The Great Bankruptcy Rush of 2005 and its Aftermath The View from Texas
America has witnessed many mass social phenomena in its history. Events such as the California Gold Rush of the 1840s-50s and the Dust Bowl Migration of the 1930s affected many thousands of individuals and left their stamp upon the nation's consciousness. Arguably, the Great Bankruptcy Rush of 2005 may occupy a similar position in our history. At a minimum, the signing of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) set off a massive rush to the bankruptcy courts. This article will examine how the Great Bankruptcy Rush affected filings in the state of Texas both before and after the effective date of BAPCPA.
According to its stated intent, Congress passed BAPCPA to deter "abusive" filings of chapter 7 liquidation proceedings and to encourage debtors to repay their debts through chapter 13 repayment plans.1 The initial impact of the passage of BAPCPA, however, was a massive increase in short-term chapter 7 filings and a decrease in long-term payment plans in chapter 13 filings. As a result, creditors reported massive write-offs during the middle period of 2005,2 while distributions under debt-repayment plans were dramatically reduced.
Understanding the Numbers
BAPCPA was signed into law by President Bush on April 20, 2005, but became effective in stages, with a few provisions immediately effective while others were not effective until six months later, on Oct. 17, 2005. To understand the effects of BAPCPA in Texas, it is necessary to examine filings during three distinct periods of time: (1) filings prior to enactment of BAPCPA, (2) filings after enactment but prior to the effective date, and (3) filings after the effective date. Filings prior to enactment provide a reference point to determine what filings might be without the change in the law. The second period, which I refer to as the Great Bankruptcy Rush, reflects the time after the law was passed but before it became effective. Finally, the period after the effective date provides some basis for predicting what future filings may look like.
This paper relies on data available from the Public Access to Computer Electronic Records (PACER). Data was gathered from each of the four districts of Texas for both chapter 7 and chapter 13 filings. These are the two chapters most likely to be affected by the new legislation. Data was recorded based on months running from the 17th to the 16th. Because BAPCPA took effect on Oct. 17, this was the best way to measure the months both before and after the effective date.
There are two significant limitations to the use of PACER data. The first is that cases are recorded based on their status when the search was done; thus, a case filed under chapter 13 in April 2005 but converted to chapter 7 in June 2006 would be counted as a chapter 7 filed in April 2005. Additionally, chapter 7 filings include individual consumers as well as corporations and partnerships. The filings by non-natural persons under chapter 7 are unlikely to be effected by BAPCPA. However, there is no effective way to back these cases out of the data.
The Baseline Filings
The pre-BAPCPA period, referred to as the baseline period, is measured based on filings from April 17, 2004, to April 16, 2005. During these 12 months, 92,872 cases were filed under chapters 7 and 13 in Texas. The filings reflect an average rate of 4,415 chapter 7 cases and 3,324 chapter 13 cases per month. The mixture of cases reflects that approximately 57 percent of the cases were filed under chapter 7 and 43 percent were filed under chapter 13. These figures were skewed somewhat by the Northern District, which had both the highest level of filings and a rate of chapter 13 filings of 48 percent. The other three districts had only a 40 percent proportion of chapter 13 cases.
The monthly filings prior to BAPCPA were fairly stable for 11 out of 12 months. During this period, the average filing level was 7,739 per month, while the low and high ranged from 6,301 per month (December/January) to 9,943 (March/ April). The filings in March/April 2005 were 28.5 percent above the average and very likely reflected an initial reaction to the pending litigation.
The Rush Period
During the six months from enactment to effective date there was a dramatic rise in filings as debtors sought to take advantage of the existing law. From April 17, 2005, to Oct. 16, 2005, there were a total of 87,915 chapter 7 and 13 filings in the state of Texas. This compares to 92,872 filings during the entire previous year. The differential is even greater when only chapter 7 filings are considered. During the rush period, there were 65,797 chapter 7 cases filed compared with 52,985 filed during the entire year before.
Two important patterns are apparent. First, there was a substantial increase in filings. Second, most of the increase consisted of chapter 7 cases. Average filings per month under chapter 7 during the rush period increased by 154 percent compared to the same six months during the baseline period. However, average filings per month under chapter 13 increased by a mere 11 percent during the same time period. The rise in filings is even more dramatic when examined on a month-by-month basis. For five out of six months, chapter 7 filings were up by less than 100 percent when compared to the same period in the prior month. However, they dramatically increased in the last month before BAPCPA became effective. In fact, nearly half of the chapter 7 filings for the six-month period occurred in just the final month. To put this in perspective, the 35,561 cases filed from Sept. 17 to Oct. 16, 2005, was approximately equal to eight months of chapter 7 filings during the prior year.
