HEADS UP!! Major Changes Made to CONSUMER BANKRUPTCY PRACTICE
What the “Occasional Practitioner” Needs to Know Now About Consumer Bankruptcy Practice Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

By Ann D. Zeigler, Heather H. McIntyre & Cheryl R. Brown

This article briefly summarizes the major consumer-related changes to bankruptcy practice re-sulting from the passage of the Bankruptcy Abuse Prevention and Consumer Act of 2005 (the “Act”). Although most changes apply to cases filed on or after October 17, 2005, a few, related to the homestead exemption cap, were effective on April 20, 2005. The Act contains hundreds of changes to the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, the Internal Revenue Code, and other statutes, rules and regulations. There will be major financial exposure for missteps by lawyers and there are numerous traps for their clients. Here, in no particular order, are a few of the major areas of change.

The Law Firm Representing Debtors Is A Regulated Debt Relief Agency
Under the Act, law firms representing debtors face more significant exposure than they had under previous statutory language. For example, law firms now are included in the definition of a “debt relief agency,” which is an agency that, in exchange for money, provides bankruptcy assistance to a debtor whose debts consist primarily of consumer debts and who has less than $150,000 in nonexempt property. The Act places comprehensive restrictions on the conduct of law firms as debt relief agencies, and specifies various representations a debt relief agency must provide a debtor. Notable among the many restrictions is that a debt relief agency may not advise a person contemplating bankruptcy to incur more debt, even to pay an attorney or bankruptcy preparer for services in connection with filing bankruptcy. Debt relief agencies are financially liable to a debtor if they violate those restrictions, and also may face separate civil actions from state officials for damages and/or injunctive relief. In addition, a debt relief agency incurs liability for, among other things, providing assistance in a case that is dismissed or converted due to intentional or negligent failure to file required documents; or intentionally or negligently disregarding the regulations. Unfortunately, waivers of protections against law firms as debt relief agencies are not enforceable.
The Act also regulates “advertising” (which includes “specific mailings, telephonic or electronic messages, or otherwise”). It specifically requires the following clear and conspicuous disclosure in all communications other than to a current client: “We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.” Law firms will need to document that they have trained their staff to make these disclosures in all communications that could, even in part, be considered “advertising.” Records of disclosures to actual and potential clients, as well as written contracts with debtor clients, must be maintained for two years.

Credit Counseling Requirements.
Under the Act, an individual may not file a petition for bankruptcy relief unless he or she (in the case of spouses, both) completes an approved credit counseling course within 180 days before filing. The bankruptcy petition must be accompanied by the certificate of completion from an approved credit-counseling agency, along with any agency-prepared repayment plan. The debtor may delay taking the course until after the filing if he can prove the filing was caused by circumstances that he could not have known about in time to take the course. The “exigent circumstances” would not include filing to stop a foreclosure, since the debtor would have had notice of default and foreclosure for a significant length of time before filing the pre-petition.
In addition, once in bankruptcy, the debtor must complete a financial education mini-course before obtaining a discharge.

Exemptions and Lien Avoidance
The Act’s restrictions on the homestead exemption were effective April 20, 2005, and include:
Two Year Domicile Requirement for State Exemptions. To be eligible to take the Texas exemptions at all, a debtor must have resided in the state for two years before filing. If the debtor moved from another state within the two years, she may use the exemptions of the state she lived in for the longest period during the 180 days prior to the two years. The effect of this requirement on active-duty military families, or families moved involuntarily by a company transfer, is unknown.
Cap on State Homestead Exemption for Resident Here Less Than Three and One-Third Years. A debtor taking the state exemptions may exempt a maximum of $125,000 of the equity in a homestead if it was acquired during approximately three and one-third years (1,215 days) before the petition date. The equity exemption includes equity rolled over from a previous homestead only if the prior homestead was in the same state.
Non-Exempt-to-Exempt Transfers Within 10 Years May Reduce the Homestead Exemption. There is no equity homestead cap for long-time residents of Texas. But if a portion of the debtor’s homestead equity is attributable to transfers that meet the §548 requirements (hinder, delay or defraud a creditor), the debtor’s homestead exemption is reduced by that amount. This rule clearly prohibits “bankruptcy planning” transfers of non-exempt assets to exempt homestead. This also may mean that taking a financial planner’s advice to pay down the mortgage by additional principal payments will come back to bite the debtor because the Trustee must look back ten years, and the debtor must have the documentation. It also appears that this determination of the reduced homestead exemption amount must be accomplished before the deadline for objections to exemptions. In addition, new provisions require the Trustee to “bust” asset-protection trusts and other self-settled trusts, apparently giving the Trustee federal exemption power to avoid many kinds of “wealth protection products.”

