Business debt is dischargeable in a personal bankruptcy in Michigan under certain circumstances.
However, it is important, firstly, to keep in mind that there is a difference between the debt owed by your business and the debt owed by you, personally.
It may be that you are the sole owner of your business or that you operate a Michigan sole member LLC—but, if you do conduct business through a corporate entity or LLC, that debt may or may not be owed by you, personally. It may be owed by the LLC or corporation only.
In that case, the debt will not be dischargeable in your Michigan Chapter 7 or Chapter 13 personal bankruptcy.
Business Debt vs. Personal Debt: Understanding the Difference
If you are self-employed or operate your business as a Michigan sole proprietorship or general partnership, your business’ debts are your own, personally guaranteed debts. If the business doesn’t pay its debts, you owe the money.
Likewise, if you file a Michigan Chapter 7 or Chapter 13 personal bankruptcy case, the debts of your sole proprietorship or partnership not only can be included and discharged—they must be.
In a bankruptcy proceeding, you have no option to exclude or “leave out” debts that you owe, contrary to popular belief.
Anyone that you owe money to must be listed in your bankruptcy petition schedules. Anyone listed will receive a notice of the bankruptcy. Any creditor to whom you owe money will have its debt discharged, unless it is the few sorts of debt that are not dischargeable in bankruptcy, the creditor successfully contests the discharge on the basis of some fraud committed by you, or unless your case is dismissed.
As to other sorts of Michigan business entities than sole proprietorships or partnerships, it is important to keep in mind that, under law, a corporation, S-Corp, or LLC is a separate “legal person” than you are.
Although the extent to which this is or isn’t true varies with context, a corporation or LLC has the right to enter into contracts as if it were a human being, buy and sell property, lend money—and owe money.
The question is whether or not you, personally, have guaranteed or co-signed for the entity’s debt.
This will be a matter of contract.
The bankruptcy attorney you hire to assist you with your Chapter 7 or Chapter 13 proceeding will need to review any leases, contracts, or promissory notes that you signed on behalf of your business.
Did you sign them on behalf of the entity and in your corporate capacity as Owner, Director or other Officer with signing authority? Or did you sign them in your individual capacity?
Is the lease between your business office’s landlord and your LLC? Or is it between the landlord and you, in your personal capacity?
If you aren’t sure, this is a good reason to hire an experienced Metro Detroit bankruptcy attorney to assist you.
How Is Business Debt Handled in Michigan Chapter 7 and Chapter 13 Bankruptcy?
Business debt that you have personally guaranteed is handled like any other debt in bankruptcy: according to its “classification.”
Under the US Bankruptcy Code, debt in bankruptcy is classified as “secured,” “unsecured,” “priority unsecured,” or “non-priority unsecured.” (Lease or executory contract obligations are a separate animal, explained below.)
Secured debt is that debt which has been “secured” with a contractual security agreement. This is an agreement which pledges some property or cash or other ownership interest in return for a promise to repay the loan.
The most common security agreement that you might have encountered would be your home’s mortgage. This contract, separate from the Note personally obligating you to make X payments in X amount for X years, pledges the home as collateral securing that Note obligation to pay. If you don’t pay, the house is lost to foreclosure.
Businesses have the ability to enter into security agreements just as you do.
If a debt is not a secured debt, it is by default unsecured. It is a contractual obligation to pay without a pledge of collateral. If you don’t pay, the creditor can sue you for a money judgment which can be executed in various ways under Michigan law, forcing you to pay.
Priority debts are those unsecured debts that are classified as such because the Bankruptcy Code says that they are. The sorts of priority debts that would tend to be owed by a business (some would not be, such as child support obligation) include:
- Tax obligations;
- Debts owed to employee pension plans; and
- Wages owed to employees within certain time periods prior to the filing of the bankruptcy case.
Lease and executory contract obligations, are either “assumed” or “rejected” in bankruptcy. If rejected, the unpaid contractual obligation is treated as a non-priority unsecured debt.
Non-priority unsecured debts are, when creditors are paid through a bankruptcy proceeding, paid last, after all other classes of creditors.