The chapter 13 numbers show a much different story. For most of the same period, chapter 13 filings were either down or flat in 2005 compared to 2004. It is only when the 90 percent increase in filings during September/October is included that an average increase of 9.33 percent is achieved.
The comparative numbers between the baseline and rush periods suggest several conclusions:
1. The imminent change in the bankruptcy laws was well known to the bar and the public. As a result, many people sought to file before the new law became effective. Some of these filers no doubt accelerated their decision to file bankruptcy. Because of the change in the law, others may have filed who would not otherwise have filed.
2. The changes in the law were perceived as affecting chapter 7 filings much more than chapter 13 filings with the result that the rise in chapter 7 cases was much more dramatic than the negligible increase in chapter 13 filings.
3. There may have been some impulsive or hysterical behavior at work. Chapter 13 requires a long-term commitment. Therefore, people are less likely to file chapter 13 without giving it more consideration. On the other hand, chapter 7 is a "quick fix." Anecdotal evidence from the clerk's office tells of people filing for bankruptcy despite not having any creditors. The author witnessed multiple instances of pro se debtors filing chapter 7 and then asking to dismiss their cases on the basis that they did not need to file in the first place.
The BAPCPA Period
It has now been nine months since BAPCPA took effect. There were virtually no filings during the first month after the law took effect. Over the succeeding months, filings have increased but remain well below the baseline period.
The filings to date show both a significant decline in filings as well as a change in the mixture of cases filed. For the nine-month period, there were 7,682 chapter 7 cases and 11,512 chapter 13 cases filed for a total of 19,194 cases. This compares to 40,331 chapter 7 filings and 28,819 chapter 13 cases for a total of 69,150 during the comparable months of the baseline period.3
In the first month of BAPCPA, chapter 7 filings constituted an anemic 4.62 percent of filings during the baseline period, while chapter 13 cases were not much better at 15.08 percent of baseline period filings. Chapter 7 cases have recovered to approximately 25-30 percent of their prior levels, while chapter 13 cases are back to 45-55 percent of their earlier levels. As shown in Chart 1, both chapter 7 and chapter 13 filings appear to be on somewhat of an upward trend (the most recent month notwithstanding). One interesting result of BAPCPA is that chapter 13 cases now predominate over chapter 7 cases, whereas previously, chapter 13 cases made up just 43 percent of the cases; under BAPCPA, they make up 60 percent.
It is difficult to predict the long-term effects of BAPCPA on bankruptcy filings. In the 15 months since BAPCPA was passed, the aggregate number of chapter 7 cases filed has increased over the filings for the comparable period prior to BAPCPA, while the number of chapter 13 cases is down. This is because the massive increase in chapter 7 filings during the rush period has yet to be offset by the decrease in filings during the BAPCPA period. On the other hand, since the increase in chapter 13 filings was extremely modest during the rush period, there has been a net decrease in chapter 13 filings. Thus, when the rush period plus the BAPCPA period is compared to the average level of filings during the baseline period, chapter 7 filings are up, while chapter 13 filings are down.
It is important to note that the increase in chapter 7 filings is short-term in nature. If chapter 7 filings remain at 25-30 percent of previous levels, then the net increase in cases will be offset in another two to three months. However, the net decrease in chapter 13 filings appears to be a long-term phenomenon. If chapter 13 levels remain at 45-55 percent of prior levels, then the impact to creditors could be substantial.4
What does the future hold? In part, that depends on how long it will take to overcome the short-term effects of BAPCPA, which appear to be driven by several factors:
1. With respect to chapter 7 cases, the large number of filings during the rush period created a bulge that had to be worked through the system.
2. With respect to both chapter 7 and chapter 13 cases, there is likely to be a learning factor for both practitioners and the public. BAPCPA greatly changed the requirements of consumer bankruptcy practice, increasing the complexity of filings and the consequences for incorrect filings. Some lawyers have and will continue to drop out of the field, while others will go slow until they are more comfortable with the new law. There was a significant amount of publicity given to BAPCPA during the rush period. Some individuals who did not file during this time may be reluctant to do so now that the law has changed. This may be due in part to misperceptions that consumer bankruptcy had been abolished rather than simply revised or reformed. In time, the publicity will fade while debt burdens remain high, and consumers will be more likely to consider bankruptcy again.
