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How Does the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Affect Your Rights?

M. Lewis Hall, III

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”), making the most significant change to the Bankruptcy Code since 1978.  Most of the changes made by the Act do not go into effect until October 17, 2005.  A few of the provisions, particularly the limitation on the homestead exemption, became effective immediately upon enactment.  The majority of the changes made by the new Act primarily affect individual consumer bankruptcy filings, but there are provisions affecting both corporations and small businesses.  This article briefly highlights some of the most important changes created by the Act with respect to individuals.

At the heart of the new Act is the abuse standard for Chapter 7 (liquidation) filings.  The abuse standard mandates that in order for a debtor to seek Chapter 7 relief under the Bankruptcy Code, he or she must pass one of two income tests, otherwise the debtor will have to resort to either a Chapter 11 (reorganization) or a Chapter 13 (reorganization) for bankruptcy relief.  The first test is passed if the debtor establishes that his or her income is at or below the applicable median income for his or her place of domicile as published by the Bureau of Census.  The Census Bureau currently sets the median income for a family of four in Florida at approximately $59,500.  Thus, if the debtor’s income exceeds $59,500, assuming a family of four, then a presumption of a bad faith arises subjecting the filing to possible dismissal.  To avoid dismissal or conversion, the debtor must pass what is called the “means test,” which uses a detailed formula to determine a debtor’s net income after allowable deductions.  If the debtor fails to pass the means test, it indicates that the debtor has the ability to re-pay some of his or her debt, making Chapter 7 relief unavailable.  

The limitation on the homestead exemption could be the most significant new provision in Florida, due to Florida’s unlimited homestead exemption.  The provision provides for a reduction in the debtor’s homestead exemption for additions in value made to a homestead through the use of non-exempt property by the debtor, “with intent to hinder, delay, or defraud creditors” during the 10 year period prior to the debtor’s filing.  The provision also states that any value in excess of $125,000, without regard to the debtor’s intent, added to the debtor’s homestead during the 1215 days (approximately 3 years and 4 months) prior to the filing may be included in a debtor’s estate, unless the added value was transferred from another homestead in the same state.  In addition, the provision provides for an absolute cap of $125,000 on the homestead exemption, if it is determined that the debtor is convicted of a felony that demonstrates that the filing is an abuse. The absolute homestead cap of $125,000 also applies where the debt arises from a criminal violation of a securities law, fiduciary fraud, racketeering, or where the debtor is guilty of an intentional tort or willful and reckless misconduct that causes serious physical injury or death to an individual.  However, even the absolute homestead cap has an exception.  The Bankruptcy Court has the discretion not to apply the absolute cap to the extent the equity in the homestead is reasonably necessary for the support of the debtor or the debtor’s dependents.  One example of the application of the applicable cap might result from an automobile accident in which a jury determines that the debtor was willful or reckless in causing the injury or death of another individual.  Under these circumstances, a bankruptcy filing might not protect the equity in the homestead in excess of $125,000.  In addition, the debtor’s homestead could be subjected to a forced sale in the bankruptcy case.

The new Act also contains a two-year residency requirement provision for state property exemption laws to apply.  The two-year residency requirement states that the debtor’s place of domicile for the previous 730 days will govern which state’s property exemption laws apply in the filing.  If the debtor did not maintain a domicile in a single state during the required period, then the Act provides for an alternative method (beyond the scope of this Article) in determining the applicable property exemption law.  

In addition, the new Act increases the list of possible exclusions from a debtor’s bankruptcy estate.  The most noteworthy of these exclusions include contributions to qualified benefit plans, education accounts or tuition credit accounts, and property transferred to tax-exempt organizations.  The qualified benefit plan exclusion specifically allows amounts withheld by an employer or received from an employee as a contribution to either a retirement plan subject to ERISA, deferred compensation plan, tax-deferred annuity, or health insurance plan to be excluded from a bankruptcy estate.  Currently,Florida law exempts from the debtor’s bankruptcy estate any interest in retirement plans that are qualified under 401(a), 403(b), 408, 408A, and 409 of the Internal Revenue Code of 1986. However, the new Act broadens the list of retirement plans that are exempt from the debtor’s bankruptcy estate, to include interests in a traditional Individual Retirement Account (IRA), Roth IRA, 401(k), 403(b), or 457 plan.  The Act does place a limit on the exemption for a traditional IRA or Roth IRA in the amount of $1,000,000 (adjusted for inflation), but the limit does not include amounts rolled over from employer tax-exempt retirement plans.  The exemption will not be affected by direct transfers from one qualified account to another or by distributions from qualified accounts that are deposited in another qualified account with 60 days.

Other notable changes within the Act include longer wait times before filing subsequent bankruptcy cases, greater document production requirements, mandatory credit counseling as a prerequisite to filing a bankruptcy petition, and a provision allowing the a Trustee to pay a tardily filed claim under certain circumstances.  The Act expands the list of non-dischargeable debts to include credit card debts for luxury goods in excess of $500 purchased within 90 days of the petition date or cash advances from a credit card in excess of $750 within 70 days of the petition date. Other non-dischargeable debts include property settlements in divorce, student loans from for-profit and not-for-profit organizations, condominium dues, and pension plan loans.  The Act also established new provisions dealing with the assumption of lease contracts for personal property and non-residential real property.  Important to the fishing industry in our area, the Actextends special Chapter 12 provisions (generally known as the Family Farmer Reorganization) to include family commercial fishing operations and aquaculture businesses.  Lastly, the Act reduces the automatic stay provision (the prohibition of collection activities) for second time filers.
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