By John L. Duoba, Business Owner's Toolkit Staff Writer

As lawmakers in the House and Senate continue struggling to find compromise on reforming U.S. bankruptcy laws, the nation's debtors currently are filing for relief in record numbers, likely anticipating more restrictive rules in the future.

New bankruptcy filings during the second quarter of 2001 (April 1 - June 30) rose nearly 25 percent over the same period a year ago, according to data released August 24, 2001, by the Administrative Office of the U.S. Courts and the American Bankruptcy Institute (ABI), a nonpartisan advocacy organization. Filings increased from 321,729 to 400,394, making it the highest three-month filing period ever in U.S. history.

Moreover, bankruptcy filings are now on pace to surpass the record-breaking year of 1998, when 1,442,549 new cases were filed. Through the first six months of 2001, 767,235 cases have been filed, a 21 percent increase over the first half of last year, and 5.4 percent over 1998's half-year mark.

"The figures for the first half of this year are alarming, if not shocking," said Samuel J. Gerdano, executive director of the ABI. "While we expected the second quarter to be high, given historic patterns, breaking the 400,000 mark sets a pace for a new bankruptcy record this year, shattering the 1998 record of 1.4 million total cases."

The Effect of Politics

Certainly, the recent downturn in the U.S. economy is playing a role in these inflated figures, but Congress's much publicized attempt to reform bankruptcy laws in recent years cannot be ignored.

The last time Congress got this close to overhauling the bankruptcy laws was during 1998. Over the course of six months, both houses of Congress passed reform measures, and final passage seemed imminent. But as the 1998 session drew to an end and elections approached, the bill died in conference committee. Meanwhile, debtors filed for protection in record-setting numbers, fearing tougher new laws.

Then, reform efforts in 1999-2000 were again thwarted, this time by constant veto threats from then-President Clinton. When Congress finally did approve a bill late in 2000, Clinton killed it in the waning days of his administration. Lawmakers knew it never stood a chance of becoming law, since Clinton was against it all along.

Now fast-forward to the 2000 national elections. Credit card and finance companies, and their advocates--some of the major supporters of reform--were not happy about the missed opportunities in recent years, and sought to have their voices heard. According to federal election records, these groups donated $9.2 million to federal candidates and the Democratic and Republican parties, more than doubling the $4.3 million they donated in 1996. At the same time, contributions from commercial banks surged from $16.6 million to $28.5 million.

MBNA, the world's largest credit card issuer, increased its political donations from $741,904 in 1996 to $3.5 million during the 2000 election cycle, in addition to being the largest single contributor to George W. Bush's run for president (Citigroup and Morgan Stanley, the second and third largest credit card companies, also finished in Bush's top 10 donors list).

Shortly after the elections, the first major piece of legislation to emerge from Congress was--hold your breath--bankruptcy reform. The House of Representatives passed a measure in early March of 2001, followed by the Senate a few weeks later on March 19.

Currently, a conference committee from Congress is trying to settle differences between the two bills. For example, the Senate bill would eliminate the unlimited homestead exemption in some states that allows a debtor to keep a home and some possessions despite their value (which could reach into the millions), while still having all of their debts wiped out. The House version leaves this exemption intact. This point of contention could still doom reform efforts again, as Congress is deeply divided over the issue.

Coincidentally, the recent spike in new bankruptcy filings began around the same time these measures were debated and passed. Obviously, debtors felt the newly proposed rules would not be as favorable to them as current law. And they would be right.

Proposed Law Hurts Small Business

Under current law, a small business deep in debt can file for Chapter 7 bankruptcy protection, which basically wipes out all unsecured debts (read: credit card debt), after some liquidation of assets to pay off the secured debt. Then the debtor is given a clean slate.

Under the reform proposal, Chapter 7 will no longer be an option for most small businesses in trouble. Instead, a means-test will be used to determine which form of bankruptcy will apply. Specifically, all debtors above a minimum income threshold set by the IRS would be forced to repay the lesser of 25 percent of their debt or $10,000 over five years under Chapter 13 reorganization and repayment plan. The more common Chapter 7, which discharges debt after the liquidation of certain assets and does not require the repayment of unsecured debt, would not be available. Under Chapter 13, all unsecured debt, including credit cards, must be repaid. Moreover, bankruptcy filers would be required to participate in credit counseling before being granted any relief (so don't wait until a few days before foreclosure to file--it's too late--by law, you must complete counseling first).

