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Bankruptcy filings went up by 23.6 percent in May compared to the same period of time in 2022. The Department of Justice officially estimates that filings could double from pre-pandemic lows before the end of the calendar year 2025. 

The rapid rise in bankruptcy filings occurred under all chapters – including chapter 7 liquidation, chapter 13 consumer repayment plans, and chapter 11 business and financial reorganizations. Chapter 11s exploded last month by 113 percent. Chapter 13s continued to experience the biggest increase in consumer filings by climbing more than a quarter (26 percent) over May 2022. Chapter 7s filings, which continued to drop until the middle of last year, went up last month by a robust 20.2 percent.  

 

A Closer Look by Bankruptcy Chapter     

With major problems in the retail sector and higher interest rates that limit options for businesses, chapter 11 cases more than doubled. Of course, some of that increase is due to related case filings, but even stripping that away, companies facing financial challenges are turning in significantly higher numbers to chapter 11.         

Importantly, small businesses show continued signs of distress. For example, small businesses, which generally file under subchapter V, went up by two-thirds (67 percent) over last May.            

It is somewhat remarkable that chapter 13 cases keep climbing even ahead of the traditionally more popular chapter 7 filings. These wage-earner repayment cases, filed most often to retain houses and cars, are particularly sensitive to interest rates because refinance alternatives to bankruptcy are not as viable any more. Interestingly, the stronger-than-expected jobs market may continue to make chapter 13 filings rise higher than chapter 7 because more wage-earners will have regular income to fund a repayment plan.         

The largest number of cases continue to be filed under chapter 7, but the number of such filings was substantially depressed due to COVID-relief assistance which has now run out. With more than a 20 percent monthly increase over the previous year, chapter 7s continue their climb back to pre-pandemic levels.           

Although there may be seasonal slow-downs in raw numbers of filings month-to-month, we should continue to focus on the difference from the same month in the previous year. By that measure, it is easy to predict that overall year-end filings will be substantially higher than in 2022. Even with an expected pause in interest rate hikes by the Federal Reserve, new credit is scarcer than it was a year ago and it is harder to repay existing debts taken out at high interest rates.      

Department of Justice Projects Major Bankruptcy Filing Increase

Over the past many months, AIS commentaries have emphasized the likelihood of substantial increases in bankruptcy filings. This view has set us apart from many other commentators who expressed more tentative views. For those who think that AIS may have exaggerated its prognostications, read below. We have not been nearly as bold as the Department of Justice (DOJ)!         

In its "FY 2024 Performance Budget Congressional Submission,” DOJ’s U.S. Trustee Program (USTP) provided bankruptcy filing projections to support President Biden’s appropriations request for next year.1          

The USTP’ submission to Congress estimates that bankruptcy filings will experience a 75 percent increase between 2022 and 2024 and then continue higher until they reach pre-pandemic levels – which is double last year’s filing number.          

The USTP makes the only official Executive Branch projection of bankruptcy filings each year. It does so as part of federal budgeting requirements, which require estimates of workload and revenues from case filings and quarterly chapter 11 fees. The USTP does not perform economic modeling, but traditionally bases its estimates on slope lines reflecting recent trends. The USTP concludes that "modeling filings on a gradual increase to [pre-pandemic] levels, filings could double in the next three years.”  (DOJ/USTP FY 2024 Performance Budget, p. 18.)           

If DOJ is right, then the rollercoaster will continue to steeply climb until it reaches about 800,000 filings. 

The Broader Economic Context

As aggressive as the DOJ/USTP estimates appear to be, they are supported by most economic data. Here is a round-up of some of the more salient economic news during May:         

• As widely reported, the escalating number of "Big Box” and other corporate bankruptcies continues as national retail businesses increasingly seek relief. Even beyond retailers, the financial press widely covered an S&P Global report calculating that, in the first four months of this year, the number of large bankruptcy cases reached its highest level since 2010.
• Also much ballyhooed in the financial press, the Federal Reserve reported that banks continue to tighten loan standards and expect to ratchet up requirements even more. Among other reasons, regional banks are tightening due to concerns about capital requirements which are unlikely to ease anytime soon.
• The Wall Street Journal (5/16/23) focused on another Fed Report showing that, in the first quarter of the year, debt balances that were 90 days or more delinquent jumped by 50 percent from the previous year. The WSJ further noted that things could get worse because payment of $1.7 trillion in outstanding student loan debt has been largely frozen, but may not remain frozen for much longer.
• On May 15th, The Hill, a Washington, D.C. insiders’ daily paper, published a deep dive analysis of Fed numbers and highlighted that first quarter consumer debt beat all records at about $17 trillion. 

Conclusion

Lenders with national loan portfolios should expect a growing number of account delinquencies. The number of bankruptcy filings has been artificially low for more than two years and may now be doubling until filings reach sustainable pre-pandemic levels. This increase may strain lender resources because bankruptcy loan administration is often manual and more expensive. As the bankruptcy rollercoaster ride continues, we are on a steep climb, with perhaps a few drops along the way, before we reach an apex where we may stay for a while.

1 Fiscal Year (FY) budgeting reflects data from October 1 to September 30.  For example, FY 2024 will start on October 1, 2023, and end on September 30, 2024. USTP estimates also exclude the six judicial districts is North Carolina and Alabama which are not part of the USTP.  

 

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

AIS President, Tom Clark, unpacks the transformative role of managed services in banking automation.

Drawing from your extensive background as a bank CIO and InfoSec Executive, can you share your insights on working with managed service providers (MSPs) and their role in banking operations?

Over the past 25 years, I have collaborated with MSPs in various capacities within the financial services industry. These providers offer invaluable scalability and specialized expertise that may be difficult or costly to obtain.

For smaller and mid-sized companies, managed service providers bring scalability and specialized knowledge that may otherwise be unaffordable or impractical. For larger organizations, MSPs can efficiently handle non-core activities at a lower cost, allowing internal resources to focus on customer-facing differentiators.

I have witnessed firsthand the immense value MSPs contribute to supporting back-office functions, optimizing IT infrastructure, bolstering cybersecurity, and simplifying regulatory compliance. For instance, MSPs can provide flexible staffing and surge capabilities in tasks supporting residential mortgage fulfillment. Since volumes are highly dependent on interest rates, a sudden increase in volumes may exceed a provider's capacity to staff fulfillment positions. In such situations, an experienced MSP with robust process controls can create instant capacity to manage the surge.

Currently, as part of the AIS team, I work closely with our experts to develop and implement managed services and RPA solutions for banks, helping them enhance operational efficiency, reduce costs, and focus on their core objectives.

How do AIS's "Managed Services" differ from traditional outsourcing?

AIS's managed services deviate from traditional outsourcing by fostering long-term partnerships centered around continuous improvement and alignment with client goals. 

We act as an extension of our clients' teams, collaborating closely to achieve shared objectives and boost efficiency. This collaborative approach sets our managed services apart from conventional outsourcing, enabling us to deliver customized, strategic solutions that drive success for our clients.

What advantages can banks gain from outsourcing processes to an MSP before implementing RPA solutions?

While there are many benefits of outsourcing to a managed service provider, efficiency and cost savings seem to be the most significant advantages. By outsourcing processes to a managed service provider initially, you can immediately cut costs in half.  In our many years of experience, we have often found that client processes are not well documented or sufficiently mature for immediate automation. Starting with managed services enables our associates to become familiar with the process, document it and establish tighter process controls. 

This allows us to work with our process engineers to optimize it and create a more efficient, better process from the start. As we assess the improved process, we can then determine if automation through RPA is a suitable fit. This entire process takes place with minimal intervention from the client. If the process isn't a good fit for automation, we can continue using our skilled personnel to maintain cost-effective operations, ensuring that your business remains competitive and efficient. 

Which back-office functions are the best candidates for transitioning to an MSP, and what is the typical timeline for enhancing these functions with RPA?

Ideal candidates for transitioning to an MSP include highly repetitive, rule-based, manual back-office functions prone to human error. Financial Spreading, Positive Pay, and Deposit Document Indexing are just a few examples.

Depending upon client environment testing and customizations, bot deployment could take between 3 to 6 months.

What advice would you give to a bank evaluating different providers?

