What is Consumer Debt?

• Author: Ondersma, Chrystin

Our existing consumer credit landscape is a troubled one. One in ten American adults has filed for bankruptcy, with hundreds of thousands of individuals and families seeking relief every year. (1) Twelve years after enrolling, white borrowers still owe 60 percent of their loans. But Black borrowers owe 13 percent more than what they borrowed when they graduated, and Latinx students owe 85 percent of what they initially borrowed. (2) After twenty years from graduation, white graduates, on average, owe 6 percent of what they borrowed, but Black graduates still owe a full 95 percent of what they borrowed. (3)

Our consumer credit policies are not working, because they are rooted in flawed and mistaken assumptions regarding the nature of personal and household borrowing. Our policies incorrectly assume that consumer debt is incurred to expand opportunities and resources and that transparency and consumer education can correct any problems in the consumer credit market. This is not the empirical reality. Instead, many individuals and households rely on debt to meet their survival needs. (4) Moreover, the ubiquity of predatory lending means much debt incurred in the hopes of achieving a new opportunity actually works to the detriment of the borrower. (5) As a result of decades of historical discrimination, exclusion, and dispossession, marginalized borrowers are more likely to encounter predatory debt and more likely to need to incur debt to survive, so our consumer credit policies are entrenching marginalization and inequality. (6)

Small adjustments are not sufficient to remedy these outcomes. Rather, an entirely new framework and a new taxonomy of personal and household debt is essential to coherent, logical, and equitable household credit policies. Such a framework should, at a minimum, be grounded in the empirical realties surrounding household debt. As it stands, even something as fundamental as the concept of consumer debt is disjoined from the reality of household debt burdens.

This paper is a step forward in developing a new framework and taxonomy for personal and household debt. I intend to critically analyze the key components of consumer household debt in a series of writings that culminate in a book, as the issues deserve more attention than a single paper. This paper thus serves as a synecdoche or metonym for the larger project and focuses on the distinction between consumer and non-consumer debt as pertains to [section] 7 07(b) of the Bankruptcy Code.

Section 707(b) provides that individual debtors whose debts are "primarily consumer debts" cannot file for chapter 7 bankruptcy relief if their filing would constitute an "abuse" of chapter 7. Abuse is presumed if the debtor's disposable income is above a given threshold. (7) This hurdle--commonly called the means test--creates barriers to relief for any debtor deemed to have primarily consumer debts. The distinction between consumer and non' consumer debt is illogical and arbitrary because the entire concept of "consumer debt" is rooted in mistaken assumptions about the nature of the debt' ors who seek bankruptcy relief. As we will see, in crafting barriers to relief, proponents of these barriers assumed that the classic case of an individual with debt was one who splurged for consumption purposes, intending to keep future income from the hands of creditors. In empirical reality, however, most individuals seeking bankruptcy relief have incurred debt to survive an adverse event, such as job loss, a medical emergency, or a family break-up. (8)

This mismatch has resulted in incoherent doctrine. I discuss the need to replace the distinction between consumer and non-consumer debt with a new taxonomy and offer strategies for mitigating the harm of the existing distinction in the short term.

This paper proceeds in three parts. In Part I, I provide an overview of [section] 707(b) and discuss the barriers to bankruptcy relief that it creates. I also discuss the legislative history of [section] 707(b) and show that the subsection is rooted in flawed assumptions about the nature of individual debtors. Specifically, members of Congress believed (or at least professed to believe) that most individuals seeking bankruptcy relief become indebted as a result of "splurging" on consumer goods when in reality, most individuals seeking bankruptcy relief become indebted as a result of a medical emergency, job loss, or family break-up. In Part II, I review the case law developed around the distinction between consumer and non-consumer debt in the [section] 707(b) context. In doing so, I demonstrate that, because this distinction is not tied to the empirical reality of the typical debtor, the resulting outcomes are often arbitrary and inequitable.

