Academic journal article Journal of Accountancy

Bankruptcy Reform Is Here: At One Time a Chapter 7 Filing Let Debtors off the Hook - No More

Academic journal article Journal of Accountancy

Bankruptcy Reform Is Here: At One Time a Chapter 7 Filing Let Debtors off the Hook - No More

Article excerpt

EXECUTIVE SUMMARY

* CPAs NEED TO UNDERSTAND THE IMPACT of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 so they can advise clients how their relationships with or as debtors is altered. The two most important changes are the terms of access to Chapter 7 and changes to the homestead exemption provisions.

* IN CHAPTER 7 DEBTORS NOW HAVE TO undergo financial counseling and a budget analysis from a court-approved, nonprofit agency. The court appoints a trustee to accumulate all assets and distribute monies. Paid first are secured parties, administrative costs, unpaid wages and pension obligations, alimony, child support and taxes; then general unsecured parties are paid pro rata. Exempt assets vary by state.

* THE THREE MAIN BANKRUPTCY LAW CHAPTERS are 7, 11 and 13. Under the new law individual debtors have to undergo a means test to qualify for Chapter 7 relief but businesses do not. Chapter 11 lets a business develop a recovery plan and holds off creditors while it is implemented. Chapter 13 lets wage earners develop a recovery plan without discharging much debt. Both 11 and 13 help debtors develop payment plans, become financially stable and repay their debt.

* CHAPTER 13 ALLOWS FINANCIALLY DISTRESSED individuals to create a court-supervised five-year repayment plan. Before debtors can complete either a Chapter 7 or 13 bankruptcy action and receive a discharge, they will be required to complete a financial management course.

* DEBTORS CAN'T EVADE RESPONSIBILITY by moving to a state with a better homestead exemption; they must live in the state for at least two years before filing for bankruptcy.

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The ease with which debtors have been able to walk away from debt has frustrated creditors for years. But all that changed last April when President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 into law. Most provisions became effective last month. The legislation--in the works for eight years--is the result of intense lobbying, mainly by banks and credit card companies. Now debtors with severe financial problems will find it harder to secure relief, and many consumer-protection groups fear that restricted access to Chapter 7 will unfairly hurt individuals whose impoverishment results from calamities like Katrina and Rita. CPAs need to understand the changes so they can advise clients. This article will bring them up to date.

THE KEY CHAPTERS

To grasp the impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, it helps to understand the characteristics of the three most common forms of bankruptcy: Chapter 7 (liquidations), Chapter 11 (reorganizations) and Chapter 13 (adjustments). Traditionally Chapter 7 discharged most debts completely, allowing debtors to secure a flesh start. Many creditors have viewed it as an invitation to abuse.

Chapters 11 and 13 essentially are unchanged under the new law. Chapter 11 lets a troubled business reorganize and develop a recovery plan; it holds off creditors while the plan is implemented. Chapter 13 lets wage earners develop a recovery plan but doesn't discharge significant debts. The goal of 11 and 13, which are more creditor-friendly than Chapter 7, has been to help troubled debtors develop realistic payment plans, become financially stable and repay their debt.

THE CHAPTER 7 PROCESS

The primary feature of the new legislation is that distressed individuals no longer have free access to Chapter 7's easy discharge of debt. Now, debtors must undergo a "means test" and credit counseling to assess whether to permit them to choose Chapter 7 relief. As a result, many individual debtors likely will be funneled into Chapter 13, which requires them to repay their debt over time.

To obtain Chapter 7 relief, a debtor files a petition with the bankruptcy court. For eligible debtors (formerly both businesses and individuals, now businesses and some individuals) the process is not much changed. …

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