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Special Report
The secret struggles of serial bankruptcy
The stories you hear about people deliberately filing for bankruptcy multiple times arent all true. Some people just have major problems that would overwhelm anyone. A few, however, do game the system.
By Liz Pulliam Weston
John has a financial plan, of sorts. About every seven years, the New City, N.Y., resident files for Chapter 7 bankruptcy to erase his debts.
John, 46, insists that he isnt deliberately taking advantage of the system. All three of the bankruptcies hes filed, John says, were precipitated by a job loss. Each time, hes had no trouble getting more credit.
Usually five months (after a bankruptcy is completed), the creditors start giving me credit cards when I apply for them, said John, who spoke on condition of anonymity.
Until recently, a bankruptcy filing was considered a catastrophic financial event -- a moral as well as a personal failure. Now, however, bankruptcy is often seen as just another financial tool, and one thats used repeatedly by a significant number of bankrupts.
A look at repeat filers
Exact statistics are impossible to come by, since the bankruptcy courts dont specifically track repeat bankruptcies. The few studies done so far, said Sam Gerdano, executive director of the American Bankruptcy Institute, show that repeat filings vary widely by court district and type of filing, ranging from a low of 1% to more than 20%.
In Utah, which has one of the highest per-capita bankruptcy rates in the nation, the recidivist rate for Chapter 7 liquidation filers in 1997 was about 8% while that for Chapter 13 repayment plan filers was as high as 27%. Overall, about one in seven Utah filers studied had tried bankruptcy at least once before.
| Summary of Utah bankruptcy filings, 1997 | | Chapter 7 | % of total | Chapter 13 | % of total | Conversions* | % of total | | Total filings studied | 1,486 | 100.0% | 941 | 100.0% | 139 | 100.0% | | No previous bankruptcies | 1,364 | 91.8% | 726 | 77.2% | 102 | 73.4% | | 1 prior bankruptcy | 113 | 7.6% | 201 | 21.4% | 34 | 24.5% | | 2 prior bankruptcies | 7 | 0.5% | 12 | 1.3% | 2 | 1.4% | | 3 prior bankruptcies | 2 | 0.1% | 2 | 0.2% | 1 | 0.7% |
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*Chapter 13 repayment plan converted to Chapter 7 liquidation. Source: A Profile of Consumer Bankruptcy Petitioners. By Jean Lown and Barbara Rowe, Utah State University
Repeat filers tend to fall into three groups:
Repeat liquidators. Some filers, like John, use loose lending standards to run up new bills after a Chapter 7 liquidation, then wipe out those outstanding amounts using laws that allow them to file another liquidation six years later. Others, like Gary and Arlin Johnson of Craigmont, Idaho, file repeatedly because of health crises and inadequate insurance. In fact, medical bills -- along with job loss and divorce -- are major triggers of both first-time and repeat Chapter 7 filings, according to research by Jay L. Westbrook, Teresa A. Sullivan and Elizabeth Warren, authors of The Fragile Middle Class: Americans in Debt.
Those who fail with repayment plans. Others filers try, but fail, to satisfy their creditors with Chapter 13 repayment plans. These debtors can try another repayment plan, since there are few restrictions on how often Chapter 13s can be filed. Or they may take the more common option and convert the Chapter 13 to Chapter 7 liquidation.
Peter Sylwester of Vancouver, Wash., is a high-tech worker who said he was forced to convert his repayment plan to a Chapter 7 liquidation as his sources of income dried up. We never lived extravagantly but have endured a long downward spiral in the amount of compensation that I've been able to expect, Sylwester said. Dot bomb, layoffs, closures, pay cuts, you name it -- I'm your poster boy.
Serial filers. Some use bankruptcy laws as a strategy to deliberately thwart their creditors attempts to collect, usually with no intention of following through on their filings. They take advantage of bankruptcy provisions, known as an automatic stays, that temporarily halt collections, foreclosures and evictions.
Massachusetts home improvement contractor James R. Pallone, for example, attempted to evade claims from dissatisfied and mostly elderly customers by filing at least 15 bankruptcies between 1991 and 2002, according to the U.S. Trustee in Boston. Some of the filings were under his own name; others were under those of relatives. All, however, were designed to prevent creditors from attaching Pallones assets, the trustee said. Pallone ultimately pleaded guilty to 36 violations of Massachusetts laws governing contractors.
Rent skimming and other tricks
Many serial filers use bankruptcy to frustrate evictions or foreclosures. A few run elaborate rent skimming operations, in which they continue collecting rent on properties while filing Chapter 13s to delay foreclosures.
Bernard Gross was accused by the U.S. Trustee in Santa Ana, Calif., of running such an operation on more than 500 properties. Gross was eventually convicted of making false statements to the bankruptcy court.
Repeat bankrupts would seem to be exactly the kind of people who should be targeted by any bankruptcy reform, and lenders have argued that multiple filings are a sign the system is being abused. Yet the proposals Congress has considered would do little to curb repeat filing and may even exacerbate the trend.
The bankruptcy reform bills Congress voted on last year that passed both houses last year would have forced more filers into Chapter 13 repayment plans. Since about two-thirds of such plans currently fail, opponents of the bills predicted many of those required to file Chapter 13s would likely wind up filing again for Chapter 7s.
Will better consumer education work?
