Closing down a business can be messy. A bankruptcy filed to deal with its financial fallout is often more complicated than a normal consumer bankruptcy case. But not necessarily.  In one respect at least, a business bankruptcy can actually be much easier than a consumer one.  

If you’ve owned a small business that you have already shut down, or are about to, you may be afraid of filing bankruptcy because you’ve heard that “business bankruptcies” are terribly expensive and not a good way to wrap up the affairs of a business. In the next few blogs I will address this concern by showing ways that bankruptcy can be a relatively simple and effective solution.

Today I start with a little twist in the “means test” that favors certain former business owners over normal consumers.

The “means test” determines whether you may file a “straight” Chapter 7 case to discharge your debts in a matter of a few months, or instead must file a 3-to-5-year Chapter 13 payment case. Unless you need some of the other benefits of Chapter 13, Chapter 7 is usually preferred because it gets you to a fresh start much more quickly and cheaply.

In many situations, a former business owner will NOT be able to pass the means test and so will be required to go through Chapter 13. For example:

• If, after closing her business a business owner succeeded in getting a good job before filing bankruptcy, the income from that job may be higher than the “median income” applicable to her state and family size. So she may well not pass the “means test.”
• If the business was operated by one spouse while the other continued working and earning a decent income, that other spouse’s income alone may bump the couple above their applicable “median income,” again with the result of not passing the “means test.”
• If a debtor’s income is higher than the applicable “median income,” he may still be able to pass the means test by deducting from his income his actual and/or approved expenses. But a former business owner will not be able to deduct monthly payments to secured creditors on business collateral he is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that he will have enough allowed expenses to pass the “means test.”

But here’s the good news for some former business owners: the “means test” only applies if your “debts are primarily consumer debts.” (See Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you essentially can skip the “means test.”

Careful, because by “debts” the law means all debts, including home mortgages and personal vehicle loans. So your business debts will usually have to be quite high to be more than all your consumer debts.

And to apply this law we must be very clear about the difference between these two types of debts. So what’s a “consumer debt”? The definition may sound familiar: it’s a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).)  So, for example, if you took out a second mortgage on your home a few years ago explicitly to fund your business, the current balance on that second mortgage would not likely be a consumer debt.

Sometimes the line between these is not clear, so this is something you need to discuss thoroughly with your attorney if you want to avoid the “means test” under this “primarily business debts” exception.

The multibillion-dollar deal, more than a year in negotiations between the biggest home mortgage servicers on one side and the states’ attorneys general and federal agencies on the other, may be just days from being finished. The deadline for each state’s attorney general to decide whether to sign was Friday, February 3, but that has now been extended to Monday, February 6.

This settlement is to resolve allegations about an extensive series of foreclosure and mortgage loan-servicing abuses that came to light in the summer and fall of 2010. State and federal officials have since then been negotiating an agreement with five major mortgage servicers. It would provide some very specific mortgage relief to homeowners and would establish strict requirements for how banks could conduct foreclosures. The negotiations have gone back and forth, with various proposals being floated, resulting in very public displays of protest by various bank-friendly sets of attorneys general on one hand and by other more aggressive attorneys general on the other. A settlement now looks imminent, in large part because of the timing of the current election cycle, as well as the dire need for progress on the never-ending home foreclosure front —and because this has dragged on for so long.

Since this story is evolving every day, I’m going to provide you with a few recent news articles about it, introducing each one to help you decide if you want to look at it.

This USA Today article gets right to what we all care about, “Who benefits from possible $25B mortgage settlement?”  It’s actually a good summary—in a Q&A format—of the likely terms of the settlement and its effects on homeowners and the housing market. Some of the questions include: “How might the $25B be spent?” “Who will get [mortgage] principal reductions?” “How tough are the potential settlement terms on the banks?

“Mortgage deal would give states enforcement clout” from Reuters addresses the concern “that banks have not adequately followed through on prior settlements, a concern that has pushed government negotiators to establish more forceful enforcement mechanisms in this deal than have been used in the past.” So this deal gives the states, along with a separate “monitoring committee,” the power to go to court to enforce the terms of the settlement and to ask for penalties of up to $5 million per violation.

