You’re going broke!

Despite the stigma, bankruptcy remains a vital tool for some whose finances spin out of control. So why do Congress and credit-card companies want you to believe you can no longer file for it?

Illustration By Nick Kubley

“You load sixteen tons, what do ya get? / Another day older and deeper in debt / Saint Peter don’t you call me ’cause I can’t go / I owe my soul to the company store.”
—“Sixteen Tons” by Merle Travis, 1946

There are few institutions in American history as pernicious as the company store. Such establishments were owned and operated by coal-mining firms and forced employees to buy goods at inflated prices, often by paying miners with “scrip” that could be redeemed only at the company store. An employee could literally wind up owing more money than he could ever possibly hope to earn working. I wasn’t born yet when Tennessee Ernie Ford turned “Sixteen Tons” into a nationwide hit in 1955, but the concept of owing more money than I could ever possibly pay back is one with which I’m entirely too familiar.

I am one of the record 1.7 million Americans who filed for bankruptcy last year. Like most of my cohorts, I put off the decision to file for as long as I could. Thanks to a divorce, a failed business venture and legal bills, I had accrued nearly $30,000 in debt, all of it on credit cards. I lost my job, but, living on rice and beans, I managed to never miss a payment. I just had too much pride to file for bankruptcy.

What finally pushed me over the edge was the well-publicized bankruptcy “reform” passed by Congress and signed into law by President Bush last April. Media reports suggested that once the new Bankruptcy Abuse Prevention and Consumer Protection Act legislation took effect on October 17, it would be nearly impossible to file for bankruptcy. So, like hundreds of thousands of my fellow debtors, I filed just before the October deadline. It turned out to be one of the best decisions I’ve ever made. The immense relief I felt after my debt was discharged outweighed all the misgivings I had before filing.

Nevertheless, the stigma of bankruptcy, combined with the mistaken notion that the new law prevents people from being able to file, will dissuade many in need of this vital financial tool. Some critics of the bankruptcy reform say we have returned, in essence, to the bad old days of the company store. Gary Fraley, one of Sacramento’s most experienced bankruptcy attorneys and a lifelong Republican, put it this way: “Nowadays, the company store is the credit card. The credit industry extends more credit than people can possibly pay. What they want are indentured servants. They’re eating up people. They’re eating up lives.”

Fear of financing
Fraley has been around long enough to remember the last major change in bankruptcy law, which occurred in 1978, when the Bankruptcy Act of 1896 was supplanted by the Bankruptcy Reform Act. The act established Chapter 7 and Chapter 13 bankruptcy protection. The former permits debtors to discharge most if not all of their debt. The latter prescribes a plan to pay some if not all of the debt back.

There’s no comparison between 1978’s change and last year’s, according to Fraley. “In 28 years, I’ve never seen the bankruptcy law changed so dramatically and so punitively for people who need help,” he said. The new law now attempts to force some debtors who formerly qualified for Chapter 7 into Chapter 13 instead, even if that means forgoing basic items such as, say, groceries.

At least today’s debtors are better off than their ancestors. In Roman times, the debtor and his family could be sold into slavery to pay off creditors. In cases where there was more than one creditor, the debtor’s body was severed into pieces and divided up. England chucked deadbeats into its notorious debtor prisons and executed more serious offenders well into the 18th century. In colonial America, creditors branded the offender’s palm with a T (for thief) or placed him in stocks, with his ear nailed to the pillory. The ear was cut off upon release to mark the debtor for life. Think about that the next time you earmark a book.

Today’s bankruptcy code is fairly benign by comparison—filing Chapter 7 is a heck of lot more civilized than having your ear lopped off—yet the fear debtors felt in earlier times has seeped into our DNA. Emotionally, the common denominator linking together the vast majority of people contemplating bankruptcy is sheer, unadulterated terror. For months, I huddled in my apartment, paralyzed, refusing to turn on the heat, saving every last penny in order to make my credit-card payments.

And I had it easy.

“I’ve had clients who have to choose between buying food and buying medicine,” explained James Keenan, another Sacramento bankruptcy attorney. One of his current clients is a 70-year-old woman on a fixed income with $4,000 in credit-card debt and a $3,000 life-insurance policy. “She was concerned that the life insurance for her burial cost would be chewed up by her credit-card debt.”

