Should Katrina Victims be Exempted from the New Bankruptcy Law?

by Jillian McClelland September 20 2005, 00:19

The aftermath of Hurricane Katrina has sparked renewed debate over stricter provisions in the new bankruptcy law that takes effect on October 17th. Higher filing fees, more stringent document requirements, and mandatory credit counseling are all cited as especially burdensome for victims of natural disasters. Democrats are concerned that the controversial financial means test will deny Katrina victims the ability to declare a fresh start, and have proposed an exemption in a bill referred to the Senate Committee on the Judiciary on September 8th. [1]

Republican backers of the new law instead urge that the stricter standards won't apply to those most in need and that judges will retain the discretion to take Katrina into account when processing bankruptcy claims. The reluctance to accept any exemption could be a costly move politically, given the much-publicized lag in aid at the outset of Katrina. Now with recovery efforts in full swing, the Administration can ill afford any charge that it is withholding relief, especially to the benefit of corporate lenders.

Will an exemption from the bankruptcy law really assist those affected by Katrina? A reading of the new law in light of the special circumstances brought about by this disaster is needed to evaluate the competing claims.

The Immediate and Projected Effects of Hurricane Katrina

Katrina's storm surge brought with it a wave of devastation across the Gulf Coast states of Louisiana, Mississippi, and Alabama, where more than 90,000 square miles are covered by a Federal Disaster Declaration. [2] More than 1 million residents were forced to evacuate, and thousands will return to find little or nothing left of their homes and businesses. The receding floodwaters in New Orleans have left behind a sickly sludge of pollution and waste on those buildings left standing, the long term health effects of which are yet unknown. [3]

Risk Management Solutions, a leading provider of catastrophic risk quantification and management, estimates that the total financial losses attributable to Katrina will top $125 billion, $40-$60 billion of which are private insured losses. [4] That leaves a staggering $65-$85 billion in uninsured losses. Since flood damage is excluded from standard insurance policies [5], it is unclear whether those home and business owners who are insured will be able to recover the funds necessary to repair and rebuild. Meanwhile, they are still liable for debts attached to their damaged or worthless properties.

Federal and private aid is now pouring into the affected region. The Federal Emergency Management Agency (FEMA) estimates that it has disbursed assistance to over half a million families, to the tune of $1.1 billion. [6] According to FEMA guidelines, however, individuals must register to qualify for aid, most of which is provided in the form of subsidized loans as opposed to grants. [7]

Evaluating the Argument for an Emergency Bankruptcy Exemption

As described in a previous article, the new bankruptcy law will make it more difficult for some individuals to obtain the asset liquidation and "fresh start" options under Chapter 7, and will instead force more cases into Chapter 13, which carries with it a mandatory repayment plan set over five years. All debtors will be required to undergo credit counseling six months prior to discharge, at their expense. Critics of the law have long cited this provision as inappropriate for those who have suffered catastrophic financial reversals, such as medical emergencies, death in the family, call up to military duty, terrorist attacks, and natural disasters.

In light of the unprecedented devastation caused by Hurricane Katrina, politicians and advocacy groups are calling for additional debt relief in the form of an exemption from the new bankruptcy law for up to one year, which would presumably favor Chapter 7 filings for those affected. In a joint statement issued on September 1st, Jerrold Nadler (D-NY) voiced the concern that:

... just as survivors of Hurricane Katrina are beginning to rebuild their lives, the new bankruptcy law will result in a further and unintended financial whammy. Unfortunately, the new law is likely to have the consequence of preventing devestated [sic] families from being able to obtain relief from massive and unexpected new financial obligations they are incurring and by forcing them to repay their debt with income they no longer have, but which is counted by the law. [8]

Nadler is referring to the fact that under the new law, the calculation of "current monthly income" for the purposes of determining a debtor's ability to repay his creditors actually means the "average monthly income from all sources... derived during the 6-month period ending on (i) the last day of the calendar month immediately preceding the date of the commencement of the case ... " or a date fixed by the Court. [9] This definition ignores unemployment as a leading contributor to the declaration of bankruptcy and assumes a continuing ability to pay down debts (including taxes, which are excluded from automatic stay provisions).

Indeed there is a rebuttable presumption built into the new statutory scheme that debtors are able to meet their obligations to creditors and should be held accountable notwithstanding personal circumstances. In fact, it is referred in the law as the "presumption of abuse", i.e. that debtors seeking Chapter 7 coverage do so to escape their obligations rather as a legitimate means of financial reorganization. Opponents to the law find it contains little sympathy for victims of Katrina.

