Lenders Deal with New Bankruptcy Realities
Eight years in the making, and six months after it was signed into law, credit unions are now beginning to grasp some of the realities of the new bankruptcy reform law that went into effect in October.
What is becoming clear is just how unclear some aspects of the law are, including calculating the so-called "means-test" to determine ability to repay, a new mass of paperwork, particularly for the member declaring bankruptcy, and what one expert has said are potential "traps" when it comes to reaffirmations.
Jeff Kertman, an attorney who specializes in bankruptcy and who has primarily represented creditors with Klehr, Harrison, Harvey, Branzburg, Ellers, LLP, said credit unions are going to have to adjust to the new world created by passage of the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005 (BAPCPA).
"This is perhaps not the windfall either you or the consumer lending industry envisioned, because as you will see there are special interest groups even within the special interest groups," observed Kertman in discussing the new law with lenders attending the CUNA Lending Council's annual meeting here.
What the BAPCAP set out to do was rectify so-called bankruptcy law "abuse" by forcing consumers who could repay some of their debts to repay those debts by moving them from a chapter 7 filing to a chapter 13 filing. Kertman said the law will most certainly do that, in large part by placing greater liabilities on attorneys in chapter 7 filings.
In addition to that change, Kertman noted the BAPCPA also "raises the bar on bankruptcy eligibility" by:
* Creating a "means test" for filers for those who can pay at least in part.
*Requiring pre-filing credit and budget counseling for filers under both chapter 7 and chapter 13.
* Making discharge harder.
* Requiring attorney certifications of client financial information.
"I call these the gatekeeper provisions, and I think it's clear these will severely curtail the use of chapter 7 and herd filers to chapter 13," he said.
Under the credit counseling requirement, filers must obtain a briefing from an accredited credit counseling agency within the 180-day period preceding the bankruptcy filing. "There are no more 'eve of foreclosure' bankruptcy filings or to stave off the repo man," he noted.
The exceptions to the credit counseling requirements are for individuals who live in districts where no credit counseling is available, for people who are incapacitated, disabled or on active military duty in a war zone.
Kertman's comments came less than an hour after former CUNA Chairman Dick Ensweiler lamented to the CUNA Lending Council that to date no credit union has registered as a credit counseling agency.
In order to prove compliance, the credit counseling agency providing services must file a certificate with the bankruptcy court and a copy of the plan, if any, developed by the agency for the filer in the event of a bankruptcy filing. Kertman noted the new bankruptcy reform act also provides a "bevy of new paperwork. There is a continuing obligation for the debtor to provide documents, such as tax returns, in an ongoing bankruptcy case. The old paperwork norm has now been expanded. The paperwork obligations on consumer-debtors has grown substantially."
Despite the demands for more paperwork, Kertman said that as a practical matter he failed to see how it would make much difference for lenders. In fact, he noted that one Tennessee bankruptcy judge had observed that he believed lenders would be better off with a prorated return on all the new filing cabinets that will be required for all the new bankruptcy paperwork.
Perhaps the biggest challenge to credit union lenders in grasping the new reform act lies in the means-testing component that determines how much an individual will repay, and how often. As Kertman noted, "Abuse is presumed if the amount of the debtor's current monthly income exceeds allowable monthly expenses multipled by 60 by the lesser of: $10,000, or the greater of 25% of unsecured non-priority claims, or $6,000."
That, Kertman summed up as "Huh?"
"No one wants to do this math to determine the existence of presumption of abuse," he told lenders. "The government has spent six months developing software that will seek to make the calculation relatively automatic. Think of it this way, if the debtor can repay a minimum of $6,000 of his or her debts over the next five years, they cannot take advantage of chapter 7."
Within the means test are other components for figuring expenses relative to national and local standards and issued by the IRS, while other expenses are exempt, such as health and disability insurance, expenses paid for the care of the elderly or disabled family member, and up to $1,500 per year for school expenses for a dependent child. In determining the allocation of secured debt payments to the allowable expense calculation, the aggregate secured debt payments that will be made over the five-year period after the bankruptcy filing are divided by 60.
With many credit union lenders nodding in agreement, Kertman said, "It leaves me wanting, frankly, for a simpler, more cogent means test. If you have any discernible excess income beyond your monthly expenses you are going to be shoveled over to chapter 13. The commentary I've seen is the means-test will only affect about 25% of the chapter 7 filers today. I don't agree with that as a practical matter, because of the complexity of the matter."
Under BAPCPA, the signature of the debtor's attorney on the bankruptcy petition is a certification that the attorney has performed a reasonable investigation into the facts and financial disclosures described by the debtor.
"This has created a chill in the air for those attorneys who specialize in consumer chapter 7 debtors," said Kertman. "I've represented about 50 individual (filers) in my career, and that number will never reach 51, as there is no way I will permit myself or my firm to be subject to the liabilities. Counsel are effectively becoming guarantors of the accuracy of their clients' financial disclosures. It's ingenious really. Congress has made sure that no attorney would counsel anyone into chapter 7 based just on the attorney's own liabilities. The risk is simply not worth the reward. Those who remain in this arena will have to charge even more than they previously did, and that also makes the barrier to entry higher."
The New Strip-Down
Credit union lenders are also now dealing with new aspects related to the "strip-down" of automobile liens. Under the old law, a chapter 13 debtor could bifurcate debt according to secured and unsecured amounts. That is no longer the case; now a vehicle's value is its retail replacement value.
"The bottom line here is more debtors are going to pay more of their auto loan debt as a chapter 13," said Kertman, before adding wryly, "Congratulations. You're now in the position of putting used car salesmen on the stand at trial as your expert witness."
Under the new law, the plan must pay secured claims in full without regard to the value of the underlying collateral. "This is a pretty significant change to the prior law," noted Kertman. "I think what is going to happen is that if the filer is unable or unwilling to pay on that claim, the debtor is going to abandon the collateral. So be prepared for that. Perhaps you'll want to negotiate a discounted loan payoff if you don't want the collateral."
Some other changes:
* The time period in which a debtor can get another discharge has gone from six years to eight years.
* IRAs and similar retirement funds are now exempt. Someone who has filed can continue to put money into a retirement account as an allowable expense. "Some have suggested this favors relatively wealthier" filers, observed Kertman. "Any 529 (student) account is excluded from debtor's estate if opened 364 or more days prior to filing."
* The law addresses "intent" to swap non-exempt assets for exempt assets, that is to protect assets. Filers may no longer exempt real estate valued at more than $125,000 that was bought within 1,215 days prior to filing.
Not Everything Favors Lenders
* The act is not completely tilted in favor of lenders, Kertman said. A credit union, for instance, must credit even partial mortgage payments to loan balance or suffer potential liability. "This is a reform designed to curb practices of some lenders that failed to credit payments that might be somewhat less than the contracted loan amount."
Another area in which the BAPCPA seems to favor debtors, said Kertman, is reaffirmations.
"There is a presumption against approval of reaffirmation agreement that arises where debtor's income minus expenses does not permit payment, except for credit unions. I congratulate you and your lobby for getting this built into the bill," he said of a provision that was inserted with backing from the credit union lobby.
"The new rules should be read as traps," Kertman continued. "You will undoubtedly be seeing a lot of prebankruptcy settlement proposals from your credit-challenged borrowers equal to 60% of their debt. Otherwise, you risk the debtor's subsequent allegation that your refusal to do so was unreasonable. This is a new development that will likely be used against you."