A Medical Bankruptcy?

The United States Congress, the governing body for Bankruptcy law in the US, will be considering changes to the current Bankruptcy Code with the introduction of a bill last week from Senators Sheldon Whitehouse (D-RI) and Elizabeth Warren (D-Mass).  The bill, titled the Medical Bankruptcy Fairness Act of 2014 (S. 2417), seeks several far-reaching changes to certain parts of the Bankruptcy Code in order to allow individuals with primarily medical related debts an easier path to bankrupt them.

Current data indicates that medical debts are the leading cause of personal bankruptcies in the United States.  In fact, three-quarters of the families that are driven to bankruptcy because of medical debts have health insurance. [1] The proposed bill would create a new class of debtors referred to as “medically distressed”.

The bill proposes several sweeping changes to the current Bankruptcy Code.  Among these changes, the bill would amend the Federal Homestead Exemption (the amount of equity a debtor can protect in real property) from $20,200.00 for an individual debtor ($40,400.00 for joint debtors) to $250,000.00.  The bill would also exempt “medically distressed” debtors from the Means Test.  Further, the bill seeks to waive the requirement for the required Credit Counseling courses. Lastly, and perhaps most surprising, the bill would lower the standard by which student loans are discharged in bankruptcy.  Currently, debtors must prove that repaying student loans would “impose an undue hardship on either the debtor or the debtor’s dependents”.

Under the proposed change, the debtor would only have to prove that he is “medically distressed”.  Anyone that has ever practiced bankruptcy law knows that proving “undue hardship” in order to have student loans discharged in bankruptcy is next to impossible.  The new standard of “medically distressed” appears far more lenient.

So, what is a “medically distressed” debtor?  In order to qualify as a “medically distressed” debtor under the proposed bill, the debtor would first have to meet certain qualifications.  Those qualifications are:

(A)    a debtor who, during the 3 years before the date of the filing of the petition—

(i) incurred or paid aggregate medical debts for the debtor, a dependent of the debtor, or a nondependent parent, grandparent, sibling, child, grandchild, or spouse of the debtor that were not paid by any third-party payor and were greater than the lesser of—

(I) 10 percent of the debtor’s adjusted gross income (as such term is defined in section 62 of the Internal Revenue Code of 1986); or

(II) $10,000;

(ii) did not receive domestic support obligations, or had a spouse or dependent who did not receive domestic support obligations, of at least $10,000 due to a medical issue of the person obligated to pay that would cause the obligor to meet the requirements under clause (i) or (iii), if the obligor was a debtor in a case under this title; or

(iii) experienced a change in employment status that resulted in a reduction in wages,

salaries, commissions, or work hours or resulted in unemployment due to—

(I) an injury, deformity, or disease of the debtor; or

(II) care for an injured, deformed, or ill dependent or nondependent parent, grandparent, sibling, child, grandchild, or spouse of the debtor; or

(B)    a debtor who is the spouse of a debtor described in subparagraph (A) [2]

The standard set forth above to prove a debtor is “medically distressed” is far less strenuous than the current criteria to prove “undue hardship”.  In fact, the proposed bill would change the language of the current Bankruptcy Code, 11 USC §523(a) (7) to add “the debtor is a medically distressed debtor or” and would read:

“unless “the debtor is a medically distressed debtor or” excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

(A)

(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;

In other words, the debtor would not have to prove the nearly unprovable standard of “undue hardship” if he can prove that he is “medically distressed”.  This is a mammoth change not only because the bar for discharging student loan debt would be lowered, but also because the definition of “medically distressed” is much clearer than the arbitrary “undue hardship” standard.  Under the current “undue hardship” standard, the Courts require that the debtor file an adversary proceeding (a separate lawsuit filed within the debtor’s bankruptcy case) in which the debtor must convince the Court that repaying the student loans would create an “undue hardship”.  In the absence of proper guidance from Congress on what constitutes “undue hardship” most courts apply what is commonly known as the Brunner Standard.  The Brunner Standard is actually the test derived from a 1987 bankruptcy proceeding from the Second Circuit Court of Appeals.  The Court ruled that to prove “undue hardship”, the debtor would be required to prove three things:  One, that the borrower and any dependents cannot maintain a minimal standard of living based on current income and expenses; two, that additional circumstances indicate this is likely to be the case for a significant portion of the borrower's repayment period; and three, that the borrower made a good faith effort to repay the loans.  The proposed bill would except “medically distressed” debtors from the “undue hardship” standard and allow student loan debt to be discharged just like any other unsecured debt.

Another change to the current Bankruptcy Code would be increasing the Federal Homestead Exemption to $250,000.00.  At present, only a handful of states allow debtors to protect up to $250,000.00 of equity in real property.  This change would be beneficial for clients that live in states that use the Federal Exemptions (Tennessee does not) or for clients that have recently moved from one state to another.  This change can get very convoluted to explain.  Please consult an attorney at Bond & Botes for ways this change might affect you.

The proposed bill would also waive the requirement for debtors to complete the “Means Test” or “Calculation of Disposable Income”, depending on which chapter of bankruptcy is filed.    For Chapter 7 debtors, this is huge.  Presently, debtor’s whose income is over the median income for their family size in their particular state may not qualify for Chapter 7 bankruptcy protection.  Currently, there are several classes of debtors that are excepted from the Means Test; including debtors with a majority of business related debts, certain military debtors, etc.  The proposed change would add a new class of debtors that are exempt from the Means Test.  As long as a debtor qualifies as a “medically distressed” debtor, he would be excluded from the Means Test.  This is also a very significant change to the existing Bankruptcy Code.  The purpose of the Means Test is to force high income debtors into Chapter 13 Bankruptcy, thus allowing some portion of the debtor’s unsecured debts to be repaid over time.  The proposed change would eliminate that requirement for “medically distressed” debtors and stop some objections to plan confirmations in Chapter 13 if the debtor is considered “medically distressed”.

The bill would also exclude “medically distressed” debtors from taking the Bankruptcy Court’s required pre-filing and post filing Credit Counseling and Personal Financial Management courses, respectively.  The rationale being that “medically distressed” are not filing bankruptcy because they mismanaged personal finances, but because of non-financial circumstances beyond their control.  The purposes of the pre and post filing Credit Counseling courses is mainly to look at a debtor’s finances and money management.

Keep in mind that the above is just a bill that was proposed for review.  This bill will probably not pass and thus the above changes would not go into effect, or if it does pass, significant changes could be made by both the House of Representatives and the Senate prior to becoming law.  If you are in favor of the changes addressed in this bill, please contact your local representatives in both the House and the Senate to express your desire to see these changes.  To contact your local representative, follow this link https://www.govtrack.us/congress/members. Regardless of whether this bill passes or not, it is encouraging to see Congress address bankruptcy legislation in a manner beneficial to struggling individual debtors, instead of large, multi-national corporations, banks and insurance companies.

[1] http://www.acainternational.org/governmentaffairs-senators-introduce-measure-to-help-families-struggling-with-medical-debt-32265.aspx

[2] https://www.govtrack.us/congress/bills/113/s2471/text