STATEMENT OF THE AMERICAN FINANCIAL SERVICES ASSOCIATION
BEFORE THE SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW
COMMITTEE ON THE JUDICIARY
UNITED STATES HOUSE OF REPRESENTATIVES
MARCH 18, 1998
The American Financial Services Association (AFSA) appreciates this opportunity to express our views on H.R. 3150, the "Bankruptcy Reform Act of 1998". AFSA is the trade association for a wide variety of non-traditional, market-funded providers of financial services to consumers and small businesses.
We look forward to working with the Subcommittee to pass H.R. 3150 and to achieve a bankruptcy system that protects responsible borrowers through the provision of an appropriate needs based mechanism ensuring that those who can clearly repay a significant portion of their debts, do so. Before directly addressing some of the secured provisions in the bill, AFSA would like to comment on some of the issues that have continually come up when needs based bankruptcy reform is discussed.
CAUSATION-- IS IT AS SIMPLE AS TOO MANY CREDIT CARDS?
Opponents of bankruptcy reform claim that the industry has created the problem by indiscriminately extending too much credit in the form of credit cards and simply wants to "turn the government into a bill collector". Nothing is further from the truth on a both a statistical and qualitative basis. First of all, if bankruptcy was simply a matter of too much credit, bankruptcy rates would be uniform across the country. In fact, they are not-- they show wild variations across the nation and within the individual states. For example, Shelby County, Tennessee has a bankruptcy rate that is 32 times the national average-- does Shelby County get 32 times the amount of credit that the rest of the country does? No, of course not. Well, then, if not too much credit, what does cause bankruptcy? The causes are very complex and frequently a number of factors are present. Some of the main causative correlations include divorce, lack of health insurance, lack of mandatory automobile insurance laws (7 states) and so on. Unemployment in and of itself is not a big factor. Urban areas have the highest bankruptcy rates-- they also have the highest divorce rates. Young adults between the ages of 21 and 25 have low rates of bankruptcy filing as do adults over the age of 41. The age group most likely to file are those in their early 30s, particularly age 32. Poor people and minorities have relatively low rates of overall filing while filings take off as you approach a total annual household income of between $32-36,000 and remain high thereafter. There is no way to really screen for most of these types of events and characteristics during the underwriting process. Should we not lend to 32 year olds? Should we ask applicants if they are happily married? The Subcommittee has heard from Stuart Feldstein of SMR Research and his work addresses many of these issues in depth.
What about credit cards? Bank credit cards account for approximately between 5 and 6 percent of total consumer debt. If you include other types of credit cards, you might get to 9 percent, depending on how you account for convenience users who pay off their balance every month. Is this 9 percent of consumer debt causing all of the problems while the other 91 percent maintains a benign budgetary impact? This is counterintuitive-- as all of us know, our big obligations are our housing, car, student loan s etc.. Do credit cards play any role in bankruptcy? Of course, but they are in no way the principal cause. In general, the role that credit cards play is that they are the last form of credit available for use before filing for bankruptcy. When a debtor gets into financial trouble for whatever reason, they will frequently try to float themselves using their credit cards, or if a debtor is planning to file a bankruptcy of convenience, they will frequently use their cards to acquire certain goods or make certain payments prior to filing. We have learned to identify some of this behavior and can sometimes reduce our losses, but particularly in case of planned or non-insolvent bankruptcies, this is virtually impossible.
SECURED CREDIT ISSUES
In 1978, during the last major overhaul of the bankruptcy code, one of the major changes that unbalanced the code between debtor and creditor and, in our view, has provided a substantial impetus to the increase in bankruptcies of convenience is the extraordinary device known as the "cram-down".
This is a statutorily based mechanism, found in Section 506(a) of the Code, which provides that every claim filed which is secured by a lien on property is an "allowed secured claim" to the extent of the creditors interest in such property. To the extent that that creditor's interest is less than the total amount of the claim, the claim is an allowed "unsecured claim." Under the present Code, a secured claim cannot be an allowed secured claim in an amount greater than the value of the collateral.