Keenan’s rule of thumb is that if a client owes a total debt of more than three to five times his or her monthly income, filing for bankruptcy is definitely worth considering. My debt-to-income ratio was more like 15-to-1 before I filed, and I am by no means unique. “I think most of the people I see would have benefited a lot more if they had come in months or even years earlier,” Keenan said. “Hope springs eternal. People try to make things work out.”

“Most people I see don’t want to do it,” agreed local bankruptcy attorney David Meegan. “That’s where a lot of the sponsors of the [new bankruptcy] bill were real coldhearted. Many of the people I see are mortified about the prospects of filing for bankruptcy. If there was a way to avoid it, they would.”

Chelsea Killion’s husband’s Army salary wouldn’t cover her single-mom debts. Bankruptcy gave her young family of four a fresh start.

Photo By Larry Dalton

“I don’t see people coming into my office laughing,” said attorney Scott CoBen. “Often, they’re crying and bawling their eyes out.”

Debt spiral
Watching your financial life spin out of control isn’t pleasant, as freelance photographer Karen Medder can attest. The divorced mother of four was holding her head above water until several clients neglected to pay her for assignments. The next thing she knew, she was behind on her mortgage, and the foreclosure vultures began circling for the kill. “It was horrendous, people knocking on the door and telling my daughters they were going to lose their house,” she said. “For anybody with pride, it will definitely humble you down.”

Fiercely independent, Medder filed for Chapter 13 bankruptcy without an attorney, or pro se, just days after the October deadline passed. The decision to go it alone would later come back to bite her because of changes in the new regulations.

“John,” one of CoBen’s clients, has found his brush with debt equally humbling. The Sacramento resident, who filed for Chapter 7 protection after the new law passed, requested anonymity because he’s not exactly keen about publicizing his indebtedness. He’s in his early 30s, a divorced father of one and recently remarried. Over the past 10 years, John has amassed nearly $150,000 in credit-card debt. The debts began mounting after he got divorced, when he began using credit cards to pay for attorney fees and the increased living expenses that come with setting up a separate household.

At first, he kept up with the payments. He didn’t worry when he began to fall behind. “I’ll work harder, take a second job,” he told himself. Then he got injured in an automobile accident, and “that option was no longer there.” Eventually, he was forced to go on disability full time. “Once I stopped having money come in, disability wasn’t even close to cutting it. It was real frustrating when I reached the point where I realized I couldn’t pay the debt. It was hard because I knew I was upside down—I was done—yet I had never missed a payment. It was extremely stressful.”

Attorney Keenan helped Chelsea Killion, 22, file for Chapter 7 before the new law took effect. Killion moved out of her parents’ Sacramento home with her newborn daughter at age 17. The single mother earned her GED and went to work at PetSmart, where she eventually became a supervisor making $9 an hour. “I was feeding my daughter and just barely making it on my own,” she remembered. Then her roommate moved out, and Killion had to use most of her earnings to cover the rent. “With my credit card, I bought food. I had a gas credit card and used that to buy gas. I couldn’t afford clothes, so I put them on another credit card.” She quickly found herself down $8,000 to the credit-card companies. Her car was repossessed, adding another $11,000 to her debt.

A year-and-a-half ago, Killion married Michael Runfola, 30, an Army corpsman. Soon afterward, she gave birth to a second daughter, and her husband shipped out to Iraq. “When your husband’s in the military, and you have two kids, and he doesn’t get paid very well, it’s impossible to pay off the debt,” said Killion, who was wary of bankruptcy’s stigma. “But my husband told me to get it done before the law changed because we weren’t sure what the change would bring. That was pretty much the final push.”

Go to the Federal Building in downtown Sacramento, where the U.S. Bankruptcy Court keeps records for California’s Eastern District, and you’ll find thousands of similar hard-luck stories. Bankruptcy filings are public record, and any citizen may peruse the files free of charge on three computers provided for that purpose. Each file depicts a unique financial disaster, naked and exposed to the public eye, the modern-day equivalent of the pillory. Filings since the October 17 deadline include: a man disabled from birth, living on a fixed income of $812 a month with $34,000 in credit-card debt; a firefighter running a second business with almost $500,000 in secured debt (debt for which collateral such as a home or a car exists) and another $122,000 in unsecured credit-card debt (“unsecured” because no collateral for the loan exists); and a defunct West Sacramento oak-furniture store with a net income of roughly $1 million and operating costs of $3 million, resulting in a “profit” of negative $2 million.

