Bankruptcy Reform Act

If you need to file bankruptcy, in most cases, you can still file bankruptcy. The Bankruptcy Reform Act makes it more difficult and expensive, but most people can file. Since the new laws are very complex, it is more important than ever to talk with a qualified local bankruptcy attorney [The National Association of Consumer Bankruptcy Attorneys lists local members on its website]. Unless you do not own real estate and have very few assets we suggest you have an experienced bankruptcy attorney file for you.

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Compact Guide to the Bankruptcy Reform Act”

LAST UPDATED IN 2006 - use only as an INTRODUCTION to the law


1. Credit Counseling BEFORE you can file you MUST receive an individual or group “briefing” (in person, by telephone, or on the internet) from a credit counseling agency APPROVED by the Bankruptcy Court (click here for list - we recommend HBCCE and MMI). The briefing outlines the opportunities for credit counseling AND assists you in performing a budget analysis.

Credit Counseling Agencies can solve financial problems and help individuals avoid bankruptcy. Some people can reach compromises and pay their debts, either with the help of a counselor or on their own. However in a great number of situations they do not offer enough help. In general, Credit Counseling Agencies that belong to the NFCC (never choose a counselor that is not a NFCC member) are both ethical and dedicated, that fact does not alleviate the financial pressures they work under. NFCC members receive about 70% of their funding from Creditor fair share contributions, essentially a 7% to 15% commission on the payments made through voluntary repayment plans. You need to consider that the close ties to the creditors who fund NFCC create an incentive to advise against filing bankruptcy, even when it is in your best interest to get a “fresh start”.

After you file you MUST complete a Financial Management Course intended to help Debtors identify and correct the financial mistakes that led to bankruptcy.

2. Help Filing – Bankruptcy Petition Preparers (non-attorneys) and Debt Relief Agencies (attorneys) will be closely regulated and must give you a detailed contract stating what they will do and how much they will charge. The new laws are complex (especially the Means Test), so if you need to file bankruptcy you should hire an experienced, QUALIFIED, bankruptcy attorney. Regrettably, there is much more work involved in filing a petition under the Reform Act, so attorney fees will be higher than they were under the previous Act.

3. Prohibited Advice – The Act prohibits an attorney from advising you to incur more debt in contemplation of filing bankruptcy. This means that your attorney cannot, for example, tell you to sell a high mileage gas guzzling SUV, pay off the loan, and use the proceeds for a down payment on a reasonable family car which you could continue to pay for after filing bankruptcy. You will have to read books about debt consolidation (e.g. - “Slash Your Debt” by Gerri Detweiler, “How to Be More Credit Card and Debt Smart” by Scott Bilker) and bankruptcy to get that important advice. You should NOT incur any additional debt that you do not intend to pay in full, however it is both ethical and in the best interest of both you and your creditors for you to reduce total debt, even if doing so involves obligating yourself to pay a new debt. Be sure you can make all future payments before giving your house as security for any loan.

4. Multiple Filings – The length of time after a Ch 7 case that you must wait before filing another Ch 7 case has been increased to 8 years.

You may not receive a discharge in a Ch 13 case for 4 years if you received a discharge in a case filed under chapters 7, 11, or 12 during the past 4-years, or for 2 years if you received a discharge in a case filed under chapter 13 during the past 2-years. This does not mean that you cannot file a Chapter 13 case, but it does affect what you can accomplish in a second case.

5. Domicile & Homestead - You are limited in the assets you can protect from creditors by - investing them in a house within about 3 years of filing ($125,000); by spending non-exempt assets on improvements to your residence within 10 years of filing with the intent to keep creditors from taking them; or by moving to a state with better exemptions within 730 days of filing. With one exception, there is an absolute cap of $125,000 on the homestead exemption if you are found to have engaged in bankruptcy abuse and certain criminal acts, intentional torts, and willful or reckless misconduct.

6. Notice to Creditors – You need to keep the bills you receive from creditors and collection agencies because notice may not be effective (the automatic stay may not protect you from collection efforts and in some cases the debt might not be covered by bankruptcy) if you do not use the address and account number provided by the creditor on the latest bills.

7. Automatic Stay – If you file a second or third case within 1 to 2 years after a prior case was dismissed or pending – the automatic stay (the provision that stops creditors from continuing to collect from you) may AUTOMATICALLY END or MAY NOT go into effect at all. If you filed a previous case within 2 years it is possible that the current case will NOT STOP A FORECLOSURE SALE or other collection activity.

Even if you have not filed before, if a landlord obtains an eviction order that allows them to take possession of your apartment, filing a bankruptcy petition MAY NOT STOP the landlord from having you EVICTED IMMEDIATELY.

Filing bankruptcy DOES NOT STOP, or even slow down, any collection activity regarding child support or alimony; dissolution of a marriage (except the property settlement part); domestic violence proceeding; suspension of license; jail term for contempt; etc.

