Bankruptcy Laws: 

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Overview

On March 10, 2005, the Senate passed S. 256, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. President Bush signed the bill into law, which became effective on October 17, 2005. The following summary discusses changes in the consumer bankruptcy law affected by the bill. Unless otherwise noted, all references are to the United States Bankruptcy Code (“Code”). Either directly or indirectly, the content of the new law will have a material effect on consumer debt, real property transactions and home ownership.

General changes affecting consumer chapter 7, 11 cases under the Bankruptcy Code

• Time between discharges, multiple filings

Section 72(a)(8) was amended to subject a Chapter 7 debtor to denial of discharge if the debtor received either a chapter 7 or 11 discharge in a case field within 8 years of the filing of the subsequent case. This is designed to prevent multiple consecutive bankruptcy filings that are often used to delay foreclosures or other judgment executions.

Section 1328 was amended to include a new subsection (f) providing that a chapter 13 debtor will be denied discharge if the debtor received a discharge (1) “in a case filed under Chapter 7, 11 or 12 … during the four-year period preceding the date of the order for relief” in the pending case, or (2) “in case filed under chapter 13 … during the two-year period preceding the date of such order.” This is meant to discourage repeat filers, especially under Chapter 7. These provisions may have a material effect on the sub prime market as relates to borrowers who may have substantial incomes and even favorable mortgage credit histories, but are unable to immediately discharge unsecured debt based on the “means test” provisions referenced herein. Further, Chapter 13 may not be available as a subsequent tool to delay a mortgage foreclosure in the case of a previous filing.

• Required production of income tax returns and other documents; case dismissal for non-production

Section 521 of the Code has been amended to impose a number of new document production requirements on debtors. This material is aimed at determining the income of the debtor. First, a new subparagraph (a) (1) (B) provides that unless the court order states otherwise individual debtors must file together with their schedules:

• A certificate of an attorney or petition preparer indicating that the debtor was given an informational notice required by amended § 342(b), or, in the case of a pro se debtor, a certificate of the debtor that the debtor has received and read the notice;

• Copies of all payments advices or other evidence of payment received within 60 days before the filing of the petition, by the debtor from any employer of the debtor

• A statement of the amount of monthly net income, itemized to show how the amount is calculated and

• A statement disclosing any reasonable anticipated increase in income or expenditures over the 12-month period following the date of the filing of the petition.

“Monthly net income” is not a term defined in the Bankruptcy Code as amended by S. 256. The use if this term in § 521(a) (I) (B) requires a statement of “ current monthly income” (which, as referenced below, is a defined term used for both the new § 707(b) means test and for the amended “disposable income test” of § 1325(b)), together with the total amount of appropriate deductions for support expenses and secured debts. The difference between these two figures would appear to be the “monthly net income” required to be itemized.

Tax returns will not necessarily provide an indication of the debtor’s actual income, and various mortgage lenders have geared underwriting standards to “stated income” or other non-1040 verifications such as bank statements. This is a de facto acknowledgment of tax avoidance (if not evasion) and unclear how debtors who are in a foreclosure scenario, including perhaps a foreclosure involving a home equity credit line or second mortgage, are going to able to tie the income verification requirements of the new bankruptcy law to what was originally submitted as part of the loan application, including the FNMA 1003 and 1008 forms. With mortgage fraud rampant in certain parts of the country, this sets up a potential bank fraud scenario in every bankruptcy case that may involve a dispute with a debtor over income.

Second, new subparagraph (e) (2) (A) requires that each debtor, at least seven days prior to the 341 meeting (an initial meeting of creditors which under the old laws would be pro forma and last 15 minutes), provide both to the trustee and to any creditor making a timely request, a copy of the federal income tax return or transcript of the return (at the debtor’s portion) for the period for which the return was most recently due and for which the debtor filed a return. These requirements may apply only to individual debtors in Chapter 7 and 13 cases, since § 521(e) (1) (requiring the court to give copies of certain filings to creditors) is limited in this way. A failure by the debtor to produce the return or transcript requires dismissal of the case (presumably on motion if the trustee or requesting creditor) unless the debtor demonstrates that the failure to produce the return or transcript was beyond the debtor’s control. Currently, transcripts of tax returns may be obtained by completing Form 4506 and submitting the same to the IRS with a fee of $23. It is interesting to note that in amongst the maze of paperwork that is executed as part of a typical portfolio loan, many lenders have borrowers execute Form 4506 as part of “stated income” underwriting. The Small Business Administration (“SBA”) has bee requiring 4506 transcripts in front of the underwriting for years. 

Third, new paragraphs (f)(1)-(3) provide that each individual debtor in a case under Chapter 7, 11 or 13, must also, on request of a party in interest or the judge, file with the court, at the same time filed with the IRS, copies of any federal income tax return (or at the debtor’s option, a transcript of the return) for a tax year ending while the case is pending and for a tax year that ended during the three years before the case was filed, as well as copies (or transcripts) of any amendments filed to those returns. New paragraph (g) (2) provides that the filed returns or transcripts are to be available to any party in interest.

A new § 521(i) provides that if an individual debtor in a voluntary Chapter 7 or a Chapter 13 case fails to file all of the information required under § 521(a)(1) (including the new § 521(a)(1)(B) discussed above) within 45 days after filing the petition, the case must be dismissed on the 46th day and that any party in interest may request a court order to that effect, which must be entered within fives day of the request. The automatic dismissal may be delayed for up to 45 additional days on motion of the debtor made within the original 45-day period and on motion of the trustee, filed prior to automatic dismissal, showing that the debtor attempted in good faith to file the debtor’s payment advices and that the best interest of creditors would be served by administering the case. It is unclear whether this exception would apply only when the debtor has satisfied the other filing requirements of § 521(a) (1). Accordingly, debtors are going to have a limited ability to delay mortgage foreclosure proceedings in the event they do not comply with these disclosure requirements.

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