Till Debt Do You Part: What If You Can’t Afford to Go Bankrupt?

By Paul Kiel

(The Washington Post) – It’s a ritual of spring in America. Tens of thousands of people get their tax refunds, and when they do, they are finally able to afford the thing they’ve thought about for months, if not years: bankruptcy.

It happens every tax season. With many more people suddenly able to pay a lawyer, the number of bankruptcy filings jumps way up in March, stays high in April, then declines.

For the past year, I’ve traveled the country trying to understand why bankruptcy often fails those it’s supposed to help. I analyzed millions of filings and interviewed dozens of judges, lawyers and people struggling with debt. The answer turns out to be simple: People are too broke to go bankrupt. Filing costs money, as does hiring an attorney, which is the best way to make sure you actually get debt relief.

Scores of people considering bankruptcy told me the same thing again and again: If they had $1,000 to pay an attorney, then they probably wouldn’t need to file in the first place. “It’s funny how you buy bankruptcy,” marveled Trina Wright of Memphis.

People who hire lawyers to help them file under Chapter 7 have their debts wiped away almost without fail, national filing data shows. And debtors with attorneys fare far better than those who go it alone, filing pro se. Studies show clear benefits for those who successfully wipe out their debts, from higher credit scores to higher incomes. Moreover, this sort of targeted relief can help buoy the broader economy.

Those who can’t afford attorneys often turn to bad options with predictably bad outcomes. Some try to wrangle the complicated bankruptcy forms on their own, risking costly mistakes. Others are lured by unregulated “petition preparers” who promise bankruptcy on the cheap. In Los Angeles, I found a whole industry of petition preparers who often flout bankruptcy laws because of a lack of enforcement.

In the South, debtors often avoid the up-front costs by filing bankruptcy under Chapter 13. Unlike Chapter 7, which clears debts after a few months, Chapter 13 is a payment plan that usually lasts five years. Lawyers in the South will often start a Chapter 13 for $0 down, allowing their much larger fees (usually $3,000 to $4,000) to be paid through the plan. This provides immediate protection to low-income debtors, but most are unable to keep up with the payments. If they fall behind and their cases are dismissed, their debts return.

Faced with options like these, many people simply try to muddle through, often under the threat of having their wages seized by creditors.

Over the past decade, the number of consumer bankruptcies filed each year has ranged from about 800,000 to 1.5 million. That’s a small share of the millions of financially struggling households; researchers have long argued that many more people would benefit from filing. And while the reasons someone may or may not file for bankruptcy can be complex, it’s clear that an important ingredient is affordability.

So if attorney fees can determine whether, and how, someone declares bankruptcy, can anything be done about them? The good news, I found, is that the answer is yes. The bad news is that none of the fixes are easy.

In a Chapter 7 case, attorney fees, like any other debt, are wiped out. As a result, most bankruptcy lawyers require that clients pay in full before filing, because otherwise their bills would be erased, too. There’s ample evidence that people struggle to gather the money to do this. It’s what you’d expect in a country where nearly half of adults say that if they were hit with an emergency expense of $400, they wouldn’t have the cash on hand to cover it. African Americans are particularly likely to have low savings, resulting in a variety of bad outcomes such as being unable to save up to file for bankruptcy.

A 2005 bankruptcy bill made the problem worse. In the name of preventing people from cheating their lenders, the bill heaped new requirements on debtors and their lawyers. The scope of such abuses was questionable, but the burdens of the new requirements drove up attorney fees nationwide by about 50 percent. The average attorney fee for a Chapter 7 today tops $1,100, with court fees adding $335 more. The result? Fewer filings, especially by low-income people.

The cleanest solution would be to change the law to allow more flexibility in how debtors pay their lawyers in Chapter 7 cases. That’s an idea with broad support among bankruptcy judges, and Sen. Elizabeth Warren (D-Mass.), a bankruptcy scholar herself, told me she thought it’s a needed reform. But the near-term prospects for legislation in Congress are, to say the least, unclear.

In the interim, there are some lawyers who try workarounds: One of the oldest is for clients to hand over a stack of postdated checks before filing for Chapter 7. After the case is filed, these checks are deposited over several months, resulting in a jury-rigged installment plan. Most judges have decided that arrangement violates the law, but not all.

