Minority bankruptcy filers less likely to get debt forgiven, study finds

Last year, over half a million U.S. bankruptcies were filed.

While entering bankruptcy can be painful and leave a financial scar, it’s often a necessary last resort for those trapped in a cycle of debt. Studies have shown that a successful bankruptcy — when a court wipes away a portion of outstanding debt — improves not only the lifetime earnings of bankruptcy filers, but the lifetime earnings of their children as well.

But while roughly 1 in 10 Americans file for bankruptcy at some point in their life, nonwhite bankruptcy filers face higher odds of actually receiving any benefit from the process, a study found.

A recent working paper published in the National Bureau of Economic Research found that minority filers are roughly 13 percentage points more likely to have their bankruptcy cases dismissed without debt relief in Chapter 13 bankruptcy cases.

Chapter 13 bankruptcy protection is typically designed for debtors hoping to retain significant assets, like a home or car. Last year, 200,000 households filed for Chapter 13.

“We found not only are minorities much more likely to have their bankruptcy cases dismissed without debt relief, we found that the race of the legal officials that they interact with in the bankruptcy process can be predictive of success in their bankruptcy case,” said Sasha Indarte, a study co-author and an assistant professor of finance at the University of Pennsylvania’s Wharton School.

When the study controls for other characteristics, like income level or whether a filer hires an attorney, the racial disparity narrows to 3.5 percentage points.

But Indarte said that disparity is still meaningful and indicates implicit bias may be unfairly punishing minority bankruptcy filers.

“When you’re not able to get that debt relief after experiencing financial hardship, that can allow you to experience new hardships going forward,” Indarte said.

The study pins much of the bias in bankruptcy outcomes on trustees, the legal officers in charge of overseeing Chapter 13 bankruptcy proceedings.

In order to keep bankruptcy protections, debtors must make monthly payments on a court-approved payment plan for up to five years. Trustees make sure debtors make those payments, and they have considerable discretion on when to recommend to a judge that a debtor should be kicked out of their plan because of missed payments.

Lon Jenkins, head of the National Association of Chapter 13 Trustees, doesn’t buy the study’s conclusions.

“This determination to file a motion and dismiss, if we get to that point, is purely an objective process,” said Jenkins, who administers bankruptcy proceedings in Salt Lake City. “It’s ‘Here’s the case, here’s the case number and the name, and they’ve missed three payments.’ So we’re going to file a motion, but we don’t pay attention to what the race of the debtor might be.”

Jenkins argues that no Chapter 13 trustee keeps a record of a debtor’s race. And the staff that interacts with the debtor at the beginning of a bankruptcy case is often different than the staff that simply checks whether payments are being made.

Jenkins also said since trustees make their money from a percentage of those monthly bankruptcy payments, there’s no benefit to a Chapter 13 trustee to dismiss cases prematurely.

“We are definitely not incentivized to dismiss cases,” Jenkins said.

Jenkins points to systemic factors that may make minority debtors more likely to miss payments, such as less access to family wealth.

Whether implicit or explicit bias from trustees is partly to blame for racial disparities in bankruptcy outcomes, minority debtors that lose bankruptcy protections will confront a host of new financial problems.

“So bankruptcy for those individuals is a way to have that lifeline,” said Elizabeth Gonzalez, a consumer attorney for the nonprofit law firm Public Counsel. “That I don’t have to worry about my wages being garnished or my bank account being levied, or, frankly, just being hounded by creditors.”