INTRODUCTION: WHAT IS THE CHAPTER 7 BANKRUPTCY MEANS TEST?
The Chapter 7 bankruptcy “Means Test” is the mathematical formula that determines whether or not an individual is eligible to file for bankruptcy under Chapter 7 rather than under Chapter 13.
Essentially, the Means Test averages the gross (pre-tax, pre-deduction) income earned from all sources other than Social Security age and disability benefits by each member of the debtor’s household, regardless of whether those other household members are jointly filing the bankruptcy or not.
The Means Test then multiplies that 6-month income average by 12 (months) to calculate an annual household income amount.
This annual household income amount is then compared to the median income for a household of that size for the state in which the bankruptcy case is filed.
If the annual income amount is under the state’s median income, the debtor is eligible to file for Chapter 7 bankruptcy.
If the annual income amount is over the median, the debtor’s bankruptcy attorney will need to apply a number of deductions representing some of the expenses of the household, peeling away as much of the gross income of the debtor’s household as possible.
If enough income can be deducted, the debtor may still be eligible for Chapter 7 bankruptcy. Otherwise, the debtor will be required to file bankruptcy under Chapter 13.
It is a cynical formula drafted by financial industry lobbyists, inserted into the US Bankruptcy Code by bought-and-paid-for Congress-people and Senators, and designed to thrust people from Chapter 7, in which they need repay nothing to creditors, into Chapter 13, in which they must, at least partially.
That said, at least until the Bankruptcy Code is further revised, the Means Test remains a solid, iron gate through which only those it deems of “good faith” may enter.
There are other ways through it, however, than income alone.
The nature of the debt owed by the individual seeking Chapter 7 is one of them.
BUSINESS DEBT AND THE CHAPTER 7 MEANS TEST
People are often surprised that the amount of debt that they owe has nothing to do with Chapter 7 eligibility.
That is true. However, the Means Test does not apply, in the first instance, to “non-consumer” or “business debtors.” This is one of the common mistakes made in calculating the means test.
What does this mean?
It means that, if the debtor seeking the protection of Chapter 7 bankruptcy, holds “mostly” non-consumer debt, the Means Test need not be calculated.
It is simply filed, with a box checked noting that this is the case, and with no income information provision at all.
Section (707)(b) of the Bankruptcy Code allows this. It is a safe harbor provision the purpose of which is to enable entrepreneurs to attempt to build a business and create economic opportunity in the US without fear of failing.
A “non-consumer” Debtor is one of these types for which the US Trustee (the “policeman” of Chapter 7 eligibility, a functionary of the Department of Justice) may not pursue an “abuse”-based dismissal of a debtor’s bankruptcy case.
A “non-consumer” Debtor is a Debtor whose debts are “primarily” non-consumer debts.
Largely, non-consumer debts are business debts but may also include tax debts and other sorts of non-consumer financial obligations. Arguably, if 51% or more of the total debt of all types owed by the debtor are “non-consumer” debt, it will qualify the debtor for this Means Test business debt exception.
If a Debtor meets this criteria, the Debtor need not file a Means Test and will be eligible for a Chapter 7 regardless of the income they’d earned in the six months prior to filing, the period of time that the Means Test specifically looks at to compute the Debtor’s average household income.
In most prospective bankruptcy clients’ cases, a home mortgage or student loan debt is what prevents the debtor from being classified as “non-consumer” as the home mortgage—or mortgages— is a debt that can out-strip the value of all of the Debtor’s other debts alone.
But not always.
The Bankruptcy Code defines a “consumer” debt as “debt incurred by an individual primarily for a personal, family, or household purpose.”
Courts have largely determined that a “non-consumer” debt is one which has been incurred with a profit-motive, such as a business investment or credit card debt incurred to fund a for-profit business enterprise.
Tax debt has additionally been found to be a “non-consumer debt.”
ALTERNATE “Good Faith” Test for Business Debt in Chapter 7 Bankruptcy
This is not to say that all scrutiny is removed from a Chapter 7 case in which the majority of debt held is non-consumer.
To the contrary, another section of the Bankruptcy Code—707(a)—still applies to non-consumer cases.
Section 707(a) contains the essential “good faith” test of the Bankruptcy Code.
The moment a Means Test is filed with the “non-consumer” debt box checked, a red flag springs up in the office of the US Trustee.
The US Trustee is a functionary of the Department of Justice tasked with, among other things, standing in front of that Chapter 7 bankruptcy eligibility gate, ensuring that no “bad faith” debtor slide through.
The US Trustee will review the information contained in the petition, demand more as needed, and, if not satisfied by what they see, will file a motion to dismiss the bankruptcy case.
Even if the Means Test is properly avoided, Section 707(a) enables the US Trustee to move to dismiss a bankruptcy case where the debtor has not demonstrated true need.
This is a highly fact- and case-specific review of the debtor’s income, debt, expenses, and general lifestyle.
The Eastern District of Michigan Bankruptcy Court has dismissed Chapter 7 cases in which the debtor’s Bankruptcy petition and Schedules reflect a lavish and extravagant lifestyle, a failure to reduce expenses or “tighten the belt,” or a failure to offer, through Chapter 13 bankruptcy, to offer to repay at least a portion of the debt owed when it is clear that the debtor has the ability to do so.
As Judge Rhodes (now retired) ruled in one such case: “Nothing in the bankruptcy code suggests that a debtor who has primarily business debts but who can pay those debts is entitled to chapter 7 relief.” [sic]
If you are driving a Lamborghini to Bankruptcy Court, be prepared for some push-back.
CHAPTER 7 BANKRUPTCY & THE BUSINESS DEBT EXCEPTION: THE BOTTOM LINE
The bottom line with regard to the Means Test “business debt exception” is that it is no magic bullet.
If you believe that you would qualify for Chapter 7 based on this concept alone, it is essential that you seek the advice of an experienced Michigan bankruptcy attorney to truly determine whether this is accurate.
If it is not, filing a Chapter 7 bankruptcy case is simply a doorway to litigation.
Attorney Walter Metzen has represented over 20,000 consumers in Chapter 7 and Chapter 13 bankruptcy cases in Michigan. A Board Certified Bankruptcy Expert, Attorney Metzen has dealt with aggressive creditors and the US Trustee for over 30 years.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing a Chapter 7 or Chapter 13 bankruptcy in Michigan.