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If You Owe Lots of Business Debt You Can Maybe Skip the “Means Test” and Qualify for Chapter 7

One benefit of owing more business debt than consumer debt is that it gives you a largely free pass into a Chapter 7 bankruptcy case. 

 

The Role of the “Means Test”

If your income is too high, you have to pass a “means test” to discharge—legally write off—your debts through a Chapter 7 “straight bankruptcy.” The point of this test is to prevent you from discharging your debts if you have the “means” to pay a meaningful portion of them. So it’s essentially an income and expenses test.

If you don’t pass the “means test,” you could be found to be under a “presumption of abuse” of the bankruptcy laws. If so, you would not be allowed to continue with your Chapter 7 case.  

One way to get out of the “means test” is by having less income than the permitted “median family income” for your state and family size. Most people who file under Chapter 7 have low enough income to avoid the “means test.” But the “median family income” amounts are quite low. If your income is above permitted amount, you have to go through the “means test.” As a result you may be forced into a lengthy and relatively expensive 3-to-5-year Chapter 13 payment plan instead of a usually-less-than-four-month Chapter 7 case.

If You Owe More Non-Consumer Debts than Consumer Debts

Because the “means test” was intended for consumer bankruptcies not business ones, it only applies to consumer cases. What’s critical is how the law distinguishes between the two.

You can avoid taking the “means test” altogether—including the “median family income” step—if your debts are not “primarily consumer debts.” That’s the standard. If your debts are not “primarily consumer debts,” you would be eligible for a Chapter 7 case regardless of your income, even if it’s above the “median” amount.

In fact if you don’t have “primarily consumer debts,” you avoid other kinds of “presumptions of abuse” as well. You can avoid not just the income-and-expense “means test,” but also other ways that your Chapter 7 case could be challenged in a consumer case. Congress has apparently decided that if your debts are mostly from a failed business, you should be permitted an immediate Chapter 7 “fresh start” without the precautions in the law supposedly designed to prevent abuse of the bankruptcy laws by consumers.

What’s “Consumer Debt”?

To determine whether you can avoid the “means test,” we need to be clear what a “consumer debt” is. The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.” (Emphasis added.)

The focus is on the purpose for which you initially incurred the debt, even if the debt would otherwise seem like a consumer debt. Small business owners often finance their business’s start-up and ongoing operation with their consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these might qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to learn how the local bankruptcy judges are interpreting this issue.

 What Does “Primarily Consumer Debts” Mean?

If the total amount of your “consumer debt” is less than the total amount of your debts that are not “consumer debts,” then your debts are not “primarily consumer debts.”

So you have to decide (with the help of your attorney) separately for each one of your debts whether it is a “consumer debt” or not. Then you add up the two columns of debts, and if the total for those that are not “consumer debts” is larger than the total for those that are “consumer debts,” then you do not owe “primarily consumer debts.” And you can skip the “means test.”

Some Business Debts May Be Larger Than You Think

Even after looking closely to see if some of your seemingly “consumer debts” may have actually had a business purpose, you may still believe that you have more of the “consumer debts.” But sometimes business owners have business debts that end up being larger than they thought they were. That could push their not-“consumer debt” higher than their “consumer debt.”

For example, if you had to break a commercial lease for your business premises when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Same thing with a business equipment lease.

Or closing your business may have left you with other hidden or unexpected debts, such as obligations to business partners or unresolved litigation, with potentially large damages owed (and to be discharged in bankruptcy).

Conclusion

The potential good news about such larger-than-expected business debts is that they may result in your non-“consumer debts” outweighing your “consumer debts.” That would enable you to skip the “means test” and avoid other “presumptions for abuse.” That would allow you to discharge all your debts through a Chapter 7 case instead of being forced to pay all you could afford to pay of those debts under a lengthy Chapter 13 case.

 

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Chapter 13 Can Especially Protect Your Co-Signers

Chapter 13 “adjustment of debts” goes a big step further than a Chapter 7 case by protecting your co-signers and their assets.

 

The Regular “Automatic Stay”

The automatic stay—your protection against just about all collection efforts by your creditors—kicks in just as soon as your bankruptcy case is filed. It applies to all bankruptcy cases, including those filed under Chapter 7 and Chapter 13. It is one of the most powerful and important benefits of filing a bankruptcy case.

But it protects only you—the person or persons filing bankruptcy—and your assets. It does not protect anybody else who may also be legally liable on one of your debts.

The Very Special “Co-Debtor Stay”

The very first section of Chapter 13—Section 1301—also deals with the automatic stay, but adds another layer of protection—applicable to your “co-debtors, or co-signers—that only applies to cases filed under Chapter 13.

