Partners, Volume 15, Number 2, 2005
Partners, Volume 15, Number 2, 2005
|Bankruptcy Reform Legislation|
Designed to curb abuses of the current U.S. Bankruptcy Code, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Act) establishes a needs-based system of qualifying for protection under the law.
The Act was signed by President Bush in April 2005, and most of its provisions become effective in October of this year.
Currently individuals file for either Chapter 7 liquidation or Chapter 13 reorganization bankruptcy relief. Chapter 7, the most common bankruptcy filing, allows debtors a fresh start by requiring them to relinquish all of their nonexempt assets, which are liquidated to pay creditors. Any debt in excess of the amount collected from asset liquidation is then forgiven. Chapter 13 filings allow debtors to repay specified debts over a three-year period, and forgive any debts not included in the repayment plan.
Under current standards most individuals opt to file under Chapter 7. According to U.S. Bankruptcy Statistics 1.1 million filed for Chapter 7 relief in 2004, while nearly 450,000 filed for relief under Chapter 13.
Qualifying for bankruptcy protection
Debtors capable of paying creditors more than $10,000 ($166.66 per month) over a five-year period are assumed to be abusing the system and will automatically be denied Chapter 7 relief.
Debtors whose income is below the state median income level are exempt from the “means test” and will automatically qualify for Chapter 7 protection. These debtors, however, can still be redirected to a Chapter 13 repayment plan if they are able to pay a minimum of 25 percent of their outstanding unsecured debt over a three-year period, as opposed to the five-year period specified for other filers.
The Act continues to provide protection for individuals who face extenuating circumstances such as a serious medical condition or other hardships. These cases, however, must be supported by documentation detailing expenses or deductions from income.
Income and expense calculation
Credit card debt in excess of $500 accumulated within 90 days of filing will not be discharged. Currently the law states that amounts in excess of $1,225 accumulated 60 days prior to the filing cannot be discharged. The dischargeable limit for cash advances accumulated within 70 days (currently 60 days) of filing will be reduced from $1,225 to $750. Furthermore the cash advance limitations apply to any items purchased, not just luxury goods.
Currently, unlimited state homestead exemptions are available to the debtor 180 days after establishing residency in a state. Under the new guidelines, if the debtor files for bankruptcy within two years of moving to another state, he will have to claim the homestead exemption of his previous state of residency. Once residency has been established for a minimum of two years, he can claim only $125,000 of the state’s maximum homestead allowance. After three years of residency the debtor is eligible for the state’s full exemption.
For example, suppose John Doe relocates from Georgia to Florida and purchases a $300,000 home. Within a year of moving, John falls upon hard times and must file for bankruptcy protection. Because John has lived in Florida for less than two years, he must use Georgia’s homestead exemption allowance of $5,000. John would have been eligible for a $125,000 exemption if he had filed for protection two years or more after moving to Florida. Further, if John had filed for protection after more than three years, he would have been able to claim the unlimited exemption allowed in Florida or the full value of his home.
While some states offer unlimited homestead exemptions, others offer limited exemptions or none at all. Homestead exemption limitations for Sixth District States are as follows: $5,000 for Georgia, Alabama, and Tennessee; $15,000 for Louisiana; $75,000 for Mississippi; and unlimited exemption for Florida. Alabama, Georgia, and Mississippi allow exemptions to be doubled for couples filing jointly. Tennessee allows a $7,500 exemption for joint filers. Louisiana does not increase homestead exemption for joint filers.
In lieu of state exemptions, debtors may have the option of claiming the federal homestead exemption of $18,450, but state law must authorize their right to do so.
An additional limitation placed on homestead exemptions is an absolute $125,000 maximum imposed on debtors who have been convicted of certain fraudulent crimes or criminal acts that caused serious injury or death.
Unlike other provisions of the law that go into effect in October, the homestead exemption limitation rules were declared effective upon enactment of the law on April 20, 2005.
Small business provisions
Another new requirement states that within seven days of filing for the order of relief, the small business debtor must submit a recent balance sheet, statement of operations, records of cash-flow, and federal income tax information. On a periodic basis small business debtors must also file reports on profitability, projections of future cash receipts and disbursements, comparisons of actual receipts and disbursements to earlier projections, payment of taxes, and a statement of compliance with bankruptcy rules, tax, and other governmental filing obligations. Reporting requirements will not be mandatory until official forms for such information have been developed.
Under the new law the small business debtor has 180 days to file a reorganization plan. After that time any individual that has a stake in the bankruptcy case may file a plan up to the 300-day deadline. The previous time frames for these events were 100 and 160 days, respectively. Currently Chapter 11 plans can drag on for years because of repeated filings for extensions. Extensions are significantly restricted under the new law.
The new regulatory and reporting requirements for small businesses are more onerous than in the past to ensure that reorganization plans are filed in a timely manner and that the businesses are performing according to the plans. If, upon inspection of the business and review of reports, the U.S. Trustee assigned to a particular case determines that the reorganization will not work, the business can be directed more quickly into liquidation to allow more timely repayment of creditors.
Other significant provisions
However, while the new legislation provides creditors with increased ability to collect on debt obligations owed by consumers, it does nothing to constrain abuses by creditors who use mass marketing and lax credit underwriting to lure consumers further and further into debt without consideration for the likely negative consequences.
This article was written by Lisa Easterwood, financial analyst in the Supervision and Regulation division at the Atlanta Fed.