At this point, it is difficult to do more than speculate about what provisions of BAPCPA will have a long-term effect on filings. However, it is possible to rule out or minimize the effects of some provisions:
1. The means test will have some effect on the level of filings, but probably not very much. Prior to BAPCPA, it was estimated that 3-10 percent of filers would be affected by the means test.5 Some of the people who fail the means test will elect to file chapter 13. Therefore, the net reduction in people filing bankruptcy as a result of means testing alone should not be more than a few percentage points.
2. Restrictions in a number of substantive areas, such as application of the stay to subsequent cases and restrictions on homestead exemptions, may affect a few debtors at the margins but should not have a major effect.
3. Procedural restrictions, such as requiring credit counseling, may reduce the number of pro se debtors,6 but this should have little impact on cases filed by attorneys.
4. Americans are unlikely to change their borrowing habits. As long as the credit card industry continues to target individuals who would not otherwise qualify for credit, there will be a large pool of individuals who have incurred more debt than they can afford to pay.
5. Out-of-court repayment plans are unlikely to turn many people away from bankruptcy. Early indications are that credit counselors are seeing a negligible percentage of people who could qualify for a repayment plan.7 As long as participation in repayment plans is voluntary for both debtors and creditors, there will always be debtors who don't want to participate as well as creditors who refuse to agree to payment schedules. Indeed, in a multiple-creditor setting, the one creditor who pursues unilateral action will always do better than the 10 who go along with the program.
Assuming that short-term factors drop off and the factors listed above do not have significant impact, what is likely to drive future bankruptcies? Probably the biggest factors (and the hardest to predict) are cost and complexity. Because the system is substantially more complicated now, bankruptcy will become a harsher and more unforgiving world for the pro se debtor. Some attorneys will leave the practice rather than trying to adapt to the new requirements. The remaining attorneys are likely to charge more to compensate for the added work they will be required to do, as well as the added risk they will assume. This may lead to the development of a larger pool of people who are simply too poor to file for bankruptcy and who are not sophisticated enough to properly complete the bankruptcy paperwork. These people may start the process, but may never actually file for bankruptcy.
1 H.R. Rep. 109-31 (2005).
2 Gelsi, Steve, "Fitch, Moodys Eye Delinquencies," Marketwatch, 9/13/05, www.marketwatch.com/News/Story/Story.aspx?dist= newsfinder&siteid=mktw&guid=%7B2251DA44%2DCBF2%2D4429%2DB29E%2D87481B14EFF6%7D&link=&keyword=credit%20card%20&%20bankruptcy.
3 In order to get a true apples-to-apples comparison, each month under BAPCPA was compared to a comparable month during the baseline period of 2004-05. The data for 4/17/06-7/16/06 was compared to the same months during 2004 so that it would not be affected by numbers during the rush period. As a result, these months were compared to filings two years prior, while the filings from 10/17/05-4/16/06 were compared to filings just one year prior.
4 In Fiscal 1998, chapter 13 trustees distributed approximately $3 billion. Flynn, Ed, "Distributions and Expenses in Chapter 13," American Bankruptcy Institute Journal (May 2000). This is an old number, so the current amount is probably much higher. However, assuming a 50 percent drop in chapter 13 filings and distributions of $3 billion per year, this could translate into a loss to creditors of approximately $1.5 billion per year.
5 Prof. Marianne Culhane offered a 3.6 percent estimate in "Taking the New Consumer Bankruptcy Model for a Test Drive: Means-Testing Real Chapter 7 Debtors," 7 ABI Law Review 27 (1999), while the 10 percent estimate comes from a study by Ernest & Young, Jensen, "A Legislative History of the Bankruptcy Abuse and Consumer Protection Act of 2005," 79 Am. Bankr. L. J. 485, 521, n. 208 (2005). The Ernst & Young study has been justifiably criticized, since it failed to account for such items as payment of secured debts and administrative expenses incurred in chapter 13 cases. Prof. Culhane's study appears to have done a better job of considering these factors.
6 Compare In re Navarro, No. 06-51007 (Bankr. W.D. Tex. 6/27/06) (per L. Clark) (not knowing about credit counseling requirement can be an exigent circumstance for a pro se debtor) with In re Gallardo, No. 06-50724 (Bankr. W.D. Tex. 7/7/06) (per R. King) (not knowing about requirement does not excuse court from enforcing law as written). Both opinions are available at www.txwb.uscourts.gov/opinions.
7 Said, Carolyn, "Study Says Bankruptcy Law Hurts; Lawyers Say Those Who Need Aid Find It Difficult to Get," San Francisco Chronicle, 2/23/06, www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2006/ 02/23/BUGESHCVK41.DTL (study finds that 96.7 percent of 61,335 persons going through credit counseling did not qualify for a repayment plan).