Consumers pay price as lenders cash in, Bankruptcy bill 'the best law money could buy' for lenders

Sagging under $300,000 in debt and seeing no choice, Scott W. Hudson of Middletown filed for Chapter 7 bankruptcy in March.

Hudson was among the first in Delaware to confront a new bankruptcy law that imposes tougher requirements and hundreds of dollars in additional costs on consumers who use federal law to wipe out debts.

"It's a very long and drawn-out process," said Hudson, a 39-year-old father of two. "Bankruptcy is not an easy out."

One year ago, on Oct. 17, a law went into effect that overhauled the bankruptcy system, implementing sweeping changes that included higher fees for filing and mandating consumers get advance advice from counselors.

Wilmington-based credit card giant MBNA Corp., now owned by Bank of America, had been among the law's leading proponents, saying consumers who could pay were abusing the old system and walking away from credit card and other debt.

Consumer advocates and bankruptcy lawyers criticize the law for putting too much of a burden on people in dire straits because of illness, divorce, job loss, or some other major setback.

In the year since the Bankruptcy Abuse Prevention and Consumer Protection Act became a reality, bankruptcy filings have plummeted. The number of consumer Chapter 7 filings -- the type that let consumers shed debts such as credit card balances and medical bills -- in Delaware is down 84 percent, according to statistics supplied by David D. Bird, clerk of the court for U.S. Bankruptcy Court in Delaware. The steep drop parallels the national trend, Bird said.

New requirements for documents, income eligibility restrictions, additional costs and new liability risks for bankruptcy lawyers, who now must certify the validity of clients' claims, all played a part in driving down filings by consumers. A rush of filings before Oct. 17 last year also has depressed filings because many people who would have filed this year moved up their timetable to escape the new requirements, bankruptcy lawyers said.

"Last year, before Oct. 17, it was insane," recalled Doreen H. Becker, a Wilmington bankruptcy lawyer who represented Hudson. "We were turning away cases because there were so many."

Paying the price

From the standpoint of consumers, the most notable change has been a steep rise in the cost of filing for bankruptcy.

Citing additional documentation burdens, lawyers have raised their fees, so bankruptcy filings that would have cost consumers about $1,000 can now cost more than $2,000.

Court filing fees consumers pay have climbed. The fee to file a Chapter 7 bankruptcy is $299, 43 percent higher than before Oct. 17. The Chapter 13 court filing fee has jumped 41 percent, to $274. In addition, consumers have to pay for a credit counseling session and a class on debt management, each of which costs around $50.

The tumble in filings has been a boon to lenders, including Bank of America and JPMorgan Chase, both of which have credit card operations based in Wilmington and collectively employ more than 15,000 Delaware workers. With the credit card industry such a significant employer in the state, Delaware's congressional delegation -- Sens. Joe Biden and Tom Carper and Rep. Mike Castle -- all supported the law.

Bank of America and Chase have said their credit card businesses enjoyed sharply higher profits in the first half of this year thanks to the steep decline in consumer bankruptcies. Late last year, though, it was a different story. Bank of America, Chase and other credit card banks took a short-term earnings hit in the fourth quarter because of the surge in filings by consumers who wanted to get ahead of the new rules. Long term, analysts expect the credit card industry will reap benefits from the changes in the law, as filings remain below the record levels seen in the past several years.

In the five years leading up to passage of the new bankruptcy law, the banking industry contributed about $25 million to federal candidates and political parties, according to the Center for Responsive Politics, a nonprofit in Washington that tracks political giving.

Unexpected difficulties

In the "vast majority of cases," consumers are forced into bankruptcy by "major and unforeseen expenses," according to the National Association of Consumer Bankruptcy Attorneys. Job loss accounts for about 40 percent of consumer filings and medical expenses 33 percent, according to the association. The association said the survey found that about 8 percent of cases are tied to spending on nonessential items.

"It's not that people are setting out to avoid paying their creditors back," said Erin K. Brignola, a bankruptcy lawyer in Bear. "The only way out for them is to file a bankruptcy case. All this new law has done is increase the amount of work, and money that debtors have to pay, to enter into the process."

Rashmi Rangan, executive director of the Delaware Community Reinvestment Action Council, a consumer advocacy group focused on banking, objects to the bankruptcy law because, she said, it didn't rein in "predatory" lending practices through which consumers are enticed to take loans at high interest.

"I still say it was the best law money could buy against the consumer," Rangan said.

