Being broke is getting tougher. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, designed to curb abusive consumer bankruptcy filings, affects anyone who files for bankruptcy beginning Oct. 17, making it tougher for individuals to file for bankruptcy. The new rules have been given a great deal of publicity so many consumers are rushing to file prior to the new law taking effect. According to the American Bankruptcy Institute, the number of filings was anticipated to increase another 10% to 20% by the end of the third quarter 2005…and second quarter 2005 was the largest single filing quarter in history with 458,597 filings.
So what is changing so drastically with the new laws?
First of all, the costs associated with filing for bankruptcy will most likely increase by three to four times the current amount, purely due to the complexity of the new law. Second, the new law requires that prior to filing bankruptcy, an individual must have sought credit counseling from an approved agency, within the six months proceeding filing for bankruptcy. Third and probably most dramatic, many bankruptcies will now have to use Chapter 13 – a reorganization of debt – as opposed to the more commonly used Chapter 7 – more often a complete clear out of debt, allowing the protection of certain assets.
Chapter 13 requires that a plan be filed with the court to repay the debts associated with the bankruptcy in three to five years. But if the filer could not keep up with the set payment plan, the individual could change the bankruptcy from a Chapter 13 to a Chapter 7 and have the remaining debts cancelled. The new law may no longer allow individuals to make this switch.
The rule reads that if someone earns less than the median household income for their state, they will be allowed to file Chapter 7. But if someone earns more than the median income and can afford a $100 per month debt payment, then generally Chapter 13 will be the only option. And the IRS will be the ones determining this based on the persons income and expenses – the individual will not be allowed to make this determination.
A wide range of provisions will force consumers into lengthy, expensive proceedings potholed with potential pitfalls. Miss one filing deadline and your bankruptcy could be dismissed, leaving you facing a series of escalating penalties when you refile that will make it that much harder to get back on your feet, financially.
And that’s not the worst part. A complicated means test, administered by your own attorney, will determine whether you’ll be allowed to file under the more-forgiving Chapter 7 or a Chapter 13 proceeding.
In addition, your collateral, including furniture, cars and other possessions, will be assessed at a higher value, inflating the overall value of your assets.
When you’re worth more, your creditors can potentially get more out of you. It will also be harder to get out from under car loans, overdue taxes, student loans and credit card debt.
While cracking down on deadbeats who abuse the system isn’t going to leave anyone reaching for the tissue box, many of those who file for bankruptcy are pushed to the edge by unemployment and catastrophic health problems.
As always, it is important to seek the advice of a legal professional on laws governing your particular area.
Means test. The means test is a major change in the law. It is used to determine whether an individual can file under Chapter 7 or Chapter 13 and is administered by the client’s attorney. Chapter 7 generally liquidates the debts of consumers, while Chapter 13 requires them to pay back their secured debt and as much of their unsecured debt as possible.
Here is an overview of the means test:
Income: Using your state’s median income, your attorney determines whether your income, determined by averaging those of the past six months, is above or below that median. That figure must be used even if it is no longer accurate; that is, if the consumer has lost his or her job, or now makes less money.
Expenses: After excluding mortgage or rent payments, car payments, past due taxes and child support, and $1,500 in private school tuition, your attorney figures out whether the you can still pay $100 a month, or more, over the next five years to your unsecured creditors. Those expenses are based on IRS norms for such expenses, which may be way below what your expenses actually are.
Bottom line: If your income is above the state median income, you must file under Chapter 13 instead of Chapter 7, unless the bankruptcy court rules that your circumstances are extraordinary. Even if you pass the first part of the means test and have an income lower than your state’s median, if you can pay more than $100 a month of your unsecured debt over the next five years you have to file Chapter 13 — unless the court rules that your circumstances are extraordinary.
Residency requirements. Bankruptcy laws exist at both the state and federal level, and some states’ laws are more favorable than both other states’ and federal law. The new law is designed to prevent debtors from “jurisdiction shopping” to find the state with the most favorable laws, moving there and immediately filing bankruptcy.
Collateral valuation. Your personal possessions, including furniture, clothes and electronics, will now be assessed at a higher value than were previously assessed. The law mandates that these possessions, known as collateral, be assessed at their replacement value, taking age and condition into consideration.
Increased paperwork and expense load
Paperwork overview. The burden on the consumer to document income and expenses has vastly increased under the new law. According to the American Bankruptcy Institute, consumers must provide:
A list of all creditors, secured and unsecured.
– Schedules of assets and liabilities.
– Schedules of income and expenses.
– Certificate of credit counseling.
– Evidence of payment from employers, including pay stubs of the past 60 days.
