Means testing will decide how individuals can file under changes effective Oct. 17
By Rocky Wilson

With what’s being called the biggest change in U.S. bankruptcy law in the last 25 years coming Oct. 17, several bankruptcy attorneys here say they don’t understand the new law well enough yet to be able to predict how it will impact them or their clients.

Most decline to comment on it until after they’ve had a chance to attend a professional seminar on the subject, some of which are slated this month. Some who have boned up on the new law question whether it will be effective or even fair.

The new bankruptcy law, called the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005, is generally viewed as making it tougher on consumers who can afford to pay off some of their debts. Rather than filing for Chapter 7 liquidation, which largely enables debtors to wipe clean their debts and start over, those debtors whose income is above the state median and who can pay at least $6,000 toward their debts over the next five years would have to do that under a Chapter 13 repayment filing.

One of few Spokane bankruptcy attorneys willing to comment on the act, Ian Ledlin, of Phillabaum, Ledlin, Matthews & Sheldon PLLC, contends that the new law won’t achieve in Eastern Washington one of its intended goals.

He says one intent of the bill is to reduce the number of Chapter 7 filings, the biggest incidence of all bankruptcy cases, and shift some of those cases to Chapter 13 filings.

Yet, because of the new regionally-structured means test provided for in the bill to determine which bankruptcy category an individual can file for, Ledlin thinks many potential bankruptcies here will remain at the Chapter 7 level and not be elevated to Chapter 13 status. He says the means test is based on debtor income, family size, and other factors, and the median income in Eastern Washington is lower than the state average, which is heavily influenced by the more affluent Puget Sound region. Many Eastern Washington filers, he says, won’t have high enough income to force them to file under Chapter 13, and thus will end up filing under Chapter 7.

Federal bankruptcy laws don’t require that a debtor be insolvent to file for bankruptcy, Ledlin says.

Kevin O’Rourke, a partner in Southwell & O’Rourke PS, of Spokane, says the federally-derived income tables used for means testing are based on state income levels determined by U.S. Bureau of the Census figures.

He adds that those responsible for putting together the tables and drafting the detailed forms needed to enact the bill have only had six months warning that the bill was coming.

Individual filers under Chapter 7 generally aren’t required to use their income or proceeds from property that’s exempt from bankruptcy to pay off creditors, says O’Rourke. Non-exempt assets under a Chapter 7 filing normally are liquidated and the proceeds are used to pay creditors, and the entire process is resolved in four to five months, he says.

Individual states have been granted federal authority to draft their own list of exempt properties or use a federal list. Washington will use both, giving the debtor the option of choosing one or the other, but not a combination of both, O’Rourke says. Limits on exempt Chapter 7 properties include up to $18,450 per debtor in the federal plan and a maximum of $40,000 in the state plan for the home equity a homeowner or home buyer has, and up to $1,225 per debtor in the federal plan and $1,000 per debtor in the state plan for jewelry, he says.

Ledlin says that 96 percent of Chapter 7 cases don’t result in any payments to creditors.

In contrast, those who file for Chapter 13 bankruptcy protection commit their disposable incomes to fund a low- or no-interest repayment plan for three to five years.

Other forms of bankruptcy include Chapter 11 and Chapter 12. Chapter 11 is for individuals or businesses who can either liquidate their assets or draft a reorganization plan, says O’Rourke. Chapter 12 allows family farmers to create a reorganization plan. Chapter 7 filings are used both by individuals and businesses, while Chapter 13 calls for a repayment plan and is limited to individuals.

The vast majority—83 percent—of bankruptcy claims filed in the Eastern Washington District of the U.S. Bankruptcy Court through July 31 this year have been Chapter 7s, followed by Chapter 13s, at 16 percent, the court says. The remaining less than 1 percent of filings have been under chapters 11 and 12.

Those bankruptcy attorneys who would talk about the new law say it will create more work for lawyers and thus will cost filers and the legal system more.

Ledlin says he works more with creditors than debtors, and because of that, won’t have his workload impacted as dramatically by the new law. He says he wasn’t surprised that Chapter 7 filings through July are up 10 percent over a year ago. Those thinking of filing are aware that costs will rise after the new law is enacted, he says.

Joe Esposito, an attorney with Esposito, George & Campbell PLLC, of Spokane, and a bankruptcy trustee since 1972, says the new means testing will require lawyers to do a more thorough analysis of client financial records before filing a claim.

Although some parts of the new bill haven’t been released, and attorneys here who comment on the issue occasionally differ on their interpretations of how the law will be applied, O’Rourke cites section numbers in the new law that he says will make attorneys liable for civil penalties if they instigate a bankruptcy claim for a client that doesn’t fit the means-testing criteria. He says the penalty hasn’t yet been defined, but will be monetary.

“Until Oct. 17, an attorney will continue to qualify a client for Chapter 7 in good faith with no civil penalties,” says O’Rourke. “But after that date, attorneys may become less aggressive in filing such claims and possibly choose not to represent clients who fall into gray areas.”

Several local bankruptcy attorneys referred questions about the new law to Jake Miller, assistant trustee for the U.S. Trustees’ Office here, but Miller, who’s been studying the law for five of the seven years it’s been under consideration, also declined to comment much.

“I work for the federal government, and my job is to enforce the law, not make comments about it,” Miller says. He did say there are a lot of consumer provisions in the bill that will create a lot of work for debtor attorneys.

One of many objectives of the new law is to adjust legal priorities regarding which types of creditors are paid before other creditors when assets are liquidated or a Chapter 13 repayment plan is drawn up.

The biggest change is with child-support payments, which currently are ranked seventh on the list, just above taxes, but will be moved ahead of everything except payments to trustees under the new law, says Ledlin.

He disagrees with that change, arguing that back wages should remain ahead of child- support payments on the list. “If you get fired by an employer who owes you $2,000 and goes bankrupt, it’s fairer to give you that money than someone not having those child- support dollars all these years.”

Those who are preparing to file for bankruptcy after the bill goes into effect must participate in debt counseling before they file and attend a debt-management class after they file, says O’Rourke. He says it’s not been determined who will give the counseling, but asserts “it’s likely to be a non-government entity approved by the government.”

Under current law, a person who files for bankruptcy can retain the option of staying current on debts such as a car loan. O’Rourke says that option will go away, leaving the debtor with the choices of paying off the debt in full, signing a binding contract to repay the obligation, or surrendering the asset.

Some attorneys express concerns about the upcoming legislation.

Esposito, one of Spokane’s most experienced bankruptcy lawyers, contends there is “inherent unfairness” in the act. “In many instances,” he says, “there are no-fault debtors who have become that way by injury, accident, or illness. Now, it may not be possible for them to file for a Chapter 13 repayment plan.”

Ledlin doesn’t think the number of bankruptcy filings will decrease, but that many individuals will attempt to curb the increased cost of bankruptcy filing by using paralegal services or representing themselves, a combination that could create “nightmares” for trustees, the courts, and attorneys, he says.

He predicts that increased mistakes made in technical filings by non-lawyers will create more work for the courts.