Bankruptcies Soar as New Federal Law Goes in Effect

U.S. bankruptcy filings rose 10% in 2005 to a record 1.78 million, driven in part by a more restrictive law that went into effect in October, a federal report said Tuesday.

About 542,000 filings were made in the third quarter, the most ever in one quarter, according to the report by the Administrative Office of the U.S. Courts.

“The new law makes it more expensive and difficult for people to file for bankruptcy,” said Lynn M. LoPucki, a UCLA School of Law professor and an expert in bankruptcy issues. “But ultimately, the number of bankruptcies is determined by debt levels, and consumer debt is at an all-time high.”

The new law forces people with incomes above their state’s median to file for personal bankruptcy under Chapter 13, which requires repayment of a portion of debts. Previously they could use Chapter 7 of the law to avoid repayment.

Business bankruptcy filings in the third quarter also rose as companies including Delphi Corp., Delta Air Lines Inc. and Northwest Airlines Corp. sought protection from creditors.

The new bankruptcy law, which went into effect Oct. 17, limits the amount of time a debtor can spend in bankruptcy before filing a reorganization plan.

Five of the 20 largest Chapter 11 cases in U.S. history were filed in 2005. The companies were Delphi, Delta, Northwest, Refco Inc. and Calpine Corp., the largest case of the year with $26.6 billion in assets. WorldCom Inc. filed the largest U.S. Bankruptcy Court case in history -- $103 billion in assets in 2002.

Judge Thomas Hogan, chairman of the U.S. Judicial Conference’s executive board, said federal courts around the country had devoted extra staffing to handle the influx of cases.

“I don’t think it’s going to overburden the courts,” said Hogan, also the chief judge of the U.S. District Court in Washington.

Personal bankruptcies rose along with consumer debt and the change in the law, said Sam Gerdano, executive director of the Alexandria, Va.-based American Bankruptcy Institute. A 2% drop in business bankruptcies for the year can be explained by low interest rates and the healthy economy, he said.

“Interest rates have been low for a sustained period of time, which makes it easier for companies to refinance their balance sheets,” Gerdano said.

“The reason why bankruptcy filings can go up during an otherwise healthy economy is because they are driven by household debt. Personal bankruptcies accounted for about 98% of the filings and they are almost always driven by consumer debt,” Gerdano said.