The New Bankruptcy Law: How Much Will it Help Creditors?
Bankruptcy reform, which was 8 years in the making and vetoed by President Clinton, finally became a reality April 20 when President Bush provided his signature to a new bankruptcy law. It's effective October 17. But while opponents lament its tougher standards and proponents laud its ability to cut down on fraud, it's not exactly clear how much good it will do the credit industry, according to industry analysts.
For example, much debate centers on whether a new means test will translate into more money for creditors. The means test is a formula that replaces a judge's decision on whether a debtor can file for Chapter 7 to wipe out debts or Chapter 13 to create a repayment plan. According to Todd J. Zywicki, a Georgetown University law professor and a widely quoted hearing witness, that may translate in up to a 10 percent shift from Chapter 7 to Chapter 13 bankruptcies. That would mean $3 billion of the $40 billion in debt now discharged annually might be repaid, according to Zywicki.
Others, however, are not so optimistic. Moody's Investor Services said in April that the bank credit card industry wrote off about 13 billion owed last year because of Chapter 7 filings. If 10 percent of these were shifted to Chapter 13, that translates into $1.3 billion for credit card companies. Since 30 percent of Chapter 13 filers currently complete their refinancing plans, that means only about $325 million may actually be repaid, which is small compared to the $660 billion the industry had in outstandings in 2004, Moody's points out.
Still, creditors say one of the main benefits of the new law is that the means test should eliminate high-end abusers, and industry analysts say that while the number of people who may have to file Chapter 13 instead of Chapter 7 is small, for the most part, they are people who hold larger amounts of debt.
The Law's Provisions
Some changes to the bankruptcy system that will result from the law include:
- The means test replaces a judge's decision on whether a person can file Chapters 7 or 13. The test is a formula that takes into account whether a debtor's household income is above or below the state's median plus what percentage is left over to pay certain living expenses, secured debts and other qualified expenses.
- If a person qualifies for Chapter 13, the court will apply living standards derived by the Internal Revenue Service to determine what is reasonable to expect to pay for living and other expenses. Currently, the judge talks to the debtor, then determines what can be repaid.
- The right for creditors to contest a filing in court has been expanded to include Chapter 13 cases.
- The time between when bankruptcies can be filed is increased to eight years for Chapter 7 and five years for Chapter 13.
- Charges or cash advances that can be made before filing are now limited to $500 and 90 days for charges and $750 and 70 days for cash advances for each line of credit.The homestead provisions that some states have for protecting equity in a home are now limited to $125,000 per bankruptcy filer if a home was acquired less than 40 months before filing.
Regardless of how much creditors stand to benefit or consumers stand to lose by the bankruptcy law, one factor most analysts agree upon is that the nation can expect to see a rush of filings just before the October 17 deadline. According to Fitch Ratings, March filings increased dramatically as media reports covered the bill's passage. However, the company predicts that by the end of the year, filings will probably even out to about what happened last year because of continued economic recovery and job gains.
Copyright © 2005 Bankers' Hotline. Originally appeared in Bankers' Hotline, Vol. 15, No. 6, 7/05
First published on 07/01/2005