“I saw people from Hurricane Katrina who came out here,” said Fraley. “They had a good job. When the flood came in, it destroyed their house, their car, their job. It didn’t destroy their mortgage or their car payment.”

Almost every case is a horror story, but a notion persists that those who file for bankruptcy are losers out to shirk their obligations and cheat the system. “America is a nation of personal responsibility, where people are expected to meet their obligations,” President Bush declared before signing the new law. “If someone does not pay his or her debts, the rest of society ends up paying them.” While researching this story, I got into a heated discussion on the subject with a friend, who has opposed every decision George W. Bush has made except the new bankruptcy law, because he thinks people should be responsible for paying their debts. “What if something happens, and they can’t pay?” I implored. “What about people like me?!” was the implied question. His laser-beam eyes scorched a “T” into my forehead. People should pay their debts. Period.

“Companies such as United Airlines and Kmart see bankruptcy as a business call,” said Keenan. “I don’t see anyone putting a stigma on them for doing it.”

Yet, the stigma for ordinary people is encoded in the new legislation’s title, the Bankruptcy Abuse Prevention and Consumer Protection Act. How prevalent is such alleged abuse? One attorney who asked not to be named noted that under the old law, a few people would file repeatedly in order to stave off creditors, a practice that was legal but considered abusive when taken to the extreme. But all of the attorneys interviewed for this story agreed that such flagrant abuse is uncommon. This observation is supported by the credit industry itself, according to the U.S. Public Interest Research Group (PIRG), the national government-watchdog organization that protects the rights of consumers.

“Independent studies, such as those of Harvard Law School professor Elizabeth Warren, show that 90 percent or more of bankruptcies are still filed by people who get sick, get laid off or get divorced, not by abusers,” PIRG reported before the new act was passed. “The industry can only document that 3 percent of filers may be abusers, yet the bill would harm all debtors.”

As far as Fraley is concerned, there was nothing wrong with the old law. It’s the new code he takes exception to. “It’s been written by the credit industry for the credit industry,” he said. “It’s like they said, ‘This works, so we’re going to break it.’”

Attorney Gary Fraley likens the new bankruptcy law to designing a horse by committee. “That’s how you get a camel,” he said.

Photo By Larry Dalton

Breaking the law
For those convinced that government has grown fundamentally dysfunctional, the first effect of the new legislation designed to reduce the number of bankruptcies was predictable: The number of bankruptcies increased at an astonishing rate. Burlingame-based information-technology firm Lundquist Consulting reports that an all-time high of 2 million personal bankruptcies were filed across the country in 2005, a 32-percent increase. In the Sacramento region, debtors stampeded the Eastern District Court, filing 60 percent more cases than in the previous year. According to court records, Chapter 7 and 13 filings increased from 13,000 in 2004 to 21,000 in 2005.

The brunt of the increase came just days before the new code became law in October. “In the two to three weeks prior to October 17, we received about 40 percent of our annual caseload,” Eastern District Court Judge Michael McManus explained. Many of those cases are still working their way through the system. Normally, McManus deals with 60 to 70 cases per week; in the stampede’s aftermath, he’s handling up to 100 cases per week.

The rush was caused by the near universal perception that the new law would make filing for bankruptcy virtually impossible. Such is not the case, but some attorneys note that the myth plays right into the hands of the bankruptcy act’s major sponsors, the credit-card companies. “I think it was deliberate,” said attorney David Meegan. “There are a fair number of people out there who think you can’t file.”

“The credit-card companies have scared them all into thinking they can’t file bankruptcy,” agreed Peter Macaluso, another Sacramento bankruptcy attorney. “Well, yeah, you can.”

With earnings of more than $30 billion annually, the credit-card industry is the most profitable one in the United States. Charging interest rates as high as 30 percent and late fees as much as $39, the industry literally rakes in cash. Apparently, it’s not raking in enough. Since 1990, the industry has spent more than $150 million lobbying elected officials to change the bankruptcy laws, doling out roughly twice as much money to Republicans as Democrats, the Center for Responsive Politics reports. According to PIRG, Bank of America-owned MBNA, the nation’s largest credit-card company, was also President Bush’s largest corporate campaign donor in 2000. The company donated $1.5 million to Republicans and Democrats in 2004. Fraley likens the industry’s largesse to the Jack Abramoff scandal. “We have the best Congress and president money can buy,” he lamented.

