Uneven impact feared in new bankruptcy law

Critics say small businesses and neediest people will face daunting costs in seeking a fresh start

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A new federal bankruptcy law tries to reduce what some see as abuse among debtors by requiring more monitoring, repayment plans, tighter deadlines and higher costs.

But some critics said there is no evidence that a substantial amount of abuse or fraud went undiscovered or unpunished, while the increased cost and requirements in order to file may deny needier people and riskier businesses the fresh start the bankruptcy system was designed to offer. Estimates of debtor fraud range from 1 percent to 10 percent of the cases.

Some experts said that, under the new law - most of which takes effect Oct. 17 - more small businesses will dissolve and more people will be forced into repayment plans or unable to afford using the bankruptcy system at all.

Such individuals may then have property foreclosed or repossessed, have their wages garnished and be subject to other creditor collections.

"A significant number of businesses could be forced to liquidate, but the bigger effect over the next several years will be perhaps hundreds of thousands of individuals who will be priced out of bankruptcy protection because they can't afford the higher filing and attorney's fees," said Henry Sommer, president of the National Association of Bankruptcy Attorneys in Washington.

For individuals, those with an income above the state median will undergo a means test. If the court then determines that filers have at least $100 a month in discretionary income after some necessary expenses are paid, they may not be able to file under Chapter 7, through which they might lose some property but would be freed from most debts.

Instead, those individuals will have to file under Chapter 13, which requires a repayment plan.

Under the new law, debtors are required to assume new and higher costs, which will vary. They must pay to attend financial counseling before and after filing and are likely to pay higher fees to lawyers because the new rules make cases more complex. Lawyers also are subject to additional court penalties for false statements by clients.

"With the extra cost and effort, experienced bankruptcy attorneys will shy away" from many cases, said Paul Silverman, a bankruptcy attorney who is interpreting the new law for the New York State Bar Association. He represents debtors, creditors and acquirers of liquidated property in 14 states for the Atlanta-based law firm of Alston & Bird LLP.

For small businesses, there's a 10-month limit for filing a plan of reorganization. For businesses that file under Chapter 11, the new law limits the time in which they have the exclusive right to submit a reorganization plan to 18 months.

Previously, a court could extend deadlines for a reorganization plan without a specific time limit.

Supporters of the new law said it seeks a better balance between allowing debtors a fresh start and demanding responsibility.

"It tries to crack down on abuse," said Todd Zywicki, a professor at George Mason University School of Law, who has promoted the law since 1997 and worked with congressional Republicans to draft it.

But some experts said the more rigorous requirements in the law are designed to discourage some small businesses - defined as those with no more than $2 million in debt - and individuals from filing at all so creditors can continue to collect payments.

Lynn LoPucki, a bankruptcy expert and professor of law at UCLA, said, "The thinking was that dumping administrative burdens on small debtors that don't apply to large ones would mean fewer bankruptcies."

That could benefit landlords, creditors, car lenders and other financial services firms, said Sommer of the bankruptcy lawyers group.

"With the new law, all the leverage is on the side of the creditors," he said. Nonetheless, since he believes that abuse of the system is limited, Sommer said, "I expect their collections to only rise about 1 percent.

"The big losers will be small businesses and individuals, some of whom will be priced out of filing and may lose their home and car," he said.

How much fraud is there, by whom and why? "We don't necessarily know," Zywicki says, but he assumes that about 10 percent of the cases involve fraud; people concealing "piles of cash, jewelry and property in other states," he said.

Individual and business filings - which are up sharply in recent months in response to the legislation - totaled nearly 1.6 million last year, up from nearly 300,000 in 1978, the year of the last major overhaul of the law.

Zywicki said that jump comes despite the economic prosperity of the ensuing decades, which he measures by low unemployment and interest rates and a stable divorce rate.

"The plausible explanation is that people are filing for bankruptcy not because they have to, but as a tool of convenience," he said.

In considering whether federal statistics that show rising poverty might also explain the increased bankruptcies, he said, "I haven't heard any theories that tie them [poverty and bankruptcy rates] together."

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