In 2005, Congress passed a massive overhaul to the bankruptcy system. The law, called the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), made a number of important changes to bankruptcy rules and procedures. The law changed the eligibility requirements for filing for Chapter 7 bankruptcy, created a new requirement that all filers complete credit counseling and debt counseling, and changed the rules for debtors who move from one state to another, among other things.
Eligibility for Chapter 7 Bankruptcy - The Means Test
In Chapter 7 bankruptcy, debtors ask the court to discharge (wipe out) all of their debts. (Certain debts survive bankruptcy and can't be discharged, including back child support and most tax debts.) In exchange for this discharge, debtors must give up any property they own that isn't exempt from collection. Most states exempt essential items, such as clothing, furniture, some home equity, tools, and a car. Nonexempt property can be taken and sold, so the proceeds can be distributed to creditors.
The 2005 law imposed a new requirement for those who wanted to file for Chapter 7 bankruptcy: Debtors must show that they wouldn't have enough money left over, after subtracting their necessary expenses from their income, to fund a Chapter 13 repayment plan. In Chapter 13 bankruptcy, debtors keep all of their property, but must repay some or all of their debts over time. Chapter 13 filers pay a monthly amount to the bankruptcy trustee, who uses the money to pay back the filer's creditors. If the court decides that someone who wants to file for Chapter 7 could repay some portion of what he or she owes, the court will not allow that debtor to use Chapter 7. A Chapter 13 repayment plan will be the only available bankruptcy option.
To figure out whether Chapter 7 bankruptcy is a possibility, debtors must take "the means test." First, debtors must compare their income to the median income in their state. If a debtor's income is below the median, the debtor passes the means test and can use Chapter 7. If not, the debtor must add up the particular expenses that are allowed under the 2005 law and subtract them from his or her income. If the amount left over is less than about $110 a month (this amount changes every few years), Chapter 7 is still an option. If the amount is more, the debtor may not be allowed to use Chapter 7.
The means test is complicated, to say the least. For more information on exactly how it works, check out Nolo's article The Bankruptcy Means Test: Are You Eligible for Chapter 7 Bankruptcy? You can also use Nolo's online means test calculator, which will guide you through all of the necessary math to figure out whether you can get a passing grade.
Pre-Bankruptcy Counseling Requirements
Before filing for Chapter 7 or Chapter 13 bankruptcy, debtors are required to take a credit counseling course. The purpose of this counseling is to figure out whether the debtor really needs to file for bankruptcy or could instead reach a repayment plan with creditors outside the bankruptcy system. If the credit counseling agency proposes a repayment plan, the debtor doesn't have to agree to it. However, the debtor will have to give a copy of the plan to the bankruptcy court, if the debtor decides to file for bankruptcy.
Before receiving a bankruptcy discharge (which happens at the end of a bankruptcy case), debtors must complete another counseling session, this time on debt management and personal finances.
The basic system and structure of bankruptcy is part of federal law; those are the same in every state. However, state laws play a role in bankruptcy, too. Every state has its own exemption laws, which determine what types of property debtors can keep in bankruptcy. These exemption laws vary widely: Some states allow debtors to keep all of their equity in a home, no matter how much it's worth; others protect only a set dollar amount of equity, sometimes as low as $5,000 or $10,000; others don't allow debtors to protect any home equity at all. Similarly, some states have very generous exemptions for personal property, bank accounts, and so on; others don't.
Because of these variations, Congress believed that some debtors were moving to states with more favorable exemption laws in order to file for bankruptcy there and "game the system." In response to this perceived problem, the 2005 bankruptcy law creates residency rules (the law calls them "domicile" requirements):
- Filers who have lived in their current state for at least two years may use that state's exemptions. Filers who have not lived in their current state for at least two years may have to use the exemptions available in the state where they used to live. (For details, see Bankruptcy Exemptions: Which State Exemption System Can You Use?)
- The time period is longer for homestead exemptions, which protect home equity. Filers who have lived in the current state for at least 40 months may use that state's exemption. Filers who have not may be subject to a cap on the amount of equity they can protect.
If you are considering filing for bankruptcy, you have a significant amount of equity in your home, and you have moved from one state to another in the last 40 months, you should speak to a bankruptcy lawyer to find out how much equity you will be able to protect in bankruptcy. Similarly, if you have valuable personal property that you want to keep, a lawyer can help you figure out what effect these residency requirements may have on you.
The 2005 bankruptcy law made a number of other changes as well. For example, bankruptcy lawyers are now required to personally vouch for the accuracy of the information their clients provide to the bankruptcy court. This requirement, along with the new paperwork and restrictions imposed by the 2005 law, makes it more time-consuming for attorneys to represent bankruptcy clients, which in turn leads to higher attorney fees. You can find detailed explanations of all of the changes imposed by the 2005 bankruptcy law in The New Bankruptcy: Will It Work for You?