CONSUMER
BANKRUPTCY REFORM
STATUS
On April 20, 2005, President Bush signed into law
P.L.
109-008, the Bankruptcy Abuse Prevention and Consumer
Protection Act.
ANALYSIS
Under previous law, debtors could file for bankruptcy under
Chapter 7 or Chapter 13 once every six years. Consumers who
file under Chapter 13 agreed to a court-approved plan to repay
their debts over three to five years using future earnings.
They do not have to liquidate their current assets to repay
creditors. Consumers who filed under Chapter 7, however, had
to use their present wealth above an exemption to repay their
debts, but their post-bankruptcy earnings remained untouched.
The exemption included personal items, equity in
owner-occupied housing, retirement accounts, and cars.
Since the exemption levels were usually high or filers had few
nonexempt assets, in over 90 percent of Chapter 7 cases there
was no property to be liquidated. As a result, creditors got
nothing and were not compensated. Most consumers who filed
for bankruptcy did so under Chapter 7 rather than Chapter 13.
As
more and more consumers filed for bankruptcy and discharged
their debts, interest rates for consumer credit increased to
compensate lenders for their losses. According to the Cato
Institute, the average borrower pays $500 a year in extra
charges to compensate lenders for those unpaid loans.
Therefore, since consumers are paying for the sins of the
guilty debtor, the old system worked against honest debtors.
Opposing View
Those who oppose bankruptcy reform believe that the current
laws are based on the principle that debtors facing impossible
financial situations should be given an opportunity for a new
start in order to regain their role as productive citizens,
and that reform would deprive them of this opportunity.
Opponents argue that 90 percent of all bankruptcies are
triggered by the loss of a job, high medical bills, and
divorce, and therefore most debtors are not deadbeats.
Opponents of reform also claim that the current bankruptcy
system is good economic policy. If reform legislation were
enacted, there would be an increase in people on welfare and
more of a burden on hard-pressed local charities. Finally,
opponents of reform charge that the legislative proposal would
provide a windfall to financial institutions at the expense of
ordinary debtors. The bills contain nothing to stop the owners
and managers of major companies that file for bankruptcy from
reneging on benefits to employees or outstanding bills to
small suppliers.
LEGISLATION
P.L. 109-008 addresses many areas of bankruptcy practice,
including consumer filings, small business bankruptcy, tax
bankruptcy, ancillary and cross-border cases, financial
contract provisions, amendments to chapter 12 governing family
farmer reorganization, and health care and employee benefits.
The following is a summary of the legislation.
The new law instills a greater level of personal
responsibility by closing various loopholes and eliminating
incentives in the current bankruptcy system that encourage
opportunistic consumer bankruptcy filings and abuse. The
bill's needs-based provisions target, for example, those
debtors who have a demonstrated ability to repay their debts
and channel them into a form of bankruptcy relief that
requires debt repayment. Furthermore, under this bill courts
are given greater powers to dismiss abusive bankruptcy cases
and to punish attorneys who encourage their clients to file
such cases. Debtors who have committed crimes of violence or
engaged in drug trafficking will no longer be able to use
bankruptcy to hide from their creditors. Likewise, deadbeat
parents will be prevented from using bankruptcy to shirk their
child support obligations. In addition, this legislation
prevents debtors from avoiding their responsibility to pay for
luxury goods and services purchased on the eve of filing for
bankruptcy.
Needs-based reforms
P.L. 109-008 implements an income and expense analysis to
determine whether a debtor has a demonstrated ability to repay
a significant portion of his or her debts. If a debtor has the
ability to repay debts, he or she must either be channeled
into a form of bankruptcy relief that requires repayment or
risk having the bankruptcy case dismissed as an abusive
filing. This needs-based test specifies certain expense
amounts - derived from the
Internal Revenue
Service's expense standards and other
specified expenses - that are deducted from the debtor's
income. These include expenses for food, clothing, housing,
and transportation as well as certain educational expenses for
the debtor's children. The debtor may rebut the presumption of
abuse by demonstrating special circumstances warranting
additional expenses or income adjustment.
Spousal and child support protections
P.L. 109-008 prioritizes the collection and payment of spousal
and child support in bankruptcy cases by giving these claims
the highest payment priority (current law gives these
claimants only a 7th level payment priority). The bill
requires bankruptcy trustees to give child support claimants
important information about the availability of state child
support enforcement assistance and to notify the proper state
child support enforcement authorities of the deadbeat parent's
bankruptcy filing. P.L. 109-008 allows various enforcement
actions to be brought against a bankrupt, deadbeat parent,
including the withholding of his or her driver's license, or
the suspension of the debtor's professional or occupational
license. It also allows state child support enforcement
agencies to intercept a debtor's tax refund for nonpayment of
spousal or child support. In addition, it ensures that
deadbeat parents do not escape responsibility to pay a child's
medical bills. The National Child Support Enforcement
Association says P.L. 109-008's reforms are "crucial to the
collection of child support during bankruptcy."
