Chapter 7 Bankruptcy Filers with Primarily Business Debts Exempted from Means Test

February 21, 2011

By: David M. Serafin

Several times per year, I’m retained by higher income individuals who, but for the existence of primarily business debt, would otherwise be pushed into chapter 13 bankruptcy.  A debtor is not required to take and pass the Means Test if over 50% of their debt is business related (e.g. non-consumer debt).  

Business debt is typically personally guaranteed by an individual business owner (or else the bank or lender would refuse financing) which can be fully discharged in chapter 7 bankruptcy.  These clients are pleasantly surprised to learn that the Bankruptcy Code treats those with primarily business debt more favorably than those with primarily consumer debt.   

Under the Bankruptcy Code, Section 11 U.S.C. 101(8) defines personal or family debts as consumer debts.  Consumer debts include debt incurred for medical bills, credit cards, pay day loans, car loans (for a vehicle individually titled), and for a mortgage or home equity line of credit.  Because a house is usually the single biggest investment one will ever make, it is the existence of mortgage debt alone which typically disqualifies a debtor from the business debt exemption from the Means Test.

In the abstract, the distinction between business and consumer debt seems straightforward enough, but courts nationwide have had difficulty applying this exemption.  Most have ruled that employment taxes, and even personal income taxes, are not consumer debts as per Section 11 U.S.C. 101(8).  Conversely, another court held that a second home which produced rental income remains consumer debt, despite the business usage of the property.  The court found controlling the fact that the debt was originally incurred for consumer purposes.

Bankruptcy debtors who intend to file should nonetheless anticipate the United States Trustee requiring them to prove the existence of primarily business debt, particularly when it’s a close call.  (Even in situations where the business debt exemption from the Means Test is not at issue, the U.S. Trustee will look for any legally available way to force a debtor into a chapter 13 reorganization, where unsecured creditors are paid some or all of the debt back.)

Bankruptcy courts have also issued inconsistent rulings as to whether a chapter 7 debtor who has incurred primarily business related debt can still face an abuse motion based on a totality of the circumstances if he has the ability to pay back his debts.

In Schedules D, E and F, which accompany the Bankruptcy Petition, we always make sure to label business debts as such.  Also, we’ll investigate why a debt was originally incurred in the hopes that an existing consumer debt may once have been incurred for business purposes.  Further, proper preparation of Schedules I and J will indicate the likelihood of the debtor with disposable income facing an objection by the U.S. Trustee.          

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