Bankruptcy Reform

Under the test, secured debts (e.g., mortgages and car notes) and necessities (alimony, child support and living expenses) are subtracted from the debtor's monthly income to determine what amount of money is left over for repayment of unsecured debts, such as credit cards. If there is enough left over so that the debtor can pay at least $10,000 toward unsecured debts over 5 years or $166 per month ($10,000 / 60 months = $166 per month), the debtor must file Chapter 13 bankruptcy and make repayments.

SIDEBAR: Debtors (with an average median income) who can find at least $100 left over after expenses are prohibited from filing Chapter 7 bankruptcies. This “means test” will limit Chapter 7 filings to individuals and families with little or no cash flow. Under prior law, courts did not have any set formula to determine how much leftover cash tips the debtor out of Chapter 7 and into Chapter 13.

SIDEBAR: Debtors are no longer able to include many items as necessary expenses that were previously allowed. For example, cell phone service, cable television, Internet services, movie rentals and some dining out can no longer be added to the debtor’s expenses.

The new law makes the means test inflexible. Previously, a bankruptcy court had great latitude in considering a debtor’s personal circumstances in permitting her to file for bankruptcy. Under the new law, personal circumstances, no matter how sympathetic, are irrelevant.

SIDEBAR: Historically, almost two-thirds of consumer bankruptcies have been filed under Chapter 7, which allows consumers to wipe out credit card debt.

SIDEBAR: “Reasonable” living expenses for food and clothing, transportation and housing are determined by IRS guidelines. The guidelines take into account the region of the country where the debtor lives. A debtor is also allowed to deduct other reasonable living expenses, including:

• up to $1,500 in expenses annually for grade and high school (per each minor child)
• expenses of caring for elderly, chronically ill or disabled household family members, including children and grandchildren
• a domestic support obligation that first becomes payable after the petition is filed
• charitable contributions of up to 15 percent of gross income
• payment of expenditures needed to continue, preserve and operate a business

Can I file under Chapter 7 if I pass the “means test”?

Individuals who pass the means test must file Chapter 13 bankruptcy and enter into a plan to repay creditors. The means test requires a debtor whose income, based on the size of his family, is more than his state average to file under Chapter 13. Choice between chapters in filing for bankruptcy is virtually eliminated under the new law.

How do the new bankruptcy laws affect state exemptions?

Debtors who are eligible to file under Chapter 7 must have lived in the state for 2 years to use the state exemptions. This provision prevents debtors from moving to big-exemption states (such as Florida and Texas) to avoid losing assets to liquidation.

We are in the middle of our Chapter 13 plan. Will the new bankruptcy law affect us?

No. The law does not affect bankruptcies filed before its effective date.

What happens under the new law if we fail to complete our Chapter 13 bankruptcy plan?

The court can dismiss the case and your creditors will resume collection activities against you.

Can a Chapter 13 bankruptcy be converted to a Chapter 7 under the new law?

Yes. If you are unable to complete the repayment plan under Chapter 13 due to circumstances beyond your control, such as unemployment, illness or a decrease in income, you can petition the court to have your debts discharged completely.

SIDEBAR: The court can revise the Chapter 13 repayment plan and require smaller payments because of a change in circumstances.

How can I avoid bankruptcy?

Although a bankruptcy does have an advantage in that it provides debtors with a fresh start, the damage to credit can have enormous consequences. Individuals should seek to avoid bankruptcy when finances become tight by getting a clear picture of their current financial situation.

• Write down all your debts—the amounts, the interest rate and the monthly minimum payments.
• Calculate all the net income you have available.
• Add up your expenses and forego items such as cable TV, cell phone service, housekeepers and lawn services.
• Make a budget and stick to it.
• Sell any personal property and vehicles that you do not absolutely require.
• Cut up credit cards (except for an emergency card) and make purchases with a debit card only.
• Reduce late fees by signing up for direct debiting from your bank account on some bills.

Once you have a complete understanding of your financial situation, negotiate with creditors, primarily credit card companies, to lower interest rates and monthly payments. Do not tell the creditor you are thinking about filing bankruptcy—they will flag your file and close your credit line.

TIP: Credit counseling services that negotiate with creditors on your behalf and pay them directly are not recommended. Typically, these services negotiate down your unsecured debts and have you pay the service one large payment, which is then distributed by the credit counselor to your creditors. Not only is your credit rating immediately damaged when the credit counselor contacts creditors, payments may be made late or not at all.