– Statement of monthly net income.
– Tax returns for the most-recent tax year.
– Tax returns for several years prior to the filing, if those returns hadn’t previously been filed with the IRS.
– Photo identification.
If these documents aren’t provided to the bankruptcy court within 45 days of the initial filing, the court will automatically dismiss the case. You can file for one 45-day extension, which may or may not be granted.
Legal costs. It is estimated that legal costs involved in a bankruptcy filing will double once the new law goes into effect.
Besides increased costs, lawyers will labor under increased burdens. They will be required to certify that their client’s claims in terms of assets, liabilities, income and expenses are accurate and could face court sanctions if they aren’t.
Lawyers are also placed in the odd position of being unable to advise their clients to take on new debt before they file for bankruptcy, including the debt of legal fees. “You can’t advise your client to incur additional debt, but paying the lawyer will result in more debt,” says Ehrenberg. “You have violated the code if you have encouraged them to incur an additional debt, whether that is legal fees or other costs, even if that is the best advice you can offer.”
Refiling and serial filings
Refiling. If your bankruptcy case is dismissed for any reason and you still can’t pay your bills, you’ll have to refile. Before Oct. 17, this isn’t much of an issue because completing a case is much easier and there aren’t penalties for refiling. But that is changing.
“There are provisions in the law that sharply limit relief if you are filing after a prior case has been dismissed,” says Penn. “You will probably see people who try to do it themselves end up having their case dismissed, and by the time they come back for round two the terms won’t be as good.”
When a bankruptcy case is filed, the court automatically stops the collection efforts of debtors’ creditors. This includes both secured and unsecured creditors. Secured creditors are those with loans securedby property such as a home, car, boat or furniture. Unsecured creditors are those that don’t have any interest in property and include credit card companies.
However, this stay isn’t automatic if you previously filed a bankruptcy case that was dismissed. Under the new law, such refilings are automatically treated as abusive, even if the prior case was dismissed because you weren’t aware that you had to file certain documents or you made a mistake.
You’ll have to ask the court for a stay within 30 days of your second filing. If the court finds that this filing was made in good faith, you’ll get the stay on creditors. If not, you won’t, and your house or other property could be repossessed despite the fact that you are in bankruptcy. If it is your third time around, the stay is even more difficult to get.
Serial filers. While the old law forced consumers to wait a certain period of time between bankruptcy filings, it was much easier to file for one type of bankruptcy after filing for another. For example, in legal circles, consumers who file a Chapter 13 to hold on to their secured property and then file a Chapter 7 to get out from under debts held over under the Chapter 13 are known as “Chapter 20” filings.
The new law lengthens the amount of time between Chapter 7 filings to eight years, there must be four years between a Chapter 7 and a Chapter 13, and two years between consecutive Chapter 13s, according to the American Institute of Bankruptcy.
The bright spot
Reducing unsecured claims. The biggest bright spot in this law allows bankruptcy courts to impose debt reductions of up to 20 percent on unsecured creditors who don’t cooperate with consumer credit counseling agencies’ efforts to negotiate payment plans with those creditors. While many creditors are usually willing to reduce interest rates in repayment plans, few offer any reduction of principle. This provision gives consumers and consumer credit counseling agencies some real leverage in negotiating, says Plunkett.
In many cases, unsecured creditors are the credit card companies who were a driving force behind this bill. And while credit card companies ultimately stand to recoup more from consumers in bankruptcy, this provision will actually let consumers do something meaningful to reduce their overall debt load into a more payable amount.
A court can force this 20-percent reduction of principal on unsecured creditors if they refuse an offer from a debtor through a consumer credit counseling agency, offering to pay 60 percent of the debt due if the plan is proposed within 60 days of filing a bankruptcy petition.
Enhanced disclosures. For debtors who sign agreements with creditors to continue paying back debt during and after bankruptcy, known as reaffirmation, the law specifies that these consumers must be fully informed of their rights and the exact terms of these agreements. Consumers have the right to change their minds within a certain period of time and receive documents stating the date payments are to begin, as well as the interest rate to be paid.
Retirement and college savings gain protection. If a consumer entering bankruptcy has funds in a retirement plan such as a 401(k), 403(b) or an IRA, those funds aren’t included in the bankruptcy as an asset available to creditors. College savings accounts for children are also exempt, and debtors are allowed to continue to fund retirement plans, if they can.
Support obligations. Child support obligations now receive top priority in bankruptcies, ahead of all other unsecured claims except administrative and legal fees. Debtors in Chapter 13 must pay back all child support arrears before their bankruptcy can be completed or discharged.