Judicial Discretion and the Means Test Should Protect those Most in Need

Representative F. James Sensenbrenner, the Chairman of the House Judiciary Committee, is currently refusing to hold a committee hearing on bills proposing an exemption to the bankruptcy law, and is backed by the chief architect of the new law, Senator Charles Grassley (R-IA). Sensenbrenner rebuffed the calls of Nadler, Russ Feingold (D-WI) and others to alter the law, implying their fears are unwarranted:

If someone in Katrina is down and out, and has no possibility of being able to repay 40 percent or more of their debts, then the new bankruptcy law doesn't apply. [10]

The financial means test provides an objective standard for judges to follow in filtering cases into the different Chapters. In order to qualify for Chapter 7 (and rebut the presumption of abuse), a debtor must show that his average annual income is equal to or less than his state's median family income. [11] Those who were poor prior to Katrina will thus be guaranteed a fresh start under Chapter 7, which includes many families in those areas hardest hit. In Louisiana, for example, the median income in 2004 was $42,886 and Orleans Parish was listed among the top-20 poorest counties in the U.S., with an average median family income of only $31,369. [12]

Furthermore, despite the strict terms of the new law, judicial discretion should not be underestimated. It is likely that bankruptcy judges will give broad reading to the "special circumstances" provisions in the law to facilitate Chapter 7 filings wherever appropriate. The Interim Rules of Bankruptcy Procedure, [13] which will be in effect on October 17th (and until such time as the Judiciary Committee on Rules of Practice and Procedure have fully distilled the 500-page bill into new procedural guidelines) provide that filing fees, although now higher, may be paid in installments or waived altogether. Similarly, although document requirements are more stringent, a judge may also be satisfied with a sworn statement that the document in question no longer exists, which is particularly applicable to those who have lost homes and records.

Finally, the generosity of Americans towards those affected by Hurricane Katrina has been overwhelming. In addition to assistance from FEMA, the Red Cross, Habitat for Humanity and countless other charitable donors, many corporate and government creditors are offering relief in the form of debt forgiveness, payment holidays, and other concessions. Currently, Ford, GMAC, Chrysler, Visa, Bank of America, American Express, MBNA, Freddie Mac and Fannie Mae, and even the IRS are offering assistance. With continued collaboration and compassion, victims of Katrina may yet be able to ride out the storm.

Sources

[1] Hurricane Katrina Bankruptcy Relief and Community Protection Act of 2005, S. 1647, 109th Cong. (2005), available at http://thomas.loc.gov/cgi-bin/query/D?c109:25:./temp/~c109dCTl03:

[2] Department of Homeland Security, Hurricane Katrina: What Government is Doing, http://www.dhs.gov/interweb/assetlibrary/katrina.htm (last viewed on Sept. 19, 2005)

[3] Environmental Protection Agency, Potential Environmental Health Hazards When Returning to Homes and Businesses, http://www.epa.gov/katrina/sep14returnhomeadvisory.htm (last viewed on Sept. 19, 2005)

[4] RMS Increases Insured Loss Estimate for Hurricane Katrina, http://www.rms.com/NewsPress/PR_090205_HUKatrina_insured_update.asp (Sept. 9, 2005)

[5] Flood insurance is provided as optional coverage through the National Flood Insurance Program. See http://www.floodsmart.gov/floodsmart/pages/options.jsp (last viewed on Sept. 19, 2005)

[6] Department of Homeland Security, Hurricane Katrina: What Government is Doing, http://www.dhs.gov/interweb/assetlibrary/katrina.htm (last viewed on Sept. 19, 2005)

[7] FEMA: A Guide to the Disaster Declaration Process and Federal Disaster Assistance, http://www.fema.gov/rrr/dec_guid.shtm#assist (last viewed on Sept. 19, 2005)

[8] Nadler, Conyers, Watt, Jackson Lee to Introduce Bill to Relieve Debt Burden on Katrina Survivors, http://www.house.gov/apps/list/press/ny08_nadler/DebtreliefKatrina090105.html (Sept. 1, 2005)

[9] Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 101, 119 Stat. 23, 32 (2005).

[10] Martin H. Bosworth, No Bankruptcy Relief for Katrina Victims, Consumer Affairs.Com, Sept. 15, 2005, available at http://www.consumeraffairs.com/news04/2005/katrina_bankruptcy03.html

[11] For the means test calculation, see Fed. R. Bankr. P. Form 22A (Chapter 7), available at http://www.uscourts.gov/rules/new_and_revised_official_forms.html (last viewed on Sept. 19, 2005)

[12] U.S. Census Bureau, Median Family Income by Size and State, http://www.census.gov/hhes/www/income/medincsizeandstate.html; US Census Bureau, Income, Earnings and Poverty from the 2004 American Community Survey, 5, available at http://www.census.gov/hhes/www/income/income.html (last viewed on Sept. 19, 2005)

[13] Interim Rules and Official Forms Implementing the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, available at http://www.uscourts.gov/rules/interim.html (last viewed on Sept. 19, 2005)

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