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REPORT OF THE BOARD OF TRUSTEES B of T Report 9 I-03 Subject: Presented by: Referred to: Family Protection Act William G. Plested, III, MD, Chair Reference Committee L (Albert L. Blumberg, MD, Chair)
Resolution 205, (A-03), as amended and adopted, asks the American Medical Association to “study potential mechanisms for legal reforms which would limit the use of an individual’s personal assets to pay excessive liability awards with report back at the 2003 Interim Meeting.” This report presents an overview of current laws that limit the use of an individual’s assets to pay obligations to creditors, and discusses the reasons why such laws do not provide adequate protection. The final sections of the report discuss possible legal reforms. Resolution 205 asked that this report focus on possible legal reforms. This report i.e. does not address personal financial or estate planning, which should be undertaken as soon as practicable in a physician’s career, with the advice of financial and legal advisers who are familiar with the physician’s individual circumstances. LAWS GOVERNING CREDITORS’ ACCESS TO DEBTORS’ ASSETS A variety of laws limit the use of an individual’s personal assets for payment of debts, including liability awards. These include limitations on garnishment of wages; state laws exempting specified assets from attachment in legal proceedings; and exemptions under federal and state bankruptcy laws. If a physician faced with an excessive liability award has not declared bankruptcy, all of his or her assets, except those specifically exempt under state law, may be attached and applied to the payment of the award. In addition, the physician’s future wages and other earnings may be garnisheed, up to the legal limit on garnishment. A. Restrictions on Wage Garnishment Federal law provides that the amount of an individual’s wages for any week which may be garnisheed for the payment of debt cannot exceed the lesser of (a) 25 percent of that individual’s disposable earnings for that week, or (b) the amount by which the disposable earnings exceed 30 times the current minimum wage. The 25 percent limit is currently applicable to individuals with disposable earnings of more than $206 per week. Many states have lower limits.
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B. Federal Bankruptcy Law 1. General The federal bankruptcy law is designed to allow debtors a “fresh start.” This is accomplished in different ways under various chapters of the Bankruptcy Code. The most significant chapters for individual debtors are Chapter 7 and Chapter 13. Under Chapter 7, the debtor’s assets become part of a bankruptcy estate. All assets of the estate, other than those specifically exempted, are liquidated and the proceeds used to pay the debtor’s obligations. Obligations that cannot be paid from the assets of the estate are discharged. Under Chapter 13, the debtor’s earnings for a specified period of time are earmarked for payment of debts, but the debtor retains his or her existing assets. Debts that are not paid under the Chapter 13 plan are discharged at the end of the payment period, thereby protecting future earnings and future acquired assets. To be eligible under Chapter 13, a debtor must (a) have a regular source of income sufficient to cover normal living expenses and make significant repayments of debt, and (b) have debts not exceeding specified limits (currently unsecured debts of less than $269,250 and secured debts of less than $807,750). Since liability awards are generally unsecured debts, an award in excess of $269,250 would preclude relief under Chapter 13. The amount of asset protection a physician would receive under Chapter 7 is determined by the applicable exemptions. This depends upon a complex interaction between federal and state law. The Bankruptcy Code contains a list of exemptions, but allows states to opt out of the federal exemptions. Thirty-five states have elected to opt out. Debtors who are residents of those states can use only the state exemptions. Debtors residing in the remaining states and the District of Columbia can choose between federal and state exemptions. 2. Exemptions Bankruptcy exemptions are designed to allow a debtor to retain sufficient assets to make a meaningful fresh start. Unfortunately, the amounts exempted under the Bankruptcy Code and many state laws are too small to accomplish this objective. State exemption laws often appear to have been written for primarily agrarian economies and not updated to reflect subsequent inflation or the development of a more urban economy. For example, the Michigan statue allows a debtor to retain “10 sheep, 2 cows, 5 swine, 1000 hens, 5 roosters, and a sufficient quantity of hay and grain…for properly keeping the animals and poultry for six months,” and a homestead “not exceeding 40 acres of land” in a rural area or one lot in a city town or village with a value not exceeding $3,500. Neither of these exemptions would provide meaningful protection to a physician facing an excess liability judgement. Moreover, such outdated criteria have resulted in hard-to-understand decisions by courts forced to interpret and apply such exemptions in an industrial/service oriented society.
