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Debtors hurry to file bankruptcy: Law that takes effect Oct. 17 makes filing harder, requires more to make restitution

September 26, 2005

Consumers who have been contemplating bankruptcy are now flocking to file before more stringent regulations take effect Oct. 17.

Federal lawmakers passed a bankruptcy reform measure in March to make it harder for people to wipe away unsecured debt while keeping some protected assets.

The aim is to curb perceived abuses of the system by shepherding more filers through Chapter 13-instead of Chapter 7-which requires consumers to at least repay some debt.

Indiana already has a high bankruptcy rate. The state ranked fifth in the nation in households per filing (46.2), as of March 31, 2004, according to the not-for-profit American Bankruptcy Institute in Washington, D.C. But filings are surging higher as consumers race to beat the deadline.

At the federal bankruptcy court in Indianapolis, which covers the southern half of the state, total bankruptcies in August were up 37 percent compared with the same time last year. Moreover, Chapter 7 bankruptcies spiked 46 percent, according to the Office of the U.S. Trustee.

"There is definitely a huge bump in filings right now," said Kevin Dempsey, assistant U.S. trustee. "The greatest change [under the law] is in the individual debtor arena, particularly Chapter 7."

The approaching law, known as the Bankruptcy Abuse Prevention and Consumer Protection Act, establishes means testing in bankruptcy proceedings. That is, bankruptcy courts will be required to look at the filer's income to determine what chapter of the bankruptcy code the debtor may file under.

Debtors who earn more than the median income in their state, and who can repay some of their debts, will no longer be able to have their debts erased as before, but will be put on five-year repayment plans.

Another important change requires debtors to undergo credit counseling from a not-for-profit agency within 180 days of filing. Critics contend the extra step will add more time to the pre-filing phase and increase the cost for those who can least afford it.

Christopher Baker, a bankruptcy lawyer at Hostetler & Kowalik PC, is chairman of the Indiana State Bar Association's bankruptcy and creditors' rights section. He foresees the cost to file a Chapter 7 rising from roughly $750 to $1,750, and a Chapter 13, from $2,500 to $3,500.

Part of the reason is that lawyers will need to verify the financial information, much like what is required of corporate executives under the Sarbanes-Oxley Act.

"This is something that, unfortunately ... is going to be a difficult and time-consuming process," Baker said. "It will be a new experience for everybody involved."

The Office of the U.S. Trustee, for example, will approve the credit-counseling agencies wanting to provide services to debtors and the education courses in financial management consumers need to exit bankruptcy.

Momentive Consumer Credit Counseling Service, a locally based not-for-profit that has counseled clients since 1965, has applied to provide both credit-counseling and debtor-education services.

President Connie Russell said she is preparing the staffs of the agency's 11 offices for what will be required, should Momentive receive approval. It has eight offices in Indiana and three in western Kentucky.

To be considered, credit-counseling agencies must have offered services for at least two years and have certified counselors.

The law is heavily supported by the banking and credit-card industries. Creditcard issuers say the new regulations will protect them from consumers who took advantage of loopholes to saddle the industry with losses of roughly $4 billion per year.

Upon passage in March, the American Bankers Association in Washington, D.C., lauded the legislation as a common-sense solution that was long overdue. The law continues to provide the Chapter 7 option for those who need a fresh start but closes it for "higher-income" filers who exploit the system, the ABA said.

Bankruptcy lawyer Mark Zuckerberg blamed the credit industry for the losses it has incurred.

"It's a mean-spirited law aimed at consumers and bankruptcy attorneys," he said. "This was a law bought and paid for by the credit industry. They extended credit to people they shouldn't have and now they're crying foul."

While Zuckerberg continues to take new clients, he said some of his brethren have stopped because they are reluctant to promise debtors they can file the paperwork before Oct. 17.

Zuckerberg predicted the number of filings will drop following the deadline but will rise again in the spring, after the holidays. He said the ripple effect from Hurricane Katrina and the high gas prices could be contributing factors.

"People are still going to get divorced," he said, "and they're still going to have medical bills."

Earlier this month, consumer groups had asked Congress to grant Katrina's victims relief from the new measure. But senior Republicans countered that the new law would not harm people unable to repay their debts.

Even before the hurricane, record numbers of people were rushing to file. Nationally, quarterly filings for the period from April through June were the highest in U.S. history, at 467,333-up 11 percent from the same quarter a year ago, according to the ABI.

For the period ending March 31, 2004, Utah led the nation, with one bankruptcy per 36.5 households, about double the national rate of one per 72.8.
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