Bankruptcy trends in the US: Filings decline for the seventh year

Bankruptcy trends in the US: Filings decline for the seventh year

By Samuel J. Gerdano and Ed Flynn, American Bankruptcy Institute

The bankruptcy laws in the United States are designed to provide a fresh start to debtors and to give fair treatment to creditors. Many prominent corporations have filed in recent years, and about one out of eight adults in America has filed a personal bankruptcy case at least once during their lifetime. In this article, we present a brief overview of recent bankruptcy developments in the US.

 

Bankruptcy cases can be filed under six different chapters of the American Bankruptcy Code.1 The three major types are:

  • Chapter 7 (Liquidation): In chapter 7, a court-appointed trustee sells non-exempt property of the debtor and distributes the proceeds to creditors. Most chapter 7 cases are completed within four to six months of filing, at which time many of the debtors’ pre-petition debts are eliminated.
  • Chapter 13 (Repayment Plan for Wage-Earners): Chapter 13 allows debtors who have a regular source of income to pay some or all of their debts over a three- to five-year period. Chapter 13 is often used by individuals who are in danger of losing their homes to foreclosure due to missed mortgage payments. About 38% of chapter 13 cases result in a completed repayment plan. The other cases are either dismissed or converted to chapter 7.
  • Chapter 11 (Reorganisation): Chapter 11 is typically used to reorganise or liquidate an insolvent business, which may be a corporation, sole proprietorship or partnership. It is also used on occasion by certain individuals not eligible for chapter 13.

The three remaining chapters of the Bankruptcy Code are rarely used and account for less than one in 1,000 cases:

  • Chapter 12 (Reorganisation for Family Farmers and Fishermen).
  • Chapter 9 (Adjustment of Debts by Municipalities).
  • Chapter 15 (Cross-Border Cases).

 

Caseload

During calendar year 2017, there were 789,020 total bankruptcy cases filed in the US. This was the seventh consecutive annual decline in bankruptcy filings, down by 50.1% from the most recent peak in 2010. In the past, declines in bankruptcy filings typically lasted for one to three years, and the total decline from the peak was in the 10% to 20% range. The current decline is unprecedented in length, although larger proportionate declines occurred after the end of both World Wars.

Filings of both chapter 7 and chapter 13 cases declined less than 1% during 2017. The cumulative decrease in filings since 2010 has been 57.3% for chapter 7 cases compared to 32.9% for chapter 13 cases.

Figure 1 shows the extreme volatility of bankruptcy filings in recent years. Between 2001 and 2004, total filings averaged 1.58 million per year. In 2005, bankruptcy reform legislation was enacted and the surge in filings prior to the October 2005 effective date pushed filings up to over two million for the year. This was followed by a 70% decline in filings during 2006. Filings rebounded to pre-reform levels by 2010 as the Great Recession took hold in America, followed by the current seven-year decline.

 

Figure 1: Total bankruptcy cases filed 2000-17

 

Pro se cases

Between 8% and 9% of debtors file their bankruptcy case pro se (without an attorney).2 Often this does not end well for the debtor. Pro se filings rarely result in successful reorganisation for chapter 11 debtors, nearly all pro se chapter 13 debtors do not complete a repayment plan, and pro se chapter 7 debtors are far more likely to have their cases dismissed than those who are represented by attorneys.

 

Bankruptcy fees

There are a number of “user” fees associated with the American bankruptcy process. Together these fees raise over US$1bn per year. Consequently, administration of bankruptcy courts requires fairly little taxpayer money. The first fees are the ones due at filing. The current case filing fees can be seen in Figure 2.

 

Figure 2: Bankruptcy case filing fees

Type of case Amount
Chapter 7 US$335
Chapter 13 US$310
Chapter 12 US$275
Chapters 9, 11, and 15 US$1,717

 

 

Chapter 7 debtors may be granted a waiver of the filing fee if they can demonstrate an inability to pay. During FY 2017 approximately 4% of chapter 7 debtors were granted a filing fee waiver. In chapter 7 cases in which estate funds are collected and distributed by a trustee, the trustee is entitled to a percentage of the funds administered. The current fee schedule allows for a fee of 25% on the first US$5,000 administered, 10% on amounts from US$5,000 to US$50,000, 5% on amounts from US$50,000 to US$1,000,000 and 3% for amounts over US$1,000,000.

Chapter 13 trustees receive a fee of up to 10% of distributions, depending on location.3 For most debtors the fee is in the 5% to 8% range, and these fees pay the entire cost of the trustee operations.

