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Update on Bankruptcy Law Change

Over the course of the past seven years powerful credit card companies and financial institutions have successfully lobbied Congress to make changes to current bankruptcy laws. Congress has been close to passing a new bill in each of the last two years, only to be held up by the controversial Schumer Amendment. The amendment, sponsored by Senator Charles Schumer D-NY, would deny a discharge for government fines imposed on those arrested for abortion clinic violence. This amendment, among many others, has recently been voted down in the Senate, paving the way for a decisive Senate vote.

It is likely the Senate will ratify the measure, S. 256, and House Republican leaders have promised to take up the bill within weeks if the Senate passes it free of amendments. Also, President Bush has made it clear he will sign the law if it crosses his desk. This will result in major bankruptcy overhauls becoming active in the next few months.

Under current law, the majority of consumers who file for bankruptcy do so under either Chapter 7 or Chapter 13. Under Chapter 7, a debtor is able to liquidate his or her debts and get a fresh start. Under Chapter 13, a debtor repays his or her creditors a portion of the debt owed to them over a period of three to five years. If the bill passes in its current form more debtors will be required to file under Chapter 13.

Currently, it is up to the court to determine whether a case qualifies for Chapter 7 protection. Under the new legislation, a debtor’s income will be subject to a two-part “means test.” This test uses a formula that exempts certain expenses (rent, food, etc.) to determine whether the debtor can afford to pay 25% of the non-priority unsecured debt, i.e. credit card debt, medical bills and utilities. The income will then be compared to the State’s median income. If the debtor’s income is above the State’s median income and the debtor can pay 25% of the unsecured debt then the debtor will not be able to file under Chapter 7.

In addition, if the debtor’s income is below the state’s median but he or she can still pay the 25% of unsecured debt, they may be able to file under Chapter 7. However, if the court believes that the debtor would be abusing the system by filing under Chapter 7 it may force the debtor into a Chapter 13.

Currently, when a debtor files under Chapter 13, the court determines what a debtor can or cannot pay based on what the debtor and court deem to be reasonable and necessary expenses. Under the new bill, the court would apply living standards as derived by the Internal Revenue Service (IRS) to determine what is reasonable and necessary for rent, food, etc. The IRS standards are much more stringent than those accepted by the courts today and any challenge to those would require more time and expense.

Additional requirements under the new legislation would call for more fees from a debtor. Those fees will be incurred through mandatory credit counseling within the six months prior to filing and a money management class before the debts can be discharged. Finally, the time allowed between filing a bankruptcy under Chapter 7 will be increased from six years to eight years.

Before any proposed legislation becomes law, consumers who need financial relief should consider filing sooner rather than later. This would ensure protection under the current, more favorable bankruptcy laws. Filing sooner would also provide a last chance opportunity to avoid the potential hardships and extra costs associated with the proposed changes.