Chapter 7 Filings Rise Before Law Takes Effect
Lashea Flint was standing in line at a Los Angeles courthouse last week, doing something she had never imagined she would do -- filing for bankruptcy.
A divorce had strained her finances to the breaking point, she said. She would have preferred to work out her problems on her own, but with new bankruptcy rules taking effect Oct. 17, she decided her best option was to file for Chapter 7 liquidation now -- while she was certain she still could.
“My cousin’s an attorney, and she told me that if I file before Oct. 17, they’d accept it,” said Flint, 27, as she waited to file papers at the U.S. Bankruptcy Court downtown. “I might as well discharge it all and start a new life while I’m still young.”
With the new rules on the horizon, stories like Flint’s can be found in bankruptcy courts around the country.
“Every good debtor’s lawyer is advising anyone who comes in their office -- anyone who calls on the phone -- that if they are going to file bankruptcy, they ought to file before Oct. 17,” said J. Scott Bovitz, a Los Angeles bankruptcy attorney. “It would be malpractice not to mention to a debtor about the upcoming dates and amendments.”
The numbers bear that out. In the three months ended June 30, filings under Chapter 7 of the U.S. Bankruptcy Code were up 18% nationwide from the first three months of the year.
Most commonly filed by individuals, Chapter 7 liquidation petitions are also known as “fresh start” bankruptcies because they allow people to clear away all debt.
The Bankruptcy Abuse Prevention and Consumer Protection Act, signed by President Bush in April, will affect all bankruptcies, including the Chapter 11 reorganization bankruptcies filed by businesses. But the measure largely took aim at Chapter 7 filings. It was pushed by creditors who said too many people with the means to pay their debts were taking the easy way out with Chapter 7 filings.
Under current law, judges have great discretion in deciding whether to allow an individual to pursue a Chapter 7 bankruptcy. Under the new rules, however, judges will have a set of guidelines, including a “means test,” to help make that determination.
As a result, more people are expected to be forced to file under Chapter 13 of the Bankruptcy Code, requiring them to make at least partial payments on their debts.
In addition, individual debtors will have to fill out more paperwork and go through counseling and credit education programs before filing -- and before emerging from -- bankruptcy. Although some experts believe the counseling might prove helpful, the additional paperwork and requirements are sure to boost the cost of filing, attorneys contend.
“The duties of a bankruptcy lawyer have increased dramatically,” Bovitz said. “Firms that don’t have a nonlawyer filling out the financial statements would have to charge $1,000 just for that. The poorest of the poor will not be able to afford the fees.”
Yet what some lawyers say is the most onerous provision of the law is the means test, which is imposed on anyone whose income exceeds the median income in their state.
The formula for the means test requires debtors to average their monthly income over the previous six months and compare that monthly income with the monthly spending allowed under Internal Revenue Service collection standards, which vary by geographic region.
There are exceptions, but generally, if there appears to be more than $100 a month in discretionary income after doing that calculation, debtors will be forced into payment plans.
John Ventura, a Houston attorney and bankruptcy specialist, said the IRS list of standard expenses was in many cases too low for what people actually spend.
“If you are paying $800 a month for housing but the guideline says you should only be paying $600, the $200 difference is money they consider available to pay on debt,” he said.
That’s almost certain to cause an increasing number of debtors to fail to meet the provisions of payment plans, lawyers contend. If they do, their bankruptcy filings will be dismissed, but their debts won’t be discharged, leaving them in much the same position as before the bankruptcy filing.
“There are definitely people who will not be able to receive bankruptcy relief and who will go off the radar,” Bovitz said.
Creditors say the new rules will prevent fraudulent filings, which they say boost everyone’s cost of credit by an average of about $400 a year.
Bankruptcy lawyers acknowledge that some filers could pay their debts and are abusing the process but maintain that it’s a relatively small portion of the population.
“I see about 200 [bankruptcy filings] a year. Most people have overused their credit cards. They didn’t account for the possibility that they might lose their jobs and were unable to ever catch up,” said Bovitz, who represents creditors as well as debtors. “There are about 10% who do not comply with the rules or who are affirmatively dishonest. That’s where I make my living from the creditor’s standpoint.”
Several studies conducted in the last three years tend to back up Bovitz’s assertion. Although the precise number of “abusive” filings varies from study to study, they all estimate the abusive cases at 5% to 20% of the total. The majority of filings are spurred by one of three events -- the loss of a job, a divorce or a major medical problem not covered by insurance, the studies indicate.
“We know that many Americans are living from paycheck to paycheck. But most people manage to squeak by,” said Howard M. Ehrenberg, bankruptcy attorney at SulmeyerKupetz in Los Angeles. “It’s the out-of-control event that tips them into bankruptcy.”
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Limits to a ‘fresh start’
The maximum expenditures for food, housing and other costs allowed under the new bankruptcy law vary based on family size, income and location. Those who exceed that amount may be forced into a payment schedule. Here are the caps for sample households earning $60,000 annually for the following counties.
*--* Single Couple* Family of 4* Los Angeles $2,607 $3,031 $3,860 Orange 2,792 3,216 4,112 Riverside 2,361 2,785 3,527 San Bernardino 2,297 2,721 3,441 Ventura 2,748 3,172 4,052
*Assumes two cars
Source: Internal Revenue Service
Los Angeles Times