Liens on Exempt Property
The Act does not specifically limit the personal property exemptions under state law. It does, however, provide a specific and extremely limited list of the exempt personal property household goods on which the debtor can compel the release of liens. The amendments specifically exclude from “household goods” all works of art (unless by the debtor, or her relative); electronic entertainment equipment with a total fair market value (“FMV”) of more than $500 (except one television, one radio and one VCR); items acquired as antiques with a total FMV of more than $500; jewelry with a total FMV of more than $500 (except wedding rings); and a computer (except one PC and related equipment), motor vehicle (including a tractor or lawn tractor), boat, or a motorized recreational device, conveyance, vehicle, watercraft or aircraft.

Reaffirmation Agreements
The Act prevents abuse of reaffirmation agreements by setting out in considerable detail the disclosures a creditor must make before reaffirmation of a debt. Before the debtor signs such an agreement, creditors must give a written disclosure that details the debtor’s rights and specifies: (1) the amount of debt reaffirmed, (2) the rates of interest, (3) the date payments will begin, (4) any filing requirements with the court, and (5) the right to rescind. The reaffirmation agreement also must include a certification that it does not impose an undue hardship on the debtor. This mandatory certification is made by both the debtor and the debtor’s attorney (who also must certify separately that he made an independent inquiry and believes the debtor will be able to make the payments on the reaffirmed debt).
A presumption of hardship arises if the debtor’s household expenses, in-cluding the reaffirmed debt, exceed the debtor’s income. If the presumption arises, the debtor must explain to the court how he can afford to satisfy the debt and identify any additional sources of funds to make the payments.

Statement of Intent as to Secured Property
The debtor must now carry out his Statement of Intent, specifying which secured property he will surrender, reaffirm, or redeem within 30 days after the creditors’ meeting. The automatic stay terminates 45 days after the creditors’ meeting on all secured debt that the debtor has not addressed. There will be no more “fourth option ride-through” under the debtor’s Statement of Intent; in other words, he cannot keep secured property while merely continuing to make regular monthly payments without reaffirming the debt, redeeming the deficiency, or surrendering the collateral.

Many Backup Documents Now Must Be Filed or Produced
The debtor now must keep that envelope full of documents he used to prepare his Schedules and Statement of Financial Affairs and (coming soon) Current Income Calculation. The Act lists specific documents that debtors must file in the bankruptcy case public records or provide the Trustee before the creditors’ meeting. A notable example is tax returns, which a debtor must give to the Trustee at least seven days before the first creditors’ meeting. Upon request, the debtor must supply this return to the creditor. Any tax return due post-petition must be filed with the court. Failure to submit tax returns results in dismissal of the case, unless the debtor shows circumstances beyond her control. The debtor must also file or produce all documents showing household income from all sources.

