Blog sponsored by Bankrupt-Law.com


New bankruptcy law's fallout a tough call
Sunday, February 5, 2006

By KEVIN G. DeMARRAIS
STAFF WRITER

Special Report: Forecast '06

By the numbers, bankruptcy filings exploded in 2005.

But this is one case in which the numbers lie, or at least mislead. That's
because the law changed drastically in October, making it more difficult for
individuals to file for Bankruptcy Court protection.

That led to a surge in filings before the law took effect on Oct. 17 and a
big drop-off over the last 2½ months of the year, making comparisons with
previous years and predictions for trends in 2006 difficult.

"Clearly, Congress intended to make bankruptcies harder than before, and
maybe they did," said Jack Ayer, a visiting professor of law at New York
University and the Scholar in Residence at the American Bankruptcy Institute
in Alexandria, Va.

But little blips on the radar show "the target may be more elusive than they
expected," said Ayer, professor emeritus at the University of California at
Davis.

Still, there's no question that the controversial Bankruptcy Abuse
Prevention and Consumer Protection Act has had an impact:


Filings in New Jersey were up 20 percent last year to 49,583 from 41,303 in
2004, according to court statistics. That includes consumer and business
filings.


Nationally, 2.04 million consumers filed for bankruptcy protection in 2005,
a 31.6 percent increase from the 1.55 million a year earlier, according to
Lundquist Consulting Inc., a California-based financial research company.


Monthly filings dropped sharply after the new law took effect, with New
Jersey reporting 15,052 new filings in October, but only 869 in November and
December combined. In recent years, the monthly average was around 3,500.


Nearly 60 percent of the filings since Oct. 17 came under the more
restrictive Chapter 13 than under Chapter 7, which requires a means test,
Lundquist reports. Before the law took effect, only 30 percent were under
Chapter 13.

Under the new law, consumers with above-average incomes are barred from
filing for protection under Chapter 7 of the U.S. Bankruptcy Code, through
which their debts can often be wiped out.

Instead, many are forced to file under Chapter 13, which requires a
five-year repayment plan.

"Clearly there are some abusers, the notorious cases that get the publicity
and deserve the publicity," Ayer said.

But there are questions about how many potential filers will be above the
minimum income level, the "linchpin of the act," he said. The amount varies
by state.

Even with the new law, there are some signs that, at the least, the total
number of personal bankruptcies is not likely to drop because consumer debt
continues to be a concern.

The American Bankers Association reported in mid-January that even with a
small drop in delinquencies, the proportion of consumers who were behind on
their credit card bills remained at near-record levels in the third quarter.

"The fall in delinquencies was a welcome change, but signs of financial
stress still are present," said James Chessen, the ABA's chief economist.

"The persistent interest rate increases by the Federal Reserve and
record-high gas prices in the third quarter provided a one-two punch that
continued to inflict pain on personal budgets," he said.

Part of the problem was Hurricane Katrina, but the full impact of the storm
will be felt into the first quarter of 2006, Chessen said.

While most of the focus on the new bankruptcy law was on individuals, it
will also affect corporate filings, Ayer said. But the changes are in
keeping with the incremental adjustments made over the past 25 years, he
said.

Perhaps the biggest change is a new limit on what's known as the exclusivity
period, the 18-month span during which a company in Chapter 11 has the sole
right to propose a reorganization plan. Under the old law, companies could
have unlimited extensions of the exclusivity period, but they lose that
right under the new law.

The new law also gives a creditor who provides services to a company within
the 20 days of a Chapter 11 filing the right to full payment for the
services. Previously, they often got only get a fraction of what they were
owed.

The net result is that debtors have less leeway than they did before,
especially among small and midsize businesses.

"When I started doing this stuff in the '70s, a lot of creditors were
suppliers who needed [the filer] as much as he needed them," Ayer said.

Starting in the mid-'80s, a secondary market for debt emerged, with
arbitrageurs buying debt at a deep discount, perhaps 20 cents on the dollar,
and looking to sell it for 25 cents, he said. Unlike suppliers, they don't
have the same incentive to keep companies operating.

"That has become much more the norm," he said.

As in past years, big-company filings are a small percentage of the overall
number, but they get most of the attention.

That is especially true when they are consumer-oriented companies, such as
Delta Airlines and Northwest Airlines or Winn-Dixie Stores, a major Southern
supermarket chain, which sought protection in 2005. The three reflect
serious financial problems across the supermarket and airline industries
that also led to the demise last month of small Independence Air.

Among New Jersey companies filing for bankruptcy protection last year were
Levitz Home Furnishings Inc., which sold its assets to a Long Island-based
retail investment company; Able Laboratories, a generic drug maker from
Cranbury; NVE Pharmaceuticals, a diet-pill maker from Newton; and Everest
Broadbands Network, a Fort Lee communications company.

But Donald Trump's Atlantic City-based Trump Entertainment Resorts Inc.
emerged from Chapter 11 protection in May, and Mahwah-based Footstar Inc.,
which operates shoe departments in Kmart and Rite Aid Stores and distributes
Thom McAn brand shoes through Kmart and Wal-Mart, expects to shed its
protection this quarter.

Last year also saw two of the largest public companies ever to file, with
Refco Inc., a New York-based financial services company, and Calpine Corp.,
a California-based energy company, seeking Chapter 11 protection.

The seeds that led to most of the major filings last year "were planted a
long time ago, based on decisions made a long time in their past," said
George Putnam, chief executive of BankruptcyData.com, a Boston-based Web
site that tracks bankruptcy filings.

"The were all largely caused by legacy costs of one kind or another," he
said. "With the airlines, they were exacerbated by high fuel costs."

Going forward, high-yield debt could lead companies to seek protection, he
said. "The economy has been strong, and banks have been fairly free with
their lending, as has Wall Street." As those high-yield bonds come due,
"you'll see a lot of bankruptcies," he said.