As written in the National Consumer Law Center's Consumer Bankruptcy Law and Practice, the cram down power provided to the Bankruptcy Court in favor of the debtor by the 1978 Code represents a significant example of a statutorily-supported wealth transfer between a debtor and creditor:
One of the greatest advances for consumers under the (1978) Bankruptcy Code came in the powers they were given with respect to secured debts. Under the prior Bankruptcy Act, relatively little could be done to protect consumer debtors from the holders of such claims. A straight bankruptcy did not generally affect the status of otherwise valid liens or security interests and, as a practical matter, few Chapter XIII plans could get very far with respect to secured claims unless the holders of those claims agreed to the plan or were not affected by it. Now, in contrast, almost every conceivable type of security interest can be altered in some way through bankruptcy , often to a tremendous degree and with very significant benefits for the debtor.
Consumer Bankruptcy Law and Practice, 4th Ed., p. 203.
The workings of the cram down with both real estate and non-real estate have created a large body of law on this mechanism alone. The most recent significant case on how to value collateral for the purposes of determining how to determine the value of the allowed secured claim was Associates Commercial Corporation v. Rash, which provided that the value of a creditor's collateral for cram down purposes should be what the debtor would have to pay for comparable property ("the replacement-value" standard).
Secured credit is usually the only "deep pocket" in a consumer bankruptcy case. Since 1978, debtors' advocates have been moderately successful in "unlocking" the secured creditor's pocket through cram downs, "ride throughs", nonpayment while a plan is being confirmed, Chapter 13 conversions to Chapter 7 after cramdown or cure, and the like.
These various developments erode the fundamental distinction between secured and unsecured credit. There are very definite reasons that a lender chooses to extend secured credit over unsecured credit and one of them is certainty of repayment. H.R. 3150 addresses these issues to varying degrees and AFSA supports these provisions. We do feel that the bills' prohibition on cram downs 180 days prior to filing should be substantially extended for secured vehicle lenders, as they suffer the greatest losses on cramdown in the early years of the vehicles life when depreciation is the greatest. We believe that this is an important fact in pre-bankruptcy planning.
SECURED ISSUES ADDRESSED BY H.R. 3150
Chapter 7 and 13 Cases
Multiple Filings. The Bill regulates abusive multiple filings by restricting availability of the stay on the second filing within one year, backed up by a national filing system keeping track of all debtors who file for bankruptcy relief.
The phrase "household goods" as it now appears in section 522(f) of the Code is defined by using the definition already used in a similar context by the Federal Trade Commission in the Trade Regulations Rule on Credit Practices, 16 CFR º 444.1(I).
Chapter 7 Cases
Chapter 7 cases should quickly resolve themselves into reaffirmation or return of the collateral. Debtors are required to fill out a statement of intention with regard to any secured property, and they must either perform their stated intention or return secured property within a short period of time. The need for lift stay litigation is significantly decreased.
The "ride through" is effectively barred. It is now established law in the Second, Fourth and Tenth Circuits, while three other circuits have ruled against it.
Lift stay litigation should be more rapid. There is a sixty day maximum period for the court's decision to be rendered.
Serial or installment redemptions are barred.
Chapter 13 Cases
Clarifies that the inclusion of incidental property in a mortgage on the debtor's principal residence will not disqualify that mortgage from protection under section 1322(b)(2). It also makes clear that if the debtor resided in the house during the six months previous to filing and still owns it, or if the residence is a mobile home, condominium or cooperative apartment, technically treated as personalty in a number of states, the protection of section 1322(2)(b) applies.
Cram downs of consumer goods are limited to retail value, and not available at all for filings within the first 180 days.
Failed chapter 13 cases cannot be converted to 7 if a convenience user is involved, and even when converted, the cram down is lost.
Interim interest and principal payments must be maintained so that the cash flow stream will not be interrupted by a filing.
When the creditor is crammed down, the unsecured portion is more likely to be paid because of the disincentives to dismiss or convert and the five year plan requirement for those with more than 75% of median national income.
The automatic stay will not be violated if a prepetition foreclosure proceeding is postponed during the pendency of a Chapter 13 proceeding so long as any prepetition default remains uncured by actual payment in full according to the plan.
Creditors are given better opportunity to get notice of chapter 13 proceedings, the contents of the plan, the hearing upon confirmation, and the like so that rush plans will not be confirmed without creditor participation. At the same time, long delays during Chapter 13 cases, particularly long delayed confirmation, are limited.
Again, AFSA appreciates the opportunity to express its views. We strongly support the efforts of the Committee to develop a modern legal framework for bankruptcy and urge you to move forward with H.R. 3150.