Bankruptcy Filing Flood Swamps Federal Courts

Chapter 7 bankruptcy filings jumped by about 50 percent last year in Fayetteville and Harrison.

On April 20, the president signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act.

The action sent an avalanche of Chapter 7 personal bankruptcy filings to federal courthouses across the country before Oct. 16, which was the last day to file before the new rules went into effect.

Between Aug. 1 and Oct. 16, Chapter 7 filings in Fayetteville increased by more than 100 percent when compared to the first seven months of 2005.

A total of 2,124 Chapter 7 cases were filed in Fayetteville in 2005, with 1,110 of them filed from August through October.

Lawyer Terry Lee doesn’t think the new law, which makes filers meet new requirements in order to discharge debt, will affect the ability of debtors to file a Chapter 7 bankruptcy as much as many people thought.

“I think it will pick back up,” Lee said. “The act does not do much to impede filing. There are lots of people out there that need to file.”

Lee is one of three federally appointed bankruptcy trustees who handles bankruptcy cases for the Fayetteville and Harrison divisions. A bankruptcy filer will hire an attorney for representation, and it’s Lee’s job to make sure the filer’s assets and ability to pay are correct.

On all non-asset cases, trustees get a flat fee of about $60 per case. But in the case of a Chapter 7 bankruptcy where there are assets to distribute to the creditors, there is a minimum fee of 3 percent of the amount of assets seized for distribution, said Charles Tucker, assistant trustee for the bankruptcy court’s Eastern and Western Districts of Arkansas.

Lee said the biggest bankruptcy asset case he completed was that of Charger Inc., a Springdale trucking company that initially filed for Chapter 7 bankruptcy late in 1999. That case raised $8.3 million, mostly through lawsuits he filed to recoup funds.

Before the filing rush, Lee said he was handling about 30 cases per month. He said about 75 percent of his business is trustee work, with the rest of his work divided between creditor and debtor representation.

Means Test

Bankruptcy Court Judge James Mixon of Little Rock said the new law might not change much for most Chapter 7 filers.

There were a total of 35,000 bankruptcy filings statewide last year, which was a 17 percent increase from 30,000 in 2004. Of those 35,000, 17,000 to 18,000 cases — or about 50 percent — were filed in the two months prior to the Oct. 16 filing deadline.

Mixon surveyed the Chapter 7 bankruptcies filed statewide in 2005.

He found that more than 80 percent of filers would still be eligible for Chapter 7 bankruptcy under the new rules, which requires filers in a certain income bracket or above to take a new “means test.”

The means test is an investigation into the financial health of a person to determine whether there is a “presumption of abuse,” Tucker said. The test uses statewide median family income, which for Arkansas in 2004 ranged from $37,178 for a two-person family, to $49,790 to a four-person family, as a benchmark to determine whether a person has to take the test.

“All [the means test] creates is a presumption under the law that there may be abuse [of finances] and that the presumption is rebuttable,” Tucker said. “The test, by its nature is a formula. It doesn’t use what your real income is now, it uses what your income was six months ago.”

So if a person lost a job or became terminally ill, the means test wouldn’t factor that in.

Tucker said a filer could pass the means test, and could even be below the income level to take the means test, but under the law there is still a provision that the person has to prove they aren’t abusing the system.

“We’ve had a number of cases that we’ve pursued in the past where there wasn’t an ability to pay, but there were other factors that warranted a dismissal of the case because there was an abuse of the chapter,” Tucker said.

A dismissal means the filer didn’t get the right to discharge unsecured debt, which is rare, Lee said.

And even if someone fails the means test, that person could still file Chapter 7 if payments on debt are 85 percent of total income.

“You can squeak by the means test if you don’t have any disposable income,” Lee said.

Even so, debt becomes more of a burden to the filer because filing bankruptcy is more expensive under the new rules, Mixon said.

“It’s more of a hassle now,” Mixon said. “You have to pay for credit counseling, and there are more forms to fill out.”

And time is money. Attorneys will have to spend more time ensuring that the information is correct because the new law holds them accountable for errors.

The American Bar Association said on its Web site that it supported some of the aspects of the new law but “strongly opposed” the requirement that the attorney for the debtors has to certify the accuracy of assets or face “harsh court penalties.”

“There are so many changes in the law that have left questions as to what Congress meant,” Mixon said. “The only way to resolve it will be litigation.”

Mixon said he watched the same situation unfold when the bankruptcy code was adopted in 1979 and litigation followed.

“When you have 20 years of interpretation by the Court of Appeals, the law gets sort of settled,” Mixon said.

Both Mixon and Lee, with more than 20 years of bankruptcy experience each, agreed that most of the bankruptcy filers are consumers in truly dire circumstances.

“I disagree with the premise in which the law was passed, which was that people were engaged in wholesale fraud,” Mixon said. “I just don’t believe that was it. I think people file because of these dad-gum credit cards and become overextended and they are still.”

The list of hardships runs long.

“Failed businesses, spouses dying, a remarkable number of people that are on Social Security and one spouse dies,” Lee said. “Most of the individuals I see, something drastic in their lives has happened.”

Creditors

The new act does change distribution to creditors.

In theory, the new rules were supposed to increase distributions, or payments, to unsecured creditors, such as credit card companies.

Tucker said below-income filers aren’t going to be affected that much by the new Chapter 13 rules, and above-income filers could conceivably have more wiggle-room with their disposable income.

The wild card in the statute essentially is the “other” secured debt category.

“If you go line by line and start looking at what is allowed and not allowed under expenses, you’ll find that there is a broad range of allowances including secured debt payments that can allow a person to avoid the presumption of abuse,” Tucker said.

Mixon said a person can discharge unsecured debt in a Chapter 13 just like in a Chapter 7.

“You just might have to pay more in a Chapter 13, whereas in a Chapter 7 the debt is discharged,” he said.

Lee said for example, if a person owes $20,000 in car debt, and the car is worth $10,000, under the old law, the debtor only had to pay back the $10,000. Under the new law, the debtor can’t “write down” the debt, so they will still owe $20,000.

On the other hand, unsecured creditors could get more.

In a Chapter 13, the debtor sets up a payment plan for secured debt, such as a house payment. And unsecured debt payments are made according to what the person has left to use after allowable living expenses are deducted. The new act placed caps on allowable living expenses.

For example, in Washington County, a three-person household has a $665 per month mortgage allowance and if that household rents, the limit is $393.

A person also can’t set up an outrageous five-year mortgage plan versus a 30-year and try to slide by. A judge would throw it out, Mixon said.

“If someone had a lot of income, they could try and beat the system,” Mixon said. “Now, the statute dictates what the limits are.”

Tucker said the new law created a boost in filings to beat the deadline, but before that, the courts were seeing a 5 percent to 10 percent annual decline in the number of cases filed.

“I think slowly the attorneys will get used to the new law and get more comfortable with what is required,” Tucker said. “I think the filings will gradually increase.”

He said about 300 to 400 Chapter 7 cases have been filed statewide since the Oct. 16 deadline.

Tucker said filings typically increase in May and June, after income tax returns are issued. Sometimes people will use their return to pay attorney’s fees to file bankruptcy, he said.

Click here for a look at bankruptcy filings in Faytetteville and Harrison.