However, Laura Fisher, spokeswoman for the American Bankers Association, the country’s largest banking trade association, refutes the notion that the credit industry bought and paid for the new legislation. “The financial-services industry in general has many issues before Congress,” Fisher said. “You can’t say that they contributed this money just to pass the bankruptcy bill.”

“There was a lot of politics involved,” Keenan commented. “The credit-card industry has traditionally rattled its saber about the acceptance of bankruptcy. A lot of this had to do with Bush needing to show he had accomplished something. Bush is not exactly the friend of the little guy, and bankruptcy is.”

The new law almost exclusively targets poor and middle-class consumers. Chapter 11 bankruptcy, which large corporations normally file for protection, was barely touched. Amendments designed to protect the most vulnerable debtors and regulate predatory lending practices were gutted. For the average citizen, Fraley said, “Congress wanted a minefield, and they designed it well.”

Watch your step
One of the first mines debtors must avoid concerns the requirement to complete an approved credit-counseling course before filing for Chapter 7 or 13 bankruptcy. This rule is especially troublesome for those who file without an attorney, since there’s no credit-counseling form in the extensive paperwork that must be submitted to the court. The certificate of completion is issued by the credit counselor—the course can be conducted over the phone in 15 minutes—but if you don’t know that and file without it, your case will be dismissed.

That’s what happened to Karen Medder when she filed for Chapter 13 bankruptcy protection shortly after the new law took effect. Like many people who file Chapter 13, she hoped to buy enough time to catch up on her payments and save her house. “I had no intention of stiffing anybody,” she said. But because she was unaware of the credit-counseling requirement, her case was automatically dismissed. That’s when she realized she might be in real trouble. “I thought, ‘It looks like I’m going to lose my house after all,’” she said.

Medder was more right than she knew. Another new rule concerns the automatic stay that prevents creditors from attempting to collect debt for the duration of the case, which can last for months. Now, when a case is dismissed the first time and then refiled, the stay is reduced to 30 days, after which creditors are permitted to collect debts. In Medder’s case, those circling foreclosure vultures would be free to pick at her corpse.

“When the automatic stay is in place, creditors can’t sue, garnish wages, levy, foreclose or even call debtors on the phone,” bankruptcy attorney Roman Rector clarified. “Now, when you file a new case, because you had a case before, that invisible shield is gone after 30 days.” Fortunately for Medder, she encountered Rector while she was at court and later hired an attorney from his firm to refile her case and negotiate for a lengthened stay.

There are other pitfalls that come with filing without an attorney. The new regulations require far more detailed financial information, including pay stubs, tax returns and utility bills from the previous six months. Again, failure to meet the requirement can lead to automatic dismissal. Individuals are well-advised to hire a lawyer the first time around, and therein lies another rub: Because it takes more time to file a case, attorneys have raised fees, yet not being able to afford attorney fees is the main reason most people file pro se. I scouted in vain for an attorney I could afford and was forced to go it alone—and that was before the law changed.

Adding to the expense are increased court-filing fees. The fee for filing Chapter 7, for example, increased from $209 to $254 last October. To add insult to injury, the Republican-dominated Congress buried fee increases for Chapter 7, 11 and 13 bankruptcies in its most recent budget. The fee for Chapter 7 now approaches $300. The increase, if passed, would raise an additional $553 million to help cover Bush’s tax cuts, and Fraley, the lifelong Republican, is indignant.

Bankruptcy attorney Scott CoBen says people come into his office “crying and moaning, but at the end of the day, they’re pretty darned happy.”

Photo By Larry Dalton

“Let’s go to the poorest segment of the population and make it harder for them,” he fumed. “Let’s not go to people who can afford it and tax them.”

For some, the most worrisome tenet of the new code is its core facet, the means test. “I call it the ‘mean test’ because it’s intended to hurt people,” Fraley said. “It’s intended to keep people from being able to file, and it’s doing its job.”

The means test requires debtors who earn more than the state’s median income to fill out income and expense worksheets similar to the Internal Revenue Service’s alternative-minimum-tax form. If they fail the test, they must then file Chapter 13, which establishes a court-supervised five-year plan to pay back some or all of the debt.

It sounds fair enough, but the problem is that the majority of Chapter 13 cases, approximately 75 percent, end in failure. Most people in dire financial straits find it difficult to make payments for the entire five-year period. Fraley predicts Chapter 13 failure rates may reach as high as 95 percent.

The Republican and Democratic supporters of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 were aware of this shortcoming in the bill but voted for it anyway. They’ve never had much of a problem with the company store. Heck, they practically own it.

