Whoever said change is good was not referring to recent bankruptcy reform. On October 17, 2005, Congress instituted federal bankruptcy changes that were supposed to eliminate the "deadbeats" filing bankruptcy. The changes were designed to make it more difficult for those consumers trying to run from debt through bankruptcy.
Under the changes, the new first step is to undergo credit counseling. The counseling step is designed to analyze debt to income ratio and the ability to pay debt. The system is designed to determine which people could be steered into a debt management plan and away from bankruptcy. Moreover, this step is designed to deter abuse of the bankruptcy system. However, a study by the National Association of Consumer Bankruptcy Attorneys (NACBA) concluded that 97 percent of consumers were unable to repay any debt. More surprisingly, 79 percent of consumers were put into "dire financial straits by circumstances beyond their control, such as the loss of a job, catastrophic medical expenses or the death of a spouse."
Once a consumer concludes credit counseling, consumers face even more hurdles in determining which specific chapter to file. The two types of consumer bankruptcy chapters are 7 and 13. Chapter 7 provides the debtor a discharge of his or her debts via a liquidation of assets. In Chapter 13, the debtor receives a discharge through payment into a reorganization plan. Here, the debtor pays a monthly amount into a plan that cures overdue debts. In the past, Chapter 13 was not widely used as Chapter 7 provided a discharge without any obligation to pay debt. In addition, most people protected their most prized possessions through federal or state bankruptcy exemptions.
However, new hurdles like the "means" test has affected the eligibility of many would-be Chapter 7 filers. Now after the reform, debtors must pass what is known as the "means" test in order to file Chapter 7. A debtor is forced into Chapter 13 when he or she fails the "means test." The "means" test states that if the prospective filer's current monthly income (CMI) multiplied by 12 exceeds the median income for a family of the same size in the same state, then the debtor is forced to file Chapter 13 bankruptcy. This provision was designed to limit the number of people abusing the system. In reality, it creates a presumption of abuse. As a result, consumers are now given limited freedom in choosing which bankruptcy chapter to file.
The legislature did not leave out Chapter 13 in terms of change. It also endured an overhaul. For instance, the length of repayment plans is now five years. Also, unsecured creditors are now treated more favorably under bankruptcy laws. As such, Chapter 13 plans will not be approved if they provide less to unsecured creditors than if the debtor liquidated his or her assets in Chapter 7. As a result, some consumers might not be able to file bankruptcy at all.
For example, if Debbie Debtor's CMI is $3,333.33 ($40,000 per year) in Houston, Texas, and the current median income for a one-person household in Texas is $38,000 per year, then Debbie is forced to file Chapter 13. She is forced into Chapter 13 because she has flunked the "means" test. Chapter 13 provides the debtor with a reorganization plan to cure any pre-petition arrearage rather than liquidation of all assets not exempt. Essentially, this would allow Debbie to catch up on her debt. Upon completion of the plan, Debbie would receive a discharge. In this reorganization plan, Debbie pays off her debt in no more than five years (when forced into Chapter 13 for failing the means test) unless the plan provides for full payment of all unsecured claims in a shorter time period. Unsecured claims are all debt owed to unsecured creditors. Unsecured creditors are all those creditors who hold no assurance of payment. Secured creditors have security in payment and are considered priority creditors, meaning they get first dibs on being paid.
For instance, the mortgage holder on Debbie's house is a secured creditor and must receive payment through her plan if she were behind. However, credit card debts are considered unsecured claims. Unsecured creditors would receive money through her plan only if there is money left over after the priority creditors receive payment.
But, if it turns out that Debbie's unsecured creditors would actually make it out better in Chapter 7 liquidation, then she is required to file Chapter 7. However, in this case, Debbie was already "kicked" out of Chapter 7 for flunking the means test. So, under new bankruptcy laws Debbie has no way out. She can't file Chapter 7 due to flunking the "means" test nor can she file Chapter 13 because her unsecured creditors are better off in Chapter 7. This would leave her without any form of relief in bankruptcy. This goes against the general position that bankruptcy is a tool that provides a consumer with a "fresh start." Unfortunately, in this scenario, the law works in a way that drives people further into debt rather than towards a new beginning.