When selecting a provider, banks should:

• Assess the provider's domain expertise and industry experience.
• Examine the provider's track record offering a blend of managed services with RPA implementation and process optimization.
• Evaluate the provider's technology stack and its compatibility with the bank's existing infrastructure.
• Ensure the provider prioritizes security and compliance to mitigate potential risks.
• Seek providers that offer flexible engagement models and can scale with the bank's evolving needs.
• Consider the provider's ability to collaborate and communicate effectively with the bank's internal teams.

 

Total bankruptcy filings in April rose by 9.3 percent compared to the same month last year. This is the ninth consecutive month of overall filing increases. The rate of increase was less than last month’s increase, but March often reflects the response to the shock of holiday bills. Total filings for the first four months of 2023 are up by 15.7 percent over last year. This data analysis reinforces  that the American bankruptcy system had better prepare for a sustained period of significant filing increases.

 

Breakdown of Data by Major Chapter
The number of monthly chapter 7 liquidation cases rose by 4.9 percent over April 2022. Although this increase is down from the 12.1 percent increase last month, it reflects a significant and continuing rebound from the historic COVID-era decreases.  

Chapter 13 cases filed in April rose by another 15.1 percent compared to last year, which is remarkable given the extraordinary growth we already have seen. Moreover, the most recent talk in trustee and consumer attorney circles is that previous home value increases have provided debtors with substantial home equity, even in spite of the recent cooling of home sales. Add to that mortgage interest rates that are unaffordable and less available, and chapter 13 makes even more economic sense for homeowners.

Chapter 11s went up by a very strong 58.2 percent over last April, albeit led by the multiple filings made by Bed, Bath & Beyond. The stress on corporations is increasingly apparent. This is even more so with Subchapter V small business filings, which rose by a stratospheric 85.9 percent compared to last year. The strain of high interest rates and restrictive lending may be showing most conspicuously in the small business numbers.  

 

 

Round-Up of Some Significant Economic Data Points

Beyond the now obvious reasons for the rise in consumer filings (namely, the government exploded all past records of government cash and other assistance during COVID), other economic reports in April continue to flash warning signs about what is on the horizon. These signs are ominous regardless of whether the national economy falls into an officially declared recession. Here are a few signs worth noting:

• The banking sector remains in flux and there are indications of a retrenchment in lending, especially by smaller regional and community banks. Moody’s even "downgraded its outlook for the entire U.S. banking sector to negative from stable . . . .”  (Source: Michael Eisenband, FTI, Consulting, Inc., in Law 360, 4/18/23.)  
• Even with easing inflation – which is still more than double the Federal Reserve’s two percent target rate – average real weekly earnings for non-supervisory employees have dropped by 3.6 percent over the past two years. (Source: WSJ, 4/7/23.)
• The Fed just hiked interest rates by another quarter point, so the target rate may reach 5.25 percent. That will adversely affect all borrowers, both corporations and consumers alike. Even if the Fed can avoid future rate increases, the economic effect of past hikes may be long-lived and rates not reduced until inflation is better tamed.
• Corporate defaults may be about to rise significantly. According to Bloomberg, "[r]ratings firms are on track to cut the most US corporate bonds to junk since the early part of the pandemic, further boosting the funding costs for some companies just as economic growth in slowing.”  (Source: Olivia Raimonde, Bloomberg, 4/9/23.)  Add to that a recent piece by Emeritus Professor Edward I. Altman of the NYU Stern School of Business in which he concluded that the corporate credit picture might be about to worsen, with "risky debt default rates rising to perhaps 10%, or more, over one or two years.”  (Source: Creditor Corner, 4/12/23). 

The News Is Not Better for Consumer Credit

Macroeconomic and corporate bond trends do not always follow a straight line with bankruptcy filings, but a drill down on consumer credit news also yields major red flags. Although the quality of credit portfolios varies markedly among lenders, evidence of previously reported expansions of consumer credit continues to lead to more negative reports on consumer debtor defaults.

A Businessweek headline sums up some of the recent news:  "The Repo Man Returns as More Americans Fall Behind on Car Payments.”   Fitch ratings show more than a doubling of subprime auto borrowers who were 60 days or more delinquent in making payments compared to the May 2021 pandemic low. That is higher than the delinquency rate at the height of the Great Recession. (Source: Clare Ballentine, Businessweek, 4/19/23.) 

Added to all this are anecdotal reports that bankruptcy practices are receiving more regulatory scrutiny. That is exactly what happened when filings rose during the Great Recession. One difference is that there is another cop on the block this time. The CFPB now has supervisory powers over banking institutions that it has no hesitation in using. CFPB views its scope as encompassing violations of both bankruptcy and consumer protection laws.  

Another cautionary note: debtor counsel can also expect to be more aggressive. A recent unpublished decision illustrates the point. In Orlansky v. Quicken Loans, BAP No. NV-22-1181 (filed April 14, 2023), a debtor challenged the monthly mortgage statement sent to debtors for incorrectly placing its notice of pre-petition fees. The Bankruptcy Appellate Panel reversed a bankruptcy court decision and found a violation of the automatic stay. In that case, the court expects damages to be "relatively minimal.”  (Kudos to Bill Rochelle of the American Bankruptcy Institute for flagging the case in his daily report posting on the ABI website.)

Conclusion

Here’s a wrap-up for April:  Bankruptcy filings are climbing higher than most analysts expected. General economic news is ominous, including for consumer lending. As expected, regulators are perched and ready to pounce. So, auto and mortgage lenders beware.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

With the number of bankruptcy filings now in for the first calendar quarter of 2023, we know that the rapid rise in the number of individuals and companies seeking bankruptcy relief continues unabated. From January through March of this year, 18.1 percent more bankruptcy petitions were filed compared to the same period in 2022. In March alone, overall filings increased by 17.5 percent. This is the eighth consecutive month of year-over-year filing increases. And there may be no looking back.   

Bankruptcy Filings Under All Major Chapters 
Total bankruptcy filings reached 42,552 in March. The growth in chapter 13 filings made up the majority the increase.  Here is a breakdown by chapter: After plummeting due to the pandemic, chapter 7s began to rise last year, and now the pace of increases persists in the double digits. In March, chapter 7 filings jumped by 12.1 percent, likely validating predictions last year that the end of COVID-era cash assistance would lead to more bankruptcy filings.                   

The significant increases in chapter 13 filings continue unabated. In March, chapter 13 filings rose by 25.9 percent compared to last year. The size of the increases is surprising given the torrid pace at which chapter 13 rose throughout most of 2022 and into the current year.           

Chapter 11 filings steeply climbed by more than 70 percent in March. The increase was somewhat inflated by one week, during which two debtors with many affiliates filed.1 But even considering those misleading numbers, chapter 11s are still on a steep skyward trajectory. Perhaps unexpectedly, small business Subchapter V cases remained steady but did not increase over last March’s number. Overall, chapter 11 filing numbers suggest that businesses are facing some significant headwinds and require a bankruptcy breathing spell to have chance to reorganize their debts and return to profitability.

The bar chart below shows the first quarter growth in overall filings.

 

The table below provides the chapter-by-chapter breakdown.  

 

 

* Total bankruptcies include chapters 9, 12 and 15

Turbulence in the Banking Sector
On March 22nd, AIS posted a quick review of some consequences of, and questions posed by, the spectacular failures of Silicon Valley Bank and Signature Bank. During the intervening weeks, one major question was answered: the Federal Reserve decided to continue to increase interest rates. With warning signs of further financial turbulence, including a possible slow-down in lending as banks shore up their balance sheets and take other measures to avoid a run on deposits or regulatory action, consumers and businesses may have fewer ways to stay afloat and avoid bankruptcy.   

Added to these negative economic signs, credit card and automobile loan delinquencies are way up, the commercial real estate market is nearing crisis, and American home values are past their peak. Easing inflation is a good sign, but prices are still rising at more than the Federal Reserve’s long-stated target of two percent.   

While there remains hope of a soft landing and avoiding recession, the economy is in transition from the unsustainable growth of government spending and other emergency government action taken during the pandemic.   

Conclusion

The upward trajectory in bankruptcy filings continues and shows no signs of reversal in the immediate future. Banks and other lenders are addressing increasing default risk in some portfolios. It is time to declare the pandemic era of free money over for both consumers and businesses. The bankruptcy system is designed to provide a lifeline for debtors and an efficient means for repayment for creditors.  We may need it now more than at any time in recent memory.

