Bankruptcy Act Storms Its Way Through Congress

It may be too early to call it a sure thing, but the oft-proposed and never fully-passed legislation known as “Bankruptcy Reform” is moving quickly through Congress this session.  The legislation, formally known as the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” (the “Act”)   faces few,  if any,  obstacles, and looks as if it is headed for the President’s desk.  The Senate passed the Act in March by an overwhelming 74-25 margin  (H. Clinton abstained).  The House will take it up when it returns from its recess on April 5. 

The effect of the legislation will be to greatly restrict the ability of individuals to discharge debt, as is currently done in the chapter 7 bankruptcy system.  Instead, individual debtors will be “means tested” to determine whether they have “discretionary income” to repay some of their debts over a 60-month period. 

Here is a how means testing will work:  To determine the existence of discretionary income, a calculation will be first considering the debtor’s current income,  The expense side of the means test, however, will  consider not the debtor’s current expenses, but what the expenses “should be” based on Internal Revenue Service guidelines.  If it appears that, under  this formula of real income minus “IRS approved” expenses,  they have discretionary income” which could result in the payment of at least $100-$166 per month to unsecured creditors over a 60-month period, then their chapter 7 case is branded as “abusive” and will be dismissed. 

The alternative for those individuals who fall outside of the means test, and the chances are that this will be a large group, will be to simply remain in their debt-ridden state, or to file a chapter 13 case and hope to confirm a plan to repay debt.  In chapter 13, filers use their discretionary income (under current law this is actual income minus actual expenses) to fund a plan to pay creditors over a 36-60 month period.   The Act, however,  makes chapter 13 much more restrictive.  If the debtors’ “real” expenses, as compared to the IRS approved expenses, are higher than their income,  then their attempts at chapter 13 will fail.  At this point, their alternatives for debt relief become non-existent.  If debt-burdened families qualify for neither chapter 7 or chapter 13 relief, then they will become members of an unprotected debtor class, something this country has not seen since the late 19^th Century.  Whether the ranks of such a class will swell, only time will tell.

The entity responsible for “means testing” each filer is the Office of the United States Trustee.   Shortly after House passage of the Act, the Executive Director of the Executive Office of the U.S. Trustees, Lawrence Friedman, resigned

There will be a window of six months from the time that the legislation is signed by the President until the Act goes into effect.  If and when the legislation is passed into law, the Reederlaw Report will follow with a more detailed description of the effect of the legislation on both individual and business bankruptcy cases.

For a concise history of bankruptcy reform, from 1997,  to the present, see the Reederlaw Report article “Bankruptcy Reform – The Flying Dutchman of the Legislative World?” (October, 2004)