On October 17, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (“Act”) of 2005 became effective. The Act created a system that increased the proof necessary to qualify for filing for bankruptcy. It passed at the height of the housing market bubble that exploded the amount of consumer debt. According to the United States Federal Reserve, at the beginning of 2002, total consumer debt was $7,133.3 trillion. On the date that the Act became effective, total consumer debt was in excess of $8,261.8 trillion.
The Act was sponsored by Charles Grassley along with 10 Republican and two Democratic co-sponsors. In the Senate, 18 Democrats and 55 Republicans voted to pass the Act. In the House of Representatives, 229 Republican representatives were joined by 73 Democrats to pass the Act. Not a single Republican senator or representative voted against the Act.
How has the Act affected residential foreclosures? Before answering this question, it is important to set the stage. A study by Dr. David Himmelstein, an associate professor of medicine at Harvard Medical School, reported that half of all U.S. bankruptcies are caused by soaring medical bills. The study, published in the journal Health Affairs, estimated that medical bankruptcies affect about 2 million Americans every year. According to the U.S. Census Bureau third-quarter 2008, approximately 67.9 percent of all U.S. residents are homeowners. Between the effective date of the Act and December 31, 2008, approximately 3.5 million homes were sold. This calculates to as many as 9.5 million homes sold in the 1,215 days leading up to the effective date of the Act and the end of 2008. All of these homes are potentially under threat of foreclosure under the Act.
The Act contains provisions that may be perceived as inimical to the interests of otherwise honest, hardworking middle-class Americans by modifying or eliminating certain consumer protections in favor of creditors.
• Section 102 replaces the presumption in favor of granting the relief sought by the debtor with a presumption that abuse exists if the debtor’s current monthly income exceeds an amount determined according to specified formulae. Generally, a Chapter 7 bankruptcy filing may be dismissed if the debtor’s income is greater than his state’s median income. Debtors who meet this new standard are shifted to a five-year repayment plan in Chapter 13.
• Section 106 prohibits an individual debtor from filing under Federal bankruptcy law unless the individual has received a briefing from an approved nonprofit budget and credit counseling service prior to filing a bankruptcy petition, unless the U.S. trustee or bankruptcy administrator determines that the service for the district in which the debtor lives is not reasonably able to provide adequate services to the additional individuals who would otherwise seek credit counseling because of such requirement.
• Section 322 states that a debtor may not exempt a Homestead interest acquired during the 1,215-day period leading up to the effective date of the Act (or thereafter) which exceeds in the aggregate $125,000 in value in specified real or personal property. This includes real or personal property claimed by the debtor or dependent of the debtor as a Homestead.
An involuntary Chapter 7 or Chapter 11 petition can be filed against anyone or any entity that owes money, except for:
- Nonprofit groups
- Insurance companies
- Credit unions
- Savings-and-loan institutions
Prior to the effective date of the Act, there was no presumption that debtor abuse existed and no means test required. Residents of states with strong Homestead laws were effectively protected in their Homesteads from the effects of a bankruptcy filing because the Homestead laws permitted them to place their home outside of the grasp of the bankruptcy courts by placing no limits on the amount of market value subject to Homestead Act protections during bankruptcy proceedings, and all Homesteads (with certain carved-out exceptions) were includible for protection under the old Act. Furthermore, even if a debtor was forced into an involuntary bankruptcy, Homestead-protected property retained its unlimited market value protection.
Under the current act,
these consumers protections have been removed in favor of a presumption of debtor abuse. This is ironic, given the Harvard Medical School study's statistical finding of medical bills being the responsible for up to 50 percent of all bankruptcies.
Under the current Act, these consumer protections have been removed in favor of a presumption of debtor abuse. This is ironic, given the Harvard Medical School study’s statistical finding of medical bills being the responsible for up to 50 percent of all bankruptcies.
More importantly for mortgage borrowers, the Act requires homeowners to obtain credit counseling and develop a budget analysis in the 180-day period before filing for bankruptcy. Under the Act, borrowers cannot get into a bankruptcy court until they’ve satisfied credit counseling requirements. In many jurisdictions, foreclosures can be accomplished in far less than 180 days, meaning that the property can be lost before a borrower is even allowed to file a bankruptcy claim.
The results of the “anti-abuse” changes under the Act were predictable. Bankruptcy filings fell and foreclosures increased. According to court filings, there were 1,597,462 bankruptcies in 2004 and 2,078,415 bankruptcies in 2005. In 2006, bankruptcy filings declined 70 percent, to 617,660 cases. According to Realty Trac, the number of foreclosures soared in 2007, with 405,000 households losing their homes; that’s up 51 percent from the 268,532 homes that were repossessed in 2006. About 1.3 million homes received foreclosure-related warnings in 2007, up from 717,522 in 2006. Foreclosure filings rose 75 percent from the previous year to 2.2 million. The number of foreclosures soared in 2007, with 405,000 households losing their home. RealtyTrac’s 2008 US Foreclosure Market Report shows nearly 3.2 million foreclosure filings for 2008.
The falling number of bankruptcies and the rising numbers of foreclosures are related. Under the old bankruptcy rules, it was often possible to delay a foreclosure action by stalling the creditor in court and using that time to sell or refinance the property. Under the Act, borrowers stuck in unaffordable home loans must cure their defaults and, in addition, make monthly payments on the loans according to their terms or lose their homes. “No other creditor in personal bankruptcy or business bankruptcy can leave a borrower in such a position,” says a study produced jointly by the National Consumer Law Center, National Association of Consumer Bankruptcy Attorneys, Consumer Federation of America, National Association of Consumer Advocates and the Center for Responsible Lending.
CPA and forensic accountant Stanley I. Foodman has worked extensively in federal and state courts as an expert. He is a former auxiliary special agent for the Florida Department of Law Enforcement and has worked as a consultant to the Miami office of the U.S. Attorney in the area of civil RICO money laundering recoveries. Foodman is a member of the Association of Certified Fraud Examiners and a member of the Supreme Court of Florida Circuit Grievance Committees On The Unlicensed Practice of Law.