The vast majority of civil actions are debtor-creditor cases. They begin when a credit card bill or invoice was not paid as agreed, a rent payment was missed, a mortgage or car payment was missed, or taxes are not paid when due.
This system is flawed in different ways for different categories of cases.
Where The System Works: Dispute Resolution Between Solvent Parties Over Large Debts
The system works reasonably well to enforce or refuse to enforce debts based upon contracts in writing where both the creditor and debtor can afford to hire lawyers and recognize the need to do so, but the debtor refuses to pay due to a dispute, bona fide or not, in significant dollar amount cases (realistically something in the vicinity of $50,000 to $100,000 and up).
The trouble is that very few cases in the court system fit this description.
Dispute Resolution For Intermediate Sized Debts
The current system is not a good means of dispute resolution for intermediate dollar claims between solvent parties, although serious efforts, thus far mostly unsuccessful, have been made in Colorado to change that reality.
While Colorado's limited jurisdiction courts for civil claims under $15,000 provide a fairly cost effective (and not entirely pro se party unfriendly) forum to disolve these disputes on the merits through a fairly prompt trial on the merits (three to six months typically) with little or no meaningful pretrial motion practice or discovery (which isn't really doesn't pass cost-benefit muster in cases with dollar stakes this low in simple collection cases), Colorado's general jurisdiction courts for larger civil claims routinely require the parties to incur litigation costs that are disproportionate to the amount in dispute to resolve these intermediate sized claims of more than $15,000 but less than something on the order of $50,000 to $100,000.
Inability To Pay Cases
The vast majority of cases involve creditors who can afford to hire lawyers and debtors cannot afford to pay and cannot afford to hire lawyers given the cost of hiring a lawyer relative to the amount in controversy, or because the debtor is currently illiquid even if the debtor might someday have an ability to pay the lawyer.
In these cases, when there is no bona fide dispute over the debt, there is an incentive to throw up some kind of defense, even if it isn't very strong, in order to allow the debtor to hold onto all of his assets and income for as long as possible. Also, frequently, the debtor owes debts to multiple creditors whose debts in the aggregate exceed the ability of the debtor to pay, and the current system gives unjustified preference to whomever makes it to court first, or whomever the debtor choses to be most cooperative with in negotiations with creditors, in each case, for all sorts of reasons that shouldn't matter in prioritizing the extent to which all of a debtor's creditors should be repaid out of assets insufficient to repay them all. Also, a debtor who has claims hanging over his head that have not been fully repaid, whether or not reduced to judgment, but for whom bankruptcy is unattractive for any of a variety of reasons from inability to pay for attorneys to being uncollectible anyway, has no incentive at that point to make any effort to maximize his income and ability to repay those creditors.
The non-bankruptcy debt collection system isn't a total failure and can work well enough when there are just a few creditors who care enough to resort to litigation, payment plans and compromises can be worked out in connection with the court process of debt collection, in the shadow of the involuntary collection methods the process makes available. Yet, ironically, in the cases that best fit this profile, such as insolvent corporations whose debts are mostly consolidated into bonds enforceable by a small number of bond trustees and institutional investors, or in single asset companies with a single bank lender, debtor resort to the bankruptcy process seems to be particularly common.
Undisputed Debts Greater Than The Ability To Pay Where The Full Amount Claimed Is Disputed That Aren't Litigated
The system is particularly unfair and/or wasteful of both creditor and debtor and court system litigation resources in cases where the debtor is unable to pay the amount that the debtor admits is owed, but still disputes significant amounts of the debt, whether or not the debtor can afford an attorney.
In these cases, if the debtor can't afford to mount a legal defense and as a result, for example, a default judgment or judgment due to some other kind of failure to property participate in the court process produces a judgment that doesn't address the merits of the disputed amount, if the debtor later comes into money, the debtor may be forced to pay an excessive judgment amount that can not be revisited due to the strong rule of finality for civil judgments. Effectively, the debtor has been denied due process.
