Disorderly and Discriminatory: the Bankruptcy Code's Treatment of Disabled Debtors

• Publication year: 2021

Disorderly and Discriminatory: The Bankruptcy Code's Treatment of Disabled Debtors

Madeline Thatcher

DISORDERLY AND DISCRIMINATORY: THE BANKRUPTCY CODE'S TREATMENT OF DISABLED DEBTORS

Abstract

Disability benefits in bankruptcy face uncertainty under the current exemption system. The enumerated federal exemptions are poorly drafted, lack useful legislative history, and classify benefits depending on the benefit's source. The opt out provision found in section 522(b) of the Bankruptcy Code allows jurisdictions to limit debtors to the state's exemptions rather than the federal exemptions. Depending on which exemption the court places the disability benefits under, the benefits may be fully exempt from the bankruptcy estate, limited to the amount reasonably necessary for the debtor's support, or unexempt. The bankruptcy courts struggle to uniformly apply the federal and state exemptions, resulting in three main issues. First is the classification of the disability benefits, which determines if the benefit will be fully exempt, unexempt, or partially exempt. Second is the poorly drafted federal exemptions create temporal issues for disability benefits, including past benefits and the right to future benefits. Third is the courts' struggle with the form of the disability benefits, especially if the benefit is not cash, and struggle to decide whether the exemptions also cover funds deposited and goods purchased with the funds.

This Comment proposes several amendments to the Code to combat the three main issues for disability benefits: first, defining the term disability benefit in section 101 of the Code; second, redrafting the exemptions in section 522; and third, eliminating the opt out provision solely for disability benefits in section 522(b). Finally, the proposed system is directly compared with the current exemption system, demonstrating the proposed system's equity and ease of application.

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Introduction

Imagine an ordinary man named Joe. Joe worked a blue-collar job for years and was injured at the workplace. Although Joe received disability payments through his job, he was unable to return to work due to his injuries. Joe began to fall behind on his mortgage. Joe accumulated credit card debt paying for basic necessities. Faced with hounding creditors, Joe turned to bankruptcy and filed a chapter 7 case. Joe soon finds out his only source of income—the disability payments he received from his employer—are being reduced by the court to pay off creditors. As Joe is waiting outside the courthouse, he bumps into an old friend, Bob. Bob has also filed for bankruptcy following a workplace injury. Bob was awarded Social Security Disability Income (SSDI). Bob tells Joe that his SSDI is not available to his creditors. In disbelief, Joe calls up his friend Suzy from a few states over and finds out she is in the exact same situation; however, she gets to keep all of her private disability payments. This unfair situation occurred because the Bankruptcy Code allows for the inequitable treatment of disabled individual debtors depending on where the debtor resides and the form of disability received.

The Code discriminates against disabled debtors in several ways. First, the Code allows for states to "opt out" of the enumerated federal bankruptcy exemptions, which results in different results in different jurisdictions. Second, the Code and various state laws classify disability payments differently depending on their source. For example, social security, a private disability policy, a worker's compensation award, and personal bodily injury are all classified differently. This classification determines whether the payments are exempt in full, partially exempt, or not exempt at all.

This Comment will explore the harsh realities that disabled debtors face as courts struggle to apply the exemptions in section 522(d) and applicable state law to determine whether the debtor's disability payments are entirely exempt, partially exempt, or nonexempt.¹ This Comment will first demonstrate the conflicting applications of the current exemption system. Next, this Comment will propose several amendments to rectify the issues. Finally, this Comment will demonstrate the equity of the proposed system by directly comparing it to the current exemption system.

Section 522(d) lists the exemptions from the bankruptcy estate for individual debtors.² This Comment will discuss the following exemptions in detail: section

