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We have certainly come a long way from the period in our history when debtors' prisons existed. Today, debtors are in a much more favorable position-they can fi le for protection under bankruptcy law. Indeed, after the Bankruptcy Reform Act of 1978 was passed, some claimed that we had gone too far toward protecting debtors and had made it too easy for them to avoid paying what they legally owed. Critics of the 2005 Bankruptcy Reform Act were concerned that the pendulum had swung too far in the opposite direction- favoring creditors' interests and making it too difficult for debtors to obtain a fresh start. Clearly, it is hard to protect the rights of both debtors and creditors at the same time, and laws governing debtor-creditor relationships have traditionally been perceived, by one group or another, as being unfair.
It is obviously impossible for the law to protect both debtors and creditors at all times under all circumstances. Attempts to balance the rights of both groups necessarily raise questions of fairness and justice. In this Focus on Ethics feature, we look at several aspects of debtor-creditor relationships that frequently involve issues of fairness, and we examine the ethical ramifications of the bankruptcy reform legislation for debtors and creditors.
Section 9-503 of the Uniform Commercial Code (UCC) states that "[u]nless otherwise agreed, a secured party has on default the right to take possession of the collateral. In taking possession, a secured party may proceed without judicial process if this can be done without breach of the peace." The underlying rationale for this "self-help" provision of Article 9 is that it simplifies the process of repossession for creditors and reduces the burden on the courts. Because the UCC does not define "breach of the peace," however, it is not always easy to predict what behavior will constitute such a breach.
One problem is that the debtor may not realize what is happening when agents of the creditor show up to repossess the collateral. Often, to avoid confrontation with the debtor and any potential violence or breach of the peace, a secured creditor will arrange to have the collateral repossessed during the night or in the early-morning hours, when the repossession effort is least likely to be observed. But a debtor who awakens in the night and sees his or her car being towed away may not realize that it is being repossessed.
At the same time, repossession can be risky for the creditor; if the repossession results in a breach of the peace, the creditor may be liable for substantial damages. Inevitably, repossession attempts will occasionally result in confrontations with the debtor. Indeed, some contend that the self-help provision encourages violence by providing an incentive for debtors to incite creditors to breach the peace, which may entitle the debtors to damages.
Ethics and Bankruptcy
As we have discussed, the first goal of bankruptcy law is to provide relief and protection to debtors. Society generally has concluded that everyone should be given the chance to start over. But how far should society go in allowing debtors to avoid obligations that they voluntarily incurred?
Consider the concept of bankruptcy from the point of view of the creditor. The creditor has extended a transfer of purchasing power from herself or himself to the debtor. That transfer of purchasing power represents a transfer of an asset for an asset. The debtor obtains the asset of funds, goods, or services, and the creditor obtains the asset of a secured or unsecured legal obligation to repay. Once the debtor is in bankruptcy, voluntarily or involuntarily, the asset that the creditor owns most often has a diminished value. Indeed, in many circumstances, that asset has no value. Yet the easier it becomes for debtors to discharge their debts under bankruptcy laws, the greater will be the incentive for debtors to use such laws to avoid paying amounts that are legally owed.
Clearly, bankruptcy law is a balancing act between providing a second chance for debtors and ensuring that creditors are given reasonable protection. Understandably, ethical issues arise in the process.
Bankruptcy and Economics
Among other things, when the number of bankruptcies increases, creditors incur higher risks in making loans-because bankruptcy shifts the cost of the debt from the debtor to the creditor. To compensate for these higher risks, creditors take one or more of the following actions: increase the interest rates charged to everyone, require additional security (collateral), or become more selective in granting credit. Thus, with more lenient bankruptcy laws, debtors who find themselves in bankruptcy will be better off, but debtors who will never be in bankruptcy will be worse off. Ethical concerns regarding this trade-off must be matched with the economic concerns of other groups of individuals affected by the law, especially in the economic environment after the Great Recession.
Consequences of Bankruptcy Under bankruptcy law, fi ling for personal bankruptcy (particularly under Chapter 7) is difficult. Although the stigma attached to bankruptcy today is less than it once was, bankruptcy is never easy for debtors. Many debtors feel a sense of shame and failure when they petition for bankruptcy. After all, bankruptcy is a matter of public record, and there is no way to avoid a certain amount of publicity. In one case, for example, a couple who fi led for Chapter 7 bankruptcy wanted to use their attorney's mailing address in another town on their bankruptcy schedules in an effort to prevent an elderly parent and one of their employers from learning about the bankruptcy. The court, however, held that debtors are not entitled to be protected from publicity surrounding the fi ling of their cases.1
A court in another case held that the public interest in information involving a particular bankruptcy debtor (Gitto Global Corporation) was important enough to justify disclosing a previously sealed report from a bankruptcy examiner. In essence, the court gave the media access to the bankruptcy examiner's report on the misconduct of more than 120 individuals at the debtor company.2
Bankruptcy also has other consequences for debtors, including blemished credit ratings for up to ten years and higher interest charges for new debts, such as those incurred through the purchase of cars or homes. Some private employers may even refuse to hire a job applicant who has filed for bankruptcy. The courts provide little relief for applicants who are denied a job for this reason.3
Thus, bankruptcy can have adverse effects for both debtors and creditors. Because of the consequences of bankruptcy, debtors do not always get the fresh start promised by bankruptcy law. At the same time, creditors rarely are able to recover all that is owed them once a debtor petitions for bankruptcy.
Investment Risk Management and Bankruptcy In the years leading up to the Great Recession, many investors opted to invest most or all of their funds in risky propositions that promised to yield ultra-high returns. Rather than simply seeking a healthy profit, these investors were looking for extraordinary gains. Too often, they were so certain of success that they failed to manage the risk of investment by diversifying their portfolios or holding some funds in reserve. Many were so overconfident that they borrowed additional funds to invest. When the recession hit, however, those risky investments came crashing down, and many investors were left unable to pay their debts and had to fi le for bankruptcy.
The combination of overdependence on credit and overconfidence in investments helped bring on the global economic crisis from which the United States has not yet fully recovered. What these investors lacked was a sense of self-sufficiency and a clear understanding of the importance of minimizing debt. A person or firm that minimizes debt and is financially self-reliant will be less affected by fluctuations in the market or difficulties in obtaining credit, and therefore will be less likely to be bankrupted in a recession.
So long as a breach of the peace does not result, a lender may repossess goods on the debtor's default under the self-help provision of Article 9. Do you think that debtors have a right to be told in advance about a planned repossession? Some observers argue that the self-help remedy under Article 9 should be abolished. Do you agree? Why or why not?