Critics of the bill are unhappy with the one-size-fits-all standard for means-testing, as well as the elevation of unsecured credit card debt to the front of the repayment line. Many opponents of the bill have connected the high number of bankruptcies to the aggressive marketing tactics of credit card companies, and they believe these companies should be punished, not rewarded, for preying on consumers who can't handle the debt.

So what brought on all of these changes? Many lawmakers believe too many people are taking advantage of the current bankruptcy laws.

"This bill seeks to restore personal responsibility and integrity to the bankruptcy system and ensure these laws are fair to both debtors and creditors. Abuse of the current system--estimated to cost the rest of us approximately $4 billion each year--is the driving force behind this bipartisan, balanced and comprehensive reform legislation," said House Judiciary Chairman James Sensenbrenner (R-Wisc.) upon House passage in March.

In addition, the bill amends the Truth in Lending Act to require that extensive disclosures be given to borrowers for many types of credit plans. Lawmakers hope the increased disclosures will help people make wiser decisions regarding their credit, by further clarifying the rules regarding minimum payments, introductory rates, payment deadlines and penalties.

Conclusion

Reforming bankruptcy for the better is an admirable goal, but this measure too heavily favors creditors over debtors, especially unsecured creditors. For years, credit card and finance companies have been extending this unsecured debt--and continue to do so at record pace. Now they want to change the terms of the agreement under which all of this credit was extended. While every business owner can sympathize with the difficulty in collecting money owed, it is likely that most wouldn't like it if the terms of a contract were changed by one party only. These companies, of their own free will, chose to play in the game, and now they want to change the rules at halftime. And Congress has obliged.

The result is that if your business gets into financial trouble, it will likely stay there, with little hope of getting out. A business or person that much in debt is usually filing for protection because they can't pay the bills, and the newly proposed bankruptcy system is just going to send that business or person another bill, whether the business goes under, your health or marriage fails, a family member dies--whatever the reason. It doesn't matter.

So what used to be a fresh-start, last-resort option for those desperately in need may be turned into a punitive payback plan benefiting banks, finance and credit card companies. The message for small business seems to be: Once you're down, stay down.

For those businesses not facing that situation, count your blessings and hope for the best. But if you're facing very serious financial difficulties and the outlook for improvement doesn't look good, you would be wise to consider using this last-chance option, while it's still available. If Congress does come to an agreement about state homestead exemption limits, the bankruptcy reform bill becomes law 180 days after signing by the president. Expect another huge spike in filings at that time.

While some people and businesses certainly do try to abuse the system, government statistics show that the majority of bankruptcies are filed because of some unforeseen tragedy resulting in financial disaster. As a result of this reform, those who want to cheat the system will most likely find a new way to do it, while those truly in need will have less help to turn to.

Meanwhile, as your financial options become more restrictive, isn't it nice to know that lawmakers and their election committees won't be filing for bankruptcy protections anytime soon? With donations from these "constituents" coming in at the rate they are, they'll be able to run for office and pass even more reform measures benefiting the public.

Or maybe the bill will die in conference committee over disagreements about the homestead exemption, leaving the current law intact. But then you can expect another spike in filings--of donations to the various political parties and election committees.

Related items:

Senate Passes Its Version of Bankruptcy Reform

House Approves Bankruptcy Reform Bill of 2001

President Vetoes Bankruptcy Reform Bill

Congress Agrees on Bankruptcy Reform Act; Veto Likely

Bankruptcy Reform Legislation of 1999 Stalls in Congress

Senate Approves Bankruptcy Reform Act of 1999, Includes Minimum Wage Increase

Decline in Personal Bankruptcies Downplays Need for Bankruptcy Reform Bill

House Passes Its Version of Bankruptcy Reform Act of 1999

Bankruptcy Reform Act of 1999 Introduced in the House

Bankruptcy Reform of 1998 Stalls in Senate

Senate Overwhelmingly Passes 1998 Bankruptcy Bill, Tough Conference Looms

Bankruptcy Reform Legislation of 1998 Approved by House; SBA Asked To Study Impact