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Effects Of The New Bankruptcy Law: Twelve Months Past The Reform

The changes to the federal bankruptcy law that went into effect October 2005, which were intended to weed out the so called “deadbeats” from trying to use bankruptcy as a way to avoid debt, have the current number of filings at a 20-year low. Consumers rushed to beat the Oct. 17 deadline, leading to long lines outside the courthouses and unprecedented number of filings. More than 2 million consumer cases were filed in 2005, including 619,588 in October alone. Many consumers who could have possibly managed through their financial troubles decided to file prior to the law change since they felt bankruptcy would not be an option afterwards. According to the American Bankruptcy Institute, one in every 60 households filed a consumer bankruptcy in 2005, compared to one in every 79 households in 2004. Through the first quarter of 2006, the rate has plunged to one in 261.

Many finance companys, especially credit card companies who lobbied so hard to get the law passed, were caught by surprise due to the large pre-implementation surge. Many wound up facing much larger than expected losses. Delinquency and charge off levels spiked for many finance companys during the last quarter of 2005 and first quarter of 2006. Many experts predict that the levels will return to “normal” but will not drop. If individuals do not have the money to pay their debt, they may not file bankruptcy, but their accounts will still be charged off.

In our top 12 markets for the second quarter of 2006, Chapter 7 bankruptcy filings, which provide customers with the greatest relief of debt, were 32 percent of what they were during the same period in 2004. Chapter 13 filings, which require consumers to repay a part of their debt, have become a much higher percentage of total consumer cases filed as opposed to historic rates. Signs are already evident that the filings are picking up because the root causes of unpaid debt were never addressed.

The slowdown indicates, at least initially, that the law has achieved its objective by making people think twice about filing bankruptcy. Seasoned observers worry that several economic factors will collide this year to increase filings in the months ahead. With increasing interest rates, higher energy costs, increasing minimum credit card payments and the increases in debt service costs on adjustable-rate mortgages, many experts predict bankruptcy filings will return to previously high levels.

The reason is that many bankruptcies are filed by consumers who are faced with circumstances beyond their control. According to Celent, a Boston-based research and consulting firm, “About 30 percent of bankruptcies filed normally are due to job loss and 46 percent due to overwhelming medical expenses.” Divorce and the death of a spouse are also major contributors leading individuals to file for bankruptcy.

And while the rules for filing have changed since October, bankruptcy is still a financial option and consumers are using it. Potential filers are now required to undergo credit counseling from an approved tax-exempt or non-profit agency which can take place in-person, over the phone or online. Credit counselors are already reporting record numbers of debtors seeking help, and many of these may well enter the bankruptcy pipeline within the next year. In a recent study conducted by the National Association of Bankruptcy Attorneys, approximately 97 percent of the people who have undergone credit counseling since the law passed truly couldn’t pay their debts. The pre-filing counseling also makes it more difficult for debtors to avoid last minute foreclosures and repossessions. The reality is that consumers who really need bankruptcy protection can still get it.

Probably the biggest change is that it is more complicated and expensive to file. Previously, consumers could decide if they wanted a reorganization (Chapter 13) or liquidation (Chapter 7). Now they must satisfy a “means test” which involves filling out a lot more paperwork. The debtor’s income is averaged over the last six months less any secured debts, priority debts and allowable expenses to see if there are sufficient funds available to pay the unsecured creditors. If it is determined by the bankruptcy court that there are sufficient funds available, then the debtor will most likely be required to file a Chapter 13. If not, then the debtor will proceed with liquidation. There are several loop holes to the calculation, and debtors, as well as attorneys, continue to find ways to manipulate the system.

The laws have also increased attorney responsibilities, which in turn increase the client’s cost to file. Now if an attorney submits a bankruptcy filing with inaccurate information, the attorney can be held liable. This increase in responsibilities and liability has caused many attorneys to stop taking bankruptcy clients. Jack Ayer, a resident scholar at the American Bankruptcy Institute in Washington D.C., reports that “about one-third of bankruptcy filings are currently being made by people who do not have legal representation. These cases are getting bounced out of the courts, and there is no indication as of yet what is happening to them next.” Most experts guess that these individuals are simply biding their time, hoping to juggle their debt problems as long as possible before obtaining legal representation to file.

Bankruptcy experts agree that if finance companys – especially those that are unsecured – want the new bankruptcy laws to achieve the desired objective, they are going to have to work with one another to create a manageable repayment plan for the debtor outside of bankruptcy court. This would eliminate a lot of unnecessary court costs for both parties and allow the money to be applied towards debt instead of the costs associated with bankruptcy proceedings. Joseph Prochaska, chairman of the Consumer’s Bankruptcy Committee for the American Bar Association’s business section, said that “the only way to encourage consumers to work out their financial problems outside of court is if all the finance companys involved in a case consent to a repayment plan … But if one finance company decides they want a larger share on a monthly basis, which is quite possible, then it is not going to happen.”

There were some specific changes in the new legislation that help finance companys with recoveries. The new laws try to limit repeat bankruptcies by tightening up the timeline for proving that a second bankruptcy will succeed. Under the Chapter 7 provision, debtors are no longer able to retain secured property (such as automobiles) without reaffirmation by continuing payments. Where previous retained accounts go will depends on the debtor’s equity position in the collateral. If positive or near positive, then they will most likely reaffirm; if negative, they most likely will surrender. Chapter 7 debtors cannot receive a discharge if a prior discharge was received within eight years (rather than six) of the new filing. The debtor must file a Statement of Intent within 30 days of filing bankruptcy or the stay lifts. The stay is terminated after 30 days if there is a filing within 1 year after a prior case was dismissed or if the debtor does not perform stated intent within 30 days after the 341 meeting. If two or more cases were dismissed during the prior year, then the automatic stay does not go into effect at all. This all leads to faster liquidation of the collateral for the finance company, depreciation savings for a minimum of two and a half months and savings in litigation expenses.

Under the Chapter 13 provision no “cram-downs” will be allowed on motor vehicles used for personal use purchased within 910 days of the bankruptcy filing (approximately two and a half years). Experts estimate this will eliminate “cram-downs” on 65 percent of the previously cram-downed accounts, although it will increase the number of vehicles that are surrendered. Confirmation hearings must take place no longer than 45 days after the 341 meeting date. Chapter 13 plans must provide for payment of allowed secured claims in equal installments, as least sufficient to provide adequate protection. This will have a positive impact on charge offs and delinquencies due to earlier resolution. Traditionally, two-thirds of Chapter 13 bankruptcies fail.

Will more people be discouraged from filing bankruptcy, thinking it is not an option? Will more people continue to file Chapter 13 instead of Chapter 7? If and when will Chapter 7 filings ever return to previous levels? Will more people choose alternatives to bankruptcy? With so many uncontrollable economic factors, it is just too soon to tell. Early numbers show that the number of bankruptcy filings is slowly on the rise, and it appears that the lull will be short lived.
 
Vol 3, Issue 10
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