 

1 As noted in previous bulletins, chapter 11 filing are subject to wilder fluctuations than other chapters, including because of the impact of affiliate filings.  This was true even during the halcyon days of corporate filings when large businesses and retailers drove chapter filings to 7500 cases and more each year (e.g., Footstar, Inc.).

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

With the failure of Silicon Valley Bank (SVB) and Signature Bank, many in the bankruptcy community ask what – if any – impact there will be on bankruptcy filings and the bankruptcy system. Following is a snapshot of some of the issues and impacts being discussed:

If bank regulations tighten, will filings go up or down?

That may depend on the extent of any regulatory crackdown. Right now, with the federal government back-stopping any losses to depositors, it would appear that the crisis is contained. But if the regulatory reaction leads banks to reduce lending, businesses could be on a rough ride, and chapter 11 filings may rise. In turn, that could lead to job losses and other adverse economic effects that may also push some consumer debtors over the edge into bankruptcy. 

According to a story in the Wall Street Journal, "Main Street businesses and American families are likely to find it harder to get a loan because of turmoil in the banking industry, denting economic growth and raising the risk of recession.”  The paper goes on to cite data showing that smaller and medium-sized banks, which are facing the greatest scrutiny right now, are more likely to retrench. Banks smaller than the top 25 banks make about 38 percent of all outstanding loans and a whopping 67 percent of commercial real estate loans. As smaller and medium-sized banks are most vulnerable to a regulatory crackdown, the current bank climate may lead to accelerated bankruptcy filings over time. 

What happens to bankruptcy filing rates if the Federal Reserve stops raising interest rates?

If the Fed responds to the current banking problems with a pause or reversal of interest rate hikes, then the rate of increase in the number of bankruptcy filings may move lower. If the federal government also permanently expands the $250,000 deposit insurance limits and takes steps to encourage banks to make business and consumer loans, then the rapid pace of bankruptcy filings may further slow in the near-term.

It is still hard to see how the overall number of filings could dramatically reverse the current upward trend. In fact, it seems that only a reversal in the Fed’s interest rate policy can prevent an even bigger increase in bankruptcy filings than we have been seeing. I guess we should wait for a few more Fed meetings and commentaries by economic experts before changing expectations for many more bankruptcies in 2023.        

Are bankruptcy estate funds protected?

Short answer – the law unambiguously requires it. The longer answer – it’s more complicated than that.

Payments to creditors depend upon the safety of cash deposits and investments from bankruptcy estates. Each year, up to $10 billion are disbursed by chapter 7 and 13 trustees. Chapter 11 estates disburse additional huge sums in conducting business while in bankruptcy and paying creditors under confirmed reorganization plans. That is why Congress enacted section 345 of the Bankruptcy Code, which provides that bankruptcy estates must make deposits and investments that "will yield the maximum reasonable net return on such money, taking into account the safety of such deposit or investment.” The law requires that financial institutions holding estate funds protect all amounts that exceed federal insurance limits by posting collateral or bonds.

The Justice Department’s United States Trustee Program (USTP) polices compliance with section 345 by limiting bankruptcy estates to authorized depositories that agree to USTP monitoring for compliance. This works very well in cases controlled by USTP-appointed private trustees. However, things get a bit dicier in chapter 11 cases in which management stays in control of the debtor company. Although the USTP is strict in its application of section 345, the law allows courts to make exceptions. This came to a head in the BlockFi crypto-currency case, which had not protected its money as directed by the USTP. Fortunately, no money was lost in BlockFi or other cases.

The current banking problems should serve as a significant caution to businesses, and their lawyers, that failure to adhere to section 345 protections may carry huge consequences.   

Why haven’t Silicon Valley Bank and Signature Bank filed for bankruptcy?

Banks are not eligible to file for bankruptcy. When banks become insolvent, they are liquidated through bridge banks and overseen by a banking regulator to protect depositors instead of creditors. Banks are often owned by holding companies, however, that do file for bankruptcy. The holding company for Silicon Valley Bank recently filed a chapter 11 bankruptcy petition.     

It will be interesting to see if an independent bankruptcy examiner will be appointed to investigate SVB – apart from other reported criminal and civil investigations. The purpose of the bankruptcy investigation would be to issue a public report into the causes of the collapse and possible stakeholder causes of action. During the Great Recession, Washington Mutual (the largest bank collapse in American history) and other lenders were subject to such independent bankruptcy examinations. Given the deference paid by bankruptcy judges to management and law firms representing large chapter 11 debtors, however, I would not hold my breath.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

  

February 2023 bankruptcy filings rose by a hefty 18.2 percent compared to the same month last year. This uptick matched the January percentage increase. After falling during the first part of 2022, filings began to climb, slowing beginning last summer. The rapid acceleration experienced over the previous two months is the greatest since the Great Recession in 2009. If this trend continues, about 70,000 more cases will be filed this year than in 2022.  

Filings Rose Across the Board

With total February filings of 32,032, all major chapters of the Bankruptcy Code saw a significant rise compared to last February. As has been the case for the past year, chapter 13s led the way with a huge increase of 29.3 percent. Chapter 7s, which have consistently lagged behind other chapters since the pandemic, are also in an upward tilt mode with a strong rise of 10 percent. Chapter 11 cases skyrocketed by 77.2 percent last month as they stay on a steep upward path. Small business subchapter V cases registered a solid gain of 23.9 percent.

Of course, there may be many blips ahead. But the strong filing rates in February continue a strong upward trajectory that may not stop very soon. 

Possible Reasons for the Rapid Increases

The current rocketing numbers may be fueled by the same economic conditions described in previous AIS reports, except now the fuller effects of adverse economic conditions are being felt in fuller force. The economic picture is mixed, but the positive data, such as lower unemployment rates, have not offset the hardships caused by the negative economic factors.

Historically, bankruptcy filings are influenced by macroeconomic conditions and more specific factors so that, during some periods, increased numbers of consumer and business debtors have needed bankruptcy relief during prosperous times. That makes sense because good times usually involve relaxed credit and more opportunities to make risky bets or take on too much debt.

In February, the Federal Reserve published data showing that revolving debt reached nearly $1.2 trillion in 2022, surpassing pre-pandemic debt levels. That is often a sure sign of economic travails to come for those in shakier economic circumstances.

A prominent chapter 13 trustee recently suggested that wage-earner repayment plans may continue to rise because of high home mortgage interest rates. In the past, some consumers who owned homes would walk away from their mortgages with confidence that they could buy another home in a couple of years when they could better afford it. Today, overburdened homeowners know they are likely to confront higher mortgage interests rates in the future and choose instead to make chapter 13 plan payments and keep the current family home.

The evidence continues to mount that consumers have lost their cash cushion from pandemic-era government assistance. The Wall Street Journal recently reported an estimate by Goldman Sachs that, by the end of the year, consumers will have spent down 65 percent of the cash they had built up during the pandemic. Other cited data showed that the problem is even more acute for lower-income Americans. As we know, those are the debtors who may be the first to be pushed over the bankruptcy cliff.  

The prime rate now stands at 7.75 percent, which reflects an almost 140 percent rise from a year ago. That affects consumers and businesses across the board.

Perhaps the best summation of the national economic news was provided by the Director of Congressional Budget Office (CBO), who said: 

"For 2023, we project stagnant output, rising unemployment, gradually slowing inflation, and interest rates that remain at or above their current levels at the beginning of the year – before the economy subsequently rebounds.” 

The impact on consumers is detailed in a report by Ares, an alternative credit manager and lender (source: the Creditor Rights Coalition’s weekly Creditor Corner), which summarized the situation this way: "[S]avings are depleted and households increasingly turn to debt to finance their continue spending . . . . [W]e are seeing a rapid transition from increasing savings to increasing indebtedness at the microeconomic, household level.”  Ares goes on to describe increased withdrawals in pension funds and "massive losses with residential mortgages” suffered by banks.

CBO also paints a gloomy picture on government debt levels, but we will leave the implications to economists, rather than bankruptcy watchers.

Conclusion

For now, all we can do is monitor next month’s bankruptcy filing numbers and see how lenders begin to cope with bankruptcy filing increases not seen in recent memory.   

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

For many years, consumer bankruptcy has been beset by controversies and misconceptions. Some stakeholder groups continue to wage war against the Bankruptcy Abuse Prevention and Consumer Protect Act of 2005 (BAPCPA) which changed consumer practice in fundamental ways. Perhaps the debate could be a bit more constructive and less vitriolic if there was a common understanding of basic facts. This is the first in an occasional series of short analyses AIS will post on some of the controversies that have received the most attention. We will start with the Means Test, which is probably the hottest of the hot-button issues in the consumer bankruptcy world.    

