Bankruptcy Filings Drop After Changes in Law

The ranks of people seeking to erase their debts have thinned in the year since the biggest changes in U.S. bankruptcy laws in a quarter-century took effect.

At a public session at the U.S. trustee’s office in Alexandria, Va., on a recent morning, only about half the 50 or so chairs were occupied in a room that used to be jammed with anxious people and their attorneys.

Most were there seeking to file under Chapter 7 of the U.S. Bankruptcy Code, which wipes the debt slate clean after certain assets are forfeited.

After an eight-year campaign by banks, retailers and credit card companies, Congress changed the law to require for the first time an income-based test for measuring a debtor’s ability to repay obligations. The new law took effect Oct. 17, 2005.

Those deemed to have insufficient assets or income can still file a Chapter 7 bankruptcy. But those with income above their state’s median who can pay at least $6,000 over five years are forced into Chapter 13, in which a debt repayment plan is ordered.

In Virginia, where the median annual income is $43,000, more cases are ending up in the latter category.

“It’s designed to make life miserable for anybody who owes money,” said Lawrence Brooke, an attorney in Alexandria. “It’s a help-the-banks, squish-the-little-guy law.”

Brooke is one of several lawyers in northern Virginia who have abandoned consumer bankruptcy work since the new law took effect.

“I won’t have anything to do with it,” he said.

Brooke said the paperwork hurdles for debtors to qualify for Chapter 7 have become insurmountable for many, and the workload and aggravation for attorneys have increased.

The income test for Chapter 7 means more forms for people to give their lawyers -- tax returns and pay stubs -- and more questions from a bankruptcy trustee in the mandatory public sessions that already had probed into details of a person’s mortgage, bills, life insurance, child support obligations and car payments.

“It’s a whole different game now,” said Gordon Peyton, one of the trustees in Alexandria. “It’s much harder to file bankruptcy now.”

There were 263,660 personal bankruptcies filed nationwide in the first half of this year, down from 851,683 in the first six months of 2005 and 809,867 in the same period in 2004, according to the American Bankruptcy Institute, an organization of bankruptcy judges and lawyers.

Chapter 7 filings accounted for 58.8% of this year’s first-half total, down from 75.8% in the first half of 2005. Filings under Chapter 13 debt reorganization jumped to 41.1% from 24.1% a year earlier.

Peyton, who used to preside over three or four of the so-called Section 341 sessions on the Thursdays it was his turn, says he now holds only two. His one-on-one interviews of the people filing, who sit across from him at a table after raising their right hand and being sworn in, can take 12 minutes or more -- compared with an average of 35 seconds or so before the law took effect, he said.

“It’s gotten so tricky. There are a lot of pitfalls,” said Peyton, a private attorney appointed as a bankruptcy trustee.

Bankruptcy lawyers say the required changes have meant more work for them, and they are charging clients more. Fees in some cases in northern Virginia have jumped from $750 or $1,000 to $1,500 or more.

In addition, under the new law people seeking bankruptcy protection are required to take credit counseling courses, for which they must pay. “It really does price a lot of people out of the market,” said Nora Raum, a lawyer in Arlington, Va.

The American Bankers Assn. disputes that, noting that the bankruptcy law allows courts to waive filing and credit counseling fees for low-income debtors.

Proponents of the law say it has created a more balanced system that eliminates abuse and provides debt relief at the level at which people truly need it. They argue that bankruptcy frequently has been the last refuge of gamblers, impulsive shoppers, divorced or separated fathers avoiding child support, and even multimillionaires.

But some experts predict that bankruptcy filings will eventually rebound. There was a huge rush of filings by financially strained consumers between the enactment of the legislation in April last year and the Oct. 17 deadline for the new means test and other requirements. Personal bankruptcies soared 30% to a record high last year, surpassing 2 million for the first time at 2,039,214.

Then came the precipitous drop.

Filings “will come back,” said John Hartgen, spokesman for the American Bankruptcy Institute. After the shakeout period, with the underlying causes of indebtedness, such as job layoffs, still prevailing, equilibrium should return, he said.