Wednesday October 12, 2005

A Wave Of Bankruptcies

The bankruptcy of Delphi, the nation's largest auto supplier, just days before a new bankruptcy law goes into effect will spur a new wave of filings, a University of Dayton law professor predicts.

Delphi's filing for bankruptcy could spur a wave of consumer and business bankruptcies -- all after a more stringent federal bankruptcy law takes effect Oct. 17, according to Jeffrey Morris, a University of Dayton law professor who recently finished a one-year stint as scholar-in-residence at the American Bankruptcy Institute.

"Reports suggest that the Dayton area will experience more than its share of pain," Morris said. "Layoffs will put people here in a position where they'll go from a pretty decent living to one where they'll be hard-pressed to find similar work. They'll be working for half or less than their current income. The prospect of a wave of individual bankruptcies resulting from this is a real one."

Delphi, the nation's largest auto supplier, filed Chapter 11 reorganization bankruptcy on Saturday.

Suppliers to Delphi also may be forced into bankruptcy if they can't generate new sales. Unlike Delphi, these companies won't have the same flexibility in filing a reorganization plan because the new law gives both companies and individuals less time to erase their debts.

"This is an added difficulty for the suppliers that they can't control because of the timing," Morris observed.

Last week, more than 10,000 people a day sought bankruptcy protection through Chapter 7 -- a pace Morris predicts will continue this week as people try to beat the clock. Personal bankruptcy filings surged to an all-time high of 467,333 in the second quarter, according to the American Bankruptcy Institute.

"It's either pent-up demand, or the media letting people know that changes are coming," said Morris, an expert in consumer bankruptcies. "The new law is more restrictive and more expensive."

Under the Bankruptcy Abuse Prevention and Consumer Protection Act, the courts use a mathematical formula "to test whether filers are abusing the bankruptcy system," according to Morris. He said debtors who earn more than their state's median income and can pay back at least $6,000 to $10,000 of their debt over five years must file Chapter 13, instead of Chapter 7. Proponents of the new law say it will stem the rising number of personal bankruptcies and prevent misuse of Chapter 7, where debts are erased or reduced. Filers must also take courses in credit counseling.

"It attacks a problem that certainly exists. Some bankruptcy filers are getting more relief than they need, but the number is relatively small," Morris said. "I think proponents of this law will be disappointed they won't catch more people. The biggest problem with this law is that it adopts the premise that there is substantial fraud in the system. That's a bias that's unproven."

Morris, who has testified before Congressional subcommittees on bankruptcy issues and written a bankruptcy case book for use in law schools, is a member of the National Bankruptcy Conference, a group of approximately 65 lawyers, law professors and bankruptcy judges who have achieved scholarly distinction in the field of bankruptcy law. Its purpose is to study the operation of bankruptcy and related laws and proposals for their reform.

Morris doubts mandatory credit counseling will be effective. "It will be an exercise, a 45-minute phone call from the lawyer's office to satisfy the requirement. It won't delay the filing but will cost the filer more money," he said. "I'm skeptical these courses will change the lifestyle of debtors. The shock of bankruptcy is more likely to lead to a change."

While the new law waives the filing fee for a small number of persons, Morris predicts the overall costs will jump for filers because of increased paperwork requirements, mandatory counseling and legal certification. He says the new means test form that individuals must file has been described as "a 1040 on steroids."

Under the new law, "you have to provide a lot more documentation, and lawyers are required to certify the accuracy of the information. That means they'll have to do background checks on their clients -- a service for which debtors must pay," Morris said. "Because of the liability, some lawyers are going to refuse to help debtors. That will lessen the choice for debtors and increase the cost because of supply and demand."

Morris contends that bankruptcy filings have soared, not because Americans are abusing the system, but because it's too easy to borrow money. Earlier this month, the Federal Reserve reported that total consumer debt grew to $2.15 trillion.

"The average income of people filing for bankruptcy is under $30,000. These are people living at the margins. Any blip -- an income interruption, a $400 repair bill or a cutback in overtime -- and they're facing an untenable situation. And this is true for people at every economic level. The savings rates in this country are insufficient."

Contact Jeff Morris at (937) 229-3315.