8. Means Testing in Ch 7 Cases – A “means test” will determine if you can file a Chapter 7 case. If you have more income than the test allows, or if the Court finds that you are abusing the system based on the totality of the circumstances of your financial situation or because you filed a petition in “bad faith”, then your case will be DISMISSED, unless you agree to pay a portion of your debts under a Chapter 13 reorganization plan. (Note that some attorneys believe that if you pass the Means Test your case cannot be dismissed or converted for abuse.)

There are two objective tests applied to income and expenses to determine if your case will be dismissed or converted based on a presumption of abuse:

Median Income Test - The First test is to see if your Current Monthly Income (CMI) is MORE than the State Median Income. In reality CMI is not Current, not Monthly, and not Income - rather it is an amount based on your gross income during the six month before the month you file in, calculated using a complicated form, that has nothing to do with your actual income on the date of filing. “Median Income” means that there are an equal number of people in your state with incomes that are higher and an equal number that are lower than the median income amount. Basically this test looks to see if your family is better off than half of all the other families around you.

Means Test – If you fail the median income test - the Second test checks to see if your Current Monthly Income (CMI) reduced by IRS and other allowed monthly expenses for a family of the same size, exceeds a certain amount. The Means Test is essentially an excess income test that determines if what is left over out of your monthly income after deducting reasonable expenses leaves enough money to be able to give a meaningful dividend to your unsecured creditors.

If your Current Monthly Income is LESS than the State Median Income, there is NO presumption of abuse.

If your Current Monthly Income is MORE than the State Median Income, but your excess income is LESS than the amount allowed under the Means Test, there is NO presumption of abuse.

If your Current Monthly Income is MORE than the State Median Income, AND your excess income is MORE than the amount allowed under the Means Test, A PRESUMPTION OF ABUSE EXISTS.

If the presumption of abuse exists, and there are no special circumstances to rebut the presumption, you will have to repay a portion of your debts through a Chapter 13 plan, or have your case dismissed.

The actual test is so complex we strongly suggest that if your family income is more than the Median Income for your state, you go to a qualified bankruptcy attorney to find out if you can or cannot file a Chapter 7 case.

9. Household Goods – Liens on household goods securing loans that were NOT used to purchase the items CAN be avoided (you can keep the household goods without paying the creditor the value of each item) on clothing; furniture; appliances; 1 radio; 1 television; 1 VCR; linens; china; crockery; kitchenware; educational materials and equipment for minor dependents; medical equipment and supplies; furniture for children and elderly or disabled dependents; personal effects (including toys and hobby equipment of dependent children and wedding rings) of the debtor and the dependents of the debtor; and 1 personal computer and related equipment, AND CANNOT be avoided on other household goods and furnishing, including most works of art; most electronic entertainment equipment; antiques with aggregate fair market value of more than $500; jewelry with an aggregate fair market value of more than $500 (except wedding rings); and a computer, motor vehicle, boat, or a motorized recreational device, conveyance, vehicle, watercraft, or aircraft.' Which means that if you file a Chapter 7 bankruptcy you may have to pay a creditor to keep some items, or surrender them. If you file a Chapter 13 case, to keep some items you may have to pay a reduced amount to a creditors through the plan.

10. Reaffirm, Redeem, or Ride-Through – You MUST reaffirm or redeem a loan that is secured by property within 45 days of the meeting of creditors, or the creditor may repossess the property under state law (it is still possible that they won’t bother to repossess low value items). You may keep property by paying a creditor in a Chapter 13 case, or you may keep property in a Chapter 7 case by paying the Creditor the current value (i.e. – by redeeming it). You must work out an agreement to assume a lease within 30 days, or the lease may terminate.

11. Disposable Income in Ch 13 Cases  - The projected disposable income that you must pay to Creditors under a Ch 13 reorganization plan is determined using almost the same complex formula that is used in the Means Test. In some cases the amount to be repaid on credit card and other unsecured debt will be close to zero. Some experts believe that if you have substantial income above the minimum payment amount determined by the disposable income test, you will be required to pay that extra income to your creditors. Other experts disagree and believe that you can keep any income over the required payment amount. Some jurisdictions base the amount you must pay on your current income and expenses, and not on the income test. If your income meets or exceeds the mean’s test, then the commitment period for a Chapter 13 Plan must be 5 years, instead of 3 years, unless the plan pays all claims in full over a shorter term. 

12. Adequate Protection – While it is difficult to predict, it would seem that if your Creditors actively seek “adequate protection”, you will be required to make slightly higher payments to the Chapter 13 Trustee, than under previous law, to keep the balance owed to each secured creditor less than the depreciating value of their security. While this may have been a general requirement in the past, under the Act it is given new emphasis that the Court and Trustees will need to address.

 Example referred to below -
AMOUNT STILL OWED ON CAR:                                                             $10,000
Less NADA BLUE BOOK VALUE OF CAR:                                             -$5,000
UNSECURED PORTION OF DEBT:                                                           $5,000

The car dealer gets at least the $5000 Secured portion of debt since you gave them the right to sell the car and keep the proceeds if you defaulted on the loan.                          

