The long-awaited Bankruptcy Abuse Protection and Consumer Protection Act ("the Act") was signed by President Bush on April 20, 2005. The consumer credit industry, which complained that too many people who could pay were abusing the system and walking away from their debts, was a major sponsor of the legislation. Thus, the Act reflects the principle that individuals who can pay something, should, and employs a "means test" for evaluating a debtor's ability to pay. It drastically limits the availability of Chapter 7 liquidation for debtors who earn more than their state's median income.

For the most part, the changes favor creditors. But there are also changes which will affect corporate debtors and employees. Other changes provide enhanced consumer protection, including new disclosures under the Truth in Lending Act.

Changes in the bankruptcy law which might affect entities in the financial services industry fall primarily in six of the Act's titles:

1. "Needs-Based Bankruptcy" (Title I);

2. Provisions intended to Discourage Bankruptcy Abuse (Title III);

3. General (and Small) Business Bankruptcy Provisions (Title IV);

4. Preventing Corporate Abuse (Title XIV);

5. Enhanced Consumer Protection in bankruptcy cases (Title II); and,

6. Consumer Credit Disclosure (including changes in Truth in Lending law) (Title XIII).

TITLE I: Needs-Based Bankruptcy Requirements

For Individual Filers

* Under the old law, Chapter 7, in which a debtor's non-exempt assets are liquidated and distributed to creditors and the debtor discharges all debts and gets a fresh start, was available to everyone regardless of income or the value of one's assets. Under the Act, Chapter 7 is limited to persons with insufficient income. Those with income above their state's median income who can pay at least $6,000 over five years must file under Chapter 13 and pay at least a portion of their debts under a Chapter 13 plan. The Act creates a presumption of abuse and grounds for dismissal (or conversion to Chapter 11 or 13) in Chapter 7 cases where a debtor's income is sufficient to pay $6,000 in unsecured claims over 5 years.

* Individual debtors must receive (and pay for) credit counseling within 180 days before filing.

Likely Effect Of "Needs Based" Bankruptcy Provisions

* The means test in the Act is complicated and may require expensive professional assistance, which may discourage individuals from filing for protection altogether. Unsecured creditors may receive little more than they do under the old law, because Chapter 13 debtors typically pay small amounts to unsecured creditors.

Likely Impact On The Financial Industry

While banks and retailers pushed for the Act, the means test may have a negative impact on the industry's bottom line. Fewer filings by individuals in Chapter 7, and increased costs associa ted with filing Chapter 13, are likely to lead to fewer bankruptcy filings overall, increasing the overall consumer debt load. Consumers strapped with more debt will be less credit-worthy, and unless the credit industry tightens standards for extending credit, the increase in loans to low creditworthy customers will likely lead to higher overall delinquencies and charge-offs, and a negative impact to the bottom line.

TITLE III: Provisions Intended To Discourage

Bankruptcy Abuse

Tough new provisions intended to discourage bad faith and repeat filings, primarily targeted at individual debtors, include the following:

For Individual Debtors

* Relief from automatic stay will now be granted as to "any action with respect to a debt or property securing such debt," or any lease, 30 days after filing against debtors who had prior cases pending during the preceding year which were dismissed, absent a demonstration that the later case was filed in good faith as to creditors stayed. The act creates a strong presumption (rebuttal by clear and convincing evidence) that a case was not filed in good faith, if an earlier case filed by a debtor and pending during the one year period preceding current filing was dismissed.

* Automatic stay relief will also be afforded to creditors of Chapter 7 debtors as to personal property secured by purchase money liens unless the debtor reaffirms debts or redeems property within 45 days of the first meeting of creditors.

* Stays as to personal property will also terminate automatically in Chapter 7 or 13 cases if the debtor fails to file a timely statement of intention to retain or surrender personal property.

* Stays of residential eviction proceedings against a debtor will be denied if the lessor obtained a judgment for possession before the filing date, or submits a certificate of specified debtor offenses.

* Chapter 13 debtors will not be able to cram down (reduce) the value of motor vehicles securing purchase money interest if the debt was incurred within 910 days of filing.

* Debtor's replacement value must be used in valuing claims secured by other personal property.

* The "super-discharge" has been eliminated for Chapter 13 debtors for credit/money obtained by fraud, false pretenses, or arising from fraud or defalcation while acting in a fiduciary capacity.

* The pre-filing state residency period required to claim state law exemptions has been increased from 180 days to 2 years.

* The homestead exemption will be limited to $125,000 if property was acquired less than 3 months and 3 years before filing for bankruptcy relief.

Provisions Primarily Affecting Corporate Debtors

* Severance payments to insiders of the debtor generally will not be treated as administrative claims entitled to be paid ahead of other creditors.

