Several unexpected yet major changes have been brought about by the Bankruptcy Abuse and Consumer Protection Act of 2005 ("BACPA"). The original intent of the BACPA when it was proposed in 1997 was to curb co-called "abuses" in consumer bankruptcy. To that end, both the proposed and final legislation addressed implementation of means testing, presumptions of abuse, mandatory pre-bankruptcy credit counseling, mandatory post bankruptcy financial management courses, and other provisions thought to be generally favorable to unsecured creditors (or at least not favorable to debtors).
The long and tortured history of the legislation however, reveals that an innumerable range of special interest groups jumped on the "reform" bandwagon in order to hoist provisions into the final bill favorable to their respective industries – primarily credit card and finance companies. This makes it all the more ironic that the BACPA as passed actually makes an unsecured creditors’ portion of the debtor’s pie even smaller than it would have been before passage. In short, the BACPA is proof of that old adage, be careful what you ask for – you might get it.
The basic concept of bankruptcy is that creditors have to be paid the liquidation value of a Debtors estate in order for a Debtor to get a discharge. Creditors, however, do not maintain equal footing in the order of the payment they receive from a Debtor’s estate. Unsecured non-priority creditors, such as credit card debt (the primary financiers of the money used to support the legislation in Congress), are the last parties to get paid in a distribution from a bankruptcy estate. Because bankruptcy law also reflects a certain degree of social legislation, the order of priorities that creditors get paid in becomes "the devil in the details." Certain special interest groups managed to move themselves up in line in BACPA, allowing them to get paid before any unsecured, non-priority debt. This article points out the groups that really benefited from the new Code.
Before BACPA, domestic support obligations were subject to issues of non-dischargeability and required the filing of an adversary proceeding in order to enforce those provisions. Under BACPA, all domestic support obligations are now classified as "first priority" claims under §507(a)(1) of the United States Bankruptcy Code (the "Code"), meaning those obligations get paid in full before any other creditors.1 Second, domestic support obligations that are assigned to a governmental unit are also given first priority.2 Basically, any child support that is owed to probation or to the local county board of social services is also given priority status.
In addition, §523(a)(5) of the Code relating to dischargeability of debts now makes all support obligations non-dischargeable under all chapters (7, 11, 13, et al.).3 All property settlement debts that are owed to a spouse, former spouse, or a child of the debtor are also non-dischargeable in Chapter 7.4 Therefore, a non-debtor spouse is no longer technically required to file an adversary complaint to block a debtor spouse from trying to bankrupt debt that is owed under a property settlement agreement.
Finally, BACPA excepts proceedings dealing with child custody, visitation rights, domestic violence, and divorce from the automatic stay provisions of the Code;5 that is creditors who are owed child support may continue their collection actions without coming to bankruptcy court and asking for permission to modifying the automatic stay. In effect BAPCA makes explicit a social judgment long implied in the law: that the bankruptcy process is subservient to the divorce or child support case. Family law now takes explicit priority over bankruptcy, the automatic stay provisions in §362 no longer automatically stop a divorce or child support action in progress.
As domestic support obligations are now first priority, non-dischargeable obligations, absent an adversary proceeding to change their treatment, it is safe to say that the group of creditors arising from family law proceedings (spouses, children, others) have benefited more than any other under the BACPA’s new distribution scheme, and have done so at the expense of other creditors.
Another class of creditors that benefited materially from BAPCA were landlords holding non-residential leases. Under the pre-BACPA Code, a chapter 11 debtor who is a tenant in a non-residential lease was required to assume or reject those leases within 60 days of filing bankruptcy. The Debtor was allowed to obtain one or more extensions of time to assume or reject the non-residential lease, even over the objections of the landlord. Extensions of time allowing the Debtor time to decide whether to assume or reject the lease were routinely granted and, oftentimes, those extensions would be granted till confirmation of a plan of reorganization as long as the Debtor kept current on post-petition rent.
BAPCPA significantly alters the procedure regarding assumption or rejection of non-residential leases in Chapter 11 cases. Under BAPCA, a chapter 11 Debtor now must assume or reject non-residential leases within 120 days after the filing of its petition. 11 USC 365(b)(4)(A). In addition, time to assume the lease by the Debtor may be extended only once for 90 days, and only if the extension is obtained during the initial 120 day period. 11 USC 365(b)(4)(B). Extensions after the initial period plus the initial extension are available to the Debtor only with the prior written consent of the landlord. If the extensions are not obtained, the lease is deemed rejected as a matter of law and the lease is at an end with the landlord having all remedies available to it under state law. 11 U.S.C. § 365(d)(4)(A).
