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

by David Yen

The new bankruptcy law, Public Law No. 109-8, was signed by President Bush on April 20. The changes that affect low- and moderate-income debtors in Illinois apply to cases filed on or after October 17, 2005 (180 days after enactment). As mentioned in my article in the March 2005 issue of Illinois Welfare News (“Don’t Believe the Hype: Bankruptcy Bill Will Harm Low- and Moderate-Income Debtors”), 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 has public benefits overpayments that are alleged to be fraudulent. Elimination of the Chapter 13 “superdischarge” for debts incurred by fraud means that (a) if overpayment was fraudulent, it will not be discharged in a Chapter 13 plan; (b) even if it was not, debtor may have to rebut a claim that the overpayment was fraudulent or else the debt will not be discharged in Chapter 13. Many debtors cannot afford the legal fees needed to show that the overpayment was not the result of fraud. Under existing law, debts incurred by fraud are discharged when a debtor successfully completes a Chapter 13 plan even if the debts were not paid in full. This means that the debtor who files a Chapter 13 plan in good faith does not have to litigate the issue of fraud. Since debts incurred by fraud will no longer be discharged in a Chapter 13 case, if the debtor cannot rebut an accusation that the debt was the result of fraud, the debtor will have to pay 100 percent of all debts in order to get a discharge.

Debtor owes money to utilities or other creditors due to alleged fraud, theft, embezzlement or a willful and malicious tort which caused personal injury or death but which was not the result of drunk driving. Elimination of the Chapter 13 superdischarge also applies to these debts. (Debts resulting from drunk driving were already not dischargeable in either a Chapter 7 or a Chapter 13 bankruptcy). Debtors frequently have problems proving that these debts should be discharged since a trial may be required, the debts may be old, and the creditor may have better records and more resources. The consequences can be dire. If a utility claims that service was stolen and the debtor cannot rebut the charge, the debtor will have to pay 100 percent of all debts in order to get a Chapter 13 discharge. If the debtor does not have enough income to do this, then the debtor may not be able to obtain a Section 8 voucher. A debtor who has a large, nondischargeable tort judgment arising out of willful and malicious conduct may be faced with 20 years of wage garnishments.

Debtor is “upside down” on a car purchased after April 21, 2003. A debtor is “upside down” on a car when the debtor owes more than the car is worth. Under existing law, the debtor can “strip down” any debt where the value of the collateral is less than the amount owed. The debtor pays 100 percent of the value of the collateral, with interest, and the difference between the value of the collateral and the amount owed is paid along with other unsecured debts, without interest, usually at much less than 100 percent. The new law eliminates a debtor’s ability to strip down a loan that was used to finance the purchase of a vehicle within 910 days before the filing date. If a car was purchased before April 21, 2003, the debtor will still be able to strip down the loan. However, if the car was purchased after April 21, 2003, and the case is filed after the new law becomes effective, the debtor will have to wait until it has been more than 910 days since the car was purchased to strip down the loan. If the loan has a very high interest rate, the debtor may be able to reduce the interest rate by filing for Chapter 13, but the debtor will not be able to reduce the amount that has to be repaid to reflect the real value of the car. This is not limited to new cars—it applies to used cars purchased by the debtor as well.

Debtor received a discharge in a case filed between October 17, 1997, and October 16, 1999, and is in need of Chapter 7 bankruptcy relief. The time between Chapter 7 discharges has been extended from six years to eight years. This means that the debtor who got a Chapter 7 discharge during this period may get a discharge if a case was filed within six years and before the new law goes into effect but would have to wait up to two additional years if the debtor does not file before October 17, 2005.

Debtor received a Chapter 7 discharge after October 17, 2001, or a Chapter 13 discharge after October 17, 2003, and is in need of Chapter 13 bankruptcy relief. Under current law even if the debtor has recently received a bankruptcy discharge, the debtor may still file for Chapter 13, and as long as a plan is filed in good faith and meets other requirements for confirmation, the debtor may confirm a Chapter 13 plan even if the plan pays less than 100 percent as long as the plan represents the debtor’s best efforts to repay the debts for at least three years. This may preserve or reinstate a driver’s license needed for employment, preserve or restore essential utility service, protect wages from garnishment, or prevent recoupment or offset of public benefits. The new law says that if the debtor received a Chapter 7 discharge within the previous four years or a Chapter 13 discharge within the previous two years, the debtor may not get a Chapter 13 discharge. The debtor would either have to wait until the time period passed to be able to file for Chapter 13 or would have to propose a plan that would pay 100 percent of unsecured debt, with interest, and this may be beyond the debtor’s ability to pay. A debtor who needs to file for a Chapter 13 bankruptcy to stop a mortgage foreclosure may still do so, but such a filing may be more expensive if the debtor also owes other debts.

This is the first half of a list of reasons to file bankruptcy before the new federal law goes into effect. Next month’s issue of Illinois Welfare News will feature four more reasons.

David Yen is the bankruptcy specialist at the Legal Assistance Foundation of Metropolitan Chicago (312.347.8372).