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BANKRUPTCY BY THE NUMBERS
Planning for Change: Credit Counseling at the Threshold of Bankruptcy
Executive Office for United States Trustees (1)
It is plausible that the 107th Congress will pass a bankruptcy bill and the
president will sign it. The bill is likely to contain many of the same consumer
bankruptcy provisions that were already approved in S. 3186, incorporated into
and passed by the House as Bankruptcy Reform Act of 2000 (H.R. 2415), and
subsequently pocket-vetoed in December.
Section 106 of that legislation requires every individual debtor, no more
than 180 days before filing, to have received from an approved agency "an
individual or group briefing (including a briefing conducted by telephone or on
the Internet) that outlined the available opportunities for credit counseling
and assisted that individual in performing a related budget analysis."
This provision substantially alters the threshold requirements for all
consumer filers under §109 of the Code. It also creates a new relationship
between consumer credit counseling organizations and the agencies in the
government (U.S. Trustees, the bankruptcy administrators in Alabama and North
Carolina, and the bankruptcy clerks' offices throughout the country) that are
assigned by the statute to approve initially, review periodically and supply
notice to would-be filers about the credit counseling operations. And, beyond
doubt, the enactment of this provision would create a large amount of new
business for credit counseling organizations. There are many aspects to this new
threshold of bankruptcy that will need careful analysis and administrative
Here, we take a first look at one small part of this potential development.
We compare the financial profiles of consumer debtors in bankruptcy and clients
of a consumer credit counseling agency (CCA) in one geographical area. We also
compare the expense analyses used by the CCA in counseling their clients with
the expense analyses, based on IRS guidelines, that are required by other
sections of the legislation as part of the means-testing regime for all consumer
The bill as now worded requires a CCA to "provide adequate counseling with
respect to client credit problems that includes an analysis of their current
situation, what brought them to that financial status, and how they can develop
a plan to handle the problem without incurring negative amortization of their
debts..." Among a client's alternatives, arguably, are the opportunities for
avoiding negative amortization through chapter 7 or 13.
Our data all arose from CCA clients and bankruptcy debtors in southeastern
California, in the area known as the Inland Empire. There are places of holding
court, with standing trustee offices, in Riverside and Santa Ana. There is also
a large CCA headquartered in Riverside with offices and clients throughout the
area. The chapter 7 data came from the set of chapter 7 cases that the Executive
Office for U.S. Trustees examines on an ongoing basis. The chapter 7 cases were
filed in late 1998 and early 1999. The CCA files were opened in 1998 and 1999.
The chapter 13 cases were closed during 2000, which means that they had been
opened from less than one to more than three years earlier.
Table 1 shows the average and median annual after-tax incomes for CCA clients
and bankruptcy filers.
The chapter 13 group shows a substantially larger average net annual income
than the other groups. This is due in part to the presence of very significant
outliers on the high end of the income distribution. There were 71 cases (2
percent) with annual net incomes greater than $100,000; three of these reported
annual net incomes of more than $1 million. The effect of these outliers is
removed by using the median, as shown in the last column in the table.
Disposable Income Comparisons: CCA and Chapter 13
CCA clients and chapter 13 debtors must determine how much money they will be
able to devote to their repayment plans. In chapter 13, the debtor may be
required to put all disposable income into servicing the plan (11
U.S.C. §1325(b)). The CCA forms that we have examined do not use "disposable
income" as a technical term, but they do subtract allowed expenses from
after-tax income as a basis for determining repayments under a Debt Management
Table 2 compares disposable incomes of CCA clients and a subset of chapter 13
debtors for which we have the disposable income calculations. A certain
percentage of each group reported zero or negative disposable incomes. These
cases are not included in the group statistics shown in the table.
The data suggest that, in general, chapter 13 debtors were found to have more
disposable income than CCA clients. The CCA population displayed very large
variability, with extreme outliers on the high side of the distribution and a
quarter of all the population with no disposable income. With the data in hand,
we cannot determine whether the difference in disposable income between the two
groups arises from the higher incomes of chapter 13 debtors (Table 1), different
approaches to and results of expense calculations (Table 3), or both. In a
future article, we will report on the rates of returns to creditors in CCA and
chapter 13 plans.