Means Test by the Numbers         

The cornerstone of the 2005 consumer bankruptcy amendments was the Means Test, that was designed to limit bankruptcy relief to debtors with modest or no disposable income after deducting for allowable expenses set by the Internal Revenue Service. The Means Test applies to individual chapter 7 debtors with primarily consumer debt. It also applies to chapter 13 wage-earners in calculating the amount of income that must be devoted to a repayment plan.            The major criticism of the Means Test is that the numerical expense limitations would disqualify many needy debtors. Guess, what? It didn’t happen. So now the debate has shifted to whether the extra financial information required under the Means Test and other provisions of the law have added unnecessary costs to filing.         

Let’s look at the facts (using round numbers that hold true year after year):  only about 10 percent of all chapter 7 (liquidation) debtors earn more than their state’s median income. The rest are exempt from the Means Test. Of those debtors with above-median income, less than 10 percent have excess disposal income that exceeds the statutory maximum of about $250 per month. That shows that the overwhelming majority of debtors who seek to wipe out their debts are truly in financial crisis and not simply taking advantage of their creditors. Not only that, but the U.S. Trustee Program (USTP) has found that more than 60 percent of all chapter 7 cases with excess income are not abusive because of recent job loss or ongoing medical expenses for which the Means Test formula cannot take into account. Congress gave the USTP the discretion not to file motions to dismiss in cases of debtors with exceptional circumstances, and it prudently exercises that discretion. The bottom line is that less than one percent of chapter 7 filers are dismissed because they "fail” the Means Test.         

Not only do these facts speak for themselves, but everybody who practiced or observed the consumer bankruptcy system before BAPCPA knows that there was a gross disparity in judicial decisions on what constituted "substantial abuse” justifying dismissal. The old (and universally known) joke was that a lawyer knew her client’s case was in trouble if the debtor drove a better car than the judge. Inherent in the notion of justice is equality – the fundamental principle that like cases should be decided alike regardless of the court where the cases were filed.   

Debtor Attorney Fees         

With the argument that the Mean Test disqualifies needy debtors laid to rest, opponents of BAPCPA say, with some justification, that the costs of filing bankruptcy are too high. This is a legitimate point.  By far the most significant cost increase has been in debtor attorney fees. Over the nearly 20 years since the enactment of the 2005 amendments, debtor attorney fees have skyrocketed by a multiple of the less than $1000 that used to be charged for a simple chapter 7 case. It is true that the Means Test paperwork is substantial, but about 90 percent of chapter 7 debtors do not even have to fill out most of the paperwork because their income is below their state’s median for a family of their size. Yet, even the simplest cases cost significantly more. Even though the 2005 law also imposed some additional non-Means Test documentation (e.g., proof of income), how can that alone justify legal fee increases that dwarf inflation? The problem is even more acute when considering that the debtors who pay the fees are in dire financial straits.             

It is absolutely true that debtor lawyers have been in rough economic times. With filings so relatively low, it is hard for firms to realize economies of scale without sacrificing the quality of work.1 By law, unpaid chapter 7 legal fees are discharged in the bankruptcy case. So chapter 7 lawyers have to be paid upfront before the case is filed. (Chapter 13 debtor attorney fees can be paid over the life of the repayment plan.)  Some attorneys have turned to "bifurcated” fee arrangements whereby the scope of the pre-petition engagement is limited, and so are the upfront fees. Others argue for changing the law so that chapter 7 legal fees are not discharged. These solutions all have significant drawbacks worthy of a separate analysis.   

Perhaps the best solution may lie in technology improvements. For example, new software might allow debtors to complete more paperwork themselves if they have few or no assets subject to liquidation under bankruptcy law. A few pioneers in this area, such as Law Professor Lois Lopica at the University of Denver, have made some progress. But talk of innovative solutions has largely been drowned out by a cacophony of political rhetoric and self-interested arguments designed to justify higher legal fees. There is also some serious academic and legislative debate on rethinking the bankruptcy system. But, for any of the flaws of some of those ideas, at least they represent a non-self-interested effort at improving access to bankruptcy relief.         

All in all, blaming the Means Test for burgeoning attorney fees may be a bit exaggerated. The solution to the legal fee dilemma may reside outside of any changes to the Means Test.    

Conclusion         

As with many political debates, the controversy over bankruptcy policy and practice is fraught with misconceptions. But the debates also raise many legitimate issues worthy of consideration. That debate will best flourish, and contribute to better public policy, only when we work from the same set of facts.   

1 The significant increases in the number of consumer bankruptcy filings in recent months may provide some compensation relief to debtors’ attorneys.

 

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

The upward drift of bankruptcy filings seen in the last half of 2022 was turbo-charged in the first month of this year. After increasing by five percent during the last two quarters of 2022, bankruptcy filings increased by 18.9 percent last month compared to the previous January, for a total of 31,285 new filings. This was the most significant increase since March 2010. As our December report and Webinar suggested two weeks ago, big increases in filing numbers may be in store for this year. 1

Drilling down just a bit chapter by chapter may provide more clues on what to expect.2  

 

Chapter 13

Chapter 13 filings maintained their torrid pace and climbed by 33.5 percent over last January. During the fourth quarter of last year, the chapter 13 filing increase slightly cooled to a still red-hot 27 percent. This means the upward trajectory is getting even steeper. Chapter 13 filings continue to far outpace chapter 7s.

Chapter 7

The key to filing rates this year may lie with chapter 7s filings. They stopped their steep decline last summer. Insofar as chapter 7s constitute a majority of all bankruptcy filings, any upward turn in total filings will also require chapter 7s to increase. That is precisely what happened last month.  

Chapter 11
Chapter 11s were on a roller-coaster last year but showed signs of moving upward. As noted in previous AIS analyses of filings, chapter 11s can be erratic because the total number of cases is a small proportion of all bankruptcies and changes in a single industry can make a difference. In January, chapter 11 filings rose by an extraordinary 65.2 percent. With big retailers speculated to file soon, chapter 11 filings may be higher than normal again next month because retail companies are often organized in a way that causes multiple affiliates to file as separate cases.

Subchapter V small business cases robustly rose by 33.4 percent compared to last January. Subchapter Vs were fairly steady last year, so this major increase may be a blip on the screen or, maybe more likely, augur a more sustained increase. But the numbers are small (130 subchapter Vs last month), so monthly variations are to be expected. 

What Might Be the Reasons for the Major Increase?

Consumers do not appear to be faring all that well these days. They are cash-strapped, facing higher prices, and paying more to borrow money. The Wall Street Journal posted a graph on January 30th that showed how personal savings rates peaked when COVID cash assistance was disbursed but plummeted as the government money ran out. The personal savings rate is dwindling fast. Personal savings out topped out at 33.8 percent of income in April 2020 and now stands a tad above 3 percent. 

With the exception of the recent jobs report, it is not easy to find rosy economic news. Inflation is moderating but remains high. Much of the rest of the economic news is negative, and most economists expect it to stay that way for a while longer. Most data suggest consumer distress, as shown by higher amounts of credit card debt, growing delinquencies (e.g., a large auto lender reported that the number of loans more than 60 days overdue almost doubled in the fourth quarter), and continued upward ticks in interest rates.

On the business front, the Creditor Rights Coalition cited an expert prediction that retail bankruptcies will increase because inflation is hurting consumers, retailers are overextended on inventory, and capital markets have tightened.  

 

Conclusion

Bankruptcies are way up to the start of the year. Although we may see some blips, there are a few reasons to expect a return to historically low filing numbers. It has been more than a decade since overall bankruptcy filings increased so briskly. AIS will continue to monitor and report filing rate trends and the impacts that they may have on consumers, creditors, and the bankruptcy system.  

 

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

Calendar Year 2022 was filled with lots of economic and other surprises. Unfortunately, few of them were good. So perhaps it should come as a relief that the December bankruptcy filing data contained No Surprises.

 

Chapter-by-Chapter Trends

 

Annual Filings

• Overall filings will increase by 10 percent this year. With economic conditions at best middling and at worst foreboding a significant recession – not to mention with little new economic assistance in the political cards and possibly more student loan borrowers seeking bankruptcy relief (see previous blogs for a discussion of changes in the Department of Justice legal position on dischargeability of student loan debt) -- bankruptcy filings are primed to rise by a tad more than double the rate of the past six months. However, that would still be about 45 percent less than the "normal” pre-pandemic level.
  
