Bankruptcy reform cleared its first legislative hurdle Thursday when a Senate Judiciary subcommittee overwhelmingly ap-proved a bill that would require higher-income consumers to repay some unsecured debt.

The bill, adopted 6 to 1, would allow creditors to ask a judge to force consumers in bankruptcy to repay some unsecured debts. Currently, only court-appointed bankruptcy trustees may challenge Chapter 7 filings.

Under the legislation, creditors or trustees would have to prove a debtor is "abusing" the bankruptcy system. The bill defines abuse as any attempt to eliminate all debts in Chapter 7 when the filer could afford to repay at least 20% of unsecured debt over five years.

Today, trustees must prove "substantial abuse," which is a much higher legal standard.

The subcommittee unanimously adopted an amendment by Sen. Richard J. Durbin, D-Ill., that would prevent creditors from asking for repayment if the debtor earns less than 100% of the national median income. Trustees, however, could still ask courts to order repayments.

Lenders praised the action taken by Sen. Charles E. Grassley's subcommittee, but said they still prefer legislation in the House that would use a formula to determine if debtors could eliminate all their unsecured credit in Chapter 7.

"We are very supportive of needs-based reform that the Senate subcommittee enacted," said William P. Binzel, vice president of government affairs at MasterCard International. "But we continue to favor the approach taken by the House because it is a much simpler system and would not require extensive litigation."

"We are pleased to see that Sens. Grassley and Durbin see the need for bankruptcy reform and are treating this with a sense of urgency," said Robert L. Towne, vice president for bank card research at Visa U.S.A.

Republican leaders hope to enact bankruptcy reform this year. The full Judiciary Committee is expected to vote in April and it could go to the Senate floor in late spring. Rep. George W. Gekas' version of needs-based bankruptcy will be voted on by House Judiciary's commercial and administrative law subcommittee April 24. A full committee vote is scheduled for April 29.

"I think that time is more of a factor than substance," Sen. Grassley said. "I hope we can move it to the President's desk."

During debate on the Grassley bill, the committee approved several amendments that prevent debtors from protecting the bulk of their assets.

By a 4-to-3 margin, the subcommittee voted to prevent debtors from cramming down loans on property purchased less than 90 days before the bankruptcy filing. A cramdown allows the consumer to eliminate the portion of their loan that exceeds the value of the collateral. Cramdowns have become an increasing problem in car loans because vehicles depreciate significantly as soon as they leave the dealer's lot.

The subcommittee also voted 3 to 2 to make it harder for consumers to discharge any unsecured debt assumed 90 days before a bankruptcy filing. Instead of being able to eliminate these debts, consumers would have to list the charges and could only get rid of those that were not luxury purchases.

"This is not a matter of making debt nondischargable," said Sen. Jon L. Kyl, the Arizona Republican who sponsored the amendment. "It is making those who run up debt explain it."

In a unanimous vote, the subcommittee limited to $100,000 the value of property a debtor may shield from creditors. Some states allow debtors to shield million-dollar homes and racehorses.

An amendment by Sen. Jeff Sessions, R-Ala., adopted 7 to 0, would require consumers to seek credit counseling before filing for bankruptcy.

The Grassley bill also would impose fines on creditors that harass debtors. For instance, the debtor would receive attorney's fees if the court dismisses a creditor's claim or reduces it by more than 20%. But the bill also would subject debtors to punitive damages if they raise unjustified claims.

Most of the votes on amendments split along party lines. Still, both sides agreed to try to resolve their disputes before the committee markup.

Sen. Grassley said he hopes to lower to 75% of median income the safe harbor for those exempt from the needs-based system. That is the same threshold contained in Rep. Gekas' bill.

Sens. Kyl and Sessions also said they would favor a more formulaic approach to needs-based bankruptcy, similar to Rep. Gekas' approach. "This would be a big improvement over current law," he said. But "a better approach would be to direct the filer to the correct chapter before they file."

Earlier in the day, the Consumer Federation of America blasted both the Senate and House versions of bankruptcy reform, saying the record number of filings are a result of economic troubles, not defects in the law.

"People who have closely studied the bankruptcy system have consistently rejected the arguments of the credit industry," said Mary Rouleau, the group's legislative director. "This Congress should too."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.