Bankruptcy Law Explained

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has important implications for people filing for bankruptcy. Simply put, the new law has:

1. Introduced a means test to make filing bankruptcy more difficult
2. Made bankruptcy more cumbersome
3. Raised eligibility standards (for Chapter 7)

Complicating the filing process is simply a move to discourage people from going bankruptcy and at the same time offer creditors better protection. The new law has also increased eligibility standards forcing debtors to pay some or all of their debt.

Credit Counseling

The new bankruptcy has made attending a credit counseling class compulsory. The credit counselor will want to review your financial situation with a view to advising the best course of action. The counselor may suggest a repayment plan as an alternative to bankruptcy depending on your circumstances – bankruptcy is not a certainty. In fact, it is the counselor’s job to suggest an alternative to bankruptcy if possible. It is not unrealistic to say that counselors are in effect working on behalf of credit card companies.

If the counselor proposes a repayment plan as a bankruptcy alternative, you must submit the plan with your bankruptcy petition. You are not, however, obliged to follow the repayment plan if you still prefer bankruptcy as a solution to your debt problems – you decide. Unfortunately, however, whether you qualify for bankruptcy remains a matter for the court.

Once your bankruptcy term has been completed you will be required to attend another credit counseling class. The second counseling appointment will focus on budgeting and financial planning. Your bankruptcy will not be discharged unless you attend this second counseling session!

Find approved credit counseling agencies by clicking here

Income restrictions

There was a time your income had no bearing on your eligibility for bankruptcy. The new bankruptcy law, however, has changed all that. There are now three categories that are applied to debtors considering bankruptcy as a debt solution:

1) High income groups – can only file for ‘bankruptcy under new bankruptcy laws’
2) Family income below State average – eligible for chapter 7 bankruptcy
3) Family income above State average – bankruptcy eligibility determined by Means test

The Means test formula

It can be argued that the Means test has been the biggest contributor to falling bankruptcy statistics since the new law was implemented in 2005. The Means test has undoubtedly had the effect both government and creditors were anticipating.

To qualify for Chapter 7 bankruptcy you must comply with the Means test. The test is completed by form and will establish whether you can file for Chapter 7 based on disposable income.

If your family income is above the State average and you want to file for Chapter 7 you will be asked to deduct essential costs, ie mortgage repayments and transport from your monthly income. Any other non-dischargeable costs such as child alimony must also be subtracted. If your ‘disposable’ income is calculated above $166 you will be denied Chapter 7 bankruptcy. If this is the case your alternative is Chapter 13.

If the means test calculates your ‘disposable income’ is less than $100 you will automatically qualify for Chapter 7.

In the event your disposable income is somewhere between $100 and $166 your chapter 7 eligibility is calculated in a slightly more complex way. So let’s take an example.

Typical example

The Johnson family has an income above the State median, a debt of $50,000 and disposable income of $125. The means test will therefore multiply $125 by 60 months, which equals $7,500.

The cut off point for Chapter 7 eligibility in this calculation is always 25% of the debt. As $7,500 is less than 25% of the Johnson’s debt ($50,000), they would qualify for Chapter 7. If this figure were greater than 25%, they would have to consider Chapter 13 bankruptcy.

The means test is not to be feared. Many people find they easily qualify for bankruptcy chapter 7 after completing the test. In fact, some have argued a formulaic test makes filing bankruptcy easier because the onus is no longer on judges to decide.

Note: You can file for bankruptcy before completing the means test. The bankruptcy courts do not necessarily approve it of but many debtors have prioritized filing because of desperate circumstances.

Chapter 7 loophole

An unfortunate scenario arises when people find themselves disqualified from Chapter 7 because disposable income only just exceeds the $166 threshold. In this instance many people have successfully exploited a loophole that allows you to donate up to 15% of your income to charity. If making a charity donation brings your disposable income below $166 or more specifically $100 – you will be able to file for Chapter 7.

Chapter 13 and the new law

Chapter 13 filers can expect to allocate a larger proportion of their income to repaying creditors. Previously, the filer and the bankruptcy court determined the repayment level once necessary costs had been deducted from income. Under the new law, however, the bankruptcy court calculates affordable repayments based on an IRS system. The IRS determines ‘reasonable living expenses’ for necessities such as rent, transport and food – not the person filing.

Costs of filing bankruptcy

Strictly speaking, the cost of filing bankruptcy has not increased under the new law. What the new law has done however, is implement charges and fines. If during the course of your bankruptcy file your information is deemed inaccurate of insubstantial, your bankruptcy attorney could face a number of fines. The affect this has on the debtor is significant because attorneys are now less willing to deal with bankruptcy cases. In addition, bankruptcy attorneys have now increased their rates, some by as much as 100%.

Debtor benefits under the new bankruptcy law

As you may have realized, the new law offers little benefit to debtors. The purpose of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was intended to readdress the bias (as seen by creditors) towards the debtors. Some debt charities argue the sweeping changes have been too extreme and have done little to help people in a financial crisis. Debts must agree – the new law punishes those who need help the most.

The new law has in fact made filing bankruptcy more difficult, expensive and inconvenient. Counseling sessions are particularly offensive to people who feel they are being treated for an illness rather than a financial problem.

Yet there are some benefits to the debtor that should not be ignored.

1) Courts can impose a 20% debt reduction on creditors who have not cooperated with counseling agencies. This is mostly the case when the creditor refuses to accept 60% repayment proposed within 60 days of filing bankruptcy.
2) Retirement plans are not included in bankruptcy as an asset for creditors.
3) Child support has been awarded top priority under the new law, over all other unsecured debts.
4) Chapter 13 debtors are forced to repay all child support arrears before bankruptcy can be discharged.

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