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2005 change in US bankruptcy law

The main questions are (1) in what ways the law changed the fundamentals of the bankruptcy process and (2) distortion in bankruptcy statistics, i.e. to what extent bankruptcies that would have occurred later were drawn forward in time.

Summary

26 Jun 2010.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, effective Oct 2005, was mainly intended to make it more difficult for individuals to file for Chapter 7 bankruptcy, under which most debts are forgiven, encouraging rather Chapter 13, under which more is repaid. This was in reaction to a long-term, five-fold increase in bankruptcies from 1980 to 2002.

The Act also made Chapter 11 business reorganizations more difficult and costly. For example, the court can no longer extend leases beyond 7 months without the consent of the lessor, vendors have stronger rights to reclaim goods already delivered or seek priority payment, and utilities may demand deposits in order to continue service.

As a result of the change in law, there was a peak in bankruptcy filings in 2005 and a drop in 2006. This exaggerated the growth in bankruptcies in the credit crisis of 2007 and following.

Graph

26 May 2011. Data through the Q1 of 2011.

Click for larger image. Data are from the Administrative Office of the US Courts, via the American Bankruptcy Institute.

Highlights

Clippings below covered through 26 Aug 2009.

Confounding with credit crisis effects (9 Feb 2008) Consumer difficulties, seen, for example, in credit card defaults, increased significantly in 2007 relative to 2006. But this was in part because bankruptcies, and hence many consumer defaults, were accelerated into 2005 due to the change in the law.

Effect on business reorganizations (15 Aug 2008) Although most of what has been written about the act was regarding consumers, the new law also made business reorganizations (chapter 11) more difficult and costly. For example, (1) the court used to be able to extend leases indefinitely, but now leases can only be continued past 7 months with the consent of the lessor, (2) competing reorganization plans can be submitted earlier, (3) utility companies may demand a deposit or other credit enhancement in order to continue service, (4) vendors have improved rights to reclaim goods already delivered, or to demand priority payment, (5) employees have higher priority claims to at least some part of their wages.

Foreclosure and chapter (9 Feb 2008) Under Chapter 13 foreclosure is delayed while a repayment plan is negotiated.

Intent, and effect, on personal (26 Jun 2010) The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, effective Oct 2005, was mainly intended to make it more difficult for individuals to file for bankruptcy under Chapter 7, under which most debts are forgiven, and to force individuals to file under Chapter 13, under which part of all of the debts are repaid under a plan. However the fraction of Chapter 13 filings was unchanged in the long run.

Longer term bankruptcy growth (9 Feb 2008) 1980 - 2002 there were two important trends. The absolute number of non-business bankruptcies rose from about 288,000 to about 1,538,000 (more than five-fold), and the non-business bankruptcies as a share of total bankruptcies rose from 87% to 98%.

Sources

See also

Clippings below were used in the construction of this page

Longer term bankruptcy rates

Sep 2003. Minneapolis Fed.

http://www.minneapolisfed.org/pubs/fedgaz/03-09/cash.cfm

“Cash me out. Frank Jossi”

“American Bankruptcy Institute (ABI) reported that more Americans filed for bankruptcy in the first quarter of this year than in any quarter in history, a total of more than 413,000—on pace for another record year. … Since 1980, bankruptcy filings have exploded. Last year bankruptcies grew to 1.6 million, about five times the 1980 figure. … In 1980, 87 percent of the nation's 331,264 bankruptcies were filed by consumers. By 2002, that figure had grown to 98 percent.

Consumers and businesses also have different filing options available. Most consumers pursue what's known as Chapter 7 bankruptcy, a measure releasing them from most debt liability after they pay off as much as they can. In most cases Chapter 7 allows consumers to keep their houses, an automobile, insurance, wages and retirement funds and some property. A Chapter 7 shows up on credit reports for a decade, making it more difficult for consumers to get credit again without paying high interest rates. Chapter 13, in contrast, allows debtors the option of paying back secured creditors—banks, mortgage companies and so forth—as well as unsecured creditors, who usually receive a portion of the total payment over a three- to five-year span. (A rule of thumb is 10 cents on the dollar, but those figures are determined by a bankruptcy trustee and the debtor.) Chapter 12, meanwhile, is designed for family farms, and Chapter 11 handles business bankruptcies, although consumers can also use it in rare cases.

