Business Owner Credit Card Deals and the Bankruptcy Abuse Prevention and Consumer Protection. Act of 2005 (S.256)

July 09, 2007

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect in October, 2005. The goal of the act was to decrease the number of bankruptcies, especially Chapter 7. Bankruptcy statistics follow a fiscal year that ends in March, so BAPCPA took effect halfway through FY 2006. As expected, the number of bankruptcies filed that year increased considerably as people filed prior to the new law taking effect.

During the last quarter of FY 2006, bankruptcies did fall dramatically to below pre-1985 levels.

The figures for FY 2007 haven’t been posted yet, and it’s not certain whether BAPCPA has had the intended effect or not. What is certain is that the law has made it more difficult for an individual or small business owner to file Chapter 7.

The Results of Bankruptcy Reform

The impetus behind bankruptcy reform was the rapidly growing number of bankruptcies involving unsecured, or consumer credit card debt. In bankruptcy proceedings, unsecured debts are repaid after secured debts, and millions of dollars in consumer credit card debt was simply being written off.

There was also a perception that people were using bankruptcy as an easy out of paying their debts. High income individuals were able to file bankruptcy and get debt relief as easily as low income individuals.

Many people feel that the real reason behind the increase in bankruptcies was free and easy credit. You know those hundreds of credit card deals you get in the mail every month. Some people argued that credit card companies were preying on people by making it too easy for them to get unsecured credit.

The result of bankruptcy reform was to make it more difficult for individuals and small businesses to get credit relief, especially through Chapter 7.

Types of Bankruptcy

It is difficult to separate individual and small business bankruptcies. Most small business owners use their own funds — often unsecured credit card debt — to finance their businesses, so business bankruptcy often involves personal bankruptcy. According to the National Association of Consumer Bankruptcy Attorneys, 20% of consumer bankruptcies are due to the failure of a small business.

There are three types of bankruptcy that a small business owner or individual could become involved in: Chapters 7, 11 and 13.

Chapter 7 is debt liquidation or straight bankruptcy. Your assets are sold and the money is given to your creditors. Anything that can’t be paid is “discharged,” or written off. Secured debt is paid first, so unsecured debt (like credit card debt) often goes unpaid.

Chapter 11 is usually a business bankruptcy, and it allows the business to reorganize its finances and make a plan to pay off their debt.

Chapter 13 is a debt repayment plan. The court, individual debtor and creditors agree on a plan for the debtor to repay part or all of his debt over a period of time. Debt repayment is administered by a Trustee, who collects and distributes the money and makes sure the debtor fulfills any obligations the court requires.

Bankruptcy Changes

The new bankruptcy law made several changes that affect small business owners and individuals. The most important changes are as follows:

• You are required to seek help from a credit-counseling agency at least six months before filing for bankruptcy.
• In order to qualify to file for Chapter 7, your situation is judged against a “means” test. If your income is at or above the median for your state and you can repay 25% of your debt you cannot file Chapter 7 bankruptcy.
• Three-year Chapter 13 repayment plans have been pretty well eliminated; almost all Chapter 13 repayment plans last five years now.
• Your debt will not be discharged until after you take a court approved money management class.
• Filing fees have changed
• Your petition for bankruptcy will automatically be dismissed if you don’t provide all required documentation within 45 days of starting the process.
• There is more accountability and liability for attorneys. Attorneys are liable if you submit false information to the court, and they cannot advise you to do certain things to qualify for bankruptcy. This ruling may cause attorneys to be reluctant to represent people who are filing for bankruptcy and to increase their fees. Because the new law is more complicated, it is harder for a lender to file without legal representation, so this puts some people in a double bind.
• There are stronger limits on how often you can file for debt relief. You can’t discharge a debt through Chapter 13 if you have filed another bankruptcy in the past four years. If you file Chapter 7, you cannot refile for eight years. (The waiting period used to be six years.)

Preventing Personal Bankruptcy from Business Failure

Many small business owners use their own finances, assets and credit to start their business. They may also use personal assets to secure business credit cards. Any time you do not separate your personal and business finances, you risk personal loss if the business becomes bankrupt. One way to prevent this is to incorporate the business, forming an LLC (Limited Liability Corporation) or other corporation.

Effects of the New Bankruptcy Law

Many business start-ups, however, aren’t incorporated at first. Because a third of all small businesses fail, the new bankruptcy law makes the more risk-averse entrepreneurs wary. One potential result of bankruptcy reform may be that fewer new businesses are started.

Although the BAPCPA will probably decrease the number of Chapter 7 bankruptcies filed, it is expected to increase the number of Chapter 13 filings. Debt relief through bankruptcy is still available; you just have to go through a lot more hoops to obtain it. Prior to 2005, twice as many people filed Chapter 7 as filed Chapter 13. Those numbers are expected to be reversed as an effect of the new law.

Another effect of the law is the increase in the number of credit counseling agencies. Credit counseling agencies are supposed to help consumers figure out their finances and negotiate repayment with creditors without going through the courts. Some are better—by far—than others. Many credit counseling agencies charge a fee, often a percentage of the total debt repayment. This is one more payment that someone on the verge of bankruptcy has to make. If you are considering bankruptcy, check with the Better Business Bureau before signing a contract with a credit counseling agency to make sure you get actual help from a reputable company.

Preventing Bankruptcy

Bankruptcy has never been an easy fix for credit problems, but it is even harder now. The cost for filing bankruptcy is higher than it was, and there are a lot more hoops to go through. The consequences are longer-lasting. More than ever before, it’s important to avoid bankruptcy if at all possible.

The first step in avoiding bankruptcy is to live within your means. The old maxim of give 10%, save 10% and live on 80% is still wise advice.

Use credit only when you need it and pay it off as quickly as you can. Ideally, pay your credit card balances off every month. If that’s not possible, always pay more than the minimum.

If you start getting behind, ask for help. Get advice and counsel, and borrow from family members, if possible, before taking out more credit. Contact your creditors yourself and make repayment arrangements and follow through.

If you have a small business, keep meticulous records and run Profit and Loss statements weekly. That way you will catch reversals early and can correct them without resorting to bankruptcy.

The BAPCPA has far-reaching effects for consumers and small businesses. Bankruptcy should always be your last option for debt relief, but it is sometimes unavoidable. If you are faced with inevitable bankruptcy, start now to look for a good consumer credit counseling agency and a good bankruptcy lawyer. You will need both.