Lawyers Push High-Fee Bankruptcies
December 14, 2010
Five of each 1,000 American households filed for bankruptcy last year. That's four times the 1980 rate. Almost as worrisome as the jump in filings is new evidence that suggests lawyers often recommend a bankruptcy path that triples fees and brings clients less relief than cheaper options.
Bankruptcy is the process through which the insolvent are relieved of debt. There are six main variations described in the U.S. Code, two of which apply broadly to individuals (as opposed to entities like corporations and municipalities or to members of specific occupations like family farmers).
Chapter 7 bankruptcy (named for its place in the Code) involves the liquidation of assets followed by a speedy discharge of most unsecured debt (apart from some exempted items, like federal student loans). Under Chapter 13 bankruptcy, the debtor keeps personal property and sets up a court-approved repayment plan lasting several years. Upon completion, remaining debts are discharged. Both forms of bankruptcy free individuals from further collection attempts and correspondence by creditors.
Broadly speaking, Chapter 7 bankruptcy brings faster and greater relief. Only 5% of Chapter 7 cases involve asset liquidations because most filers have few assets that courts are interested in seizing (think paid-off property, not microwave ovens). Chapter 7 bankruptcies stay on credit records longer, but ironically, they often make filers better credit risks because they carry no ongoing payments.
Also, Chapter 7 carries much lower fees – a little over $700 for a typical filing, versus more than $2,400 for Chapter 13. There's an income limit for Chapter 7 filers, but it takes debt payments into consideration, and some 95% of filers qualify.
Only about two-thirds of filers choose Chapter 7 over Chapter 13, however.
Researchers at Brigham Young University and Rutgers have reason to believe the number should be much higher. In a paper published recently in the Berkeley Electronic Journal of Economic Analysis & Policy, they show that when a client visits a lawyer who favors Chapter 13 in general, their chances of filing under 13 increase by 35 percentage points.
Their chances of a failed bankruptcy soar, too. Some 60% of Chapter 13 cases are dismissed because clients fall behind on their payments.
Some clients feel it's their moral duty to continue paying under Chapter 13, but too often they end up paying lawyers rather than creditors. Chapter 13 legal fees tend to be built into payment plans. (That makes clients less sensitive to the size of the fees, researchers say.) The rules allow lawyers to collect their fees from the earliest payments before other creditors are paid. In a post-mortem on failed Chapter 13 cases in Texas, the aforementioned study authors found that filers paid less than 2% of their unsecured debts. In 40% of cases, lawyers were paid more than all other creditors combined.
"The right number of Chapter 13 cases is not zero, but it's likely closer to one-tenth of cases rather than one-third," says Lars John Lefgren, one of the study authors and an economics professor at Brigham Young. "Considering their financial incentives, lawyers perhaps shouldn't be the ones steering people into Chapter 13."
Five of each 1,000 American households filed for bankruptcy last year. That's four times the 1980 rate. Almost as worrisome as the jump in filings is new evidence that suggests lawyers often recommend a bankruptcy path that triples fees and brings clients less relief than cheaper options.
Bankruptcy is the process through which the insolvent are relieved of debt. There are six main variations described in the U.S. Code, two of which apply broadly to individuals (as opposed to entities like corporations and municipalities or to members of specific occupations like family farmers).
Chapter 7 bankruptcy (named for its place in the Code) involves the liquidation of assets followed by a speedy discharge of most unsecured debt (apart from some exempted items, like federal student loans). Under Chapter 13 bankruptcy, the debtor keeps personal property and sets up a court-approved repayment plan lasting several years. Upon completion, remaining debts are discharged. Both forms of bankruptcy free individuals from further collection attempts and correspondence by creditors.
Broadly speaking, Chapter 7 bankruptcy brings faster and greater relief. Only 5% of Chapter 7 cases involve asset liquidations because most filers have few assets that courts are interested in seizing (think paid-off property, not microwave ovens). Chapter 7 bankruptcies stay on credit records longer, but ironically, they often make filers better credit risks because they carry no ongoing payments.
Also, Chapter 7 carries much lower fees – a little over $700 for a typical filing, versus more than $2,400 for Chapter 13. There's an income limit for Chapter 7 filers, but it takes debt payments into consideration, and some 95% of filers qualify.
Only about two-thirds of filers choose Chapter 7 over Chapter 13, however.
Researchers at Brigham Young University and Rutgers have reason to believe the number should be much higher. In a paper published recently in the Berkeley Electronic Journal of Economic Analysis & Policy, they show that when a client visits a lawyer who favors Chapter 13 in general, their chances of filing under 13 increase by 35 percentage points.
Their chances of a failed bankruptcy soar, too. Some 60% of Chapter 13 cases are dismissed because clients fall behind on their payments.
Some clients feel it's their moral duty to continue paying under Chapter 13, but too often they end up paying lawyers rather than creditors. Chapter 13 legal fees tend to be built into payment plans. (That makes clients less sensitive to the size of the fees, researchers say.) The rules allow lawyers to collect their fees from the earliest payments before other creditors are paid. In a post-mortem on failed Chapter 13 cases in Texas, the aforementioned study authors found that filers paid less than 2% of their unsecured debts. In 40% of cases, lawyers were paid more than all other creditors combined.
"The right number of Chapter 13 cases is not zero, but it's likely closer to one-tenth of cases rather than one-third," says Lars John Lefgren, one of the study authors and an economics professor at Brigham Young. "Considering their financial incentives, lawyers perhaps shouldn't be the ones steering people into Chapter 13."
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