CHAPTER 7 BANKRUPTCY: LEGISLATIVE REFORM 2005

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THE NEW BANKRUPTCY: BASICS AFTER REFORM

Anybody can run into financial problems. A sudden illness, a job layoff, an auto accident followed by a lawsuit -- these incidents which are outside your control can land you in financial jeopardy.

Sometimes, there is no alternative but to file bankruptcy.

In April, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This new law makes sweeping changes in the nation's bankruptcy rules, and the impact of these changes must be examined carefully by those who consider filing.

BANKRUPTCY BASICS

For consumers, there are two types of bankruptcy. First is Chapter 7 (or straight bankruptcy), which allows you to wipe out most of your debts and "start over." This is the most common type. Under Chapter 7, everything you own generally will be divided into three categories:

Exempt items are things you are permitted to keep.

Secured assets, or the sale proceeds up to the amount of the debt, go to the creditor.

Non-exempt items are sold by the court, and the proceeds are used to pay as much of your debts as possible. Most remaining debts you owe will be forgiven.

Second is Chapter 13 bankruptcy, which allows you to come up with a plan approved by the court to pay off some or all of your debts over time. Payments to creditors can be made over a three-to-five-year period, and you can keep your house, car and other property.

CHAPTER 7 EXEMPTIONS

What do you get to keep if you file for Chapter 7 bankruptcy? The short answer is "not much":

The equity in your home up to $5,000. If you and your spouse jointly own the home, and you both file for bankruptcy, you can keep up to $10,000.

Benefits from certain pensions, annuities and life insurance.

$400 "wild card," which you can apply to increase any of the other categories.

Your interest in one motor vehicle, up to $1,000 ($2,000 if husband and wife own jointly).

Cash and accounts up to $400.

Clothing, beds and bedding up to $200 per item.

One stove and one refrigerator, up to $300 per item.

Other personal and household items, including furnishings, books, appliances, ani mals, musical instru ments, firearms, hunt ing and fishing equipment, and jew elry, up to $1,500 per household ($2,000 if you don't own a home; $3,000 if husband and wife, and you claim the exemption for home equity), with no one item to exceed $200 in value (except one piece of jewelry can be $400).

Up to $750 worth of professional books and/or tools of your business or trade.

Professionally prescribed or medically necessary health aids.

A burial plot.

Benefits from Social Security, workers' compensation, unemployment compensation, Aid to Families with Dependent Children, and General Assistance.

Alimony and child support necessary for the support of you and/or your dependents.

NON-DISCHARGEABLE DEBTS

Most debts are permanently released in Chapter 7 bankruptcy. But you can't escape some debts including:

Most federal, state and local taxes.

Alimony and child support (with limited exceptions).

Money, services, property or credit obtained by fraud.

Most government fines, including traffic tickets.

Most student loans. But if repayment would cause you or your dependents undue hardship, the debt may be discharged.

Damages caused to accident victims as a result of driving while intoxicated.

Damages caused to others as a result of your willful and malicious acts (like a bar brawl).

BANKRUPTCY RAMIFICATIONS

Imagine life without credit cards, having to pay cash for everything. That's what life is like after bankruptcy. And bankruptcy may affect your ability to get or keep a job, too, as more and more employers review credit histories before hiring or promoting.

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ELIMINATING DEBTS WITH THE "NEW" CHAPTER 7 IS NOW MUCH MORE DIFFICULT THAN BEFORE

Congress has just enacted sweeping changes to the federal bankruptcy laws. Let's review the ways the new laws will make it harder for many Americans to wipe out their debts and get a "fresh start" under Chapter 7.

MEANS TEST

To file for Chapter 7 bankruptcy, you will have to pass two tests. First, your income must be less than the state median; in Ohio, the median income for a family of four currently is $66,000. This figure may be adjusted by the time the means test of the bankruptcy law goes into effect in October 2005.

If your income is less than this threshold, you can file Chapter 7. With income above the median, you must then pass a second, three-part test:

If your net monthly income (reduced by allowable expenses) is less than $100 per month, you can file for Chapter 7.

If your net monthly income (reduced by al lowable expenses) is $166.67 per month or more, you cannot file for Chapter 7.

If your net monthly income (reduced by allowable expenses) is between $100 per month and $166.67 per month, you may not file for Chapter 7 if you can pay 25 percent of your unsecured debts (debts which are not secured by particular property) over a five-year period.

