Bankruptcy Reform - BAPCPA Legal Changes

The Bankruptcy Reform and Consumer Protection Act of 2005 ("BAPCPA) became fully effective for all cases filed after October 17, 2005.  Bankruptcy reform laws have made drastic changes to the bankruptcy system for individuals, but made very few changes to laws relating to business reorganizations filed by corporations, partnerships and other business entities.  However, although the bankruptcy process is now much more difficult, complicated and document intensive, relief is still available and beneficial for over 90 percent of people that were able to file under the prior law.  In most cases, only people whose debts are "primarily consumer debt" and who earn very high incomes will be ex­cluded from filing.

1. Means Testing.

1.1  Dismissal for Abuse.  Under the both old and new law, the court could dismiss a bankruptcy case if the person that filed for bankruptcy is guilty of "abuse" of the bank­ruptcy process.  The main the factor in determining whether a person is guilty of abuse was and still is whether he can afford to repay at least some of the debt that he seeks to discharge in bankruptcy.

1.2  Determining Abuse Under the Old Law.  Under the old law, the bankruptcy court would look at a debtor’s budget to determine whether he could afford to repay some of the debt.  The court would review whether the debtor's income was calculated accurately, and whether his expenses were reasonable and necessary. There were no specific rules to determine whether a specific expense was reasonable or necessary, or how much could be spent on any particular expense item.  The judge had a large amount of discretion in determining what was reasonable or necessary, and how much could be spent on any particular item.  If the budget showed that the debtor could afford to repay a significant portion of the debt, the case would be deemed abusive. The court would then normally give the debtor an opportunity to convert the case to Chapter 13 and propose a repayment plan, or dismiss the case if the debtor refused to convert.

1.3  Determining Abuse Under the New Law (the "Means Test").  The new law adds a complex and arbitrary “means test” to the prior abuse analysis.  Under current law, the bankruptcy court has much less discretion to determine whether a debtor's income is too high, whether the claimed expenses are reasonable, or whether a debtor can afford to repay a portion of the debt.  Under the "means test" the income and debt amounts which make a case abusive are set forth in the statute.  Many of the permis­sible expense amounts are determined by IRS guide­lines, not by the judge's opinion.  Persons that fail the means test are not permitted to file under Chapter 7 unless they can establish special circumstances that make their case exceptional.  They must file under Chapter 13 and propose a court supervised plan to repay some or all of the debt.

The means test requirement will limit the availability of Chapter 7 bankruptcy relief for some high income earners. However, do not be discouraged.  With good legal counsel, in approximately 90 percent of the cases, even high income persons will be able to successfully obtain a Chapter 7 discharge.  Strangely, in some Chapter 13 cases, the means test actually helps some debtors and will allow them to pay less in a payment plan than they would be required to pay under the old law.

1.4  Business Cases - The Means Test Does Not Apply.  There is no doubt that bankruptcy law favors business cases over consumer cases.  A court can not dismiss a business bankruptcy case under the abuse standards that apply to consumer cases.

Business cases are the biggest exception to the new means testing  requirements.  Means testing only applies if the debts are “primarily consumer debts."  The "means test" does not apply to cases where a person incurs most of the debt in connection with the operation of a business.  Business bankruptcy cases are completely exempt from the means testing requirements.

A debt is a "consumer debt" if it is incurred primarily for a personal, family, or house­hold purposes.  An analysis of whether the debts are "primarily" consumer debts is made by looking at both the total amount of debt and the relative number of creditors.  In the Fifth Circuit, there is case authority which suggests that the case may be considered a business case if either:

(a) the total amount of business debt exceeds the total amount of consumer debt; or

(b) the total number of business creditors exceeds the total number of con­sumer creditors.

Note, however, most Courts and the U.S. Trustee will probably argue that the case can not be considered a business case unless the total amount of business debt exceeds the total amount of consumer debt, regardless of the relative number of business and con­sumer creditors.

