Originally published Summer 2005
After several years of failed efforts, banks, credit card companies and other advocates for bankruptcy reform got their way. Congress approved the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the BAPCP Act) on April 17, 2005. In many respects, the changes are sweeping and analysts have predicted a run on the bankruptcy courts between now and October 17, 2005, the date most of the BAPCP Act changes go into effect.
For physicians and other professionals faced with ever-increasing malpractice litigation risk and astronomical malpractice premiums, the possibility that any negotiation advantage they may have to settle or minimize claims can be thwarted by bankruptcy reform is unsettling. There is reason for their concerns. The top 10 jury awards for 2002 totaled more than $31 billion; three of the awards came from malpractice verdicts.
The most noted changes affect Chapter 7 of the Bankruptcy Code, which enables individuals and companies in debt to obtain a complete discharge of their obligations. The changes also affect Chapter 13 of the Bankruptcy Code, under which individuals in debt can pay off their obligations over time. The BAPCP Act provides that under certain circumstances, an individual cannot use Chapter 7 to discharge his or her debts if the individual’s projected five-year income, after certain expenses and a modest living allowance, will produce a "surplus" that can be used to repay the individual’s creditors. Chapter 13 workout plans now must include a five-year payout requirement utilizing a similarly calculated surplus to reduce the individual’s debts and obligations.
Another noteworthy change is the power given to bankruptcy judges to set aside earlier transactions. Under prior law, certain transfers made within one year of a bankruptcy filing could be set aside. The new law increases the look-back period to two years. It also adds a specific provision aimed at compensation paid to business insiders, like corporate officers or professionals who own a medical or law practice. The bankruptcy court can now reach compensation paid within two years prior to its bankruptcy filing. The new act also adds special 10-year look back periods to certain transfers related to residential real estate.
The Bankruptcy Code historically has offered debtors the ability to protect at least some of their assets when in bankruptcy through various exemptions. For example, Florida’s unlimited homestead exemption has received notoriety because it encouraged debtors to move to Florida before filing bankruptcy so that they could maximize their exempt assets, thereby protecting more of their assets from creditors.
Under prior law, such exemptions were available after an individual had resided in the state for 180 days or more. Under the new law, debtors must wait two years to obtain these protections. Another provision in the BAPCP Act severely restricts the value of residential real estate that can be exempted under state law. The new cap is $125,000, and it applies to any interest acquired in a residence within three years prior to filing for bankruptcy.
Despite these and other 2005 changes in the Bankruptcy Code, not all is gloomy for individuals concerned about protecting their assets in today’s litigious society.
First, the provisions allowing judges to dismiss Chapter 7 filings only apply to consumer debts. Liabilities arising out of underinsured malpractice claims, or automobile accidents are not consumer obligations, and thus can still be discharged under Chapter 7. Furthermore, a professional who has filed bankruptcy cannot be forced to work out his or her debts over a five-year period under Chapter 13.
Thus, despite the changes wrought by the BAPCP Act, professionals will continue to have the ability to negotiate settlements or be discharged from catastrophic uninsured obligations; but, because of the two- and the ten-year look-back provisions, and the residential cap, last minute planning clearly will not work. Like exercise and sound health maintenance efforts, asset protection strategies will have to become a way of life. Protection strategies should be integrated into the financial planning activities of a professional at as early a date as possible.
The BAPCP Act also brought some important and expanded protection for professionals. Under the prior law, retirement plans covering only owner-employees and their spouses are not protected by ERISA. The new law adds special sections exempting IRAs and retirement plan benefits for all debtors. There is no limitation on the amount that can be accumulated in retirement funds, with one exception. Amounts accumulated in IRAs – other than from rollovers from qualified plans, SEPS or simplified retirement plans – are limited to $1 million and earnings thereon.
For many professionals, retirement plan accumulations have always been a major source of their wealth. The addition of a special exception for retirement funds should encourage professionals to carefully consider this asset and maximize its potential. From our experience, however, sufficient advice is not always provided when professionals make retirement plan decisions.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has changed the rules and focus of asset protection planning. But, as with all changes in our laws, for those willing to plan and work within the framework provided, successful asset accumulation and protection strategies can be achieved.
* This article is based upon a comprehensive study of asset protection strategies available to professionals: Richard O. Jacobs and Tye J. Klooster, Asset Protection for Florida Professionals, Strategies to Pursue and Strategies to Avoid, www.hklaw.com/publications.