In the Southern District of Alabama, the chief bankruptcy judge, Henry Callaway, is working on a different fix. Troubled by the fact that more than 70 percent of bankruptcies in the district are under Chapter 13, he’s drafting a rule that would allow lawyers to break their fees into two parts for a Chapter 7 filing instead. The first would cover services rendered before the bankruptcy petition is filed; the second, services afterward. Because the second agreement is signed after the petition, it has a different legal status and isn’t wiped out like other debts.

It is, to be sure, a convoluted arrangement. But some judges consider it legal, including a federal appellate court and bankruptcy judges in Florida and Michigan, and more and more attorneys are trying it all over the country. Typically, the first agreement is for $0, and the client pays the full fee through the second agreement in installments. (Unlike in a Chapter 13 case, where debt relief is conditioned on completing a payment plan, this would give clients relief and then allow payments to lawyers over time.) This can be salvation for people who wouldn’t be able to file for bankruptcy otherwise, but there are pitfalls: Attorneys are often tempted to raise their fees. Sometimes that’s because of uncertainty that they’ll be paid in full. Other times, it’s to cover the cost of hiring outside companies that facilitate these arrangements.

Compared with these complicated maneuvers, another solution to the problem of attorney fees seems blessedly simple: Find a way to make legal help with bankruptcies free. But civil legal aid organizations, which are the main source of this kind of assistance, are also financially strapped.

“We don’t have enough resources to provide bankruptcy services in all of our counties,” said Steven McGarrity, executive director of Community Legal Aid, which serves clients in central northeast Ohio.

This year his group, along with legal-services organizations in 11 other states, will begin using a new tool called Upsolve to help more poor debtors file. Developed by a nonprofit in New York, Upsolve is a kind of TurboTax for bankruptcy, walking debtors through the process of gathering the necessary documentation and asking questions in plain language. The software populates the small stack of forms necessary to file, and then a lawyer reviews them. Cases are filed pro se, but if complications arise, the debtor can get help from the lawyer.

Perhaps in the future, free help will be available to all who need it. Or maybe Congress will rewrite the law to allow debtors to pay attorneys over time. In the meantime, people struggling with debt will keep on doing what they’ve always done: waiting and hoping for relief.

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A Closer Look at Personal Bankruptcy

By Daniel Agress

David Reeder is an attorney in the Los Angeles area who has practiced in the areas of individual and business bankruptcy for over 30 years. David is a frequent speaker and author on bankruptcy topics pertaining both to individuals and businesses. He has also founded a subcommittee of the LA County Bar Association dealing with individual bankruptcy issues. The information in the following interview is for informational purposes only and is not meant to take the place of legal or financial counsel.

If a person is heavily in debt and needs to  decide whether bankruptcy is the next step, what advice do you typically give?

The first thing you need to do is to speak with a competent bankruptcy attorney, because bankruptcy is complicated. I’ve found myself speaking with very sharp businessmen and they’ll ask a bankruptcy question and I’ll try my best to kind of roll through it. Partway through my response they’ll say, “Man, this stuff is complicated.” And yes, it is. There’s no such thing as a simple bankruptcy because of all the different pieces: assets, debts, exemptions, dischargeability. There’s just a lot of moving parts to any bankruptcy case, whether business or personal.

Even for an individual with a simple financial life? Can they go it alone?

Going it alone is always a mess. Absolute best case, they can somehow bump through, but most of the time, after reading the forms and realizing that they’re in a different language, they throw up their hands and find their way to a capable bankruptcy attorney.

Even if your finances are simple, there are complex procedural and substantive aspects to the bankruptcy. All the right questions have to be asked, because bankruptcy is very disclosure-oriented. Any failure to disclose assets, debts or financial details in the rather comprehensive statement of financial affairs and schedules can be very troublesome for the case.

What do you suggest an individual look for in a bankruptcy lawyer?

Basically, someone who is experienced and has done individual cases on a regular basis for a long time. If it’s bankruptcy and divorce and personal injury and criminal, then they’re dabbling and you want to avoid them. In nearly every legal market, there are attorneys who are bankruptcy specialists — that’s who you want to be talking to.

But what about before contacting the lawyer — if you’re trying to figure out if you actually need to declare bankruptcy?

