By Joe Liberman, J.D. candidate, Harvard Law School
STUDENT VOICES: The views expressed below are those of the student author and do not necessarily reflect the position of the Access to Justice Lab.
Bankruptcy is central to the American justice system. It is enshrined in the Constitution, and it is fundamental to our economy. More bankruptcy cases were filed in 2024 than all other civil cases in federal court combined. But our bankruptcy system is not designed for people to navigate it successfully.
A quick primer for those unfamiliar with the bankruptcy system: Individuals file for bankruptcy under either Chapter 7 or Chapter 13. Chapter 7 involves selling much of the debtor’s property to pay creditors. Assuming no other issues, the debtor is then discharged from liability for most debts, even if the sale of the debtor’s property raised was not enough to pay all debts back. The whole process typically takes less than six months to complete. Chapter 13 bankruptcy takes longer, but it may allow the debtor to keep more property. Over three to five years, the debtor follows a plan to pay all or a substantial portion of their debts. Any remaining debt is discharged at the end of the plan.
Most observers familiar with the system believe that bankruptcy is almost always too complicated to navigate without some kind of assistance, perhaps from a lawyer. The following figures are suggestive, although they did not come from a randomized study. Only 0.8% of Chapter 13 cases filed without a lawyer end in discharge, and Chapter 7 cases are nearly ten times more likely to fail when filed without a lawyer. But lawyers cost money, and hiring a bankruptcy attorney is not as easy as it sounds. Chapter 13 filers can take on debt to their attorneys to pay their fees later, but that debt gets discharged in a Chapter 7 and attorneys cannot be paid out of the bankruptcy estate. Accordingly, attorneys tend to require all of their Chapter 7 fees up front. The result is that despite Chapter 7 being an easier path to relief, the poorest filers are sometimes steered into ill-fated Chapter 13 filings by attorneys offering “no money down” bankruptcies. These offers are tempting, but the subsequent bankruptcy is usually unsuccessful and often leaves filers in worse financial straits. “No money down” bankruptcies are a growing problem, and one of our own making.
In short, the problem proceeds in three steps: (1) bankruptcy is so complicated that lawyers are necessary to navigate it successfully, but (2) the bankruptcy pathway best suited to the poorest filers is often too expensive, and (3) attorneys are incentivized to steer their clients away from Chapter 7.
Solutions, therefore, must make bankruptcy less complicated, less expensive, and realign attorney and client incentives. In my last blog, I introduced a few incentive-based solutions. This blog picks up where I left off: exploring possible solutions, understanding their tradeoffs, and proposing how we might study them.
Change Incentives
To recap the solutions proposed in my last blog: the authors of a recent paper sought to address “no money down” bankruptcies by changing attorney incentives. They suggest that if courts increase scrutiny on bankruptcy attorneys’ fees, which courts decide whether to approve, the expected profit for an attorney steering a client into an ill-advised Chapter 13 is lowered. The profit margin on “no money down” bankruptcies is already relatively slim, so if courts no longer rubber stamp attorneys’ fees, the decision to steer a client into an ill-advised Chapter 13 becomes less attractive to the attorney.
This proposal makes economic sense and does not require any congressional action, as courts set their own standards for approving bankruptcy attorneys’ fees. However, this change might only make a marginal difference. Data suggests that “no money down” bankruptcies are geographically concentrated and vary greatly by attorney and by race of the filer. This suggests that factors other than a pure profit calculation might be contributing to the phenomenon. Courts in locations where “no money down” bankruptcies proliferate would need to make these changes, and it would take time for a subtle incentive effect to take effect. As stated in my previous post, a randomized control trial should evaluate how effective judicial scrutiny is at curbing the abuses of “no money down” bankruptcies.
There is one additional flaw with this proposal: increasing judicial scrutiny does not make this overly complicated proceeding any simpler.
