A federal panel Friday rejected creditors' proposal for "needs-based" reforms and voted to recommend legal changes that are expected to make debt collection more difficult.
On a 6-to-2 vote, the National Bankruptcy Review Commission backed measures that include a ban on reaffirmations-the right of a debtor to remove a loan from the bankruptcy process by agreeing to repay it.
Commission member Robert E. Ginsberg, a Chicago bankruptcy judge, said the move would prevent creditors from bullying consumers into repaying debts that normally would be discharged. He pointed to a recent case in which Sears, Roebuck and Co. agreed to repay millions of dollars for improperly enticing consumers to reaffirm credit card obligations.
Commissioners clashed over this proposal as well as plans to treat the portion of a second mortgage that exceeds the value of the home as unsecured debt and to prohibit secured loans under $500.
The recommendations will be included in an Oct. 20 report to Congress that is expected to serve as a blueprint for a rewrite of the bankruptcy code.
Commissioner Edith H. Jones, a judge on the U.S. Court of Appeals for the Fifth Circuit, urged her colleagues to dump the entire proposal, saying it made too many changes that favor debtors and not enough to aid creditors or reduce bankruptcy filings, which hit a record 1.1 million last year and may exceed 1.4 million this year.
"We lose our credibility because in our work we have not dealt with their concerns," Judge Jones said. "Let's abandon this framework."
But by the end of the debate, the panel yielded to commissioner Babette A. Ceccotti, a partner at the New York law firm of Cohen, Weiss & Simon, who said the package on the whole benefits debtors and creditors.
"This is a framework because it is supposed to work together," she said. "None of us like all of the provisions."
The commission was able to approve the package of consumer bankruptcy revisions only after M. Caldwell Butler said he would present a substitute proposal at an Aug. 11-12 meeting in Washington.
Substantive changes, however, may prove difficult. At least three of the commission's eight members strongly support the framework and are likely to try and block any reconsideration. Also, the agenda for the August meeting is crowded, leaving little room for extensive debate on consumer bankruptcy issues.
Still, lenders vowed to continue lobbying for needs-based bankruptcy, which would force consumers with high incomes to repay at least some of their unsecured debts.
"Commission members are looking for an alternative," said William P. Binzel, vice president for government relations at MasterCard International. "This vote is not final. We will continue to advocate that the commission recommend that Congress fix the fundamental flaw in the bankruptcy system, which is that it allows people who can afford to repay a portion of their debts to simply walk away."
"This is an opportunity to work constructively with them to make this framework viable because right now it is on shaky ground," said David Sandor, director of public affairs for Visa U.S.A.
The commission also agreed to recommend limiting the ability of consumers to make repeated bankruptcy filings and requiring debtors who file under Chapter 13 to make a minimum payment to unsecured creditors.
"This will encourage more Chapter 7 filings," said Philip S. Corwin, a lobbyist at Federal Legislative Associates who represents the American Bankers Association. "This proposal fails to address creditors' concerns."
A home equity provision would treat as unsecured debt the portion of a second mortgage that exceeds the value of the home. Currently, all home equity loans are treated as secured debts that must be repaid.
"The second mortgage is a very useful tool," said James I. Shepard, a tax lawyer and member of the commission. Eliminating it "will result in a raising of rates. I simply can't accept that."
But Judge Ginsberg said there is no reason to punish other unsecured creditors by giving second mortgage lenders special rights. If the bank had to foreclose, he noted, it only would recoup the value of the property.
The package would ban secured loans of less than $500 used to purchase personal or household goods. It would also prevent consumers from filing for Chapter 7 more than once every six years and from filing for Chapter 13 more than once every two years.
It also provides for an automatic conversion from Chapter 13 to Chapter 7 for consumers who stop making payments to creditors. Lenders could block the conversion if the borrower had filed for Chapter 7 within six years.