The US Trustee Program,4 a component of the US Department of Justice, serves as the primary government entity to ensure compliance with bankruptcy laws. Their entire budget is paid for from a portion of the case filing fees and a fee on quarterly distributions in chapter 11 cases. The quarterly fee can be quite steep in the larger chapter 11 cases. In late 2017, the US Congress approved a bill which allows the quarterly fee to be as high as US$250,000 for cases with over US$25,000,000 in quarterly disbursements.

 

Chapter 11 cases

While chapter 7 and chapter 13 filings showed slight declines in 2017, filings of chapter 11 cases have increased very slightly for three consecutive years. However, even with these increases, chapter 11 filings are now less than one-half as high as their most recent annual peak in 2009.

Largest cases. Most chapter 11 filings involve relatively small entities. However, a small number of cases involve very large corporations. In these cases, billions of dollars of assets can be at stake, and total professional fees associated with the cases often amount to tens or even hundreds of millions of dollars. In 2017, there were 19 chapter 11 filings by publicly-held companies with over US$1bn in pre-petition assets, down from the 25 such cases in 2016.

 

Figure 3: Chapter 11 case filed nationwide 2000-17

 

Retail bankruptcy

There were an unusually large number of filings by retailers during 2017, especially during the first half of the year. In particular, there were a number of filings by retailers of clothing for teens and children. Although total sales volume continues to show healthy annual increases, competition from on-line retailers has squeezed some brick-and-mortar retailers.

The most prominent retail filing during the year was by Toys “R” Us, a very large toy retailer with more than 1,600 stores and 64,000 employees worldwide. Other prominent retailers that filed during the year included Gymboree, AeroGroup International, Rue 21, Payless Shoes, Max Azria, Wet Seal, HH Gregg, Alfred Angelo Bridal, Charming Charlie, and Radio Shack (a followup to their March 2015 filing).

 

Venue

There are 94 federal judicial districts in the US and its territories. In general, consumer debtors file in the federal district in which they live. Business debtors often have at least several possible places where they can file, including the state of incorporation, the location of principal assets, or in the district in which an affiliated company has already filed. In actual practice, this has meant that many of the largest business cases have been filed in the Southern District of New York (New York City) and the District of Delaware. These districts account about two-thirds of filings by large publicly held corporations.

From time to time legislation is proposed to require corporations to file where their principal assets or principal place of doing business is located.5 Proponents of venue reform argue that the current system allows forum-shopping and that cases are now filed in locations that have little connection to the debtor and its’ employees and creditors. Opponents of venue reform argue that business debtors should be allowed to choose to file in a district that has the expertise and experience necessary to handle complex reorganisations.

 

Puerto Rico

Puerto Rico has over US$70bn in public debt built up over a period of decades and the commonwealth has little ability to meet its debt obligations as they come due.6 Although citizens and businesses in Puerto Rico are able to file for bankruptcy relief under the various chapters of the Bankruptcy Code, the commonwealth of Puerto Rico and its municipalities are not eligible to file under chapter 9.

In June 2016, Congress enacted the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). A seven-member Financial Oversight and Management Board panel has been appointed to allow Puerto Rico to make reforms and achieve a resolution of claims with creditors. PROMESA established a legal framework similar to chapter 9, that allows Puerto Rico to restructure its’ debt, and in May 2017 there were a number of bankruptcy-like filings made.

Complicating efforts to restructure the debt in Puerto Rico debt was the catastrophic damage caused by Hurricane Maria in late September. More than five months later, electric power had not been restored to about one in six homes there.

As of early 2018 it is unclear how the twin problems of public debt and disaster recovery in Puerto Rico will play out. The court cases, which have been assigned to Southern District of New York Judge Laura Taylor Swain, are proceeding along. Rebuilding and recovery will require tens of billions of federal aid. Clearly, the situation in Puerto Rico will not be resolved for a number of years.

 

Clergy Abuse Chapter 11 cases

About 22% of the US population identifies as Roman Catholic. Bankruptcy courts continue to play an important role in resolving the aftermath of the clergy abuse crisis that has plagued the Roman Catholic Church in America. To date there have been 19 chapter 11 filings by dioceses or religious orders, including three that filed in 2017 (Diocese of New Ulm, Minnesota and the Diocese of Great Falls, Montana, and the Crosier Fathers and Brothers) and one that filed in early 2018 (Diocese of St. Cloud, Minnesota). To date, 13 of the cases have resulted in approved plans or reorganisation or dismissal, while work continues on the remaining six cases.

