Volume 7, Issue 2 - Personal Bankruptcy in the 21st Century: Emerging Trends and New Challenges

Traditionally, civil law jurisdictions in Scandinavia and the continent of Europe have not been willing to acknowledge the appropriateness of extending bankruptcy relief to consumer debtors and discharging any part of their debts. The opposition was based on the importance of upholding the sanctity of contractual obligations: pacta sunt servanda. This attitude stood in contrast to the fresh start philosophy of US bankruptcy law, which embraced a more forgiving attitude, focusing on the reintegration of the insolvent debtor into society, substantially free of debt, after he has filed for bankruptcy and surrendered his non-exempt property for distribution among his creditors. The relaxation of credit controls and the rapid increase in the number of insolvent debtors in the late 1980s and early 1990s has forced many continental jurisdictions to reconsider their traditional opposition. They have since adopted debt adjustment plans providing various forms of debt relief to overcommitted debtors but only a substantial number of years after the initial proceedings. The American reaction has gone in the opposite direction. With the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the United States has reversed its century old liberal fresh start tradition. The 2005 Act imposes a formidable means test as well as other preconditions to determine whether a debtor has sufficient discretionary income to pay off twenty percent of his or her unsecured debts under a Chapter 13 plan. If the answer is yes, the debtor is denied the right to file a bankruptcy petition under Chapter 7 of the Bankruptcy Code. This paper asks whether these developments on opposite sides of the Atlantic suggest that facts on the ground are more important than dogma and deeply entrenched beliefs. The author’s answer is that while there is certainly a trend towards convergence between continental European and US approaches to consumer insolvency, it is much too soon to speak of a common culture and a common approach. He notes, however, that Commonwealth jurisdictions (notably Australia, England and Canada) have long adopted a means test to determine a debtor’s eligibility for discharge from debt and suggests that continental scholars would have done better to study the Commonwealth experience as embodying a suitable compromise than to flirt with the US fresh start philosophy, only to reject it as too alien to the continental moral sense.

Consumer bankruptcy scholars typically stress either a structural or a cultural account of individuals’ problems with debt. Drawing on the history of poverty research, this article argues that research on consumer overindebtedness and bankruptcy should avoid the pitfall of seeing structural and cultural factors as opposing explanations. Deregulation of the credit industry and an incomplete social safety net are key structural conditions that lead to a culture hospitable to overindebtedness. Furthermore, the interaction of structure and culture has practical policy implications. Structural changes such as interest-rate deregulation inevitably transform both business and consumer culture. Policies designed to create a different consumer culture will have a hard time when pitted against strong structural causes of overindebtedness. At a minimum, efforts to create a culture of personal financial responsibility need a strong structural base, such as public education starting at a young age, and could easily require a generation or more to take hold.

In this paper, Professor Wiggins explores the relationship between conservative economic theories and major bankruptcy reforms recently enacted by the United States Congress. First, she describes three key components of conservative economic theory as advanced by the Bush Administration and conservative scholars. These include: (1) a strong preference for private ordering over public ordering, (2) the promotion of private property as a means to expand personal freedom and liberty, and (3) the encouragement of individual risk internalization. Next, she describes two theoretical components of the new bankruptcy reforms. These include: (1) a preference for creditor collection over debt relief and (2) the promotion of individual risk internalization. Then Professor Wiggins examines two questions: First, is there meaningful theoretical symmetry between conservative economics and the new bankruptcy law? Second, is there significant operational symmetry between the two? The paper suggests theoretical convergence for two reasons: First, both conservative economics and the new bankruptcy law aim to promote private bargains over administratively adjusted ones. Second, both seek to force individuals to absorb more of the risks of financial decision-making. The paper suggests, however, that at the operational level there exists significant divergence between the aims of conservative economics and the predicted consequences of the new law. Professor Wiggins concludes, among other things, that economic conservatives should pay more rigorous attention to personal bankruptcy policy because operational asymmetry between their theories and the new legislation could blunt their ambitious economic agenda for American consumers.