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Other states have significantly larger exemptions. In Texas, for example, a debtor can exempt a homestead of up to 10 acres in an urban area or 100 acres (200 acres for a family) in a rural area with no limit on the value plus up to $30,000 ($60,000 for a family) of specified types of personal property. Florida, Iowa, Kansas, South Dakota and the District of Columbia have similar unlimited homestead exemptions. Thus the degree of protection a physician may have varies widely from state to state. The following are some of the more significant exempted items. a. Homestead. The Bankruptcy Code exempts a “debtor’s aggregate interest, not to exceed $17,425 in value, in real property that the debtor or a dependent of the debtor uses as a residence….” Most states provide a homestead exemption. But, as the table below indicates, the value varies widely and, in most states, is far too small to protect even the least expensive residence. State Homestead Exemptions Number of States Opt-Out States Non-Opt-Out States 1 3 15 2 1 1 7 5 1
Amount of Exemption 0 $10,000 or less $10,000 for a single person $20,000 for a married couple $10,000 per occupant $12,500-$50,000 $54,000-$100,000 $125,000 $200,000 urban, $500,000 rural Unlimited
5 3 1
5
2
b. Retirement Plans. Depending on the type of plan, the assets in a retirement plan may be either excluded from the bankruptcy estate or wholly or partially exempt. Section 541 of the Bankruptcy Code provides that the bankruptcy estate does not include an interest of the debtor in a trust that contains a “restriction on the transfer of [such] interest … that is enforceable under applicable nonbankruptcy law….” In Patterson v. Shumate, 504 U.S. 753 (1992), the Supreme Court held that this provision excluded assets in “ERISA qualified” retirement plans from the bankruptcy estate. Thus assets in pension plans established by employers for their employees which are qualified under the Internal Revenue Code are protected because they do not even become part of the bankruptcy estate. But assets in plans for selfemployed individuals (“Keogh” plans) and individual retirement plans (“IRAs”) are included in the bankruptcy estate and are protected only to the extent that they are covered by federal or state exemptions. The Bankruptcy Code exempts a debtor’s right to receive “a payment under a stock bonus, pension, profitsharing, annuity or similar plan…to the extent reasonably necessary for the support of the debtor and any dependent of the debtor….” The exemption has two serious shortcomings.
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First, although it does cover regular IRAs, it does not cover Roth IRAs or Keogh plans. Second, the amount “necessary for the support of the debtor” depends on the specific facts and can be quite small. Some courts have held that no amount is necessary for the support of a debtor who is young enough to save sufficient amounts for retirement after a bankruptcy filing. State exemptions for retirement plan assets vary widely. Several states have exemptions covering assets in all plans subject to the Internal Revenue Code, including IRAs, Roth IRAs and Keogh plans. A few exempt all assets in such plans except those contributed within a specified period before a bankruptcy filing, usually 120 days. Some cover IRAs but not Keogh Plans and/or Roth IRAs. Some limit the exemption to amounts necessary for the debtor’s support, specified dollar amounts or the amount needed to fund a specified annuity. And a few states have no exemptions for assets in retirement plans. c. Personal property. Both federal and state laws provide exemptions for various types of personal property. For example, the Bankruptcy Code exempts the debtor’s interest, not to exceed $2,275, in one motor vehicle; $9,300 in aggregate value of household furnishings, household goods, wearing apparel, appliances, books, crops or musical instruments; $1,150 of jewelry; $1,750 of professional books or tools of the debtor’s trade; and $925 plus up to $8,725 of any unused part of the homestead exemption of any other property. Most state laws contain similar exemptions. The amount exempted is generally too small to protect a significant portion of the assets of a physician facing an excessive liability award. d. Life insurance. Both federal and state law generally exempt unmatured life insurance policies. But there are generally limits on the amount of the loan value which is exempt. For example, the Bankruptcy Code only exempts up to $9,300 of accrued dividends or interest and loan value under such policies. e. Periodic payments. The Bankruptcy Code exempts a debtor’s right to receive various payments, including social security benefits, unemployment compensation, disability benefits, and alimony and similar payments “to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.” Most states have comparable exemptions. C. State Debtor-Creditor Laws
Most states provide the same exemptions that are available in bankruptcy in any civil litigation. Thus a physician faced with an excessive liability award can protect some assets without declaring bankruptcy. But such nonbankruptcy exemptions do not prevent creditors from garnishing a portion of the physician’s future income or attaching assets the physician accumulates in the future. Thus such exemptions do not provide the fresh start available under the bankruptcy laws. POSSIBLE LEGAL REFORMS The most significant exemptions under both bankruptcy and nonbankruptcy law are the homestead exemption and exemptions covering retirement plans. A physician who lives in a state with an unlimited or substantial homestead exemption will be able, in conjunction with the other exemptions, to retain significant assets. And an adequate exemption for retirement plans will allow a physician to retain all or a significant portion of the assets he or she has saved for retirement. But a physician who lives in a state with an inadequate homestead exemption and has