  
• The number of filings under each chapter will rise. At the risk of climbing out even farther on the proverbial prognostication limb, here's to predicting that chapter 7 filings will reverse their downward trend and rise by 5 percent. Distressed borrowers can hold out for just so long. Chapter 13s will rise by the same 27 percent that they rose in the past quarter of CY 2022, but behind the torrid 46 percent pace of the quarter before that.
  
  
• Chapter 11s will rise the most among all chapters, perhaps by 25 to 50 percent over last year. Suppose interest rates are as key to business filing patterns as the Wall Street bankruptcy experts have told us for the past decade (we can name names). In that case, the DOUBLING of the prime interest rate over the past year, along with the Fed Chair’s promise for more increases to begin the new year, suggests a lot more filings throughout 2023.
  
  
• Small business subchapter V cases will increase by the same 14 percent as they did in 2022. This is because the upward trajectory in subchapter Vs was relatively steady last year, and they are not subject to same kind of industry-specific collapse (think cryptocurrency) that brings a wave of new cases crashing against the business reorganization shores. 

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

Bankruptcy filings dropped nearly 7 percent over the last 12 months, but that gap has closed significantly in the second half of 2022.  November marked the fourth consecutive month in which overall filings were above the same month in the previous year.

 

Broader Economic Trends

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

Chapter Breakout

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

AIS recently informed its clients about a new U.S. Department of Justice (DOJ) policy that was more favorable to the imposition of independent monitors to oversee corporate compliance. The previous Administration disfavored such appointments. In September, Deputy Attorney General (DAG) Lisa Monaca strengthened the new DOJ policy on monitoring and holding individual company employees and executives accountable for corporate non-compliance. The policy pertains directly to criminal prosecution decisions in corporate cases, but civil enforcement components can be expected to apply the principles to a wide range of regulatory and other non-criminal actions as well, perhaps including bankruptcy violations.   

New DOJ Policies

In a speech at New York University Law School that was followed by a detailed 15-page directive to DOJ officials, the Deputy Attorney General set forth detailed revisions to "Corporate Criminal Enforcement Policies” that will bind prosecutors in making charging decisions and entering into non-prosecution settlements (the "Monaco Memorandum). Much of the policy quite conceivably could apply to civil actions taken by DOJ components as well, including in bankruptcy matters.

Among the many significant features of the new DOJ policy are the following:

1. Monitorships are no longer disfavored. DOJ has historically deferred prosecutions of some corporations that agree to alternative relief, including the appointment of corporate monitors who will ensure that the company meets its obligations under the DOJ agreement. This often involves reviewing the company’s development and compliance with extensive internal procedures to avoid the recurrence of misconduct. Many bankruptcy creditors may recall the use of monitors in the $25 billion National Mortgage Settlement (NMS) entered by several banks and government agencies. In addition to being a party the NMS, DOJ’s United States Trustee Program (USTP) also imposed corporate monitors in settling other bankruptcy enforcement actions. Those agreements generally involved both payment of hefty sums to debtors who were harmed by creditor conduct and also major changes to internal bankruptcy compliance procedures. The corporate monitors were selected to oversee and evaluate adherence to the court-ordered settlements and the banks’ new compliance regime.
    
2. Corporate officials responsible for legal violations will be investigated and held accountable. According to DAG Monaco, "[t]he Department’s first priority in corporate criminal matters is to hold accountable individuals who commit and profit from corporate crime.”  To that end, DOJ will extend "cooperation credit” if a company turns over non-privileged documents revealing individual wrongdoing. Importantly, company compensation policies also will be scrutinized to ensure that employee compensation plans provide "affirmative incentives for compliance-promoting behavior” and penalizes non-compliance, including through claw-backs of bonuses awarded to executives who are responsible for the company’s violations of law. Compensation packages that are geared toward revenues without balancing the necessity of compliance would clearly put the company at risk under the new policy.
   
   
3. Corporations that expeditiously self-report and self-correct violations will receive more favorable treatment by DOJ. Companies that have robust compliance programs may identify violations before government agencies. Those companies should act with alacrity and remediate as soon as possible. In encouraging these responsible corporate behaviors, DOJ is not changing its policy but is instead laying out a clear marker of what is expected in what may be a stricter enforcement environment going forward. In several provisions of the Monaco Memorandum, the importance of compliance programs is highlighted, including the presence of strong internal controls to "detect and prevent” violations, escalation procedures when "red flags” are identified, and looking "at what happened in practice at a corporation – not just what is written down.”  
   
   
4. Past misconduct – "including previous criminal, civil, and regulatory resolutions” -- will be considered by DOJ. DAG Monaco warned that "repeated misconduct may be indicative of a corporation that operates without an appropriate compliance culture of institutional safeguards.”  Although this aspect of the new DOJ policy is in accord with traditional law enforcement criteria, it seems that DOJ is also making clear that past offenders must be especially energetic in crafting and following appropriate compliance policies.  

Implications for Bankruptcy and Other Non-compliance
The new DOJ corporate misconduct policies covering criminal prosecutions, considerations of deferred prosecution instead of guilty pleas, and cooperation credits in seeking punishment may be instructive in other contexts throughout the Department. After all, many factors that are cited in determining criminal enforcement actions likewise are present and weighed in civil actions as well.

It would not be hard to imagine, for example, that the USTP would be aggressive again in seeking corporate monitors as it did in the past. And although there would be many hurdles to overcome before a bankruptcy court could penalize a corporate employee directly, it would not be surprising for future bankruptcy compliance settlements to encourage claw-backs of compensation and new personnel policies that give more weight to compliance.  

Conclusion
Large corporations and financial institutions will likely pay careful attention to the Monaco Memorandum with respect to all of its operations. Bankruptcy operations should not be spared from this heightened review. The memo reflects a tougher line on federal enforcement against corporate violators. If bankruptcy filings rise and violations of bankruptcy rules multiply, then federal enforcers may now have a few more arrows in their quiver when seeking appropriate remedies.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

The September 2022 official bankruptcy filing statistics bring to mind a musical oldie from Sonny and Cher, "The Beat Goes On.” The number of consumers and businesses seeking bankruptcy protection continues to trend upward as the economy grows more problematic and federal regulatory actions become more aggressive.

Overall, bankruptcy filings are up by more than seven percent compared to September 2021, led by another significant increase of more than 40 percent in chapter 13 filings (Figure 1). This is the second month in a row of an overall increase and the first back-to-back increase since January 2020, well over two years ago.   

Figure 1

Round Up of the Bankruptcy Filing Numbers

After two years of significant drops in bankruptcy filings, a new pattern is emerging with signs it may persist for quite a while. Although there undoubtedly will be zigs and zags along the way, more and more consumers and businesses appear to need bankruptcy protection. Chapter 13 filers, who are usually trying to retain their homes and automobiles, now constitute 44 percent of all filings. That far surpasses the historical norm of about one-third of all filings. That is due, in part, to drops in chapter 7 (liquidation) filings. 

The number of chapter 11 cases, which are mainly businesses, skyrocketed again by more than 71 percent compared to the previous September and reached the highest monthly filing number in the last two years. In addition, small business filings using expedited subchapter V procedures rose by more than one-half and continue to represent about one-third of all chapter 11s.

To put matters into perspective, the data from six months ago looked much different. In March 2022, total filings over a twelve-month period were down by 16.5 percent. In contrast, in September 2022, the decrease was only seven percent, reflecting a significant increase over the past six months. Also, in March 2022, the comparison to filings in the same month in the previous year showed a drop of more than 17 percent, whereas in September, the overall numbers increased by seven percent. 

National Economic and Regulatory Outlook

AIS does not have an econometric black box from which to project future national economic performance. But clearly, most economists are concerned about trends, even if not all the indicators are going in predictable directions. Again, to put matters into perspective, the prime rate charged for borrowing six months ago was 3.5 percent. By late September, it rose to 6.25 percent and may be going higher. Moreover, even though businesses are trying to hire more employees, the unemployment rate has edged upward from 3.6 percent in March to 3.7 percent, according to the latest Labor Department data.  