Also, the excessive award in favor of one creditor may deny other creditors their fair share of the available assets. As a general rule, there is no way that one creditor of a debtor can dispute the amount of another creditor's money judgment, even if they had the incentive that the debtor did not, to litigate the issue on the merits. But, once a debtor is undeniably insolvent, a debtor has no more incentive to dispute totally bogus claims than he does to dispute valid claims.
A variant on this situation which is also very common is the case where a default judgment is entered against a debtor (typically a consumer debtor) who is either not properly served with process, or is too unsophisticated to understand how important it is to take action before a particular date (which the debtor may not accurately determine anyway). A significant number of consumer debtors (and even moderately sophisticated small business debtors) don't take legal process seriously until it results in a garnishment or seizure of property and are astounded to discover that it is very hard to raise any defense on the merits to the money judgment at that point because a default judgment was entered against them.
Undisputed Debts Greater Than The Ability To Pay Where The Full Amount Claimed Is Disputed That Are Litigated
On the other hand, if the debtor can afford to mount a legal defense, he has a strong incentive to do so to defer collection of the undisputed portion of the creditor's claim and prevent a judgment in amount greater than the amount actually owed from being entered so that he is not forced to pay to much if he is later able to pay the debt. But, if it turns out that the debtor is never able to pay even the undisputed amount of the claim, the litigation over a legal defense inappropriately delays collection of the undisputed amount and reduces the total size of the pie available to creditors on a disputed issue that is purely theoretical and contingent upon an improvement in the debtor's fortunes that will never happen. From the point of view of efficiency in the use of legal system resources for all parties and the court system, it would be better if litigation of the disputed portions of the debts on the merits was deferred until the debtor actually had sufficient funds to pay more than the debtor's undisputed debts.
Value Impairing Collections
In addition to the concern that the collections process can be inequitable between multiple creditors of the same insolvent debtor and impairment of earning incentives of debtors, who does not resort to the bankruptcy process which provides more fair relative recoveries and better incentives for any of a variety of reasons, the collections process also often inappropriately reduces the size of the pool of funds available for collection.
An involuntary disposition of property other than money garnished from bank accounts or wages, pursuant to a pre-judgment lien or the collection process that a money judgment makes available to creditors routinely discharges less of a debt than the price that could have been secured in a disposition of the property in the ordinary course by a non-distressed seller. This hurts other creditors of the debtor (and the debtor), if the creditor accepts the seized property in a full settlement of a debt that is smaller in amount than the amount owed. If the disposition is at an auction where there is a third party bid, it may also hurt the collecting creditor.
Moreover, when the fact that the debtor is distressed is known to potential buyers, the likelihood that the debtor will end up parting with the property at less than fair market value also impairs the value at which the debtor can dispose of the property voluntarily because would be buyers know that the debtor can't afford to wait for a better offer for very long.
And, while debts are hanging over a debtor, he has a reduced incentive to earn income, to be thrifty, and to drive hard bargains in any of his other dealings, in his personal life or business dealings.
Claim Priority Issues In Bankruptcy
The priorities of claims in bankruptcy law are also not optimal. As a general rule, bankruptcy awards creditors an equal percentage payout from available funds. But, sometimes this formal equality is inequitable.
This rule encourages creditors to inflate their claims in bankruptcy, once they know that they probably won't be receiving payment in full, with high default interest rate and late payment penalties. Punitive damages and similar statutory penalty damages in excess of the amounts necessary to b e compensatory have a similar effect when a debtor is insolvent and has multiple creditors. Rather than first repaying the amounts which creditors would have been entitled to expect in the absence of a default before paying "extras", the bankruptcy priority system treats all of these amounts claimed as equal priority general creditor claims.
There are other faults to the priority system, of course, particularly in business bankruptcies, but the equal priority given to default interest and penalties is most pertinent to relatively run of the mill, non-business cases.