You need the lawyer to figure that out because individuals aren’t able to make that call on their own. They know that there’s pressure and hurt and difficulty, but they need to go to a lawyer to sort it all out. I’ve had people come to me who were in a world of hurt because of $3,000 worth of debt. My response to them was, “You’re not going to file bankruptcy because of $3,000. You’re going to pay it off over time. You’ll talk to the creditors, you’ll make as long-term an arrangement as you can. But you’re not going to file bankruptcy over $3,000.”

When people are in financial difficulty what they need is information. A competent bankruptcy attorney knows the answers when the questions are halfway out. They know that your goal is to maximize your discharge and minimize any lifestyle disruption. And if there’s some reason why filing bankruptcy is a bad idea, they’ll tell you that.

What are the differences between Chapter 7 and Chapter 13?

Chapter 7 bankruptcy is more desirable for most people. The goal of chapter 7 is to discharge personal unsecured debt — credit cards, personal loans, medical bills. In a chapter 7 case the discharge can be issued as soon as 90-120 days from the time the case is filed. There’s also a laundry list of non-dischargeable claims — support debts arising from family law cases, taxes and student loans. Home mortgages and other secured debt is not dischargeable.

Chapter 13, with its five-year payment plan, should be avoided except in very specific circumstances. Basically, in Chapter 13 you can take home-mortgage-payment arrearages — which is the total amount that you’re behind — and pay that back over 60 months. In theory, this can provide relief for someone trying to “save the family home.” However, most of the time the numbers don’t work. I’ve had people come in who have not paid their mortgage for a year, the number’s pretty big, and there’s just no room for their current expenses and a sixty-month payment plan. One of the big downsides of chapter 13 is that, even if the case goes well, you are “in bankruptcy” for the entire five-year payment period. That takes away a lot of your financial flexibility for a pretty substantial period.

How much do you have to part with when declaring bankruptcy?

Many people coming in are too pessimistic about what bankruptcy will do. No, you don’t automatically lose everything. When you file bankruptcy, all of your property becomes property of what is called the bankruptcy estate. You get your property back from the bankruptcy estate by claiming exemptions. The exemptions vary greatly from state to state and are quite complicated, but basically you can exempt household goods and furnishings, some equity in a car, some equity in your personal residence, and many other asset types.

Regarding your home lease, it’s pretty much bankruptcy-neutral. If you are current with your lease, you do what’s called a reaffirmation of the lease, you keep on making your payments, and life goes on. If you are not current with your lease, and cannot get current, then, as soon as the bankruptcy is over, or earlier if the court gives permission to the landlord, the landlord can start eviction proceedings. The same process applies with secured claims on consumer items like cars — you do a reaffirmation agreement with the car lender, you keep making payments, and you keep your car.

When you see people a year after bankruptcy, how has it affected their life’s trajectory?

It’s amazing how therapeutic bankruptcy can be. I’ve counseled many people who, after struggling years with unmanageable debt from a business failure, a medical situation, or a period of unemployment, finally seek advice. When they come in, even though they’re trying to be on their best behavior, they’re depressed, they’re functioning at only some percentage of their potential. Because all the time they’re tracking their debt and spinning it around their head. They get up with it, they go to bed with it. It’s a heavy burden. Once it is determined that a bankruptcy case is the way to proceed, we file a bankruptcy, and there’s a discharge of debt, it takes a couple of months for them to realize that it’s actually gone. Then, when I see them a year later, many people have started businesses, they’ve started families, they’ve gotten back in the game. So yes, I’ve seen bankruptcy be extremely therapeutic.

One of the reasons for bankruptcy for individuals is that there should not be a permanent debtor class. Think about it: If you can’t discharge your debts, they stay with you for life, until you’re in your eighties or nineties or beyond. So you don’t educate your children, you don’t send them to yeshivah or seminary, you don’t pay for their weddings, you don’t open a business — because your creditors are always in your pocket. The consumer bankruptcy system was created so that individuals in debt can return to being fully-functioning members of society.

Very seldom do people declare bankruptcy simply because they can’t control their spending. Usually, something happened — a spate of unemployment, unexpected medical expenses, or the failure of a small business. You know, starting a small business is high-risk behavior. We reward entrepreneurialism, and the fact that there is a bankruptcy system is what allows people to take risks and recover if they fail.

