Proposed legislation to change the
bankruptcy laws by Holden Lewis, Bankrate.comSM
Bankruptcy reform bills in Congress contain a number of measures that are designed to reduce abuse of the bankruptcy system. Most of them would make it more expensive or more difficult to declare bankruptcy.
Some of the most important changes called for in the legislation are listed below. The links in each item takes you down to a fuller explanation.
Means Test: This test requires people filing Chapter 7 to pass a "Means Test" which is used to determine if you can file chapter 7, or chapter 13. Chapter 7 allows people to wipe out debts and get a fresh start.
Vehicle Protection: Under the proposed law it would be harder to protect one's personal vehicle from creditors. Internal Revenue Service standards for vehicle expenses would be adopted. Right now, it is up to the judge to decide whether vehicle expenses are reasonable.
In some cases, a house worth more than $250,000 would not be protected in bankruptcy, and it would be harder to move to a state with generous homestead laws, sink all your assets into a big house, then declare bankruptcy while keeping the house.
Education & Counseling: Although not required now, people who want to file bankruptcy would first have to receive education about the alternatives to bankruptcy and credit counseling.
Child Support and Alimony: These payments would have a higher priority. Creditors could ask the bankruptcy judge to throw out an individual’s bankruptcy petition or ask the judge to convert a Chapter 7 filing to Chapter 13. Right now, those with a financial interest in the proceedings, such as creditors, can't make such requests.
Tithing: People filing for bankruptcy could give as much as 15 percent of their income to charity without being challenged.
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Bankruptcy Means-testing
The means test is designed to force more filers out of Chapter 7 and into the more-unpleasant Chapter 13. About 70 percent of personal bankruptcies are filed under Chapter 7 and the rest are filed under Chapter 13.
Chapter 7 is designed to give the chastened consumer a fresh start. The debtor is allowed to keep some assets -- such as a house, work tools and, usually, a vehicle -- and the rest of the debtor's property is sold by a trustee. The proceeds from the sale are distributed according to priorities set by law. Once that is done, the debts are discharged -- the slate is wiped clean!
Chapter 13 allows the debtor to repay creditors in full or in part over three to five years under court supervision and protection. During the repayment period, creditors can't start or continue collection efforts. Credit-card companies want more people to file under Chapter 13 so they can get more money back.
Although there are safeguards, bankruptcy courts operate on the honor system. If you can repay some of your debts, you are expected to file for Chapter 13. But lenders believe that thousands of people file for Chapter 7, releasing them from most debts, when they could file for Chapter 13 and pay up.
If means-testing is instituted, bankruptcy filers would have to:
- File three years of tax returns
- Show six months of pay stubs and documentation of other income
- Give a detailed breakdown of all debts and monthly expenses
Then, you essentially would be asked three questions whose answers would be based on the above information:
- Does your family (even if it's a family of one) earn more than the majority of families of the same size?
- The latest figures, from 1997, are $18,762 for a household of one; $39,343 for a household of two; $47,115 for a household of three; and $53,165 for a household of four.
- If the answer is no, you could go ahead and file Chapter 7 bankruptcy.
- But if your family earns more than the median income of its size, there are two more questions to answer:
- Could you pay off $5,000 worth of debt over the next five years? (That's the House version. The debtor-friendlier Senate version asks if you can pay off $15,000 worth of debt in five years.)
- If your remaining monthly income were applied to unsecured debt (loans that are not backed by collateral, such as credit cards) over the next 60 months, would you be able to repay at least 25 percent of that debt?
If you could answer yes to either question, you would have to file Chapter 13, unless you could demonstrate that "extraordinary circumstances" would prevent you from repaying.
Up Vehicle Protection
If you owe more than the vehicle is worth -- and that often is the case -- you might not fare well under bankruptcy reform because you'll have to abide by the terms of the loan contract that you signed.
Let’s say your car would bring you $2,500 if you sold it today, but you're making payments of $250 a month and you still have 20 months left on the loan. You owe $5,000 for a car that's worth half that. Under current bankruptcy law, you would still have to pay the $2,500 value of the car to keep it, but the other $2,500 would be treated just like credit card debt. In bankruptcy, you might end up paying none of it, all of it or some of it, depending on the circumstances.
But under the proposed legislation, you would have to keep making the payments for the full amount of the loan or you would lose the car.
Up Automobile Expenses
The issue here is just how auto expenses will be counted.
What if you own an old car that is already paid for? Will you be able to buy another car during the five years you are paying off debts under Chapter 13? What happens if the transmission goes out or you need to buy a set of tires?
Under the proposed legislation, you might be out of luck if something bad happens to your paid-off car. If the transmission goes out, you could ask the court to restructure your Chapter 13 agreement while you make arrangements to buy another car or have your car repaired.
"This legislation is very inequitable because if you bought a $30,000 car right before you filed, you can keep it and pay it in full," says Marianne Culhane, a Creighton University law professor who co-wrote a study on bankruptcy reform. On the other hand, if you have an 8-year-old car when you file, you're probably in for some tough choices over the Chapter 13 repayment period.
Up Education
In essence, when you appear at the bankruptcy clerk's window, you would be required to consider alternatives to bankruptcy, such as credit counseling, before you could file. To file for bankruptcy, you would have to show that you received credit counseling within the past 90 days unless you have a good excuse, such as a lack of credit counseling agencies in your area.
After filing, you could be required to attend financial management classes. Another aspect of education is that the court would be required to tell you that if you don't tell the whole truth about your finances, it can send the FBI after you.
Up Child Support and Alimony
Right now, child support and alimony rank seventh in priority of debts to be repaid. The legislation would make them the first priority -- ahead of paying the bankruptcy attorneys. It's a laudable thought, but it wouldn't make much difference to anyone except bankruptcy attorneys. Child Support Collections Laws
Under the Senate bill, if you had taken a cash advance on a credit card to pay child support or alimony, you might be able to write off that debt in bankruptcy -- if you got the advance more than three months before you filed. But if the court casts a suspicious eye, you might have to pay off the cash advance anyway.
On a related note, people have been known to scam the bankruptcy system by taking cash advances on credit cards, using the money to pay student loans (which generally you have to pay, even in bankruptcy), then declaring bankruptcy and getting the cash advance written off. This kind of unethical practice would receive more scrutiny under bankruptcy reform, and you're unlikely to get away with it.
Up The Tithing Act
The legislation does not allow the court to consider your religious or charitable giving (up to 15 percent of your income) in the means-testing. This opens up a big loophole that savvy debtors can take advantage of.
If during the means test phase it is found that you would have $100 left each month to pay unsecured debts, placing you in danger of having to file Chapter 13, you could start donating $20 a month to a religious or charitable organization. Presto: Your excess cash drops below $83 a month and you might be eligible for Chapter 7. And the bankruptcy isn't supposed to question your new found philanthropic impulse.
"It seems to me a way to escape being pushed into Chapter 13," says Culhane, co-author of the Creighton report that was critical of the means-testing provision.
Rich's Enterprises, L.L.C.,
Prattville, Alabama
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