And if you want to get a taste of how complicated these negotiations have been on the technical side (without even accounting for the intense political pressures), here is a letter dated January 27, 2012 from the Nevada Attorney General to the officials who have been spearheading the settlement. In the letter, she asks for written answers to 38 questions so that her state can decide whether or not to sign on to the settlement. It’ll make your head spin. Don’t say I didn’t warn you.

The headline story: many more Americans now believe that strong conflict exists between the rich and the poor. The surprising backstory: our attitude has NOT changed about how the rich got to be that way.

This follows up on my last blog about the very recent report by the Pew Research Center titled “Rising Share of Americans See Conflict Between Rich and Poor.” In just the last couple of years there has been a major spike in public perceptions that serious class conflict exists in our society. I would think that with a big shift like this, people’s attitudes about how the wealthy acquired their wealth would have changed, too. But it hasn’t.

So how would you answer this survey question?

“Which of these statements come closer to your own views—even if neither is exactly right: Most rich people today are wealthy mainly because of their own hard work, ambition or education.  Or, most rich people today are wealthy mainly because they know the right people or were born into wealthy families.”

In the Pew survey, slightly more people—46%—said that a person’s wealth is the result of connections and birth, than those—43%—who said that it is a result of that person’s own efforts. Those percentages have virtually not shifted in the last three years. So if I’m reading this right, at the same time that many more Americans are feeling there’s more class conflict, no more of us are feeling that wealth is only for those born into it. In other words, just as many people continue to believe that wealth is attainable for those willing to work hard for it.

That belief may be a false hope for many since there is a lot of evidence that upward class mobility has taken a serious hit in America in the last decade or two. This may be reflected in the Pew report where it breaks down the differing responses among different categories of people:

• Age:  More young people than older ones believe that wealth is a matter of birth and connections than personal effort. The percentage of people who believe that wealth is a result of personal effort went down with each younger age category—65+, 50-64, 35-49, and 18-34. It would be interesting to know if this greater doubt among younger people about not being able to gain wealth has persisted over time. Or are younger people just more keenly aware of –and in fact daily experiencing—serious challenges to their upward mobility.
• Race:  Although Whites are split right down the middle—44% to 44%—on this question, a full 10% more Blacks—54%—believe that wealth is a matter of birth and connections. It’s hard not to see in this difference a greater lingering perception of discrimination among Blacks.
• Politics:  My favorite breakdown is this one: Republicans and Democrats have the exact same percentages—32% and 58%—but on the opposite sides of the question! 32% of Republicans believe wealth is primarily a matter of birth and connections while 58% believe it’s a matter of hard work; 58% of Democrats believe it’s a matter of birth and connections and 32% believe it’s a matter of hard work. And independent voters? THEY are split down the middle. It all sounds like a fitting metaphor for our current political stalemate.

Many more Americans now believe that strong conflicts exist between the rich and the poor. After years of very high unemployment, millions of home foreclosures, and months of the Occupy Movement dominating the news, maybe this is not so surprising. But there ARE some unexpected aspects of this change in attitude.

In mid-January, the Pew Research Center released a report titled “Rising Share of Americans See Conflict Between Rich and Poor.”

You’ve likely heard about the Pew Research Center, but you may not know that it is a highly respected public policy research organization that is not only nonpartisan, it does not even take positions on issues. Instead it sees its role as “provid[ing] information on the issues, attitudes and trends shaping American and the world.” This report is an example of data it puts out for others to debate about their policy implications.

The survey analyzed in this report was conducted in mid-December, and compared the results to those of the same survey in 2009. The main conclusion is that the percentage of people who believe that there are either “very strong” or “strong” conflicts between the rich and the poor has increased in just two years from less than half—47%– to about two-thirds—66%–of us. Even more dramatic, the percentage stating the conflict is “very strong” doubled in these two years, from 15% to 30%.

If these attitudes are not just temporary, and especially if this trend continues, the social and political consequences for our nation would be huge.

