Levitin on Bankruputcy: Creditors Looking in the Wrong Places

Adam Levitin looks at the bankruptcy petitions related to the notorious White House gatecrashers and draws an important lesson:

What is interesting about the Oasis cases is that they indicate that Congress might have been looking for bankruptcy abuse in the wrong place. Cries about bankruptcy abuse are normally aimed at plain vanilla consumer bankruptcies. The Oasis cases show that there is a specter of abuse (and much more galling abuse) in small business bankruptcies, where the small business is the alter ego of the owner. Wealthy debtors are often smart enough to operate behind some sort of corporate form. They might have to give personal guarantees of some of their debts, but the corporate form insulates them from tax authorities, public utilities, tort creditors, and unsophisticated creditors. (Card issuers usually want to see substantial corporate income before forgoing a personal guarantee.) Corporate law is relatively forgiving when it comes to veil-piercing---disregarding the corporate form to hold the business's owners personally liable. If corporate formalities (record keeping, e.g.) are honored, extraordinary facts are generally necessary to pierce the veil. This means that for small businesses, the corporate form offers a way to screw government, involuntary, and unsophisticated creditors. Of course, none of those groups come with the lobbying might of the sophisticated creditors who cried abuse over credit card debt being discharged in consumer 7s.

Link. A couple of afterthoughts. A lot of bankruptcy professors have decried the 2005 Amendments (which so tightened the screws on consumer bankrupts) on grounds of fairness. I'm not very sympathetic with the 2005 amendments either, but for a slightly different reason. My own take is that they were/are unlikely to lead to any substantial increase in the collection of debts from consumers, while increasing the cost of collection--a deadweight loss. My take is that the amendments were sold not by "the creditors" per se so much as by the creditors' lobbyists. Recall that lobbyists live on lust and fear and thwarted hopes--lust for more goodies, or fear of something bad, or the thwarted hope that they could get something if only Congress got out of the way.. It was the lobbyists, I suspect, who sold their customers on the proposition that (a) there was a lot of money out there hiding behind bankruptcy discharges; and (b) they could get it if only they made bankruptcy more costly or inconvenient.

What's wrong with this logic? The defect is that these debtors are broke. Not completely broke, of course--otherwise they wouldn't need bankruptcy protection. But broke enough that increased collection efforts are unlikely to yield much beyond mere increased costs. Net out the costs of lobbying and there is likely nothing left for creditors at all. So the legendary gains that the 2005 amendments seemed to promise were just that--a legend--from the very start. The data so far is fragmentary, but it seems to bear the point out.

There are, of course, the horror stories that make (or used to make) the news--the rich dentist with a sex abuse conviction who succeeds in walking away with all his live assets in a protected retirement account, or some such. But on all the data, these cases have to be few and far between. And as Letvin points out, the chances are that a good many of them weren't "straight" bankruptcy cases to begin with.