Decrease Complexity: Congressional Action
Because attorneys’ incentives contribute to the expansion of “no money down” bankruptcies, the problem might be best solved upstream by reducing the need for lawyers. The way to do that? Make bankruptcy less complex.
Bankruptcy was last reformed in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Those reforms were designed to and succeeded at reducing the number of Chapter 7 filings. BAPCPA made the process more complex, more expensive and more full of pitfalls for filers. After BAPCPA, over two-thirds of dismissed pro se Chapter 7s are due to failure to file required information, more than double the pre-BAPCPA rate. Increasing complexity, including via a complicated means test to file for Chapter 7, increases both the dismissal rate and attorneys’ fees. BAPCPA also added steps that bankruptcy filers must take outside of the required paperwork. Individual filers must complete credit counseling and debtor education despite a GAO study indicating that such counseling is largely ineffective. Further, the credit counseling and debtor education requirements must be completed separately, adding burden for filers.
Authors of a paper about how to enable access to justice in consumer bankruptcy propose several statutory reforms to simplify the process: reform and simplify the means test, make filing fee waivers (currently available to people with incomes less than 150% of the poverty line) easier to access, eliminate required credit counseling, and reduce duplicative information requirements. The advantages of these proposals are straightforward. Making the Chapter 7 process easier to navigate will enable more people to complete it without a lawyer’s help. Unfortunately, each of these proposed changes would require an act of Congress, and Congress has not passed bankruptcy reform in nearly two decades.
Decrease Complexity: Non-Congressional Action
There are promising avenues to reduce procedural complexity without congressional action. For example, anyone who files for bankruptcy must attend a 341 Meeting, or a meeting with the filer’s creditors. The trustee holds this meeting for the purpose of verifying the filer’s identity. Though straightforward (the meetings typically last only a few minutes), they are anything but easy for the filer. Legal aid providers describe the meeting as stressful because the debtor must confront their creditors, and—as is true for any other court appearance—they must leave work, arrange childcare, and figure out travel. Creditors rarely attend, but if the filer does not attend, their bankruptcy can be dismissed.
COVID prompted a change. The United States Trustee Program moved all 341 meetings online, and early qualitative evidence about the experience for bankruptcy attorneys and clients is promising. The Trustee Program is planning to make the change permanent. To the extent that there is random variation in the prevalence of remote versus in-person 341 meetings, further study could help quantify the effects of this change.
The Trustee and the Administrative Office of the US Courts could also work to improve their websites. The current webpage of bankruptcy forms lists over 130 forms without any explanation besides the title, a search feature, or any sort of assistant tool. Many government services are hampered by arcane web design. Making the website more helpful to filers would make the process easier to navigate.
Increase Information
While incentives have fostered an environment for “no money down” bankruptcies to proliferate, they have not made them a foregone conclusion. Some firms, even in areas where “no money down” bankruptcies predominate, navigate a high percentage of even their poor clients through Chapter 7. With more affordable fee structures and higher success rates available, why don’t more clients turn to these attorneys? The problem might be lack of information.
Requiring attorneys to disclose their bankruptcy statistics, or even a service where clients could review their lawyers, might help filers navigate the important differences between attorneys. If some jurisdictions began requiring such reporting, studies could compare “no money down” bankruptcies in jurisdictions with and without reporting.
While a fix that relies on people to do extensive research using a system with which they are unfamiliar might not yield dramatic results, it would be relatively straightforward to implement. Just as bar associations can require law firms to disclose their pro bono participation, they could require similar reporting regarding bankruptcy. The US Trustee’s website even directs filers to their state bar for information regarding firms offering bankruptcy services.
Conclusion
This year, hundreds of thousands of people will file for bankruptcy. Many will be unsuccessful because the system is too complicated and expensive. Many will be preyed upon by “no money down” bankruptcies that only leave them in greater debt. Bankruptcy needs an overhaul—and rigorous study to tell us what works.
If you’re interested in more on this topic, listen to our Proof Over Precedent podcast episode.