business debt

Small Business Debts and Chapter 7 Bankruptcy

The bankruptcy code provides for large business debt relief with Chapter 11 bankruptcy. When Westinghouse, or the Penguins, or Donald Trump, filed for bankruptcy, it was a Chapter 11 bankruptcy. This is a very expensive and very complicated bankruptcy that allows for the restructuring of debts and/or liquidation of assets. With smaller businesses, Chapter 11 is unnecessary, and a normal consumer Chapter 7 bankruptcy can be filed instead.

Chapter 7 bankruptcy is normally filed on consumer debt (such as credit cards, medical bills, mortgages, and car payments). However, it can also be used to eliminate business debts that were personally accrued during the operation of the business. This is important because these debts are often quite large, larger than most personal debts. Fortunately, Chapter 7 bankruptcy can be used to eliminate these business debts once you decide to shut down the business.

What types of business debts can be discharged in Chapter 7 bankruptcy? Almost all types related to a small business. The most important type of debt is the remaining time on a business lease. Landlords can go after the entire remaining lease once you stop paying, and considering that commercial leases are normally for multiple years and tens-of-thousands of dollars, this can be quite significant. In most small business cases, the debtor is personally obligated on the lease, which allows the landlord to sue both the company and individual. Given the large amounts of money at stake with these leases, Chapter 7 bankruptcy may almost be a necessity. The lease can be eliminated whether there are 3 months or 3 years remaining, so there is no need to continue the business once you have decide it is best to shut it down.

Business loans and debts personally backed by debtor are also dischargeable. The range of these types of debts is as broad as the range of different types of businesses. It can include (but is not limited to) debts to vendors, service providers, or leased property. Loans used for equipment or products can be wiped out (though the items themselves could be property of the bankruptcy). It can also discharge loans that are part of a lawsuit.

Personal credit cards used in purchases related to the business can also be discharged. Debtors will often use their personal credit cards to keep a business going, often racking up tens-of-thousands of dollars of debt. These debts will be treated the same as business loans, and unless they were used to pay taxes, they will be dischargeable. These can be discharged along with personal credit card debt on consumer purchases.

Business vehicle loans can also be wiped out. A vehicle used in the business, but secured by a loan signed by the debtor can be surrendered and discharged. This is even the case if the vehicle was (or wasn't) used for personal reasons. Of course, the vehicle will need to be returned to the creditor.

One final point about Chapter 7 bankruptcies filed on business debts is that there is no means test. The means test (which looks at the last 6 months of income for a debtor looking to file bankruptcy to determine the type of bankruptcy they can file) does not apply when the debts listed are "primarily business in nature". This will be helpful for filers with higher incomes at the time of filing.

Contact us if your small business is facing large debts and you are considering bankruptcy. The bankruptcy code may allow you to avoid personal obligation and move on with your life. The end of your business doesn't need to be the end of your financial future.

The Means Test and Non-Consumer Debts

Individuals looking to file for relief under the Bankruptcy code will normally be subject to the "means test". The means test is a six month look-back of all income earned by the household in the period right before filing bankruptcy.

This definition of income is broad. It will not only include salaried income, overtime, commissions, and bonuses, but it will include one time payments such as lottery winnings and inheritances. It will include unemployment compensation, and it will even include money that is not taxable, such child support. This broadly defined income will be compared against household size, and if your income is above the threshold, you may be required to repay your creditors in a Chapter 13 bankruptcy. For a household of one, the threshold is about $25,000 in gross income over the previous six months. The threshold increases with household size.

The means test is very important, as the result can lead to thousands of dollars of repayments if it is failed. In the vast majority of bankruptcy filings it applies and must be completed. The vast majority of cases... but not all.

The means test does not apply when the majority of your debts are business in nature, not consumer. 11 United States Code 707(b) says the means test only applies when, "debts are primarily consumer debts." So, if you your debts are primarily from a failed business, the look-period on your income described above does not apply. This is obviously very important if your income is potentially above the threshold. You may be able to avoid filing a Chapter 13 bankruptcy.

So, when are debts primarily business? Is it the number of debts, or the dollar amount? Most courts hold that the dollar amounts of your debts is the determinant amount, and this makes sense. A handful of credit cards in the thousands with a single massive business debt in the hundreds of thousands could hardly be described as "primarily consumer" in nature. Still, it is advisable to consult an experienced bankruptcy attorney with debts of a mixed business and consumer nature, or when the amounts could be in dispute. Generally, if the debt was used to pay primarily personal, family, or household debt, it is consumer, and you will be subject to the means test.

What kind of proof will you need that your debts are primarily non-consumer? The statements themselves will often make it clear, especially if they show the purchase of business assets. The Court may want to see original paperwork related to loans from banks, so you may want to gather that information. Proof of other business statements, such as LLCs and operating agreements can also show that the debts were incurred while in business, for the benefit of the business. Any proof you can provide that show non-consumer intent will be helpful in your bankruptcy case.

Contact us if you have significant business debt. The Bankruptcy Code can be used to your advantage to eliminate these debts and give you a fresh start. We will be happy to discuss your situation in a free consultation. Don't let old business debts drag down your future.