Bankruptcy Law Changes Make it Harder to Flee Financial Obligations

Newly enacted changes to U.S. bankruptcy law attempt to make it more difficult for individuals to avoid financial obligations by filing for bankruptcy. The result? More people will be forced to work out repayment plans.

Supporters say the changes initiated by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 will end the practice of people abusing the bankruptcy system. By "abuse," they refer to people who recklessly run up debts and then avoid paying by filing for bankruptcy; fathers who use the laws to avoid child support; and multimillionaires who use the law to shelter sizeable assets.

Opponents say it will hurt those who can least afford it - low-income working people, single mothers, minorities and the elderly - and would remove a safety net for those who have lost their jobs or face crushing medical bills.

Means Testing: The new law sets up what is referred to as "means testing." That is, assess or "test" the "ability to pay" of each person who wants to file bankruptcy. This will be done by simply adding up the petitioner's income and assets and measuring "ability to repay." Those with sufficient income or assets will not be able to file Chapter 7 and thereby eliminate all their debt. Instead, they will only be able to file Chapter 11 or 13, which means they must work out a plan for paying all or a portion of their debts.

Homestead Exemption: Supporters of the changes say bankruptcy is often abused by multimillionaires who buy mansions in states with liberal homestead exemptions in order to shelter assets from creditors. Kansas, Oklahoma, Texas, Florida, Iowa and South Dakota have unlimited homestead exemptions. That allows wealthy people to file for bankruptcy and keep their mansions in those states sheltered from creditors.

The new federal law restricts a state's homestead exemption to $125,000 if the person in bankruptcy bought his or her residence less than three years and four months before filing and the purchase was not made with equity from the sale of a homestead in the same state.

Child Support: The new law makes it harder for a filer to use the bankruptcy law to avoid paying child support. In fact, it gives child support payments a priority claim over other creditors on the income and assets of the filer.

Credit Counseling: The new law requires the completion of credit counseling before bankruptcy.

Asset Protection Trust: The new law leaves largely intact an increasingly popular mechanism called asset protection trusts. These trusts are used as a means for protecting assets from creditors even after filing for bankruptcy. Setting up these trusts can cost many thousands of dollars. Maintaining them and paying an in-state trustee can cost thousands more, making this mechanism viable only for the wealthy.

Until 1977, these trusts could only be opened offshore. But since then, eight U.S. states - Alaska, Delaware, Utah, Nevada, Rhode Island, Oklahoma, South Dakota and Missouri - have passed laws exempting assets held in the United States from federal bankruptcy laws. People opening one of these trusts don't have to be a resident of the state but merely establish the trust there.

The new law does stipulate, however, that transfers of assets into such a trust can be nullified if the transfer is found to have been made with the intent to hinder, delay or defraud a creditor.

This article was adapted from work provided by the law firm of Hall Estill and was reviewed by Steve Soule, attorney with Hall Estill and U.S. Bankruptcy Trustee. See www.HallEstill.com.