Chapter 13 Plans and Further Exceptions from Discharge
Lien Stripping in Chapter 13 Cases. The Act changes §1325 to disallow lien stripping of a purchase money security interest in personal motor vehicles acquired within 910 days (two and one-half years) of the petition date, or of liens on other collateral acquired within one year of the petition date. Secured claimants retain their security interest until the entire balance is paid (regardless of the collateral’s value), or a discharge is entered under §1328.
More Debts are not Dischargeable, Even in Chapter 13. Domestic support obligations (alimony, maintenance, child support) and property settlements are non-dischargeable.
Debt Incurred to Pay Non-Discharge-able Debt. Under Code §523, the Act excepts from discharge any debt incurred to pay taxes to a governmental unit, other than the United States (which already were non-dischargeable), that would be non-dischargeable. That is, debtors cannot replace non-dischargeable debt with dischargeable debt.
Student Loans. Under the subtitle “Priority Child Support,” the Act expands the types of student loan obligations excepted from discharge. The education loan exception to discharge now includes any qualified education loan, as defined in section 221(d) (1) of the Internal Revenue Code, incurred by a debtor.
Limitation on Luxury Goods. The Act expands the non-dischargeability of debts for luxury goods or services and cash advances. Consumer debts owed to a single creditor greater than $500 for goods or services (currently, $1,225) incurred within 90 (not 60) days before the order for relief are nondischargeable. Also non-dischargeable are cash ad-vances of $750 or more (as opposed to $1,225), incurred within 70 (not 60) days before the order for relief.

The (Semi) Automatic Stay (Not)
The “old” automatic stay under Code §362 was relatively simple and clear: it went into effect instantly and automatically upon the filing of the petition, and stopped all actions to collect a debt from the debtor or property of the debtor. Now, almost every aspect of the stay is riddled with exceptions and even can vanish without any action. The stay does not apply to governmental enforcement actions.
Termination of the Automatic Stay for Bad Faith Repeated Filings. The automatic stay terminates after 30 days if the case is filed by an individual debtor within one year after he had a case dismissed, unless a court continues the stay upon a finding that the refiling was in good faith. Courts must presume that a filing is not in good faith if: (1) the debtor had filed more than one case under chapter 7, 11, or 13 within the preceding one-year period; (2) a previous case was dismissed because the debtor failed to comply with a court order to amend the petition or schedules, perform the terms of a confirmed plan, or provide adequate protection; or (3) the debtor’s financial affairs have not substantially changed since the dismissal of the previous case. If two or more cases were pending within the previous year, the stay does not go into effect upon the later filing, unless the court, upon the request of a party in interest within 30 days of filing, finds that a filing is in good faith.
Terminating the Stay Against Real Property. A court may terminate the automatic stay against secured real property if the court finds that the debtor’s filing was part of a scheme to hinder, delay, or defraud the creditors. An order terminating the stay against real property, when properly recorded in the County Real Property Records, is binding in any other case filed under the Bankruptcy Code within two years. In a later filed case, the automatic stay would not apply to enforcement of liens recorded as a result of a properly recorded order.
Continuation of Pre-Bankruptcy Evictions. The Act allows the continuation of certain pre-bankruptcy eviction proceedings. The automatic stay does not apply to proceedings by a lessor against a debtor if the lessor: (i) obtained a judgment for possession prior to the bankruptcy filing date; or (ii) furnishes the court with certification of specific offenses by the debtor that necessitate an eviction. Debtors, however, are given 30 days from the date of petition to demonstrate and certify to the court that they are allowed to cure the default as a matter of law and that they have in fact cured the default.
Payments to the Bankruptcy Court Clerk on Lease Defaults. The Act in-cludes new provisions under which a debtor tenant must submit to the Clerk, with the petition, the payment of overdue lease payments, which the Clerk’s office must promptly transmit to the landlord. The debtor must continue making the rent payments to the Clerk during the bankruptcy, until stay relief is formalized by an order concerning the property. The timing issues under this provision appear to be a recipe for confusion, particularly in light of the regulations governing funds-handling by the Clerk’s office, resulting in circumstances in which there may be a “hovering stay.”
Priority for Domestic Support Obligations: the Stay Does Not Apply. Unsecured claims for domestic support obligations have first priority status over all other unsecured claims, including administrative expenses, except administrative expenses of a trustee to the extent the trustee administers assets that are otherwise available for the payment of such claims. For chapter 13 and individual chapter 11 debtors, the court may only approve or confirm a plan if the debtor makes all domestic support payments, required by statue or court order, due after the date of filing of the petition. A proposed plan must provide for payment of all domestic support obligation claims or must otherwise provide for the application of all of the debtor’s disposable income for the next five years to make payments under the plan. A case may be converted for failure to pay domestic support obligations.
To obtain a discharge under chapter 13, debtors must certify that all domestic support obligations due at the date of certification are paid. Debt due and owing for domestic support obligations is non-dischargeable, and exempt property under section 522 of the Code is still liable for that debt. Transfers to pay domestic support obligations are protected from preferential transfer actions under section 547.
The automatic stay does not stay a civil action or proceeding regarding: (i) establishment of paternity; (ii) modification of domestic support obligations; (iii) child custody or visitation; (iv) dissolution of marriage, except to the extent a property distribution is sought; (v) domestic violence; (vi) withholding income for payment of domestic support; (vii) restricting use of licenses; (viii) reporting overdue support; (ix) interception of a tax refund; or (x) enforcing a medical obligation under the Social Security Act.
There are many other stay-related amendments related to non-bankruptcy litigation and family law matters, a number of which are not located under §362.

