Financial Fallout

The new bankruptcy act requires greater involvement by companies in the financial lives of their employees -- in potentially positive and negative ways.

Tuesday, November 1, 2005
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"Well, I got a job and tried to put my money away,

But I got debts that no honest man can pay.

So I drew what I had from the Central Trust,

And I bought us two tickets on that Coast City bus." 

      "Atlantic City," Bruce Springsteen

Going broke is never easy. But as many human resource professionals know, not everyone who files bankruptcy rides out of town and leaves their bad debts unpaid.

Many people stay and try to climb out of the hole they've dug for themselves, often with the help of federal bankruptcy laws that make it easy for a person to make a new start.

Now, though, a new law -- the Bankruptcy Abuse and Consumer Protection Act of 2005 -- went into effect on Oct. 17 and it's going to affect HR professionals as companies get more involved in the bankruptcy process. Employers may find themselves more often garnishing wages from employees, while at the same time, companies will need to comply with new rules governing the handling of retirement-benefits processing and other issues.

HR executives also need to be mindful of the potential violence inherent in such a stressful situation -- as when an employee is under such financial pressure that he or she opts for bankruptcy protection.

"There are several changes in law that human resource executives will be required to look at closely," says John Graham, regional director for compliance research at The Segal Group, a New York-based consulting firm. "Some changes are bigger than others. But the biggest danger here is not being informed."

Tightening Standards

The purpose of the legislation, which represents the largest overhaul of the bankruptcy code in nearly 20 years, was not only to upgrade bankruptcy laws, but to instill greater personal responsibility in individuals who resorted to bankruptcy filings to avoid repaying debts, according to backers of the legislation.

The backdrop to the bill's passage was a multimillion-dollar lobbying effort over eight years by banks and credit-card companies -- which stand to recover millions of dollars in assets. Supporters argued the law will prevent bankruptcy abuse by gamblers, deadbeat dads and even multimillionaires seeking to shelter assets from creditors.

Perhaps the most compelling change, however, involves what can happen when a person files for bankruptcy, and how those debts will then be treated. In the past, a person teetering on the financial edge could file for Chapter 7 bankruptcy, which was the most widely used option because debts would be forgiven, although selling a home or car was often part of the deal.

Now, though, the law tightens standards for filing Chapter 7 bankruptcy and as many as 100,000 people a year may be swept into Chapter 13, according to some reports.

This places debtors on a tight, five-year repayment schedule -- which includes garnishing wages -- in order to ensure that as many creditors as possible are repaid.

The shift is apparently something that many individuals want to avoid: Throughout the summer, the media filed periodic reports detailing a sharp rise in bankruptcy filings, as many people hoped to avoid the new law and the more onerous requirements a Chapter 13 filing would impose on them.

This is where employers are going to be pressed into duty. Although the administrative act of garnishing wages is certainly not new to many companies and their human resource departments, experts predict the volume of Chapter 13 filings will be so large that some companies will be unprepared to confront the fallout.

"What you'll see is that, in many districts around the country, a bankruptcy court will impose Chapter 13 on debtors and require them to pay a portion of their income each month to satisfy creditors," says Ira Herman, a partner at the New York law firm of Bryan Cave and a former chairman of the New York State Bar Association business law section.

"So if there are more Chapter 13 filings, it's more likely that employers will be required to make payments to Chapter 13 trustees pursuant to court orders.

No one really knows how many more such filings will be made. But there are many who are assuming it could be a large number."

Violent Reactions

There's another aspect to this overhaul, say some experts: the possibility of workplace violence in response to the projected increase in Chapter 13 filings. The very fact that more employees will be forced to repay debts suggests that anger and frustration will result, prompting more incidents to occur, experts say.

"It's an issue that's clearly on the front burner," says Paul Viollis, president of Risk Control Strategies, a New York-based consulting firm that specializes in workplace-violence issues.

"The task of garnishing wages is a significant catalyst for workplace violence. Unfortunately, the human resources team is at risk of being targeted -- they're seen as delivering the message," he says.

Even companies experienced in garnishing wages will now have to ensure they have an updated set of procedures not only for fulfilling this responsibility, but also mitigating the possibility an employee will react violently, Viollis says. If recent trends are any indication, such preparation will be more important than ever.

Ten percent of companies surveyed last April by Risk Control reported an employee assault on a colleague or senior manager within the previous 12 months. The firm queried 602 senior executives responsible for security or human resource functions at companies with between 300 and 900 employees. 

The survey also found that, overall, 82 percent of the companies say the number of incidents involving workplace violence rose in the past two years. And almost 80 percent of the companies believe workplace violence, in general, is a bigger problem today than in 2003. 

While this may be the more dramatic consequence raised as a result of the new law, there are other issues related to garnishing wages that experts say human resource departments should watch carefully. In particular, they point to the changes made in the way automatic "stays" issued by courts affect an employer's actions.

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A stay instructs the employer to refuse a garnishment sought by a creditor, according to Ted Novy, a legal consultant at Hewitt Associates, a consulting firm in Lincolnshire, Ill. In the past, a court might typically issue such an order after an employee filed bankruptcy. 

Now, though, he says, employers are required to scrutinize the chronology of events involving their employee. If, for example, an employee in the prior year filed for bankruptcy protection, and it was dismissed, and then, he or she files bankruptcy again, the length of any automatic stay will be limited to 30 days, says Novy. 

"The attention paid to bankruptcy, within the whole payroll realm, has to be raised a couple of notches," he says. "The employer really has to watch timing, which means keeping an eye on the receipt of letters from creditors and courts regarding garnishment orders. Companies just have to be more careful."

Additional Changes


Garnishment isn't the only issue confronting human resource departments. On a very different note, experts say, the new law requires companies to change the way they handle certain employee-retirement benefits, such as 401(k) plans and repayment of participant loans.

For instance, a 1992 U.S Supreme Court ruling determined that ERISA protects funds in an employee's pension from creditors in a bankruptcy case. The new law, however, makes clear that the same protection also applies to other plans that are tax exempt, such as public-sector retirement programs and individual retirement accounts, such as a 401(k). 

In addition, an employee who has filed for bankruptcy protection can continue repaying loans made from a retirement plan within ERISA and Internal Revenue Code limits, according to Graham at Segal. 

That is a change from the past -- and a significant improvement, say benefits experts. It provides human resource departments with a wonderful opportunity to remind their employees that there is light at the end of the tunnel, experts say. 

"Here's how it worked before: An employee filed bankruptcy and an automatic stay would lock in, which meant 401(k) loan repayments had to stop.

But, of course, if you don't repay the loan, after a period of time, you're in default. So that put the employee in an even worse financial situation, which was counterproductive, says Hewitt's Novy.

Under the new law, when an employer receives notice of an automatic stay, they no longer have to turn off 401(k) deductions.

Novy predicts many companies will feel "a lot more comfortable. In the past, you could see the writing on the wall -- it was like piling on. And it didn't seem to be a way to help somebody get into a better financial situation." 

For employers, who in the past had to carefully track intimate developments in an employee's life, this means much less administrative work and, significantly, much less legal uncertainty, according to Ian Levin, an employee-benefits attorney at the New York law firm of Orrick Herrington & Sutcliffe. 

"These were some of the things that made an employer's life miserable," says Levin.

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