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New Bankruptcy Law Tightens Rules, Adds Paperwork

It's Now Much Tougher to Get a Fresh Start

By Joan E. Lisante
ConsumerAffairs.com

October 14, 2005
If you're a consumer in financial trouble, your theme song might be "I Got Plenty of Nothin'" from Gershwin's Porgy & Bess. But if you think you've got plenty of nothing now, the new "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" could shrink even that.

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Effective October 17th, the Act is a coup for banks, credit card issuers and stores -- otherwise known as "unsecured" creditors (those owed money that isn't backed by an asset, such as a car or home.) It overhauls laws last modified in 1978, tightening requirements for filers and for bankruptcy lawyers who handle their cases.

A major goal: to shift filers from Chapter 7 ("straight") bankruptcy, in which consumer debt is typically liquidated, to Chapter 13 ("reorganization") bankruptcy, which requires that you repay secured and much unsecured debt within five years. No "clean start" in this case.

Here are some of the major changes under the new law:

• The "Means Test" This is a new wrinkle that challenges the assumption that a debtor is filing in good faith. Now the burden is on you to show that your use of bankruptcy relief isn't "abusive." The means test calculates your monthly income minus certain allowable expenses. Each state uses its "median income" as a guide. If the balance left is more than about $100 a month, the filing is considered abusive, unless you can show "special circumstances." If you flunk the "means test," it's Chapter 13 for you.

• Stringent expense allowances Guidelines for allowable expenses are set by the IRS and are stingy. For example, the food allowance is around $200 per month and housing allowance about $800. Too bad if your actual costs are much higher.

• Residency requirements There are both federal and state bankruptcy laws and some state laws are more favorable than others. For example, both Florida and Texas have generous "homestead allowances," which permit debtors to shield assets under the umbrella of homeownership. But the new law aims to discourage "shopping around" for the best deal, so you can't file in a more favorable state unless you've lived there for at least two years.

• Mandatory credit counseling You must take an approved credit counseling course within 180 days (six months) of filing a petition. This isn't free -- average cost is estimated at $75.00.

• More paperwork In the new "get tough" environment, consumers will have to provide a lot more documentation to show that bankruptcy is warranted. The American Bankruptcy Institute lists some of the proof debtors must provide: a list of secured and unsecured creditors; documentation of credit counseling; monthly income and expenses; assets and liabilities; most recent tax return and any earlier returns that were not filed; pay stubs and photo ID.

• Heftier legal fees The burden on bankruptcy lawyers is at least doubled under the new statute. Besides merely gathering the facts from a client, an attorney must now "certify" that a client's numbers are accurate. If they aren't, both lawyer and client could face sanctions. So, in effect, your lawyer must do more fact-checking and investigation to assure that both your information and his/her own certification are above-board. This takes time, which translates into money. Many lawyers are getting out of bankruptcy practice, not wanting to put their careers on the line for filing cases that don't pay very well anyway.

• Filing fee changes Charges vary from state to state, but in general, you'll pay more for filing under Chapter 7 and slightly less under Chapter 13.

• Valuation increases The law provides that "collateral," which includes your furniture, clothes, autos and electronics, be assessed at a higher value than under the previous law. The new benchmark: replacement value. Chances are, by the time you add up the total value of your possessions using this formula, it will be pretty high.

• You'll wait longer to file again If your situation requires another bankruptcy filing, you'll wait longer to do so. The new law provides that, under Chapter 7, eight years must elapse before you can re-file. If you go for Chapter 13 after a Chapter 7, you must wait four years. Going from one Chapter 13 to another, two years must elapse.

• No loading up on last minute luxuries The new law requires that any luxury items purchased within 60 days of filing for bankruptcy be repaid in full. Likewise for cash advances and services worth more than $500.

• Beware those student loans Under the old law, you couldn't get rid of student loans backed by the government or a non-profit. This protection has been extended to private lenders as well.

Scant Comfort

Despite all this bad news, there are a few pluses. Your house, retirement plans and college savings are exempt, and you can continue to fund the last two (a laughable notion for someone filing in the first place.)

If an unsecured creditor (say, MasterCard) refuses to accept your repayment offer, the court can reduce your principal debt by up to 20%. This is to encourage creditors to cooperate with credit counseling agencies, which often mediate settlements between debtor and creditor.

For those owed child support, this obligation jumps ahead of any other unsecured claim except administrative or legal fees. Also, there are special provisions for a few groups: military personnel on active duty, low-income veterans and people with severe medical disabilities.

So if you're hoping to change your theme song to "For the Love of Money," take note of these changes and get expert advice before you discover that financial "freedom" costs more than you bargained for.

For more information:

American Bankruptcy Institute

U.S. Department of Justice Trustee Program

www.BankruptcyAction.com, which provides comprehensive information on the new Act as well as a state-by-state list of bankruptcy attorneys.

Joan E. Lisante is an attorney in Fairfax County, Va.

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