One of the most controversial bills to pass through Congress of late is the bankruptcy reform legislation President Bush recently signed.The new law will make it more difficult for individuals to qualify for Chapter 7 bankruptcy and avoid their debts.
What does this mean? Individuals normally file either Chapter 7 or Chapter 13 bankruptcy. Chapter 7 allows a person to keep exempt assets, such as home equity and retirement plans, and receive a “discharge” on most debts. A few months after the Chapter 7 is filed, a discharge is entered and the individual is given a fresh start to rebuild his financial stability. Under Chapter 13, individuals pay their monthly disposable income into a plan for three to five years, and a trustee distributes the plan payments to creditors. The Chapter 13 filer does not receive his discharge until all plan payments are made.
Under the new law, individuals will be required to meet with a credit counselor before filing bankruptcy. In addition, a means test will be applied to determine if the person’s income is above the state’s median and if he can afford to pay 25 percent of his unsecured debt. If so, he will be required to follow a five-year repayment plan under stricter guidelines. While in the past, the judicial system could evaluate a person’s monthly expenses on a case-by-case basis, the new law is fairly strict in its requirements, affording little leniency.
Since more bankruptcy debtors will be forced into payment plans, small business creditors are more likely to receive payment (albeit a small payment) if their customer files bankruptcy. In preparation for the influx, accounts receivable managers should learn how to properly file a proof of claim and familiarize themselves with the provisions of the new law.
What does this law mean for low-income individuals, single women and minority groups? Perhaps the biggest opponents of the new legislation, truly low-income people, will still be able to file a Chapter 7 and discharge their debts. However, this will be a fairly limited class of people.
The law will cause changes for bankruptcy attorneys as well. If the information in a bankruptcy filing is found to be inaccurate or fraudulent, the bankruptcy attorney may be subject to fines and sanctions. This can only result in fewer attorneys willing to file bankruptcy petitions, and those who do will charge more for their services.
Will this law work? Supporters claim it is a strong effort to prevent individuals from abusing bankruptcy laws and shirking financial responsibility. Opponents feel it is designed to assist credit card companies and financial institutions without regard for how the debtor came into his financial crisis. For example, an individual with extensive medical debt is treated the same as an individual with high credit card debt.
Regardless of its intent, however, the new law does resolve some glaring problems for creditors, such as reducing the Chapter 13 “super discharge.” Under the old law, a debtor could discharge fraud and embezzlement claims by filing Chapter 13 and paying his disposable income into a plan. Also, debtors will not be able to use Chapter 13 to reduce their car payments through a “cram-down” process.
Individuals who are truly in need of a fresh start may no longer benefit from filing bankruptcy. Only time will tell whether the new law is an effective tool for forcing personal responsibility or a weapon for creditors to collect loans that should never have been approved in the first place.