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Tougher personal bankruptcy law looms

Harried consumers forced into bankruptcy will face even more obstacles to recovery if a bill that died in the 2002 session of Congress is revived, consumer groups fear.

The bill, sponsored by Sen. Chuck Grassley, R-Iowa, and vigorously supported by the finance industry, would create a host of new requirements for consumers who want to declare bankruptcy.

Proponents of the bill say the requirements are necessary and long overdue to prevent abuse. Opponents say the bill is grossly weighted in favor of creditors and punishes people in debt through no fault of their own.

More than 1.5 million Americans filed for personal bankruptcy during the fiscal year that ended in September, according to statistics from the Administrative Office of the U.S. Courts. Of those, more than 1 million filed for Chapter 7, the form that wipes out most debts.

Under the new proposal, those filers would have to pass a test to qualify. New bankruptcy regulations would measure the debtor's disposable income to determine the money available to pay creditors with an emphasis on earning potential, rather than actual income. The new system also would limit a filer to housing, transportation and food allowances based on regional norms.

Proponents say the changes would update the bankruptcy code and prevent abuse.

"We maintain that there is a lot in this bill that is good for consumers," says Gary J. Kohn, vice president of legislative affairs for the Credit Union National Association, an industry organization that was part of the coalition behind the bill.

Kohn and other proponents claim the new rules would benefit consumers in several ways, including requiring credit card companies to furnish information to consumers on how long it would take to repay their debts with minimum payments.

And consumers considering bankruptcy would be required to go through credit counseling.

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Bankruptcy bill imbalance?
Critics charge that if this bill becomes law, it will slow the bankruptcy process and make it more complicated and more expensive, effectively removing it as an option for many of those who truly need it.

"This particular bill would do more harm than good," says David Butler, spokesman for Consumers Union, the nonprofit group that publishes Consumer Reports. "It's so heavily weighted against debtors and toward lenders."

And with a soft economy and many people out of work, "The timing of the bill couldn't be worse."

Both sides of the debate admit that the bankruptcy system needs to be updated. But consumer groups contend that the current bill is not the right tool for the job.

"While it may be intended to solve some small problems, it may create several large ones," says David A. Greer, vice chair of the American Bar Association business section's consumer bankruptcy committee.

Consumer advocates worry that in trying to eliminate abuse, policy makers are throwing out the baby with the bath water.

"A bill that was originally aimed at preventing bankruptcy abuse has turned into a bill that would make it difficult for many other people to [declare bankruptcy]," says Butler.

Greer says that filing under current law is almost instantaneous, which is a boon to many consumers who file at the last possible minute to hang on to their homes.

The new bankruptcy process
The proposed system would add a few more steps.

First, individuals would have to attend credit counseling before they could file. Filers also would be required to present much more detailed paperwork to the court, including several years of tax returns. And their attorneys would be required to certify that the information was correct.

To qualify for a Chapter 7 bankruptcy, which under current law wipes out most debts, filers with more than a median income would have to prove they couldn't pay back either 25 percent of their unsecured debt over five years or $167 a month, whichever is less, says Henry J. Sommer, author of "Consumer Bankruptcy: the Complete Guide to Chapter 7 and Chapter 13 Personal Bankruptcy."

But here's the hitch, according to consumer advocates, the test looks at the amount of money an individual should be making and spending, not his or her actual income and expenses.

The new regulations would average the income for the past six months. This would be a particular hardship to people who turn to bankruptcy after losing a job, say consumer advocates.

"It may be assumed [they] have money left to pay debts that really isn't there," says Celia Wexler, director of research for Common Cause, a nonprofit organization that studies campaign reform.

Disposable income would be calculated based on regional norms for housing, transportation and food costs.

"The means test formula uses numbers that may not be accurate in terms of a debtor's real circumstances," says Samuel J. Gerdano, executive director of the American Bankruptcy Institute.

Proponents of the bill say that anyone with extraordinary circumstances, such as a chronically sick or handicapped child or an elderly parent in the home, would have some leeway. But consumer advocates counter that the way the bill is written, there isn't that much room to give.

In addition, they say the changes, which are backed by a coalition of financial services industry groups, shift the leverage in bankruptcy to creditors.

"It's a 450-page bill and it's very creditor-oriented," says Gerdano. "Whatever type of creditor you are, chances are there is something in this bill that favors you over the debtor. It changes the leverage between creditors and debtors."

Sommer also believes that the bill will open debtors up to coercion from creditors.

"[Under the proposed legislation] if you spend $500 on luxury items in the 60 days [prior to filing] bankruptcy, you will be presumed to have committed fraud," says Sommer, a Philadelphia attorney.

Defending the charges, even if they are false, would cost thousands, he says. The end result? Many consumers would be forced into repayment agreements that negate the point of their bankruptcy.

And the credit counseling requirement could create a nightmare for credit counselors, said Lydia Sermons-Ward, vice president of marketing and communications for the National Foundation for Credit Counseling, the nonprofit umbrella organization behind the nation's largest network of nonprofit credit counseling centers.

"It will push millions [of people] through the door," she says.

The bill died in Congress in mid-November largely because of an abortion protest-provision that had been attached to it. Whether the measure would be on the bill if it came back is open to debate. The provision, known as the Schumer amendment, added by Sen. Charles Schumer, D-N.Y., aimed to prevent abortion protesters from discharging protest-related penalties through bankruptcy.

The way the bill is currently written, the new regulations would take effect six months after it was adopted. In that period, both sides predict, filings would skyrocket.

"It's a virtual certainty that it will come back," said Travis B. Plunkett, legislative director for the Consumer Federation of America, a nonprofit consumer group. "I don't think the sponsors of the bill will just drop it."

-- Posted: Jan. 9, 2003

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