Bankruptcy law updates close loopholes in repaying debt

By Ben Woolsey

The 2005 Bankruptcy Abuse Reduction Act went into effect in October 2005 and substantially rewrote the bankruptcy code in a way that makes it tougher for consumers to file for dismissal of their debts.

The law was passed with the support of the credit card industry. It contended that the law plugs loopholes that enabled people to avoid repaying credit card and other types of debt that could have been repaid. Consumer advocates unsuccessfully opposed its passage, arguing that most bankruptcy filers aren't deadbeats but ordinary people saddled by debt due to unavoidable events such as divorce or illness.

Here are the law's key provisions.

Means testing: A bankruptcy attorney must analyze the potential filer's financial situation and then determine whether the person is able to file for Chapter 7 or Chapter 13 bankruptcy. Chapter 7 Bankruptcy allows debts to be dismissed; Chapter 13 bankruptcy requires a court-supervised repayment plan of three to five years. 

The means test involves taking an average of filers' past six month's of regular income (regardless of whether they are still employed) and subtracting typical expenses for rent, food, insurance, transportation and child support (if applicable). These expense averages are determined by the IRS based on averages and do not have to reflect the filer's actual expenses. If there is at least $100 remaining after this calculation, the filer will be required to file under Chapter 13 and, if accepted, would be required to establish a repayment plan.

Jurisdiction shopping banned: Before the law, applicants could file in states that offered a more lenient bankruptcy climate . In particular, the state of Florida has been a favorite spot for opportunistic filers because they could shelter unlimited amounts of money in their personal real estate.  With the law's passage, permanent state residency became a basic requirement for filing within a given jurisdiction.

Prefiling counseling: A "debtor education class" is required before filing becomes official. A certificate attesting to its successful completion became the "ticket in" for bankruptcy. Classes are available in person or online, and generally take 90 minutes and cost $50.

See related: "Bankruptcies up 38 percent in 2007"

Updated: April 17, 2008