In case you haven’t noticed, there is an epidemic in this country that is preventable. We're not talking about AIDS or a new strain of the Flu. We are talking about people filing bankruptcy when perhaps there is no need to do so.
In the year ended December 31, 2000 1,217,972 individuals filed for protection from their creditors under the U.S. Bankruptcy Laws. Not all of these people were unable to pay their bills. Some of them could pay their bills, but they would have to forego some of the lifestyle that piled up their mountain of debt. Not willing to take the time and make the sacrifice necessary to meet their obligations, some people opt to use the Bankruptcy Code to reduce or eliminate their debt. Sometimes, these can be quite wealthy individuals who retain a large portion of their wealth after the bankruptcy proceedings are completed.
In general, the foregoing is the argument for reform used in recent debates over changing the federal bankruptcy law in the House of Representatives and the Senate. The arguments against changing the law generally center on the profits made by credit card companies and banks, along with the belief that those same credit card companies and banks have created many of the bankruptcies by indiscriminately issuing credit cards.
Whoever may be correct in the debate, the fact is on March 15, 2001, the United States Senate approved a bill which made sweeping changes to the United States Bankruptcy Code. The Senate’s version of the bill is now in the reconciliation process with the House’s version of the bill.
At issue, is the perception that the rich are able to use the bankruptcy laws to avoid paying their just debts, while retaining substantial assets. On the face of it, this certainly seems unfair and it is. However, any time laws targeting those who abuse the system are enacted, innocent people are often adversely affected. This bill is no different. Some of the provisions could negatively affect those the Bankruptcy Code is meant to help, while trying to plug some of the holes in the current system. What follows is a review of some of the key points on the proposed laws as they now stand.
First, we need to define a few terms:
- Available to both business and non-business debtors, this portion of the Bankruptcy Code seeks to provide a fair distribution of assets by first paying off or reaffirming secured and priority claims. Unsecured debt that is not paid is discharged and the debtor starts off fresh.
- Available for both business and consumer debtors, this chapter of the Bankruptcy Code seeks to rehabilitate a business as a going concern or reorganize an individual's debts to allow for payment of the debts in a court approved plan.
- Available to individuals with regular income and whose debts do not exceed a specified amount, this chapter of the Bankruptcy Code seeks to budget the individual's future earnings under a plan through which creditors are paid in whole or in part.
Major Provisions of Proposed Legislation
Chapter 7 Provisions
One of the major points to the new bill is the automatic dismissal of a Chapter 7 case or (with the debtor's consent) conversion to Chapter 13, upon a finding of abuse. In general, a finding of abuse can occur in one of two ways:
- If current monthly income, less allowable deductions, exceeds a specified amount, then there is a presumption of abuse. There are two trigger points: 1) if monthly income less allowable deductions equals or exceeds $166.67, abuse is presumed regardless of the debtors unsecured debt and, 2) if the debtor has $100 or more in available income and that available income will pay at least 25% of the unsecured debt over 5 years, abuse is presumed. The starting point for the determination of available income is the median income in the state where the debtor resides, but the debtor will have a chance to show the amount of available income is less than computed by statute based on special circumstances.
- If the presumption of abuse does not exist, then a showing that the debtor filed the petition in bad faith or, based on the debtor's total financial picture, abuse is indicated, then the court can find abuse exists. The bankruptcy administrator, the U.S. Trustee or the judge utilize this method to assert abuse. Creditors are limited in their ability to assert abuse only to cases where the debtors monthly income exceeds the state median income.
A second and powerful weapon for creditors under the proposed laws is the addition of stiff penalties on the debtor's counsel. In general, debtor's counsel will be subject to payment of costs and fees to the trustee if the trustee can prove the attorney violated certain rules. Additionally, debtor's counsel is subject to stiff penalties in the event counsel fails to follow new disclosure and record-keeping requirements.
Payment of family support obligations would be established as a priority ahead of the costs of administering the bankruptcy estate, but payment of property taxes is specifically mentioned as a priority ahead of family support obligations.
Other provisions would make it more difficult to reaffirm debt or redeem collateral and trustee compensation would be based on a commission formula rather than factors applicable to other professionals.
Reduction of secured claims to the value of their collateral will be limited. Depending on the final version of the bill, reduction of debt to the value of the collateral for auto loans will be limited for autos purchased within three (Senate version) to five (House version) years of filing for bankruptcy. Both bills would preclude reduction to the value of collateral for debts incurred within one year of bankruptcy.
Where the debt can be reduced to the value of the collateral, the collateral must be valued at replacement (retail) cost.
The bills would also add certain categories of debts that could not be discharged, including unfiled, late filed or fraudulent returns; debt resulting from fraud, including credit card misuse; debt related to a creditor who was not timely notified of the bankruptcy; debt arising from embezzlement or breach of fiduciary duty.
Chapter 7 and 13 debtors would be required to file tax returns for the period most recently due as of the filing of the bankruptcy, and any becoming due during the bankruptcy proceedings, with the trustee. These would be available to creditors, subject to maintenance of applicable privacy rights. Any party in interest may also require an annual statement of income and expenditures for the prior tax year, and showing monthly income of a Chapter 13 debtor.
Chapter 11 cases will be treated like Chapter 13 cases. Individual Chapter 11 debtors won't be discharged from bankruptcy until their plans are completed.
There are a number of general provisions. Among them is a requirement that Individuals cannot file for relief under any chapter of the Bankruptcy Code unless they have received credit counseling - through a court-approved service - within 180 days of the filing. There are certain requirements that must be met for the credit counseling services to be approved.
Provisions affecting the present homestead exemption are treated radically different under each bill. The House version provides for an exclusion from the exemption of any value added to the home by the debtor, with the intent to thwart creditor's claims, during the 7 years before the bankruptcy filing. Additionally, value in excess of $100,000 added to the homestead for the two years prior to bankruptcy filings would be available to satisfy creditors' claims. The Senate version would limit the amount of the homestead protected from creditors to $125,000.
The new law would take effect for cases filed 180 days after the date of enactment.
While there are numerous other provisions in the bills as they presently stand, it is clear the laws aim to reform the Bankruptcy Code in favor of creditors. The object, of course, is to reduce the abuse inherent in the present system. Whether this will ultimately benefit the country and consumers remains to be seen.
While we hope you will never have cause to deal with the bankruptcy court, it is wise to be aware of your rights, not only as a potential debtor, but also as a creditor. If you should have need of any assistance in whatever role you may find yourself, please give us a call. As always, we are here to serve you.