|Sign of the times: The amount of debt and the number of creditors involved in local bankruptcy filings is way up. But 20,000 people seeking credit counseling say theres a way out of the financial crunch, even in a slow economy. Heres how.
Each year, numerous businesses and households find themselves overwhelmed with debt and struggling to keep up with their monthly payment obligations to creditors. More so in a slow economy.
Many local consumers are still choked in debt they acquired during 10 years of economic prosperity. Now facing dwindling incomes because of the slow economy, theyre cutting back on consumption. This, in turn, is aggravating the bottom line for many businesses, with an increasing number of them falling into bankruptcy.
Although recent statistics indicate the number of local bankruptcy filings has decreased since peaking in 1998 and 1999 because of Hurricane Georges, the amount of debt and the number of creditors involved in these have gone up.
According to the Puerto Rico Bulletin, year-to-date creditor debt (proof of claims) amounted to a whopping $877.2 million as of August 2002, a 21% increase over the same period in 2001. This amount includes secured, unsecured, priority, and nonspecified debt.
Secured (collateralized) proof of claims reported by local creditors between January and August of this year totaled $416.7 million, an increase over the same period last year.
Fewer bankruptcies, but beefier business cases
Despite the fact that Chapter 13 (personal reorganization) and Chapter 7 (total liquidation) cases are down in comparison with the same period in 2001, Chapter 11 (business reorganization) cases are up for the same period.
Chapter 11 is generally used for businesses, although an individual (self employed) may file under it too. It allows the debtor to continue business operations as he or she proceeds to the desired goal of a confirmed reorganization plan, which must meet certain statutory criteria.
"The fact that we have fewer personal bankruptcies despite the economic recession should be good news, but the number of big cases in these personal bankruptcies, involving large assets and long lists of creditors, as well as the larger debt in business cases, have increased considerably," Chief Bankruptcy Judge Gerardo Carlo, U.S. Bankruptcy Court, District of Puerto Rico, told CARIBBEAN BUSINESS.
According to Carlo, the increase in Chapter 11 filings is both an indication that more businesses are filing for bankruptcy and a reflection of todays economy. In 2001, there were 125 Chapter 11 cases filed on the island, of which 105 (84%) were businesses, 78% higher than in the previous year.
The rise in the amount of debt from individuals and businesses has a direct impact on the number of business failures: The less money people and businesses spend, the less economic activity is generated.
As of August 2002, the year-to-date number of new bankruptcies filed under all chapters amounted to 9,244, 4% less than during the same period last year. The number of all commercial bankruptcies, including Chapter 11 business filings and smaller d/b/a filings under Chapter 13, stood at 549, 1% less than in the same period last year, according to the unofficial Puerto Rico Bulletin.
Chapter 13, the good bankruptcy
The precise causes of excessive debt burden are numerous, but generally trace to one or more events such as a job loss, income interruption due to illness or disability, divorce/separation, or just plain poor financial management.
Of the 14,374 bankruptcy cases filed in Puerto Rico in 2001, 9,971, or 69.4%, were Chapter 13, down 5% from 2000. Frequently referred to as the wage earner chapter, Chapter 13 allows personal debtors to set up a court-sanctioned payment schedule to satisfy creditors while helping them retain their homes and their cars. It also protects the credit and property of those who have co-signed debtors loans. It is an alternative to Chapter 7 for individuals with a regular income who desire to pay their debts but currently cannot.
In Carlos opinion, local personal bankruptcies have gone down during a recession because of a combination of several factors. "Although highly speculative, you could say that debtors are becoming more responsible and are not assuming more debt. They are better at paying and are more careful in their spending habits," said Carlo, who leads the U.S. Bankruptcy Court on the island with two other bankruptcy judges. "Banks are also tightening their credit policies."
Island is nations top Chapter 13 filer
Puerto Rico ranks No.1 among the jurisdictions in the nation with the most Chapter 13 cases, said Chapter 13 Trustee Jose Carrion.
