BANKRUPTCY REFORM LEGISLATION
The good, the bad and the unknown
By Linda Reid

History of the Current Bankruptcy Reform Legislation
    In June, 1998, the House of Representatives passed what nearly became the most sweeping bankruptcy reform legislation in twenty years. A comparable but slightly less stringent bill was passed by the Senate in September, 1998. The Senate and House versions were reconciled just before Congress adjourned in October, 1998. The House approved the reconciled legislation but the Senate never voted on the final bill and it died on the Senate floor.
    Similar legislation was introduced in 1999. That legislation failed to pass in the fall session of Congress. Nearly identical reform legislation was passed by Congress at the close of the 2000, but was subsequently "pocket vetoed" by former President Clinton.
    Bankruptcy reform legislation was introduced in the 107th Congress on January 31, 2001, in the form of H.R. 333, the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2001," and S.
220, the "Bankruptcy Reform Act of 2001." These bills were essentially identical to each other and to the bill passed last year. The House passed a slightly amended version of its bill on March 1, 2001.
    The Senate Judiciary Committee marked up its bill and reported out a clean bill, S. 420, which was passed on March 5, 2001.
    On July 17, 2001, the Senate voted 82-16 to adopt Senate bankruptcy reform language (S. 420), passed in March, under the bill number of the House-passed H.R. 333. Senate Majority Leader Daschle (D-SD) and Senate Minority Leader Lott (D-Miss.) appointed seven Senate Democrats
and six Senate Republicans as conferees to resolve the differences in the House and Senate versions of the reform bills.
    The Democrats include: Biden (DE), Durbin (IL), Feingold (WI), Kennedy (MA), Kohl (WI) (author of the Senate homestead amendment), Leahy (VT) and Schumer (NY). The Republicans include: Grassley (IA), Sessions (AL), Kyl (AZ), McConnell (KY), DeWine (OH) and Hatch (UT).
    On July 18, 2001, the Senate sent a motion to the House floor to go to conference on bankruptcy reform legislation (H.R. 333). On July 31, House Judiciary Chairman James Sensenbrenner (R-Wis.), who will preside over the House-Senate conference committee, named a total of 12 House Republicans and seven Democrats to join the 13 Senate conferees to reconcile House and Senate versions of bankruptcy reform (H.R. 333) in conference.
    The Republicans named include: Representatives Sensenbrenner, Bachus (R-Ala.), Barr (R-GA), Barton (R-TX), Boehner (R-OH), Castle (R-DE), Chabot (R-OH), Gekas (R-PA), Hyde (R-IL), Oxley (R-OH), Smith (R-TX), and Tauzin (R-LA). The Democrats include: Representatives Boucher (D-VA), Conyers (D-MI), Dingell (D MI), Kildee (D-MI), LaFalce (D-NY), Nadler (D-NY), and Watt (D-NC).
     Sensenbrenner has announced that he wants conferees to meet formally for the first time soon after members return from their summer recess on September 4, 2001. Once a conference bill is worked out it must be approved by both houses before it is submitted to the President.

The Proposed Legislation
    A primary intent of the bankruptcy reform legislation is to make it more difficult for consumer debtors to discharge debts under Chapter 7 of the Bankruptcy Code, thereby pushing more debtors into Chapter 13. Some of the changes in both bills that will impact consumer bankruptcies include:
    Means testing. The bills establish a "means test" for consumer bankruptcies that would force individuals who have the capacity to pay back some of their debts to do so through Chapter 13 instead of wiping their slates clean through Chapter 7. The testing, designed to determine the extent of a debtor's ability to repay general unsecured claims, has three elements: (1) a definition of "current monthly income" measuring the total income of a debtor is presumed to have available; (2) a list of "allowed deductions" from current monthly income, for purposes of support and repayment of higher priority debt; and (3) defined thresholds at which the income remaining after the allowed deductions would result in the presumption of abuse in the filing of a Chapter 7 petition.
