Client Alert

Creditor's Rights Report

9/12/2005

A New Chapter in Bankruptcy

Bankruptcy reform is here. When the majority of the provisions from the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" go into effect on October 17, 2005 (certain disclosure rules in the new law are subject to further rule-making by the Federal Reserve Board), abuses in Chapter 7 bankruptcies should decrease, and more debts should be repaid—a good thing, certainly. While celebrating this long-awaited reform, however, creditors need to take steps now to prepare for the impact of this new law and ensure that their own conduct is in compliance with the new requirements.

To reduce the overall number of bankruptcy filings and curtail abuses in Chapter 7 bankruptcy cases, the new law imposes a number of new requirements on consumers contemplating bankruptcy, including mandatory pre-filing credit counseling and the application of an objective, needs-based test to determine whether consumers will be able to repay their debts over time. These changes should result in fewer Chapter 7 debt discharges and more Chapter 13 repayment plans being approved by the bankruptcy courts.

Creditors must take careful note of the new requirements imposed on them under the new law. Significantly, lenders will be required to make additional disclosures (most of which will be implemented through regulations promulgated by the Federal Reserve Board) to consumers in solicitations, promotional materials, and applications for new credit extensions, including disclosures relating to "teaser" or introductory rates. "Open end" creditors—including most credit card and home equity line creditors—also will need to include new minimum payment-related disclosures in their periodic statements and establish a toll-free telephone number where consumers can obtain information about the time it will take to repay the account balance if the consumer makes only the minimum payment. Moreover, creditors will be required to make additional disclosures to debtors when seeking a binding reaffirmation of consumer debt.

The new law encourages pre-bankruptcy settlement of debts. While requiring consumers to obtain credit counseling before filing, it also penalizes creditors who "unreasonably" refuse to consider a debtor’s pre-bankruptcy repayment proposal. Creditors therefore should be prepared to receive and address increased numbers of requests from consumers for pre-bankruptcy payment restructuring and work-outs after October 17.

Meanwhile, bankruptcy filings hit a new record in the second quarter, probably in anticipation of the new law.

For further information, contact Eric Olson (eolson@mofo.com).

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