If the Debtor elects to reject a previously assumed lease, BAPCPA provides that the landlord’s claim for breach of the now rejected lease has administrative priority status over all other priority and non-priority unsecured creditors for a period of two years following the rejection date. In addition, the landlord is entitled to payment of the remaining balance due under the now rejected lease as an unsecured, non-priority claim in a fixed amount. 11 U.S.C. §503(b)(7); 11 U.S.C. §502(b)(6).
The time limitation in the assumption provision for non-residential leases favors the landlord by making the Debtor decide whether to assume or reject the lease within a much shorter period of time without cause. Many landlords did not appreciate being strung along while the Chapter 11 Debtor reorganized without knowing whether they were going to be part of the reorganized Debtor or not. Further, landlords being given administrative claim status for rents owed for two years after a previously assumed lease is rejected in a Plan means that Debtors have to pay a huge price for assuming a lease and then rejecting it in a Plan. The price that is paid, of course, is out of the wallets of unsecured, non-priority creditors. Once again, a class of creditors has made the share of the Debtor pie available for unsecured non-priority creditors even smaller.
One final class of creditors that benefited from BAPCA is utilities. §366 of the Code provides constraints upon utility service providers once a bankruptcy case is filed. Utilities may not terminate or modify their services for a period of time after commencement of the bankruptcy case. 11 USC 366(a). The Debtor is granted uninterrupted access to all utilities for a limited period of time. Once the applicable period expires, utility providers may discontinue service without further notice or authorization from the bankruptcy court unless the debtor provides "adequate assurance of payment" for post-petition services. 11 USC 366(b). Normally, the Debtor would file a motion requesting that a Court determine what was adequate assurance as part of the filing of a Chapter 11 case
Prior to BAPCA, many courts weighed in heavily on behalf of Debtors when it came to the "adequate assurance" requirement. Because there was no definition of what adequate assurance was under the Code, bankruptcy judges tended to decide the question on a case-by-case basis. Some courts required the Debtor to furnish a deposit or collateral but others held that only minimal adequate assurance payments were required in the form of payment for post-petition services.
BAPCA removed this case by case analysis that oftentimes favored the Debtor by providing a statutory definition of "adequate assurance of payment.’ The BAPCA version of § 366 now lists much more substantial forms of payment, such as cash deposits, letters of credit, certificate of deposits, surety bonds and prepayment of utility services as satisfying the adequate assurance requirements and specifically excludes as adequate assurance the often-time useless grant of an administrative priority status to the utilities’ post-petition claims. 11 USC 366(c)(1)(A) and (B). Because the Debtor now has to do more than just keep its utility bills current, it appears likely that the Debtor will have to provide some form of adequate assurance post petition more than just a pre-petition deposit and keeping current on its post petition bills. In other words, a Debtor will have to pay the utilities something after the filing of petition to keep its utility services on, once again putting the utilities in front of other pre-petition creditors.
Hence, though BAPCA was designed to stem the tide of consumer bankruptcies and get more of Debtors money to unsecured non-priority creditors such as credit card companies, the practical effect of BAPCA is that the amount available to pre-petition non-priority creditors has actually shrunk. This results from the re-characterization of certain types of debts as priorities that come before other creditors. Hence, unlike pre-BAPCA law, domestic support obligations, landlords, and utilities all come before unsecured creditors in new ways that shrink the amounts available to be distributed in asset estates to unsecured non-priority creditors. Such a result was certainly not what was intended by the many lobbyists who worked so hard to get BAPCA passed, but the overall effect of the new law is far away from the original intent of the bill.
1 11 USC 507(a)(1)(A).
2 11 USC 507(a)(1)(B).
3 11 USC 523(a)(5).
4 11 USC 523(a)(15).
5 11 USC 362(b)(2).
Michael J. Davis is a partner in the law firm of Springer Brown Covey Gaertner and Davis. He received a B.A. with honors in 1975 from the University of Notre Dame and received his J.D. in 1980 from VanderbiltUniversity School of Law. He is licensed to practice law in Illinois and Florida, and is a member of the DuPage County Bar Association as well as the American Bankruptcy Institute. He is also past chairperson of the Bankruptcy Committee of the DCBA and member of the Editorial Board. Mike is a frequent contributor of articles relating to creditor and debtor issues in Illinois. He concentrates his practice in consumer and corporate bankruptcy, commercial litigation, bankruptcy litigation, loan workouts and assignments for the benefit of creditors.