Bankruptcy's Next Chapter

A Bill Tightening Debt-Relief Rules for Individuals Leaves Some Holes Unplugged

It took eight years of political maneuvering, but a bill to overhaul the nation's bankruptcy system now looks close to becoming law. If it does, that's when the real fight will begin.

Lawyers who have combed through the 501-page bill say that despite its attempt at specificity and bright-line tests to tell the truly destitute -- who would still get to erase most of their debts -- from the casual spendthrifts attempting to wriggle out of inconvenient bills, much remains open to argument and interpretation.

For example, a key test for whether someone can qualify to wipe out almost all debts in bankruptcy would be based on whether the debtor's income is above the median for his state. Each state's median will be based on U.S. Census numbers -- the bill spells that out -- but would have to be adjusted for inflation, and how to calculate that adjustment has not yet been defined.

The stated goal of the new legislation, which was pushed by the credit card, auto and retail industries, is to end abuse of the bankruptcy system. But many bankruptcy experts worry it will only add cost and red tape to the process of filing for bankruptcy and not necessarily curb abuse.

Indeed, lawyers are already discussing ways that the legislation's hard-and-fast measures might make it easier than current law to manipulate the bankruptcy system.

Joseph Gold, a bankruptcy trustee for eastern Virginia, predicted "many creative lawyers" will get around many of the new restrictions.

Under current law, bankruptcy judges have wide discretion to determine who is unfairly filing under Chapter 7, a more pro-debtor bankruptcy option that allows filers to wipe out most of their debt. The new law would have more cut-and-dried formulas that judges would have to use to decide who is eligible for Chapter 7.

If a person is ineligible for Chapter 7, he would file under Chapter 13, which requires some repayment of what is owed to creditors.

Here's the test judges will now have to apply to people with income above the median in the state in which they live, with examples of how someone could purposely shape the results.

• A debtor's reasonable monthly expenses will be subtracted from estimated monthly income. If the remainder, known as discretionary income, is below $100 a month, the debtor can file for Chapter 7. If discretionary income is over $100, the debtor might not be allowed to file for Chapter 7.

How to game the system under the new law: Buy a new car. The payments are an allowed expense. If they are high enough, they could push discretionary income below $100 a month, which would now make the debtor eligible to file for Chapter 7.