And Now, The News You Have Been Waiting For:
THE MEANS TEST: PRESUMPTION OF BAD FAITH
[I – (E + SD + PC)] x 60 > (i) or (ii), whichever is less

“I”		is the six-month average of debtor and spouse’s
		current monthly income from all sources;
“E”		is the debtor’s monthly expenses per IRS allowances
		(without any payment on any debt);
“SD”		is the debtor’s average monthly payments on all
		secured debts; and
“PC”		is the debtor’s expenses for payment of priority claims
		(including taxes and child support)
(i)		25% of the debtor’s unsecured debt or $6,000,
		whichever is greater; or
(ii)		$10,000.

If the Chapter 7 debtor could pay at least $100 per month for 60 months (five years), the presumption of abuse arises and the Court must dismiss or convert to a Chapter 13. If converted, the debtors face an additional means test to determine whether they are eligible for a three-year Plan or a five-year Plan, and what amount they must contribute to their Plan.
“Extra Income”: The presumption of abuse arises if the debtor’s available monthly income under this calculation is:

<$100.00		No presumption arises
$100.00		Arises unless unsecured debt exceeds $24,000
$150.00		Arises unless unsecured debt exceeds $36,000
$166.66		Arises unless unsecured debt exceeds $39,998.40
>$166.66		Always arises

We are going to work through two hypothetical families’ means test to give you an idea of the problems with the test as it is set out in the Act.

Immediate Problems 1 & 2
Are the “state median income” and the debtor’s six-month average “current monthly income” gross income OR net of withholding? The Act and legislative history do not specify, and various language in the legislative history can be interpreted either way.
The preliminary filter is clear: If the debtor’s household gross six-month-average monthly income is at or below the state median income, skip the means test calculation entirely.
What Are the Real Median Income Numbers for Texas?
From the five median income numbers we found through the IRS link to the Bureau of the Census, we randomly chose the following 2004 median annual/monthly incomes for Texas. THIS IS AN ASSUMPTION. The 2004 median annual/ monthly figures for Texas for this exercise are:

1 person		$30,013/$2,501
2 persons		$39,248/$3,271
3 persons		$48,483/$4,040
4 persons		$57,718/$4,810

If the median income for a smaller household is a larger amount, the debtor in a larger household can take the larger amount from the smaller household, hence the oxymoron “highest median income.” The question is, how far above the state median can debtors be and still pass the means test after subtracting (E+SD+PD)?

