It's a Whole New World:
Understanding the Radical Changes to the Bankruptcy Code
Frederick J. Petersen
Since 2001, Congress has spent considerable time every year attempting to reform the bankruptcy code. After several years of failure, due to the attachment of "pork" amendments, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was approved by Congress this spring, and signed into law by President Bush on April 20, 2005. Most of the provisions in the Act will become effective on October 17, 2005.
At more than 700 pages long, the Act makes sweeping changes to the bankruptcy code, which has been changed little since its 1994 amendments. The widespread changes have left bankruptcy practitioners, bankruptcy trustees, and bankruptcy courts scrambling to understand the new Code, and prepare for implementation of several new provisions. Although commercial bankruptcies will be impacted, the changes will primarily have an effect on individual bankruptcies.
Credit Counseling
Before any individual is eligible to file for bankruptcy protection, he or she must first attend an individual or group credit counseling session. In the session, the credit counselor will perform a budget analysis, and explain to the debtor what efforts could be taken to resolve debt issues without a bankruptcy filing. Additionally, once a debtor files for bankruptcy, he or she must attend a second educational class that will explain budgeting and money management techniques. The Act makes these changes with the hope that repeat filings will be decreased.
The "Means" Test
More than 70 percent of individual bankruptcies filed last year were under Chapter 7 of the bankruptcy code. A Chapter 7 bankruptcy, also known as a liquidation, allows a debtor to turn over all non-exempt assets to a Chapter 7 Trustee in exchange for a discharge of most debts.
The Bankruptcy Act makes it much more difficult for individuals to file for Chapter 7 bankruptcy protection. Also, the timing between Chapter 7 bankruptcies has been extended to 8 years. Previously, debtors could obtain a discharge every 6 years. (Further, after obtaining a Chapter 13 discharge, a debtor must now wait 4 years to file for Chapter 7 bankruptcy.)
It will now be considered an "abuse" of the bankruptcy code for an individual to file for Chapter 7, unless the debtor first passes a "means" test intended to demonstrate an inability to pay creditors over time. The means test prevents individuals from filing for Chapter 7 bankruptcy if their annual income is more than the state median, based on family size, or if after deducting certain expenses, they would be unable to pay the lesser of $10,000 or 25% of their unsecured debt over a 5 year period. If the means test reveals that a Chapter 7 filing would be an abuse, the debtor must either convert the case or have their case dismissed.
Length of Chapter 13 Plans
Because many debtors will be unable to file a Chapter 7 bankruptcy, the Bankruptcy Act will result in a substantial increase in the number of Chapter 13 filings next year. In Chapter 13, an individual debtor is required to make monthly payments equal to their "disposable income" to a Trustee. The Trustee then distributes those funds to the creditors. The Act makes substantial changes to Chapter 13 of the Code, which will be imposed on any filings after October 17, 2005.
Currently, debtors can propose a repayment plan that spans between 36 and 60 months. The Bankruptcy Act will require Chapter 13 debtors, with some exceptions, to propose a repayment plan of at least 60 months. The resulting longer payment term will presumably increase payments to creditors.
Chapter 13 "Lien Stripping"
Traditionally, Chapter 13 has been used to "lien strip" certain auto and personal property loans, when the debtor wishes to retain the collateral. A debtor was previously allowed to keep the asset by paying the secured creditor its liquidation value as of the filing. The amount of the loan meant little with regard to the amount a debtor was obligated to pay. The Bankruptcy Act now prevents this practice. Under the Act, a debtor cannot retain an asset that is collateral for a loan, unless the full loan amount is repaid.
Further, both Chapter 7 and Chapter 13 debtors must now promptly make a decision to keep or return collateral assets, and promptly act with regard to secured auto and personal property liens. The Bankruptcy Act requires debtors, within 30 days of their first meeting of creditors, either to reaffirm the loan, or redeem the collateral. Under the old Code, collateral could be redeemed for its liquidation value. Now the Act will require debtors to pay the retail replacement value of the asset in order to keep the collateral.
Chapter 13 Discharge
The scope of a Chapter 13 discharge has been dramatically narrowed. Previously, almost any debt could be discharged in a Chapter 13, as long as the debtor made all scheduled plan payments. The Bankruptcy Act imposes several new exceptions to a Chapter 13 discharge. Specifically, debts incurred by fraud, misrepresentation, breach of fiduciary duty, or because of an intentional tort that caused serious bodily injury or death are now nondischargeable in a Chapter 13.
Domestic Support Obligations
Domestic Support Obligations, including spousal and child support obligations, continue to be nondischargeable. The Act grants those obligations a first priority for payment in a bankruptcy case, even ahead of bankruptcy administrative expenses including attorney's fees and other post-petition obligations. A debtor in Chapter 13 is now required to stay current with all spousal and child support obligations. Before a debtor may be granted a discharge, he or she must demonstrate that all spousal and child support payments, whether arising before or after the bankruptcy filing, have been paid current. Additionally, property settlements and debt payment agreements between spouses, which used to be dischargeable upon a showing of hardship, are now nondischargeable.
Conclusion
The eventual impact of the Bankruptcy Act is hard to predict. When interpreted as a whole, its provisions are certainly more harsh on debtors seeking a "fresh start" from their debt problems. Some have speculated that the additional burdens will force individuals to take their financial activities "underground." The net effect would be less tax dollars, because income would go unreported. Others have speculated that the continued lending practices of credit card companies will lead to an economic crisis because people are now less able to discharge those obligations. Still others believe people will act more responsibly with their finances because the "fresh start" of a bankruptcy has been limited. The certainty is that the Bankruptcy Act will have a substantial and lasting impact on the economy. Only time will tell what consequences the new bankruptcy world will bring.
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