"Although there has been a decline in the number of cases, nearly 70% of all bankruptcies filed in Puerto Rico are Chapter 13, which is the type of bankruptcy all the other jurisdictions are trying hard to promote," said Carrion, one of two Chapter 13 trustees on the island.
Ironically, nearly 70% of all stateside bankruptcy filings fall under Chapter 7, which is used primarily by individuals who wish to free themselves of debt, though it may also be used by businesses that want to liquidate and terminate their ventures. Debtors assets are sold and distributed among creditors, but there are no repayment plans as there are in Chapter 13.
There are cultural reasons for the predominance of Chapter 13 over Chapter 7 on the island; one of them is our desire to pay, said Carrion,
"For different reasons, in Puerto Rico the preferred bankruptcy chapter is 13 instead of seven, which is the exact opposite of what happens nationwide," said Carrion. Sometimes they may just need a little breather, which is what the Chapter 13 repayment plan provides, but "basically, Puerto Ricans want to pay," he added.
Unlike their stateside counterparts, local financial institutions require collateral (a co-signer) when issuing a loan. Debtors want to protect their co-signers, hence their desire to file Chapter 13 and work things out instead of trying to walk away scot-free under Chapter 7.
Chapter 7, also known as liquidation, is an arrangement available to individuals, partnerships, and corporations. Lawyers refer to it as a straight bankruptcy.
It is used primarily by individuals who wish to free themselves of debt simply and inexpensively, though it may also be used by businesses that want to liquidate and terminate their operations.
Last year, there were 4,276 Chapter 7 bankruptcy filings on the island; between January and July of this year, there were 2,469.
Importance of the bankruptcy system
"People talk about bankruptcy, but not of its importance. Chapter 13 and Chapter 11 cases are the best known. Most of these involve salaried individuals, government employees, and mom-&-pop-type businesses that usually dont keep their accounting books or finances straight," said Carrion.
Last year, the two local Chapter 13 trustees disbursed $59.8 million to creditors. Thats nearly $5 million that goes into the local economy every month.
Chapter 13 trustees are nonprofit, private entities that answer to the U.S. Department of Justice but arent part of the judicial system. To cover operating expenses, trustees charge a fee, usually between 7.5% and 8% of the total disbursement.
"I have an office with a complicated operation and 42 employees. That has a price and we try to cover it through a percentage of the disbursements paid to creditors," explained Carrion, adding that trustees are like referees that try to balance the interests of all parties so that no one takes advantage of the other.
"I cannot allow a debtor to manipulate the information provided on income & expenses or the value of assets. By the same token, I cannot allow creditors to collect on something to which they have no legal right," said Carrion. "Im everyones enemy and everyones friend."
Currently, there are 30,375 active Chapter 13 cases on the island, with an average disbursement per case of $1,969. Chapter 13 cases last a maximum of five years (the repayment period). Local Chapter 13 trustees and judges handle some 500 cases a month.
"Theres a certain stigma regarding bankruptcy. It is viewed as something negative and unfortunately, filers are criminalized. In reality, its a social need protected by the U.S. Constitution," said Carrion. "Bankruptcy is not a sin. Its a right."
"What bankruptcy truly does is automatically interrupt and paralyze any action [called an automatic stay] by creditors against the debtor and his or her assets," said Carlo. "The automatic stay provides the debtor an opportunity to breathe, time to reorganize."
Carlo describes the bankruptcy system as the "ultimate safety net, which is necessary to provide to debtors, especially in an economy such as ours where everybody is free to take loans with minimum regulations."
"The bankruptcy court gives order to the system. It organizes all the creditors and establishes priorities. There is an organized distribution. Without a bankruptcy court there would be chaos, because banks wouldnt be able to issue loans across jurisdictions," noted Carlo.
In addition to Carlo, the other two local U.S. Bankruptcy Court judges are Sara De Jesus and Enrique Lamoutte.
An alternative to bankruptcy
An alternative to bankruptcy that has become popular among consumers in the past few years is the use of credit counseling or debt management agencies. Rough estimates indicate that as many as 20,000 people call or visit these agencies locally each year. But only a fraction of them actually end up getting help.