It appears that with income above the median of $66,000, most people's net monthly income will exceed $166.67 per month - and, therefore, they will not be permitted to file for Chapter 7.

Even if your income is less than $66,000, the bankruptcy judge may still require you to file for Chapter 13 (which sets a payment plan for your debts instead of wiping them out), as long as you are able to pay 25 percent or more of your unsecured debt.

ALLOWABLE EXPENSES

When calculating your net monthly income, you may reduce the gross amount by allowable monthly expenses. These are not your actual expenses. Instead, you will have to use the amounts established by IRS rules (which, unfortunately, may be much less than your real costs), for things like food, clothing, personal care and entertainment.

ATTORNEY PENALTIES

The new bankruptcy law is likely to make it harder to find a lawyer willing to help you with your case. And if you do find a lawyer, the fees are likely to be higher. Here's why:

When filing a bankruptcy case, an attorney includes schedules listing his client's assets. Typically, an attorney gets that information from the client.

Under the new law, the lawyer will have to certify that, based upon a reasonable inquiry, the information he has submitted is correct. If it is later discovered that the information was not correct, perhaps there were more assets that had not been listed, then the attorney may be subject to costly penalties.

This requirement puts the lawyer in a very difficult position. What must an attorney do to make a "reasonable inquiry?" Hindsight is 20-20, and if assets are later discovered, the lawyer's prior actions will be scrutinized.

Attorneys filing other kinds of lawsuits have long had a requirement that they not make "frivolous" claims. But this places a much higher burden on lawyers.

The bottom line is that the new law will make it much harder to file for Chapter 7 bankruptcy. More Americans will be forced into Chapter 13 bankruptcy, which requires a payment schedule, or will be precluded from bankruptcy entirely.

BANKRUPTCY PROTECTIONS REDUCED UNDER NEW LAWS

The new bankruptcy law makes it harder to get a "fresh start" under regular Chapter 7 bankruptcy. You must meet complicated new income requirements to qualify.

If you do satisfy the rules to file for Chapter 7, most of your debts will be wiped out. But major changes in the bankruptcy law reduce the available consumer protections. Let's examine three:

CAR LOANS

The new law makes it harder to eliminate a car loan. Even after bankruptcy, you will have to repay the full amount of loans taken out in connection with an auto purchase within 30 months of the bankruptcy filing.

HOMESTEAD EXEMPTION

Another major change will make it harder to take advantage of the liberal homestead exemption available in a few states, like Florida and Texas.

In many states, you may keep up to only $5,000 ($10,000 for a married couple if both file) of your home equity. That's not much. Other states allow homeowners to protect a lot more. For example, Florida and Texas allow individuals to keep their home no matter what it's value. In those states, wealthy people have been known to take their "exposed" assets, such as bank and brokerage accounts that would have to be turned over to the creditors in bankruptcy, and use them to buy an expensive home, which is exempt.

The new bankruptcy law makes it a little harder to protect assets by purchasing an expensive home.

A long-time residence is still protected regardless of value. But under the new law, a debtor who buys a home within 1,215 days of the bankruptcy filing will be allowed to protect home equity of "only" $125,000 plus the amount of equity rolled over from a prior house into the new home within that 1,215-day period.

So rich Floridians who previously could easily shelter millions of dollars in bankruptcy now will have to plan a little more in advance if they wish to use that legal loophole.

Could an "out-of-stater" move to Florida to take advantage of their liberal homestead protection? Don't laugh, some have done just that. Before the new bankruptcy rules, you could move and take advantage of the exemptions offered in your new home state as long as you lived there six months before the filing. Under the new law, you can't move to Florida (or any other state) and get the benefit of that state's homestead protection for a residence purchased within 1,215 days of the bankruptcy filing.

AUTOMATIC STAY

One of the best protections of the bankruptcy law is the automatic stay, which immediately stops most legal actions involving your money or property. Under the "old" law, the stay would halt (at least temporarily): Utility disconnections; Evictions; Collection of overpaid public benefits; Loss of driver's license or professional license; Wage garnishment; Home foreclosure; Loss of unemployment benefits; Divorce and lawsuits related to domestic violence.

However, the new law limits the use of the automatic stay. It can no longer be used to stop or delay evictions, loss of driver's or professional licenses, divorce and domestic violence lawsuits.

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