The ABI statistics show nationally around 70 percent of debtors have filed Chapter 7 bankruptcies since 1990. In the Ninth District, Chapter 7 represents more than 80 percent of the filings in every state.”

Summary of changes that affect business reorganizations under chapter 11

May 2005. A summary prepared by the State Bar of Texas.

http://www.texasbusinesslaw.org/bankreform.pdf

“S. 256: THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005”

“a significant portion of the Act amends commercial provisions to title 11, United States Code (the “Bankruptcy Code” or the “Code”). These commercial amendments will have an impact on many companies, including debtors and those that deal with Chapter 11 debtors in commercial relationships. This summary identifies and summarizes the most significant changes. …

[Leases:] Unexpired leases of nonresidential real property in which the debtor is the lessee are deemed rejected and must immediately be surrendered to the lessor by the earlier of 120 days after the commencement of the case, or the date of the confirmation of a plan. The court, for cause may extend the 120 day period for an additional 90 days, but any extension subsequent to the additional 90 days is available only with the consent of the lessor. … [previously] the court had the authority to grant unlimited extensions of [an initial] 60 day period, for cause shown by the debtor. …

[Representation on committees:] The Act also allows the court to order the U.S. Trustee to allow small business concerns that hold a claim that is, in comparison with its annual gross revenue, disproportionately large, to the creditors' committee. …

[Warehouseman's lien:] The Bankruptcy Code previously allowed a trustee or debtor-in-possession the authority to avoid certain statutory liens. This amendment clarifies that a warehouseman's lien is not avoidable under Bankruptcy Code Section 545. …

[Preference Lawsuits:] This amendment to the Bankruptcy Code is designed to prevent business debtors or liquidating trustees from filing preference actions against smaller creditors – i.e., creditors who received a preference payment that is less than $5,000. …

[Exclusivity:] The previous law provided that only a debtor may file a chapter 11 plan in the first 120 days of the case. However, the court could extend or reduce the 120 period on a showing of good cause. The new law provides the same 120 day initial period, however, it denies the court the authority to extend the exclusive period beyond 18 months after the petition is filed. … In large commercial cases, this may lead to committees or large creditor groups submitting competing plans more frequently. …

[Utility Companies:] The Act clarifies the requirement that a debtor provide its utility companies with “adequate assurance of payment” in exchange for the prohibition against a utility from refusing service … This amendment addresses utility companies' complaints that courts frequently order such utility companies to continue service to debtors without what they perceive as a real assurance of payment of future charges. …

[Seller's Right to Reclaim Goods:] A seller now has a right to reclaim goods received by the debtor 45 days prior to the commencement of the case and gives the seller up to 45 days to send written demand for such reclamation. …

[Vendors' right to priority payment:] Even if a seller does not meet the requirements for a reclamation claim, the value of any goods received by a debtor in the ordinary course of its business within 20 days prior to the commencement of a case now receive administrative priority. This is a very significant change in the law which is highly favorable to vendors dealing with bankruptcy entities. …

[Fraud look back:] The expanded look-back period allows a trustee or debtor-in-possession to avoid a transfer that meets the elements of a fraudulent transfer within two years (instead of one year) prior to the commencement of a case. …

[Wage Priority:] This amendment is an attempt to provide expanded protection to employees of companies that file bankruptcy. The law increases the amount that an employee can claim as a priority claim, such employee's prepetition claims for wages and other benefits, including contributions to employee benefit plans from $4,650 to $10,000. Priority claims receive payment ahead of general unsecured claims, and such claims typically are paid at the beginning of the case. …

[Key Employee Retention Plans:] includes limitations on the payment or allowance of retention bonuses and severance pay to key employees of the debtor.”

