In Search of Life After Debt

New bankruptcy law helps debtors survive financial woes

James and Lynda Hobson, a Salt Lake City couple in their early thirties, owed creditors more than $18,000 in secured and unsecured debts* when they appeared in court last month--a considerable burden for a family with an annual income of only $15,000 and a fourth child on the way. An $8,000 loss on a house they had built--and then had to sell before ever moving in--was one reason they were in trouble; another was the $1,200 that they had accumulated in medical bills. Hard pressed for cash, the couple had begun to rely heavily on credit cards late in 1978. "We'd borrow from Diners Club to meet the utility payments and from Visa to pay for groceries," recalls Lynda. Eventually, that house of cards collapsed. Buried under bills and harassed by creditors, the Hobsons turned to an attorney, who sought shelter for them under the recently overhauled federal Bankruptcy Act. The Hobsons paid a $60 filing fee, and soon afterward a judge approved a three-year plan calling for repayment of 16-c- on every dollar owed to unsecured creditors as part of $150-a-month payments that also cover the secured creditors. Under the plan's terms, the couple will still be able to afford a $140 monthly tithe to the Church of Jesus Christ of Latter-day Saints.

The Hobsons' financial woes typify the debt crises facing the increasing number of Americans who end up in bankruptcy court. These days, family finances are stretched so tight that a change in circumstance--loss of job, divorce, birth of a child--can be disastrous. With Americans overdosing on credit and the economy threatening to nosedive, a surging personal bankruptcy rate may well eclipse the record of 224,354 cases set during the recession year of 1975.

Throughout this century, the federal

Bankruptcy Act of 1898 was the final resort for the debt ridden. Before the revised act went into effect last October, the typical debtor went into "straight bankruptcy": many of his possessions were taken from him and sold. Secured creditors, attorneys' fees, court costs and taxes were paid first. What was left went to the unsecured creditors on a pro rata basis. Many of the creditors remained unpaid, while the debtor had little left with which to start a recovery. Only in about 15% of the cases did debtors choose to proceed under Chapter 13, or the "wage-earners' plan," which permitted partial repayment of debts over three years and sometimes longer, but subject to the creditors' veto.

Much of that changed when the new law, before Congress for five years, came into effect. Most important among its provisions was a liberalization of Chapter 13 --on the theory that easing the debtor's hardship would give him or her the financial strength to pay a reasonable percentage of what was owed.

Bankruptcy lawyers were pleased with the new law; some began swarming into courtrooms on Oct. 1, 1979, with cases they had been holding back in anticipation. "It's a beauty," says Los Angeles Attorney Hugh Slate. "There are all sorts of little goodies in there." What most excites lawyers are more liberal eligibility rules for Chapter 13 and greater freedom to repay less than 100-c- on the dollar. The power of unsecured creditors to veto repayment schedules has been cut back sharply. Once a compromise plan has been approved, creditors may not talk unwitting debtors into making additional payments. Cosigners are freed from liability. As before, debtors may retain almost all their assets. Chapter 13 proceedings do remain on credit reports, but just for ten years, a period during which credit will be hard to get--but perhaps easier than after a straight bankruptcy. Some who have faced bankruptcy proceedings suggest that they may be better off without too much credit in any case. Lynda Hobson admits that before going into Chapter 13, "I had no control. I would just say, 'Charge it.' "

Whether Congress was successful in striking the proper balance between a creditor's rights and a debtor's need for a fresh start is still a matter of debate. Critics, among them loan companies and some bankruptcy judges, argue that the new Chapter 13 is too lenient on debtors. "We're seeing some awfully low [repayment] plans," concedes Harry Dixon, an Omaha lawyer who helped shape the legislation. "I'm concerned that high-income types who could pay off debts will not pay off as much as they can. They'll slide through Chapter 13, taking advantage of all those new provisions."

The House Judiciary Committee is leaving it to the courts to toughen up Chapter 13. One bankruptcy judge, Robert L. Hughes of Oakland, Calif., has done just that. He created a storm in February by rejecting a plan that met all statutory requirements but called for payments that he did not think high enough. Hughes ordered minimum repayments of 70-c- on the dollar. Maine Bankruptcy Judge Conrad K. Cyr suggests that the critics are overreacting. "You can't legislate blood out of a stone," he says. "We have a lax credit system. Should we load this burden on the family or on the creditors?"

The Hobsons, for their part, think that the revised act is working well. "We can see daylight for the first time in two years," says Lynda. They are confident that they can meet their monthly payments. Their ability to do so will depend on the success of James' five-month-old business: a credit collection agency.

*Unsecured credit is granted against nothing more than the debtor's promise to pay, while secured credit is given against property that would be forfeited in case of default.

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