Some have argued that better consumer education might help prevent future bankruptcies, and the bills would have required credit counseling for those diverted into Chapter 13. Most filers would avoid that requirement, however, since only those with above-average incomes would be subject to such diversion.
More than 80% of filers had incomes below the medians for their area, according to a 1998 study by the Executive Office of the United States Trustees, which supervises bankruptcy court administration. The Utah study found the median household income of filers was $24,000 for Chapter 13 filers and $16,500 for Chapter 7 filers, compared to a median household income in the state of over $45,000.
The reform bills did put more limits on automatic stay provisions, but they didnt change debtors ability to file a new Chapter 7 liquidation every six years. That repeated chance for a fresh start actually has roots in the Old Testament, which exhorts that debts be forgiven every seven years.
Theres something inherently American about the second chance, said Brady Williamson, a corporate bankruptcy attorney from Madison, Wis., who chaired a federal commission seven years ago that recommended modifications, rather than sweeping reform. The bankruptcy system offers the opportunity to try again.
The issue is academic for now since the Senate and the House could not agree on a compromise bill. Few congressional observers expect the issue to be revived before the November elections.
Are reports of repeat filers exaggerated?
But some bankruptcy experts question whether repeat filing is even an issue that requires congressional intervention.
Keith Lundin, a Nashville, Tenn., bankruptcy judge with 22 years on the bench, is one of those convinced that the impact of repeat filings has been exaggerated.
(Lenders) stood up in front of Congress and said we have to change the bankruptcy laws because the repeat filing thing is epidemic, Lundin said. Theres no data to support that claim. This is all anecdotal.
Lundin said provisions already in the bankruptcy code, such as lenders ability to have automatic stays lifted, can curb the most flagrant abuse. And he points out that many repeat Chapter 7s wouldnt happen if creditors werent so willing to lend to bankrupts.
You cant go broke unless someone is lending you money, Lundin said.
Glen Koster Sr. of St. John, Kan., found it difficult . . . but not impossible to get credit immediately after both of his bankruptcies. Koster filed the first bankruptcy in 1986 because of $35,000 in credit card debt and the increasing burden of an adjustable-rate mortgage; his second bankruptcy was the result of an eight-month stretch of unemployment.
The road to rebuilding our credit was accomplished the same way both times: the purchase of an automobile at above-market interest rates, Koster said.
Koster acknowledges that his first filing was a result of my own shortcomings, but he believes the second was out of his control. In either case, he doesnt feel he misused the bankruptcy system or walked away from any debt he could afford to repay.
Bankruptcy expert Williamson believes filers like Koster are far more the rule than the exception.
Do some people abuse the system? Of course they do, Williamson said. The question is, do you penalize the 98% or 99% who file because they have no choice to get at the ones who do?
Too little debt is erased
Researchers who have studied the issue say that far from receiving too much relief in bankruptcy court, many filers return because not enough debt was erased the first time around.
The Utah study, for example, found wiping away credit card and medical debts gave filers some breathing room, but many were left with substantial student loan, tax or child support obligations that couldnt be erased, according to professors Jean Lown and Barbara Rowe of Utah State University. Some try to hang on to homes despite burdensome mortgage and home equity loans.
Even after discharging their unsecured debts, the researchers wrote, these debtors are in trouble.
These so-called fragile consumers also seem more likely to be the victims of multiple setbacks, said Elizabeth Warren, who teaches at Harvard and recently co-authored The Two-Income Trap: Why Middle-Class Mothers & Fathers Are Going Broke. Once laid off, they may be forced to take poorerlower-paying jobs that leave them even more strapped -- and perhaps more vulnerable to future layoffs. Or they may have recurring medical problems and have trouble finding or paying for insurance.
Medical crises can cause multiple filings
Someone who has a serious medical problem, who has run up medical bills and has inadequate insurance, Warren said, is at serious risk of having it happen a second time.
Case in point: the Johnsons of Idaho. They filed Chapter 7 in 1986 and again 10 years later after being overwhelmed by family medical bills.
We had three children: one was asthmatic, one was born with a cleft lip and the other was ADHD (attention deficit/hyperactivity disorder), Arlin Johnson explains. I had three major surgeries from 1979 to 1984. My husband had one major hospital admission. My children had two major surgeries and chronic illness problems.
Like more than 40 million other Americans, the Johnsons were uninsured during that period. Studies by VISA indicate medical costs play a role in one out of five bankruptcies, and Elizabeth Warrens research indicates doctor and hospital bills directly cause 150,000 filings a year, or about one out of 10.
The bills are typically so high that they would overwhelm most emergency funds -- presuming the typical American family had such an account, and most dont. Only about one in three American households has savings equal to three or more months worth of income, according to a number of studies. More than 40% of American households have less than $1,000 in liquid savings, according to an analysis of Census Bureau financial data by SMR Research of Hackettstown, N.J.
Why save when you can always borrow?
That certainly describes John, who has never maintained an emergency fund and who has frequently used credit cards for living expenses when unemployed. He says he sees no reason to save as long as lenders are willing to extend him credit.
Ironically, lenders often see recent bankrupts as a better credit risk than those struggling with debt. The bankrupts owe less, since many of their bills have been erased, and they cant resort to Chapter 7 liquidation for another six years.
Besides, John says, anything I put together (in savings) would just get taken by the court in his next filing.
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