Countdown To Major Bankruptcy Law Changes

by Andrew M. Thaler, Esq.

After the expenditure of multi-millions of dollars by lobbyists for the credit card industry over a period of eight years, Congress enacted a new bankruptcy law that will take effect on October 17, 2005.  The new law is called the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”).  Despite its name, the provisions for the most part, have little to do with protecting the consumer.  Although this legislation was promoted as a way to curb consumer abuse, its effect will be to discourage bankruptcy filings by non-abusing citizens who incur primarily consumer debt.  Under the old law, there was a presumption of granting a debtor a discharge and a debtor could more easily enter bankruptcy and obtain a “fresh start” which would discharge most debts.  BAPCPA shifts most burdens to the debtor, including the creation of a presumption that anyone who files bankruptcy seeking to discharge primarily consumer debt is an “abuser”.   In the opinion of bankruptcy experts, the  abuse which BAPCPA seeks to eliminate simply did not exist anywhere near the levels claimed.   BAPCPA fails to (i) address the growing debt problem in this country from the credit side, (ii) implement measures designed to curb predatory credit practices (for example, creditors that disseminate millions of unsolicited credit offers in the form of pre-approved credit cards, checks and the like to persons who are not creditworthy), or (iii) require credit information disclosure before people sign up for credit.  In any event, the effective date of the new law is quickly approaching and those who might consider filing bankruptcy will have to deal with it.

The hallmark of the new law is a “means test”, a test designed to filter out bankruptcy filings by people who can, it is argued, afford to pay their consumer debts.  The problem with the law is that it really does not measure what people actually can pay, but relies upon many assumptions which result in fictitious numbers being used to determine the debtor’s income and expenses.   The first prong of the means test requires the debtor to average his or her past six months earnings.   This test may penalize an individual who worked hard to maintain or increase his or her income and rewards individuals who become unemployed or minimize income receipt during this six month look-back period.   Once that figure is calculated, it is compared to the median income of the state in which the debtor resides adjusted for family size.   If one falls below the median, there is no means testing.   If one falls above the median, then the persons expenses must be calculated and considered.   But the expenses are not all of one’s actual expenses.   The test utilizes Internal Revenue National and Local Standards, (based on levels designed and used by the IRS for collecting money from people, including tax cheats, who do not pay their taxes) for things such as housing, utilities, food and household expenses.   Additional enumerated “Other Necessary Expenses” and “Special Circumstances” also apply, but the burden is on the debtor to justify that they are reasonable and necessary.   Debtors will have to produce documents to establish that those expenses have actually been regularly incurred and paid.   An example might be expenses associated with the care of a severely handicapped child.   While the debtor might ultimately prevail in having these expenses approved, the cost to hire competent and knowledgeable bankruptcy counsel to assist in the analysis and to defend possible challenges by creditors could be cost prohibitive.   The formulae are so complicated that many seasoned bankruptcy practitioners are themselves struggling to get a handle on it.   The economic reality is that bankruptcy under BAPCAP may not be affordable by the working class poor, and, as discussed below, may become a tool for those who can afford it.  For instance, payment of a secured debt is an allowable expense.   A “wealthier” Debtor can be rewarded for driving a more expensive car.  Inexplicably, people with higher incomes are allotted more money for food.

Attorneys and debtors will be required to document much more information than under current law.   For instance, all debtors will have to produce and file with the court all pay stubs for the past 60 days or risk having the petition automatically dismissed for that reason alone.   Debtors will have to produce tax returns at a very early stage of the case (7 days before the initial meeting of creditors), or have the petition dismissed.   The debtor will also have to document all expenses by producing bills and perhaps independently establishing the value of various assets with appraisals and/or other valuation tools.    

It will be more expensive to file bankruptcy because, in addition to the increase in filing fees, attorneys will be compelled to perform significantly more legal work to meet the requirements of the new law.   One of the things that will also drive legal fees higher are new provisions that hold the attorney potentially liable if information that finds its way into the petition is “not correct”.   In particular, attorneys will be required to certify that they have no knowledge, after an inquiry, that the information in the schedules filed with the petition is incorrect.  In addition, the debtor must obtain a certificate that proves that he/she obtained credit counseling within 180 days before filing, as well as a post-filing certificate for yet another course on debtor education.   These certificate requirements will add to the debtor’s costs and may discourage persons from filing for bankruptcy altogether.
 
