Bankruptcy Reform and Consumer Protection Act of 2005

November 2, 2005

By: Gregory Arcaro

We knew it was coming, and we knew it would be bad for debtors in bankruptcy. We still don't know just how bad it will be. But we are beginning to realize that the Bankruptcy Reform and Consumer Protection Act of 2005 is here after almost a decade of near misses, so we might as well try and cozy up to it as best we can. The upshot, however, is that the bankruptcy rules have drastically changed, altering the relationship between creditor and debtor forever.

Obtaining bankruptcy relief prior to the passage of the Bankruptcy Reform and Consumer Protection Act of 2005 (the "Reform Act") was fairly predicable and streamlined process. Some may have thought the matter all too painless, but the fact is that honest debtors who have gotten themselves in over their heads, either through poor decisions of their own or through circumstances beyond their control, could seek and very often receive a fresh financial future through the invocation of the bankruptcy laws. Over the years, however, the feeling developed among the credit card industry that large portions of Chapter 7 filers were abusing the bankruptcy process and could, in fact, repay their debt or some percentage of it anyway, with future income. They were correct that there was abuse in the bankruptcy system, although, in my opinion anyway, not in large scale. My experience, having represented hundreds of debtors in bankruptcy proceedings, is that the overwhelming majority of debtors need and deserves bankruptcy relief due to divorce, illness and disability, failed entrepreneurial endeavors, and temporary loss of employment. In fact, a joint study conducted by Harvard Medical School and Harvard Law School found that roughly half of all bankruptcies filed in 2001 were caused, at least in part, by illness or medical debts.

After the effective date of what can safely be called the most radical change in the bankruptcy laws ever, October 17, 2005, obtaining bankruptcy relief is now much more challenging, and some may find it impossible. Below are the major changes to the bankruptcy law and how each will affect the debtor's ability to obtain bankruptcy relief:

Means Test for Chapter 7 Eligibility

The trustee or any creditor can ask the Bankruptcy Court to dismiss the case if the debtor's income is greater than the state median income. Bankruptcy abuse is presumed if the debtor's current monthly income exceeds, by more than $100.00 per month, certain allowable expenses as set forth in local and regional standards published by the internal revenue service. If there is an abuse, the debtor will be forced to choose between a dismissal of their Chapter 7 case, or a conversion to a Chapter 13, where creditors will be repaid some or all of their debt over a period of five years.

If a debtor's income falls below the state median, only the Bankruptcy Court can dismiss the case.

In determining whether the median threshold has been reached, the law looks at the number of people in the debtor's household (which the census bureau defines to be all the people occupying a dwelling unit) compared to census figures adjusted by the CPI. The presumption of abuse may only be rebutted by demonstrating "special circumstances that justify additional expenses or adjustments of current monthly income."

Median income tables can be found at http://www.census.gov, and the allowable expense tables can be found at www.usdoj.gov/ust/bapcpa/meanstesting.htm.

Mandatory Credit Counseling

No individual may be file a bankruptcy case unless they have, within 180 days prior to filing, received credit counseling from an "approved nonprofit budget and credit counseling agency", either in an individual or group briefing. Said counseling agencies are to be approved by the Office of the U.S. Trustee, and arm of the United States Justice Department. (There are exceptions where there is an emergency and the person could not receive counseling within five days, or where the U.S. Trustee has determined that the approved agencies are not adequate to provide the required counseling.) If a debt-management plan is developed, it must be filed with the court.

Mandatory Debtor Education

If credit counseling is your ticket into bankruptcy, Debtor Education is your ticket out of bankruptcy. The court may not grant a Chapter 13 discharge unless the debtor has completed an education course in personal financial management as approved by the U.S. Trustee. A debtor can be denied discharge in a Chapter 7 case if he or she fails to complete the course.

Limit on Automatic Stay

The Automatic Stay, a mandatory hold placed on all creditor activity, and the most profound immediate relief obtained by filing a bankruptcy petition, has been severely limited in scope. The new law limits the application of the stay or provides that it does not go into effect, in certain circumstances, where there are serial filings under circumstances that would indicate bad faith or abusive filings.

In addition,

Dismissal for Failure to file Documents and Schedules

In addition to the list of creditors, schedules of assets and liabilities, income and expenses, debtors must provide: certificate of credit counseling; evidence of payment from employers, if any, received 60 days before filing; statement of monthly net income and any anticipated increase in income of expenses after filing; tax returns or transcripts for the most recent tax year; tax returns filed during the case including tax returns for prior years that had not been filed when the cases began; a photo ID, among other items.

Failure to provide the documents within 45 days after the petition has been filed (with a possibility of a 45-day extension) results in automatic dismissal of the case after the time period has passed.

Attorney Verification Required

Attorneys must make "reasonable inquiry to verify that the information contained" in petitions and schedules are "well grounded in fact." "The signature of an attorney on the petition shall constitute a certification that the attorney has no knowledge after an inquiry that the information in the schedules filed with such petitions is incorrect". The impact on debtors is plain: attorney's fees are going to increase dramatically. It has yet to be determined what a "reasonable inquiry" means precisely. But you can be assured bankruptcy practitioners will spend extra time, and possibly independent means, to verify a debtor's assets prior to signing his or her name to the petition. This cost will be passed on directly to debtors.

The foregoing are the major changes affecting the ability of persons having financial difficulty to obtain bankruptcy relief. The changes are dramatic and broad in scope, which reflects the drafters' (the credit industry) mistrust of debtors in bankruptcy. The Bankruptcy Code as it exists after the Reform Act is a walk in a minefield of potential mistakes and oversights. Bankruptcy will once again be an area of practice reserved for specialists in the field. Bankruptcy relief, however, remains an available option, especially for those individuals who earn less than the state median income. Those above the state median income will likely be forced to find a non - bankruptcy solution to their financial difficulties, or submit to repayment of their debt over a period of years in a Chapter 13 bankruptcy proceeding.