Advocates for creditors and debtors disagreed sharply Wednesday over how to reform the consumer bankruptcy system, though both sides conceded that some changes are warranted.
At issue is a bill in the House that would prevent consumers from eliminating all their debts under Chapter 7 if they could afford-after deducting living expenses-to repay at least 20% of their obligations over five years. The bill exempts those earning less than 75% of the median income.
In a debate on Capitol Hill organized by the American Bankruptcy Institute, lawyer George J. Wallace called for adoption of this needs-based system, which was introduced by Rep. George W. Gekas, R-Pa., and is strongly supported by lenders.
"We have a system today that provides welfare benefits without any means testing," said Mr. Wallace, a partner in the Washington office of the Eckert, Seamans, Cherin & Mellot law firm. "It is a system that statistics indicate is being abused."
For instance, Mr. Wallace said a study by Harvard University Professor Elizabeth Warren found that 10% of Chapter 7 filers could afford to repay all their debts. That coincides with more recent studies conducted by Georgetown University and accounting firm Ernst & Young. "These people are using Chapter 7," Mr. Wallace said. "Is that appropriate?"
Gary Klein, a lawyer at the National Consumer Law Center, questioned the statistical findings, saying they did not account for higher attorney fees or consumers who fail to complete repayment plans. Adjusting for these factors means that needs-based bankruptcy would help creditors collect less than 1 cent for every $1 owed, he said.
"No creditor would do this outside of the bankruptcy system," he said. "Instead, they want to use the bankruptcy system, which costs taxpayer money."
Still, Mr. Klein said, some reform may be worthwhile. Instead of radically changing the system, he said lawmakers should encourage judges to pull high-income consumers out of Chapter 7 and require them to repay debts under Chapter 13.
"The current system is not perfect," he said. "But we don't need to set up the whole process as a collection agency for creditors."
The American Bankruptcy Institute is a nonpartisan group made up of more than 6,000 lawyers, bankruptcy judges, lenders, accountants, and academics. A House Judiciary subcommittee is expected to hold at least five hearings next month on needs-based bankruptcy.