Means Test and Counseling

New bankruptcy legislation, designed to prevent abuse and require debtors to pay for debts that they can afford to pay, went into effect on October 17, 2005. The legislation made it more difficult to erase debt and receive bankruptcy protection under Chapter 7 and Chapter 13 bankruptcy. Moreover, fewer people will be permitted to file for Chapter 7 bankruptcy under the new law, and more debtors will be forced to file for bankruptcy under Chapter 13.

Chapters 7 & 13 Bankruptcy

A debtor under financial strain can file for Chapter 7 or Chapter 13 bankruptcy. With a Chapter 7 bankruptcy, all of the debtor's unsecured debts are completely wiped clean. Additionally, debtors can keep their car and home if they are current with their payments and there is not significant equity in the property. The debtor's non-exempt assets are liquidated and given to his creditors, all the remaining debts are cancelled, and the debtor is given a clean or fresh start.

With a Chapter 13 bankruptcy, an interest-free repayment plan will be established. All of the debts are consolidated and the debtor makes payments on the consolidated debt total for up to five years. While the debtor has Chapter 13 protection, individual creditors must follow the consolidation plan and cannot collect directly from the debtor. Any debts that are not included in the repayment plan do not need to be repaid.

Means Testing

One of the most significant changes in the new bankruptcy legislation is the "means test.". The new means test is a two-part test, and it is used to determine whether a debtor has enough income, in addition to the income he needs to survive, to pay off a portion of his debt. Debtors who are deemed under the law to make enough money to pay off their debts will not be allowed to file for Chapter 7 bankruptcy. Under the old bankruptcy law, judges had greater discretion in allowing debtors to file for Chapter 7 bankruptcy based upon their personal circumstances.

Under the first part of the means test, a formula will be applied that exempts permitted survival expenses, such as rent and food, to determine whether the debtor can afford to pay 25 percent of his nonpriority unsecured debt, such as credit card debts. If debtors can afford to pay 25 percent of the nonpriority unsecured debt, then they will not be permitted to file for Chapter 7 bankruptcy. Under the second part of the means test, the debtor's income is compared to his state's median income. If the debtor's family has a combined gross income that is greater than the median family income for his state, then the law may require the debtor to file for Chapter 13 bankruptcy and utilize a repayment plan, as opposed to being allowed to file for Chapter 7 bankruptcy and clear his debts.

Essentially, with the addition of the means test, debtors will generally not be permitted to file for Chapter 7 bankruptcy if their income is above their state's median or they can afford to pay 25 percent of their nonpriority unsecured debt. The new law does however permit debtors to make a case that they have special circumstances and that a crisis beyond their control has forced them to file for bankruptcy. In qualifying cases of special circumstances, the judge may allow the debtor to file for Chapter 7 bankruptcy, even if the debtor doesn't technically qualify under the means test.

Mandatory Credit Counseling

A second significant change in the new bankruptcy law is that debtors filing for bankruptcy relief are subjected to a mandatory credit counseling requirement. In the six months prior to filing for bankruptcy, debtors must meet with an approved credit counselor in their jurisdiction for a 90 minute session. Additionally, before the debts are discharged, the debtor must attend money management classes at his own cost. If a debtor files for Chapter 13 bankruptcy and a creditor refuses to accept and negotiate a repayment schedule that has been proposed and approved by an approved credit counseling agency, then the judge can reduce the debts owed to that credited by up to 20 percent. Exceptions to the credit counseling requirement can be made if a debtor cannot receive counseling from an approved counselor within five days, or the U.S. trustee determines that the approved agencies are not adequate to provide the necessary counseling.

Related Resources