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New law would require pre-bankruptcy counseling
Scripps Howard News Service


April 10, 2005

Key bankruptcy law changes
Scripps Howard News Service

Sweeping legislation making it tougher to walk away from debt by filing for bankruptcy is expected to clear Congress as early as next week for President Bush's signature. The measure, which was stalled for eight years, makes these key changes:

Credit counseling. Anyone considering bankruptcy must attend credit counseling no more than six months before filing. Debtors also must complete a personal finance course before the bankruptcy court discharges their case.

Means testing. Debtors can no longer wipe out debts by filing Chapter 7 bankruptcy if their income is above the median for their state. Instead, they will file Chapter 13 bankruptcy, which requires them to work out a plan to repay creditors and to live under a bankruptcy court budget that restricts a debtor's spending for three to five years.

Homestead. People could still protect their house against creditors even in Chapter 7 bankruptcy liquidation if they live in one of five states that allow unlimited "homestead exemptions," however pricy the house. However, the federal law will be changed to require that debtors own the house for at least 40 months before they file for bankruptcy, not the open-ended exemption that has made Texas and Florida into magnets where technically bankrupt millionaires can hide in their mansions.

Asset-protection trusts. The new law won't close this "millionaire's loophole" either, which lets wealthy people protect substantial assets from creditors after bankruptcy. Long set up offshore to keep their money out of reach of domestic creditors, asset-protection trusts have been legalized by Delaware and four other states for people who live anywhere in the United States.

Retirement accounts. Up to $1 million in Individual Retirement Accounts would be shielded. The change will limit this week's Supreme Court ruling, which said IRAs are entitled to the same full protection from creditors as pensions and 401(k)-style retirement savings plans.

E-mail Mary Deibel at DeibelM(at)

With Americans typically carrying a $7,500 credit-card balance with less than $25,000 saved for retirement and bankruptcy rates at record levels, it's tough to argue that we don't need to brush up on our financial skills.

Now, President Bush and Congress are about to require more than 1.6 million Americans who declare bankruptcy each year to go through credit counseling and financial education.

Part of a larger bill to toughen the bankruptcy code so it's harder to walk away from debt, this first-time federal mandate requiring finance lessons raises a host of questions, says Sam Gerdano, head of the nonpartisan American Bankruptcy Institute.

"Not only is it an unfunded mandate on people who can't afford it, but who's going to provide the counseling, given the stress the industry is under from all sides?" he asks.

The Executive Office of U.S. Trustees, which oversees the bankruptcy courts, has six months from the day Bush signs the bill to develop coursework guidelines, come up with a list of approved providers to counsel debtors before they declare bankruptcy and provide budgeting education once they file.

The bill specifies that upfront counseling be provided face-to-face, by phone or Internet by a nonprofit credit-counseling firm that can charge a "reasonable" fee, although the fee can be waived for those who cannot afford to pay.

"Counseling-before-filing is like the 'informed consent' a doctor requires before surgery: It helps people understand the potential consequences of filing for bankruptcy when it can be the most significant financial step they take in their lives," says William Binzel, chief counsel with the National Foundation for Credit Counseling.

Binzel says foundation members - 120 nonprofit agencies with more than 1,000 local offices, usually known as Consumer Credit Counseling Services - charge $15 for a 90- to 150-minute session.

But government-ordered tutoring confronts a continuing crisis in the credit-advice business:

  • The Federal Trade Commission has brought 70 cases against firms it says falsely promised to repair credit. In recent weeks, it settled with three debt-management firms it says "scammed consumers out of more than $100 million" and settled separately with AmeriDebt. The agreement shuts down bankrupt AmeriDebt, a nonprofit firm charged with sluicing $170 million in client business to related for-profit, high-fee firms.
  • States have brought another 25 complaints. However, a new National Consumer Law Center survey concludes that state law enforcement and compliance is lax, a troubling accusation when the center reports that 80 percent of credit counselors don't belong to the standard-setting National Foundation for Credit Counseling and Association of Independent Consumer Credit Counseling Agencies.

In advance of the bankruptcy bill's passage, the Internal Revenue Service reports that applications to start nonprofit credit-counseling services have spiked to more than 600.

Stung by criticism that the IRS hasn't policed the industry, IRS Commissioner Mark Everson says half of the nonprofit counseling sector is under scrutiny.

"These organizations get tax-exempt status because they are supposed to be educating and assisting people who have credit or cash-flow problems," Everson says. "Unfortunately, too many of these organizations instead operate for the benefit of insiders, or are improperly in league with profit-making companies."

To escape IRS examination, some operators have pressed states to allow for-profit counseling, which Virginia recently approved and Maryland is considering.

"It's clearly an end-run around intensified IRS scrutiny, now that the IRS isn't going to let the for-profit tail wag the nonprofit dog," says Consumer Federation of America legislative director Travis Plunkett.

He says 11 states that license credit counselors allow for-profit counseling: California, Illinois, Kansas, Michigan, Nebraska, New Hampshire, Ohio, Oregon, Vermont, Wisconsin and newcomer Virginia. Six without licensing allow for-profits, too: Florida, Georgia, Montana, South Dakota, Utah and West Virginia.

"It would be a great time to go into the credit-counseling business, even legitimate counseling, because business is about to boom," says Ohio University professor Deborah Thorne, project director for the Consumer Bankruptcy Project, which has studied bankruptcy issues for 15 years.

Thorne, who has taught credit counseling and volunteered at her local Consumer Credit Counseling Services office, says the bankruptcy bill "assumes people go bankrupt because they couldn't manage their money and that credit counseling will help, but the irrefutable evidence is that people file for bankruptcy because they lost a job, had a medical crisis or got divorced.

"These are people who could teach household finance and don't need to be students," she says. "They live on budgets so tight they squeak: They're not cutting back on lattes and the cable bill."

FTC consumer-protection chief Lydia Parnes advises that consumers steer clear of credit-counseling and management operations that:

  • Insist you pay a high monthly fee.
  • Promise to eliminate unsecured debt or keep unsecured creditors from suing.
  • Ask you to pay them every month instead of paying your creditors.
  • Claim they can get accurate negative information erased from your credit report.

And whether you're considering bankruptcy or just trying to set your financial house in order, Parnes suggests checking any credit-management service for complaints with the state attorney general, local consumer protection agency and Better Business Bureau.


E-mail Mary Deibel at DeibelM(at)

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