If your Chapter 13 Plan proposes to pay 20% of UnSecured Debts,
the Car dealer ALSO gets: 20% of $5,000
20% of UNSECURED PORTION OF DEBT:                                              $1,000

In summary, the car dealer gets the:
     SECURED PORTION OF DEBT:                                                            $5,000
 Plus 20 % OF THE UNSECURED PORTION:                                           $1,000
                           FOR A TOTAL OF:                                                              $6,000 + interest


13. Lien Retention and Effect of Conversion – As shown in the example above - you can propose to pay a creditor the value of the property securing a loan, and NOT the balance due on the loan (there is a new exception we will discuss below). The problem is that if you pay the entire $5,000 secured portion of the claim, AND then convert from Ch 13 to Ch 7, you DO NOT GET TO KEEP THE CAR UNLESS YOU PAY WHAT YOU WOULD HAVE PAID IF YOU HAD NOT FILED. The amount owed on the secured claim would jump to what it would have been UNDER NONBANKRUPTCY LAW and the car would continue to be security for the debt! So you would have to pay another $5,000 plus interest to keep the car, or surrender it to the creditor (which most people would do), or redeem it by paying the then current value.

Remember, ,his penalty applies only when a case is converted to Ch 7.
IF YOU COMPLETE THE CH 13 CASE you get to keep the $10,000 car for $6,000 plus interest, and when the case is closed the creditor will release the lien. Nonetheless, not being able to convert to Chapter 7 will create a hardship on people with chronic illnesses who need to convert to discharge medical bills incurred during the 3 to 5 years a Chapter 13 plan is in effect.

There is another new provision – You MUST pay the secured and unsecured portions (the principal) of a claim IN FULL if you purchase or lease a car for personal use within 910-days before filing, OR buy anything on credit within 1 year of filing. The number of payments and the interest rate can be changed (e.g.- if you owe 20 monthly payments of $400, you can stretch the payments out so that you might have 40 payments of $200 to make through the plan).

14. Luxury Goods & Cash Advances - Consumer debts incurred within 90 days before filing, totaling more than $500, and owed to a single creditor for “luxury goods or services”, along with cash advances from a single creditor totaling more than $750 obtained within 70 days, are presumed [rebutable] to be nondischargeable (i.e. – they must be paid in full).

15. No More Ch 13 “Superdischarge – A Chapter 13 discharge DOES NOT discharge claims resulting from:

1. unfilled, late-filed within two years of the petition date, and fraudulent tax returns (willful tax evasion);

2. liability for “trust fund” taxes, income taxes for 3 pre-petition tax years; and certain other taxes and duties.

3. credit extended under false pretenses or representations or actual fraud other than a financial statement;

4. credit extended under a written financial statement that the Debtor made with intent to deceive that was materially false and reasonably relied on by the creditor;

5. debts that were neither properly listed nor scheduled in the petition to permit timely filing of a proof of claim (and in the case of claims regarding luxury goods, fraud by a fiduciary, and willful injury, sufficient time to challenge dischargeability), unless the creditor had notice or actual knowledge of the case so as to permit a timely filed proof of claim;

6. fraud by a fiduciary, embezzlement, or larceny;

7. a domestic support obligation;

8. educational loans (as expanded by the Act - absent undue hardship);

9. death or personal injury caused by unlawfully operating a motor vehicle, vessel, or aircraft under the influence of intoxicants;

10. criminal restitution or a fine included in a sentence on the debtor's conviction of a crime; and

11. civil restitution or damages as a result of willful or [Ch 7 “and”] malicious acts resulting in personal injury or death of an individual;

A Chapter 13 case DOES discharge three types of debt that cannot be discharged in a Chapter 7 case, claims resulting from:

1. property settlements in a divorce [not support obligations];

2. willful and malicious injury to property; and

3. debts incurred to pay non-dischargeable tax obligations.

Note that if you are ordered to pay specific debts (like joint credit card debt) in a divorce proceeding you CANNOT discharge those debts in a Chapter 7 case. You MAY be able to discharge them through a Chapter 13 plan.

16. Tax Returns – For practical purposes - you must file all returns with taxing authorities that you have not filed, provide copies of previous year returns, and, in some cases, provide the last 4 years of returns. Your creditors may review copies under strict privacy rules. If you do not timely file tax returns as required under the Act, AND provide required copies to the Trustee, AND file all required copies with the Bankruptcy Court, your case will be DISMISSED.

17. Student Loans – Unless you prove that repayment of a student loan would create an undue hardship on you and your dependents, which is very difficult to prove absent a severe disability, all student loans are now non-dischargeable, even where the lender is a non-governmental, commercial, entity.

18. Priority for Support Payments –Claims for domestic support obligations are given a First Priority under the Reform Act – to be paid before priority taxes and any unsecured consumer debts.

19. Pension and Profit Sharing Plans - 401K Loans –Deductions for retirement, pension, and profit sharing plans, and for repayment of amounts borrowed from those plans, receive special, favorable, treatment under the Act.

Again, if you think you may need to file bankruptcy, consult a qualified bankruptcy attorney before proceeding. Unless you are certain you can do it right, don’t try to file without the help of an attorney. If you make a mistake you may unnecessarily risk losing your house, car, and money!


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