Historically, individuals who file for bankruptcy protection have been viewed harshly by society. The negative perception of bankrupts was manifested in the punitive measures employed against bankruptcy petitioners, in the degrading public rituals directed at them, and in the contemptuous discourse used by officials to refer to the bankrupts. This traditional negative image of bankrupts was shared in colonial America, and vigorously continued throughout the Victorian era and into the 20th century. By the 1960s, a number of critics began to voice their concerns about the dramatic rise in consumer bankruptcy filings in the United States. The critics have mostly attributed the increase in filings to an alleged decline both in morals and in the shame associated with bankruptcy. Charges of the fading stigma of bankruptcy have recently intensified. A number of recent studies have attempted to corroborate assertions of the declining stigma of bankruptcy through the use of indirect variables as proxies. These attempts to measure bankruptcy stigma have been roundly criticized. The disapproval centers mainly on the studies’ failure to directly measure changes in public perception of bankruptcy. This study attempts to measure the evolution of stigma in bankruptcy by addressing the methodological concerns attributed to previous empirical studies on this subject. Rather than measuring bankruptcy stigma through the examination of indirect bankruptcy stigma proxies or through the questioning of former petitioners, this study measures evolving public perceptions about bankruptcy by examining the expressed sentiments of the general public. To ascertain whether the negative image of bankrupts has eroded in the United States over the past century and a half, 171 newspaper articles published between 1864 and 2002 about personal bankruptcy were examined for content. Examination of the content of personal bankruptcy related newspaper articles provides valuable information about the evolution of public perceptions of bankrupts during that period. This study detected a noticeable shift, beginning in the 1960s, in public attitudes towards individuals filing for personal bankruptcy. However, it did not find that the changing public perception necessarily prompted an increase in the bankruptcy filings.

This Article explores the relationship between consumer credit markets and bankruptcy policy. In general, I argue that the causative relationships running between borrowing and bankruptcy compel a new strategy for policing the conduct of lenders and borrowers in modern consumer credit markets. The strategy must be sensitive to the role of the credit card in lending markets and must recognize that both issuers and cardholders are well placed to respond to the increased levels of spending and indebtedness. In the latter parts of the Article, I recommend mandatory minimum payment requirements, a tax on distressed credit card debt, and the subordination of payments to credit card lenders in bankruptcy. I also argue that many aspects of the American bankruptcy system, as recently reformed, are overly protective of credit card issuers.

This Article argues that when credit suppliers market and advertise their credit products, they utilize and enhance consumers’ cognitive biases, particularly their optimism bias and illusion of control. We apply the concept of manipulation to this practice. The biased and manipulated debtors attribute unrealistically low probability to negative life events, such as job loss, illness, accident or divorce, and high probability to positive life events. As a result of the manipulation, the biased debtors are triggered to borrow more than they would have borrowed otherwise. This additional borrowing may contribute to the default of these debtors and to their eventual bankruptcy. Empirical studies of the causes of bankruptcy show that before their default, bankrupts have often experienced negative life events that decrease income, increase expenses, or both. The bias and its manipulation justify legal intervention. The Article discusses various justifications for legal intervention and offers tentative and partial prescriptions for intervention. It analyzes the comparative advantages and shortcomings of ex ante intervention, in the form of regulation of credit marketing practices and credit contracts, of tax and insurance, and ex post intervention, at the bankruptcy stage. Its main contribution is in bringing together bodies of literature on cognitive biases, consumer decision making, lifecycle, social influence, advertising and marketing, behavioral law and economics, economic analysis of bankruptcy and socio-legal studies of bankruptcy. By combining these bodies of literature, the Article provides a new perspective on bankruptcy and credit and offers a promising framework for future work.

The article offers a new reading of the home ownership-mortgage relationship in Israel. It points at the duality characterizing Israeli law regarding home ownership and its protection. While home ownership is a cherished social value, there is a reluctance to provide it with sufficient protection. The significant implications of repossession in the personal, social, and economic realms call for new thinking concerning the assurance of sustainable housing. Current protection laws focus mostly on ex post solutions, aimed at alleviating the plight of the defaulting mortgagor. The article emphasizes the need for ex ante policies, introducing innovative mechanisms in home purchasing.

American bankruptcy law has offered a "fresh start" in every state for over one hundred years. As a result, econometric studies of consumer bankruptcy often focus on one of the few aspects of the law that has varied significantly across time and across states: exemptions. Professors Gropp, Scholz and White published the first article to test the effect of exemptions on credit markets. Consistent with theory, they found that residents of states with larger exemptions pay higher interest rates than those in states with lower exemptions and face an increased probability that they will be denied credit. These effects were most pronounced for poor households. This result is surprising because exemptions only allow a household to keep what it has. The difference between a $100,000 exemption and an exemption with no dollar limit should not matter if the household has little or no assets to exempt. This essay examines alternative explanations for why exemptions appear to have a disproportionate impact on the poor. Unfortunately, however, none of these alternative explanations proves entirely satisfactory.

