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 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.
Here are some of the most important changes
called for in the legislation. The link in each item will
take you down to a fuller explanation.
- A
means test would be required for people filing for Chapter
7, the section of bankruptcy law that allows a filer to
wipe out debts and get a fresh start. No means test is required
now.
- 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.
- People
who want to file would first have to receive education
about the alternatives to bankruptcy and get credit counseling.
These are not requirements now.
- Child-support
and alimony 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.
- People filing for bankruptcy could
give as much as 15
percent of their income to charity without being challenged.
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.
(Back
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Protecting
a vehicle from creditors
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.
(Back
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Automobile
expenses
The mystery 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.
(Back
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Education
In essence, there would be a detour sign at the bankruptcy
clerk's window, requiring you 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 sic
the FBI on you.
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.
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.
(Back
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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 newfound 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.
(Back
to top)
-- Posted: Feb. 2, 2000
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