You must consider both the debts you intend to avoid and the debts you intend to keep. Most home mortgages and vehicle loans are consumer debts. You must consider the total payoff amount of all home mortgages and vehicle loans when determining wheth­er the debts are primarily business or consumer debts.

1.5  Income Level - Above or Below Median Income?  The threshold question in de­ter­mining whether a debtor will pass or fail the "means test" is whether the person has earned more or less than the median income for a family of the same size.

(a) Definition of "Current Monthly Income." “Current monthly income” is defined as the average monthly income received from all sources during the 6-month period before the case is filed. The six month sample period ends on the last day of the calendar month immediately before the case is filed.

Strangely, the definition of current income may not reflect current income at all. If the debtor worked for five months before filing for bankruptcy but is completely un­employed on the date he files for bankruptcy, his current income monthly income must be calculated as an average of the prior six months.

(b) Below Median Income - Automatically Pass.  Persons that earn less than me­dian income will automatically pass the means test and will qualify for both Chap­ter 7 and 13.  The rules for determining abuse will be the same as the old, pre-reform rules.  Persons below the median income line will still need to show that they can not afford to repay a significant portion of the debt, but they will be judged under the old, pre-reform standards.  Persons that fall below the median income line will not be subject to further means testing under the new rules.

There are some bankruptcy reform requirements that apply to persons that earn less than median income.  Such individuals will be required to obtain credit counseling before the case is filed, and must complete a financial management course (similar to a driver education course) after the case is filed. They will also be required to provide more backup documentation, including pay check stubs and tax returns.  However, these requirements will not affect whether the person will qualify to file for bankruptcy.

(c) Above Median Income  - Full Means Testing Required.  Since the passage of bankruptcy reform, many credit card companies and debt collectors have been pro­moting the myth that bankruptcy has been eliminated as an option.  These scare tactics are being employed to discourage debtors from seeking legal advice.  Even some media sources including personal finance expert "Suze Orman" have in­correctly reported that Chapter 7 bankruptcy has been completely eliminated for persons that earn more than the median income.  These reports are completely false.

The truth is that persons that earn more than median income will be subject to full bankruptcy means testing.  The process will be more complicated.  The legal cost will be higher for persons above the median income line.  However, with proper legal counseling, most persons that fall above the median income line will still qual­ify for both Chapter 7 and 13 bankruptcy.  Good legal counseling and planning is now absolutely crucial.

1.6  Full Means Testing Process

(a) IRS Collection Financial Standards. The main feature of full means testing is that a debtor's expenses are determined in accordance with the expenses specified in the IRS Collection Financial Standards. For some expenses, the amount the debtor actually spends is irrelevant. The maximum amounts specified in the IRS standards will determine the permissible expense deductions for food, clothing, per­sonal care, housing, utilities, and transportation costs.

(b)  Means Testing Forms.  You must prepare, with the help of an attorney, a fair­ly complex form listing your income and certain expenses incurred during the six months before you anticipate filing for bankruptcy. The full means testing process is very similar to a tax return.  To prepare a tax return, you must list certain income and permitted deductions incurred over the prior calendar year. To prepare the re­quired "means testing" form, you must list certain income and expenses incurred during the six calendar months prior to the bankruptcy filing.

Most people will not be able to prepare the required means testing form without the aid of an attorney. To properly prepare the form, you will also need to calculate your exact income and the exact amount spent on certain expenses during the six month time period before the anticipated bankruptcy filing.  You will also need to be able to obtain the median income and expense data from proper sources.

(c) Factors Affecting the Outcome of the Means Test.   As specified above, the IRS Collection Standards will set the limit of the permissible deductions for some expenses such as food, clothing, personal care, utilities, and transportation costs.  However, the means testing process permits you to "deduct" the full amount of some additional expenses listed below.  Tax advisors minimize the taxes paid by their clients by providing proper tax counseling and planning.  Similarly, proper bank­ruptcy counseling can also help a high income debtor pass the means test.  The following are some of the additional permitted expenses, and their effect on a per­sons ability to pass the means test:

(1) Large Monthly Mortgage Payments. You are permitted to deduct the full value of your mortgage payments. High income earners with high mortgage debt are more likely to qualify to file under Chapter 7. High income earners that either rent, have low mortgage payments, or no mortgage payments are less likely to qualify.

