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Four Months Later: The New Bankruptcy Law

The new bankruptcy law is primarily designed to make it harder for filers to fully escape unsecured debts.

By LIZA ROCHE

The newly enacted Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has spelled financial trouble for lower-income people attempting to file bankruptcy, but plenty of pitfalls are in store for more financially secure people and businesses seeking to do the same.

Any high-income individual may now be hard-pressed to find an attorney who will attempt anything but the payment-plan focused Chapter 13-type bankruptcy, says one Chicago attorney.

The new bankruptcy law, which took effect on October 17, 2005, is primarily designed to make it harder for filers to fully escape unsecured debts, such as credit cards. Under the new law, those seeking to file bankruptcy must first undergo credit counseling and financial management education.

But according to the legislation, filers may also have to undergo a "means test," which implicitly steers higher-income people toward filing a Chapter 13 bankruptcy ? and setting up a five-year payment plan on their debts--rather than filing a Chapter 7 bankruptcy, considered a liquidation of assets, and walking away with a cleaner slate.

One recent study showed that prior to the new rules, about 70 percent of all consumer bankruptcies were filed through Chapter 7 and that almost all of those people had so little unencumbered property that in the end nothing was liquidated. Because many people who were able to file Chapter 7 in the past had below average earnings, they would not be affected by the new "means test."

In Illinois, those with above-average annual incomes, such as approximately $70,000 for a family of four, would have to take the means test, says attorney Melvin James Kaplan, who has had a practice in Chicago for decades.

It would then be determined from that point whether the individual would have enough disposable income to make payments to creditors and whether he or she would file through Chapter 7 or Chapter 13.

Using IRS-allowed exemptions, Kaplan says he has been able to show virtually no disposable income in clients with salaries of $80,000 or $90,000 per year.

But trustees assigned to the case can still file a "good faith objection" on such a filing that aims to bring a high-earning filer into Chapter 7. An expensive mortgage, payments on a second car or recent credit card use could be cited in such an argument, Kaplan adds. And if a trustee were to win that fight, lawyers could be left holding the bag for costs involved in making the case for declaring Chapter 7, he says. Lawyers must now certify they were truthful in verifying their client's information about debts and holdings.

On top of the financial exposure, lawyers say the new bankruptcy law is creating an increased workload, creating higher filing and legal fees for customers, who are already in financial straits. Kaplan says it's questionable in the new law how easily lawyers can be paid for their services.

"Lawyers are learning to be reluctant [in filing Chapter 7 bankruptcies] because of exposure," says Kaplan.

Potential bankruptcy filers seemed to have figured out that filing before the new laws were to take effect would be one smart financial move. On the last day of filing under the old rules, about 10,000 bankruptcy filings were registered in the federal bankruptcy court in Chicago alone.

In the second half of October, after the new law came into effect, Kaplan says only about 30 such filings were made in the court. In terms of consumer filings, "it has almost come to a dead halt," he says.

While the majority of those who file bankruptcy have modest or unsteady incomes, nearly anyone could need to declare bankruptcy if unexpected events occur. A Harvard study published in February, 2005, showed that about one-half of all bankruptcies stem from costs related to major illnesses.

Businesses are also finding the new bankruptcy law to be more restrictive. The window for reorganization plans have been shortened to a maximum of 18 months for companies and 10 months for smaller businesses. The move, some experts say, could create a new negotiating tool for unions because businesses would be inclined to settle with them before creditors could submit their own repayment plans to the court.

New limits have also been placed on companies providing special perks to executives and employee groups, while the new law also gives special repayment assurances to suppliers of a bankrupt company that provided materials within 20 days of filing. Unlike consumer bankruptcies, the new rules do not appear to have affected the rate of filings among businesses.

Published: February 01, 2006
Issue: Winter 2006