But beyond this headline-grabbing main finding, the report also contained the following surprises:

• This perception of conflict is perceived to be greater among rich and poor than within other longstanding social conflicts in society—more than between immigrants and native born, between blacks and whites, and between young and old.
• This perception is NOT one held only by those with lower income.  To the contrary people of all incomes share a similar increase in perception of conflict.
• Younger people perceive more class conflict than do older people, women more than men, Democrats more than Republicans, and African Americans more than whites and Hispanics.
• In spite of increases in perceptions of class conflict among virtually all groups, the report does “not necessarily signal an increase in grievances toward the wealthy” nor “growing support for governmental measures to reduce income inequality.” Specifically, “there has been no change in views about whether the rich became wealthy through personal effort or because they were fortunate enough to be from wealthy families or have the right connections.”

Very few people who want to file Chapter 7 bankruptcy need to take the means test all the way to its limit. But if you do, you better have some iron-clad “special circumstances” to defeat your “presumption of abuse.”

The means test triggers whether or not your case is presumed to be an abuse of Chapter 7. Each step of the means test gives you a way to avoid this presumption of abuse. So, you avoid the presumption IF ANY of the following apply to you:

1. your income is no more than the median family income for your state and your size of family;

2. your income is more than the applicable median family income, but, after subtracting a list of allowable expenses, your remaining monthly disposable income is less than $117 per month; or

3. your income is more that the applicable median family income, your remaining monthly disposable income is between $117 and $197 per month, AND when you multiply your specific monthly disposable income amount by 60, this total is less than 25% of your “non-priority unsecured debts” (debts not secured by collateral, excluding special “priority debts”—certain taxes, support payments, etc.).

(See my last few blogs about these earlier parts of the means test.)

A large percentage of people who want to file Chapter 7 avoid the presumption of abuse on the first step—having sufficiently low income. Many others do so because their monthly disposable income is low enough at the second step, or their monthly disposable income is low enough in comparison to the amount of their debt.

BUT, if after all this you still have a presumption of abuse, your case will either be dismissed (thrown out) or else changed into a Chapter 13 case (requiring payments to your creditors). Your last chance to avoid this is if you can show “special circumstances.” The Bankruptcy Code lays out this law as follows:

[T]he presumption of abuse may only be rebutted by demonstrating special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces, to the extent such special circumstances… justify additional expenses or adjustments of current monthly income for which there is no reasonable alternative.

So when pushed to the limit, a test that is supposed to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy comes down to a very subjective question about whether any “special circumstances” apply.

To be fair, much of the means test IS objective, in the sense that it involves a whole lot of number-crunching to see if you can escape that dreaded “presumption of abuse.” But when a lot of those numbers—such as the allowed expense amounts, or the above-mentioned $117 and $195 amounts—appear arbitrary or do not accurately reflect your honest reality, then that “objectivity” has gotten away from the purpose for which it was supposedly intended.

Regardless, if you want to file a Chapter 7 case and, after going through all the steps of the means test, you are among that small minority of people still with a presumption of abuse, how likely are you going to be saved by the remaining subjective step in the process? Will you be able to persuade the judge that your “special circumstances” defeat the presumption of abuse?

This is a prime example of when you want a very experienced and conscientious bankruptcy attorney at your side. Why? Because the ambiguousness of the law, as you saw in the excerpt above, means that your attorney will need to 1) know how the local bankruptcy judges are interpreting this law, 2) carefully apply that to the details of your case when advising you about your options before filing your case, and then 3) if necessary be persuasive in making your case for “special circumstances” in court.  

The means test is supposed to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy. So what’s so objective about whether your “monthly disposable income” is less than $117 or more than $195? Sounds pretty arbitrary to me.

Before getting to this step of the means test, let me bring you back to its beginning.  I can’t emphasize enough that many, many people qualify for Chapter 7 strictly based on their income.  As I explained a few blogs ago, if your income is no more than the published median income for your state and family size, you skip the rest of the means test. You’re presumed to qualify for Chapter 7.

