Proposed Bankruptcy Changes How They Affect Consumers and Small Business Owners

By Paul Hollender & Marylou Ducey Martin

PROPOSED BANKRUPTCY CHANGES

HOW THEY AFFECT CONSUMERS AND SMALL BUSINESS OWNERS

Current Legislative Status

In May 1999, the House of Representatives passed bankruptcy reform bill H.R. 833. On February 2, 2000, the Senate passed S. 625 ("The Bankruptcy Reform Act of 2000"). The House and Senate will now work on a joint version of the bill.

Effects on Consumers

The Senate Proposals will make it very difficult for middle and lower income consumers to recover from unexpected loss of a job, death of a spouse, or emergency expenses. The Bill as it now reads, will make Chapter 7 unavailable to many consumers, by requiring a "means test" be applied to potential Debtors, under which rigid IRS expense standards (now used only to evaluate ability to collect back taxes) will be used to determine certain monthly expenditures, without taking into account a family's actual reasonable and necessary monthly expenses. While "special circumstances" can be considered for expense adjustments, it is unclear how such determinations will be made.

Under this "means test" the family's monthly expenses (as determined by IRS standards) are deducted from the monthly household income. The difference, if any, if multiplied by 60 (months) to determine the Debtor's ability to repay his debts. If that amount is greater than or equal to the lesser of $15,000 or 25% of the Debtor's unsecured debt, then Chapter 7 would not be available. As an example, if a family owes $40,000 in credit cards, and, after application of the IRS expense standards, there is remaining the sum of $170 per month of "available" income, it will be presumed that over the next five years, they will have the ability to pay their creditors at least $10,200. Since this is greater than the lesser of $15,000 or 25% (i.e., $10,000) of their unsecured debt, they would not qualify for Chapter 7. Instead, these consumers would have to file a Chapter 13 case and, at a minimum, pay back at least $10,000 of their credit card debt over a five year period. This legislative mandate fails to recognize what bankruptcy practitioners are well aware of: rarely are consumers successful under Chapter 13. Far more Chapter 13 cases are dismissed than are successfully completed, due, in part, to the stringent financial requirements which often fail to take into account the realities of supporting a family. By forcing more consumers to file Chapter 13, the proposed Bankruptcy Reform, will, in effect, make bankruptcy unavailable to those who need it most. As a result, more families will remain burdened with unmanageable credit card debt, and an increasing number of home foreclosures will take place.

The Bill passed by the Senate also includes changes to cases filed under Chapter 13. These debtors will be required to file tax returns for the last 6 years (perhaps if not even required by the taxing authorities). This could create an onerous burden on consumers and small business owners who typically seek Chapter 13 relief to prevent foreclosures and in other emergency situations.

Under present law, if the Court does not approve a chapter 13 Plan, all plan payments made by the debtor are returned. The proposed changes require the Chapter 13 Trustee to pay secured creditors before the Court approves the debtor's Plan. If the Court does not approve the debtor's Plan, then the secured creditors would be allowed to keep the money even though the debtor would be losing the property. This will result in Chapter 13 debtors losing substantial amounts of money should the Court deny confirmation of their Plan (which occurs regularly, even under current laws!).

There are also more stringent provisions with regard to debts which willbe considered nondischargeable under Chapter 13. Certain tax obligations and credit card debts will not be discharged under Chapter 13, notwithstanding a Plan providing for partial payment based upon the debtor's disposable income. This modification will remove a major incentive for some people to file Chapter 13 in order to deal with debts which cannot be completely discharged in Chapter 7.

The proposed changes also include the elimination of the automatic stay for many tenants facing eviction, even if they pay rent after filing bankruptcy, which could have a devastating impact on lower income families who would otherwise be seeking bankruptcy protection to provide children with the basic necessities of life.

The proposed amendments further adversely impact on the ability of middle and lower income individuals to seek bankruptcy relief by imposing additional extensive filing requirements, mandatory credit counseling as well as financial management courses in order to obtain a discharge. These additional requirements are likely to drive up legal fees for people who, even now, have trouble raising the funds necessary for competent professional representation.

