be scientifically proven to influence the choice of chapter under which debtors are proceeding.  Were I a social scientist, grad student or law professor trying to get tenure, I could investigate the causes more extensively. On the other hand, if there is a sufficiently easy way to correct the misguided preference in these poorest jurisdictions for the form of bankruptcy relief that is less useful to consumer debtors, then the cause of the problem becomes not just academic but moot.

Suggested Solution

I spent a good thought over the past two years to a way to eliminate the unnecessarily negative outcomes being inflicted upon the debtors in these poorest jurisdictions.  Optimally, it would be something that did not require legislative action, given the intensity of the battle of BACPA and the general deterioration in the lawmaking process even since then.

But I believe I have come up with a simple solution that does not require legislation, which is to adopt a rule, either as a local rule on a court-by-court basis, or, more optimally, an amendment of the Federal Rules of Bankruptcy Procedure, that says three simple things.

First, tracking language already found in Section 707(b)(6) and (7), which prevent dismissing a chapter 7 case if the debtor's income is below certain thresholds: the new Rule would provide:

Section I:  "If the current monthly income of the debtor, or in a joint case, the debtor and the debtor’s spouse, as of the date of the order for relief, when multiplied by 12, is equal to or less than—

(A)  in the case of a debtor in a household of 1 person, the median family income of the applicable State for 1 earner;

(B)    in the case of a debtor in a household of 2, 3, or 4 individuals, the highest median family income of the applicable State for a family of the same number or fewer individuals; or
                     
(C)    in the case of a debtor in a household exceeding 4 individuals, the highest median family income of the applicable State for a family of 4 or fewer individuals, plus $525 per month for each individual in excess of 4,

the debtor may only commence a case under chapter 7 of this Code."

Now the reader might react with some surprise that a Rule could be adopted that would bar a debtor from filing a chapter 13 petition, but I believe it is eminently defensible for three reasons.  First, the scope of permitted rules, per the Rules Enabling Act (28 U.S.C. sec. 2075), is that they may not "abridge, enlarge or modify any substantive right".  The proposed Rule does not do any such thing because the choice between chapters is not a "substantive" right.  It is purely a procedural  
election.  Further, to the extent any right that arises from filing for bankruptcy is "substantive", such as the relief it provides from creditors, that relief is identical in 7 and 13. Thus, the Rule does not "abridge, modify or enlarge" any such right.  Second, a chapter 7 debtor has, per Section 706(a), a "one-time absolute right" (quoting legislative history) to convert a case filed under chapter 7 to one under another chapter, such as 13.  Thus, requiring consumer debtors to file initially under 7 does not abridge or modify their ability to get relief under chapter 13.   Last, I submit, such a Rule, far from conflicting with anything in the Bankruptcy Code, actually furthers the overall legislative purpose of the income-based differentiations throughout Section 707.  Those clearly intend that debtors who fall below the specified income thresholds will proceed under chapter 7, not 13, and the Rule would just ensure that this intent is fulfilled more broadly and uniformly throughout the land.

Of course, this argument raises immediately the question, if the debtor has an absolute right to just convert to chapter 13, won't they just file such a motion a minute after they file the petition, and then their attorney will resume representing them in the 13 and earning the no-look fee, and the problem will just remain?  In response, I have two solutions.  One, more aggressive, is that, again, the right to convert is purely procedural, and thus can be limited by Rule. Two, regardless of the view one holds on that proposition, it seems beyond dispute that courts can provide how conversions are effected, and thus the second prong of the proposed Rule would be to specify that:

Section II:  "Any debtor described in Section I that wishes to exercise his or her right under Section 706(a) of the Code to convert a case under chapter 7 to one under chapter 13 may only do so after notice and a hearing that the debtor attends in person and at which he or she explains to the court the basis for his or her decision."   

This, while not purporting to bar or limit the "absolute" right of conversion in any way, will enable the Bankruptcy Judge presiding over the debtor's case to inquire whether the debtor understands the economic effect of doing so, and the resulting conversation could result  in the debtor -- of his or her own free will -- foregoing the conversion or postponing the decision to reflect on it further.

Last, because I have this lingering belief that the anomalous filing patterns in those poor jurisdictions is due, at least in part, to suboptimal and conceivably bad faith legal representation, the final section of the proposed Rule would, I hope, counterbalance any incentives that the current fee structures may be providing chapter 13 attorneys in those jurisdictions:

Section III:  "(a) Each bankruptcy court may establish reasonable fixed fees for debtors' attorneys in chapter 13 cases that have been filed (or converted from cases under another chapter of the Code) in such court in accordance with the Code and these Rules, to be awarded and paid without the need for review, in the absence of objection by a party in interest (including the U.S. Trustee), by the court under Section 330 of the Code, and may further establish such procedures and conditions for award of such fees as it deems reasonable.

"(b) Without limiting the foregoing, and without limiting the power of such Courts to employ other disciplinary measures they may deem advisable under given circumstances, each Bankruptcy Court shall retain the power under Section 330 to reduce and disallow compensation to chapter 13 debtors' attorneys, whether or not an objection has been made by a party in interest (including the U.S. Trustee) in the event the court finds, after notice and a hearing, that the case was not filed (or converted from cases under another chapter of the Code) in such court in accordance with the Code and these Rules or that the attorney failed to advise the debtor adequately concerning the relative merits of proceeding under chapter 13 versus chapter 7."

With the attorneys' fees now tied to making sure their clients start off in chapter 7 and don't convert out of it routinely, I would hope that any incentive to channel the clients into 13 for increased fees is removed or offset.  Cumulatively, I would hope that the three prongs of the proposed Rule would correct the anomalous pattern of financially burdened residents in the poorest jurisdictions being routed systematically into the less effective vehicle afforded by federal law for resolving their debts.