"The reality is that lately, it has been very easy to get credit. Consumers receive millions of credit card and consumer loan applications in the mail each year, and many take them," said Roberto Baerga, president & CEO of Consumer Credit Counseling Service (CCCS), the islands leading nonprofit credit counseling and debt management agency. "You fall into a vicious cycle as you continue borrowing and end up owing more than you can pay. You then fall behind on your payments."
Many of these consumers may be contemplating bankruptcy and look into credit counseling as a viable alternative to straighten their financial problems, added Baerga.
"What credit counseling agencies basically do is intervene with creditors to arrange a debt repayment plan and creditor concessions in the form of reduced interest rates, reduced fees, and new minimum payments with extended payment terms. This way, the debtor avoids bankruptcy, is able to safeguard his or her credit in the long run, and creditors get paid in full," said Baerga.
Last year, some 14,000 people called or visited CCCS looking for information. Of that total, 6,865 received counseling and only 25% of them required a repayment plan, indicated Baerga. Nearly 70% of clients, he added, go home needing only financial advice, a budget review, and/or education.
"Unfortunately, there are some (5%) whom we just cant help because of their situation," said Baerga.
As much as $14.4 million was paid to creditors last year, with another $91.3 million disbursed to financial institutions since the organization started operations 12 years ago, Baerga indicated.
Credit counseling vs. bankruptcy
What are the pros and cons of credit counseling vs. bankruptcy?
"One of our biggest advantages is that the people of Puerto Rico like to pay. When you compare the islands default rate with that of the rest of the U.S., you see a big difference in our favor," said Baerga. "In a repayment plan, a person repays the debt in its entirety and can obtain credit right after repayment."
Under Chapter 7, debtors retain only their home and their vehicle; all other assets are liquidated to repay a portion of their debt and their credit is affected for 10 years, explained Baerga. Under Chapter 13, the court establishes a payment plan which may cover only a percentage of the total debt. Once debtors file for Chapter 13, creditors can no longer go after them (automatic stay) and their credit can be affected for seven years.
"With credit counseling, once debtors complete their repayment plan they can enjoy credit availability. And even when theyre still on a repayment plan we can help them purchase a home, a car, or even secure another loan, if ones really needed," said Baerga.
Those that have filed for bankruptcy can still get credit afterward, but at a high interest rate, noted the CCCS president.
Another advantage of credit counseling is cost, since bankruptcy lawyers charge at least $900 just to file the case, said Baerga. Repayment fees at credit counseling agencies are usually lower than trustee fees or what banks charge on their own.
CCCS is nonprofit, meaning it doesnt charge creditors for its services. A $7 monthly contribution is suggested to cover administrative expenses, which 45% of creditors pay. Other credit counseling agencies charge nearly $50 a month, which is included in the repayment plan, plus they retain the first payment.
"The only advantage of bankruptcy is that once you file, all debt collection efforts, including calls and visits from creditors, cease immediately. With credit counseling, creditors retain the right to contact debtors," said Baerga.
Have help, will pay
"If we dont help our clients, they will end up filing for bankruptcy," said FirstBank Consumer Billing Director Michael Garcia de Jesus. "Our motto is, If a client has the willingness to pay, we will find the way to help."
To those clients contemplating bankruptcy, the islands second largest financial institution has two main options: loan refinancing and payment extension.
Loan refinancing is used for clients whose payments are too high and who need help on a long-term basis. The monthly payments are lowered and the payment terms are extended. Payment extension is used for clients who dont want or dont qualify for loan refinancing, such as those being laid off or who have had their salary reduced.
"We charge them only the interest for up to 90 days and extend the loans by a few payments," said Garcia de Jesus. "This gives them a breathing period while they find a job."
Of the approximately 100 local clients that ask for help every month, 35% do so because theyve lost their job or had their pay cut, 30% because of an unanticipated family problem (such as an illness), and the remaining 35% because of a separation or divorce, Garcia de Jesus said. According to Garcia de Jesus, clients from the southern part of the island are having the most credit troubles.