Additionally, under BAPCPA, debtors may have to invest more time and money to obtain protection from creditors.   Currently there is an automatic stay of creditors taking action to collect their debt after a bankruptcy is filed.   Under the new law, if one or more bankruptcy petitions have been filed within the last year, there will be a limited 30 day stay or none at all.   It would be up to the debtor to make a motion (again at his or her cost) to maintain the stay in place byestablishing good cause to do so.  This provision addresses problems associated with repeat abusive filers, but will have a negative effect on non-abusive filers who are compelled for legitimate reasons to file two petitions in the span of one year. 

Creditors who previously did not have standing to object to a bankruptcy petition for abuse will now under certain circumstances be permitted to do so.   Previously, that job was vested with the court and the Office of the United States Trustee, a division of the Department of Justice that oversees all bankruptcy cases.   The new law will potentially require debtors to defend such motions.   While the law has a provision for  debtors to recover their costs in the event that aggressive creditors overstep their rights, it is unlikely that most debtors will have the financial wherewithal to defend against such actions.

No longer will one be able to file a chapter 7  bankruptcy petition again after 6 years and obtain a discharge.   That time has now been changed to 8 years.   There have also been limits on how long one has to wait to even file a chapter 13 petition after the filing of a prior chapter 7 petition.   Moreover, the length of a chapter 13 plan has been increased for certain people from 3 to 5 years.

One of the few positives for debtors is that, in response to BAPCPA, some states have increased their homestead exemption.   A homestead exemption is the amount of equity in real property occupied as a person or family’s primary residence that one can keep after paying mortgages, tax and other consensual liens.   For example, in New York, the homestead exemption has been increased from $10,000 to $50,000.   When stacked, a husband and wife who own property in New York, which is occupied as their primary residence can now jointly claim a $100,000 homestead exemption.    The effect of the increased homestead exemption is that, to the detriment of unsecured creditors such as credit cards, fewer homes will be administered and sold by Chapter 7 bankruptcy trustees.

An additional benefit arises in the context of Chapter 13 for individuals who have outstanding child support and/or maintenance arrears.   BAPCPA elevates child support and/or maintenance to a priority position.   To the detriment of the unsecured creditors, such as credit card debt, an individual with priority tax liability and/or priority matrimonial debts will pay those debts first before any unsecured non-priority debts are paid.   Additionally, for those who do not have it, health insurance may be paid as a reasonable and necessary expense and deducted from what would be paid to unsecured creditors.   The net effect is that the individual with priority debts will pay more towards satisfying these non-dischargeable priority debts with less being paid over the course of a plan to unsecured creditors.   This will equate to more unsecured debts being discharged at the conclusion of a confirmed Chapter 13 plan.  

The means test applies to those with primarily consumer debts.   If the debts are primarily business related, the means test does not apply.   Arguably, those with 51% or more of non-consumer debts will qualify without a means test requirement.   Is the use of a gas credit card for use of a car to travel to and from work a consumer debt or a business debt?   If a debtor initiates his or her bankruptcy as a Chapter 13, and later converts to a Chapter 7, do they avoid the means test?        

 Recent studies have shown that, when BAPCPA was applied to pre-BAPCPA cases, only about 16% of filings nationwide would not qualify under the means test.  However, that figure probably does not take into account whether the debtor can afford the legal fees and increased court filing fees, and whether they have the ability to produce the documents needed to file bankruptcy or to make an application to the court for authorization to file without producing them.  How may people afflicted by Hurricane Katrina can produce the documents required to file bankruptcy under the new law?  The law also does not take into account the higher cost of living in the New York Metropolitan area where the state median for income may not be a good indicator of the cost of living.   

The bottom line is that under BAPCPA it will be more time consuming and costly to determine whether or not to file bankruptcy.   It behooves anyone in a precarious financial situation to investigate filing now, before the law changes on October 17.   Most bankruptcy practitioners are taking a wait-and-see approach as to how BAPCPA will be applied and interpreted by the bankruptcy courts.   Although the need for bankruptcy relief will always exist, the manner and expense of obtaining relief has changed.

Andrew M. Thaler, Esq. is a partner of Thaler & Gertler, LLP, located in Westbury, Long Island, New York.   The firm concentrates its practice in areas of bankruptcy, debtor/creditor law, real estate and business/corporate law.   Mr. Thaler is a panel Chapter 7 Trustee for the Eastern District of New York.