What Are the Rules Under the New Bankruptcy Law?

We’re speaking with Attorney Stephen Elias about the new bankruptcy law. Steve is the author of “The New Bankruptcy: Will It Work For You?” as well as, “How to File for Chapter Seven Bankruptcy,” available from Nolo.

NOLO: Steve, can you start out by giving us a summary of the differences between a chapter seven bankruptcy and a chapter thirteen bankruptcy?

STEPHEN ELIAS: Well, there are two basic types of bankruptcy available to individual consumers. One is what’s called a chapter seven, and the other’s called a chapter thirteen. Chapter seven lets you discharge most types of debt, and in exchange for that, you have to give up property you own that you can’t exempt under the applicable laws. The whole process takes about three to six months. In fact, in most chapter seven bankruptcies, you get to discharge almost all of your debt (there are a few that you can’t), and you don’t have to give up any property the way the exemption system works. You could have a no-asset bankruptcy and still come out owing recent taxes, child support, and student loans; those are three categories of debt that usually will survive bankruptcy. Chapter thirteen, as opposed to chapter seven, lets you get rid of most of your debt, and in exchange, you have to agree to apply and pay to the trustee who’s the bankruptcy official handling your case in the court, you have to pay your disposable income for a three to five year period, and that’ll depend upon what your income is. If you’re a higher income person, you’ve got to pay for five years; if you’re a lower income person, you’ll have to pay for three years. The only trick of this is you’ve got to repay at least as much as your non-exempt property is worth. So, in other words, if you have a boat, and the boat’s worth $10,000, and if you filed a chapter seven, you’d have to give it up and let it be sold for the benefit of your creditors… well, in chapter thirteen, your plan has to propose to pay at least that $10,000. So, your creditors get the benefit of your non-exempt property whether you file a chapter seven or a chapter thirteen.

NOLO: Steve, many experts believe that one of the reasons Congress revised the bankruptcy law is to force more people into filing a chapter thirteen bankruptcy.

STEPHEN ELIAS: The whole thrust of the law is that people who can afford to repay their debts must be made to repay their debts, and the way to do that is to force them into a chapter thirteen. It’s kind of a myth; there was a study done by probably the most widely used software company used by lawyers, and they studied 11,000 bankruptcies that had been filed in the six months or so before the study, and based upon their finding, only fifteen percent of the people who filed would actually have to go through a chapter thirteen under the new law. And right now, just as a matter of course, about fifteen percent of people file chapter thirteen bankruptcy. But when you get right down to it, and you start applying the tests that they have to force people into chapter thirteen, only fifteen percent of filers will end up having to file chapter thirteens.

NOLO: Considering that the leading causes for personal bankruptcy are often illness, job loss, or divorce, it seems odd that the law requires debtors to take and to pay for a personal financial management class. What are the new counseling requirements?

STEPHEN ELIAS: There are actually two counseling requirements. One, before you file, you’ve got to have debt or credit counseling, meaning you get together with somebody and then decide whether you can feasibly pay back your debts without bankruptcy; that’s the purpose of that. You’ve got to have a certificate of completion even before you file. And then, before you actually end your bankruptcy, before you get the benefits of it, you have to have a certificate of completion of, as you say, a personal financial management course. It’s a two-hour course, and there’s something in the law that says they can’t charge more than a person can pay, so I’m certain that there’s going to be a sliding fee scale. As we talk, that hasn’t been published yet, but I’m sure it will be. But, for some people, it’s going to cost, you know, a hundred bucks; this will be after they file.

NOLO: Under the new law, Congress set up criteria for filing that requires measuring your income to determine whether you’re above or below the median income of others in your state. Those below the median are considered low-income filers, and those above are considered high-income filers. But how does a person filing bankruptcy make this determination?

STEPHEN ELIAS: It’s not your actual income that you’re measuring; it’s the six-month average income before you file bankruptcy. So, let’s just say you had a $100,000 a year job, and you lose it, and you’re on unemployment, and you do that for a couple of months, and your debts are crashing down around your ears, and you say, “I’ve got to file bankruptcy.” You have to take the average of the prior six months. So, for four months, your income is going to look like it’s going to be really high, because of the $100,000 dollars. Two months, it’s just the unemployment, which is real low. Well, you throw it all in together and divide it by six… guess what? You’re very likely to come out as a high-income filer, even though you’re a low-income person. There’s no way out of that; all of the computations in bankruptcy are based upon that income figure. It’s not your true income; it’s your six-month average income – your gross income, from every source, even if it’s not taxable. You take that, you divide it by six, and then that’s your income. So, if you have to file bankruptcy soon after you lost a high-paying job, you’re going to be treated as a high-income filer, even though you don’t have high income.

NOLO: Well, what happens if you’re above the median for your state?

STEPHEN ELIAS: If you’re above the median income, it’s going to be presumed that you can’t file for chapter seven, unless you can show that you couldn’t pay back at least some of your debts. So, they kind of make you disprove that you’re qualified for chapter thirteen.