This Article discusses a triangle of forces that affect the activity of small-medium enterprises (SMEs). These forces are: limited liability, shareholder guarantees, and bankruptcy. Limited liability encourages entrepreneurship by reducing the personal risks shareholders are exposed to as a result of business failure. However, the limited liability shield creates the potential moral hazard of overinvestment. That is, the entrepreneur may involve the corporation in overly risky projects. To combat this risk, the lending practice requires entrepreneurs to sign a personal guarantee for corporate debt. The guarantee serves as a bonding device that forces the entrepreneur to internalize the costs of the corporate activity. This Article first argues that while personal guarantees can serve this economic goal, the lending industry demands them excessively and they are overused. The overuse of guarantees unnecessarily subjects good corporate borrowers as well as bad ones to this practice and causes underinvestment. The third force of the triangle, a discharge of the shareholder’s debts in bankruptcy, may balance this inefficiency. It potentially softens the effect of the guarantee and thus requires the lender to further gather borrowerspecific information at the lending stage. Unfortunately, personal bankruptcy is underused by individual debtors mainly because of the stigma it implies. To rebalance the triangle, this Article proposes to encourage the shareholder’s partial relief of the guarantee through an amicable procedure. I call this procedure Velvet Bankruptcy. Velvet Bankruptcy would first procedurally consolidate the private collection from the shareholder-guarantor with the pending corporate bankruptcy case, by authorizing the court to extend the automatic stay to protect the shareholder-guarantor. To the extent the court is convinced that the collection would render the shareholder insolvent, it could reduce the guarantor’s liability. This would effectively constitute discharge without officially declaring the shareholder bankrupt.

The project of the comprehensive reform of Japanese insolvency law started in October 1996. After many enactments and amendments, there are now two types of judicial proceedings for personal insolvencies in Japanese insolvency law. The first category is straight bankruptcy proceedings in which the debtor can be discharged; the other is special Civil Rehabilitation proceedings for individual debtors. In this Article, I will first give a brief overview of the special Civil Rehabilitation proceedings for individual debtors (Part I), including a short description of two types of proceedings, and legislative issues. Then I will give a brief overview of major amendments of the Bankruptcy Law concerning individual bankruptcies (Part II), including amendments relating to the scope of exemption and discharge proceedings.

Israeli enforcement law uses both direct and indirect enforcement — the former via attachment of assets, and the latter via imprisonment of the debtor. The use of indirect enforcement via imprisonment is problematic, as it violates the basic rights of the debtor. I will argue that in response to this problem, the law created a framework for the "debtor of limited means." I will demonstrate that not only does this create an improper definition of the task of the Chief Enforcement Officer, but that it is also an inefficient way of dealing with an insolvent debtor. I will propose that the system differentiate between debtors who cannot pay their debts and those who do not want to pay their debts. I believe that encouraging the insolvent debtor to file for of bankruptcy will avoid the problem of imprisonment and enable the Chief Enforcement Officer to return to his natural role as judge of enforcement. Additionally, I suggest creating a separate track of "consumer enforcement," which would avoid the whole system of installments, imprisonment, and debtors of limited means, at least regarding consumer credit.

The number of credit delinquents in Korea had been growing steadily since 1997 and had reached 3,700,000 by the end of 2003, which was about 8.4% of the population. The government initiated several support programs, but the number of credit delinquents has decreased very slowly. In order to allow for successful recovery of credit delinquents, it is imperative to reduce debts in a more comprehensive manner, to clear the impediments for easy use of personal bankruptcy mechanisms, and to provide incentives to encourage debtors to make progress on their repayment plans. While there has been much change in terms of learning to live with bankruptcy as an inevitable part of a market economy, there is still much to be done. The reality of "moral hazard" in bankruptcy discharge should be uncovered. Legal restraints discriminating against bankrupts must be removed. The repayment period of individual rehabilitation and individual workouts must be shortened to three years. Personal guarantors for debtors in rehabilitation proceedings should be protected as much as the debtors are during the repayment period in rehabilitation proceedings. Debtors need to be able to keep their mortgaged residences during the proceedings. The history of insolvency has shown that society can benefit as much as or more than debtors themselves from the discharge of unpaid debts because with a fresh start the debtor has an incentive to work hard. The starting point to personal bankruptcy law reform is this belief.

This Article is made up of two parts. The first part reflects on the dominant functionalist approach to comparative consumer bankruptcy and suggests that this might be supplemented by a political economy analysis that addresses the role of national and international interest groups, including professionals, and ideology in understanding different national responses to overindebtedness in North America and Europe. The second part examines current reforms to consumer bankruptcy and responses to overindebtedness in the UK through this political economy lens and concludes that competition among professional groups, the role and interests of the Insolvency Service, and the ideology of the Third Way in consumer policy will influence the ultimate structure adopted for addressing consumer insolvency. A study of the English experience suggests that there is also an element of national path dependency to consumer insolvency reform that may resist pressures towards convergence of approaches between countries in addressing issues of consumer insolvency.