Finally, in Part III, I propose solutions. I argue that ultimately, a truly effective solution will require an entirely new approach to consumer credit and household debt that would eliminate the distinction between consumer and non-consumer debt in the Bankruptcy Code. Until this occurs, however, there are interim steps we can take to mitigate the existing harms. First, [section] 707(b) should be eliminated from the Bankruptcy Code. This result is consistent with the Consumer Bankruptcy Reform Act of 2020, (9) which I encourage Congress to adopt. Second (recognising the difficulty of achieving legislative reform), I propose a method of statutory interpretation for "consumer debt" under [section] 707(b) that narrows the term in a manner consistent with both the statutory language and congressional intent. Specifically, I propose that debt incurred for survival rather than expanded household consumption should be excluded from the definition of consumer debt. Indeed, because the cases upholding the constitutionality of the distinction between consumer and non-consumer debt rely on Congress' assumption that consumer debt is voluntarily incurred for consumption purposes, this is the only approach consistent with the constitutionality of that distinction.

1. OVERVIEW

   When teaching or discussing bankruptcy relief, it is common to divide bankruptcy cases into consumer bankruptcy cases and business bankruptcy cases. This dichotomy is often inaccurate. Of course, if the business itself is the entity filing for bankruptcy, it is easy to classify the case as a business bankruptcy. Nevertheless, many individuals who file for bankruptcy have both business and consumer debt. (10) Further (and more importantly for the purposes of this paper), an individual may have debts that are not consumer debts even though those debts do not fit precisely into the category of bush ness debt. The Bankruptcy Code defines "consumer debt" as "debt incurred by an individual primarily for a personal, family, or household purpose." (11) As we will see, determining what types of debt are incurred for personal, family, or household purposes turns out to be a complicated endeavor. Here, I explain the hurdles that debtors categorized as "consumer debtors" face, as well as the legislative background giving rise to these hurdles.

   1. HURDLES FOR "CONSUMER DEBTORS"

      Whether an individual's debts are or are not consumer debts is important because the Bankruptcy Code creates extra hurdles for individuals seeking to file chapter 7 if and only if their debts are "primarily consumer debts." That is, individuals whose debts are "primarily" consumer debts are required to jump through hoops that individuals with business debts--or other non-consumer debts--do not.

      Most cases in which the distinction between consumer and non-consumer debt is key revolve around [section] 707(b), which provides for dismissal (or a voluntary conversion to chapter 13) of a chapter 7 bankruptcy petition if allowing the chapter 7 case to proceed would be an "abuse" of chapter 7. (12)

      For non-bankruptcy experts, a brief primer: Individuals seeking relief from their debt burdens can file a petition for bankruptcy relief under either chapter 7 or chapter 13. Chapter 7 allows debtors to promptly obtain a discharge of their debts (except ones that are not dischargeable, including most student loans, some taxes, and debts arising from fraud or willful injury) in exchange for giving up any non-exempt assets. (13) What the debtor can exempt varies from state to state but typically includes, at a minimum, a modest car, basic household furniture, and goods, anything the debtor needs for work, and at least some home equity. (14) Chapter 13 requires debtors to devote 100 percent of their disposable income to creditors for a period of three to five years. These debtors generally receive a discharge of their debts only after completing all payments required by the plan. (15) Most people who file for chapter 13 cannot complete the payments and never receive a discharge; two-thirds of chapter 13 cases are dismissed or converted to chapter 7. (16)

      In 2005, Congress added [section] 707(b)(2) as part of the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"). This provision was a key part of BAPCPA's erection of barriers to chapter 7 relief for "consumer debtors." As discussed, [section] 707(b) provides for dismissal (or a voluntary conversion to chapter 13) of a chapter 7 bankruptcy petition if granting the relief would be an "abuse" of chapter 7. (17) Under [section] 707(b)(2), abuse is now presumed (and this presumption can be rebutted only under extremely narrow circumstances) if a mechanical, formulaic evaluation of the debtor's future income shows sufficient income in excess of certain permitted expenses. (18) Section 707(b) does not apply to all debtors, however, but only to those debtors "whose debts are primarily consumer debts." (19) The BAPCPA amendments also created a number of other hurdles, such as requiring debtors to undergo counseling and submit a variety of documents (including pay stubs and tax returns). Thus, if an individual or household seeks bankruptcy relief and their debts...