Chapter 7 Bankruptcy Since 2005 Bankruptcy Reform Law Change

On October 17, 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) went into effect. This legislation was the biggest reform to the bankruptcy laws since 1978. The legislation was enacted after years of lobbying efforts by banks and lending institutions and was intended to prevent perceived abuses of the bankruptcy laws.

The changes to Chapter 7 were extensive.

[edit] Means Testing

The most noteworthy change occurred within 11 U.S.C. § 707(b). Congress amended this section of the Bankruptcy Code to provide for dismissal (or conversion) of a Chapter 7 case upon a finding of “abuse” by an individual debtor (or married couple) with “primarily consumer debt.” Old §707(b) provided for dismissal of a chapter 7 case upon a finding of “substantial abuse.”

New §707(b) defines “abuse” in two ways. “Abuse” can be found when there is an unrebutted “presumption of abuse” arising under a newly created “means test,” [§707(b)(2)]. The second way to find “abuse” is through general grounds, including bad faith, determined under a totality of the circumstances [§707(b)(3)].

To determine whether a presumption of abuse arises under the means test under §707(b)(2), it is necessary to look at the debtor’s income compared with the median income in the debtor’s state. Income for purposes of this bankruptcy code section is defined as “current monthly income.” “Current monthly income” is defined in 11 U.S.C. § 101(10A) as a monthly average of all the income received by the debtor (and the debtor’s spouse in a joint case) including regular contributions to household expenses made by other persons, but excluding Social Security benefits and certain victim’s payments during a defined six-month time period prior to the filing of the bankruptcy case. Note that this average income may or may not be the debtor’s actual income at the time of filing. This has led some commentators to refer to the bankruptcy code’s “current monthly income” as “presumed income.”

The applicable median income will vary by family size. Generally, the larger the family, the greater the state’s median income and the more money the debtor must earn before a presumption of abuse arises.[1]

This code section then requires a comparison between the debtor’s “current monthly income” and the median income for the debtor’s state. If the debtor’s income exceeds the median income, then the debtor must apply a “means test” designed to objectively determine the extent of a debtor’s ability to repay unsecured creditors. The “means test” requires the debtor to take the “current monthly income” and reduce it by a list of allowed deductions. Note that just as the “current monthly income” defined in the bankruptcy code is not necessarily “current,” “monthly,” or “income”, these deductions are not necessarily the actual expenses the debtor incurs on a monthly basis. Similarly, some commentators have referred to these deductions as “presumed expenses.” The deductions applicable in the “means test” are defined in §707(b)(2)(A)(ii)-(iv) and include: 1) living expenses specified under the ‘’collection standards of the Internal Revenue Service,’’ (2) actual expenses not provided by the Internal Revenue Standards including “reasonably necessary health insurance, disability insurance, and health savings account expenses,” (3) expenses for protection from family violence, (4) continued contributions to care of nondependent family members, (5) actual expenses of administering a chapter 13 plan, (6) expenses for grade and high school, up to $1,500 annually per minor child provided that the expenses are reasonable and necessary, (7) additional home energy costs in addition to those laid out in the IRS guidelines that are reasonable and necessary, (8) 1/60th of all secured debt that will become due in the five years after the filing of the bankruptcy case, (9) 1/60th of all priority debt, and (10) continued contributions to tax-exempt charities.[2]

After the debtor’s “current monthly income” is reduced by the allowed deductions as described in the previous paragraph, it can be determined whether there will be a “presumption of abuse.” The “presumption of abuse” will arise if: (1) the debtor has at least $166.67 in current monthly income available after the allowed deductions (this equals $10,000 over five years) regardless of the amount of debt, or (2) the debtor has at least $100 of such income ($6,000 over five years) and this sum would be enough to pay general unsecured creditors more than 25% over five years. For example, if a debtor had exactly $100 of “current monthly income” left after deductions and owed less than $24,000 in general unsecured debt, then the presumption of abuse would arise, [§707(b)(2)(A)(i)].