Other data show similar conflicting signs. According to the Wall Street Journal, Morgan Stanley recently reported that more retail stores open than closed last year for the first time since 1995. At about the same time, the Federal Reserve issued a report by Michael Smolyansky linking interest rates with lower corporate profits and offering no encouragement for future performance.

All this helps show why there is a perceptible increase in bankruptcy filings and why those filings may continue to climb and quite possibly quite steeply. It is also hard to see why chapter 7s would stay below previous year filing numbers. The higher cost of living is almost bound to draw down household cash (which was built in part by unprecedented government transfers during the pandemic), providing the cushion allowing many consumers to avoid filing for chapter 7 relief.

As all of this is happening, federal regulatory actions against financial institutions seem to continue to ratchet up. Very recently, newspapers reported what appear to be unusually high penalties imposed for regulatory violations. For example, one regional bank was tagged with $191 million in payments for overdraft violations and a group of the largest financial sector firms was tagged with $2 billion payments for use of unauthorized messaging systems. Moreover, the Justice Department recently unveiled a tougher new policy governing criminal corporate compliance violations.  

As filings increase and more attention is drawn to the plight of debtors, it is not hard to imagine greater regulatory scrutiny of default loan servicing to ensure that past violations and errors have not recurred since previous enforcement actions were taken.   

Conclusion

If current bankruptcy filing trends hold, lenders should brace for a lot more default loan and bankruptcy servicing challenges. Filings are still only about one-half of the pre-COVID level, and no one knows if those previous norms will return. Over the last ten years, the financial industry (secured and unsecured) has invested heavily in automation and other compliance tools. But those systems have not been tested in a high bankruptcy filing environment. With filings headed upward, the national economy in a somewhat precarious state, and financial regulators acting aggressively, the testing may be about to begin.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

Each year, millions of Americans depend upon a transparent, efficient, and effective bankruptcy system. Besides about 400,000 debtors who seek a fresh start annually, millions of creditors rely on the bankruptcy process to obtain at least some repayment of money they are owed. Add to that the impact the bankruptcy system has on preserving value, saving jobs, and providing the opportunity for individual debtors to become productive members of the economy again, and it is no wonder that the Founders made enactment of a uniform system of bankruptcy laws one of the enumerated powers granted to Congress in the United States Constitution.    

As debtors and creditors are well-aware, the bankruptcy system involves a lot of financial disclosure and compliance with rules. Failure to play by the rules may result in debtors losing their discharge of debts and creditors forfeiting their ability to receive a distribution. Beyond these and other civil consequences, certain egregious and fraudulent acts also may subject violators to criminal penalties, including incarceration.

The honesty and integrity of the bankruptcy system is so core to the general welfare and prosperity of the nation that Congress has enacted six sections in the Criminal Code identifying 18 crimes that apply specifically to bankruptcy. Those provisions are in addition to many other laws that bring certain bankruptcy-related conduct into the realm of criminal enforcement.  

Department of Justice

Each year, the Justice Department’s United States Trustee Program (USTP) makes more than 2,000 referrals of suspected criminal conduct to United States Attorneys who may prosecute these cases. By law, the USTP must make referrals and assist in the prosecution. In addition to assigning about 25 of its attorneys to help prosecute bankruptcy crimes, the USTP also directs USTP lawyers and financial analysts to work with prosecutors on investigations, grand jury proceedings, and criminal trials.

To further enhance bankruptcy enforcement, the Justice Department has organized about 60 local bankruptcy fraud and related working groups consisting of multiple federal law enforcement agencies. The most prominent participants generally include the United States Attorneys, USTP, FBI, IRS, U.S. Postal Inspection Service, Social Security Administration, and the Department of Housing and Urban Development. These groups discuss local challenges (e.g., mortgage scams), enforcement strategies, and targets of investigation (subject to prescribed limitations on information-sharing).  

By law, the USTP publishes an Annual Report of its criminal enforcement activities. The breakdown of referrals consistently shows that most crimes pertain to debtor misconduct, but far from all. The Annual Report compiles referrals into nearly 50 categories. The top five areas are tax fraud, false statements, bankruptcy fraud (e.g., continuing a fraudulent scheme by use of the bankruptcy process), concealment, and identity theft (e.g., use of false social security numbers).  

Examples of Prosecutions

The following are examples of some recent prosecutions based upon USTP referrals:

• A payday loan servicer used personal information provided by customers to create false loan portfolios. The defendant then sold the portfolios to debt buyers who filed illegitimate proofs of claim in bankruptcy cases. The defendant collected more than $7 million from the sale of the false debts, lied to a bankruptcy court about the scheme, and ultimately pleaded guilty to several bankruptcy and non-bankruptcy crimes.
• The head of a New York-based private equity fund threatened economic harm to a potential competing buyer of bankruptcy estate assets. The misconduct was revealed by the competing bidder. The USTP conducted an immediate investigation and filed a comprehensive report in bankruptcy court that was the basis for the indictment and conviction. The defendant struck a quick plea agreement that included incarceration. On a positive note, the defendant has lectured at prominent law schools about the temptations to commit unethical acts in the heat of high-stakes financial and bankruptcy transactions.
• A debtor falsified bankruptcy documents by creating false liabilities in an attempt to show an inability to repay creditors and also concealed more than a million dollars in assets, including gold coins and bank deposits. Concealment cases are all too prevalent and have included hiding valuable assets ranging from jewelry to a Maserati to a chateau in France.   
• A fraudster offered mortgage relief to homeowners facing foreclosure, received mortgage payments without trying to negotiate with the lender, and improperly filed a bankruptcy petition in the homeowner's name. The defendant defrauded more than 70 homeowners and was sentenced to 12 years in prison. Credit repair and mortgage relief schemes continue to be far too commonplace, harm lenders, and devastate families trying to save their homes. It has long been a focus on federal and state civil and criminal enforcement efforts.
• A consumer bankruptcy lawyer embezzled client funds, never performed services for which he was paid, and filed false documents in bankruptcy court. There was a large number of victimized clients, and not all of them could be identified because the lawyers destroyed client files. The bankruptcy lawyer was sentenced to 18 months in prison.

Conclusion

While it may seem that creditors are always in the regulatory crosshairs, most bankruptcy prosecutions involve debtor misconduct, and those convicted of bankruptcy crimes include wrongdoers from all walks of life. Bankruptcy criminals include not only debtors facing desperate financial circumstances but also many fraudsters who prey upon the financially vulnerable, attorneys and financial professionals, and even celebrities from the worlds of sports and entertainment. The victims of bankruptcy crimes often include both the debtor and creditors. And the list of victims always includes the integrity of the bankruptcy system on which the whole country depends.

If you have information about a possible bankruptcy crime, contact the USTP’s Bankruptcy Fraud Hotline at: USTP.Bankruptcy.Fraud@usdoj.gov.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

The August bankruptcy filing numbers are in. They not only reinforce the upward trend glimpsed in recent months but show an appreciable acceleration in filing rates. Moreover, government policy and general economic trends provide a reason to expect more of the same in the future.     

What Do the Numbers Show?

Total bankruptcy filings in August 2022 totaled 35,375. That is a significant increase of 14.6 percent over July and nearly 9.6 percent over August 2021. This marks only the second time we have seen a year-over-year increase in monthly filings since the pandemic began in early 2020. Notably, the August increase was the largest since May 2010 when the economy was feeling the ill effects of the Great Recession.              

Chapter 13 filings experienced a sizable increase of more than 15.4 percent from the previous month – and a whopping increase of more than 55 percent over August 2021. Chapter 7 filings were more mixed, with a significant 12.9 percent increase over July and a 10.9 decrease from August 2021. The previous drops in chapter 7 filings moderated in recent months, so it is no surprise to see an increase now. Although chapter 11s went up by nearly 90 percent from August over last month, many factors come into play that make analysis and predictions of future chapter 11 filings a bit harder.  

Why Are Bankruptcy Filing Rates Rising?           

Most commentators attribute steady chapter 13 increases to the resumption of foreclosures and evictions. Automobile repossessions likewise have been on the rise. Add to that inflation and interest rate hikes (which, among other things, make refinancing less viable) and employed consumers with secured debt may continue to find chapter 13 relief an increasingly attractive way to save their homes and cars while adopting a no-frills lifestyle.  