(2) Large Car Payments. You are permitted to deduct the full value of your car payments, up to a maximum of two vehicles per household.  High income earn­ers with high car payments are more likely to qualify to file under Chapter 7.  High income earners that either rent their vehicles, have low car payments, or no car payments at all, are much less likely to qualify.

(3) Non-Dischargeable Taxes and Support Payments.  A portion of any  debts owed for unpaid taxes or support obligations may be deducted. Therefore, high income earners that owe large amounts of non-dischargeable tax debts or support payments are more likely to qualify to file under Chapter 7. High income earners that either have little or no debt for unpaid taxes or support obligations are less likely to qualify.

(4) Court Ordered Payments. Court ordered payments for support, the re­pay­ment of criminal restitution obligations, or other obligations are fully de­duct­ible. High income earners that have large monthly court ordered obligations for sup­port or criminal restitution are more likely to qualify to file under Chapter 7. High income earners that have little or no court ordered obligation to pay support or criminal restitution are less likely to qualify.

(5) Miscellaneous Ongoing Expenses. The following listed expenses are fully deductible for purposes of means testing. High income earners that have large amounts of the following listed expenses are more likely to qualify to file under Chapter 7. High income earners that have little or no expenses in these cate­gories are less likely to qualify.

(d) Pass or Fail.  After all income and expense deductions are entered, the pass or fail result is determined by the amount of  monthly disposable income available to pay creditors and the total amount of unsecured debt owed by the debtor.

The table below shows the pass / fail results.  The result is always "pass" if monthly disposable income is $109 or less. The result is always a "fail" if disposable income is $183 or more. For monthly disposable incomes between $110 and $182, the pass / fail result varies for depending the amount of total unsecured debt.   A larger amount of total unsecured debt is required to pass the means test as the monthly disposable income amount increases. 

Means Test Result	Monthly Disposable Income	Total Amount of Unsecured Debt
Fail	$183 or more	Irrelevant
Pass	$182	$43,641 or more
Fail	$182	$43,640 or less
Pass	$181	$43,401 or more
Fail	$181	$43,400 or less
Pass	$180	$43161
Fail	$180	$43,160
Pass	$112	$26,841 or more
Fail	$112	$26,840 or less
Pass	$111	$26,601 or more
Fail	$111	$26,600 or less
Pass	$110	$26,361 or more
Fail	$110	$26,360 or less
Pass	$109 or less	Irrelevant

(e) Special Circumstances.  Even if you initially fail the means test, you can over­come it by proof of "special circumstances."  A case involving special circum­stances requires proof that the debtor's income will remain depressed for the foreseeable future, or that the debtor's situation requires that he spend an extraor­dinarily high amount on expenses.  To establish special circumstances, the debtor must:

(1) prove circumstances that justify additional expenses or a lower income level for which there is "no reasonable alternative;"

(2)  documentation for the expense or adjustment to income;

(3) a detailed explanation of the special circumstances the that make such ex­penses or adjustment to income necessary and reasonable.

2. Credit Counseling. Individuals are not ineligible for relief under any chapter of the bankruptcy code unless they obtain “an individual or group briefing” from an approved nonprofit credit counseling agency before the case if filed.

(a) Agencies Must Be Approved. The credit counseling agency must be approved by the United States trustee. Go to the U.S. Trustee website for a list of the approved credit counseling agencies.

(b) 6 Months Before Case if Filed. The counseling session must occur within 180 days (6 months) before they file for bankruptcy. A counseling session more than 6 months before the case does not count as a valid session.

(c) Certificate Required. The Debtor must obtain a certificate which proves that the counseling session took place. The certificate must be filed with the bankruptcy pe­tition.