 

Bankruptcy commissions

In recent years the ABI has formed two commissions to study how the bankruptcy system is performing and to recommend improvements.7

 Chapter 11 Commission. The last major overhaul of chapter 11 of the Bankruptcy Code occurred in 1978. There is a general consensus among bankruptcy professionals that chapter 11 needs an updated toolkit to deal with new types of lending and increasingly complex debt and capital structures. The ABI Commission to Study the Reform of Chapter 11 issued its Final Report and Recommendations in December 2014. The 400-page report contained more than 200 discrete proposals to modernise the law.

A number of courts, including the Supreme Court, have cited the Commission report in case opinions, and Congress has begun to consider the proposals on small and medium-sized enterprises. For example, on March 7, 2018, a Senate Judiciary Subcommittee held a hearing to assess small business chapter 11 cases and the Commission’s recommended reforms regarding the restructuring of small and medium-sized enterprises.

Consumer Commission. In early 2018 the ABI formed a Commission on Consumer Bankruptcy to research and recommend improvements to the consumer bankruptcy system that can be implemented within its existing structure. These changes might include amendments to the Bankruptcy Code, changes to the Federal Rules of Bankruptcy Procedure, administrative rules or actions, recommendations on proper interpretations of existing law and other best practices that judges, trustees and lawyers can implement.

The Commission has a 17-member expert panel that is supported by three committees (Chapter 7, Chapter 13 and Case Administration). Each committee is comprised of five commissioners and 10 other bankruptcy experts. In 2017, the Commission and its committees held six public meetings where more than 70 individuals testified. The final report of the Commission will be released by the end of 2018.

 

Outlook for 2018

The American economy is doing well, and most forecasts have been fairly optimistic. Corporate profits are strong, the stock market is at an all-time high, and tax reform enacted in late 2017 has resulted in much lower corporate tax rates. Interest rates are expected to rise in 2018, which would increase the carrying cost of debt for both businesses and consumers. Barring any unforeseen developments, we expect that overall chapter 11 filings will remain at about the same levels as the last four years. However, we expect that filings by retailers and healthcare companies will be rather high in 2018, while filings by companies in the energy sector will continue to decline.

The outlook for consumers is also generally optimistic. Unemployment is low and wages are showing some growth. Take-home pay will increase during 2018 for most workers as a result of tax reform. However, household debt levels – including credit card debt and automobile loans -have been increasing. We expect that bankruptcy filings by consumers will increase very slightly in 2018 after seven consecutive years of decline. No area of the country is expected to see particularly high increases or decreases in filings during the year, and we do not anticipate that filings will return to 2010 levels, barring economic disaster or major legislation affecting bankruptcy.

It is particularly difficult to predict if and when there will be legislative changes that affect bankruptcy. Congress may consider changes with respect to the financial restructuring of banking and investment institutions that pose a substantial and systemic risk. Venue reform and changes to the Bankruptcy Code regarding the restructuring of small and medium-sized businesses are also likely to be considered. Legislation concerning student loan debt and medical debts may be proposed as well. However, the increased partisanship in American politics of late has made it less likely that any proposals will actually be enacted into law.

 

Notes:

The American Bankruptcy Institute is a non-partisan organisation with more than 10,000 members including attorneys, bankers, professors, judges, turnaround specialists and other professionals. The purpose of the American Bankruptcy Institute is to support the analysis of insolvency issues, both in the US and internationally; to provide a source of education regarding these issues; and to serve as a forum for the exchange of ideas among participants in the insolvency process.

1 See Title 11 US Code, available at www.law.cornell.edu/uscode/text/11.

2 Pro se filings are particularly high in California – the most populous state. About 17% of filings there are filed pro se.

3 The Director of the Executive Office for United States Trustees sets the percentage fee for each trustee.

4 Bankruptcy Administrators, who are not part of the Department of Justice, serve in the same capacity in two states: North Carolina and Alabama.

5 The most recent venue reform bill was introduced in the US Senate in January 2018. One of the co-sponsors is Senator Elizabeth Warren, who was a very prominent bankruptcy professor at Harvard prior to entering the Senate. The bill would have no impact on the venue choice of chapter 15 cross-border proceedings. See: https://

www.congress.gov/115/bills/s2282/BILLS-115s2282is.pdf

6 The ABI has a section of its’ website devoted to covering the crisis in Puerto Rico. See: https://www.abi.org/PR-crisis

7 The website for the Chapter 11 Commission is: commission.abi.org,and the website for the consumer Commission is: https://consumercommission.abi.org/

 

Authors:

Samuel J. Gerdano, Executive Director

Ed Flynn, Consultant

American Bankruptcy Institute

Tel: +1 703 739 0800

Email: sgerdano@abiworld.org

Email: eflynn@abiworld.org

Website: www.abiworld.org