    More specifically, 707(b) of the Bankruptcy Code would be amended to provide for dismissal of Chapter 7 cases or (with the debtor's consent) conversion to Chapter 13, upon a finding of abuse. Abuse would be presumed if the debtor had more than $100 in monthly income available to pay general unsecured debt, based on a formula incorporating collection standards of the Internal Revenue Service. Debtors whose family income exceeds a national median for their size family would be required to go through this "means testing" on the request of any creditor. Debtors with the ability to pay 25% (Senate version) or more of their unsecured debt would be required to file a Plan under Chapter 13 and make payments for a minimum of 5 years.
     Credit Counseling/Financial Management Training. Debtors would be required to obtain credit counseling from an approved non-profit agency within 180 days prior to the filing of a bankruptcy petition. Debtors would be required to first attempt to negotiate a voluntary repayment plan through the consumer credit counseling service before filing for bankruptcy protection. This requirement might not apply if the debtor faces a potential loss of property before the debtor could complete the good-faith attempt. The debtor would be required to file a certificate from the credit counseling service with the court. If the debtor entered into a debt repayment plan, that plan would also have to be filed with the court. To seek discharge under Chapter 7 or 13, debtors would also be required to attend a personal financial management instructional course following the filing of a bankruptcy petition. Debtors who failed to complete the instructional course would be subject to denial of discharge.
    Additional Filing Requirements. Debtors would be required to provide copies of their tax returns to the United States Trustee (with disclosure to any interested party), and other information regarding their income, expenses, and assets. Failure to file this information would result in automatic dismissal of their case.
    Debtor Audits. Under the provisions of both bills, a certain number of cases (no less than one out of every 250 filings) would be pulled randomly and the petition, schedules, and statement of financial affairs scrutinized by independent certified public accountants using "generally accepted auditing standards." The U.S. Trustee would be authorized to take action when "material" misstatements in the debtor's petition and schedules were identified.
    Child Support. Under the proposed legislation, court-ordered child support and alimony payments would no longer be stayed during the pendency of the bankruptcy case. They would also receive priority over most other claims, including the trustee's fee in administering the estate. They would not, however, enjoy higher priority than property tax liens. In other words, if a debtor owed both property taxes and child support, proceeds from the sale of liened property would be applied first to the property tax claim, then to the support claim.
     Cram Downs. Cram down would be eliminated for motor vehicle loans obtained within five years (three years in the Senate version) prior to the filing of the bankruptcy petition. As to other personal property, the cram down would not be available for any loan incurred within one year of the filing of the bankruptcy petition.
    Minimum Plan Term. In order to maximize the payment to general unsecured creditors, Chapter 13 would be amended to require a minimum plan term of five years for debtors whose income exceeds the median income of the applicable state for a comparable earner.
    Non-dischargeable Debts. Luxury purchases totaling over $250.00 ($750.00 in the Senate version) within 90 days of the bankruptcy filing would be presumed to have been incurred by fraud, and all fraudulently incurred debt would be non dischargeable in both Chapter 7 and Chapter 13 cases.
    Exemptions. The Senate version contains a $100,000.00 cap on the Homestead Exemption that could be claimed in a bankruptcy action. The House version contains a $250,000.00 cap but allows states to "opt out" by subsequent enactment.
    In addition, debtors could not avail themselves of state domicile exemption laws unless a domicile of the subject state for at least 730 days prior to the filing of the bankruptcy petition (in comparison to the 180 day residency requirement). However, if a debtor's domicile was not in a single state for the 730 day period, the place of domicile of the debtor for a majority of 180 days preceding the 730 day period would determine the state of domicile of the debtor for purposes of exemption laws applicability.
     Although the bankruptcy reform statues passed by the House and Senate are principally aimed at consumer bankruptcy issues, there are several provisions in the two bills that would affect business reorganization cases as well:
    Preferential Transfers. The bills make changes in the preference recovery section (547) of the Bankruptcy Code to (1) increase the period from ten to thirty days after the granting of a lien within which a secure creditor may perfect a lien and thereby prevent the perfection of the lien from being considered a "transfer" that could be subject to avoidance as being preferential and (2) provide an exemption in non-consumer cases for what would otherwise be an avoidable preferential transfer if the amount transferred is less than $5,000.
