Reasons for Low- and Moderate-Income Debtors to File for Bankruptcy Now Before the Law Changes

by David Yen

[Editor’s Note: This is the second half of an article addressing the new bankruptcy law, Public Law No. 109-8. The first half appeared in the May 2005 Illinois Welfare News. Read on for more reasons some debtors will want to file for bankruptcy before October 17, 2005, when the new federal law goes into effect 180 days after enactment.]

The much-discussed “means test” will force some debtors whose income is more than the median income in their state into Chapter 13 instead of Chapter 7 bankruptcy. However, many provisions will affect low- and moderate-income debtors who do not have to worry about failing the means test. Below are some situations where a debtor should consider filing for bankruptcy before the changes go into effect.

Debtor is ineligible for free legal services and, while currently judgment-proof, has health insurance, is employable, and may earn garnishable wages in the future. Under current law, a debtor who is not able to obtain free legal services but is struggling financially may be able to afford fees charged by a private attorney to file for a Chapter 7 bankruptcy. Once the new law goes into effect, attorney fees are going to increase because of increased paperwork needed to file for a bankruptcy and new rules that will make attorneys liable if documents filed in the case turn out to be inaccurate. The new law will require credit counseling before a case is filed and completion of a financial education course in order to get a discharge. While credit counseling and financial education have to be provided without charge to those who cannot afford to pay, debtors who have too much income for free legal services are likely to have to pay these fees. There are many new requirements, such as a requirement to file copies of tax returns or tax transcripts that will make it harder for debtors who file pro se to complete a case. The filing fee is also going to increase from $209 to at least $274. In the past this debtor might decide to wait to file for bankruptcy since there is no immediate reason to file. However, if this debtor waits, at the least filing for bankruptcy will be more expensive. In the worst-case scenario, the debtor may never be able to file for bankruptcy once the law changes because the debtor cannot save enough money to get the bankruptcy filed.

Debtor has a student loan which is owed to a for-profit entity and which debtor cannot repay. The new law extends the student loan exception to discharge to educational loans made by for-profit entities. This may include loans that are made by a debtor’s employer and that the debtor is expected to repay in addition to those made by for-profit trade schools.

Debtor owes a substantial amount of child support that has been assigned to someone other than the parent, legal guardian, or responsible relative of the child, the spouse or ex-spouse of the debtor, or the child and will be filing for a Chapter 13 bankruptcy. While never dischargeable in any kind of bankruptcy under current law, child support that has been assigned to a third party, such as the state child support agency, does not have to be paid in full during a Chapter 13 case. The Chapter 13 debtor must completely catch up on child support obligations to the custodial parent, but support that has been assigned to the state does not have to be paid in full during the Chapter 13 plan. The debtor pays as much as possible, and the rest will be paid after the Chapter 13 case is over, usually in three years. Under the new law, the debtor will have to pay all child support in full or, if that is not possible, will have to be in Chapter 13 for five years.

Debtor has been convicted of a crime of violence or a drug-trafficking felony and does not have reasonable prospects of being able to complete a Chapter 13 case in the near future. The new law adds a section which provides that if the debtor files a voluntary Chapter 7 petition but has been convicted of a crime of violence or a drug-trafficking felony, the case will be dismissed when dismissal is in the best interest of a victim of the debtor, unless the filing of the case is necessary to satisfy a child support, alimony, or maintenance obligation of the debtor. This is especially problematic if the debtor has been convicted of a “drug-trafficking crime” since who would have standing to object to the case as a victim of the drug-trafficking crime is not at all clear. May the state’s attorney object? How about a relative of someone who purchased drugs from the debtor? While there are certainly some cases where justice would be served by denying a Chapter 7 discharge, in other cases this could interfere with an ex-offender’s rehabilitation efforts.