It is permissible for a person filing Chapter 13 bankruptcy to continue to run a business during the bankruptcy process.
In fact, it may even be necessary, if that business is the source or a partial source of the funds required to fund the Chapter 13 Plan proposed by the debtor.
However, there are limitations to the freedom to run a business in Chapter 13—and obligations.
Limitation: The Chapter 13 Plan Shall Provide for All Future Earnings
The overriding limitation to one’s ability to conduct business while in a Chapter 13 bankruptcy is the requirement that the Chapter 13 Plan filed by the debtor must commit all future earnings to the Plan.
This is a mandate of the US Bankruptcy Code, the Federal statute that governs the bankruptcy process in the United States.
It is an underlying and sometimes implicit requirement of the Chapter 13 process that creeps into much of the discussion and controversy and litigation that occurs once the bankruptcy case is filed.
Essentially, this mandate requires that the debtor filing the Chapter 13 case not do anything that reduces the amount of money he or she has available on a monthly average basis with which the Chapter 13 plan payment must be made.
In other words, a debtor in Chapter 13 cannot:
- Over-deduct from gross monthly earnings;
- Exaggerate monthly household expenses;
- Maintain luxury, or non-necessary, household or personal expenses;
- Retain non-primary residential real property that does not earn positive income;
- Continue to run a business that is losing money rather than earning it.
This is not an exhaustive list, but that last bullet-point is the focus of this article.
A debtor in Chapter 13 bankruptcy cannot continue to run a business that is not earning money on a monthly average basis.
This requires a brief discussion of the Chapter 13 bankruptcy process itself.
Chapter 13 Bankruptcy: A Brief Overview
A Chapter 13 bankruptcy is a reorganization bankruptcy.
That is, in a Chapter 13, you do not simply discharge and wipe out your debt as you do in a Chapter 7 bankruptcy.
Instead, you prioritize some types of debt over other types in a 3-5-year monthly payment plan. Once that payment plan is completed, you then discharge in balance whatever (dischargeable) debt has not been paid.
You do not pay your creditors directly in a Chapter 13 (for the most part). Instead, you make a monthly payment to the Chapter 13 Trustee assigned to your case by the Federal Bankruptcy Court.
The Chapter 13 monthly payment is your net “take-home” pay, remaining after allowable paycheck deductions are applied and after the payment of necessary, allowable household expenses.
Note the use of the word “allowable.”
Many possible paycheck deductions (such as a huge 401(k) contribution) or unusual or unusually large household expenses (such as private school tuition or the monthly installment payment for a recreational boat) have already been litigated in the Eastern District of Michigan Bankruptcy Court and have been found to be not allowable.
That Chapter 13 Trustee takes your payment and disburses it out to your creditors in the order of priority described in the Chapter 13 Plan that you and your bankruptcy lawyer draft and file.
Thus, in a Chapter 13 bankruptcy, you are able, for example, to prioritize the payment of a secured mortgage arrearage and payment over unsecured credit card and medical debt and save a home from foreclosure.
Unsecured creditors, in fact, are always paid last in a Chapter 13. They receive only what is left over after all other creditors, the Trustee, and your bankruptcy attorney are paid first.
One of the roles of the Chapter 13 Trustee, therefore, in addition to acting as disbursing agent, is to ensure that the provisions of the Bankruptcy Code regarding the Chapter 13 Plan.
They act on behalf of the unsecured creditors, whose role in the process is largely constrained, unless they can with reason argue that you incurred the debt you owe them through fraud.
It is the Chapter 13 Trustee’s job to ensure that you are paying ALL of your future earnings into the Plan.
If your gross income is being diverted—or wasted—to non-allowable or non-money-producing sources, the Chapter 13 Trustee will object to the confirmation (approval) of your Plan.
Income-Producing Business Required
Thus, to continue operating your business throughout a Chapter 13 proceeding, it must be profitable.
The business only needs to earn a nominal amount of net profit to pass muster. So long as it is not costing you money to run on a monthly average basis, the continued operation of the business will likely be allowed.
You should expect the Chapter 13 Trustee to demand a profuse amount of both personal and financial documentation, however.
Any attempt to over-beneficially re-allocate income for the purpose of artificially lowering it for tax or other purposes or to shelter assets, etc., will not only be rooted out by the Chapter 13 Trustee but will likely also be referred to the US Trustee for further action.
This “further action” means a motion to dismiss your case and/or deny your discharge or even criminal prosecution.
At the very least, the Chapter 13 Trustee will likely require, in the judicial order that ultimately confirms or approves your Plan, language committing you to increase your monthly Plan payment if your business profitability increases during the bankruptcy process.
Running a Business during Chapter 13: Other Obligations
That requirement to provide updates regarding the operation of the business is, in fact, also required by the Bankruptcy Code.
The Code states that the debtor may continue to operate a business, subject to limitations and restrictions imposed by the Court, but that the debtor must also file with the Court, the US Trustee, and all applicable tax authorities, periodic reports and summaries of the operation of the business.
This must include a statement of receipts and disbursements, and any other information required by the Court and US Trustee.
Otherwise, the debtor is permitted to enter into business transactions, including the sale or lease of property, without notice or any court hearing, so long as it is in the ordinary course of business.
This means that permitted transactions are those that the business would undertake in the course of its usual operation, within its particular industry.
However, if the business or the debt on behalf of the business is required to incur debt or apply for credit in pursuit of the operation of the business, the debtor will be required to file a motion requesting an order approving the application with proper notice and service to all interested parties, depending on the amount of the loan or line of credit being applied for.
Business Operation in Chapter 13 Bankruptcy: The Bottom Line
The bottom line with regard to running a business in Chapter 13 bankruptcy is that it can complicate an already complicated legal process enormously.
If the business has valued assets, accounts receivables, and itself has value as a going concern or in a hypothetical liquidation, a Chapter 13 bankruptcy will be a far more safe form of bankruptcy for its owner than would be a Chapter 7 bankruptcy.
In a Chapter 7, the business can be operated by a Chapter 7 Trustee standing in the debtor’s shoes and, potentially, spun out of existence for the benefit of the debtor’s personal creditors.
It is the debtor who stands in the Trustee’s shoes in a Chapter 13 with regard to the operation of the business. And no assets are ever liquidated.
However, retaining an experienced bankruptcy attorney is crucial to the success of the Chapter 13 and the continued existence of the business.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process. Attorney Metzen is a Board Certified bankruptcy expert and has represented thousands of clients in Chapter 13 bankruptcy for over 28 years.
Contact us now to discuss your possible Chapter 13 case.