Chapter 7 filings may have avoided similar significant upticks because of the lag time between the expiration of a record-breaking amount of government cash handed out during COVID and consumer debtors running out of money to pay their bills. According to the most recent Federal Reserve survey, consumer debt jumped by more than 10 percent in the quarter ending in June, with an even more significant 13 percent rise in credit card balances. Apart from the inevitable limit on credit available to middle and lower-income consumers, interest rates make borrowing for essential purchases more out of reach. It is hard to see how chapter 7s can avoid the upward trend we have seen in chapter 13s. 

Although private equity continues to keep many businesses funded through more challenging times, the Creditor Rights Coalition recently highlighted a Morgan Stanley report saying that corporate economic strength may be flagging and the impact of interest rate hikes may "become more apparent in the coming quarters.”  It is worth noting that not only did overall chapter 11 filings dramatically increase in August, but small business filings under the popular subchapter V streamlined procedures rose by 40 percent in August compared to both the previous month and to August 2021.      

What Will Happen Next?     

Predicting bankruptcy filings month-to-month or even year-to-year has proved to be an especially tricky business over the last few years. After all, despite twists and turns, annual filings have been at historic lows since the pandemic hit. But there is a paucity of objective data to suggest that the low filing environment is anything other than an aberration caused by extraordinary government actions. If filing rates merely returned to the stability we saw from 2016-2019; then filings could nearly double from the current lows.  

A cursory review of general economic news, even if tempered by optimism that the Federal Reserve will guide the economy to a soft landing without a recession, reveals factors that may portend higher bankruptcy filing rates. For example, high inflation is persistent (even if it goes down a notch), the Federal Reserve probably will continue to maintain higher interest rates, consumer credit use has expanded, and the job market has softened.   

What Does It All Mean?          

The lending community needs to prepare for higher bankruptcy filing rates. If they do not, they run the risk of being flat-footed when the demands on default servicing operations similarly increase. In the aftermath of the economic meltdown more than a decade ago, many bankruptcy lawyers prospered, but many consumers were harmed by lender servicing practices that could not keep up with dramatically elevated delinquencies. As a result, financial institutions paid unprecedented amounts in settlements to customers, as well as to state and federal regulatory authorities.         

It is not time to panic that bankruptcy filings will double and reach the pre-pandemic "normal.”  But it is also no time to assume that current historically low filing rates will persist. Recent bankruptcy filing data show an upswing that may grow steeper and last a while longer.    

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

AIS Insight Reports provide the bankruptcy community with comprehensive bankruptcy filing data with helpful narrative explanations, as well as charts and graphs that help tell the story of the previous month’s filing patterns. This information allows stakeholders to drill down into the numbers to reach their own conclusions and perhaps factor the data into their own business forecasting.       

Based off our customary data and analysis, we made the following observations:

• Chapter 13 filings continue turn in a higher direction. The number of chapter 13 cases filed in July, while slightly less than June, continued to show substantial growth when compared to the same month during the previous year and when compared to the previous 12-month period. Chapter 13 filings, which traditionally account for roughly 30 percent of all bankruptcy filings, are up nearly 40 percent year to date compared to January – July 2021.
  
  
• Chapter 7 filings continue to lag behind the previous year, but at a slower rate of decrease. Slowing trends (in either direction, up or down) are often a harbinger of a new pattern. In this case, the slowing decrease may provide a signal that chapter 7 filings will actually increase in the near or mid-term future.
  
  
• Because chapter 7 and 13 cases constitute such an overwhelming share of all bankruptcy cases, it is not surprising that the total decrease in filings in July is about 77 percent smaller than April. The percent decrease in overall filings from January to April 2022 was 17.5 percent; the overall decrease in July was a relatively modest 4.79 percent which followed the more recent pattern of the past three months. 

Below you will find two graphs that illustrate these patterns.       

Figure 1 shows weekly chapter 7 and chapter 13 filings with various gyrations. But the lines through weekly filings for each chapter show upward trends during this calendar year.

 

Figure 1

Figure 2 shows another telling point.  Chapter 13 filings increased by an extraordinary 39.48 percent compared to the previous 12-month period.     

 

Figure 2

Commentators like Ed Flynn, a premier expert on bankruptcy filing analysis at the American Bankruptcy Institute, suggest that total bankruptcy filings will finish this calendar year below last year’s low filing number. But mapping the filings by other than cumulative calendar year identifies patterns that may augur a future rise, at least in consumer filings.         

Lastly, a recent study by the New York Federal Reserve Bank, which was widely reported in the financial press, notes that consumers are starting to take on more credit card debt as stimulus payments and other pandemic-related relief runs out.  Historically, an increase in the amount of consumer debt, both in good times and bad, is a tell-tale sign of more bankruptcies to come.       

That is more than enough data to digest for now.  Financial institutions and other creditors plan far into the future.  Possible changes in bankruptcy filings may need to weigh heavily in their forecasts.

To download the July Insight Report, click here.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

For some time now, Congress has been mainly known for gridlock and uncivil debate.  But there have been many moments when Congress has come together in a bipartisan fashion to find solutions to long-standing problems. One of those moments occurred three years ago when members of both parties in both the House and Senate got together to pass the Small Business Reorganization Act (SBRA). Then a funny thing happened after the expansive new law was enacted – it worked exactly as intended.   

Background 

The SBRA was designed to address widely perceived problems that small businesses encountered when trying to reorganize under chapter 11 of the Bankruptcy Code. There was a developing consensus that chapter 11 was too costly and slow for businesses with modest assets which could not afford the financial drain and distraction of drawn-out bankruptcy processes. As a result, businesses that might be saved were dismantled and jobs unnecessarily lost. 

The new law added a new voluntary subchapter V within chapter 11 for businesses holding less than $2.7 million in debt (adjusted annually for inflation). As an alternative to navigating the complex chapter 11 process, subchapter V provided streamlined procedures and tighter deadlines for debtors to develop a plan to rehabilitate the ailing business. The key substantive change under SBRA was the elimination of the "absolute priority rule” whereby the owners of the debtor-business had to pay creditors in full or lose their equity and control. This was a major downside for closely held and family businesses that lacked bankruptcy sophistication and did not want to unduly risk losing the enterprise they had worked a lifetime to build.  

Among many other important changes, the new law also required the United States Trustee to appoint private trustees with a mandate to help ensure the filing of accurate financial information and to facilitate the filing of a consensual plan of reorganization. The trustee also is expected to identify businesses that cannot successfully reorganize and help move them to liquidation sooner before all the assets are dissipated. 

There were major challenges in implementing the law. Not the least amongst those challenges was the USTP finding about 200 new trustees with business acumen. Although many existing trustees appointed under other chapters also were appointed under subchapter V, it was important to select businesspeople who would focus on finances, rather than lawyers who might focus on litigation. In addition, there was a lot of initial concern that debtors’ counsel would be reluctant to give up partial control of the case to an independent trustee whose mandate was to assist both debtors and creditors in finding a swift business solution. 

The SBRA became effective in February 2020, just a month before much of the country shut down due to COVID. In an effort to assist more businesses facing economic hardships caused by the pandemic, Congress quickly expanded SBRA to cover businesses with up to $7.5 million in debt.  That change increased the number of SBRA debtors by one-third. The higher debt limits were temporary for one year and later extended until June 2024.   

Metrics of Success     

The early results of SBRA were favorable and those trends have continued.  Here are some of the key metrics of success:

• Three out of every four small business bankruptcy debtors choose to proceed under the expedited subchapter V process. This shows the popularity of the alternative among both small businesses and their bankruptcy counsel. To date about one-third of all chapter 11 cases are small businesses. 
• Subchapter V small businesses confirm a reorganization plan at almost twice the historical rate for small businesses (56 percent vs. 31 percent.) In addition, more than 70 percent of the confirmations are consensual plans without creditor opposition. (There are no compilations of historical data on consensual plans in non-SBRA cases.)
• Subchapter V cases are dismissed at less than one-half the historical rate for small businesses (25 percent vs. 53 percent.) This suggests that subchapter V trustees are successfully helping smaller companies stay in business.
• Subchapter V cases are resolved more quickly and spend less time in bankruptcy. Subchapter V debtors confirm plans about 40 percent faster than the historical speed for small businesses (6.4 months vs. 10.8 months). Similarly, cases are dismissed more than 20 percent faster than the historical average (4.7 months vs. 6 months).   

