Bankruptcy law still controversial 1 year later
Tuesday October 17, 6:00 am ET
Brigitte Yuille
One year and one tsunami of bankruptcy filings later, the bankruptcy law that debuted Oct. 17, 2005, is still generating controversy.
Banking industry representatives say the low number of filings prove the effectiveness for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. It is fulfilling its purpose, they say, of weeding out abuse and wringing out payments from those with the means to pay.
Critics say that the law has found little abuse and made getting out of debt more expensive and cumbersome and so confusing that many consumers aren't sure whether bankruptcy is even an option for them anymore.
The law went into effect Oct. 17, 2005, with a court-clogging fury, as a host of last-minute filers, aware that the law would become tougher, filed under the old law. More than 600,000 cases were filed within two weeks of the law's effective date.
They had reason to rush.
Major changes consumers now face in filing for bankruptcy include:
# Mandatory credit counseling before and after filing bankruptcy.
# A means test to determine eligibility to wipe out debt in a Chapter 7 bankruptcy.
# Proof of income via federal tax returns from the previous year.
# Limits on homestead exemptions.
# Unpaid domestic support takes priority over any other creditor.
# Some eliminated automatic stay protections.
# Extended time between bankruptcy discharges.
Bankruptcy filings collapsed once the law took effect. In the first quarter of 2006, bankruptcies totaled just 116,771. In the last quarter of 2005, they numbered 667,431.
But filings are slowly creeping up. Filings are now approximately 40 percent of what they were before the law. The law encouraged Chapter 13 filings, which require debt repayment under a court-supervised plan. Immediately after the law changed, Chapter 13 filings represented 57 percent of all filings. Now, they're only 39 percent. Chapter 7 bankruptcies -- in which debts are erased and consumers get a fresh chance -- are back the majority, although not as strongly as before the law.
Attorney fees and filing fees increased the law's impact. Bankruptcy attorneys, compounded with additional paperwork, hiked their fees. According the National Association of Consumer Bankruptcy Attorneys', or NACBA, survey of 700 U.S. bankruptcy attorneys, more than three-quarters of bankruptcy attorneys said that the time involved in preparing bankruptcy filing has gone up by 50 percent or more. Almost all of those questioned pointed to the paperwork as the cause of increase in the costs.
Consumers have not only had to find ways around their damaged finances to pay their lawyer but they're required to pay a $50 fee for pre-filing credit counseling and either $299 for a Chapter 7 or $274 for a Chapter 13 bankruptcy. Under the old law, there was no counseling requirement, and filing fees were $209 for a Chapter 7 and $194 for a Chapter 13 bankruptcy.
Chapter 7 filers may have to pay even more if Congress agrees to a bill, H.R. 5585, which increases both the chapter's filing fee and the trustees' compensation by $55.
The NACBA also issued a critical study of the law in February. Its provocative title: "Where are all the 'deadbeats'?"
Supporters say the critics have it wrong.
"The consumer provisions are workable," says Clifford White, acting director in the Executive Office for U.S. Trustees.
He spoke as a panelist for the American Bankruptcy Institute's, or ABI, anniversary program analyzing the law. He says the means test, which considers debtors' income and reasonable expenses, helps identify abuse.
Calling the test the "cornerstone of reform," White says it provides adequate discretion so that decisions on filing motions to dismiss can be made on a case-by-case basis, not only using the statutory formula.
He says 95 percent of the debtors filing under the new law were below the median income. Of the remaining 5 percent, those to whom the means test applies, slightly less than 10 percent were "presumed abusive." And of the presumed abuse cases that did not voluntarily dismiss or convert, United States Trustees filed motions to dismiss in about three-quarters of the cases and declined to file in about one-quarter of the cases.
Tinkering with the law and its enforcement may not be over.
The U.S. Trustee Program has been asked to oversee the financial education requirement of the new law by approving and monitoring the credit counseling requirements.
The counseling provision was touted as a vital element of the law, but so far, it has mostly amounted to a few hours of Internet-based counseling that is a money-loser for its biggest provider -- the National Foundation for Credit Counseling.
The NFCC's affiliates, which operate under the Consumer Credit Counseling Services banner, provide a majority of the approved 153 counseling agencies and 275 debtor education providers.
Based on current estimates of 600,000 bankruptcy filings in 2006 and assuming the same delivery mix, an annual funding shortfall of $7.52 million appears likely for pre-filing counseling service delivered by NFCC agencies, the foundation reports.
"With just one year's experience, it is still too early to assess the law's long-term impact," Susan C. Keating, president and CEO of the NFCC, says in a written release. "We are pleased to see that our financial education efforts are showing positive results, but we also recognize that it will take time to measure the effectiveness of the financial counseling and education requirements of the law."
Counseling agencies are required to provide their services regardless of the debtor's ability to pay. So far, NFCC agencies have waived 16 percent of pre-filing session fees and 13 percent of pre-discharge education classes.
Fee waivers are among the various issues the Trustee Program may address in final rule-making in the coming months says Jane Limprecht, spokeswoman for the Executive Office of the U.S. Trustees.
The need for the fee waivers -- and bankruptcy itself -- is still strong.
"Consumers filing for bankruptcy are upside down financially," Keating said at the ABI meeting. Keating noted that in the survey the organization found the average unsecured debt was $11, 599 greater than the average income.
The bankruptcy attorneys survey also found that, in the attorneys' view, means-test filings were rare and very few filings were about wasteful spending. They say the majority of cases involve consumers forced into bankruptcy due to unforeseen expenses.
Both credit counselors and bankruptcy attorneys are expecting filings to return to normal levels by the end of the year.
Expect more reviews of the controversial law. Quality service checks are another component of the updated law that is now under way. Trustees have begun their post-approval and on-site reviews of credit counseling agencies.
Consumers' cases will also be under review. The updated law calls for one out of every 250 consumer bankruptcy cases to be audited by an independent certified public accountant 18 months after the law's enactment to verify the accuracy of the paperwork filed.
"This regimen of audits will help to identify cases of fraud and abuse, enhance deterrence, and provide baseline data to gauge the magnitude of fraud, abuse, and errors in the bankruptcy system," says White.
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