Bankruptcy Reform Act of 2005: What it Means to the Credit and Financial Professional, The

Credit & Financial Management Review, Second Quarter 2005 by Blakeley, Scott

Reviewing an Individual Debtor's Ability to Pay: The "Means Test" (section 707)

The 2005 Act makes it more difficult for individuals to file for Chapter 7 by imposing a means test, which determines whether a debtor has the ability to repay a significant portion of their debts.

The 2005 Act employs a "means test" to determine whether an individual qualifies to file a case under chapter 7, and to determine whether, once filed, a chapter 7 case may be dismissed or converted based upon abuse of the bankruptcy system. Means testing will be employed to determine whether an individual debtor's average currently monthly income is more or less than the median income in the state where the debtor resides.

If, after computing currently monthly income, and deducting certain living expenses, and multiplying that amount by 60, the monthly income exceeds the lesser of (i) $10,000; or (ii) the greater of 25% of the debtor's unsecured non-priority claims or $6,000, than the debtor is presumed to be abusing the bankruptcy process by filing a chapter 7 case. If it is determined that a debtor is able to repay their debts, then the Chapter 7 case may be dismissed or converted to Chapter 13.

What it Means for Vendors

For a vendor holding a personal guarantee the means test may force the guarantor to repay a portion of the guaranteed debt through a Chapter 13 bankruptcy filing if the guarantor's income is too great. Likewise, for a vendor selling to a sole proprietor, the debtor may consider filing an individual Chapter 7. Should the sole proprietor's monthly income exceed the mean, the Chapter 7 case may be dismissed or converted to Chapter 13.

Expansion of Bankruptcy Court's Power Over Creditors' Committees

What is a Creditors' Committee? (sections 1102 and 1103)

Most operating companies in Chapter 11 have a creditors' committee appointed. Perhaps the best way for a vendor to protect its interests in the Chapter 11 and obtain cost-effective legal representation is to serve on the creditors' committee. The committee usually consists of five or seven members selected from the largest unsecured creditors of the debtor. Members are appointed by the United States Trustee, an arm of the Department of Justice, based upon requests to serve from creditors. The committee may hire legal counsel and financial consultants, and have the cost paid by the debtor.

The committee is responsible for protecting the interests of general unsecured creditors. This may include investigating the debtor's past transactions, overseeing the debtor's operations and monitoring its post-bankruptcy operations and progress towards a reorganization plan. The committee also has standing to negotiate the debtor's plan of reorganization, to recommend to creditors whether to vote in favor or against the plan, and to even file its own plan of reorganization.

Bankruptcy Court's Power Over Creditors' Committees (section 405)

Prior to the 2005 Act, the U.S. Trustee appointed the credtiors' committee, in addition to changing the membership of the committee. The 2005 Act provides the bankruptcy court with the authority to direct, after a request from a party in interest, the U.S. Trustee to change the membership of a committee, or increase the number of members of a committee to include a creditor that is a small business. This provision gives creditors the right to request the court to serve on the committee.