The fresh start in consumer bankruptcy

Over-indebtedness is only marginally mentioned in the provisions of the Consumer Credit Directive. However, in Member States, new legal mechanisms are being explored to free over-indebted consumers from high debt obligations. While this can be a socially desirable objective, it is clear that the interests of creditors have to be taken into account. Consumer bankruptcy has become a topical issue in the wake of the financial crisis, which has led to a marked increase in bankruptcy filings.[1]

The consumer bankruptcy discharge approach is historically part of US bankruptcy law, established by the American Federal Bankruptcy Act (1898).[2] This bankruptcy model aims to provide the debtor with the possibility of a ‘fresh start’ by terminating most of the debts existing at the time of filing in a relatively short period and to ensure that creditors are repaid to the extent that the debtor has the financial means available.[3]

The US bankruptcy law has been modified several times, most recently by the ‘Bankruptcy Abuse Prevention and Consumer Protection Act’ (BAPCPA) of 2005. This Act had been influenced by lenders lobbying for a less debtor-friendly bankruptcy law, in reaction to a significant growth of bankruptcy filings. Accordingly, the Act increased the costs of filing and introduced, in general, less favourable conditions for debtors, which are likely to reduce the requests for bankruptcy procedures.[4] Previous to BAPCPA, individuals could decide between two key bankruptcy procedures (Chapter 7 or13 ofthe US Bankruptcy Code). The option of Chapter 7 offered a quick discharge and the debtors only had to repay from their assets above an exemption level, whereas the income received after the bankruptcy remained untouched. This type of procedure was chosen for a majority of consumer bankruptcies.[5] On the other hand, the option under Chapter 13 required debtors to repay part of their debt using their income, over a longer duration (three to five years), but exempted their assets. Debtors who wished to choose this type of procedure needed to have a regular income and their debt should remain within a specific limit.[6]

Alter the adoption of BAPCPA, both types of procedure remain applicable. However, debtors can no longer choose between the two options offered under Chapters 7 and 13. Instead, in order to qualify for the procedure under Chapter 7, debtors have to show that their incomes are below a specific threshold. Otherwise, they fall under the procedure in Chapter 13.[7] Moreover, under Chapter 13 debtors can no longer propose their own repayment plans, but a new ‘means test’ establishes the amount to pay from their income.[8] Finally, among other changes, the bankruptcy costs have been increased and the minimum time between bankruptcy filing lengthened, so that the new legal regime has generally become more burdensome for the debtor.[8] Despite these changes, according to some experts, the US bankruptcy system remains still debtor-favourable in comparison to the regimes offered by a majority of EU countries in this field.[10]

Recent comparative research on bankruptcy regimes in a number ofEuropean countries shows a large variety of models.[11] For example, the UK contains a regime that is, in certain aspects, similar to the US bankruptcy model. The 1986 Insolvency Act in the UK deals with bankruptcy procedures and has subsequently been amended by the Enterprise Act 2002 to modernize insolvency law. A major modification introduced by Part 10 of this Act reduced the required duration before debt discharge from three years to one year.[12] The courts in England and Wales can start the procedure by making a bankruptcy order after a petition by the debtor or creditor has been submitted. As a result, the assets of the bankrupt are managed by a trustee who is responsible for the sale of the assets to pay the creditors and a number of restrictions are placed on the bankrupt debtor. After a period of 12 months debtors are generally discharged from bankruptcy, relieving them from their debts.

In Germany, the Insolvenzordnung Act of 1999 deals with insolvency of both companies and consumers. This Act also provides the possibility of debt relief, however, after a significantly longer period of ‘good conduct’ than in the UK. A debtor can request such a procedure, which starts with an obligatory negotiation period between creditor and debtor and then continues with a settlement before the court.[13] If these phases remain inconclusive the debtor is allowed to request the court for a discharge of residual debt, which may be granted after six years of good conduct and the regular transfer of a determined part of the income to the creditor.[13]

Other EU countries in turn have only very restrictive bankruptcy systems, such as those of Spain and Ireland.[15] However, in Europe as a whole there is a gradual trend towards adopting new bankruptcy provisions facilitating debt discharge of the debtor after a period of good conduct.[16] This is often regarded as an important social and economic policy objective to foster entrepreneurship and allow a fresh start for individuals. As we have described previously, long durations of over-indebtedness can significantly lower welfare of households, which may, in certain circumstances, impinge on the human right to dignity. On the other hand, procedures that discharge debtors too easily from their debts may be incompatible with the human right to property of the creditor.

