A Fresh Start to Bankruptcy Exemptions

Abstract

Bankruptcy has broadly failed to deliver “fresh starts” to debtors. Too often, debtors return to states of financial distress following bankruptcy. Although bankruptcy delivers a clean slate through the discharge of debts, the efficacy of a fresh start depends on a second factor: property exemptions. While discharge frees a debtor from her existing debts, property exemptions determine what property the debtor retains upon exiting bankruptcy. For many debtors, insufficient and suboptimal property exemption laws undermine fresh starts. In fact, under current bankruptcy law, each state can reject federal bankruptcy exemptions by opting out. Bankrupt debtors in “opt-out” states are forced to rely on general state exemptions—often stingy and focused on preserving homesteads—that were not designed for bankruptcy.

Existing literature explores two lines of criticism against the federal opt-out provision: (1) arguing that the law should be struck down as repugnant to constitutional notions of uniformity, supremacy, or both, and (2) making the case for repeal on normative and fairness grounds. For decades, neither solution has been forthcoming. The opt-out scheme, at first aberrant and controversial, has proved a perdurable feature of bankruptcy law.

This Article advances a different approach and proposes diffusive, state-based reform solutions. Under this approach, each opt-out state would undertake a meaningful review of its existing exemptions regime in light of the federally-declared rehabilitative function of bankruptcy. I propose a model, to be used in this review, involving three factors—nominal sufficiency, housing agnosticism, and allocative flexibility - as a conceptual framework for reforms. Addressing constitutional concerns, this Article argues that these innovative “bankruptcy-specific exemptions” schemes should survive constitutional scrutiny. The Article ends with discussion of the model and proposed reform framework.

Keywords: bankruptcy, federalism, bankruptcy reform, exemptions, exemptions reform, consumer protection