United States: President Signs Bankruptcy Reform Act

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, signed by President Bush on April 20, contains the most sweeping changes to the Bankruptcy Code since the Amendments of 1994. While the new law (referred to as the "Amendments" of 2005) primarily addresses consumer bankruptcy issues, it also makes a number of revisions that affect commercial creditors.

Changes were made throughout the Code to hold debtors more accountable. One of the most significant is a means test for individuals seeking to use chapter 7 to discharge debt. The Amendments also address "serial filings" by individuals, limiting the number of times bankruptcy relief may be invoked within a specified period and limiting the applicability of automatic stays in multiple filings.

Under the Amendments, debtors with incomes that exceed the median income of their domicile state must overcome a presumption of bad faith to file under chapter 7. Otherwise, their cases are converted to chapter 13.

The new law also addresses assumption and rejection of leases by individuals. In a chapter 7 case, an individual debtor may assume a lease of personalty if written notification is given to the lessor and the lease is assumed within 30 days of notification. The lessor may condition assumption on curing arrearages, and the automatic stay is not violated by negotiation of a cure.

In a chapter 11 or 13 individual action, if the debtor or trustee has not assumed or rejected a lease by the time the plan is confirmed, it is deemed rejected and the automatic stay is terminated.

Congress added several benefits to holders of secured claims in chapter 13 filings. These include:

• Lien stripping is disallowed in purchase money security interest transactions in which the collateral is a motor vehicle and the debt was incurred within 910 days of the petition date.

• Pre-petition arrearage on accounts of mortgage and auto loans can be cured over 60 months.

• Within 30 days of the earlier of the petition date or the plan filing, a debtor must commence making plan payments, post-petition lease payments and adequate protection payments to holders of purchase money security interests.

• Within 60 days of the petition date, the debtor must provide lessors and holders of claims secured by personalty with proof of insurance.

The Amendments also contain new responsibilities for creditors. They require added disclosures by those holding debts which are to be reaffirmed under a chapter 13 plan, and new requirements govern the content of reaffirmation agreements.

In addition to the provisions covering secured claims, other changes to chapter 13 include:

• If the family’s income is greater than the state median income for a similar size family, the plan length is five years; if less, it’s three years.

• Discharge is disallowed if a debtor received a discharge in a chapter 7, 11 or 12 case within four years prior to filing the instant petition, or if the debtor received a discharge from a chapter 13 case filed within two years of the current filing.

• Discharge is delayed if an action is pending in which the debtor may be found guilty of a felony or liable for the violation of securities laws, an intentional tort, or willful or reckless misconduct causing serious bodily injury or death.

Key changes also were made to preference action rules. The Amendments clarify the ordinary course defense—allowing creditors sued for preferences to raise the defense that an alleged preferential transfer was made in the ordinary course of its dealings with the debtor, or made according to business terms customary in the industry. Previously a defendant had to prove both.

There no longer is preference liability for amounts paid that are less than $5,000, protecting creditors from preference actions that cost more to fight than to pay.

If a lien is perfected within 30 days of giving value (rather than the current 10 days), transfer is perfected and not subject to preference avoidance. Preference risk is eliminated for non-insider creditors who make pre-petition transfers for the benefit of a creditor and insider between 90 days and a year prior to the petition date.

The look-back period for fraudulent transfers has been extended from one to two years. In addition, transfers to self-settled asset protection trust are avoidable if the transfer was made within 10 years of the petition date, if the debtor is a beneficiary under the trust, and the transfer was made with intent to hinder, delay or defraud creditors.

The Amendments made a number of changes affecting business and individual chapter 11 filings:

• The debtor’s exclusive right to file a plan may not be extended to a period beyond 18 months after the petition date.

• The Committee must provide nonmember creditors with access to information and must solicit comment from such creditors.

• Various changes have been made to the rules governing small business debtors, defined as businesses with noncontingent, liquidated debts, both secured and unsecured, of (not including debts to insiders or affiliates) $2 million or less.

The new law also revises chapter 11 provisions affecting reclamation, tax claims, disclosure statements, case dismissal/conversion, and insider payments made to induce insiders to remain with the debtor’s business.

The Amendments create a new chapter 15 of the Code (replacing section 304), implementing the Model Law on Cross-Border Insolvency. The provisions are designed to replace the need for courts in the United States and other countries to issue join protocols to address cross-border issues.

In addition, the law addresses exceptions to automatic stays granted to nondebtor parties of financial contracts, expanding the types of capital markets products covered.

One area not addressed by the law is bankruptcy venue reform. Despite widespread support from the legal community, Congress declined to include a provision that would have required corporate debtors to file for bankruptcy in their principle places of business or where their principle assets are located.

This article is presented for informational purposes only and is not intended to constitute legal advice.