Credit card companies and other lending institutions have lobbied extensively (and have contributed heftily) in order to get such bankruptcy reform enacted. They have been successful in fostering the mis-perception that these amendments will eliminate the "loopholes" which allow the wealthy to protect assets and discharge debt. Unfortunately, the current Bill does nothing to correct any of these "abuses"; rather, it takes aim of the lower and middle-income families who are legitimately in need of the financial relief which bankruptcy can offer. It does nothing to limit to spiraling issuance of credit cards to people who do not have the ability to repay, nor to require disclosure of monthly interest costs or total years to repay if only minimum payments are made by the consumer.

Effects on Small Businesses

The Bill recently passed by the Senate also provides for an overhaul in the Chapter 11 filings by small businesses, which generally owe less than $3,000,000 in debt. Rather than simplifying the procedures for small businesses, the proposals impose more extensive filing requirements and harsh rules, which will make it even more difficult for small businesses to take advantage of Chapter 11. Not only are small businesses required to meet the initial filing requirements of larger companies, they must also provide balance sheets, cash flow statements and Federal Tax Returns along with their bankruptcy petition! Schedules must be filed timely and the Court may not extend this period past 30 days from the filing of the case. Debtor's management will be forced to attend more meetings, including initial debtor interviews and scheduling conferences, in addition to meetings of creditors. More stringent deadlines are also imposed, limiting the period of time to file a plan and obtain confirmation. For a small business owner trying to run a distressed business, additional administrative demands by the Courts may stretch his time too thin to enable him to pull the business back from the brink. Furthermore, these requirements may increase the costs of a reorganization to the point that the only viable option is to close the business. Thus, these changes are likely to be counterproductive, accelerating the demise of family owned businesses which have the potential to be saved if granted a reasonable "breathing time" to change its operations and pay creditors over several years.

In addition, the Office of the U.S. Trustee is required to take a stronger role in the small business Chapter 11 case. The U.S. Trustee's Office must be provided the opportunity to inspect the business premises, and the books and records of those small businesses filing for protection under chapter 11, and must begin to investigate the debtor's viability and business plan shortly after filing. The U.S. Trustee is also required to closely monitor the activities of the small business debtor, in order to identify those companies which will be unable to confirm a plan. Essentially, these provisions are intended to require the U.S. Trustee's Office to seek dismissal of small Chapter 11 cases as quickly as possible (while permitting the larger cases to take every advantage of the otherwise applicable rules governing Chapter 11).

There are also special rules for successive Chapter 11 filings by small businesses which limit the availability of this Chapter if the company filed for relief under Chapter 11 within the prior two year period.

These proposed changes will make it not only more expensive, but much more difficult for small businesses to successfully reorganize under Chapter 11. Thus, Bankruptcy Reform, in its current form, is geared to benefit big business, while leaving little protection for smaller companies to survive when faced with financial difficulties

Paul M. Hollender, a Board Certified Consumer and Business Bankruptcy Attorney (Amer. Bd. of Certif.), has practiced bankruptcy law for 23 years, is a member of the Business and Consumer Bankruptcy Committees of the New York County Lawyers Association; editor of Bankruptcy Notes for Attorneys and Accountants; a member of the Brooklyn Bar Association Bankruptcy Committee; former Editor in chief of the Bankruptcy Bar Bulletin; and former member of the Board of Governors of the Bankruptcy Lawyers' Bar Ass'n. His articles have appeared in the NYS Bar Journal, the NY Law Journal, the Brooklyn Barrister, and the Richmond County Bar Bulletin.

Marylou Ducey Martin has practiced Consumer and Business bankruptcy law, exclusively, for the past 12 years. She is former Adjunct Professor at Brooklyn College, and has taught continuing legal education courses in the bankruptcy field.
Corash & Hollender, P.C., has offices in Staten Island, Manhattan and New Jersey.

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