April 2005 Introduction In This Issue: • Introduction — page 1 On April 20, 2005, President Bush signed the Bankruptcy Abuse Prevention and Con- • Effective Date — page 2 sumer Protection Act of 2005 (sometimes referred to as the “Amendments”) which • What Is Means Testing/Who Can is perhaps the most sweeping change to the Bankruptcy Code (the “Code”) since the Be a Chapter 7 Debtor? — page 2 Amendments of 1994. While the legislation modifies the Code in many ways, most • Notable Other Changes to the notable are the changes to provisions related to individual consumer bankruptcies. Code Impacting Only Debtors That The new statute makes it much more difficult for individuals to utilize chapter 7 of Are Persons — page 3 the Code in order to eliminate many of their debts. Under chapter 7 of the Code, • New Consumer Credit Disclosures the debtor gives up most of his or her assets (other than those which are exempt) — page 4 to repay his/her creditors. Secured creditors are paid first and thereafter unsecured • Changes to Other Sections of creditors are paid in the order of their claim’s priority as designated by the Code. Code Which May Impact Business- Generally, the debtor then receives a discharge and essentially can start anew with- es and Individuals — page 5 out any lingering debts (other than certain debts which are non-dischargeable). • New Chapter 15 of the Code Under the Amendments, many individuals that would ordinarily seek to wipe away — page 7 their debts under chapter 7 will no longer qualify for the protections of chapter 7, and will have to pay back a large part of their obligations over a period of time un- der chapter 13. Under chapter 13 of the Code a debtor formulates a plan of repay- ments pursuant to which secured debt and a portion of unsecured debt is repaid over a period of five years (but in some instances three years). Remaining debts are then discharged and the individual receives a “fresh start”. The Amendments also seek to frustrate “serial filings” by individuals by limiting the number of times that bankruptcy relief may be invoked within a specified period and by limiting the applicability of the “automatic stay” should several filings occur by the same debtor(s) within a prescribed time period. The legislation contains noteworthy changes to provisions pertaining to treatment of secured claims in indi- vidual bankruptcies, treatment of tax liabilities in individual bankruptcies, exemp- LONDON tions, executory contracts and unexpired leases, treatment of financial contracts NEW YORK such as derivatives, swap and hedge agreements, and duties of attorneys and other LOS ANGELES professionals who assist persons seeking bankruptcy protection. SAN FRANCISCO In addition to the changes to the Code, the Amendments include certain changes WASHINGTON, D.C. to the federal Truth in Lending Act (“TILA”) which are summarized below. These PHILADELPHIA changes will require additional disclosures to be made by lenders to consumers in PITTSBURGH connection with consumer credit, including mortgage loans and home equity lines OAKLAND MUNICH of credit. PRINCETON Set forth below is a summary of some of the changes brought about by the new leg- NORTHERN VA islation. For additional details, a separate notice will be emailed to you in a few days WILMINGTON providing information on a Reed Smith teleseminar scheduled for noon (EST) on NEWARK Wednesday, May 4, 2005. The forum will allow for a question and answer session. If MIDLANDS, U.K. you should have any questions, please contact kbarauskas@reedsmith.com . A complete CENTURY CITY description of the changes to the Code brought about by the Amendments, please RICHMOND visit the website of the American Bankruptcy Institute at http://www.abiworld.org . r e e d s m i t h . c o m 1
Effective Date What Is Means Testing/Who once filed, a chapter 7 case is subject to dismissal or conversion based upon Can Be a Chapter 7 Debtor? Generally, the Amendments to the Code abuse of the bankruptcy system. Means become effective as to new cases filed testing will be employed to determine Fewer Chapter 7 Cases 180 days or more from the Enactment whether an individual debtor’s average Date (April 20, 2005). There are numer- The Amendments preclude many “current monthly income” 1 is more or ous exceptions to this general rule. Most individuals from seeking the protec- less than the median income (of a family of the changes do not affect pending tion of chapter 7 of the Code. Prior to which is the same size or smaller) in the cases; but some do. the effective date of the Amendments, state where the debtor resides. If, after any individual, regardless of his or her computing current monthly income, ability to repay creditors and current in- and deducting therefrom certain allowed come level, can utilize chapter 7 where living expenses, including secured debt assets (other than those that are exempt) payments and priority unsecured debts, are liquidated to pay creditors in the and multiplying that amount by 60, the order of priority set forth in the Code. product of that multiplication exceeds T ypically, however, unsecured creditors the lesser of (i) $10,000 or (ii) the of chapter 7 debtors receive little, if any, greater of 25% of the debtor’s unsecured payment on account of their claims and nonpriority claims or $6,000, then the their claims are essentially wiped away. debtor is presumed to be abusing the bankruptcy process by filing a chapter 7 Under the Amendments, fewer individu- case. This presumption, unless success- als will qualify to file under chapter 7 fully rebutted, may lead to the dismissal due to the size of their income. Chapter of the case or its conversion to a case 7 debtors will have their income com- under chapter 13. 2 pared with their domicile state’s median income for a family of the same or Deductions from Income smaller size. If the debtors’ income falls Examples of the types and amounts of below the median, they will generally be expenses that can be deducted from an able to utilize chapter 7 of the Code. If individual’s gross monthly income to their income exceeds the median, there derive the individual’s “current monthly will be a presumption that the filing was income” are mortgage payments, util- made in bad faith. The presumption will ity payments, payments on account of need to be overcome by the debtor(s) secured debt which are necessary for in order to prevent a dismissal of the the support of the debtor and his or her chapter 7 case or a conversion of that dependants (including car payments), case to a chapter 13 case. It is anticipat- payments for food and clothing, school, ed that these changes will dramatically support and alimony, health insurance, reduce the number of chapter 7 cases disability insurance, expenses paid for and increase filings under chapter 13. It the care of an elderly, chronically ill or is also anticipated that many creditors, a disabled member of the household such has those holding claims related and other types of expenses. All ex- to credit card obligations, who were penses of a type and nature which are previously paid little, if anything, under not enumerated in the statute must be chapter 7, will now be included in the itemized and documented and deemed debtor’s repayment plan and will likely necessary and reasonable. Limits on the recoup a larger portion of their claims applicable amounts of certain expenses pursuant to a chapter 13 plan. are contained in the National and Local The Means Test Standards and actual Other Necessary Expenses as provided in the Collection The Amendments employ a “means Financial Standards issued by the Inter- test” to determine whether an individual nal Revenue Service. qualifies to file a case under chapter 7 of the Code and to determine whether, 2
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