Of course, presumptions could be rebutted and §707(b)(2)(B) requires the debtor swear to and document “special circumstances” that would decrease income or increase expenses such that the debtor’s remaining “current monthly income” would fall below the above two presumption of abuse trigger points discussed in the prior paragraph.

Even in cases where there is no presumption of abuse because the debtor’s “current monthly income” was below the median, or because the application of the “means test” did not trigger the presumption, it is still possible for a Chapter 7 case to be dismissed or converted. Only a judge or the United States Trustee (or bankruptcy administrator) can seek dismissal or conversion of the debtor’s case if the debtor’s “current monthly income” is below the median. Any party in interest can seek dismissal or conversion if the debtor’s “current monthly income” is above the median, even if no presumption of abuse was triggered. The grounds for dismissal under §707(b)(3) are “bad faith” or when “the totality of the circumstances (including whether the debtor seeks to reject a personal services contract and the financial need for such rejection as sought by the debtor) of the debtor’s financial situation demonstrates abuse.”

Longer waiting period between filings: Another change that resulted from the BAPCPA was an extension of the time between multiple bankruptcy filings. §727(a)(8) was amended to provide that the debtor would be denied a discharge if a debtor had received a discharge in a prior Chapter 7 case filed within eight (8) years of the filing of the present case. Prior to BAPCPA, the rule was six (6) years between chapter 7 filings. BAPCPA did not change the rule for the waiting period if the debtor filed a chapter 13 previously.

Credit counseling and debtor education requirements: Another major change to the law enacted by BAPCPA deals with eligibility. §109(h) provides that a debtor will no longer be eligible to file under either chapter 7 or chapter 13 unless within 180 days prior to filing the debtor received an “individual or group briefing” from a nonprofit budget and credit counseling agency approved by the United States trustee or bankruptcy administrator.

The new legislation also requires that all individual debtors in either chapter 7 or chapter 13 complete an “instructional course concerning personal financial management.” If a chapter 7 debtor does not complete the course, this constitutes grounds for denial of discharge pursuant to new §727(a)(11). The financial management program is experimental and the effectiveness of the program is to be studied for 18 months. Theoretically, if the educational courses prove to be ineffective, the requirement may disappear.

Applicability of Automatic Stay: The automatic stay in bankruptcy is the court order that requires all collection proceedings to stop. There are exceptions, of course, but generally this is the term for the “relief” from collection proceedings a debtor receives by filing the bankruptcy with the bankruptcy clerk’s office. BAPCPA limited the protections the stay provides in some re-filed cases. New §362(c)(3) provides that if the debtor files a chapter 7, 11 or 13 case within one year of the dismissal of an earlier case, the automatic stay in the present case terminates 30 days after the filing, unless the debtor or some other party in interest files a motion and demonstrates that the present case was filed in good faith with respect to the creditor, or creditors, being stayed. If the present case is a third filing within one (1) year, the automatic stay does not go into effect at all, unless the debtor or any other party in interest files a motion to impose the stay that demonstrates that the third filing is in good faith with respect to the creditor, or creditors, being stayed.

The provision presumes that the repeat filings are not in good faith and requires the party seeking to impose the stay (usually the debtor) to rebut the presumption by clear and convincing evidence.

There are exceptions. Notably, §362(i) provides that the presumption that the repeat filing was not in good faith would not arise in a “subsequent” case if a debtor’s prior case was dismissed “due to the creation of a debt repayment plan.”

BAPCPA also limited the applicability of the automatic stay in eviction proceedings. The stay does not stop an eviction proceeding if the landlord has already obtained a judgment of possession prior to the bankruptcy case being filed, §362(b)(22). The stay also would not apply in a situation where the eviction is based on “endangerment” of the rented property or “illegal use of controlled substances” on the property, §362(b)(23). In either situation the landlord must file with the court and serve on the debtor a certificate of non-applicability of the stay spelling out the facts giving rise to one of the exceptions. There is a process for the debtor to contest the assertions in the landlord’s certificate or if state law gives the debtor an additional right to cure the default even after an order for possession is entered, §362(l) & (m).