REVISIONS TO BANKRUPTCY LAW CREATE DRASTIC CHANGES

By Daniel Y. Gielchinsky, Esq.

On Wednesday, April 20, 2005, President Bush signed into law a long-expected series of legislation that drastically altered this country's bankruptcy laws. In order to fully explain the affect of this new legislation, some background is helpful.

There are three popular forms of bankruptcy relief available. A Chapter 11, which is used by corporate entities, can be thought of as a reorganization of debt. In short, the debt-ridden company can restructure its debt obligations to creditors and equity obligations to its shareholders through the use of a Chapter 11. A company can continue to run and manage its own day-to-day affairs in most cases, and the potential exists for a company in Chapter 11 to emerge from the bankruptcy with a significantly improved financial picture. In some situations, a company's management will continue to run the day-to-day affairs of the company, and the company is then referred to as a debtor-in-possession. Ironically, this leads to circumstances where the same inept management that put the company into its precarious financial situation remains in place during the company's continued management. In other circumstances, a representative from the United States Trustee's Office will be appointed by the Court to oversee the management and day-to-day operations of the company.

A Chapter 13 is a personal form of a Chapter 11. In a Chapter 13, the individual(s) who declared bankruptcy will be devising a plan to pay back their creditors over time. This form of bankruptcy is most often used when the debtors are in arrears on their mortgage for their residence. The advantage of using Chapter 13 in this circumstance is that this form of bankruptcy relief allows the mortgage arrearages to be "crammed down", or paid back to the bank over a period of time. The advantage of this form of bankruptcy is that it allows a distressed homeowner to remain in possession of the residence, and affords the debtor with an opportunity to pay back mortgage arrearages over what typically becomes a five year period. However, the debtor will necessarily be devising a plan to also pay back other creditors, such as banks, credit cards and other forms of debt.

A Chapter 7 bankruptcy can be used by corporate entities or individuals. A Chapter 7 bankruptcy is often referred to as a liquidation, since if the debtor obtains a discharge of its debts, there will be no repayments of the debts in the future. This form of bankruptcy is also most often thought of as a consumer bankruptcy, since it is most often used to discharge credit lines and credit card loans. The recent legislation is targeted directly at these consumer bankruptcies.

The bill that President Bush signed into law was not the first attempt by Congress and the Senate to limit the scope of Chapter 7 relief. The powerful banking lobby has been advocating the change in bankruptcy laws for a number of years. However, a similar bill with other measures attached to it was turned down by the Senate approximately one year ago. The recently passed legislation was strongly opposed by consumer rights groups who argued that it would prevent debt-ridden people from giving the "fresh start" that is envisioned by the bankruptcy laws.

The new law, which takes effect in six months, will have the result of converting what would have been Chapter 7 filings into Chapter 13 repayment plans. People at income levels that are higher than their respective state's median income level will have to pay some or all of their credit bills, medical bills and other obligations through a court-ordered bankruptcy plan. The new legislation encompasses a complicated formula that will be utilized to determine the type of bankruptcy relief an individual will be able to avail himself or herself. In summary, those people with discretionary incomes of $100 a month or more will be forced to use that income to repay their debts over a five-year period. It is estimated that between 30,000 and 210,000 people, representing approximately 4%-20% of those who discharge their debts through bankruptcy each year, will be disqualified from doing so under the new law.

Ironically, the legislation comes at a time when it seems to be least needed. New personal bankruptcy filings went from 1,613,097 in the year ending June 30, 2003 to 1,599,986 in the year ending last June 30, which runs counter to the upward trend of recent years. Needless to say, the downward trend will continue, although it is expected that there will be a spike in personal bankruptcy filings during the next six months, until the legislation becomes law.

Aside from the drastic effect the new law will have on those who need bankruptcy relief, one area of the legislation that was not well publicized was its impact on bankruptcy practitioners. The new provisions, which have raised major concerns among the bankruptcy bar, will require debtors' attorneys to vouch under oath for the accuracy of their clients' financial statements in a manner that greatly expands what was required under the old law. In the future, lawyers themselves could be held financially liable for their clients' misrepresentations. The net effect of these provisions will be to reduce the amount of bankruptcy practitioners, thus making it more difficult for individuals in need of bankruptcy protection to find a willing attorney to represent them. In so doing, the banking lobby has created another hurdle for individuals whose credit card bills, penalties and interest have gone over their head.

Clearly, the wide availability of a complete discharge of debt through the use of a bankruptcy will be greatly limited by the new legislation. Those who find themselves in a constrained financial situation are well advised to take advantage of the current bankruptcy laws before the new legislation goes into effect. We at Herten Burstein are able to provide a full range of bankruptcy services, including both debtor and creditor representation, bankruptcy litigation, relief from stay applications, and defenses of preferential transfer and/or fraudulent transfer claims.

Daniel Gielchinsky is an associate in our litigation department with extensive bankruptcy experience.