Section 1301 states that once a Chapter 13 case is filed, “a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any other individual that is liable on such debt with the debtor.” (Emphasis added.)

A creditor on a consumer debt is already prevented by the regular automatic stay from doing anything to collect a debt directly from the debtor. Now, under Chapter 13 only, and only on consumer debts, that creditor is also prevented from collecting on the same debt from anybody else who has co-signed or is otherwise also obligated to pay that debt.

A Very Special Protection

If you think about it, that’s rather powerful, and quite unusual. The person being protected—your co-signer—has nothing to do with your bankruptcy case filing. The co-debtor stay gives you the power to protect that person—likely somebody you really care about—who is not filing bankruptcy and so is not under the direct jurisdiction of the court. The person may not even know that you are protecting them from the creditor.

Conditions and Limits of the Co-Debtor Stay

Besides being limited to consumer (not business) debts, the “co-debtor” protection:

1. Does not protect spouses from joint liability on income taxes. That’s because income tax debts are not considered “consumer debts” for this purpose.

2. This protection does not extend to those who “became liable on… such debt in the ordinary course of such individual’s business.”

3. Creditors can ask for and get permission to pursue your co-debtor to the extent that:

(a)  the co-debtor had received the benefit of the loan or whatever “consideration” was provided by the creditor (instead of the person filing the bankruptcy)—in effect that you were co-signing for him or her; or  

(b)  the Chapter 13 plan “proposes not to pay such claim.”

4. Even if a creditor does not seek or get the above permission, this co-debtor stay expires as soon as the Chapter 13 case is completed, or if it’s dismissed (for failure to make the plan payments, for example), or converted into a Chapter 7 case.

Conclusion

Choosing between Chapter 7 and 13 often involves weighing a series of considerations. If you want to protect a co-signer or someone liable on a debt with you from being pursued for that debt, seriously consider Chapter 13 because of the co-debtor stay. 

 

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Are You Eligible to File a Chapter 7 Bankruptcy Case? How About a Chapter 13 One?

Eligibility depends on 1) the kind of debtor, 2) the kinds and amounts of debts, 3) the amount of income and 4) of expenses.

 

1) The Kind of Debtor

If you are a human person, you may be eligible for either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” case. You and your spouse may also be eligible to file one or the other of these together in a joint case.

However, if you are the owner or part-owner of a business partnership, corporation, limited liability company or other similar business entity, that business entity could not file its own Chapter 13 case. But it could file a Chapter 7 one. Regardless what your business entity itself could file, you could individually file either a Chapter 7 or 13 case, to address your own personal liabilities (beyond whatever liability for which the business itself would be responsible).

2) The Kinds and Amounts of Debts

If your debts are “primarily consumer debts” (more than 50% by dollar amount), then to be able to file a successful Chapter 7 case you have to pass the “means test.” That’s a test related to your income and expenses (discussed more below.)  If 50% or more of your debts are not consumer debts, than you can skip the “means test.”

Chapter 7 does not limit the amount of debt you can have to be eligible to file a case. However, you cannot file a Chapter 13 case if your debts exceed the maximums of $383,175 in unsecured debts and $1,149,525 in secured debts (or if you do file a case it will very likely be “dismissed” (thrown  out)).

3) Amount of Income

You can quickly and easily satisfy the “means test” and be eligible for a Chapter 7 case if your income is no more than the regularly adjusted and published “median income” for your family size and state.

To be eligible for Chapter 13 you must have “regular income.” That is defined not very helpfully as income “sufficiently stable and regular” to enable you to “make payments under a [Chapter 13] plan.”

Also for Chapter 13, if your income is less than the “median income” for your family size and state of residence, then the plan generally must last a minimum of three years (but in many situations it can last longer, especially if you need it to, but for no longer than five years). If your income is at or above the applicable “median income” amount, the plan must almost always last five years.

4) The Amount of Expenses

In Chapter 7, if your income is NOT less than “median income” for your family size and state of residence, then you may still pass the “means test” and be eligible for filing a Chapter 7 case IF, after accounting for all your allowed expenses, you don’t have enough money left over to pay a meaningful amount to your creditors.

In Chapter 13, a similar accounting of your allowed expenses determines the amount of your “disposable income,” the amount you must pay into your plan each month.

Summary

Once you recognize that you need relief from your creditors, choosing between Chapter 7 and 13 is often not difficult. But because there are many, many differences between them, the choice can sometimes turn into a delicate balancing act between the advantages and disadvantages of those two options. That’s why when you have your initial meeting with your bankruptcy attorney, it’s smart to be aware of and communicate your goals, but also be open-minded about how best to accomplish them.

 

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