Bankruptcy Just Got A Lot Tougher
By Robert D. Gifford
Winter 2005-06
In an ideal world, a person would not incur more debt than he or she can pay. Of course, this is not the reality in the United States. According to the American Bankruptcy Institute, a record 1.6 million Americans filed for bankruptcy last year.
Bankruptcy provides a mechanism to discharge or even wipe out many (but not all) debts. The effect of a discharge is to preclude the creditor forever from attempting to collect on the debt and to give honest debtors a fresh start. Its purpose, according to the Supreme Court, is to provide the debtor with "a new opportunity in life and a clear field for future effort unhampered by the pressure and discouragement of pre-existing debt."
But the comprehensive new Bankruptcy Reform Act means that bankruptcy no longer is as easy to use - or abuse. While the new law is viewed by some as harsher treatment of debtors and by others as leveling the playing field for creditors, the bankruptcy system certainly is more difficult and expensive.
In a common Chapter 7 bankruptcy, the debtor's property (with certain exceptions) is turned over to a trustee and sold ("liquidated"), and creditors are paid from the proceeds. Creditors often are not re-paid in full; indeed, most debts - including most credit card debt - are canceled. Generally, an individual can file for Chapter 7 only every six years.
Before the new law took effect, bankruptcy judges enjoyed wide discretion in determining who may have been filing unfairly for Chapter 7. Under the new law, bankruptcy judges use a complicated means test to determine one's eligibility. With this stricter threshold, many individuals may be required to file for bankruptcy through Chapter 13.
Under Chapter 13 bankruptcy, the debtor usually is allowed to keep property and pay debt according to a schedule spread over three to five years. While the debtor keeps more property in Chapter 13, the payment plan is much more difficult to complete.
In its simplest form, the debtor qualifies for Chapter 7 when earning less than the median household income in his or her respective state. If the debtor earns more than the median, then "responsible" monthly expenses (as determined by the Internal Revenue Service) are deducted from monthly income. If this total exceeds $100, then the debtor must file under Chapter 13 and is placed on a structured repayment plan.
Furthermore, the new bankruptcy bill requires debtors to complete a credit counseling program from a court-approved non-profit credit counseling agency within six months of filing for bankruptcy. Each of the country's 90 bankruptcy courts will maintain a list of approved credit counseling agencies in their respective areas.
Certain assets, such as IRAs and 401(k)s, are exempt under the new bankruptcy law; a debtor no longer is required to use funds from these accounts to pay off creditors. College savings plans (529s) also are wholly exempt if held for at least two years and limited to $5,000 if held between one and two years.
While bankruptcy follows federal law, states are allowed to determine the assets an individual may shield from creditors. This is more commonly known as the "homestead exemption." Some state jurisdictions may allow a debtor to keep large amounts of equity in the home, while others provide for little or no equity if the homeowner files under Chapter 7. Some states follow the federal law, which provides a $17,425 shelter of home equity.
The new bankruptcy law also includes a "look-back" provision to prevent people from buying expensive property at the last minute in states with larger homestead exemptions and then filing for bankruptcy with an even larger debt. In addition, the homestead exemption for anyone residing in a state fewer than 40 months is limited to $125,000, even if that state allows a larger exemption.
The complexity of the new law also may increase the cost of retaining an attorney. Attorneys now must certify to the accuracy of a debtor's representations, creating new work and additional costs.
Bankruptcy is only one alternative to the resolution of a debtor's financial difficulties. Non-bankruptcy alternatives - such as negotiation with creditors, consolidation loans, credit counseling or defending an action in court - probably will prove less expensive and more favorably received by creditors.
Many military installations offer free counseling if you need help in budgeting, saving and gaining control over your credit.
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Maj. Robert D. Gifford is an Army Reserve Judge Advocate with the 22nd Legal Support Organization. In his civilian capacity, he serves as an Assistant U.S. Attorney for the District of Nevada. The views expressed in this article do not necessarily reflect those of the U.S. Department of Justice or the U.S. Department of Defense.
