WASHINGTON - The landmark changes to the Bankruptcy Code that go into effect today give creditors a stronger hand in recovering unpaid consumer debt.
Under the law, more people who file for bankruptcy protection will be forced into repayment plans. But the new law also has more subtle benefits - and some burdens - for creditors.
The new rules are expected to cause filings, which spiked this month, to drop in the next two quarters, give lenders more opportunities to participate in proceedings, and provide banks legal certainty for derivatives and other contracts.
But creditors will have to provide consumers with new disclosures, including the costs of making only minimum payments on credit card and home equity loans and lines of credit. Those disclosures are not required until October of next year at the earliest.
"Over time, the number of people who have been filing for bankruptcy who have substantial ability to repay should tail off significantly," said Jeff Tassey, the managing partner of Tassey & Associates, who had lobbied for changes in the code since the early 1990s. "People will be given notice that there are legitimate alternatives to bankruptcy, and it's going to be a more honest system that has improved opportunities for creditors to participate. It's not going to be as expensive and cumbersome for them to participate."
Filings have increased 14% so far this year, from the 1.6 million total for all of last year. The increase was most significant in the six months between the time President Bush signed the law and today, according to Lundquist Consulting Inc., a California company that compiles statistics on filings.
More than 100,000 consumers filed in the first three days of last week, and more filings were expected by Friday. People were lined up around the block Friday at the U.S. Bankruptcy Court for the Southern District of New York, hoping to file the last business day before the new rules took effect.
Last week Keefe, Bruyette & Woods Inc. reported that Capital One Financial Corp.'s net chargeoff rate jumped 145 basis points last month, to 4.86%, "attributable primarily to the recent spike" in bankruptcy filings.
"Lenders can expect to see a dramatic decrease in filings in the fourth quarter of '05 and the first quarter of '06," said John McMickle, a partner in the law firm of Winston & Strawn LLP. "Beyond that, it's hard to predict."
Before people can file for debt relief, they must undergo credit counseling and take a course in financial literacy; creditors hope the requirement will deter many people from seeking to discharge their debt. (Gulf Coast residents affected by Hurricane Katrina, and people with special circumstances in the future, will be exempt from the requirement.)
It is impossible to predict how many people will be deterred from filing, or even how many people who file will be put into court-ordered repayment plans, but the new law gives creditors more tools to collect unpaid debt.
The fact that creditors no longer have to be represented by an attorney at the first meeting should cut their costs.
Also, creditors may now submit evidence to try to demonstrate a filer is acting in bad faith, and to seek a dismissal. "A debtor loading up on a new car and a new home prior to filing for bankruptcy could be grounds for dismissal," the American Bankers Association wrote in a 66-page book titled "The New Bankruptcy Reform Law: What You Should Know."
Additionally, creditors can designate an address to which filers must send required notices. The intent is to prevent notices from going to unrelated bank locations and departments; in the past such diversions delayed or even prevented banks from participating in proceedings.
The law also requires creditors to negotiate reasonable payment schedules recommended by a credit counselor. Courts can reduce claims on unsecured debt by up to 20% if the creditor refuses to negotiate.
The new law imposes some new requirements on creditors that will go into effect a year after the Federal Reserve Board promulgates them. The earliest that would be is Oct. 20, 2006, according to the ABA's book.
Statements for open-ended credit plans, including credit cards and home equity lines of credit, will have to explain the costs of making only minimum payments and provide an example of how long it would take to pay off the balance by doing so. Creditors also have to offer a toll-free phone number so customers can get an estimate of how long it would take them to pay off their balance.
Additionally, creditors that charge late fees will have to clearly show on the statement the date a payment is due and the amount of the penalty.
Credit card companies must make new disclosures on introductory rates in promotional materials, and they cannot terminate open-ended credit plans because the borrower has not incurred finance charges.
All financial market participants also can now breathe easier under new legal protections for swaps and other financial contracts. The law specifies that if a party to a contract enters bankruptcy, other parties can unravel the deal through a process called close-out netting.
