Bankruptcy Code Reform: A Primer

Bankruptcy reform legislation, which is virtually certain to become law, would usher in sweeping changes for the more than 1 million Americans who file for protection from creditors each year.

What should consumers expect from the new law and how should they react? Here are some answers:

Question: What does the new law do?

Answer: It completely revamps the nation’s Bankruptcy Code, requiring new tests for debtors and new obligations for attorneys. Though the bill would affect some corporate reorganizations, it’s biggest effect would be on consumer bankruptcies.

Q: What are the biggest changes in store for consumers?

A: “Means” tests would be required for many debtors who wish to wipe out their bills under a liquidation, or Chapter 7 bankruptcy filing, in which consumers turn over virtually all of their nonexempt assets in return for a clean slate.

Under current bankruptcy law, Chapter 7 filers don’t have to repay their creditors, even if their income would allow at least partial repayments. Under the proposed law, if a judge determines that a debtor could pay back a significant portion of his debts within five years, the debtor would be required to do so.

Consumers also would be required to get credit counseling before and after filing bankruptcy. And the bill proposes new limits on the number of times an individual can unload debts in bankruptcy or have legal actions such as foreclosures stalled by a filing.

Bankruptcy attorneys also would be required to do more research into their client’s financial condition and would be subject to sanctions if they improperly file liquidation proceedings for a debtor who does not qualify.

The changes probably would increase the time it takes to discharge a bankruptcy, which is likely to boost attorneys’ fees and the overall cost of filing, said Jack Williams, professor of bankruptcy law at Georgia State University College of Law.

On the other hand, parents owed child support would go to the front of the creditor line, getting paid before credit card firms and lawyers.

Q: Does the means test mean fewer people will be able to file bankruptcy?

A: No. But it might mean people who in the past would have filed a Chapter 7 bankruptcy will have to file under Chapter 13 instead. In Chapter 13 filings, consumers can keep more of their assets as long as they agree to pay all or most of their debts over time.

Under the proposed law, those with sufficient income would be required to file under Chapter 13, and a trustee would determine how much of their debt can be repaid.

Q: What’s considered sufficient income?

A: That’s an open-ended question. If you earn less than the median income in your state, you are automatically exempted from the means test and you can file under Chapter 7, as you can under current law.

If you earn more, you are subjected to the test, but those who can prove they can’t repay a significant portion of their debts within five years still would be allowed to file under Chapter 7 no matter how large their income, said Andy Caine, a Los Angeles bankruptcy attorney and president of the American Bankruptcy Institute.

The determination of who can and can’t repay their debts would hinge on how much the individual has after paying fixed expenses, including home mortgage or rent, car payments and allowances for food, clothing, insurance and other necessities. There’s a fair amount of latitude with these expenses, attorneys said.

Q: What are the education requirements and how would they affect consumers?

A: The most important of the education provisions, said one bankruptcy judge, requires debtors to get certification that they have gone through a budget review with a certified credit counseling agency before they’re allowed to file bankruptcy. Because many bankruptcies are filed on the spur of the moment--usually to forestall foreclosure or repossession of a car--this requirement could delay a bankruptcy filing long enough to cause the foreclosure to be completed before the consumer could get court protection.

Once this law is in effect--probably within six months of enactment--consumers should consider getting a budget review and counseling certificate the moment their finances become tight enough to cause a single missed car or mortgage payment.

Q: Would you lose pension, IRA or 401(k) assets in a bankruptcy under the new law?

A: No. Like the old law, this measure would protect qualified retirement assets from creditors, no matter how much is set aside in these accounts.

Q: What are the new limits on how many times you can discharge debts in bankruptcy?

A: Under the new law, debts could be discharged under Chapter 7 no more than once every eight years, compared with once every six years under current law. In addition, those who file bankruptcy frequently to thwart foreclosures or repossessions would be barred from getting court protection for those assets.

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Key Points in Bankruptcy Reform Law

* A certificate stating that the consumer has gone through a budget review by a credit counseling agency will be required before a bankruptcy filing will be accepted.

* After bankruptcy, consumers will be required to take financial education courses.

* The maximum number of Chapter 7 discharges will be limited to one every eight years, compared with one every six years under current law. Repeat filers also will be restricted from getting automatic stays from foreclosure and repossession.

* Parents owed child support will rise in repayment priority. Their debt will be repaid before credit card companies or attorneys.

* Consumers’ ability to file Chapter 7 bankruptcy liquidations will be subject to an evaluation of the ability to repay debts if the individuals earn more than the median income in their state.

Source: Times research