Advocates say bankruptcy reform hasn't been unfair to consumers because the new requirements haven't stopped legitimate filings.

"The new system ensures that the nation's bankruptcy courts are open to those who truly need them and not abused by those who don't," said Paul Hartwick, a spokesman for Chase's Wilmington-based credit card unit. "We believe the results of bankruptcy reform, such as more people using credit counseling services and improved credit quality, show that the new system is working as it was intended."

A spokeswoman for Bank of America, Delaware's largest private employer since its Jan. 1 purchase of MBNA, declined to comment for this story.

'Maybe I better not do this'

The extent to which bankruptcy law changes have curbed inappropriate filings by people who could pay their debts isn't clear.

Bird, the Bankruptcy Court clerk, said the law has probably discouraged people who would have abused the system, but that number was "relatively few" to begin with.

"My feeling is that for those individuals who have the wherewithal to pay creditors, who have pretty good incomes, they will now pause and think, 'Maybe I better not do this,' " Bird said.

But consumers who genuinely are "down and out" should realize they can still get bankruptcy protection, Bird said. He said there's a misperception among consumers that they no longer are allowed to file for bankruptcy. But he said the protection is still there for people with legitimate need. Bird said he expects bankruptcy filings to begin to rise as more consumers understand that, despite more stringent rules, they can still file for bankruptcy protection.

Another key change under the law is creation of a "means test" that can bar people whose annual income exceeds the median income for their state from filing for Chapter 7 bankruptcy, which requires consumers to liquidate assets, with proceeds going to creditors.

"You basically lose everything that you had" under Chapter 7, said Hudson, who filed for the protection in March.

In exchange, the consumer is freed from any additional obligation to pay so-called unsecured creditors, such as credit card banks. So even if the consumer's assets weren't enough to pay off the credit card bill, the bank could not pursue further collections.

But now, consumers whose incomes are higher than the state median can be forced to file Chapter 13 bankruptcy, under which they're required to repay at least some debts over a three- to five-year period. For Hudson, the means test wasn't much of an issue because he was unemployed when he filed and had only minimal income. In Delaware, the median income for a single person is $45,182, according to the latest census figures.

Consumers can file bankruptcy on their own. But, given the complexity of the process, they typically have to hire lawyers who specialize in the field.

The law has meant "more hoops to jump through," said Maria Pippidis, who teaches classes on personal finance through the University of Delaware's cooperative extension education program.

Among the new requirements, consumers who file for bankruptcy have to take classes on debt management. Pippidis teaches the classes at UD. The YWCA of Delaware also offers the "debtor education" course.

Pippidis said she considers the educational requirement of the law a positive change because the course can help consumers from repeating financial missteps.

Long-term implications

Filing for bankruptcy has a lasting impact on a consumer's ability to borrow because a filing remains on a credit report for 10 years, said Nathaniel C. Nichols, who specializes in bankruptcy law as an associate professor at Widener University School of Law in Brandywine Hundred.

The credit report, which includes a consumer's track record for paying bills, is used by lenders to assess the credit risk posed by a potential customer. People with bankruptcies on their records aren't automatically barred from borrowing, but they'll pay sharply higher interest when they do, Nichols said.

"People who have filed do get credit offers, but with exorbitant interest," the law professor said.

And consumers can find themselves cut off from credit entirely. Hudson said he recently had his J.C. Penney store charge card canceled because of his Chapter 7 filing.

"I tried to use the card and they closed my account," he said. "They told me that's the policy: If you file bankruptcy, they cancel the card. In 20 years, I had never missed a payment on that card, but they canceled it anyway. Bankruptcy really does affect you horribly."

Hudson said he wished he could have avoided bankruptcy, but didn't see another option. He had more than $300,000 in debt, including about $45,000 on business credit cards, after his small business, Glasgow Seafood, closed at the end of 2005. When he borrowed for the business, Hudson had personally guaranteed the debt, leading to his personal bankruptcy filing.

"Bankruptcy is a very uncomfortable option," Hudson said. "You've been a hard worker, and this isn't something that you want to do."

Although filing for bankruptcy was difficult and doing so will affect his ability to borrow for the next decade, completing the process has given Hudson new hope. His bankruptcy case was closed in June. Now working as an assistant superintendent in a cemetery, Hudson said he's putting his financial troubles behind him.

"It gave me a fresh start," Hudson said. "I can start my life all over again."