Disposable Income Comparisons: CCA Clients in CCA and as Hypothetical Filers
Under Means-testing Legislation
If the means-testing provisions of H.R. 2415 become law, all would-be
bankruptcy filers must first go through a CCA briefing to receive the
certificate required to become a debtor under the Code. Consumers with a debt
problem could have at least three ways to "handle the problem without incurring
negative amortization of their debts:" a debt management program through CCA, a
chapter 7 liquidation or a chapter 13 adjustment of debt. Given the exigencies
of such consumers' circumstances, rapid decision-making is often required. The
details of how this process will work have not been worked out among all those
who are responsible. But it is clear in any event that the guidelines and rules
of thumb now used by CCA to determine their clients' expenses and disposable
incomes were not developed on the basis of the IRS expense guidelines that are
the basis of expense allowance calculation in the means tests of H.R. 2415. It
is important, therefore, to ask how the disposable incomes of CCA debtors might
change if they were calculated by H.R. 2415's rules. There is a lot a stake for
the debtor in these calculations; for example, they determine whether the debtor
can qualify for chapter 7.
We have calculated the expense allowances of 5,153 CCA clients using IRS
guidelines and compared them to the expenses allowed by the CCA's.4
Table 3 divides the clients into 10 groups of equal size from low to high in
terms of net income. For each group, the table shows the percentage of cases in
which the IRS expense allowance was greater than the CCA allowance.
For almost the entire income range, IRS allowances were greater than the CCA
allowances. The relationship began to shift between the 80th and 90th centiles,
and in the top 10 percent of the cases the CCA Guidelines were greater in about
56 percent of the cases.
Income Thresholds for Assessing Abuse under §707(b)
Another important analysis of these data is based on the provisions of the
reform bill that set threshold disposable incomes for the purpose of determining
whether there will be a presumption of abuse of the Code under §707(b). In a
nutshell and slightly oversimplified, the rule is this: Debtors with disposable
monthly incomes of less than $100 are essentially safe from a claim of abuse.
Debtors with disposable monthly incomes of greater than $166 will be presumed to
be abusive unless they can show why they deserve extra expense allowances that
take their disposable incomes above $166. Debtors with disposable incomes
between $100 and $166 per month will be tested in terms of the ratio of their
disposable income (multiplied by 60 to allow for a five-year repayment plan) to
their general unsecured debt. If that ratio is less than 25 percent, they are
unlikely to be at risk for a claim of abuse (all else being equal).
As might be expected from the results in Table 3, CCA disposable income
analyses produce disposable incomes that are much more likely to put the debtor
at apparent risk of an abuse claim. For the entire population of 5,153 cases,
CCA analyses resulted in 35 percent showing disposable incomes of less than
$100, and an additional 9 percent ranging between $100 and $166. Using the IRS
allowances, 60 percent showed disposable income of less than $100, and an
additional 2 percent were between $100 and $166. Calculating disposable income
using IRS guidelines thus reveals an additional 18 percent of the population
eligible for relief under chapter 7, all else being equal.
Debtors (and their attorneys) who wish to file chapter 7 will be responsible
for knowing whether they qualify under the means-testing calculations. Debtors
must go in the first place to a CCA to learn about their opportunities to solve
their financial problems. There are no rules in place about what they should be
told regarding their opportunities in bankruptcy. What the data presented here
show, we believe, is that would-be debtors in bankruptcy should be informed
during the mandatory credit counseling, at the very least, that expense
allowances (hence budgets and disposable incomes) in bankruptcy may be based on
different principles than those that the CCA will use for its own purposes.
Absent this caveat, debtors could be misled about their opportunities for relief
under the Code.
1 All views expressed in this
article are those of the authors and do not necessarily represent the views of
the Executive Office for U.S. Trustees or the Department of Justice.
2 These are contained in §102 of
the Reform Act of 2000. See the articles available at
www.usdoj.gov/ust/press/articles/articles.htm for reviews of various aspects
of means testing and its likely consequences in consumer bankruptcy.
3 We thank Amrane Cohen, Rod
Danielson, Dianne Wilkman and their respective organizations for providing us
with data for this study.
4 The IRS allowances comprise
housing, transportation and food plus other living expenses. The housing
allowances vary with family size and county of residence. We worked with client
records from Los Angeles, Riverside, San Bernardino and San Diego counties. The
transportation allowances vary by county. We assumed that every one-person
household owned and operated one car and that every household with two or more
persons owned and operated two cars. The food allowances vary with gross income
and family size. Because CCA reports net income, we had to make a correction
back to estimated gross income. We assumed a 30 percent tax take against gross
income, which is equivalent to a 42.8 percent addition to net income [(1/.7)=
Bankruptcy Basics - For Cases Filed on or after October 17, 2005 (pdf)
Basics - For Cases Filed before October 17, 2005 (pdf)