Enacted by Congress in an effort to address perceived shortcomings in the bankruptcy system, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) went into effect October 17, 2005, and has dramatically changed the landscape of bankruptcy in America. Bankruptcy attempts to balance the need for an honest and insolvent debtor to obtain a fresh start, with the need for creditors to be repaid in whole or part. While the same three most common and basic options for bankruptcy filings still exist–Chapter 7 Liquidation, Chapter 13 Wage Earner Repayment Plan, and Chapter 11 Business Reorganization–there are significant changes under BAPCPA in terms of means testing, information disclosure, and educational requirements for credit and debt counseling, and new limitations on the automatic stay and discharge. These items alone barely scratch the surface of the changes! This past summer, I participated in a panel discussion on Tax Talk Today, summarized in this article, in which IRS officials and tax professionals reviewed the impact of BAPCPA with specific focus on the tax practitioner community.
Bankruptcy Filing Options Remain Unchanged
Even with BAPCPA in place, the same three basic options remain available to individuals filing for bankruptcy. All three allow the debtor the protection of the automatic stay and the opportunity to receive a discharge of debt–to start fresh:
Chapter 7 Liquidation: A trustee is appointed to gather all the non-exempt assets of the debtor, convert them to cash, and distribute that cash to creditors based upon the priorities set forth in the bankruptcy code. In a Chapter 7, there is no guarantee that any particular type of creditor will be paid anything; it depends on the funds available. Usually there are no non-exempt assets to liquidate and it is called a “no-asset” case. Debt discharge will usually occur within a few months after the case is filed.
Chapter 13 Wage-Earner Repayment Plan: Under Chapter 13, the debtor has no fear of a trustee seizing and selling his property. Instead, the debtor proposes a monthly payment to the trustee to repay some limited portion of the debt. The repayment plan in a Chapter 13 bankruptcy will last anywhere from three to five years, and a discharge will normally only occur after the conclusion of that period, upon completion of the agreed upon repayment. With BAPCPA, however, Congress eliminated the so-called “super discharge” which allowed certain tax and other debts to be discharged and was often a prime motivation for filing a Chapter 13 instead of Chapter 7.
Chapter 11 Reorganization: This option is normally used for businesses, but individuals can also file a Chapter 11–particularly more affluent self-employed persons. A complex and expensive repayment plan, called the “plan of reorganization,” classifies debt into different categories, and proposes how those debts will be treated. If enough classes and creditors vote in favor of the plan, its terms become the new binding contract, essentially replacing all prior legal obligations.
Automatic Stay and Discharge: Two of the most important concepts in any bankruptcy filing are the automatic stay and the discharge, which are preserved, but modified, under BAPCPA. The automatic stay, which occurs when the bankruptcy petition is filed, halts essentially all efforts to collect against the debtor or his property, giving the debtor breathing room. Garnishment ceases, foreclosure is halted, repossession is stopped, and no judgments are obtained. There remain a number of exceptions to the automatic stay, however, including the government’s ability to conduct civil audits and criminal investigations.
Historically, an insolvent debtor might be released or “discharged” from debtor’s prison upon compliance with legal conditions. With the abolition of debtor’s prisons and workhouses, the more merciful “discharge” came to refer more generally to the release of the debtor from liability for the debt. The discharge, granted upon completion of the bankruptcy proceedings, eliminates personal liability for most debt, and provides a fresh start for the debtor. Again, there are significant exceptions, including the sometimes harsh reality that taxes are generally not discharged by bankruptcy. BAPCPA now makes a debtor wait longer before being entitled to a second discharge, for example, eight years before a second Chapter 7 discharge.
The discharge must not be confused with the dismissal, which creates a very different ending for the debtor. A dismissal effectively erases and annuls the protective purposes of bankruptcy filing altogether, allowing creditors to pick up where they left off in terms of collection activities. In addition, a dismissal now becomes a much more serious strike against the debtor in any future bankruptcy proceedings, and may reduce or eliminate some of the available protections to the debtor in future filings.
The Impact of A “Creditor-Friendly” Law:
New Requirements for Debtors
By addressing the perceived weaknesses of the bankruptcy process, BAPCPA has clearly made it more difficult, not to mention more expensive, for any debtor to receive bankruptcy protection. Many think that the legislation has improved the creditor’s chances of receiving payment from the debtor.
“It’s a pretty creditor-friendly law,” said Tommy Mathews, director in the IRS’s Office of Advisory, Insolvency & Quality, during the panel discussion. For example, creditors holding favored priority claims for alimony and child support or claims secured by recently purchased (21?,,2 years) automobiles are especially protected under BAPCPA.
Some of the new bankruptcy requirements imposed by BAPCPA include:
Means testing. Does your debtor have the “means” (or ability) to repay you? If so, perhaps he won’t get the easy Chapter 7 discharge under BAPCPA. In practice, means testing is factually and mathematically complicated. In simple terms, it creates an environment in which the trustee or a creditor can force a Chapter 7 debtor to dismiss or convert to a Chapter 13–meaning the debtor then must pay at least part of the debt. But this test is far from simple. Means testing considers the monthly income of the debtor household compared to the state median income level. If the debtor’s income exceeds the median, the monthly income is then reduced for secured and priority expenses plus certain allowed expenses. If, after these calculations, the remaining balance is greater than $100 per month, a presumption arises that the debtor filed in “bad faith” and will be required to convert to a Chapter 13 and repay part of her debt through the bankruptcy process, or the case will be dismissed.
Disclosure. Drastically expanded disclosure requirements represent another aspect of BAPCPA’s impact on bankruptcy filings. The new law requires that much more information be given to a potential debtor before he can file. Attorneys and others are defined under BAPCPA as “Debt Relief Agencies” (DRA) and must provide extensive disclosure, verbatim and in writing, as set forth in the statute. Only after the disclosure documents have been read and signed can the DRA attorney begin the process of counseling the potential debtor client. After that, the process continues with the usual collection of financial information, although there is also a greater requirement for verification and due diligence on the part of the attorney, with the potential for personal liability. Furthermore, the new rules also prohibit a DRA from advising a client to incur more debt, even though it may be both legal and advisable.
Serial filings. BAPCPA also addresses the individual who files multiple bankruptcies. To combat serial filings, the law now mandates that any debtor filing a Chapter 7, 11, or 13 case within one year of the dismissal of a prior case receives a limited automatic stay, which expires automatically after 30 days. The bankruptcy court can elect to continue the automatic stay beyond that period, but only if the debtor demonstrates that the second filing was done in good faith. The automatic stay may not even go into effect with certain serial filings.
“The problem is, Congress has created certain presumptions of bad faith,” said Edward J. Laubach, Jr., a senior attorney in the IRS’s Office of Chief Counsel, during the panel discussion. “The debtor has to rebut those presumptions by clear and convincing evidence, which is a tough standard indeed.”