    Several provisions were also added with regard to "small business" chapter 11 cases. For the purpose of those provisions, a small business debtor would be a debtor with no more than $3,000,000 in the aggregate amount of secured and unsecured debts as of the date of the bankruptcy filed.
    Deadlines for Filing a Plan. Small businesses that file for Chapter 11 have only six months to demonstrate that they have a realistic chance of successfully reorganizing. Those that can't will be liquidated, with their assets distributed to creditors, or the cases dismissed.
    Single Asset Real Estate Cases. The bills would also clarify the circumstance under which a secured creditor can obtain stay relief in a "single asset" case where the sole substantial asset of the estate is real property. The bills provide that to avoid a lifting of a stay that would allow foreclosure, the debtor must, within 90 days after filing the Chapter 11 petition, commence payments to the secured creditor in an amount equal to the interest on the value of the secured creditor's interest in the real property, using applicable non default contract rates of interest.
    The bills call for the Advisory Committee on Bankruptcy Rules to propose for adoption standardized disclosure statements and form plans for reorganization of small business debtors and adopt uniform national reporting requirements. The bills also contain numerous "technical amendments" to make corrections in, and clarification of, provisions of the Code applicable in Chapter 11 cases.

Consequences of Reform in Consumer Cases
    Consumers with relatively high income compared to their unsecured debt will likely be required to file under Chapter 13 and make payments for a minimum of five years. This may work well for many debtors, but for others it takes away much of the incentive to file bankruptcy. Experts anticipate that many individuals will manipulate their financial status by reducing their present income (temporarily quitting a second job or refusing overtime) or by artificially inflating their debts in order qualify for relief under Chapter 7. For individuals with higher than average expenses (many of which would not be counted in the means testing), the new legislation may significantly hinder or altogether eliminate their ability to file for bankruptcy protection.
    The effect of many of the new restrictions intended to make it more difficult to file for bankruptcy will be that debtor's attorneys will be find themselves spending more time and effort on behalf of their debtor client. The prediction is that this will result in higher attorneys fees.
    Most bankruptcy debtors, who currently avail themselves of the bankruptcy relief offered under Chapter 7, receive their discharge in less than six months, and can be in a position to establish reasonably good credit within two years after discharge. Under the new legislation the entire process, because of the requirement of financial management training and for other reasons, will take longer. Additionally, many debtors required to file under Chapter 13 will not receive their discharge for five years.
    The legislation provides numerous benefits to creditors, including increased opportunities to object or get involved in the bankruptcy process. Creditors will undoubtedly have more leverage to obtain payments from debtors through bankruptcy. This may also mean that creditors will be more difficult to deal with outside of bankruptcy.
    If the bill becomes law, bankruptcy filings are expected to soar in the six months before it goes into effect. According to Samuel Gerdano, executive director of the American Bankruptcy Institute, anticipation of the legislation contributed to a 17.5 percent increase in bankruptcy filings in the first quarter of this year. He has already predicted that the number of bankruptcy filings will reach a record 1.5 million this year, primarily due to the slowing economy and high consumer debt.
    Last year, 9319 Chapter 7 and 7322 Chapter 13 case were filed in Arkansas. Through July 31 of this year, 7658 Chapter 7 and 4992 Chapter 13 have been filed. According to William Blevins, Clerk of the United States Bankruptcy Court for the Eastern and Western Districts of Arkansas, Chapter 7 filings have increased markedly this year. Notably, the biggest increase came in the month of March (1530 new Chapter 13 cases were filed), which was, not inconsequentially, the same month the House and Senate passed their respective bankruptcy reform bills.

Consequences of Reform in Small Business Cases
    Business bankruptcies represent a small fraction of total bankruptcy filings, but the proposed legislation is expected to have a dramatic impact on small businesses facing financial trouble. Small businesses that file for Chapter 11 reorganization have six months to demonstrate they have a realistic shot of survival. Those that can't will be liquidated, with their assets distributed to creditors.
