The 2005 Bankruptcy Reform Act

This is a brief summary and overview of (what one experienced bankruptcy attorney believes to be) the highlights of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, better known as the 2005 Bankruptcy Reform Act.  The Bankruptcy Reform movement began eight years ago based on a detailed report on bankruptcy reform by the National Bankruptcy Review Commission.  Since the report, the Bankruptcy Reform movement has worked to drastically change the nature of bankruptcy laws that were enacted in 1978.  The 1978 Bankruptcy Reform Act (as it became known) drastically changed the bankruptcy laws that had been operative since 1898.  The changes made in the 1978 Act were in compromise and balance with the changes made in the banking industry that same year, deregulating the banking industry, and giving rise to the Credit Card Industry, as we know it today.

A truly massive lobbying effort for bankruptcy reform followed, funded by the Credit Card Industry.  For various reasons, bankruptcy reform legislation failed to pass, until 2005.  Large gains by republicans in the House and Senate, coupled with the momentum of President Bush’s reelection, almost assured passage of the Bankruptcy Reform Act, despite serious opposition by scholars and consumer advocates.  In early February of this year, the Bankruptcy Reform movement introduced into the House and Senate nearly the identical bill that had failed in the preceding session.  By March 9, 2005, the House had passed its version, adopted the Senate version, and the Senate had closed debate on any new amendments.  Although the media reports passage, there has yet to be a final vote (as of March 10, 2005), and the President has not signed into law the 2005 Bankruptcy Reform Act.

What does the 2005 Bankruptcy Reform Act mean to the consuming public that has amassed nearly $10 Trillion in consumer debt?  Here are the major four talking points:

1.                  Debt Counseling:  The 2005 Bankruptcy Reform Act will deprive the consumer, the individual or couple who find themselves drowning in credit card debt, medical bills, foreclosure, divorce, or some catastrophic event, the absolute right to walk into an attorney’s office one day, and file for protection from their creditors the next day.  There is a “pass key” requirement in order to enter the Bankruptcy Courthouse.  You must have attended debt counseling through an approved non-profit credit counseling agency.  An individual cannot file Chapter 7, 11 or 13 unless he or she has received credit counseling (including phone and internet) during the 180-day period preceding the date of filing of the petition.  This requirement may be temporarily waived if the debtor submits a certification describing exigent (emergency) circumstances meriting the waiver, and stating that the debtor requested credit counseling services, but was unable to receive it within 5-days from the request. The debtor must receive counseling within 30 days of filing the petition, or an additional 15 days if extended by the court.  Today, most credit counseling agencies are owned and operated by Credit Card Issuers.  There interest in the approved agencies is prohibited under the 2005 Bankruptcy Reform Act.  So there is uncertainty with respect to how this will actually function.

2.                  Means Test:  Under the current law, experienced bankruptcy attorneys routinely counsel their clients with regards to their options between Chapter 7 and 13.  In doing so, there is a further analysis of whether they have sufficient income to pay their creditors over a 3 to 5 year period under a Chapter 13.  Here in Santa Clarita, this analysis often turns upon the amount of equity in a residence over and above the amount of the homestead exemption of $75,000 ($100,000 to $150,000 in some instances, and $50,000 in others).  Time is spent reviewing a laundry list of household expenses, and comparing them to what is reasonable and acceptable to bankruptcy trustees.  The 2005 Act requires that debtor’s income be compared to regional averages as published by the Federal Government.  If the debtor’s income is more than the median income in the state, any creditor, the trustee or the court may force conversion of a Chapter 7 to Chapter 13 or 11 if the amount of the debtor’s income left after deducting allowed expenses over 60 months is greater than $6,000.  If income, less expenses, times 60, is between $6,000 and $10,000, conversion is required only if it is more than 25% of the general unsecured claims.

3.                  Income and Expenses:  Although the IRS Standards are used as a guide today, under the 2005 Act they may become the Standard.  Lawyers will be required to verify income and expenses, and be held accountable and subject to sanctions if the information is found unreliable.  More experienced bankruptcy attorneys already insist on 3 years of tax returns, and 6 months of household expenses in the course of evaluating the options between Chapter 7 and 13.  Under the 2005 Act, all attorneys will and should insist on this information, otherwise be faced with professional liability if the disclosures made by the debtor are found to be inaccurate.  Further, all of those toys that we in Santa Clarita have in our homes and garages that exceed the Standards will be at risk.  The Court may require debtors to give up luxury items such as ATVs, motorcycles, cars, boats, electronic equipment, to name a few, that Santa Claus brought the kids, but mom and dad are paying on each month.  Santa Claus better be “cash and carry” under the 2005 Act.

4.                  Discouraging Repeat Filings:  Under the current law, debtors who find they are unable to maintain payments under a Chapter 13 Plan, because of a change in circumstances, or because notwithstanding their best efforts, they just cannot make the budget, have the near absolute right to convert their case to a Chapter 7 case.  Experienced counsel would advise filing Chapter 13 to “cram down” the current market value on a secured creditor, so that the debtor pays only the remaining secured balance (the remainder of the loan balance to be discharged as unsecured).  Under the 2005 Act, the entire balance must be paid, even upon conversion.  Reaffirmation Agreements are given greater weight.  For car addicted Californians, who drive thousands more miles annually than the rest of the country, this means having to pay on a car that is worth far less than is owed, and probably would be replaced but for lousy credit.  Under the 2005 Act, debtor’s woes are only compounded and not relieved, in this instance.  Also, if there was a filing within a year of the current filing, the automatic stay, and the court finds bad faith, there is no stay, and if there were two or more filings, there is no stay, unless upon motion by the debtor, the court finds good faith.  And, if a debtor had filed and received a discharge within 6 years, under the current law (and the 1898 Act), they can get another discharge.  This was consistent with Deuteronomy that provides for relief every 7 years.  Under the 2005 Act, notwithstanding the “moral” mandate of the 2004 Election, this teaching from Deuteronomy has been abandoned; and a second discharge must wait at least 8 years.

The effective date of the 2005 Bankruptcy Reform Act will be 180 days from the date the President signs it into law.  How the Courts and Trustees will administer the new provisions will need to be ironed out during that time.  It’s likely the Courts, Trustees, and Attorneys, and committees comprised of all of them, will meet and work through the details, so the public is protected.

During the 6 months leading up to the effective date of the 2005 Act every consumer MUST consider HONESTLY their financial condition – current credit worthiness, ability to repay, current and possible future income, taxes due and owing, likelihood of financial distress within the next year, and whether all of that stuff and the bills paid for them is absolutely necessary for the financial well being of the family.  More importantly, in the very least, debtors should pay for an hour of time from an experienced bankruptcy attorney who can guide them through the turbulent waters left in the wake of the 2005 Act.