On April 20, 2005, President Bush signed into law P.L. 109-008, the Bankruptcy Abuse Prevention and Consumer Protection Act.


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.


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.


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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