(d) Method (in Person, Telephone or Internet). The required briefing may take place in person, by telephone or on the internet. Currently, most approved agencies provide the briefings in person and by telephone. Although most of the approved agencies advertise the ability to complete the session on the internet, none of them will complete the session only via internet. The internet component usually involves filing out some of the Required information on the internet, and then completing the session on the telephone with a counselor.

(e) Fee. The law states that the agency must provide the counseling session without regard to the debtor’s ability to pay a fee. However, there are no published standards to determine the income level at which a person can be said to have an ability to pay. Most approved agencies charge a fee between $16 and $60 for the session.

(f) Exceptions. There are very limited exceptions to the credit counseling requirement. The only exceptions are for:

(1) Adequate Counseling Not Available. Districts in which adequate counseling services are determined by the U.S. trustee or bankruptcy administrator not to be available. This exception does not apply to case filed in the Southern District of Texas.

(2) Incapacity, Disability or Military Duty. Debtors who are incapacitated, disabled, or on active military duty in a combat zone. A person is considered “incapacitated” only if he has a mental illness or mental deficiency such that he is incapable of realizing and making rational decisions with respect to his financial responsibilities. A "disability" means that the debtor is so physically impaired as to be unable, after reasonable effort, to participate in an in person, telephone, or in­ternet briefing.

(3) Exigent Circumstances. The exception relied upon most is for situations involving exigent circumstances. Exigent circumstances means that the debtor was required to immediately file the case without completing the counseling session. To qualify, the debtor must:

(a) file a written certification which the court;

(b) describe exigent circumstances that merit a waiver of the counseling re­quirement;

(c) state that the debtor requested credit counseling from an approved agency before the case was filed;

(d) state that the counseling was unable to obtain the services during the 5-day period beginning on the date on which the debtor made that request.

The court cases that have interpreted this exception have been very strict in enforcing it. A debtor will almost never be able to come to a lawyer within the last few days before a foreclosure sale and file a case without completing the credit counseling session. To qualify, the debtor will always need to at least seek credit counseling at least one day before the case is filed. The debtor will never be able to excuse a failure to at least try to obtain credit counseling before filing the case by obtaining counseling on the day after (or even one minute after) the case is filed. The court simply has no discretion to allow the debtor to obtain the counseling after the case is filed if he did not even try to obtain the counseling services before the case was filed.

In most cases, the debtor will need to seek counseling at least a full 5 days before the case is filed unless the counselor indicates that they can provide the counseling session for a full 5 days (a very rare possibility).

As a result of these difficulties, a debtor that comes to a lawyer within 5 days before a foreclosure sale will almost always need to complete the counseling before the case is filed. The exigent circumstances exception will almost never help.

3. Financial Education. A debtor will not obtain a discharge unless he completes and approved course in personal financial management.

(a) Approved Provider Required. The course ca be taken only by an course pro­vider that has been approved by the U.S. Trustee of the district in which the course is held. Most of the approved credit counseling agencies have also been approved to provide the financial management course. In Chapter 13 cases, many of the Chapter 13 trustees have also bee approved to give the financial management course. Go to the U.S. Trustee website for a list of the approved course providers.

(b) Method (in Person, Telephone or Internet). The course can be take place in person, by telephone or on the internet. As with the approved credit counseling agen­cies, most of the approved course providers advertise the ability to complete the session on the internet.

(c) Fees. The only standard for fee is that they must be “reasonable” and the course be provided without regard to the debtor’s ability to pay any fee charged for the course. Currently, the fees charged by approved providers for the Southern District of Texas range between $10 and $50.

(d) Timing of Course. In Chapter 7 cases, the course must be completed within 45 days after the creditors meeting (normally about 3 months after the case is filed). In Chapter 13 cases, the debtor must complete the course prior to making the last pay­ment due under the Chapter 13 plan (between 3 and 5 years after the case is filed).

4. Extended Time Between Discharges. The time period which must pass before a person may receive a bankruptcy discharge in consecutive bankruptcy cases has been lengthened, depending upon the Chapter in which the current and previous cases were filed.  The table below specifies the legal time periods which must pass between cases under both the old and new law: