Bankruptcy and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

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Table of Contents

Introduction
Bankruptcy Abuse Prevention and Consumer Protection Act
The Law and Businesses
Positive Effects
Negative Effects
Bibliography

Introduction

The term bankruptcy probably comes from the Italian words banco, rotta meaning broken bench (Bays, 1922). The first law in 1542 was passed in England to help the creditors have some means of getting back their money from debtors. The U.S. Congress passed the first American bankruptcy law by one vote in 1800. It was similar to the English law except that the debtor could not be killed if found guilty. This law was repealed after 3 years. The Bankruptcy Act of 1898 was the first Modern American Bankruptcy Law. This law permitted both creditors and debtors to file cases. The next major change occurred as the Bankruptcy reform Act in 1978 (Stuhl, 2003) This law existed as such till the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Bankruptcy Abuse Prevention and Consumer Protection Act

The new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005(BAPCPA), S 256, was signed into law by President Bush on April 20^th 2005. It is the first major overhaul of the law for bankruptcy for the past 25 years. All bankruptcy cases filed on or after October 17^th are done so using this new Act. The intent of this legislation was to improve bankruptcy law and practice with a dominant theme of restoring personal responsibility and integrity in the bankruptcy system.

The stated purpose of the amendments to the Bankruptcy Code (“the Code”) enacted in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”)’ is to “improve bankruptcy law and practice by restoring personal responsibility and integrity in the bankruptcy system and ensure that the system is fair for both debtors and creditors.”

The Bankruptcy Legislation is bound to be accepted by the judiciary as laws providing economic regulations have never been found unconstitutional. There will be no constitutional challenge on its face. However such challenges are possible if a debtor or lawyer or other party is affected by a statutory provision.

The law has nothing much for consumer bankruptcy. Provisions for small business, corporations and farmers along with important provisions for securities, financial contracts, cross border cases, privacy, taxes, health care and employee benefits and consumer credit disclosures. The defeat of the controversial Schumer Amendment led to the bankruptcy reform. Several other amendments including homestead exemption for the elderly, exemption from means testing for veterans and debtors in bankruptcy caused by medical expenses and identity theft were also defeated in Congress. However accommodations have been made for active duty military personnel, low income veterans and seriously ill people.

Increasing serial filings and abuses in the system are to be eliminated through this new law. New responsibilities have been placed on those administering consumer bankruptcy and those who counsel debtors to get relief.

Debtors have to undergo a means test and credit counseling to decide whether to permit them to choose Chapter 7 relief (Liquidations). The means test aims at reducing the number of debtors who can pay but used to escape through the Chapter 7 filing previously and cunningly wipe the slate clean¹¹. If there is no abuse found, the debtor is permitted to file under Chapter 7. A debtor having an income of less than $100 per month for 5 years or not more than $166.67 is eligible. In the latter instance if the debtor is able to repay 25% of her debt, she loses her eligibility.

Credit counseling requirement is compulsory for all debtors except those debtors who are ‘incapacitated, disabled or on active duty in a military zone’.

Businesses and individuals have the same process in filing under Chapter 7. The court appoints a trustee who would represent the creditors. The debtor submits all his non exempt assets to the trustee at his first interview. The trustee monitors the debtor and identifies as early as possible about whether the debtor has a viable plan 66 and whether there is any cause for abuse.

. The trustee has powers to protect the creditors. They can request that payments to favored vendors be returned to the assets. They can also stop fraudulent transfers of assets just to show reduced assets. Inheritances becoming established within 180 days of filing could also be taken over to add to the assets. Debtors are allowed to keep only exempt assets which vary from state to state but generally include the home, car, tools and specific personal property.

Prior to the passing of the BAPCPA, there was a doubt whether a ride-through or 4^th option existed for Chapter 7 filers. II U.S.C. §521 (2) (A) (20() 0). The words ‘if applicable’ could be allowing this 4^th option. So this doubt continues with the new law. Close scrutiny of the provision would however, show that § 521 (a) (6) does not eliminate the ride-through in nearly all cases. This section only applies to allowed claims. If the courts were to use § 362{h), § 521{a) {6), and § 521 (d) that previous courts have used, the ride through is still possible. The ride-through could be court-protected or outside the court. Only if the debtor does not make his regular payments will the court know. In a back door ride through, a creditor acquiescence with the debtor can lead to an agreement outside of the courts. The property in question could then remain with the debtor without being confiscated as long as the debtor makes his regular payments.

Faltering businesses can file bankruptcy cases under Chapter 7 or 11 (Reorganizations). Businesses which can still be corrected are protected by this chapter. A viable recovery plan and a modified payment schedule could lead the business to recovery. This forms the basis of thought for Chapter 11. With the filing of a case, the creditors are stopped from collecting payments. The business is allowed 120 days to recover after which the creditor steps in with his plan. The bankruptcy judge is the authority to approve the plan. No trustee is appointed. If there is no hope of saving, the judge can convert it to a Chapter 7.

Consumers are protected to a certain limit. Collection activities for certain items have been exempted from the automatic stay period. These include ‘income withholding under a court order, suspension of their driver’s license, reporting undue support to credit bureaus, interception of tax funds and medical obligations. Paternity support, custody, visitation and domestic violence are also not stayed.

The new law is understood to be moving bankruptcy debtors into the Chapter 13 which presumably is favorable for the creditors who could recover more money.

A debtor in Chapter 13 finds it more difficult to adjust as the regular payments have to be made come what may. Whatever unanticipated expenses arise after that in his daily life, he has to forgo paying. Chapter 13 has a large failure rate. 85% of people fail to make it according to a bankruptcy attorney Bankruptcy filings has gone down by two-thirds and proponents of the act consider this a good sign. Some abusive filings have disappeared.

Chapter 13 repayment plans are given a longer duration. Distressed individuals with heavy debts are allowed to create a court-supervised five-year repayment plan. The previous law allowed a period of 3 to 5 years while the new makes 5 years mandatory.

Chapter 11 and 13 are more creditor friendly than Chapter 7. These two chapters help troubled debtors to develop more realistic plans for payment, become financially stable and repay their debt.

Debtors with cases under Chapter 7 or 13 need to undergo a financial management course before the discharge of the case. New debtors are to produce certain certificates for the process.

Chapter 20 bankruptcy has been eliminated in the new law.

The Law and Businesses

Old rules had no limitations of time for proposing a Chapter 11 bankruptcy case and any number of extensions was permitted. Section 1121(e) says that the exclusivity period according to the new law has been expanded to 180 days rather than the 120days for all other cases(86).

However the absolute deadline is merely 300 days,down from the 18 months. The new law puts a finish to small business cases very fast. However there is a drawback. Section 1121 (e) does not specify the consequences of failure to meet the 300 day deadline whereas Section 1112 has mentioned the consequences which are dismissal or conversion.

The proposed disclosure form has 26 pages. However the Section 1125(f) which governs the approval process does not insist on a standard form disclosure statement. This is one more example of careless drafting.

The old rules permitted a business debtor to pay his key employees retention bonuses or severance payments or other payments which may not be ethical. The new rules say that such payments can be made only if the situation requires holding back employees who have obtained bona fide job offers elsewhere.

A ‘small business debtor’ is a sole proprietor of any business or commercial activity who files for bankruptcy. This definition has some exclusions. Single estate real estate is excluded from small business. There is surprisingly another definition for ‘small business case’ All small business cases in Chapter 11 will have a small business debtor but all small business debtors in Chapters 7, 12 and 13 will not be small business cases. Section 308 has a broad reach and would include all small business debtors from many chapters. This allows creditors to insist on debtors complying with this law. Hassles could arise due to large numbers of section 308 reports adding to the existing problems of the new law. In a case Lamie v. United States Trustee where the Supreme Court had to decide what the Congress meant by deleting the words debtor’s attorney from the list of professional persons in section 330 who could be paid from the bankruptcy estate. It was purportedly a drafting error but the Court upheld it and claimed that the language was clear. The Section 308 expects small business debtors to file frequent financial reports but there is no special sanction for failure to file the reports. Maybe it is expected that he same sanctions that apply to filing reports in courts apply to this section too. Section 308 will come into effect only on February 1^st, 2009, sixty days after rules are prescribed for the forms to be used⁴². Hopefully the Government may initiate a Technical Corrections Bill and include section 308 before it comes into effect.

A new version of Rule 1020 has been released by the Advisory committee of the FRBP (Federal Rules of the Bankruptcy Procedure). It is to solicit public comment 45. A rule and an official form have been proposed. If no objections arise from any quarters, it will come into effect from December 1^st 2008. In this rule, the debtor states that he is a small business debtor and considered as such till a court order says it is incorrect. Anyone who wishes to object to the debtor’s declaration may do so within 30 days of the creditors’ meeting. The automatic stay is not permitted to a debtor who has a pending small business case or if he had a case dismissed in the last 2 years or if his case was confirmed in the previous 2 years. For a serially filing debtor, the stay will remain if his dismissed case was an involuntary bankrupt case 51 or if the debtor can prove that he filed a second case due to a situation that he did not expect at the first filing, also claiming that a plan for relief is expected.

Section 1116 imposes duties on a debtor in possession. This is a duplication as Chapter 11 already imposes maximum duties. More disclosures are required in this section.This is really a hindrance to small business debtors who are trying to reorganize their business. Extra opportunity cost is unwelcome at this crucial stage. 16 new grounds have been added for dismissal or conversion of a Chapter 11 case. Among these are the unexcused failure to submit disclosures and inability to abide by the trustee’s directions to provide information or attend meetings. Small businesses have the maximum disclosure requirements and so have more exit points too from the Chapter 11 process. In the Inre Franmar, Inc. case, the debtor filed a case against a creditor who was taking action against him. Having selected the ‘small business’ for filing the case, he inevitably had to produce more new reporting documents. Unfortunately his accountant was too busy with tax returns.

The debtor failed to comply with the trustee’s request and did not attach balance sheet, statement of operations, cash flow statement, or federal income tax return as now required by section 1116. He sought more time for getting the documents. The trustee thought fit to proceed to dismiss the Case. The Court rejected his case. They argued that Section 1116 does not include that failure to submit required documents is a mandatory ground for dismissal whereas Section 521 clearly says this.

Positive Effects

A small business debtor is actually helped by the new law. The procedure for a debtor seeking to reorganize is streamlined. “A qualifying “small business” debtor generally is one whose aggregate noncontingent liquidated debts do not exceed $2 million.” (Goldberg and Tufaga, 2005). Revised Section 1125(f) makes it easier and less expensive for small business debtors. Adequate information would be provided to the creditors to help the reorganization.

The debtor may use standard disclosure forms approved by the court or adopted under 28 U.S.C. § 2075. He may accept the plan prior to final approval provided the court has approved the disclosure statement and there is a period of 25 days to the confirmation hearing.

The new law helps to put small business representation on creditors committees in larger cases. Revised Section 1102(a) (4) allows the trustee, ordered by the court, to increase the size of the committee to include the small business if necessary. The current 10-day look back period has been increased to 45 days in the Bankruptcy code by revised Section 546.

Revised Section 365(d) (4) is beneficial to commercial real estate lessors in that the debtor has to make a decision within 120 days of the filing of the case. An extension of 90 days is possible by the Code but further extension has to be approved by the landlord in writing. A quicker decision would favor the lessors.

Section 547 (c) (2) has provisions which allow the trustee to recover certain payments made by the debtor to creditors within 90 days before filing the case. Under the current section, the creditor is bound to prove both that the transfers “were made in the ordinary course of business or financial affairs of the debtor and creditor (the so-called “subjective” test) and that the transfers were made according to ordinary business terms (the “objective” test)”. Costly expert testimony has to be arranged by him to prove the second part. The revised Section 547 (c) (2) allows him to do either one (Goldberg and Tufaga, 2005).

Previous laws allowed debtors to be let off by filing Chapter 7. Debtors who are knee-deep in debt would now find it hard to escape penalty or secure relief (Clark, 2005 Pg.51).

The incapacitated, the disabled and those on military duty are exempted from the credit counseling.

The ride-through option, though controversial in that some courts of law do not accept it, used to be a saving factor for debtors who wish to keep a property like a house or car from the assets disclosed and would not want it confiscated. The new law is assumed to allow this too.

Utility services were not paid after a business files for bankruptcy by the old rules. Pg 59 Clark. The utility services were just given adequate reassurance that the bills would be paid. However in the new law, the utility services have a greater chance of getting paid even after the bankruptcy case had been filed. Adequate assurance is translated as cash deposits and letters of credits or a document signed by both the business establishment and the utility services. This must be expected by all businesses about to file for bankruptcy.

Negative Effects

The access to Chapter 7 has been restricted. However one disadvantage forecast is that people who have been hurt unfairly like victims of the calamities Katrina and Rita may now have difficulty in securing relief (Clark, 2005). The usual bankruptcy cases are those filed under Chapters 7, 11 and 13. Previously debtors discharged most debts under Chapter 7 of liquidations and were free to start newly. Now they have to undergo a means test and credit counseling to decide whether to permit them to choose Chapter 7 relief. Many debtors would then have the option of selecting Chapter 13 which does not free them from debt. They have to repay. Chapters 11 and 13 have not been changed in the new law.

A new requirement is that attorneys have to verify that debtor’s statements are correct. Attorneys who are to see to the means testing are considering the proposition a penalty. They are to advertise themselves as debt relief agencies (79) by a new definition to Code § 101. New Code §§ 526, 527 and 528 ‘proscribe and prescribe a number of activities of some bankruptcy lawyers’, especially for those who represent individual debtors in consumer cases filed under chapter 7 and chapter 13. In Millavetz v. United States, the district court was of the opinion that ‘the restrictions on attorney advertising unconstitutionally restrict attorneys’ commercial speech, in violation of the First Amendment New Code § 526 imposes restrictions on the kind of advice that a “debt relief agency” may provide. Code § 526(a)(4) does not allow a debt relief agency ‘from advising an assisted person (and a “prospective assisted person” as well) to incur additional debt in contemplation of filing for bankruptcy relief or for the purpose of paying fees for services rendered by an attorney or petition preparer’. A debt relief agency is not allowed to advise clients to incur more debt in order to think about filing a bankruptcy case or for paying the attorney’s fees. The option of erring is open to the attorneys and they may convert their clients to Chapter 13. They would struggle in a problem of weighing their interests against those of their clients. This has led to many attorneys ceasing to represent such clients or raise their fees as an alternative. The attorneys have the extra job of generating more notices on the procedures and keeping records safely. Further the paperwork that they need to get done for the debtors has actually made filing for bankruptcy more confusing and harder on the lawyers and clients alike. (Seidenberg, 2007). Inexperienced attorneys have been scared off by Pub. L. No. 109-08, 119 Stat. 23. It has been described as having a steep learning curve. Even experienced practitioners of bankruptcy are withdrawing from the field. Incase any mistakes occur in the filing, heavy penalties are the result.

Chapter 7 filing was permitted every 6 years by the old law but now 8 years intervals only are allowed. Debtors who utilize the bankruptcy laws to frequently settle their shortfalls are disappointed. More non-dischargeable debts have been included in the new law. Loans of students from private and government sources, last minute debts incurred just before filing for bankruptcy, credit purchases of $500 or more for luxury items within 90 days of filing and loans of more than $750 taken within 70 days of filing are all non-dischargeable.

Tenants could not be evicted once they file bankruptcy cases in court previously. However now they can be evicted if they do not comply with the rental agreement if the landlord obtains a judgment of eviction before the tenant files for bankruptcy. The landlord can evict without the judgment of eviction: if the property is endangered or if drug activities have taken place there within 30 days of filing the bankruptcy case.

The absolute deadline for exclusivity for filing cases of bankruptcy in Chapter 11 cannot extend beyond 18 months from the date of bankruptcy filing. Previously any number of extensions was allowed. The new law has inconvenienced small businesses as this essential period is of utmost importance to reorganize the business.

Bibliography

Bays, Alfred, (1922), Chapter 1, American Commercial Law Series, Published by Callaghan.

Stuhl A.Seh, (2003), “Brief History of Bankruptcy Law”, Vault Guide to Bankruptcy Law Careers. Web.

CCH Bankruptcy Reform Act Briefing, Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, CCH Incorporated, Pgs. 1-8.

Bufford, Samuel L. and Chemerinsky, Erwin; “Constitutional Problems in the 2005 bankruptcy Amendments”, American Bankruptcy Law Journal, Vol. 82, 2008, Pgs 1-76.

Lawless, Robert M.; “Small Business and the 2005 Bankruptcy Law: Should Mom and Apple Pie be worried?” Southern Illinois University Law Journal, Vol 31, 2007. Pgs 585-619.

Clark, S. Lawrence et al, (2005), “Bankruptcy Reform Is Here”, Journal of Accountancy, Pgs. 51-59.

Hogan, Christopher M., (2008), “Will the ride-through ride again?”, Columbia Law Review, Vol 108, Pgs 882-928.

Siedenberg, Steve; (2007), “The 2005 Bankruptcy Act”, ABA Journal, Vol 93, Pgs 49-54, Chicago, American Bar Association.

Goldberg, Thomas D. and Tufaga, Mary Weil; (2005), “How the new bankruptcy law will affect small businesses”, Connecticut Business and Industry Association, Vol 83, No. 6.

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