What if an individual feels too much of a stigma to start the process?

The stigma, as a practical matter, is pretty much within their heads. In most parts of the country, there’s no list in the paper of who filed for bankruptcy. The attorney certainly doesn’t tell anyone, so nobody finds out. The bankruptcy code also prohibits employers and others from discriminating against someone solely because they filed a case under the federal bankruptcy laws.

In fact, lenders are very open to lending to people who just went through a bankruptcy discharge because, having just gotten rid of all of their unsecured debts, they are able to make a car payment, for example. In fact, I warn my clients that upon receiving a bankruptcy discharge, they’ll receive all kind of ads saying, “Buy a new car at such-and-such dealer” and the like. That said, I usually tell people who are filing bankruptcy that what they need is a vacation from debt, and that means a vacation from new debt as well.

House purchases are something you can start considering several years after the bankruptcy. The lenders will talk to you and will want to hear a coherent story of what caused the bankruptcy before they grant you a mortgage.

What would you say to someone who can’t afford the lawyer’s fees?

In most large cities, this should not be an issue. There are capable attorneys who charge very reasonable fees. When people blanch at the fee, I tell them, “Listen, you have $140,000 in unsecured debt. Let’s just say that I told you that if you brought me $3,000 in cash I would get all of your creditors in the room, throw the $3,000 up in the air and tell the creditors they couldn’t leave the room until they signed a full release. You’d get the $3,000. Well, I can’t do that — but I can do second best: to discharge your debts in bankruptcy.” Most people have enough access that if their world is falling apart and they owe debt they’ll never be able to repay, and they are really facing a very bleak future with few financial options, they will somehow lay hand to what’s necessary to declare bankruptcy. And $3,000 is just a hypothetical number; I know people here in LA who are very capable who charge much less than that.

I’ve read some articles by professors and whatnot arguing that attorney’s fees are keeping thousands of people from gaining bankruptcy relief. My response is that bankruptcy is not a social service that can cure your cash-flow problems; it is meant to solve your debt problem, and for a very reasonable fee it can do just that.

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A Personal Story

As told to Daniel Agress

When the U.S. went into recession in the early 1990s, my husband and I were in truly dire financial straits. We had just celebrated the birth of our first child when my husband lost his job, leaving us with a meager freelancer’s income to support the family. The struggling economy made it very difficult for my husband to find a new job. We lived in a city with very few Jews, and even hourly, unskilled jobs were hard to come by for a shomer Shabbos Jew.

With insufficient income, we began to use credit cards to pay for our basic living expenses. We were young and naïve and did not fully understand just how dangerous it was to accumulate credit card debt. Of course, there were few other options available to us, given how desperate we were for funds. We kept hoping that better jobs lay just around the corner, but they did not materialize, and our debt continued to pile up. As time passed, it made our lives utterly miserable. The debt-collecting agencies were truly abusive to us, constantly calling and harassing us on the phone.

After a very difficult year, we approached a debt counseling agency, but they told us we weren’t making enough to work with them. At that point, we felt stuck and utterly hopeless, and my husband suggested that we consider bankruptcy. I was horrified — I knew what it would do to our credit rating — but we didn’t see any other way.

Hashem arranged for me to be in a car accident, and the insurance money we received was sufficient to cover our lawyer’s fees. As soon as we went to the lawyer, everything became very simple. We prepared the paperwork, went to a hearing — and then it was done. The debt collection calls just stopped. For the first time in years, we were able to afford groceries and other basic household needs. My husband found a new job, and we even had a little extra to put away at the end of the month. I felt like I had been standing in a rainstorm and then suddenly the sun had come out.

In retrospect, bankruptcy is something I would never resort to again. I still look back and wonder if any of the debt renegotiation options which now exist could have helped us somehow avoid the bankruptcy. But if your life is unlivable because of your debt, it is the correct option.

Of course, bankruptcy won’t cure the problem which drags a person into debt in the first place. People need to recognize how truly dangerous credit cards are and realize that they should never be used as a substitute for income. They are just very high-interest loans that should be avoided except in very special circumstances. Having gone through bankruptcy, I do my best to teach my children to live within their means and realize that credit cards are not free money, but actually loans whose consequences they must eventually deal with.