SPEAKING EXTREMELY HYPOTHETICALLY
Meet our financially distressed hypothetical family number one: Joey and Jennifer Flashy (both big-bucks professionals who have been out of work recently due to the extremely unfortunate demise of their former company.) The Flashy teenagers are Ashley and Buddy, each of whom receives $1,000/month from an income-skipping trust set up by their grandparents when Joey and Jennifer went off to prison. The Flashy family lives in the part of Houston which is in Harris County. Since they got out four months ago they have started up a new real estate limited partnership investment marketing vehicle, and are bringing in $5,000/month each. (We will quietly ignore the fact that they neglected to make quarterly estimated income tax payments to the IRS due last week, although they did file their return for last year on time.)
Joey and Jennifer have just received the bills from their lawyers for defending them on various criminal and civil charges asserting fraud and securities violations. Since the lawyers turned out to be on the losing side, the Flashy family income has been drastically cut while Joey and Jennifer were involuntary guests of the United States for a year each. The Flashys are very unhappy with the size of their defense attorneys’ bills. So they decided to file a Chapter 7 to get rid of the nasty attorneys’ fees. They have had to shop around a little. But the Flashys now have a lawyer who sees things their way and is ready to do the math. Here’s how the math goes:

Income Calculation: Real direct income for Joey and Jennifer = $60,000 this month. The income numbers for the calculation, however, are not the real income, but the average of the six calendar months before the month in which the debtors file. Since the Flashys have only had income for the past month, due to paying the very steep start-up costs of their business to three corporations they created for the occasion, we start with $10,000.
There is no indication in the Act or the legislative history as to whether the income number for this calculation is “gross” or “net of tax withholding.” Since there appears to be no place to include tax withholding in the calculation, presume net/take-home income of the debtor and spouse. THIS IS AN ASSUMPTION.
The test specifies use of the income only of the debtor and debtor’s spouse. What about income (earned or otherwise, taxable or otherwise) by other household members which arguably is not “amounts paid by any other person or entity for the household expenses of the debtor or the debtor’s dependents”? We departed from the literal language, and honor the apparent spirit of the reforms, and chose to add the children’s monthly “gift income.” THIS IS AN ASSUMPTION.
Jennifer also gets $1,200/month in child support from Ashley and Buddy’s father, who has five more years to pay, assuming Ashley and Buddy live to be 21 and manage to get admitted to a college of any description anywhere. So, I=$13,200 (or maybe $11,200).

Expenses: not more than the allowances the IRS uses in calculating family budgets for tax workout plans, housing/utilities, transportation, and general household expenses. Some amounts may be subject to certain additions, after an evidentiary hearing showing necessity for specific purposes, such as maintaining a chronically ill or disabled household member or expenses for protection from family violence.
Housing/utilities, by county – actual expenses, not to exceed amounts that vary by county (e.g., Harris -$1,461, Fort Bend - $1,742, Montgomery - $1,609, Chambers - $1,384, and Galveston - $1,484). Expenses under this category do not include payment on any debt. But the amount is still designated to be taken. Does a debtor calculate the portion of the mortgage that is not payment on the actual secured debt, such as escrowed property insurance, property taxes, credit life insurance, etc.? The amount also must include a 12-month average of all utilities. What about the phone bill for a non-landline family – does it include only the debtor’s cell phones?
Transportation, by metropolitan region. The debtors get their actual expenses, not to exceed $462 in the Houston metro area. Since payment on secured auto debt is not included, this must include auto insurance, gasoline, repairs and maintenance. What happens with the family auto insurance covering non-debtors? Is the debtor’s gasoline expense, but not other household members’ to be included? The statute is unclear.
Other expenses, national average, based on actual family gross monthly income, not net. Take the whole allowance (not actual expense, if less); for a family of debtor’s size: $1,564. The debtors may be able to get an additional 5 percent for food and clothing, plus other additional amounts for health and disability insurance and health savings accounts, but only if these items are proven necessary for allowed expenses. We assume the family gross monthly income on the chart means the actual this-month gross family income, not a six-month average (THIS IS AN ASSUMPTION). So, for Harris County debtors, E= $1,461 + $462 + $1,564 = $3,487, plus whatever can be proved is really necessary, with the IRS standards as a benchmark.