"Under certain circumstances, we refer our consumer clients to credit counseling. Its a resource outside the bank, but one of which we approve depending on the case," said Garcia de Jesus. "If we dont help them, they will eventually file for bankruptcy."
U.S. Bankruptcy Court for the District of Puerto Rico
General bankruptcy statistics, 1989-2002
*Totals for 2002 are year-to-date as of July. So far, they are down 5% compared with the same period in 2001.
Source: U.S. Bankruptcy Court
Percentage of change
Chapter 11 (business reorganization) cases filed in the past five years
Source: U.S. Bankruptcy Court
Total Chapter 11 cases filed in the past three years
Source: U.S. Bankruptcy Court
Chapter 13 Total disbursement to creditorsPuerto Rico
Fiscal years 1997-2001 (in millions)
|% to secured creditors
|% to priority creditors
|% to unsecured creditors
|% to debtors attorneys
|Number of active cases
|Disbursement per case
Source: U.S. Trustee Program/Department of Justice
Top 10 local cities with the highest bankruptcy filings in 2002
(as of August)
||# of filings
||% change vs. August 2001
|1. San Juan
|6. Toa Baja
|8. Toa Alta
|9. Vega Baja
Source: Puerto Rico Bulletin
Definitions of bankruptcy chapters
Chapter 7 of the Bankruptcy Code is available to both individual and business debtors. Its purpose is to achieve a fair distribution to creditors of the debtors available nonexempt property. Unsecured debts not reaffirmed are discharged, providing a fresh financial start.
Chapter 11 of the Bankruptcy Code is available to both individual and business debtors. Its purpose is to rehabilitate a business as a going concern or to reorganize an individuals finances through a court-approved reorganization plan.
Chapter 12 of the Bankruptcy Code is designed to give special debt relief to a family farmer with regular income from farming.
Chapter 13 of the Bankruptcy Code is available to individuals with regular income whose debts dont exceed specific amounts; it is typically used to budget some of a debtors future earnings according to a plan through which creditors are paid in whole or in part.
Source: American Bankruptcy Institute
||Banks are doing their part, too
"Bad loans are made during good times. As a bank, if you are extremely aggressive during an economic boom, you could end up with a bad loan portfolio. Since 1999 Banco Popular has taken a more conservative credit policy," said Emilio Piñero, executive vice president of Banco Populars Commercial Banking Group.
The slowdown in the construction industry since early 2001, during which time few construction permits and projects have come to light, has had a negative effect on the local economy, especially on the construction industry.
"This has had a tremendous impact on contractors and subcontractors," said Piñero. "The construction industry is of vital importance, especially now that we are enjoying low interest rates."
Piñero has seen an increase in the number of contractors and subcontractors requesting help with their loan payments as well as in those filing for business bankruptcy, mostly Chapter 11.
"We always encourage our clients to come to us and tell us their problems. We can restructure a payment plan and lower the monthly payments so they are more in tune with a clients financial reality," said Piñero.
Banco Populars $4.6 billion commercial-loan portfolio grew by a mere 1% last year, though Piñero expects it to grow by 3.5% to 4% by years end and by 4% to 5% next year.
"We are now starting to be a little more aggressive and flexible with loans, but always acting with prudence," said Piñero. "To grow a loan portfolio 4% when the islands annual economic growth is less than 1% is pretty good."
Banco Populars Family Business Forums, which started as seminars and lectures on the generational transition of family-owned businesses, now cover a wider range of topics such as controlling a business operational costs, improving cash flow through better accounts receivables, and even handling difficult financial situations, to name a few. These topics have been added because clients have requested them, noted Piñero.
"The idea is to try to advise clients on the current economic situation so they can bring their businesses to reality and help them remain competitive," said Piñero. "The bottom line is to help clients reduce their operating costs and the cost of doing business."