NOLO: Does this income test apply to all of the money that you receive? For example, does gift income count?

STEPHEN ELIAS: Well, just a gift is a lump sum; that’s not really income. It’s reoccurring income, and, incidentally, social security… anything that comes from social security is not counted as income, just as an important aside. I should say also that disabled vets, if their debts come while they were in active duty, they’re not counted; they’re just fast-tracked to low-income status, and also, if you’re a business debtor. A lot of people file chapter sevens because they failed in business, and when you look at their debts, they’re really due to the business. If more of their money debt, you have a $100,000 dollar debt, and $51,000 is from your business, you’re no longer a consumer debtor, you’re a business debtor, and business debtors aren’t subject to this. So, you’ve got to kind of narrow down the categories as to who the income test applies to.

NOLO: Where can you find the criteria for applying the income test? Is there a government website?

STEPHEN ELIAS: This is a Department of Justice site, and it’s the site operated by the Office of the U.S. Trusty, and the Office of the U.S. Trusty controls everything that happens in the bankruptcy court. Of course, the judges are in there to make decisions, but every other facet the Office of the U.S. Trusty is in charge of. And you go to usdoj.gov/ust, and then there’s a link, and it’s called “means test.”

NOLO: One thing the new law supposedly does is it makes child support a higher priority for debtors. How does this work?

STEPHEN ELIAS: When there are assets in a chapter seven that are sold for the benefit of the predators, there is a list of priorities, who gets that money first, who gets it second, who gets it third, and under the old law, child support was the seventh priority, and under the new law, they moved it up to the first priority. However, in most chapter seven bankruptcies, there are no assets, there is no distribution, so there is no reason. It doesn’t make any difference where it fits on the priority list; it’s just window dressing. There’s also a lot of language in the new law requiring the trustee to give anyone who is owed child support information about the bankruptcy filer. So, there’s a lot of notification. So, if I’m owed child support, and somebody files bankruptcy, I’m going to get a notice from the trustee, “Hey, this guy’s filed bankruptcy,” and when the bankruptcy is over, I get another notice of the address. If they’re hiding from me, the bankruptcy court will help them not hide from me. So, there’s a bunch of that language in there, too.

NOLO: Every state has a homestead exemption, an amount or value in the home that the debtor’s allowed to exempt from creditors. Now, some wealthy people preparing to file move to states like Florida, where the exemption is unlimited. Does the new law do anything to deal with that sort of abuse?

STEPHEN ELIAS: If you’ve purchased your home within less than forty months from when you file for bankruptcy, you can only claim up to $125,000 exemption. Now, that looks great, and it takes care of the Florida problem. Texas has the same situation, and there’s six other unlimited homestead exemptions, mainly in the Midwest; all the rest of the states including California, New York, Massachusetts, and all the other states have homestead exemptions of some amount. They vary tremendously because it’s based upon each state’s exemption system. So, in Massachusetts, you can exempt $500,000 worth of equity in your estate; in California, you can exempt up to $150,000, in New York, you can exempt now $50,000; it was just $10,000 until this August of 2005, and then they bumped it up to $50,000.

NOLO: One thing I’ve heard about the new law is that bankruptcy attorney fees are likely to increase. Is that true?

STEPHEN ELIAS: The law is more complex, there are more things for lawyers to worry about, plus the lawyers themselves are now being heavily regulated by the Office of the U.S. Trustee. I think they’re more regulated in this particular practice now than any lawyer in any practice. All of that, by universal feeling, is going to at least double the fees of bankruptcy lawyers, and that, frankly, is, depending on where you are, whether you’re in rural or urban, you’re $1,500 to $2,000 for even a simple chapter seven bankruptcy. Let me put it this way: there’s almost no such thing anymore as a simple chapter seven bankruptcy from a lawyer’s standpoint.

NOLO: Considering that many people believe the new law makes it harder to file for bankruptcy, what are the alternatives? What happens if you don’t file?

STEPHEN ELIAS: If you don’t file bankruptcy, then you’re prey to the bill collectors, and if you’re prey enough to the bill collectors, they will hound you, and hound you, and hound you, even to get a judgment, and then garnish your wages, and take your bank account… they’ll be after you until you kind of beg, borrow, or steal money from your parents or somebody who can actually pay them off, because it’s hell to live at the mercy of debt collectors.
NOLO: So, what are the choices that a debtor has when considering bankruptcy?

STEPHEN ELIAS: You either have to hire a lawyer to represent you, or you have to be responsible for your own case. And, of course, Nolo thrives on telling people how to do their own bankruptcy, and I’m working as we speak to update the core chapter seven book, published by Nolo, which is, How to File for Chapter Seven Bankruptcy. That won’t be out until April. However, in the meantime, this book that is about to come out, we talked about, The New Bankruptcy it’s called, explains all this.