Secured Debt: Take the actual total of the mortgage payments on the primary residence for the next 60 months (presumably including likely increases in escrows – THIS IS AN ASSUMPTION), and then divide by 60 to get the average monthly amount. Under the means test formula, the Flashys’ entire $4,000/month mortgage gets deducted. Using the same calculations for the four cars would add another $4,000. Other deductions include the secured debt on “other property necessary for the support of the debtors’ household.” There may be some whining about the $700/month on the secured note for Ashley’s Steinway concert grand piano, but she might have a great career someday as a musician if she actually practiced and we certainly don’t want to spoil her life too, do we? Therefore, for our calculation SD=$8,700.

Priority Debt: This includes taxes plus unpaid child support. Due to some unfortunate IRS “deemed income” rules, Joey and Jennifer owe about $60,000 in taxes, which is divided by 60 for priority tax debt per month of $1,000. Joey owes $1,200/ month to his ex-wife. Because his involuntary confinement left him a bit behind in those payments, he owes the amount due for each month of the current 60-month period, plus the total overdue child support, divided by 60. So, PD = $1,000 + $1,200 + $240 = $2,440.
The Flashy family calculation, therefore is I=$13,200, less E ($3,487 + $8,700 + $2,440) = $14,627 = a negative number. Based upon these hypothetical calculations, the Flashys will overcome the presumption of bad faith and be allowed to remain in Chapter 7 because they do not have excess income over allowed expenses.

Now, meet our hypothetical family number two: The Andersons, a family in East Houston. The family of four has had average monthly household income over the past six months of $4,877.67 ($10 over median). Mike just lost his job working swingshift at a nearby warehouse, due to being hit by an uninsured drunk driver. The family car was totaled. Jane works as a vocational nurse at a nursing home. Both teenagers, Mark and Liz, work as many hours as the labor laws allow at their minimum wage jobs. The Andersons all get around Houston by bus; they rent their four-room duplex on the Ship Channel for $600/month and have no medical insurance. Mike has racked up $110,000 in medical, pharmaceutical and therapy bills (paid by maxing the family’s two credit cards). As a result of the accident, the family is terribly behind with several department stores, from which they buy almost everything. Their total unsecured debt is $130,000. The Andersons are current on their taxes.

Here’s the calculation:

I=		$4,877.67.
E=		housing/utilities $1,461 or actual, whichever
		is less, so $600.misc./food/clothing – take
		standard regardless of actual, so $1,298
		transportation $462 if less than actual, so $462.
E=		$1,898 / no SD / no PD, so $1,898.
I – E =		$4,877-$1,898=$2,979 x 60=$178,740, is >
		the lesser of (i) greater of 25% of unsecured
		($32,500) or $6,000, so $32,500; or (ii) $10,000.

Using these numbers, the Anderson family does not meet the means test and thus are presumed to have filed in bad faith, which may result in their dismissal or recharacterization to Chapter 13, which would require that they go through the means test again (§1322). If current monthly income means the same thing it does in §707(b) (THIS IS AN ASSUMPTION), they would be $10/month over the state median income, causing them to go to a 5-year plan instead of a 3-year plan. Since Mike has no real current income (their “current” income is based on the six-month average, including his income from before the accident), they will not be able to actually perform under a Plan. The Andersons can’t afford a lawyer but are above the federal poverty level for getting a lawyer from Lone Star Legal Aid, so they will file pro se and will likely be unable to work the system. It is likely that they will be dismissed by the Chapter 13 Trustee.

In Conclusion
This is a brief summary of a few of the major changes to the consumer provisions of the Bankruptcy Code. Please feel free to be as depressed and/or panicked as regular bankruptcy practitioners are. On the other hand, if you enjoy sentences with quadruple negatives, and can do calculations on which a family’s financial life depends without knowing what several of the major terms of the calculation are, feel free to memorize the other 585 pages of the 2005 Amendments and join us at the Federal Building. In an upcoming issue of The Houston Lawyer, we will present a few of the major changes to business bankruptcy practice. Remember, the world changes at midnight on October 16, 2005.

Ann Zeigler, Cheryl Brown and Heather Heath are associates in the bankruptcy section of HughesWattersAskanase, LLP. They are all indebted (intellectually), to law clerk Patrick McCarren for working out the formula for the means test from the text of the Act.

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