Bankruptcy

Bankruptcy

First, it is important to understand what a bankruptcy is and how the process works. From a historical perspective, Article I, Section 8, of the United States Constitution authorizes Congress to enact "uniform Laws on the subject of Bankruptcies." Under this grant of authority, Congress enacted the "Bankruptcy Code" in 1978. The Bankruptcy Code, which is codified as title 11 of the United States Code, has been amended several times since its enactment. It is the uniform federal law that governs all bankruptcy cases. 

The procedural aspects of the bankruptcy process are governed by the Federal Rules of Bankruptcy Procedure (often called the "Bankruptcy Rules") and local rules of each bankruptcy court. The Bankruptcy Rules contain a set of official forms for use in bankruptcy cases. The Bankruptcy Code and Bankruptcy Rules (and local rules) set forth the formal legal procedures for dealing with the debt problems of individuals and businesses. 

There are two basic types of bankruptcy filing available for individual debtors (as opposed to business or corporate filings), known as Chapter 7 and Chapter 13. A basic description of each is that a Chapter 7 bankruptcy discharges the debt and there is no repayment, whereas a Chapter 13 has some sort of repayment provision. 

A Chapter 7 bankruptcy is also known as a Liquidation bankruptcy and it contemplates an orderly, court-supervised procedure by which a trustee takes over the assets of the debtor's estate, reduces them to cash, and makes distributions to creditors, subject to the debtor's right to retain certain exempt property and the rights of secured creditors. Because there is usually little or no nonexempt property in most Chapter 7 cases, there may not be an actual liquidation of the debtor's assets. These cases are called "no-asset cases." A creditor holding an unsecured claim will get a distribution from the bankruptcy estate only if the case is an asset case and the creditor files a proof of claim with the bankruptcy court. In most Chapter 7 cases, if the debtor is an individual, he or she receives a discharge that releases him or her from personal liability for certain dischargeable debts. The debtor normally receives a discharge just a few months after the petition is filed. 

A Chapter 13 bankruptcy, on the other hand, is known as an Adjustment of Debts and is designed for an individual debtor who has a regular source of income. Chapter 13 is often preferable to Chapter 7 because it enables the debtor to keep a valuable asset, such as a house, and because it allows the debtor to propose a "plan" to repay creditors over time – usually three to five years. At a confirmation hearing, the court either approves or disapproves the debtor's repayment plan, depending on whether it meets the Bankruptcy Code's requirements for confirmation. Chapter 13 is very different from Chapter 7 since the Chapter 13 debtor usually remains in possession of the property of the estate and makes payments to creditors, through the trustee, based on the debtor's anticipated income over the life of the plan. Unlike Chapter 7, the debtor does not receive an immediate discharge of debts. The debtor must complete the payments required under the plan before the discharge is received. The debtor is protected from lawsuits, garnishments, and other creditor actions while the plan is in effect. The discharge is also somewhat broader (i.e., more debts are eliminated) under Chapter 13 than the discharge under Chapter 7. 

In the past, when someone got in over their head in unsecured debt (debt not tied directly to an asset like a car or home) they could file a Chapter 7 bankruptcy if they had few assets and the court would basically allow them discharge all of their debt and start over fresh. Of course the credit card companies complained bitterly about this practice of legally getting out of paying them. After extensive lobbying and protesting to Congress, in 2005 they got their way and the bankruptcy laws were amended in favor of the credit card companies. 

Consequently, we have had harsher bankruptcy laws since then. During President Bush‘s administration it became more difficult for individual consumers to seek bankruptcy relief. The 2005 Bankruptcy Reform Act became effective on October 17, 2005. Thereafter, consumer filings plummeted. There were several key provisions in the Act that precipitated this decline in filings, the primary one being what is called the ―Means Test.

The following excerpts from a November 2006 article in The CPA Journal puts a professional perspective on the new rules and how they were expected to affect bankruptcy filings subsequent to the passage of the Act. 

The Bankruptcy Reform Act of 2005: A New Landscape 

By Roxane DeLaurell and Robert Rouse 

NOVEMBER 2006 - The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Act) was signed into law on April 20, 2005, (Note: it became effective 180 days later on October 17, 2005) with the explicit intent of discouraging filings under the Bankruptcy Code. As a result, assumptions about filing for bankruptcy, unchanged in U.S. law for more than 25 years, are likely to be challenged. 

Not only was the Act highly debated, but all stakeholders also argued that the final version could have accomplished more. Whether the Act will achieve the goal of reducing bankruptcy filings is as yet unknown, but it should be noted that a previous attempt to reduce bankruptcy filings, the 1984 Amendments to the Bankruptcy Code, actually produced a threefold increase in such filings. 

It is apparent, however, that federal legislators had come to believe that filing for bankruptcy was no longer considered a stigma to be avoided, but rather had evolved into an attractive alternative to fully repaying one’s creditors. In fact, some commentators argued that the Bankruptcy Code had become a means to elude creditors and escape unwanted financial obligations, hence the need for a change in the law. The 2005 Act provided for some major changes in the Bankruptcy Code, and CPAs should examine it carefully when dealing with parties in bankruptcy. 

The bulk of indebtedness held by individuals increasingly consists of credit card debt, which carries high rates of interest and is generally short term in nature and unsecured by interests in the property of the borrower. The Act creates new responsibilities and new liabilities for the debtor/assisted person A major reform of the Act was an increase in the responsibilities of individuals seeking Chapter 7 liquidation. Persons who have little or no equity in any assets and who have mostly unsecured debt usually undertake such filings. While it has always been the case that creditors must show documentation of indebtedness—―proof of claim‖—it is now incumbent upon the debtor to demonstrate that there is no reasonable alternative to the bankruptcy process. 

The result has produced a shifting of the burden of documentation from creditors to debtors. The debtor seeking liquidation must now prove an inability to pay his debts as they are due and demonstrate a good-faith attempt to resolve such a crisis without the court’s help. 

Means Testing 

As mentioned earlier, the change in the Bankruptcy Code resulted in the creation of a debtor unfriendly ―means test for eligibility to file under Chapter 7. No longer could a person just file and eliminate unsecured debt. The Act requires a comparison of the debtor‘s income to the median income in the individual‘s home state. If the debtor‘s income is above the median and he is able to pay at least a minimal amount per month to creditors, he is not eligible to file Chapter 7 and must be so informed by any ―debt relief agency or legal counsel he has consulted about bankruptcy. 

More specifically, the Act requires that if a debtor's average gross family income 6 months before the bankruptcy filing exceeds the median for families in the debtor's state, the debtor's income and expenses must meet the means test. If the income and expenses do not meet the means test, the debtor must file a Chapter 13 bankruptcy rather than a Chapter 7 bankruptcy. An examination of these new rules makes it clear that the intent is to force as many people as possible into Chapter 13 (repayment) and make it much more difficult to just walk away from the debt. Obviously, the original intent of bankruptcy laws has been usurped and new rules favorable to the creditors have been put in their place.

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