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Bankruptcy in the '80s; filings in Arkansas appear to be slowing, yet many merchants still lose when customers file.

Bankruptcy In The '80s

Filings In Arkansas Appear To Be Slowing, Yet Many Merchants Still Lose When Customers File

What's an Arkansas merchant to do? He sells several thousand dollars worth of goods on credit and then he gets hit with the news that his purchaser has just filed for bankruptcy?

Some creditors simply do nothing and take the loss and some hire an attorney and try to recover the loss. The fortunate ones don't even know that their customer has filed for bankruptcy because they dealt with a lender who writes loans without recourse and therefore it is the lender's problem, not theirs.

Consumers who have decided on bankruptcy have two options. They can file a Chapter 7 bankruptcy, where their property, with some exceptions, will be sold and the money divided among their creditors.

Or they can file a Chapter 13, where they retain all or most of their property and their debts are consolidated. They pay a sum each month into the court which then disburses it to creditors according to a plan (usually for three years, though some go to five).

The majority of his clients, says Jack Sims, an attorney who has represented debtors for 30 years, opt for reorganization over liquidation -- preferring to pay out their debts, which should be good news for any merchant, right?

It can be if the debtor proposes to pay 100 percent of his debts, but the law sometimes permits consumers to keep the property but pay less than the amount owed. This occurs most often with unsecured creditors, though sometimes even secured creditors do not get the full amount either.

TO UNDERSTAND HOW unsecured creditors get less than the full amount it helps to look at how a Chapter 13 filing is calculated. For example, a debtor has $12,300 in debts he cannot pay, so he consults an attorney who will list their monthly income and then deduct their basic living expenses such as rent, food, clothing, utilities.

The amount that is left is their "disposable income" and this is what they will pay into the court, usually for three years. The court deems that the debtor can pay $150 per month for three years -- a total of $5,400 to settle debts totalling $12,300. First to come out of the $5,400 will be approximately $310 to cover the trustee's fee and possibly $90 for a filing fee, then about $700 in attorney's fees.

The money available to divide among the creditors then, will be about $4,300, to satisfy $12,300 in debts -- and the court will decide who gets what. In divvying up the $4,300 the bankruptcy court considers three categories of debt -- priority, secured and unsecured. The debtor owes a total of $3,300 in secured debts, such as furniture, and priority debts such as taxes, which will be paid first and in full.

That leaves about $1,000 for the unsecured creditors to scramble over. But the debtor owes $9,000 to unsecured creditors who will have to be content with about 10 cents on the dollar and since the debts were for such things as medical, dental, and credit card purchases, there is nothing to repossess.

Secured creditors, on the other hand, usually get 100 percent or they can try to repossess the merchandise, but even they must let the bankrupt keep the merchandise and accept less than what is owed in some cases.

That can happen because bankruptcy law permits debtors to pay the value of the security rather than the actual balance owed. For instance, a customer buys an automobile for $15,000 and then files a Chapter 13. Though the customer owes $13,000, he proposes to pay only $11,000 because the car has allegedly depreciated to that value or it has been wrecked. In this instance the court will consider:

* Retail versus wholesale value.

* Whether unsecured items such as sales tax, a service policy, and credit life were included in the loan.

In such a case, the auto dealer or lender may object and try to negotiate a higher value with the debtors' attorney. If that fails they may go to court to try to establish that the value of the automobile is actually $13,000, not $11,000.

Such a case occurred recently when a customer of Little Rock Dodge filed a Chapter 13 a few months after purchasing a new vehicle, seeking to pay the market value, which she alleged was $9,000, though she acknowledged she owed $11,500. The lender, Worthen Bank, objected -- a standard response, according to Paul Lawson, a bank VP.

The bank had seized the auto and wanted to repossess. An adversary hearing was held and Judge James G. Mixon of the U.S. Bankruptcy Court ruled that the bank would have to return the vehicle to the debtor, but that she would have to pay the amount owed -- $11,500 not $9,000.

Judge Mixon delivered his verdict with this caveat. "I don't think it is fair for someone to purchase a new vehicle, drive it a few months, and then pay the lesser value."

While in this case, the judge established the value at the amount owed, in many cases, the bankrupt is permitted to pay the lower amount.

"I've had many cases where the value, whatever the collateral is worth, is what the court awards to creditors," says Jack Sims.

Butch Martindill, the owner of Little Rock Dodge, testified in the case for Worthen Bank. He had sold the vehicle and knew what it was worth, but adds this is sometimes an uncomfortable situation. "You're kind of in an awkward position," says Martindill. "That lady was a customer of mine and things happen to people, circumstances change. I just tried to be fair."

Martindill also did the bank a service, because Worthen had written the loan without recourse -- meaning that Little Rock Dodge would not have suffered a loss had the client paid the lower price or not even paid at all. When lenders make loans with recourse, the seller must assume responsibility for the debt when customers file bankruptcy, which has some merchants looking for other means to finance their customers' purchases.

