A Hidden Benefit of Owing Lots of Business Debt: It’s Easier to Qualify for Chapter 7
June 7, 2010 by Oliveros & O'Brien, P.C.
If you owe more business debt than consumer debt, then you could avoid having to qualify under the “means test” to be able to file a Chapter 7 bankruptcy case. This can make a huge difference. Because if you have too much income and do not qualify under the “means test,” that usually means not being allowed to file a Chapter 7 case. So instead of writing off your debts in a matter of about three months, you could be required to pay as much as you could on those debts for up to five years in a Chapter 13 case. If you have lots of business debt, you may be able to file a Chapter 7 when your income would otherwise not allow you to do so.
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What’s the “means test” and why it matters?
Bankruptcy law says that if your income is more than a certain amount, you have to pass a “means test” to be able to go through a Chapter 7 case successfully. That test compares your income to your expenses, using a complicated set of approved expenses based on what the Internal Revenue Service considers acceptable for your region. If you have too much income left over after subtracting these approved expenses, you will generally have to go through a Chapter 13 payment plan instead of being able to get a Chapter 7 discharge.
One way you can avoid this “means test” is by having less income than the permitted “median family income.” See our earlier blog titled The Effect of the New Median Family Income Data on Your Chapter 7 Case to see how that works.
But the “median family income” amounts are relatively low. If your income is even just a tiny bit over the exact permitted amount, you have to go through the “means test,” with the significant risk of having to go through a Chapter 13 instead of Chapter 7.
Debtors with More Non-Consumer Debts than Consumer Debts
You can skip the “means test” altogether if your debts are NOT “primarily consumer debts.” This way you could be eligible for a Chapter 7 case even if your income is above the median level.
But what determines whether your debts are or are not “primarily consumer debts”?
Two issues. Both revolve around the same word, “primarily,” found in different places in the Bankruptcy Code.
#1: What is a “consumer debt”?
The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.”
The focus is on the purpose for which you incurred the debt in the first place. If you made a credit purchase or took out the loan exclusively, or even mostly, for your business, then it is not a “consumer debt.” That is a factual question that you decide on a case-by-case basis for each one of your debts.
If the purpose for the item purchased or the money borrowed changed over time, what counts is your purpose at the time you got the credit. So, for example, if you purchased a pickup truck primarily for your business, but then after the business changed or ceased operating you used the truck only for personal use, this is still not a consumer debt. It was not “incurred . . . primarily for personal, family, or household purpose,” even if that is what it was used for later.
#2: Once you have determined whether each one of your debts is or is not a “consumer debt,” how does the law determine whether your debts are “primarily consumer debts”?
The Bankruptcy Code does not make this crystal clear, but generally if the total amount of consumer debt is less than the total amount of non-consumer debts, your debts are not “primarily consumer debts.” And so you do not have to mess with the “means test.”
Watch out: credit documents often specify whether the transaction is for business or consumer purposes. This is in part because a series of consumer protection and disclosure laws may apply to the credit transaction depending on whether the credit is incurred for consumer purposes. The purpose stated in the contract may well be binding on you, even if you had a different purpose in your own mind. On the other hand, what may be a “consumer purpose” for one set of laws does not necessarily mean that this would be the same under bankruptcy law. This is the kind of situation that you need to carefully review with your attorney.
Unexpectedly High Business Debts Can Help
Small business owner have often financed the start-up and ongoing operation of their businesses with what would otherwise appear to be consumer credit—credit cards, home equity lines of credit and such. These may qualify as non-consumer debts in calculating whether you have “primarily consumer debts.”
Also, sometimes business owners have business debts larger than they thought they had, which could push their non-consumer debt higher than their consumer debt. For example, if you had to break a commercial lease when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Or your business closure may have left you with other hidden debts, such as obligations to business partners or unresolved litigation, with tremendous damages owed. The silver lining to these larger-than-expected business debts is that they may allow you to leap-frog over the “means test” and enable you to dispense with all your debts through a Chapter 7 case when you could not have otherwise.
Concluding Caution
It is very important to realize that while avoiding the means test opens the door to being able to file a Chapter 7 regardless of your income, other issues can arise. For example if your bankruptcy documents reveal that you have more income than expenses, or if some of your expenses are considered unreasonably high, you can still be pushed into a Chapter 13. This is NOT an area to make decisions without direct advice from an experienced business bankruptcy attorney. Some bankruptcy attorneys shy away from clients who are or used to be business owners. We have many years of experience dealing with all kinds of business bankruptcies. Please call Mike O’Brien at 503-786-3800 to talk directly to him about your situation, or click on Contact Us above to arrange for a free consultation.