    As recently reported in the Pittsburgh Business Times, the legislation also "creates so much administrative rigmarole" that it will cost clients more to file for bankruptcy, said Charles Docter, a Washington, D.C., attorney who has practiced bankruptcy law for 40 years. He notes, and many other bankruptcy practitioners agree, that six months is too short of a time for many small
businesses to take care of their problems. As a result, bankruptcy will be a much less attractive option. Docter advises that small businesses should do a "preliminary reading" now on how the changes would affect them. "If you think you've got real reorganization potential, you can do it outside of the bankruptcy court."

Likelihood of Passage
    Views on the likelihood that the conference committee members will be able to come up with a compromise bill that President Bush will sign vary greatly. According to Joe Rubin, director of congressional affairs for the U.S. Chamber of Commerce, which supports the legislation, the differences between the House and Senate bills are smaller than they have been in previous years and primarily concern matters only "tangentially related" to bankruptcy. Unless already resolved issues are reopened, "it should be a pretty quick and painless conference," Rubin said. Notably, however, Rubin mentioned the homestead exemption as one of those issues. This issue is expected to be the most contentious issue conferees will address.
    Proponents of the bill view Senator Joseph Biden's participation on the conference committee as a sign that Senate Majority Leader Tom Daschle is serious about passing bankruptcy reform. However, it is thought that Daschle's selection of conferees could foreshadow trouble. Three of the Democrats, Durbin, Feingold, and Kennedy, voted against floor passage of H.R. 333. Daschle had originally planned to appoint only four Democrats, but added more at the last minute. Due to the participation of several Democrats who voted against H.R. 333 on the conference committee, there is speculation that creating a "workable" bill will become more difficult, if not impossible.
    According to Congress Daily, Senator Leahy said that he would support the Senate-passed bill in conference and in subsequent votes. Leahy said he plans to fight in conference to preserve the Senate provision that would place a $125,000 cap on homestead exemptions. The Senate voted to allow debtors to shield only $125,000 of their home equity in response to concerns that some wealthy individuals are abusing the bankruptcy system by putting their assets into multimillion dollar mansions in states such as Florida, where homes are exempt from creditors' claims.
    The House bill leaves homestead exemptions up to the states, unless the home was purchased less than two years before the debtor filed for bankruptcy. In that case, the homestead exemption would be capped at $100,000.
    Senators Kay Bailey Hutchison (R-Texas) and Sam Brownback (R-Kan.) voted against cloture due to this provision. Texas and Kansas, along with Florida, are among the five states with an unlimited homestead exemption. The homestead exemption issue is "explosive," says Travis Plunkett, a lobbyist with the Consumer Federation of America, which opposes the bankruptcy reform legislation.
    President Bush has stated that he opposes the Senate bill's cap but otherwise supports bankruptcy reform. In an August 1st letter to all 19 House conferees, the Bush administration made its position clear and urged the conferees on the bankruptcy reform bill, H.R. 333, to support the House version of the homestead exemption and oppose the Senate language. Specifically, the letter states: "The administration strongly opposes the Senate passed language regarding the homestead exemption and strongly urges the conferees to return to the bipartisan compromise language that was adopted by the last Congress."
    Samuel Gerdano, executive director of the American Bankruptcy Institute, predicts that House-Senate conferees likely will work out a compromise on the homestead exemption that will address the worst cases of abuse. "The stars may finally be in alignment," Mr. Gerdano said, "although we've said that before."
    The purpose of the House and Senate bankruptcy reform bills is to reduce bankruptcy filings and increase payments to creditors. However, both bills contain a number of provisions that have the potential to impair the overall effectiveness of the consumer credit system. For example, creditors currently willing to cooperate in voluntary arrangements with debtors because the debtors may otherwise may file a Chapter 7 bankruptcy may be less accommodating if that avenue is eliminated. The longer minimum plan length in Chapter 13 may also increase the number of plans that default or fail. The legislation will likely lead to greater court involvement and generate additional expense for the courts and the parties involved in the bankruptcy process. At this point, the extent to which the changes will achieve the desired goals or create undesirable results cannot be fully known. What is clear is that, if the conference committee is able to come up with a compromise bill and the President signs it, the first groups to benefit from the legislation will be those providing continuing legal education credit for a fee.