If the lease is assumed, you must continue to honor the obligations codified in the contract or lease, during and after the bankruptcy proceeding. If you fail to do so, after the bankruptcy is over with, you will be subject to collections and collections lawsuits for breaching the contract.
It will not have been discharged in the Chapter 7 or Chapter 13.
Business Debt and the Bankruptcy Means Test
A significant advantage to the required inclusion of personally guaranteed business debt in your bankruptcy case is that enough of it offers a “safe harbor” exemption from your requirement to complete the Chapter 7 Means Test.
As has been discussed elsewhere in detail on our Bankruptcy Blog, the Means Test is the formula which determines whether you are income-eligible to file for Chapter 7 bankruptcy. In the Chapter 13 context, the Means Test also determines whether you are eligible to file a 3-year rather than 5-year Chapter 13 payment plan and whether or not there is some minimum amount that you must repay to your non-priority unsecured creditors in your Chapter 13 plan.
The Chapter 7 Means Test contains a couple of “safe harbors” allowing people to file for Chapter 7 bankruptcy without completing it.
One of those “safe harbors” is for so-called Business Debtors. Business Debtors are those Chapter 7 filers whose total debt is comprised of 51% or more of non-consumer debt.
Debt incurred for business (only) purposes is non-consumer debt for Means Test purposes.
Naturally, if you check that box on the Means Test form claiming the business debtor safe harbor exception, you should be prepared to provide all of the documentation necessary to prove this to your Chapter 7 Bankruptcy Trustee and to the United States Trustee.
What If You Don’t Want to Discharge Your Business Debt?
There may be a variety of reasons why the thought of discharging your business debt in a personal bankruptcy may give you pause for concern.
Usually, these concerns are overstated. Your bankruptcy attorney will be able to discuss any misgivings you may have with you in a confidential manner, discussing all related pros and cons.
However, often, business operators or principals who file for personal Chapter 7 or Chapter 13 bankruptcies express the following concerns:
- If the business will continue to operate, fear of spoiling necessary relationships with vendors or other parties.
- Fear of loss of business reputation in the marketplace.
- Fear of loss of assets pledged as collateral where debts are secured.
- Fear of embarrassment with regard to customers, partners, and even competitors.
- Fear (possibly justified) of contractual default of contracts or commercial leases due to the personal bankruptcy filing.
Among other concerns.
Again, some of these concerns may be weightier than others depending on specific circumstances, your specific business, and the terms of your specific contractual relationships with commercial lenders, partners, partners, and customers.
Then again, they may just be fears without a lot of substance—and this is often the case.
What If the Business Debt Is Your Only Debt?
If your business debt is the only debt that you hold, it is worth scheduling an initial consultation with a Detroit bankruptcy to explore the possibility that a personal bankruptcy may not be the best option for you.
If your business is in rough waters and you wish it to continue operating, a Chapter 11 reorganization bankruptcy may be the appropriate response.
The US Bankruptcy system has recently implemented a number of structural, statutory, and procedural changes aimed at making small business Chapter 11 proceedings simpler and most cost-effective than they have been in the past.
If your business is not going to continue to operate, a small business Chapter 7 liquidation may be worth discussing, although it is very frequently not the best solution for even a no-longer-operating enterprise.
Alternatively, a good lawyer may also be able to suggest non-bankruptcy options, including debt settlement or other negotiated resolutions, strategic default, or, in the finality of things, a legal dissolution under Michigan state law through which you remain in control of the liquidation of business assets and the repayment, as necessary, of business debt obligations.
If your only debt is business debt that you have NOT personally guaranteed, however, a personal Chapter 7 or Chapter 13 will not accomplish anything.
Discharging Business Debt in Personal Bankruptcy: The Bottom Line
The bottom line with regard to the discharge of business debt in personal bankruptcy is that the devil will be in the details.
If you operate a business or hold an ownership interest in a business, your personal Chapter or Chapter 13 bankruptcy will be significantly more complicated than a bankruptcy not involving such issues.
You will need to speak with an experienced Michigan bankruptcy attorney to explore your full array of options prior to filing any bankruptcy case.
Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has represented Metro Detroit residents in Chapter 7, Chapter 13 proceedings for over 30 years.
Contact us now to discuss your business ownership and your bankruptcy options in a free initial conversation.