by Scott Schuster

In 2005, a record number of debtors filed bankruptcy prior to the effective date of the amendments to avoid the amendments to the bankruptcy code that made it more difficult for debtors to file bankruptcy. After the amendments took effect, the number of bankruptcies being filed nosedived. Many people attributed the lower number of filings to the new amendments. Those “in the know” realized that the shortage in bankrutpcy filings was a result of the high number of bankruptcies filed just before the amendments took effect. We all believed that the new amendments, while more budensome for debtors, would not significantly lower the number of bankruptcy filings in the long term.

Not surprisingly, according to the United States Trustee’s office, bankruptcies are once again on the rise at near record levels. See http://www.uscourts.gov/bnkrpctystats/bankruptcystats.htm. Of course, with the economy in a deep recession, this news is not unexpected. With the rise in bankruptcies, here are a few things to keep in mind as a creditor:

First, debtors are finding themselves overextended with credit cards, lines of credit and other unsecured loans. If a debtor comes to you asking for credit, it is extremely important in these times to do your homework to make sure that the debtor is able to repay any credit you extend. That means more than just asking for paystubs or bank account information. Often, Debtors with high income levels have high expenses. It’s important to check both before extending credit.

Second, now more than ever, cash up front is a creditor’s best friend. If you don’t extend credit, or only extend minimum credit amounts, you’re less likely to get burned by a debtor filing bankruptcy. Right now, it may be better to turn down a sale than to sell product that ultimately is never paid for.

Finally, preference actions are on the rise. In the past few months, our office has seen a significant increase in the number of preference actions being filed against creditors. As a creditor, its important to know that you may have valid expenses that can reduce or even eliminate your preference exposure. If you find yourself on the wrong end of a preference action, experienced bankruptcy counsel might be able to help.

Bob Bernstein’s Get P.A.I.D. book has a lot of helpful tips for managing your business in a struggling economy. The economy is something that we all have to deal with and it appears that only the strong will survive. Have a plan, be prepared, and you too can survive these trying times.

Who’s responsible for this mess?

The facts of a recent bankruptcy case perfectly illustrate one aspect of the recent economic collapse - loan defaults. In the case, a 51 year old, disabled and unemployed debtor making approximately $5,000 per year from social security disability took a $20,000 cash advance from his credit card. The cash advance represented approximately three times his yearly income from social security disability. The debtor used most of the money to pay other bills, such as his mortgage and utilities. He spent the remainder of the money on miscellaneous items, such as clothing, food, and gasoline. One week after taking the cash advance, he filed bankruptcy and sought to discharge the credit card loan.

The creditor challenged the debtor and sought to have the loan declared “nondischargeable.” The creditor argued that the debtor committed fraud because it was clear that the debtor could not possibly repay the debt. The debtor’s response was that the credit card company never should have loaned an unemployed and disabled person living on extremely fixed income $20,000.

So who’s responsible? Was it the debtor for taking out a loan that he couldn’t possibly afford to repay? He was desperate to pay his bills and the credit was readily available.

Was the lender at fault for extending $20,000 in credit to someone making less than $5,000 per year? The lender argued that the credit card was opened when the debtor had significantly higher income and that the lender had no idea of the debtor’s disability.

Both sides have compelling arguments but, in my opinion, THEY’RE BOTH RESPONSIBLE. Borrowers should take responsibility for their actions and so should lenders. Pointing the finger at each other is the easy way out and does not solve the underlying problem. Similar incidents are playing themselves out across the county, only, in many instances, the “debtor” is a large bank, the “creditor” lending the money is an even larger bank, and the loans are more than $20,000; they’re more like $20 million. Everyone’s pointing the finger at the banks, but let’s not forget about the debtors that borrowed more than they could afford.

Unfortunately, the credit lending standards of the last few years were so loose and so easy that such a scenario was possible. The economy was healthy enough that the financial institutions were able to conduct little or no due diligence before lending large sums of money. Debtors (individuals, small and large corporations, and even federal, state and local governments) slowly began to rely on this “easy credit” access, resulting in deficit spending across the board.

As debtors began to get in over their heads and defaults began to occur on a large scale, the economy suffered. As the economy failed, everyone suffered, including those that acted responsibly. Responsible debtors that only borrowed what they could afford to pay back were hurt by the economy when their retirement assets lost value. Similarly, responsible lenders that conducted proper due diligence before extending credit suffered as investor confidence dropped and stock prices plummeted. Hopefully, individuals, corporations, lenders and government leaders alike will learn from these mistakes.

The logic behind Pennsylvania’s arcane wage attachment laws escapes me. I cannot figure out why the Commonwealth wants to protect debtors at the expense of legitimate creditors.  What are the drawbacks to adopting more liberal wage attachment laws? Who does it hurt? The vast majority of people pay their bills, in full, when they come due and would to be affected by wage attachment. Only small minorities of people do not pay their bills and I can see no reason why the legislature would want to protect those people. Unfortunately (and inexplicably), Pennsylvania has some of the most restrictive wage attachment laws in the country.

The vast majority of states allow commercial creditors to garnish a percentage of a debtor’s wages. For example, in Alabama and California, a creditor may attach up to twenty-five percent of a debtor’s “disposable” income (i.e. income remaining after paying certain “necessities,” such as food, shelter, taxes, etc.).

Only four states prohibit or severely restrict wage attachment. South Carolina is the only state that completely prohibits wage attachment. New Hampshire prohibits “continuous attachment,” which means that creditors must file a new lawsuit each time they want to garnish a paycheck (which is rarely cost effective). Texas allows wage attachment only to pay child support.

Similarly, in Pennsylvania, wage attachment is only available to pay taxes and child support. This is particularly problematic for creditors in Pennsylvania because Pennsylvania law prohibits execution against jointly owned (marital) assets unless a creditor has obtained judgment against both husband and wife.

Two justifications have been proposed in support of Pennsylvania’s restrictive wage attachment laws. First, the legislature is concerned that wage attachment will have the effect of forcing some debtors into poverty, thereby forcing the state to bear the cost of supporting those debtors. Second, supporters believe that wage attachment is counter productive because debtors, upon receiving less of their income and having less incentive to work, quit their jobs and apply for welfare.

In the coming weeks and months, I intend to contact our local state senators and congressmen about wage attachment in Pennsylvania. There may just be support to expand the attachment laws for the benefit of all Pennsylvanians. Stay tuned . . . 

We’ve added a couple new attorneys to our blog.  Scott Schuster, an associate with the firm’s Bankruptcy & Restructuring practice area, and Shawn McClure, an associate with the firm’s Creditors’ Rights practice area.  Look for their posts in the future.