A few caveats are in order. The law is still fairly new so trends may not hold.  Creditors also may want to crunch their internal numbers to compare their rate of recovery on debts under SBRA and the old system. Importantly, ultimate outcomes – such as whether companies that reorganize under SBRA complete their plan payments and remain viable over the long-term -- will require the passage of more time before they can be measured. 

Conclusion       

Government often-times seems broken, but sometimes it still works. All available objective data point to success so far for SBRA achieving the objectives Congress set when it passed the new law. Creditors may want to study their own internal results.  Congress will need to evaluate longer-term experience before deciding whether to extend the higher debt limits when the current SBRA expansion expires in two years.  

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

 

Bankruptcy filings have been at historic lows since the beginning of the COVID pandemic in 2020. But deteriorating national economic conditions and recent chapter 13 filing data suggest that bankruptcy increases may be on the horizon. If history is any guide, then more scrutiny of creditors’ compliance with bankruptcy and consumer protection laws and rules can be expected as well. All this may make it a good time for financial institutions and other creditors to review their bankruptcy processes to reduce the risk they will come under the regulatory microscope. 

Historical Bankruptcy Filing Rates

Although predicting bankruptcy filing rates may be more hazardous than at any time in recent memory, it is worth noting that filings have been gyrating over many years. For example, 40 years ago bankruptcy filings stood at 380,000 cases. Last year, they reached about 414,000, or 18 percent above the low-water mark of the past five decades. But charting filing numbers between those years is a lot like drawing a rollercoaster.         

The graph below (Figure 1) shows bankruptcy filing numbers for the past 20 years.  In the 1990s, bankruptcy filings climbed above million. As the chart shows, they continued to climb until they exceeded two million cases in 2005. That number was somewhat artificial, however, because Congress sought to reduce the precipitous increase in filings by passing the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which imposed a means test and made other significant changes in the law. Many lawyers tried to beat the effective date of the 2005 amendments by urging their clients to file sooner. Debtors did exactly that. Of course, that led to a sharp drop in filings the next year. Filings then began to rise to more normalized levels.          

The next blip on the chart occurs in about 2008-2010 during the Great Recession when external economic conditions drove filings skyward. After that, filings leveled off and changed very little from about 2016-2019. Then the COVID pandemic hit.  Many of us predicted that the pandemic would cause a large increase in filings. I was wrong. Instead, as Figure 1 shows, the numbers dropped – by a lot. In retrospect that is not surprising because the amount of government cash and other assistance, including foreclosure and eviction moratoria, were unprecedented. But there are new signs that filing patterns are changing.

Figure 1

Chapter 13 Filing Increases    

Figure 2 charts the past 12 months of chapter 13 filings. Insofar as chapter 13 is designed for individuals with a regular income, many of whom have fallen behind on secured debt payments and still want to save their home or car, one might expect home foreclosure and eviction moratoria to influence filing rates strongly. Figure 1 suggests exactly that. The federal eviction moratoria generally ended last July. That is where our chart begins. As the trend line shows, chapter 13 file rates are up significantly over the past 12 months. Comparing January to June rates alone, the 2022 filing rates are 32 percent above the previous year.          

In light of other economic conditions, this increase may forebode future increases as well, at least in chapter 13.

Figure 2

Deteriorating Economic Conditions    

In addition to the expiration of government aid, which eventually will have an impact on many economically vulnerable consumers who were able to delay the day of financial reckoning, macroeconomic conditions are unfavorable. For the first time since the late 1970s through 1982, we are seeing high inflation, rising interest rates, and perhaps slowing economic growth. In early June of this year, the World Bank (along with many economic mavens) warned of "stagflation.” And Chase CEO Jamie Dimon said there is an economic "hurricane” heading our way. Since those prognostications were uttered, national economic data have not painted a brighter picture.   

Reduce Regulatory Risk  

The last time we faced a sharp economic downturn, federal regulators enhanced their scrutiny of bankruptcy and other creditor practices. Among things, this culminated in a $25 billion national mortgage settlement and many other multi-million-dollar bankruptcy settlements pertaining to the accuracy of proofs of claim for secured and unsecured debt alike. Perhaps more expensive in the long-run than remediation to consumer debtors, regulatory relief sometimes entailed injunctive relief (e.g., monitors to review internal creditor practices) and severe reputational damage.With filings still relatively low, and regulatory actions concomitantly lower, this may be a good time for creditors to perform a check-up on their bankruptcy compliance systems to make sure they can withstand future regulatory scrutiny.   

Conclusion         

All reputable creditors want to treat consumer fairly and in compliance with law. But even the best of systems for handling distressed accounts need a check-up every now and again to be sure faulty practices did not seep in. Now may be a good time for a regulatory refresh before Jamie Dimons’s predicted "hurricane” hits consumers and creditors alike.

To download the June Insight Report, click here.

Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.

The United States Supreme Court recently decided the case of Siegal v. Fitzgerald-- and for only the second time in history-- struck down a bankruptcy law on the seemingly technical ground that a fee imposed on chapter 11 debtors violated the constitutional requirement that bankruptcy laws be uniform.  Although the issue may seem somewhat esoteric, its implications may be far-reaching, especially for creditors in Alabama and North Carolina.  Here’s why: 

Under Article I, Section 8 of the Constitution, Congress may establish "uniform laws on the subject of bankruptcy.”  But in 1986, Congress allowed bankruptcy courts in six judicial districts in Alabama and North Carolina to control bankruptcy administration in place of Justice Department’s United States Trustee Program (USTP), which oversees bankruptcy cases and enforces bankruptcy laws in the other 88 judicial districts around the country.  Among the USTP administrative duties is the mandate to collect quarterly fees in chapter 11 cases.  When Congress increased those fees to offset the costs of both bankruptcy courts and the USTP, it left open a statutory loophole that the courts in the six districts thought allowed them to delay collection.  Although the Supreme Court found "ample evidence” that Congress intended the fees to be collected nationwide, the disparity in fee collection practices meant that the fee statute itself was fatally non-uniform.  

Beyond the issue of how to remedy the disparity – which puts at stake more than $300 million in increased fees that the USTP properly collected – is the issue of whether Congress also acted unconstitutionally back in 1986 when it passed a statute allowing the bankruptcy courts in the six judicial districts in Alabama and North Carolina to opt out of the USTP system.   

This is where the implications for creditors and all stakeholders in bankruptcy cases come into play.  Although the Bankruptcy Code, from creditor rights to penalties for violations of bankruptcy law, applies everywhere, it is fair to say that the USTP has been more vigorous in identifying violations and going to court to impose remedies against debtors, creditors, lawyers, and others involved in bankruptcy cases.  It sounds confusing, but the USTP brings legal actions, much like a prosecutor, and judges decide the case and order relief (e.g., fines, injunctions).  In districts where the USTP lacks jurisdiction, a court functionary called a Bankruptcy Administrator (BA) plays a similar role.  Not surprisingly, the USTP as a DOJ agency places greater emphasis on investigation and litigation than the courts whose primary responsibility is to adjudicate disputes that are presented to them. 

For most other administrative and regulatory matters, such as prescribing financial reporting for chapter 11 business debtors and approving creditor counselors who provide a mandatory financial curse to almost all individual debtors, the BAs largely piggy-back onto the U.S. Trustees’ way of doing things anyway.  The big exception is that the U.S. Trustees are independent of the judiciary, centrally directed, follow consistent priorities, and more vigorously enforce the bankruptcy laws.  In contrast, the BAs are creatures of a handful of bankruptcy judges.  That is why the USTP was able, for example, to review 37,000 bankruptcy filings, litigate 300 discovery objections from financial institutions, and participate in the DOJ-led $25 billion National Mortgage Settlement of a decade ago.  Judges simply are not equipped to target law firms, banks, and other who operate nationwide and systematically violate the Bankruptcy Code and Rules.  

Although the primary impact of a merger of the BAs into the USTP will be those operating within the six judicial districts, the mandate for uniformity also will cascade into other areas where there are differences in bankruptcy practices.  With DOJ and the USTP atop the entire administrative system, one can expect a push for more consistent practices in a wide range of areas and more consistent application of the law. 

Although it will be a hard management task for the new Director of the USTP (the previous Director retired after serving 17 years at the helm – and then joined AIS) to integrate the BAs into the US Trustee system and inculcating the DOJ way of doing things, it also may make for a more consistent and constitutionally permissible system going forward. It also probably means stricter enforcement and maybe a lot more scrutiny of creditors who operate mainly in Alabama and North Carolina.