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522(d)(10)(A) (the "SSDI Exemption"), which exempts from creditors the debtor's right to receive a social security benefit;³ section 522(d)(10)(C) (the "Disability Exemption"), which exempts from creditors the debtor's right to receive "a disability, illness, or unemployment benefit;"⁴ section 522(d)(10)(E) (the "Contract Exemption"), which exempts from creditors the debtor's right to receive "payment under a stock bonus, pension, profit sharing, annuity or similar plan or contract on account of illness, disability" to the extent reasonably necessary for the support of the debtor;⁵ section 522(d)(11)(D) (the "Personal Injury Exemption"), which exempts from creditors payment, "not to exceed $25,150, on account of personal bodily injury;"⁶ and section 522(d)(11)(E) (the "Future Earnings Exemption"), which exempts from creditors the debtor's right to receive, or property that is traceable to, "a payment in compensation of loss of future earning of the debtor . . . to the extent reasonably necessary for support of the debtor . . . ."⁷ While these separate Code provisions seem simple, each may cover a disability benefit or payment depending on how the debtor receives the payments. As one court notes "parsing exemption claims concerning lost income disability payments is like hacking one's way through a thicket."⁸

The confusion does not end with the enumerated federal bankruptcy exemptions. Section 522(b) allows for the debtor to choose between the exemptions enumerated in section 522(d) and the exemptions under state law.⁹ If a state chooses, it may expressly limit debtors to the exemptions available under state law. This option, notoriously called the "opt-out" provision, has been a source of controversy since the Bankruptcy Reform Act of 1978.¹⁰ Thirty-five states have "opted out" under section 522(b) and only allow debtors to use state law exemptions.¹¹ The remaining fifteen states and the District of Columbia allow debtors to choose between the federal exemptions and state law exemptions.¹²

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I. Background

This Section will explore the origins and purposes of exemptions, the history of the federal exemption opt-out scheme, and the dated judicial basis for the lack of personal uniformity in the bankruptcy courts, which injures and discriminates against disabled debtors. Since the beginning of bankruptcy law, debtors have been able to exempt a portion of their property from the bankruptcy estate and the reach of creditors.¹³ The "purpose of an exemption is to protect a debtor and his family against absolute want,"¹⁴ preserving the fresh start.¹⁵ Although only mentioned once in the code, the fresh start strives to separate debtors from their pre-bankruptcy life and allow them to successfully reenter the economic sphere.¹⁶ Exemptions from the bankruptcy estate serve "to facilitate a debtor's 'fresh start' by allowing retention of sufficient resources to sustain basic needs; creditors are entitled to the balance, if any."¹⁷ Exemptions are only available to individual debtors.¹⁸

When the Commission on the Bankruptcy Laws of the United States was created, it criticized allowing states to use their own exemptions, calling the system "intolerable for what is supposed to be a national, uniform system and destructive to the goal of rehabilitation of individual debtors."¹⁹ The Commission advised eliminating the state exemption scheme in favor of a single federal list of exemptions.²⁰ The Senate's bill reflected the Commission's recommendations and did not offer an opt-out for states, but the House version did.²¹ Ultimately, a compromise was reached and the House version was adopted with the lower exemption dollar amounts the Senate bill contained.²²

The Constitution grants Congress the exclusive authority to establish "uniform Laws on the subject of Bankruptcies throughout the United States."²³

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While this clause seems straightforward, "[a]ny such simplistic reading of the Bankruptcy Clause has not proven correct, especially in the area of exemptions."²⁴ Interpreting the Bankruptcy Act of 1898, the Supreme Court held in Hanover National Bank that the Bankruptcy Clause does not require personal uniformity, only geographical uniformity.²⁵ Hanover National Bank allows states to draft their own exemptions without violating the Bankruptcy Clause. However, the Supreme Court has yet to interpret the current Code to determine whether Hanover National Bank is still good law.

There are numerous definitions of disability. For example, the U.S. Census defines disability to include deafness, blindness, inability to perform one or more of the functional activities, use of wheelchair, needing assistance of another to perform daily functions, having difficulty finding and obtaining a job, Alzheimer's, developmental delay, intellectual disability, and frequent mental health problems.²⁶ As of June 2020, disabled individuals account for 12.9% of the beneficiaries of Social Security.²⁷ As of December 2018, approximately 10 million disabled workers, spouses of disabled workers, and children of disabled workers received an average of $1,096.99 monthly in benefits.²⁸ While no clear statistics exist for the number of disabled individuals filing for bankruptcy, in 2010 approximately one in five Americans lived with a disability²⁹ and approximately one in ten Americans have a severe disability.³⁰ Bankruptcy filings vary by state, from 0.55 of out 1,000 residents to 5.4 out of 1,000 residents.³¹ While these statistics may...