The Bankruptcy Abuse and Consumer Protection Act of 2005 went into effect on October 17, 2005 and provides the most significant (and controversial) overhaul of the bankruptcy system in over 25 years. Backed by the credit card, retail and banking industries, the new legislation makes it more difficult for people to erase all of their debts in bankruptcy, while forcing others on payment plans instead. Conservatives and the financial services lobbies argue that the new law was needed to curb abuse of the bankruptcy system and teach people to be more financially responsible, while liberals and consumer advocates say that this law unfairly penalizes poor people who may be suffering financially due to illness, divorce or unemployment.
If you are considering filing for bankruptcy, there are some important things about this law that you will need to know before you start your proceedings. Here is a summary of some of the BAPCPA’s most significant provisions.
Persons Seeking to File Will Now Be Required to Seek Counseling
Under the new law, you are required to go into credit counseling (at your own expense) with an approved government agency at least six months before filing for bankruptcy. The first session should be at least 90 minutes in length, and give you an idea if bankruptcy is really right for you or if you can get out of debt by simply following a repayment plan that the credit counselor proposes. While you are not required to agree with the final opinion of the counselor or follow any repayment plan they propose, you will still be required to submit any repayment plans or bankruptcy alternatives that the agency has suggested to the court before being allowed to file. Once you have filed, you will then have to attend additional counseling and/or a money management class. Your debt will then be discharged when you submit a certificate of successful completion of these classes. Counseling is required even if a payment plan isn’t possible or realistic for your financial situation or you are facing debts that you are disputing and do not feel you should have to pay.
Fewer People Will Be Eligible To File Under Chapter 7
The new law makes it much more difficult for people to prove that they should be allowed to clear their debt entirely under Chapter 7 bankruptcy, a more pro-debtor option that allows filers to wipe out all of their debt entirely. When you file a Chapter 7, whatever assets you have (with the exception of your home and others assets protected in your state) are liquidated and given to your creditors and your remaining debts are discharged, giving you a “fresh start.” Under the old rules, most filers could choose the type of bankruptcy that seemed best for them, and almost always chose Chapter 7. It was then up to the judge to use his or her discretion to decide if your case qualified for Chapter 7. Under the new law, you will only be allowed to file under Chapter 7 if your income is lower than the median income in your state or if you can prove that you do not have enough disposable income to pay your debts. In order to determine if you qualify for Chapter 7, the first thing you will need to do is calculate your average monthly income over the last 6 months prior to filing and compare it to your state’s median income for a household of your size. If your average monthly income is equal to or less than the median in your state, you are automatically allowed to file for a Chapter 7 bankruptcy. If you earn more than the median, then you will need to pass a means test in order to determine if you will still be allowed to file. If basic expenses like rent, food, utilities, clothing etc. and priority debts such as back taxes, child support and alimony, leave you with less than 100 dollars at the end of the month, then you pass the means test and can still file for bankruptcy even if you make more than the median income in your state. If you are left with an amount of money between $100 and $166.66, you may still be able to pass the means test if you do not have enough money over at the end of the month to pay off more than 25% of the remainder of your outstanding bills. If you are left with more than $166.66, you will not pass the means test and will have to file for Chapter 13 bankruptcy instead.
More People Will Be Required to File Under Chapter 13
If you are deemed ineligible for Chapter 7 bankruptcy, you will now have to file for Chapter 13, which requires you to go on a repayment plan and devote all of your disposable income to repay your creditors for the next five years. In addition, the new rules do not allow you to deduct your actual living expenses (the amount you are actually spending on rent, food, etc.) from your disposable income. You will have to use allowed expense amounts according to what the IRS believes to be a reasonable amount to pay for basic living needs. Making matters worse, your allowed expenses have to be subtracted from your average income during the last six months before filing, and not from your actual earnings each month. As a result, you will have to devote much more money to your repayment plan than before.
You Stand to Lose More of Your Personal Property
The new bankruptcy law also puts much stricter limits on what personal property you are allowed to keep. Under the old laws, a debtor could typically keep items such as used cars, furniture, family heirlooms and souvenirs because the courts assumed that these items usually had more sentimental than monetary value. The new law is not as lenient, and requires that all of your property be valued at what it would cost to replace it at retail price. Since this new requirement will increase the value of your belongings significantly, your creditors will now be allowed to seize your property to satisfy your debt obligations. While many states have laws setting limits on what items can and cannot be taken from a person who is filing for bankruptcy, the new law has placed limits on those provisions as well. Under the new law, you have to live in a state for at least two years before you are allowed to claim that state’s exemption laws. If you have lived in a state for less than two years, you will now need to claim your old state’s exemption, if they have any. If you have moved frequently within the last two years, you must select the exemptions for the state you resided in for the greatest amount of time in the six months prior to filing. The BAPCPA also puts stricter limits on what debts can be “reaffirmed” during bankruptcy. In the past, a person filing for bankruptcy was still able to hold on to some of their property (a car, for example) if they were in good standing and agreed to continue to make payments on time. This was referred to as reaffirming the debt. The new law makes it more difficult to reaffirm secured debts, and filers may now be forced to relinquish their cars and other possessions that are not yet paid off.
The new law also makes some drastic changes to the very controversial Homestead exemptions that exist in many states. You may recall how the Enron executives, O.J. Simpson and other wealthy individuals were able to shelter their assets and avoid paying creditors by moving Florida and purchasing outrageously expensive homes. You will now need to have lived in a state for at least three 3 years and 4 months prior to filing before you are allowed to use a state’s homestead law to keep the equity in your home. If you have lived in your state for less than 3 years and 4 months, you will now only be allowed to retain $125,000 worth of equity.
Persons Seeking Exemption From the New Rules Will Need to Prove “Special Circumstances”
If your financial problems are the result of extenuating factors beyond your control, you may be eligible for the “special circumstances” exemption. Under the BAPCPA, debtors can sidestep the new restrictions on the bankruptcy law if they can prove that special circumstances have resulted in a loss of income or an increase in debt. Two examples of special circumstances offered by the U.S. Trustee’s Office include loss of income due to a call to duty in the military or a serious illness or injury. After the massive destruction of Hurricanes Katrina and Rita, the Trustee’s Office announced that natural disasters should be considered to be a special circumstance as well. If a judge agrees that special circumstances are the cause of your insolvency, you will not be subjected to the means test, the credit counseling requirements will be waived, and you will be given permission to file for Chapter 7 bankruptcy.
While this provision gives judges some flexibility when hearing your case, you should keep in mind that the examples of special circumstances given by the U.S. Trustee’s office sets a very high threshold for what situations should and should not qualify. Your personal situation should be at least as serious as these examples in order to receive bankruptcy relief.