Bankruptcy Reform May Have Little Effect on Bankruptcy Rates

EVANSTON, IL – Claims that many consumers will no longer have the safety net of bankruptcy once bankruptcy reform goes into effect may be unfounded.

A study by the leading provider of bankruptcy preparation software for attorneys indicates that at least 85% of debtors who file for bankruptcy under Chapter 7 would still be eligible for Chapter 7 when the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 goes into effect on October 17.

The Act, signed into law by President Bush on April 20, aims to reduce abuse of the bankruptcy system by debtors who can afford to pay some of their debts. Generally viewed as making it more difficult for consumers for file bankruptcy, the Act was heavily lobbied for by the credit industry and sharply criticized by consumer advocates.

The new law provides that debtors whose income is above the state median for their household size must submit to a means test. The means test will be used to determine whether they are able to repay some debt after certain allowable living expenses are deducted from their income.

Specifically:

• If the debtor can pay $6,000-$10,000 over five years, and that amount would result in a minimum of 25% repayment of his unsecured debt, he fails the means test.
• If he can pay at least $10,000 over 5 years, then regardless of the percentage that unsecured creditors would receive in the repayment plan, he fails.

Those who fail the means test will be able to file under Chapter 13 and submit a repayment plan to the court, but will not be eligible for Chapter 7, which discharges most unsecured, nonpriority debt.

Widespread speculation in the press has focused on the likelihood that far fewer debtors will have recourse to bankruptcy.

Best Case Solutions, Inc., based in Evanston, IL, analyzed data from over 11,000 actual bankruptcies filed in 45 states between June 15 and July 6, 2005. The study compared each debtor’s monthly income as reported in Schedule I of the petition with the state median for his household size, using inflation-adjusted 2003 Census Bureau statistics as the new law requires.

85.6% of the Chapter 7 filers in the sample had incomes below the state median, and would likely still be able to file Chapter 7 under the bankruptcy reform law. The remaining 14% would have to submit to a means test in order to file Chapter 7. The information that will be required for the means test is not currently collected in bankruptcy filings, so it was impossible to ascertain how many of that group of debtors would go on to pass the means test.

The data also show that 73% of current Chapter 13 debtors’ incomes were below the state median. In general, debtors choose Chapter 13 over 7 if they have equity in real estate, since in most states laws exempt only a small amount of the debtor’s equity in a home.

“The data back up what bankruptcy attorneys tell us about their clients: these are not wealthy people trying to scam the system. They’re people who are overextended, sometimes due to job loss, car accidents, divorce, or medical problems, and they often have high interest rates on car loans and credit cards that make it hard for them to ever get back in the black,” says Lucinda Fox, company spokesperson at Best Case Solutions. “Since most debtors have incomes below the median, bankruptcy will continue to be an option for the vast majority of them. When the dust settles, I don’t think you’re going to see the bankruptcy rates go down dramatically.”

The data for the study were collected at the time of filing by Best Case Solutions’ electronic filing system. Approximately 40% of bankruptcies in the United States are filed using Best Case Bankruptcy form preparation software.