Bankruptcy Reform

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Bankruptcy laws changed drastically on October 17, 2005. The changes are commonly referred to as “bankruptcy reform” and are part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. As a result of this reform, bankruptcy laws changed significantly, and the purpose of many of these changes was to make it “more difficult for people to file for bankruptcy.”¹ However, the majority of individuals filing for bankruptcy still qualify for Chapter 7 bankruptcy relief and can discharge most unsecured debt.²

One of the main changes of bankruptcy reform is the “means test”. The means test applies to all debtors whose debt is primarily consumer debt. Basically, the means test determines whether a debtor qualifies for Chapter 7 or Chapter 13 bankruptcy relief. Under the means test, the debtor’s annual income is calculated based on the debtor’s average monthly gross income for the six months prior to bankruptcy case filing. The debtor’s annualized income is compared to the applicable median income for the debtor’s household size.³ If the debtor’s income is below the applicable median income, then the debtor is presumed to qualify for Chapter 7 relief. If the debtor’s income is above the applicable median income, then the debtor must complete the means test by deducting specific expenses from his or her gross income. Some individuals qualify to file a Chapter 7 bankruptcy even if they are above the median income.

Changes in state homestead exemptions also changed with bankruptcy reform. Under the new law, a debtor must live in a state for two consecutive years (730 days) before he or she is allowed to use that state’s exemption laws. Exemptions define the property that is protected from liquidation to pay a debtor’s creditors. In general, a debtor is able to keep exempt property. Minnesota has a favorable homestead exemption for debtors. Under the new law, the homestead exemption limit is capped for an interest in real property that a debtor acquires less than 1,215 days (3.3 years) prior to filing bankruptcy.⁴ If a debtor acquires an interest in real property in less than 1,215 days, then the homestead exemption is limited to $125,000 regardless of the state’s exemption limit. There are only a few exceptions to this rule.

Another major change of bankruptcy reform is that debtors have additional requirements under the new law. Debtors must complete consumer credit counseling within180 days prior to filing a bankruptcy case. Debtors also must complete a debtor education course after the bankruptcy case is filed.⁵ In addition, the debtors are required to file specific income records with the court and to provide the bankruptcy trustee with their most recent tax returns.

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1. Opening statement of Sen. Chuck Grassley at the Bankruptcy Reform Hearing, 2/10/2005, Press Release, Senator Chuck Grassley of Iowa. Senator Grassley’s statement can be found at: http://grassley.senate.gov/news/Article.cfm?customel_dataPageID_1502=9716.
2. See the American Bankruptcy Institute’s website at: www.abiworld.org.
3. The US Trustee’s website lists the applicable median incomes by state, which can be found at: http://www.usdoj.gov/ust/eo/bapcpa/meanstesting.htm.
4. This exemption limit also applies if a debtor has been convicted of security law violations or been found guilty of certain crimes
5. Approved credit counseling agencies and debtor education providers can be found at the US Trustee’s website at: http://www.usdoj.gov/ust/eo/bapcpa/ccde/index.htm.