United States: Senate Passes Bankruptcy Legislation

On March 10, 2005, the Senate passed a sweeping overhaul of consumer bankruptcy law. Congress has debated passage of amendments to the U.S. Bankruptcy Code, 11 U.S.C. § 101, et seq., for the past eight years. As a response to what the business community and financial industry viewed as a meteoric rise in bankruptcy filings during the last two decades, Congress undertook to produce a sweeping overhaul of the consumer bankruptcy laws. The legislation, first drafted in 1997 and proposed in 1998, appeared to have strong support. This was, in part, the result of a strong lobbying effort by the financial industry. In the meantime, total bankruptcy filings continued to set records across the United States. Filings in Colorado reached an all-time high in 2004.

Bankruptcy reform carried considerable momentum into 1999. The House of Representatives approved a version of the Bankruptcy Reform Act of 1999 and the Senate approved a slightly different version in 2000. After differences in the House and Senate versions were worked out, consideration in the Senate was scheduled under threat of a filibuster. Before a clotured vote could be scheduled, Congress recessed. Even had the bill passed, indications from the White House were that a veto would be forthcoming. The bill has been introduced in each succeeding Congress, only to be stymied by the threat of filibuster or more pressing issues. In recent years, passage was blocked by an amendment directed to the dischargeability of debts arising from abortion protests that was backed by Senate Democrats, but considered unacceptable to the House. With the increase in Republican majorities in the Senate and House, the legislation was given its best chance of passage since it was first introduced. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has now been passed by the Senate and is expected to receive prompt attention in the House of Representatives. If enacted, it is expected that President Bush will sign the bill.

The most significant changes contemplated by the new legislation are designed to curb problems and perceived abuses among consumer bankruptcy filers. The biggest concern has been that debtors with the capability of repaying at least a portion of their debts were making no attempt to do so, opting to file under Chapter 7 instead of Chapter 13. Thus, one of the most important and controversial changes under the proposed legislation will introduce "means testing" to Chapter 7 proceedings. Debtors who earn less than the median income in their state would be entitled to file under Chapter 7 and discharge all of their debts. Those earning more than the median income and who have the ability to repay at least a portion of their debts over five years would be required to file under Chapter 13, which requires a repayment plan. Further, a debtor would be required to consult with an approved consumer credit counseling service prior to filing.

Additional documentation supporting the debtor's statements regarding disposable income will be required, including tax returns, wage statements, and other documents. All debts that the debtor is ordered to pay in a divorce proceeding will be treated as nondischargeable, regardless of hardship. Finally, the period from filing one Chapter 7 case to filing the next will be extended from six years to eight years.

Significant changes are also contemplated for Chapter 13 cases. In the past, it was not uncommon for individuals to purchase and finance new automobiles and then file for bankruptcy within a short period of time. Application of the "lien-stripping" provisions of Chapter 13 gave these debtors the ability to reduce the principal balance of their loan to the current value of the car and restructure the loan under far more lenient terms than originally contracted for. Under the new law, this will be prohibited, along with the cramdown of other undersecured claims if they have been incurred within a year preceding the filing of the bankruptcy. In addition, if the debtor's income exceeds the median income for that particular state, the Chapter 13 plan must provide for payments to be made over a five-year period. Debts formerly dischargeable in Chapter 13, such as income taxes for which no returns were filed or were filed within the preceding two years, will now be deemed nondischargeable.

One of the more controversial aspects of the new bankruptcy legislation involves the Homestead Exemption. In certain states, such as Florida and Texas, the Homestead Exemption is unlimited. Thus, in those states, debtors have the ability to shield the equity in their personal residence regardless of value. Attempts have therefore been made to cap the Homestead Exemption. The House version of the bill would create a maximum Homestead Exemption of $100,000, except for a homestead owned for two years before the bankruptcy and except for the principal residence of a family farmer. The House version would limit the exemption to $125,000, except for the principal residence of a family farmer. In addition, the domiciliary requirement to avail oneself of a state exemption would be increased from 180 days to two years.

Under the current version of the Bankruptcy Code, debtors are entitled to exempt the entire amount contained in their qualified retirement or pension plans. Under the new law, the exemption for retirement accounts would be capped at $1 million.

The bill puts an increasing burden on debtor's counsel. In particular, it provides that the signature of the debtor's attorney on the petition constitutes a certification that "the attorney has no knowledge after an inquiry that the information in the schedules filed with [the] petition is incorrect." In addition, upon a finding that debtor's counsel has violated Rule 9011 of the Rules of Bankruptcy Procedure, which prohibits the filing of frivolous pleadings or actions, the court must award a civil penalty against the attorney. Debtor's counsel is also subject to loss of fees, damages, injunctive remedies, and imposition of costs for any failure to meet new disclosure and record-keeping requirements. It is likely that Rule 9011 of the Rules of Bankruptcy Procedure will be amended to specify that documents filed by debtor's counsel will be subject to "reasonable inquiry" to ensure that the information contained in the document is well grounded in fact and warranted by law.

The new law represents a sea change in the legislative attitude toward consumer bankruptcy filings. Nevertheless, as with most legislation, it is not entirely clear that what Congress has prescribed will necessarily achieve the objective of preventing abuse of the Bankruptcy Code. Depending on which study is to be believed, the new law will change the outcome of between 3% and 15% of total consumer filings. Proponents of the law assume that lenient bankruptcy laws are the cause of increased numbers of filings and losses suffered by the consumer finance industry. While it may make compliance more difficult for filers and their attorneys, it does not address the root cause of an ever-increasing appetite for consumer credit on the part of borrowers and lenders alike.

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