CRS Issue Statement on Bankruptcy in a Distressed Economy

CRS Issue Statement on Bankruptcy in a Distressed Economy

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CRS Issue Statement on Bankruptcy in a
Distressed Economy
Carol A. Pettit, Coordinator
Legislative Attorney
David H. Carpenter
Legislative Attorney
Mark Jickling
Specialist in Financial Economics
Edward C. Liu
Legislative Attorney
Edward V. Murphy
Specialist in Financial Economics
January 6, 2010
Congressional Research Service
7-5700
www.crs.gov
IS40260
CRS Report for Congress
P
repared for Members and Committees of Congress
c11173008

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CRS Issue Statement on Bankruptcy in a Distressed Economy

rticle I, Section 8 of the Constitution gives Congress power to establish uniform laws on
the subject of bankruptcy throughout the United States. Two of the major purposes of the
A bankruptcy code—to allow overwhelmed debtors to make a fresh start and to provide for
equitable treatment of creditors—are in perpetual tension. At any given moment, either debtors or
lenders are likely to feel that the law favors the other group. Thus, there is constant pressure to
change the Bankruptcy Code. In 2005, Congress enacted significant and controversial changes in
the code with the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA; P.L.
109-8). Although it included some changes involving business bankruptcies, BAPCPA has
generally been viewed as having made bankruptcy less friendly to consumers. There was a surge
in consumer filings just before the new law took effect in October 2005. After the new law took
effect, the number of consumer filings dropped sharply, but they have risen steadily since.
In 2009, 1.41 million non-business bankruptcy filings were reported. This is an increase of more
than 30% over 2008 filings and is not far behind the filings for 2004. It is the highest number
reported since BAPCPA took effect. In 2009, total business bankruptcies also increased by more
than 30% over 2008 filings, with a greater proportion of those filings being under chapter 11
reorganization. Although some attribute the increases to the effects of the distressed economy,
others note that filings have increased by over 30% in each year after the 2006 post-BAPCPA
drop. Whatever the cause of the increase in 2009, most expect filings to continue to increase in
2010.
In addition to monitoring the implementation and impact of BAPCPA, Congress may consider
specific changes to the Bankruptcy Code. Proposals to allow modification of home mortgages
have been introduced numerous times in both the 110th and 111th Congresses. The BAPCPA-
created “means test” has also been the subject of proposed legislation that would waive
application of the test to certain debtors, including some military personnel or those who have
encountered financial difficulty as the result of medical expenses or income lost after a severe
illness or injury. General application of the “means test” for consumer bankruptcies has generated
some controversy both in the way in which monthly income is calculated and in the way in which
allowable expenses are determined.
The bankruptcies of Chrysler and General Motors have brought attention to using asset sales as a
means of reorganization. These sales, referred to as “363 sales” because they are authorized by 11
U.S.C. § 363, are viewed by some as becoming the norm for chapter 11 cases. Some believe that
they result in less money for the creditors than would be available under chapter 7 liquidations.
Also of concern is businesses’ use of bankruptcy to shift pension and other benefit obligations to
the federal government and to shed unwanted contracts without the remedies that would be
available outside of bankruptcy.
Consumers and businesses have not been alone in their economic distress—municipalities have
also been affected. At least one—Vallejo, California—has entered bankruptcy through the
provisions in chapter 9 and was allowed to reject collective bargaining agreements under the
Bildisco three-part test rather than being required to follow the procedures established in chapter
11. Nearly 20 years ago, Congress considered incorporating § 1113, which addresses the
procedure for rejecting collective bargaining agreements under chapter 11, into chapter 9, but no
change was enacted. The Vallejo bankruptcy may rekindle interest in a similar proposal.
The outcome of bankruptcy cases currently before the U.S. Supreme Court may lead to other
proposals for changing the Bankruptcy Code. These cases involve student loans, “disposable
Congressional Research Service
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CRS Issue Statement on Bankruptcy in a Distressed Economy

monthly income,” property that may be exempted from the bankruptcy estate, and both prohibited
and compelled speech.
Specific Policy Questions
Consumer
• Has BAPCPA had its intended effect of reducing abusive filings, or does it
impose unreasonable burdens on consumers in financial distress through no fault
of their own?
• Is the BAPCPA requirement that consumers complete a credit counseling course
genuinely helpful, or is it simply a costly “checkoff” item for debtors in the
process of filing bankruptcy?
• Is BAPCPA’s definition of a debtor’s “current monthly income” as the monthly
average of the debtor’s income for six calendar months immediately preceding
the month in which the bankruptcy petition was filed compatible with the twin
goals of bankruptcy? Does it, on the one hand, act to the detriment of debtors
who had barely been able to manage their debt load prior to experiencing
significant drop in income, while, on the other hand, benefiting debtors who
experience a temporary low income period?
• Should bankruptcy courts be allowed to apply the Internal Revenue Service’s
Collections Standards tables differently to debtors in bankruptcy than the Internal
Revenue Service applies those standards to delinquent taxpayers?
• Should bankruptcy courts be allowed to modify principal residence mortgages by
reducing the amount owed to the market value of the home? Would this change
enable a significant number of homeowners to avoid foreclosure? Would it have a
significant impact on the overall mortgage market?
• Should residents of one state be able to fully exempt the value of the equity they
have in principal residences from their bankruptcy estate while residents of
another state are restricted in their ability to exempt that value?
• Should student loans remain generally nondischargable in bankruptcy? Should
privately funded loans be treated differently in bankruptcy than government
funded loans?
Business
• Is bankruptcy being used as a means through which solvent debtors may easily
modify or eliminate contracts? Examples would include collective bargaining
agreements, retiree benefits and pensions, and auto dealership franchise
agreements.
• Should collective bargaining agreements enjoy specific protection only in chapter
11 bankruptcies or should they be protected in some or all other bankruptcies (for
example, municipal bankruptcies under chapter 9)?
• Have the restrictions on key employee retention plans that were introduced by
BAPCPA provided the anticipated limitations on employee compensation?
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CRS Issue Statement on Bankruptcy in a Distressed Economy

• Should limitations be placed on § 363 sales? In chapter 11, should they be
available only pursuant to a confirmed plan of reorganization?
• Should there be special provisions (perhaps a separate chapter in title 11) for so-
called “too big to fail” companies? Would it be preferable to model these
provisions after the conservatorship/receivership provisions for banks?
General
• Are bankruptcy petition preparers subjected to an unreasonable risk of identity
theft due to their being required to place their Social Security numbers on all
documents prepared by them for submission to a U.S. bankruptcy court or U.S.
district court in conjunction with a case file under title 11 U.S.C.? Should they
instead be issued a unique identifying number to use on such documents?
• Did Congress intend “debt relief agencies” to include attorneys? If so, did it
intend that the prohibition on advising incurring additional debt in contemplation
of bankruptcy apply only to advice that would be fraudulent or be an abuse of the
bankruptcy laws?

Issue Team Members

Carol A. Pettit, Coordinator
Edward C. Liu
Legislative Attorney
Legislative Attorney
cpettit@crs.loc.gov, 7-9496
eliu@crs.loc.gov, 7-9166
David H. Carpenter
Edward V. Murphy
Legislative Attorney
Specialist in Financial Economics
dcarpenter@crs.loc.gov, 7-9118
tmurphy@crs.loc.gov, 7-6201
Mark Jickling

Specialist in Financial Economics
mjickling@crs.loc.gov, 7-7784

Congressional Research Service
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