FRUSTRATED BECAUSE of a number of bankruptcy filings, Schuster's, a Little Rock furniture store, now refuses to do business with lenders who write loans with recourse and in fact deals with a national outfit.

"Arkansas' lending institutions are losing money because we do business out of state," says Roy Schuster, president of Schuster's.

Brown's Carpets also is using a national, out-of-state lender that writes loans without recourse, not necessarily because they were plagued with a high number of customers filing bankruptcy, says Joe Brown, salesman and father of Charles Brown, the owner. But now if a customer misses payments or files a bankruptcy, Brown's does not even know or get involved. Local lenders could have had the business of the carpet dealers according to Brown.

"I think Union Bank slept through probably one of the best deals they could have ever made. They used to have what is called Express Credit and we were an Express Credit dealer, but that was with recourse.

"In other words, if a customer bought carpet with us and financed through Union Bank, we had to guarantee the contract. That was not a good deal and I told Union: `You ought to work out a program for the carpet industry and finance carpet nationally.' But Bank One of Ohio did it," says Brown.

Lenders and merchants who write loans, with or without recourse, secured or unsecured, may be missing out on money that is due them simply because they neglect to submit a claim when one of their customers files a bankruptcy, according to Judge Mixon.

A claim form comes attached to the notice of the first meeting of creditors and forms are available from the court and trustees. Yet many creditors do not file because they think it will be too much of a hassle -- that they will have to appear in court or they must have an attorney, or both. Some unsecured creditors don't file because they believe they will not receive anything anyway.

But a random sampling indicates that out of 30 filings, nine debtors proposed to pay 100 percent to unsecured creditors; one proposed 49 percent; one proposed 32 percent; one proposed 25 percent and the remainder proposed to pay less than 13 percent.

According to Mixon, all you have to do is fill out the form and return it. You won't have to appear in court and you won't need an attorney, unless you want to object. "If you have a small claim it is not economical to hire a lawyer," notes Mixon.

It is the secured creditors, not the unsecured creditors, who should hire a lawyer, according to Charles D. (Skip) Davidson, an attorney who represents both debtors and creditors and frequently lectures on bankruptcy. He also urges creditors to file a claim to recover money due them.

"It's a real easy form to fill out, but unfortunately a lot of them don't do it," laments Davidson.

Marc Mathis, manager of Car Mart in Little Rock, says when a customer files bankruptcy, he handles the claim himself. "Usually I get the cars paid off," says Mathis, though he complains that sometimes debtors stop making their Chapter 13 payments into the court, with the result that the filing is dismissed.

"When this happens, a lot of times they have skipped out, moved, and I can't find them and then there is a loss," adds Mathis.

Many merchants could reduce their losses if they would try to work out a payment plan with their customers, says Davidson, even possibly reducing the total debt as well as accepting lower monthly payments, to prevent a bankruptcy filing.

AGGRESSIVE ADVERTISING practices and increased numbers of filings have led some creditors to complain that attorneys are encouraging people to file bankruptcy, and in the process getting rich at their expense.

Bankruptcy attorneys counter that the court sets the amount they may charge and each time they charge a fee, they must petition the court for approval. "You've got the judge looking over your shoulder all the time," notes Sims.

The court allows from $400 to $750 for a Chapter 13 and most attorneys charge on the average about $500 for a Chapter 7 consumer bankruptcy. Using $600 as an average then, an attorney would have to handle about 3 clients per week, or about 150 per year, just to gross $90,000. From that he would still have to deduct all of his expenses.

In addition, attorneys note that they are obligated to the client usually for three years -- sometimes five -- to answer questions and file amendments. Not all the Chapter 13s that an attorney files are confirmed and in that case the attorney gets nothing or only a small amount for his trouble.

Attorneys may be able to make more money filing business bankruptcies as opposed to consumer bankruptcies because the court allows higher fees and they require more adversary hearings which means more fees. However, business bankruptcies are extremely complex, requiring much more time.

And attorneys are finding fewer clients in the market for business bankruptcies. At the national level, business bankruptcies are actually declining -- a notable 8.7 percent from 1988 to 1989 while the number of non-business filings is up by 10.3 percent for the same time period according to the National Bankruptcy Institute. (Note the NBI calculates numbers of filings from July through June.)

While total filings here in Arkansas have more than doubled since 1980, the rate of increase is declining. Filings increased only about 5 percent from 1988 to 1989 (based on estimated figures for 1989). The year before that, total filings increased 6.7 percent, which was still lower than the 14 percent increase the year before that. And like the rest of the nation Chapter 11, business reorganizations, have been declining since 1984.

There are a myriad of reasons for increases in bankruptcy claims, including catastrophic illnesses, loss of job and, increasingly, divorce. Bad management of personal affairs and easy credit exacerbate the problem.

Sims agrees that credit is too easy to get: "Our government itself is setting a bad example by overextending itself. What is it? Over a trillion in debt now?"

Carolyn Gibson is a freelance writer living in Sherwood.
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Author:Gibson, Carolyn
Publication:Arkansas Business
Date:Jan 15, 1990
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