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.