A 2004 judgment of the European Court of Human Rights dealt with exactly this issue.[17] In Back v Finland a Finnish creditor argued that a Finnish 1993 Act on the Adjustment of Debts violated his right of property under Article 1 of Protocol 1 of the ECHR without serving a legitimate aim in the general interest. However, the Court decided that there had been no violation of property according to Article 1 of the Protocol, namely because the interference with the applicant’s property rights was justified by a general public interest, given that the Finnish debt adjustment legislation served legitimate social and economic policies. Thus, this judgment recognized the important nature of the bankruptcy procedure to promote legitimate social and economic objectives from a human rights perspective. This can justify limitations to property rights, as long as the burden imposed is not excessive.

The ‘fresh start’ philosophy inherent in the consumer bankruptcy model explained in this section in a sense reflects a capability perspective: it can quickly re-integrate consumers into the market, allowing them to regain their full capabilities, and to participate once again in the economy. Moreover, it also has a positive impact on inclusion, thus responding to a principle of solidarity.[18] Finally, by de facto imposing negative effects for improvident credit extensions, the bankruptcy discharge can also have a preventive effect on reckless lending, which has, in turn, been identified as a contributing factor to over-indebtedness.[19]

  • [1] M. Gerhardt, ‘Consumer Bankruptcy Regimes in the US and Europe’, CEPS WorkingDocument No. 318/July 2009.
  • [2] C. Tabb, ‘The Historical Evolution of the Bankruptcy Discharge’ , (1991) 65 AmericanBankruptcy L. J., p. 325.
  • [3] See U. Reifner,‘Personal Bankruptcy Law and Inclusive Contract Law’, in Niemi-Kiesilainen,Ramsay, & Whitford (eds), Consumer Bankruptcy in Global Perspective (n 18), p. 145; Gerhardt,‘Consumer Bankruptcy Regimes in the US and Europe’ (n 138), p. 2.
  • [4] See the report by A.B. Ashcraft, A.A. Dick, & D.P. Morgan, The Bankruptcy Abuse Preventionand Consumer Protection Act: Means-Testing or Mean Spirited? (Federal Reserve Bank of New York,Report no. 279, March 2007); M.J. White, ‘Abuse or Protection? Consumer Bankruptcy Reformunder «BAPCPA»’, (2006) 18/19 Revue de Plnstitut d’Economie Publique 1/2.
  • [5] Gerhardt (n 138).
  • [6] I. Livshits, J. MacGee, & M. Tertilt, ‘Consumer Bankruptcy: A Fresh Start’, (2007) 97(1) Am.Econ. Rev., pp. 402-18.
  • [7] White, ‘Abuse or Protection? Consumer Bankruptcy Reform under «BAPCPA»’ (n 141), p. 10.
  • [8] White (n 141), p. 10.
  • [9] White (n 141), p. 10.
  • [10] See the report by Ashcraft, Dick, & Morgan, The Bankruptcy Abuse Prevention and ConsumerProtection Act: Means-Testing or Mean Spirited? (n 141).
  • [11] See R. Anderson, H. Dubois, A. Koark, G. Lechner, I. Ramsay, T. Roethe, & H. Micklitz(eds), ‘Consumer Bankruptcy in Europe: Different Paths for Debtors and Creditors’, EUI WP Law2011/09; see also Gerhardt (n 138).
  • [12] For more information, see Gerhardt (n 138), p. 6.
  • [13] See Gerhardt (n 138), p. 8.
  • [14] See Gerhardt (n 138), p. 8.
  • [15] For more information see Gerhardt (n 138).
  • [16] S. Viimsalu, ‘The Over-Indebtedness Regulatory System in the Light of the ChangingEconomic Landscape’, (2010) 17 Juridica International.
  • [17] ECtHR, BackvFinland,App. no. 37598/97, 20 July 2004.
  • [18] Reifner, ‘Personal Bankruptcy Law and Inclusive Contract Law’ (n 140), p. 156;J. Niemi-Kiesilainen, ‘Collective or Individual? Construction of Debtors and Creditors inConsumer Bankruptcy’, in Niemi-Kiesilainen, Ramsay, & Whitford (eds), Consumer Bankruptcy inGlobal Perspective (n 18), pp. 46-7.
  • [19] Niemi-Kiesilainen, Ramsay, & Whitford (n 18), p. 7.
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