Till debt do us part
There’s been a lull in bankruptcy filings in the wake of the October crunch, but the new law soon may be put to the test. Americans currently share a combined $2 trillion in consumer debt, and credit-card users have just been hit with a double whammy: a new regulation requiring creditors to double their minimum payments has gone into effect just as the Christmas bills are coming in. The latest debt instrument of choice, home refinancing, accounted for an additional $400 billion in 2004 alone, and now foreclosures are on the rise. The federal government has its own $8 trillion debt to deal with. Interest rates are going up, the trade deficit is growing, and the dollar’s value is shaky. A perfect storm is brewing. Things could get ugly quick.

Despite the gloomy weather, most of the attorneys I talked to had sunny dispositions. Partly, it comes with the territory. The lives of most of their clients are in complete disarray when they first come in. Helping put those lives back together can be a gratifying experience.

“There’s nothing like talking to someone whose house is going down the drain over a few hundred dollars,” Keenan said. “The holy grail of bankruptcy law is saving someone’s home. I’ve had plenty of clients who’ve given me hugs because they’re so relieved.”

Mainly, though, most of the attorneys I talked to, with the notable exception of Fraley, are skeptical that the new law is going to change much at all. One thing helping Californians as far as the means test is concerned is the state’s relatively high median income levels: $43,436 for an individual, $55,320 for a two-person household and $61,655 for a family of three. “The vast majority of cases that are filed are going to pass the means test,” insisted David Meegan. “My personal opinion is it was blown out of proportion what this [new law] would do.”

Early returns from credit counselors seem to be bearing this out. A score of nonprofit national agencies have been approved by the U.S. Bankruptcy Court to provide services to debtors, including those who file in Sacramento. According to a recent story in The Washington Post, “the overwhelming majority of debtors seen by credit counseling agencies are filing for bankruptcy instead of using repayment plans envisioned by the law’s supporters.” Out of 14,907 people seen at one agency, only 42 signed up for a debt-management plan—or .3 percent. “Typically, consumers are too far gone when they get to us,” the head of the counseling service told the Post.

“The credit-card companies spent millions to force Chapter 7s into Chapter 13s,” Scott CoBen said. “I don’t think they’re going to get their money’s worth. Frankly, they might be better off if people got their discharge [where debt is wiped out] and started getting new credit cards.”

That’s the route CoBen’s client “John” is on as he awaits approval to have his $150,000 debt expunged. I caught up with him the day after he’d thrown a birthday party for his 13-year-old daughter. “It’s kind of nice to file the bankruptcy,” he said. “Now I can start moving forward without worrying about paying my bills. It’s nice to know I can start establishing my credit again. Credit is an important thing; it really helps you get to where you want to go in life.”

Karen Medder avoided going bankrupt but had to sell her home. Filing Chapter 13 gave her enough time to sell her house in a chilly real-estate market. She used some of the equity to pay off other debt and banked the rest. I reached her in Hawaii, where the freelance photographer was following her passion, shooting professional football players at the NFL Pro Bowl. Filing bankruptcy gave her back a sense of control over her life. “After it was filed, I could sleep at night,” she said. “No one could come and take my house.”

“I felt like a huge weight had been lifted off my shoulders,” said Chelsea Killion, whose husband is back in the States after his tour in Iraq. Their daughter is 7 months old, and Killion can now afford to stay home and care for her. Bankruptcy has set her and her young family free. “It was something that needed to be done, and it finally got fixed,” she said.

I know the feeling well. Among the dozen debtors gathered with me in court last September, I was the only one acting as his own attorney. With icy stares, the trustees froze those who came before me, debating the lawyers and disputing their clients’ listed assets. As I stepped up to the bench, I expected the worst. It was over in less than 30 seconds. “Everything appears to be in order,” one of the trustees said. That was it. I walked out of the building, jumped into the air and clicked my heels together. The official notice that my $30,000 debt had been wiped clean arrived in the mail on Christmas Eve. It’s the best present I’ve ever received. No more shopping at the company store for me.

I’d like to say I chose to file for bankruptcy, but that’s not really the truth. Bankruptcy chose me. It’s what people do when there are no options left, and as much as Gary Fraley detests the new law, he still believes bankruptcy remains a viable option for the vast majority of people who file, at least for the time being.

“I came real close to packing up and shutting down my practice,” he said. “I finally decided I wasn’t going to let Congress chase me off.”