Chapter and Verse
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Chapter and Verse

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Chapter and Verse
Be it as an individual or as a small business owner, bankruptcy is undoubtedly a situation to avoid.

Even so, some of the wealthiest individuals and greatest businesses in history have survived it. Take H. J. Heinz. His creditors forced him into bankruptcy. Walt Disney suffered bankruptcy along with a nervous breakdown. Milton Hershey came out of bankruptcy to dominate the chocolate industry. And Henry Ford actually filed for bankruptcy with his first car company before getting it right with his third endeavor (Ford Motor Company).

But why take a risk? Knowing the ins and outs of bankruptcy is the first, all-important step to avoiding it in the first place. And the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S.256), which goes into effect in October 2005, is a good place to start. Whether you're an individual or an entrepreneur - especially if you are financing your small business using unsecured, personal credit - you need to know how the new law may affect you.

The Basics

Here are the nuts and bolts, by the numbers. Chapter 7 is commonly referred to as straight bankruptcy. Your assets are sold (liquidated) to repay your debt. There are some exemptions that enable you to keep your primary residence or a vehicle so you can get to work. Anything that is not repaid is cancelled. Oftentimes, unsecured debt (which includes credit card debt) is written off entirely when you file through Chapter 7.

The other major form of bankruptcy involves reorganization, with Chapter 13 filings geared towards individuals and Chapter 11 filings designated primarily for business reorganizations. In either situation, you, the court and your creditors work out an agreement regarding the repayment of an agreed-upon proportion of your debt over a period of time.

Under the new law, it will be harder for individuals or companies to file Chapter 7; most will be forced to file a Chapter 13 bankruptcy, although mid-sized and larger companies able to demonstrate their ability to survive (with bankruptcy protection) will still be able to file for Chapter 11 Reorganization protection.

Undoubtedly, the impact on individuals and small business owners is sure to be far reaching. In 2003, there were roughly 1.175 million Chapter 7 bankruptcies in the U.S. (Source: November 14 2003 News Release, Administrative Office of the U.S. Courts). The vast majority were filed by individuals seeking full relief from their debts. During the same period, fewer than half as many individuals sought Chapter 13 protection. Given the new legislation, it's safe to assume the number of individuals seeking Chapter 13 protection going forward is likely to double, if not triple.

Put into that context and considering the fact that an estimated 20 percent of consumer bankruptcy filings (according to the National Association of Consumer Bankruptcy Attorneys) are actually attributable to small business bankruptcies, it's easy to deduce that both individuals and small business owners are going to be held liable to an extent never before experienced.

The Good News

Since it will be harder for individuals to file for Chapter 7, it will be easier for small business owners to collect what is owed to them. That's actually great news for the small business owner who is a creditor looking to collect debt from vendors or customers. Under the new law, you are eligible as an unsecured creditor to be paid for goods or services that are provided 20 days or more before a bankruptcy is filed. This is a vast improvement from the past, when unsecured creditors had to wait till the secured creditors were paid off, leaving many small business owners empty-handed.

The Bad News

On the other hand, as a debtor, you will find it much harder to have your debts forgiven as an individual. Likewise, entrepreneurs and small businesses seeking protection will find it harder than ever to simply stay in business, let alone start a new business some time down the road after filing a bankruptcy. Given that one-third of all businesses fail within their first three years of beginning operations, these stricter guidelines are sure to negatively impact the small business sector of our economy.

Regarding small business owners, the new law defines a small business debtor as an individual or entity having less than two million dollars in debt. If you find yourself in this category, you can expect to have a bankruptcy court trustee appointed who will review your financial records and determine what happens to your business. If they think your business won't survive, they can decide to make you file Chapter 7, prompting the sale of your assets to pay off your debts. Otherwise, they will determine your eligibility to file for either Chapter 11 or 13 Reorganization protection.

Whatever the determination by the trustee, the situation can be especially troublesome if your business credit is secured by or attached to your personal assets. In fact, any person doing business who does not incorporate in some fashion (e.g. LLC, Sub Chapter S Corp, C Corp, etc.), or fails to either properly maintain the entity and/or separate their business and personal credit and assets, will be personally at risk for all business debt incurred. In such cases, the small business owner is likely to lose some portion of their personal assets, be it through a Chapter 7, 11 or 13 bankruptcy.

As a result, many legal experts now fear that the new law will discourage entrepreneurs from forming new businesses if they can't clear their debt and start over. In turn, this could put a chill on new business creation and job growth in the country.

Old Versus New

According to Samuel Gerdano, the executive director of the American Bankruptcy Institute, there are a couple key considerations to be aware of when it comes to the new bankruptcy laws.

The biggest change, Gerdano says, is that as of October you must seek assistance from a credit-counseling agency six months before you file for bankruptcy. You need to show you are making a good-faith effort to sort out your financial woes. And you must attend a money management course. There are exceptions in emergency situations but that is up to the court to decide.

Under the old rules the court had wide latitude to decide what cases qualified for Chapter 7 protection. Now everyone is subject to a "means" test - a test to measure your ability to repay some portion of your debt. If your income is greater than the median for your state, the court can deny your request for bankruptcy. Your basic living expenses are taken into consideration, along with your ability to repay at least 25 percent of your unsecured debt, including credit card debt.

The net result is that if your income is above your state median and you can re-pay 25 percent of your debt, you won't be eligible for Chapter 7 protection, but you will be eligible to try for Chapter 13 protection. If your income does fall below the median for your state, but you can pay the 25 percent, your state will then make the determination as to whether you can file for Chapter 7 or 13 protection.

Another significant change is that attorneys can be held liable for any inaccurate information you submit when filing for bankruptcy. They must verify your information, disclose their fees, give you a written contract, and inform you that you are not legally required to hire an attorney to file bankruptcy. And they can no longer advise you to incur more debt in order to quality for bankruptcy. In this respect, attorneys may start charging more for their services and be less willing to go to bat for you unless your circumstances are truly dire.

Aside from a change in the filing fees, the new law also allows for automatic dismissal of your filing if you fail to provide all required documentation within 45 days of the initial request. This includes proof that you attended a credit counseling service, along with all the required financial documentation, such as tax return information, a statement of net income and evidence of employment.

Lastly, you cannot be granted a discharge of debt through Chapter 13 if you already filed Chapter 7, 11 or 12 in the past four years. Previously, if you had filed a Chapter 7 bankruptcy, you would have to wait six years to file again, but under the new law you will have to wait eight years.

5 Ways to Avoid Bankruptcy 5 Ways to Avoid Bankruptcy
Here are some tips on staying out of bankruptcy
1. Work within a budget and stick to it; don't live above your means
2. If you run a small business, be a dedicated bean counter. Keep track of your expenses weekly so you can anticipate problems well in advance
3. Try to pay more than the minimum payment on credit card debt each month. Better yet, charge only what you can pay off in full each month
4. If you find yourself swimming in debt, seek help sooner than later. Borrow from your savings or family if possible, or contact your creditors directly to work out a payment plan.
5. Check with the Better Business Bureau before signing up with a debt relief agency that promises to erase debt at a low cost - find a reputable company to work with.

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