Getting a Fresh Financial Start After Closing Down Your Small Business

Closing down a business can be messy. A bankruptcy filed to deal with its financial fallout is often more complicated than a normal consumer bankruptcy case. But not necessarily.  In one respect at least, a business bankruptcy can actually be much easier than a consumer one.  

If you’ve owned a small business that you have already shut down, or are about to, you may be afraid of filing bankruptcy because you’ve heard that “business bankruptcies” are terribly expensive and not a good way to wrap up the affairs of a business. In the next few blogs I will address this concern by showing ways that bankruptcy can be a relatively simple and effective solution.

Today I start with a little twist in the “means test” that favors certain former business owners over normal consumers.

The “means test” determines whether you may file a “straight” Chapter 7 case to discharge your debts in a matter of a few months, or instead must file a 3-to-5-year Chapter 13 payment case. Unless you need some of the other benefits of Chapter 13, Chapter 7 is usually preferred because it gets you to a fresh start much more quickly and cheaply.

In many situations, a former business owner will NOT be able to pass the means test and so will be required to go through Chapter 13. For example:

• If, after closing her business a business owner succeeded in getting a good job before filing bankruptcy, the income from that job may be higher than the “median income” applicable to her state and family size. So she may well not pass the “means test.”
• If the business was operated by one spouse while the other continued working and earning a decent income, that other spouse’s income alone may bump the couple above their applicable “median income,” again with the result of not passing the “means test.”
• If a debtor’s income is higher than the applicable “median income,” he may still be able to pass the means test by deducting from his income his actual and/or approved expenses. But a former business owner will not be able to deduct monthly payments to secured creditors on business collateral he is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that he will have enough allowed expenses to pass the “means test.”

But here’s the good news for some former business owners: the “means test” only applies if your “debts are primarily consumer debts.” (See Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you essentially can skip the “means test.”

Careful, because by “debts” the law means all debts, including home mortgages and personal vehicle loans. So your business debts will usually have to be quite high to be more than all your consumer debts.

And to apply this law we must be very clear about the difference between these two types of debts. So what’s a “consumer debt”? The definition may sound familiar: it’s a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).)  So, for example, if you took out a second mortgage on your home a few years ago explicitly to fund your business, the current balance on that second mortgage would not likely be a consumer debt.

Sometimes the line between these is not clear, so this is something you need to discuss thoroughly with your attorney if you want to avoid the “means test” under this “primarily business debts” exception.