On your mark, get set … declare bankruptcy

If you’re considering filing for either Chapter 7 or Chapter 13 protection before the new, more stringent federal bankruptcy law takes effect on Oct. 17, there’s a song that bankers and other creditors wish you would hear and heed. It was a hit recording back in 1960, an instrumental by the Ventures called, “Walk, Don’t Run.”

“You will certainly notice an increase in bankruptcy filings, and that in and of itself should be suspicious,” said Jerry Little, president of the New Hampshire Bankers Association. “What Congress has designed is a remedy for abuse. What folks who are rushing to get in before the new law takes effect probably have in mind is exactly what Congress is trying to prohibit.”

The anticipated rush to bankruptcy court is the result of the new law’s disturbance of a lot of debtors’ comfort zones, he said.

“There has become in this country a level of comfort with filing for bankruptcy to the point that with some people, it’s become a business plan,” said Little. “Unfortunately, the bankruptcy code in the United States was being abused and needed to be amended to prevent that abuse. When people misuse bankruptcy, we all pay.”

Peter Wright, a bankruptcy lawyer and professor at Franklin Pierce Law Center in Concord, agrees that abuse of the bankruptcy code is a significant problem. But he does not think that all or even most of the filers are looking to take unfair advantage of the system.

“Most people are forced into bankruptcy by prolonged unemployment, divorce or serious, chronic illness for which they often don’t have insurance,” he said. “The real abusers would tend to be those people who recently had a lot of assets, are still well positioned and have good income. They’re the ones, I think, who are most guilty of abuse.”

One of the current loopholes for which the new law is a remedy is the homestead exemption, which varies from state to state, Wright said.

“In New Hampshire, it’s $100,000 per owner,” he said. “In other words, a husband and wife who are joint owners of a home could enjoy a $200,000 exemption. When I started practicing law 25 years ago, it was $5,000.”

The increase in the exemption reflects the increase in the market value of housing. But in a few states, Florida and Texas notable among them, the homestead exemption is unlimited, allowing someone in bankruptcy to keep even a $2 million or $3 million house as an asset off limits to creditors or trustees of the bankruptcy court.

That, said Wright, is an invitation to abuse.

“What was happening was that people in some kind of business scheme made a lot of money, took the cash and went south to Florida or Texas, put the money into an expensive home, and with the homestead exemption, none of their northern creditors could reach them. So they ride out the down times, and when the boom times return, they sell the home, go up north and go back into business.”

They don’t have to pay the old debts because during their bankruptcy, those debts were wiped out, he said. But doesn’t a recent history of bankruptcy make it difficult to get credit?

“Not so much these days as it used to be, because the stigma of bankruptcy filing, which was pretty powerful in our parents’ day, is no longer the case today,” said Wright. “People understand that bankruptcy exists as a safety net and a lot of businesspeople are forced into bankruptcy, especially the way the New Hampshire economy suffered so much in the last part of the ‘80s. It’s not like you’re branded with a scarlet letter and nobody’s going to do business with you.”

In fact, while Congress passed a new law tightening up bankruptcy eligibility, federal regulators are trying to make sure that those who do survive the procedure aren’t shut out of the money market altogether.

“As bankers, we’ve been encouraged by our regulators to help people with damaged credit to repair their situation and move forward,” said Little. “So it is certainly possible that in our pursuit of helping people along and the pursuit of the American dream, we extend credit to people who have had credit problems in the past. Basically, what they don’t want us to do is offer credit only to (grade) A-credit people.”

Changing times

Under the new law, a federal homestead exemption of $125,000 per owner will supplant more generous state exemptions. And anyone with an income above the median income for his or her state will likely not be eligible for Chapter 7 bankruptcy, involving a liquidation of debt, and will instead be forced into Chapter 13 bankruptcy, which will require a court-ordered repayment of debt based on a schedule that includes the debtor’s income and expenses and money left over after expenses.

As Wright explains it, the calculation will be based on a six-month average, rather than the immediate state of finances at the time of the filing. The idea is to discourage either the liquidation of assets or the piling up of debt immediately before filing for protection.

Wright also notes that the new law requires a lawyer or accountant to certify that the client’s statements of income and expenses are accurate.

Lawyers who represent bankruptcy clients as part of their pro bono work may be more reluctant to do so, given the liability they have to undertake by swearing to the accuracy of the client’s financial statement, he said.

“It will certainly make it more difficult,” said Tim Smith, a bankruptcy lawyer in Portsmouth. “I think a lot of bankruptcy lawyers around the country are concerned that it will increase the fees. On the other hand, we don’t know if there will be as many cases as there are now.” Smith said he has seen the American way of debt grow during both good economic times and bad.

“Probably 20 years ago, the average amount of credit card-type debt someone had at the time of filing was $10,000 to $20,000. Now it’s way higher than that. I would guess it’s in the 40 thousands. And people don’t really have more assets, they just have more debt. I think a lot of people get into that downward spiral, where they reach the point of $10,000 or $15,000, and then something happens. Somebody loses a job or gets sick, then they get separated or divorced, and then it builds on itself.”

According to Chris Gallagher, a Concord lawyer-lobbyist whose clients include the New Hampshire Bankers Association, the problem is that when people get overextended or deliberately abuse credit, other consumers have to pay more to make up for it. “You shouldn’t have to be subsidizing my borrowing,” he said.

But the American ethos has undergone extensive revision since Ben Franklin was preaching in his Poor Richard’s Almanac about “a penny saved,” not thousands borrowed. “Our savings rate as a nation is dismal,” Gallagher said.

Maybe that’s because it takes too long for those pennies to add up, even in the best of economic times. After generations have grown up under the slogan, “Buy now, pay later,” debt and bankruptcies seem to rise as much in boom times as bust.

“That’s America,” said Smith. “You have to have more than your parents had. I think a lot of people live over their budgets.”

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