The new way to survive a personal bankruptcy

On the Money
From the May 6, 2005 print edition

President George W. Bush recently signed the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005,(“BAPCOP”). The new law takes effect October 17, 2005.

“By restoring integrity to the bankruptcy process, this law will make our financial system stronger and better,” Bush said in a news conference.

That sounds reassuring. However, everything in today’s financial and economic systems are intertwined, and no one action provides a complete path toward improvement.

The following explores some of the history and implications relating to bankruptcy and the new regulations.

The first official laws concerning bankruptcy were passed by England in 1542, under Henry VIII. A bankrupt individual was considered a criminal, subject to criminal punishment. Potential penalties ranged from incarceration to death.

U. S. bankruptcy laws for the protection of debtors were first enacted in 1800. However, the foundation of modern bankruptcy law and practices in the United States began with the Bankruptcy Act of 1898.

The economic turmoil of the late 1920’s and early 30’s spawned more bankruptcy legislation, notably, the Bankruptcy Act of 1933 and the Bankruptcy Act of 1934. This legislation culminated with the Chandler Act of 1938. From 1938 to the present day, bankruptcy laws and procedural rules continued to be refined.

The Bankruptcy Reform Act of 1978 created Chapter 11 reorganization and a more powerful form of personal bankruptcy, Chapter 13. In 1986, Chapter 12 was created for family farms.

Enter now BAPCOP of 2005. The American Bankruptcy Institute estimated that up to 210,000 people will be affected by BAPCOP — unless they file for bankruptcy before October 17.

The major modifications provided by this Act are as follows.

Income test. Income is subject to a two-part “means test” to determine if the debtor can afford to pay 25 percent of their “non-priority unsecured debt” such as credit card bills. Then income will be compared to the debtor’s median income. If income is above the state’s median and the debtor can afford to pay 25 percent of the unsecured debt, the debtor may not be allowed to file under Chapter 7 liquidation.

However, Chapter 13 reorganization may still be available.

Charitable tithing. Up to 15% of one’s income can be given to charity; a possible loophole allowing people who may be just over the threshold of having to file Chapter 13 to drop down low enough to file Chapter 7.

Child support and alimony. These debts become number one on the priority list as opposed to 7th under the old law.

Homestead exemption. Currently, some states allow debtors to protect some or all of their home’s equity from creditors. The new Act, however, places more stringent restrictions on the homestead exemption.

Creditors’ rights. Currently, creditors who won’t receive any money owed in a bankruptcy case may contest the ruling if it’s a Chapter 7 case, but not if it’s Chapter 13. Creditors may now challenge Chapter 13 filings as well.

Liability for lawyers. Under the new law, bankruptcy attorneys may be subject to various fees and fines if the filings are found to be inaccurate. The increased liability will make lawyers less willing to accept bankruptcy cases and if they do, costs will no doubt be higher.

Credit counseling. In a provision similar to required parenting classes in divorce cases, the new bankruptcy law requires credit counseling in the six months prior to applying for bankruptcy, and money management classes. The debtor pays for these classes.

Multiple filings. The time between effective Chapter 7 bankruptcy filings in creases from six years to eight years.

Automatic disclosure. Additional disclosures are required from debtors. Although debtors need to provide trustees with essentially any documents concerning their financial history under Bankruptcy Rule 2004, this Act makes the disclosures automatic, required and mandatory. Otherwise the case will be dismissed.

Audits. Random audits performed by certified or licensed public accountants must be done on .04 percent of filings of personal Chapter 7 and 13 cases, and on cases that vary from statistical norms. Furthermore, the discharge of debts may be denied if the debtor fails to cooperate with the auditor.

The results of these changes in the law will of course not be known for several years and opinions about the new law are expectedly varied.

Bob Waldschmidt, former president of the National Association of Bankruptcy Trustees, called the up-front credit counseling requirement a waste of time, but likes the bill’s requirement that, before leaving bankruptcy, filers take a course in managing household finances.

“This is not going to be as drastic as people make it out to be,” he said. Still, he added, “the system is going to get more expensive and burdened with more work.”

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.