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When the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) goes into effect in mid-October, it will make it more difficult for consumers and businesses seeking to get out from under an estimated $40 billion in unpaid debts. That has triggered a spike in bankruptcy filings under existing law, and experts say executives of midsized companies should take a closer look at how the changes may affect their business,customers and vendors.

BAPCPA, which was signed into law last April with a six-month grace period, is the first major upgrade to U.S. bankruptcy policy since the 1970s. The new law will make it more difficult for individuals to file Chapter 7 bankruptcy, which effectively wipes out most consumer, personal and business debts, and forces more debtors to file a Chapter 13 bankruptcy plan that requires repayment over several years. According to AccountingWeb, more than 1.5 million personal bankruptcies were filed in 2004, and industry statistics show that about 70 percent of all current filings take place under Chapter 7.

Among other reforms, the new law provides for:

• Expansion of residency requirements from 180 days to 730 days in order to establish residency for state exemption purposes.
• A qualifying test and a more strenuous "burden of proof" for Chapter 7 eligibility.
• Limits to the application of a stay in circumstances where serial filings indicate abuse.
• A tougher national standard for homestead exemptions, with a cap of $125,000.
• Adherence to IRS rules for reasonable expenses for lodging, food and other essentials.
• Attorney accountability for accuracy of the case, enforced by a system of fees and fines.
• Unlimited protection for qualified retirement vehicles, such as pensions, profit-sharing plans, and 401(k), 403(b), and 457 plans. While IRAs and Roth IRAs are shielded up to a $1 million aggregate total, there is unlimited protection for qualified rollovers to a retirement plan.

Business impact

While BAPCPA made for splashy headlines when it was signed into law, business experts remain split on its projected impact. While most agree the new law will make it more difficult for consumers to abuse the bankruptcy code, the effect on businesses and entrepreneurs is harder to predict.

The Ewing Marion Kauffman Foundation, a Kansas City, Mo., organization that makes grants to entrepreneurial companies, recently completed a study predicting that BAPCPA will have a negative impact on new business ventures — largely because the foundation believes current bankruptcy law offers an important safety net for first-time business owners. But other experts say those findings don’t reflect the driven, can-do attitude of most entrepreneurs.

"Why risk anything if you think you’re going to fail?" says Kristi Kennedy, managing director with RSM McGladrey Tax Services. "That’s not the nature of a successful businessperson or an entrepreneur."

Generally speaking, business observers characterize the new law as "good news, bad news." While companies with mounting debts will find it more difficult to dig out, BAPCPA will help other businesses collect from customers or clients who file for bankruptcy. With that in mind, the American Bankruptcy Institute (ABI) reports that filings were well above average during the summer — a trend that was expected to continue until the new law takes effect on Oct. 17.

To help ensure that your bottom line isn’t hurt by the surge in bankruptcy filings, Entrepreneur.com legal columnist Chris Kelleher offers the following business tips:

Keep an eye on your receivables. Take a hard look at your current accounts receivable and closely watch large accounts. If you suspect that a major customer may file bankruptcy before Oct. 17, discuss the account with a bankruptcy specialist.

Be on guard for large orders. Consumers or businesses in trouble will sometimes load upon orders just before filing for bankruptcy, hoping that step will force vendors to accept little or nothing for goods or services provided. Be cautious about delivering big orders or providing broad services to "suspect" customers.

Look out for large orders from new customers. Be cautious about any brand-new customers who place a large order with your business "just to see how well you can handle it." Conduct a rigorous credit check of all customers, regardless of size.

Be wary of unusually large payments from customers. In many cases, current law allows a bankrupt company to take back any money paid to your company within 90 days of a bankruptcy filing date. Be wary of customers making larger-than-normal payments, which could set the stage for them to get that payment back under a current Chapter 7 filing.

Key changes under the new law

The American Bankruptcy Institute outlines major changes to personal bankruptcy filing under BAPCPA, including these 10 key points:

Means test for Chapter 7 eligibility. The trustee or any creditor can bring a motion to dismiss if the debtor’s income is greater than the state median income.

Homestead exemption. There will be stringent restrictions on the homestead exemption. For example, filers may only exempt up to $125,000 (regardless of a state’s exemption allowance) if the home was purchased less than 40 months before filing. Unlike most other provisions in the new law, this rule is already in effect.

Limit on automatic stay. Under existing law, debtors typically receive an "automatic stay," which shields them from creditors’ collection efforts. The new law, however, disallows a stay under circumstances that indicate bad faith or abusive filings. Additionally, debtors with a prior bankruptcy filing dismissed under any chapter within the last year will qualify for only a 30-day stay, unless they obtain a court order extending it.

Duration of Chapter 13 plans. If the Chapter 13 debtor’s income is greater than the state median income, the repayment plan proposed must be for five years. On the anniversary date of a confirmed plan, a debtor must file a new statement of income and expenses.

Mandatory credit counseling. Within six months of a bankruptcy filing date, debtors must prove that they have received financial counseling from an "approved nonprofit budget and credit counseling agency," either in an individual or group briefing.

Limit on auto lien stripping in Chapter 13. A Chapter 13 repayment plan allows a secured creditor to retain its lien until full payment — not just the secured portion — is received on all vehicles purchased within 910 days (or 2.5 years) of a bankruptcy filing.

Mandatory debtor education. The court may not grant a Chapter 13 discharge unless the debtor has completed an education course in personal financial management as approved by the U.S. Trustee.

Discharge of luxury debts and cash advances. Any debt for luxury goods totaling more than $500 with a single creditor is not dischargable if the purchase was made within 90 days of filing. Cash advances of $750 or more within 70 days of filing are treated in similar fashion.

Dismissal for failure to file documents and schedules. In addition to a list of creditors, assets, liabilities, income and expenses, debtors must provide:

• A certificate of credit counseling.
• Evidence of payment, if any, received from employers 60 days before filing.
• A statement of monthly net income and any anticipated increase in income or expenses after filing.
• Tax returns or transcripts for the most recent tax year and any returns filed during the case.

Failure to provide the documents within 45 days after the petition has been filed (with a possible 45-day extension) results in automatic dismissal of the bankruptcy case.

Attorney verification requirement. Attorneys must make "reasonable inquiry" to verify the information contained in debtors’ petitions and schedules. This change places more burden on bankruptcy lawyers to ensure the accuracy of filings, which experts say will slow down the process and drive up filing costs.

As always in business, it pays to stay alert. By keeping these changes to the bankruptcy laws in mind, you can do a better job of monitoring not only your business, but actions by customers or vendors that may signal impending financial trouble.