Following this post from last week, the Senate Judiciary Committee approved bankruptcy “reform” legislation on Thursday that imprudently makes it harder and more expensive for people to discharge their personal liability for substantial debts in bankruptcy. Given Congress’ Republican majorities, the long disputed measure appears to be on track to be signed into law.
This bankruptcy reform bill is similar to others that have been batted around Congress several times during the past seven years, but each time the bills have been stymied by a combination of Democratic opposition and Republican obstinance. A nearly identical bill to the one that the Judiciary Committee just passed has been introduced in the House.
The bill’s main flaw is that it takes a “one shoe fits all” approach that would likely funnel most individuals into Chapter 13 cases under which the debtor proposes a plan to repay debts based on the debtor’s income. In attempting to accomplish that dubious goal, the bill threatens to create a huge bottleneck in the U.S. Bankruptcy Courts by requiring that the Bankruptcy Judge make a threshold determination in each personal bankruptcy case of whether the debtor is, in effect, a “good” debtor, who is simply down on his or her luck, or a “bad” debtor, who is just trying to avoid paying his or her debts. If the debtor is not sufficiently “good” to justify a complete discharge of personal liability for his or her debts in a liquidation under chapter 7 of the Bankruptcy Code, then the Bankruptcy Judges are to funnel them into a chapter 13 case.
Just to give you an idea of the administrative nightmare that this ill-conceived requirement will likely cause, note that 1.6 million personal bankruptcies were filed in the 12-month period ending September 30, 2004, according to data from the Administrative Office of the U.S. Courts. Bankruptcy Courts already have extraordinarily busy dockets, and plopping such a time-consuming process at the outset of each personal bankruptcy case on top of those crowded dockets is simply contrary to any reasonable notion of judicial economy.
Moreover, this bill does not have the support of of a wide coalition of business leaders and the leading academic experts in insolvency law, such as the then new Bankruptcy Code enjoyed when it was passed in 1978. In comparison, this reform bill is supported primarily by narrow special interests — financial institutions in the credit card business — that want to make it harder for debtors to discharge their liability for substantial credit card indebtedness. As a result, the bill makes individual bankruptcy more expensive and difficult, which undermines one of key incentives of insolvency law — that is, a fresh start for a person who desires a second chance and an opportunity to put their financial house in order.
Meanwhile, just to make certain that the bill has bipartisan contributions of bad ideas, the Committee accepted amendments from Senator Edward Kennedy that would limit companies on the brink of a chapter 11 reorganization from from paying key employees retention bonuses and would require a special trustee to be appointed in cases where corporate fraud is suspected. Not surprisingly, retention bonuses and fraud were hot button items in the politically-charged chapter 11 case of Enron Corp.
However, preventing a financially-troubled company from attempting to keep its key employees from deserting a sinking ship is a particularly bad idea because those employees are often the most important factor in planning a successful reorganization under chapter 11 that will pay creditors a dividend and preserve jobs in a community. Consequently, by taking away a financially-strapped company’s flexibility to retain key employees, Congress is increasing the risk that the company will end up in a liquidation, which means that creditors recover nothing and the community in which the company is located loses jobs. Similarly, requiring a special trustee in cases involving corporate fraud is simply unnecessary and more political grandstanding — the Bankruptcy Code already provides for the appointment of a trustee under such circumstances.
At least Judiciary Committee Democrats are promising a floor fight next month, in which they expect to propose at least 50 amendments to the bill. Moreover, Sen. Charles Schumer plans to propose the same amendment that has doomed a couple of the previous bills in the recent past — a provision that would prohibit protesters from using bankruptcy to obtain a personal discharge of liability for paying court fines resulting from intentionally blocking abortion clinics. Perhaps those tactics will prevent this ill-advised and unnecessary legislation from being enacted.
Former University of Texas and current Harvard Law School professor of law Elizabeth Warren made these comments in her Congressional testimony on the bill, and closed with this recommendation to the Judiciary Committee:

Don’t press “one-size-fits-all-and-they-are-all-bad” judgments on the very good and the very bad. Spend the time to make the hard decisions. Leave discretion with the bankruptcy judges to evaluate these families. Based on the Harvard medical study and other research, I think you will find that most debtors are filing for bankruptcy not because they had too many Rolex watches and Gameboys, but because they had no choice.
You have a choice. It’s a choice that you’re making for the American people. Adopt new bankruptcy legislation. Establish a means test that targets abuse. But do not enact a proposal written to address myth and mirage more than reality. Do not enact a proposal written for 1997 when the problems of the American corporate economy in 2007 deserve far more attention and the problems of the American middle class can no longer be ignored.
Overwhelmingly, American families file for bankruptcy because they have been driven there — largely by medical and economic catastrophe — not because they want to go there. Your legislation should respect that harsh reality and the families who face it.

This bankruptcy reform bill is not without its good aspects, such as the provision that would limit the “race to the bottom,” in which bankruptcy courts in certain jurisdictions use the liberal venue provisions of the Bankruptcy Code to market themselves to debtors’ lawyers who often choose the venue of big business reorganization cases. However, the bad provisions in this bill far outweigh the good, and Congress simply does not need to be wasting time on bad bankruptcy bills at a time when action on other key domestic issues is far more pressing.