High level view of the change in the law

31 Jan 2008. Wikipedia.

http://en.wikipedia.org/wiki/Bankruptcy_Abuse_Prevention_and_Consumer_Protection_Act

“The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Pub.L. 109-8, 119 Stat. 23, enacted 2005-04-20), providing for significant changes in bankruptcy in the United States, was passed by the 109th United States Congress on April 14, 2005 and signed into law by President George W. Bush on April 20, 2005. The effective date for most of its provisions apply to cases commenced on or after October 17, 2005. Referred to colloquially as the “New Bankruptcy Law” … the intent of the law was to make it more difficult for individuals to file for bankruptcy under Chapter 7, under which most of their debts are forgiven (or discharged) and to force individuals to file under Chapter 13 under which part of all of the debts are repaid under a plan”

A concise summary of 7 and 13, and the change to each

Nov 2008. NY Fed staff research report.

http://www.newyorkfed.org/research/staff_reports/sr358.pdf

“Seismic Effects of the Bankruptcy Reform. Donald P. Morgan, Benjamin Iverson, Matthew Botsch”

“Bankruptcy is court protection of debtors from creditors and debt collectors. While under bankruptcy, a judge stays all collection efforts—foreclosure, repossession of other assets, civil suits, garnishment of wages, and dunning—while the court determines which debts get discharged (forgiven), and which the borrower must repay from asset sales or future income. That division depends on which chapter of the bankruptcy law the borrower files under and the bankruptcy exemptions in the filer’s state. Under Chapter 13 (rescheduling), filers get to keep all their assets but commit to continue paying creditors for three to five years out of future income. Under Chapter 7 (liquidation), filers keep all their future income but lose any home equity that is not exempt under their state’s bankruptcy law (Table 2). Any unsecured debts, including credit card and personal loans, that are not paid from the proceeds of liquidation gets discharged. [after reform] only filers whose income over the previous six months is below the median for their state automatically qualify for Ch. 7 and the discharge. Better-off filers whose means (defined as income minus IRS-recognized expenses, payments to secured creditors, and priority payments) exceed $166.67 per month must continue making payments to unsecured creditors for five years under Ch. 13. If Ch. 13 filers fail to make payments, the bankruptcy stay is removed and creditors can resume collection efforts, including foreclosure.”

No useful long term effects of 2005 bankruptcy law change

26 Aug 2009. Credit Slips.

http://www.creditslips.org/creditslips/2009/08/another-sign-of-the-futility-of-the-2005-bankruptcy-law.html

“Another Sign of the Futility of the 2005 Bankruptcy Law. by Bob Lawless”

“A big feature of the 2005 changes to the U.S. bankruptcy law was supposed to be a means test that would get people into chapter 13 instead of chapter 7. Because a chapter 13 requires a 3- or 5-year repayment plan, the law's advocates pitched it as an attempt to force “can pay” debtors to repay a portion of their debts. Initially, chapter 13 rates did go up, but that was a statistical artifact of the huge surge in filings just before the 2005 law. As I have noted previously, the chapter 13 rate has been declining ever since.

I am now officially going to call it ….

Anyway you measure it, chapter 13s have returned to their historical level. In fact, one could even interpret the data to show that chapter 13s are slightly below their historical norms. As a percentage of all filings, the chapter 13 rate for July 2009 was 28.1%, and the chapter 13 rate for the first seven months of 2009 was even less–27.6%. In 2004, chapter 13s were 28.1% (the red line in the graph) and from 1999 - 004 they were 29.0%. The 2005 bankruptcy law accomplished nothing about chapter choice.

This is just another sign of the futility of the 2005 bankruptcy law. As I've said on numerous occasions, it did nothing to change the underlying economic reality for consumers in deep financial distress. It's not a surprise that the supposedly central goal of the law–more chapter 13s–has not come to pass. Of course, the unstated goal of the 2005 bankruptcy law was to raise the cost of filing and lower the benefit of doing so that consumers would wait longer to file bankruptcy while paying huge default interest rates and penalty fees. In a paper that my colleagues and I published out of the Consumer Bankruptcy Project data, we found the effect was exactly that–consumers are waiting longer to file bankruptcy.”