* Retention bonuses paid to insiders of debtors will not be treated as "administrative" expenses absent evidence that payment to insiders was "essential to the survival of debtor's business."

All Debtors

* The Act provides for mandatory stay relief as to acts against real property where the Court finds that the bankruptcy is part of a scheme to defraud a creditor whose lien is secured by the property.

* Amounts withheld or received by employers as contributions to employee benefit, deferred compensation or annuity plans will be excluded from property of the estate.

TITLE IV: General And Small Business Bankruptcy Provisions

General Business Bankruptcy Provisions

* Under the Act, investigative and enforcement proceedings by securities regulatory organizations are no longer subject to the automatic stay.

* Chapter 11 creditors' committees will now be required to provide increased access to information to the creditors represented by the committees.

* The 120-day exclusivity period for the filing of a Chapter 11 plan by the debtor has been capped by the Act at 18 months.

* The Act relaxes the standard for establishing the "ordinary course of business" defense to claims to avoid preferential transfers.

Small Business Provisions

(Applicable to debtors engaged in business with less than $2 million in total debts.)

* The Act simplifies standard forms for Chapter 11 disclosure statements and plans.

* It establishes new duties for small business Chapter 11 debtors in possession, including required attendance by senior management at meetings of creditors and equity security holders.

* The Act raises the exclusivity period for small business debtors to 180 days, with extensions capped at 300 days unless the debtor proves that the plan is likely to be confirmed in reasonable time.

* The Act places increased duties on the United States Trustee to meet with the debtor, investigate the debtor's viability, and explain reporting requirements to the debtor.

* The Act expands the grounds for dismissal or conversion of small business Chapter 11 cases.

TITLE XIV: Preventing Corporate Abuse

Changes in Title XIV of the Act reflect pressure from consumer advocates who claimed that the changes in the law punished individual consumers, but did little to prevent corporate abuse. The changes in Title XIV include:

* Increases in the amounts of wage and benefit priority claims.

* Limits to modification of retiree insurance benefits by corporate debtors who have previously modified such benefits while insolvent and within 180 days before filing.

* Debts incurred in violation of securities laws will not be dischargeable even if the judgment, order or settlement agreement for violation occurred after the bankruptcy case was filed.

* The United States Trustee will be required to move for appointment of a Trustee in a Chapter 11 case, where there are "reasonable grounds to suspect" that the debtor's current management has "participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or the debtor's public financial reporting."

* Fraudulent transfers avoidable by the trustee have been expanded as the "look-back" period has been increased from one to two years.

* Transfers or obligations incurred to or for the benefit of insiders under employment contracts within two years of filing, and not in the ordinary course of business, will be treated as fraudulent transfers.

TITLE II: Enhanced Consumer Protection

In Bankruptcy Cases

The Act imposes penalties for "Abusive Creditor Practices," including the following:

* A procedure by which a claim filed by a creditor who refuses to negotiate a "reasonable alternative" repayment schedule proposed on behalf of debtor by an approved credit counseling agency may be reduced up to 20%.

* The failure of a creditor to credit payments received under the plan may be considered a violation of the injunction against continuation of an action against discharged debtors.

* The Act unveils strict new disclosure requirements for debt reaffirmation agreements, including clear and conspicuous disclosures of the amount reaffirmed and the annual percentage rate.

* The Act preserves claims and defenses of the consumer after the sale of consumer credit paper.

TITLE XIII: Consumer Credit Disclosures

(Including Changes in Truth In Lending Law)

The Act also amends provisions of the Truth in Lending Act to require the following new disclosures and warnings:

* The Act adds a new "minimum payment warning" on monthly credit card statements to explain the manner in which making the minimum payment will increase the interest paid and the length of time needed for repayment, and a requirement that credit card companies establish toll-free numbers for consumers to call to obtain an estimate of the time it will take to repay their balance making only the minimum payments.

* The Act provides that open end credit plan creditors subject to Federal Trade Commission enforcement must provide minimum payment warnings and a toll free number established by the FTC for consumers to call for estimate of time to repay their balance.

* The Act requires new disclosures on credit applications and in advertisements for extensions of credit secured by homes.

* The Act requires new disclosures relating to "introductory rates" on credit cards.

* The Act adds new required disclosures for internet-based credit card solicitations.

* The Act adds new required disclosures of late payment deadlines and penalties.

* The Act prohibits the termination of credit card accounts solely because the consumer has not incurred finance charges.

Effective Date of Act

* The Act will be effective 180 days after it was signed into law by President Bush, except as otherwise provided in the Act. For example, Title XIV amendments (avoiding corporate abuse) and the changes in the law to the homestead exemption apply to all cases filed after the date of enactment.