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most of his or her retirement savings in non-exempt retirement funds will not have adequate protection against excessive judgments. There are at least three possible approaches to reforming the current law. The first would be to work for larger exemptions in the various states. This would benefit physicians who have not declared bankruptcy. But this approach would only help physicians who live in the states that increase amounts exempted. Also, the current exemption levels in many states, particularly for homestead exemptions, are so low that even a substantial percentage increase would not provide a significant exemption. This does not appear to be an appropriate strategy for the AMA to promote national reform. A second approach would be to create a single set of Bankruptcy Code exemptions and eliminate the ability of states to establish their own exemptions. A number of legal commentators have proposed variations on this approach. To provide meaningful protection, however, the exemption levels would have to be substantially higher than the current federal exemptions, particularly the homestead exemption. Otherwise a federal standard would reduce asset protection for physicians in states with higher exemptions without providing adequate protection for physicians in other states. Most commentators who favor this approach view it as a means to reduce what they consider excessive state exemptions rather than a way to provide adequate asset protection. A third approach would be to amend the Bankruptcy Code to establish, or require states to establish, minimum levels for specific exemptions. This would increase the protection available to physicians in states with lower exemptions without reducing the protection available to physicians in other states. The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2003 (H.R. 975) (the “Act”) contains two such provisions. Section 224 of the Act would add an exemption covering all retirement plans established under any provision of the Internal Revenue Code, including IRAs, Roth IRAs and Keogh Plans. The exemption for IRAs and Roth IRAs is limited to $1million (not including rollovers from other retirement plans), but “may be increased if the interests of justice so require.” For other types of plans the exemption is unlimited. This exemption would be available to debtors in all states, including states that have opted out of the federal exemptions. Section 225 of the Act would protect funds placed in an education IRA or a qualified state tuition program for a child, stepchild, grandchild or step-grandchild of the debtor more than 364 days before the bankruptcy filing. Protection for funds contributed between 365 and 720 days before the filing would be limited to $5,000 per beneficiary. All amounts contributed more than 720 days before filing would be protected. The Act does not contain a similar provision relating to homestead exemptions. In fact, section 322 of the Act would limit the homestead exemption under state law to $125,000 if (a) the property was acquired with the 1215-day period preceding the bankruptcy filing, (b) the debtor has been convicted of a felony involving abuse of the bankruptcy law, or (c) the debtor owes a debt arising from violations of the securities law. The expanded protection for retirement plans in the Act would significantly increase the protection of assets of physicians facing excessive liability judgments. If a similar provision were added establishing minimum exemptions for other types of assets, particularly a minimum homestead exemption, the Act could provide significant protection to all physicians.
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There are potential disadvantages to this approach. First, any additional protections would also apply to individuals who owe money to physicians and medical practices. This could make it more difficult for physicians to collect money that is owed to them. Second, opponents of medical liability reform could argue that reforming the bankruptcy law to provide additional protection for physicians’ assets reduces the need for medical liability reform. Thus promotion of bankruptcy reform might, if successful, weaken the case for medical liability reform. The Board of Trustees believes these concerns, particularly the potential effect on the campaign for liability reform, are legitimate. But it is also important for the AMA seek additional or alternative protection for physicians. It will be important to carefully coordinate such efforts so as not to undercut the AMA’s primary legislative priority: achieving medical liability reform. RECOMMENDATIONS The Board of Trustees recommends that the following recommendations be adopted and that the remainder of this report be Filed: 1. That our American Medical Association propose amendments to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2003 (H.R. 975) which would provide further protections, including establishment of a minimum homestead exemption. (Directive to take action) That our AMA develop a strategy for promoting bankruptcy reform that is consistent with our AMA’s efforts to promote medical liability reform. (Directive to take action)
2.
Fiscal note: Approximately $4,365 staff time for development of draft legislation and implementation of report by Council on Legislation.