Ten years ago this month the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) became effective. The act was designed to make filing bankruptcy more difficult by requiring filers to provide more information to court trustees that supervise the process and by installing a mathematical formula to keep higher income debtors out of chapter 7.

Is the reform act at success? Hardly. Despite the fact that some changes in the law had the effect of supplying the court with more income information and imposed limits on repeat filers, the vast majority of changes were unnecessary and are detrimental to the process.

The Good Reforms:

  1. Limits on Repeat Filers.  The drafters of the reform act felt that some people file too often, especially on the eve a foreclosure sale. BAPCPA limited how often a person could file bankruptcy. Chapter 7 cases may only be filed once every 8 years and those individuals who have been debtors in several cases within the preceding year do not automatically get protection without seeking court review of their case.
  2. Forum Shopping.  Some states have generous exemption laws that protect a debtor’s property, while other states are more frugal. BAPCPA curtailed this process by requiring debtors to use the exemption laws of the state a they lived in the majority of the two years prior to filing bankruptcy.
  3. Homestead Exemption Limits.  Prior to BAPCPA, wealthier debtors moved to states with unlimited homestead exemptions (such as Texas and Florida) and protected their money by purchasing expensive mansions. BAPCPA put a cap on homestead exemptions.  Sorry kids, no moving to a beach house when daddy’s business goes down.
  4. More Income Documents Provided to Trustees.  Debtors must supply the bankruptcy trustee with their last two tax returns and 2 months of paycheck stubs.
  5. Bankruptcy Attorneys Responsible for Accuracy of Case.  The reform act holds bankruptcy attorneys to a higher standard and requires that they perform a due diligence investigation of the information reported instead of just taking the debtor’s word for its accuracy. Good attorneys always did this, but it is fair to say that the reform act has put a healthy amount of fear in the hearts of bankruptcy attorneys.  Many attorneys, including this one, now obtain background reports to ensure that all property and property transfers are reported.

The Bad Aspects of the Reforms:

  1. Cost of Bankruptcy Skyrockets.  The cost of filing bankruptcy immediately doubled when BAPCPA was enacted, and for good reason.  Attorneys must gather substantially more information to prepare the case, they must prepare six-month income calculations and investigate the debtor’s financial condition much like an auditor.
  2. Means Test.  To keep higher income debtors out of Chapter 7 and to establish a nationwide standard of how much debt had to be repaid in Chapter 13, BAPCPA created a mathematical formula based on a debtor’s last six months of income. In practice, however, the Means Test has been a disaster to administer.  The central defect of the test is that most debtors do not have consistent income in the six months prior to filing bankruptcy. It is common that debtors have lost a good paying job just shortly before filing bankruptcy, so the six-month average does a poor job to forecasting what the debt they can really repay.  Conversely, some debtors were unemployed for a substantial time prior to bankruptcy but obtained a higher paying job just before filing. Past income is often a poor predictor of what future payments should be, but the Means Test is built on this faulty foundation. In addition, some types of income are not counted as income on the means test, such as Social Security income, so the test is often passed by debtors who really should fail.  Lastly, the means test favors secured debt so higher income debtors with big homes and fancy cars commonly pass the test while debtors who denied themselves such luxuries find they fail the means test.  Because of its complexity and poor drafting, bankruptcy courts struggle to establish a uniform method to apply the test.  The Means Test has failed its basic purpose and should be abolished.  Those who claim the means test has reduced the number of bankruptcies being filed are dead wrong.  Bankruptcy filings are down because the general rate of participation in the workforce is down.
  3. Mandatory Credit Counseling.  The drafters of the reform act require debtors to take a credit counseling class prior to filing bankruptcy and another course before the case is completed.  The idea here is that if people would just spend a little time getting the facts about budgeting and money management, perhaps fewer folks would file bankruptcy. This sounds nice, but as practiced this credit counseling is generally worthless.  Most of the courses are completed online and debtors just click through a series of mundane questions.  No real counseling is occurring.  Tragically, less sophisticated debtors without access to the internet are unable to get the credit counseling completed and, consequently, their homes are being lost to foreclosure and their paychecks are garnished. Thousands of debtors have lost their homes to foreclosure because bankruptcy attorneys are unwilling to meet with debtors whose homes are scheduled for sale until they complete the credit counseling class prior to meeting them.  Requiring a family who faces the humiliation of filing bankruptcy to learn about money management is just pouring salt in an open wound.  A single mom earning $9 per hour doesn’t need a credit counseling class–she needs housing, education, health insurance, child care and a higher paying job.
  4. Private Student Loan Discharge.  Prior to BAPCPA, a debtor could discharge a private student loan but not federally guaranteed loans.  The reform act now protects private student loans from discharge, and as a result there has been an explosion of debtors saddled with unmanageable student loan debt.  Private student loans are the single worst debt in America.  College financial aid departments steer students to these dangerous loans without any real discussion of the burden this will place on graduates and their families. Students are often unaware of the significant differences in repayment terms between federally guaranteed loans which offer income-based repayment plans and private loans which do not.  BAPCPA has created a monster student loan debt nightmare for millions of America’s young families and for the parents who foolishly co-signed these loans.
  5. Extended Duration of Chapter 13 Plans.  Prior to BAPCPA a chapter 13 case could be completed in 3 years.  Debtors with above-median incomes are now required to remain in chapter 13 for 5 years so that, in theory, they can repay more of their debt.  In reality, this change has decreased the success rate of chapter 13 payment plans and it also causes higher income debtors to load up on secured debts–especially car loans–prior to filing their case.  Debtors tied up in 5 year cases are not buying homes, cars, furniture, etc., and the economy as a whole takes a hit by taking these consumers out of the market.  Five year payment plans are too long.

Image courtesy of Flickr and Woodleywonderworks.