Closes the "mansion loophole" for greedy corporate culprits
Under current bankruptcy law, debtors living in certain states
can shield from their creditors virtually all of the equity in
their homes. In light of this, some debtors actually move to
these states just to take advantage of their "mansion
loophole" laws. P.L. 109-008 closes this loophole for abuse by
requiring a debtor to reside in the state for at least 2 years
before he or she can claim that state's homestead exemption,
the current residency requirement is only 91 days. The bill
further reduces the opportunity for abuse by requiring a
debtor to own the homestead for at least 40 months before he
or she can use state exemption law, current law imposes no
such requirement. In addition, P.L. 109-008 requires a
debtor's homestead exemption to be reduced to the extent
attributable to the debtor's fraudulent conversion of
nonexempt assets (e.g., cash) into a homestead exemption. Most
importantly, the bill stops securities law violators and other
culprits from hiding their homestead assets from those whom
they have defrauded or injured. If a debtor was convicted of
a felony, violated a securities law, or committed a criminal
act, intentional tort, or engaged in reckless misconduct that
caused serious physical injury or death, P.L. 109-008
overrides state homestead exemption law and caps the debtor's
homestead exemption at $125,000.
Debtor protections
P.L. 109-008 requires debtors to receive credit counseling
before they can be eligible for bankruptcy relief so that they
will make an informed choice about bankruptcy - its
alternatives and consequences. The bill also requires debtors,
after they have filed for bankruptcy, to participate in
financial management instructional courses so they can
hopefully avoid future financial distress. P.L. 109-008
penalizes creditors who unreasonably refuse to negotiate a
pre-bankruptcy debt repayment plan with a debtor. The bill
strengthens the disclosure requirements for reaffirmation
agreements so that debtors will be better informed about their
rights and responsibilities. In addition, P.L. 109-008
requires certain monthly credit card billing statements to
include specified disclosures regarding the increased interest
and repayment time associated with making minimum payments.
The bill also requires certain home equity loan and credit
card solicitations to include enhanced consumer disclosures.
P.L. 109-008 prohibits a creditor from terminating an open end
consumer credit plan simply because the consumer has not
incurred finance charges on the account. Further, the law
cracks down on bankruptcy petition mills and imposes
heightened standards of professional responsibility for
attorneys who represent debtors.
Protections for small business owners
Under current bankruptcy law, a business can be sued by a
bankruptcy trustee and forced to pay back monies previously
paid to it by a firm that later files for bankruptcy
protection. P.L. 109-008 contains provisions making it easier,
particularly for small businesses, to successfully defend
against these suits. It promotes greater certainty in the
financial market place. P.L. 109-008 reduces systemic risk in
the banking system and financial marketplace by minimizing the
risk of disruption when parties to certain financial
transactions become bankrupt or insolvent. Former Federal Reserve
Board Chairman Alan Greenspan says these reforms are
"extremely important."
Family farmers
P.L. 109-008 helps small family farmers facing financial
distress. While current bankruptcy law has a specialized form
of bankruptcy relief - Chapter 12 - that is specifically
designed for family farmers, its benefits for farmers are
limited because of its restrictive eligibility requirements.
The bill responds to this problem in several key respects: it
more than doubles the debt eligibility limit and requires it
to be periodically adjusted for inflation; it lowers the
requisite percentage of a farmer's income that must be derived
from farming operations; and it gives farmers more flexibility
with respect to how certain creditors can be repaid. As a
result, many more deserving family farmers, facing financial
hard times, will be able to avail themselves of Chapter 12. In
addition, P.L. 109-008 makes Chapter 12 a permanent component
of the bankruptcy laws and extends the benefits of this form
of bankruptcy relief to family fishermen.
Small business debtors
P.L. 109-008 addresses the special problems presented by small
business debtors by instituting firm deadlines and enforcement
mechanisms to weed out those debtors who are not likely to
reorganize. It also requires the court and other designated
entities to monitor these cases more actively.
Transnational insolvencies
In response to the increasing globalization of business
dealings and operations, P.L. 109-008 establishes a separate
chapter under the Bankruptcy Code devoted to transnational
insolvencies. These provisions are intended to provide greater
legal certainty for trade and investment as well as promote
the fair and efficient administration of these cases.
Privacy protections
Under current law, nearly every item of information supplied
by a debtor in connection with his or her bankruptcy case is
made available to the public. P.L. 109-008 prohibits the
disclosure of the names of the debtor's minor children and
requires such information to be kept in a non-public record,
which can be made available for inspection only by the court
and certain other designated entities. In addition, if a
business debtor had a policy prohibiting it from selling
"personally identifiable information" about its customers and
the policy was in effect at the time of the bankruptcy filing,
then P.L. 109-008 prohibits the sale of such information
unless certain conditions are satisfied.
Protections for employees
P.L. 109-008 requires certain back-pay awards, granted as a
result of the debtor's violation of federal or state law, to
receive one of the highest payment priorities in a bankruptcy
case. In addition, P.L. 109-008 streamlines the appointment of
an ERISA administrator for an employee benefit plan, under
certain circumstances, to minimize the disruption that results
when an employer files for bankruptcy relief. In light of the
disastrous impact that bankruptcy cases like WorldCom and
Enron have had on their employees, reforms that more than
double the current monetary cap on wage and employee benefit
claims entitled to priority under the Bankruptcy Code. Other
provisions would protect retirees in cases where Chapter 11
debtors unilaterally modify their benefits, such as health
insurance. These reforms would also make it easier to recover
excessive pre-petition compensation, such as bonuses, paid to
insiders of a debtor that can then be used to pay unpaid
employee wage claims.
OUTLOOK
In
May 2007, the House Judiciary
Subcommittee on Commercial and Administrative Law held
a hearing entitled “the Second
Anniversary of the Enactment of the Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005: Are Consumers
Really Being Protected Under the Act?” The hearing examined
the impact the new bankruptcy law is having on consumers and
the financial industry. While the hearing was split between
those who believe the changes made by the law benefit
consumers and the financial industry and those who believe
they simply serve to protect creditors, there does not appear
to be any major effort to revisit the law.
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