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The new federal bankruptcy law has been widely billed as reducing judicial discretion and making it far harder for Americans to promptly discharge debt. But a little-discussed loophole in the Republican-sponsored Bankruptcy Abuse Prevention and Consumer Protection Act, which took effect Oct. 17, could soften some of the controversial law’s bite — depending on how judges interpret it. The wild card in the new law is that under �707(B)(i), Chapter 7 filers can sidestep the new means test if they can show that “special circumstances” have shrunk their income or increased their debts. Victims of the recent Gulf Coast hurricanes recently were deemed to have special circumstances. But no one is sure how special circumstances will be defined and interpreted for other debtors forced into court by events beyond their control. The new law, pushed by the financial services industry, imposes a means test — set at the median income of the state in which the person lives — for filing Chapter 7 bankruptcies. If the filer doesn’t meet the means and disposable income tests, U.S. bankruptcy judges and trustees can find that the debtor is abusing the system and convert the Chapter 7 petition into a Chapter 13 case. In Florida, the median income for a single person is $35,883, while the median income for a family of four is $59,798. Most filers prefer Chapter 7 — and most creditors hate it — because a Chapter 7 bankruptcy promptly discharges all unsecured debt. In contrast, a Chapter 13 bankruptcy requires debtors to pay back some or all of their debt over a period up to five years. Previously, there was no statutory means test. The trustee’s office and the court evaluated eligibility based on whether, after comparing a person’s income with allowable expenses, the filer had any disposable income to pay his debts. Judges and trustees were required to consider the “totality of the circumstances” faced by the debtor, rather than any specific income and expenses criteria, in deciding whether there was abuse. The special circumstances provision has created uncertainty about who will get relief. Indeed, a new policy announced by the U.S. Trustee’s Office of the Justice Department in the wake of Hurricanes Katrina and Rita suggests that bankruptcy trustees and the courts will face popular pressure to provide such relief from the law’s more onerous provisions. The big question is how “special circumstances” will be interpreted. The new law offers no definition, but it does offer two examples — “a serious medical condition or a call or order to active duty in the armed forces.” Some experts say this special circumstances provision leaves judges and trustees wide discretion. “This particular provision leaves an awful lot up to the court,” said Nathalie Martin, a University of New Mexico law professor and the resident scholar at the American Bankruptcy Institute. “This does allow courts a way out if they don’t believe that there was abuse.” “This can probably vary widely across the country from judge to judge,” acknowledged Chief Bankruptcy Judge Emeritus A. Jay Cristol of the Southern District of Florida, a severe critic of the new law. Beth Levine, press secretary for Senate Finance Committee Chairman Charles Grassley, R-Iowa, who sponsored the bankruptcy legislation, said Grassley included the special circumstances language to give judges “leeway” to help people who fall on hard times. The bill also requires debtors seeking shelter in the exception to meet “specific qualifications,” she said. “There are very specific things for a judge to follow within the law, so that should keep [the exceptions] to within those circumstances,” she said. Still, she said, the senator expects debtors to pay back their creditors if they have the means to do so. He “just wants to be sure that those who abuse the system and have the means to pay part of what they owe, pay [their debts],” Levine said. PRESSURE FOR RELIEF For months, financial writers and legal experts have warned about the dire consequences of the new law, particularly the Chapter 7 changes. The bankruptcy bench and bar have blasted many of the provisions as heartless and complained that the law reduces courts’ discretion to consider individual circumstances. In the wake of Katrina and Rita, political pressure built to provide relief to financially devastated victims. Last month, U.S. Sen. Bill Nelson, D-Fla., said he and other Democrats would introduce legislation to exempt natural disaster victims, defined broadly, from the most stringent provisions of the new bankruptcy law. Sen. Mel Martinez, R-Fla., said he opposed such legislation. On Sept. 28, Louisiana’s Republican Sen. David Vitter introduced a bill to provide bankruptcy relief to victims of natural disasters. It would amend the new bankruptcy law by adding natural disasters to the two examples of special circumstances in the legislation. The law defines natural disaster victims as people whose homes have been damaged by a disaster, who cannot return to their primary home because of a disaster or who cannot work because their place of employment was affected by a natural disaster. In the face of these political developments, on Oct. 5, the U.S. Trustee’s Office in Washington, D.C., announced that it would not challenge debtors’ claims to special circumstances exemptions if they were “victims of the recent hurricanes in the Gulf Coast region.” It said it would tell bankruptcy trustees to relax the rules on producing documents proving income, attending creditors’ meetings and venue for filing for people displaced by Katrina and Rita. Jane Limprecht, a spokeswoman for the U.S. Trustee’s Office, said victims of any natural disaster that causes “widespread destruction” can claim this defense without objection from the Trustee’s Office. That could mean that Florida victims of the many 2004 and 2005 hurricanes could qualify for the exemption. She also said that future victims of subsequent natural disasters will receive the same exemption. On Oct. 4, the Trustee’s Office temporarily waived the requirement for bankruptcy filers in Louisiana and the Southern District of Mississippi to undergo credit counseling before filing for bankruptcy. Of course, judges, not trustees, determine when special circumstances apply. But trustees have discretion to file objections when a Chapter 7 petitioner claims special circumstances. BIG DIFFERENCE AMONG JUDGES? But providing new protections for disaster victims could raise questions about crafting exemptions for other groups of people who suffer financial misfortunes that also are beyond their control. A study last year by bankruptcy and medical experts at Harvard University found that more than half the personal bankruptcy filers in five federal courts cited medical bills as the cause of their insolvency. The trustee’s new guidelines, however, do not address the question of whether large medical bills or other circumstances could be considered special circumstances allowing relief from the means test and other requirements of the new law. Asked if other types of situations might qualify as special circumstances, Limprecht said that would be addressed by the Trustee’s Office on a “case-by-case basis.” The trustee’s new guidelines don’t provide any instruction about what other types of misfortunes could qualify, such as unemployment or divorce. Experts predict that judicial interpretations of special circumstances will vary. Since many bankruptcy judges detest the means test and other restrictions in the new Chapter 7 code, it’s possible that some will find the special circumstances clause elastic, which could elicit the wrath of Sen. Grassley and other lawmakers. “It really depends on what judges determine to be special circumstances,” said Patricia Redmond, a bankruptcy lawyer and partner at Stearns Weaver Miller Weissler Alhadeff & Sitterson in Miami. “Some judges will say that since the statute mentioned two things, that’s it. Others will take a broader view. “You’ll see big difference among the courts in Southern District,” Redmond continued. “You could compare that with what’s happening in New Orleans, where there will be almost a presumption of dire circumstances. Stay tuned.” The University of New Mexico’s Martin predicted that judges may apply the special circumstances exemption to bankruptcy filers who have lost jobs or faced other misfortunes, such as illness or divorce. Appellate courts eventually would have to rule on the legality of those determinations. But Tina Talarchyk, a bankruptcy lawyer at Hodgson Russ in Boca Raton who is president of the Bankruptcy Bar Association for the Southern District of Florida said the two examples provided in the law — serious medical conditions and a call to active duty — set a high threshold for special circumstances. “The courts are going to be compelled to make sure that any arguments for special circumstances meet or exceed the [two examples],” Talarchyk said. Without those examples, she argued, judges and debtors might have had more “wiggle room.” Although the special circumstances provision may provide an opening for some debtors who otherwise wouldn’t qualify to file for Chapter 7, she said, “it’s not the Grand Canyon, and it’s not even [State Road] A1A.”

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