Piñero pointed out that one way to achieve that is through the use of electronic products (software and equipment) that help increase a business efficiency. "We need to bring them to how business is done in the 21st century," he said.
Additionally, the islands top financial institution is actively promoting that accountants get more involved with their clients. "We are working with certified public accountants, exhorting them to get more involved with their clients," said Piñero. "The more control you have over your cash flow and the more up to date your financial statements are, the easier it is to have a real picture of your finances. You will then react more effectively to difficult situations."
Future of bankruptcy overhaul bill still uncertain
A bankruptcy overhaul bill on the verge of becoming law may be held up by pro-life Republicans in the U.S. House of Representatives, a sluggish economy, and growing opposition from credit unions.
The bankruptcy legislation, which has survived many hurdles and many rewrites in the past five years, passed the House and Senate last year and emerged from the conference committee in late July for final passage. But the conference report contains language that would prevent abortion protesters who have been fined from having those fines erased in bankruptcy.
Moreover, a lingering sluggish economy, a jittery stock market, and escalating healthcare and drug costs could make the bill a hard sell during an election year. Congress may find it difficult to pass legislation that makes filing for bankruptcy more difficult when many U.S. workers are facing financial ruin because of an unexpectedly long period of unemployment, a death in the family, a divorce, or some unforeseeable disaster.
The bankruptcy reform law pending in Congressthe most sweeping overhaul of bankruptcy laws in 20 yearsis intended to reduce the number of bankruptcy filings, especially Chapter 7 (liquidation) cases, which in the U.S. mainland account for 70% of all bankruptcy filings.
Some of the changes proposed under the pending bankruptcy legislation include:
- A means test would be required for people filing for Chapter 7 (you have to prove you are filing in good faith).
- It would be harder to protect ones personal vehicle from creditors.
- Internal Revenue Service (IRS) standards would be adopted to determine vehicle expenses and income limits to qualify for Chapter 7 (the IRS currently has no standards for Puerto Rico).
- A house worth more than $250,000 wouldnt be protected (homestead exemption).
- People would first have to receive credit counseling 90 days before filing.
Supporters of the bill contend the present bankruptcy law allows too many people who are able to repay to file under Chapter 7 instead of under Chapter 13 (debt repayment plan), letting them off scot-free.
"This is no reform; its deform. This law is a disaster," said Chapter 13 Trustee Jose Carrion. "It has been manipulated and structured by persons who dont know anything about bankruptcy and who have ignored academics who have stood before Congress to explain why this law is bad for consumers."
In Carrions opinion, the laws objective has changed from helping a debtor rehabilitate and pay within his or her means to paying creditors regardless of whether a debtor is rehabilitated. "In my opinion, the new law will complicate rather than simplify the entire process, making it more bureaucratic and costlier," said Carrion, one of two Chapter 13 trustees on the island.
"Since we already have more Chapter 13 filings in Puerto Rico, I dont think this new law will impact us as much as it will stateside jurisdictions," indicated Chief Bankruptcy Judge Gerardo Carlo.
It is assumed, said Carlo, that when someone files for Chapter 13, he or she is doing so in good faith, choosing a repayment plan over liquidation. But the new law could make bankruptcy less attractive and things a little more difficult for debtors, he said.
It would, however, be good for credit counseling agencies.
"Under the new law, debtors would have to receive credit counseling prior to filing. Some wont have to file for bankruptcy while others would need only a repayment plan," said Consumer Credit Counseling Services President & CEO Roberto Baerga. "Bankruptcy filings will definitely go down, because if people are already coming to us voluntarily, the number of debtors with a repayment plan through us will increase with the new law. Those that cant be helped file for bankruptcy anyway."
Meanwhile, a number of credit unions, including credit card providers, have come out against the bankruptcy bill despite the Credit Union National Associations emphatic backing of the measure. A group of 17 lenders, among them credit unions, said they believe the pending legislation would disproportionately harm vulnerable debtors while rewarding unscrupulous credit card companies.
One of Presidents Bushs top campaign contributorsand a sponsor of the billis MBNA, a major national provider of credit cards.