So if and only if your income is more than the median, you take the next step of the means test—deducting expenses from your monthly income. These allowed expenses are based on a terribly complicated set of rules I discussed in my last blog. After deducting these expenses, that leaves you with your “monthly disposable income,” a very important amount.

This brings us to those $117 and $195 “monthly disposable income” amounts mentioned above. And here’s where the “objective” rules get quite arbitrary. Catch this:

1) IF your “monthly disposable income” is $117 or less, then you are presumed not to be abusing the system to be filing a Chapter 7 case. In other words, you’ve passed the means test.

2) IF your “monthly disposable income” is more than $195, then you are presumed to be abusing the system to be filing under Chapter 7.

3) IF your “monthly disposable income” is between $117 and $195, then whether or not you are presumed to be abusing the system depends on one more step. You ARE presumed to be IF you multiply that specific “monthly disposable income” by 60, and the resulting amount is enough to pay at least 25% of your “non-priority unsecured debts.” (Priority debts are a category of special debts like certain taxes, support arrearage, and such.) If that resulting amount pays less than 25% of that set of debts, then you are presumed not to be abusing the system to be filing under Chapter 7.

So where do those critical two numbers—come from? Notice they amount to a difference of only $78 per month between being presumed to be able to file a Chapter 7 case and being presumed not to be able to.

Well, let’s take it a step further. Multiply the monthly amounts of $117 and $195 both by 60 months (the length of a maximum-length Chapter 13 case) and you get close to $7,025 and $11,725, respectively. (These used to be $6,000 and $10,000 when the law passed in 2005, and has been adjusted for inflation. The current amounts are good until April 1, 2013.) The effect of this set of rules is that:

1) if you theoretically CAN’T pay at least $7,025 to your “non-priority unsecured creditors” within 5 years of monthly payments (60 months), than it’s OK for you to be in a Chapter 7 case and write off those creditors;

2) if you theoretically CAN pay $11,725 or more to those creditors within 5 years, than it’s NOT OK for you to be in a Chapter 7 case, and instead you should be in a Chapter 13 case paying your disposable income to those creditors; and

3) if you theoretically can pay somewhere in between those two amounts in 5 years, then whether you should be in a one Chapter or the other turns on whether or not the total to be paid to the creditors would amount to at least 25% of the “non-priority unsecured debts.”

So where do these decisive $117/$195 and $7,025/$11,725 amounts come from? As far as I can tell, they are totally arbitrary.  Some creditor lobbyist or Congressional staff person likely just pulled a couple numbers out of his or her head. I can’t see any principled reason to pick those amounts to determine whether a person should or shouldn’t be allowed to file a Chapter 7 case.

Sensible or not (and the means test is anything but!), the law is the law: if your income is over the median then the amount of your monthly disposable income determines whether you are presumed to be abusing the bankruptcy system by filing a Chapter 7 case.

I will finish this series on the means test with one last blog. Because, even if you have too much disposable income resulting in a presumption of abuse, you might STILL be able to stay in Chapter 7 by defeating that presumption through “special circumstances.”

In Arizona, a mortgage lender generally begins the foreclosure process once the borrower has become at least 90 days past due on the mortgage payment. Once the foreclosure process begins, a trustee takes over the delinquent mortgage. The trustee will then send the homeowner a “Notice of Trustee Sale” which states that the property will be sold in 90 days from the date the Notice was filed and recorded. If the property is sold at the Trustee Sale, the homeowner is then required to vacate the premises in as few as 5 days.

What happens if you make too much money so that you are over “median income,” but you still want to file a Chapter 7 case?  You get to go through the “black box” that is the expenses side of the means test.

In the last couple of blogs I’ve covered the first part of the means test, the income part. That part says that if your income is no more than the medium amount for your state and your size of family, you can skip the rest of the means test and qualify for Chapter 7. But if your income is over the applicable median income amount, then you have to go through the convoluted expenses part of the means test to see whether you can still do a Chapter 7 case.

As much as I want in these blogs to help you understand how bankruptcy works, there is a limit to what can be effectively conveyed within the limitations of a blog. Much of the expenses part of the means test goes over that limit. So in this blog we will avoid that nitty-gritty. But here’s what you should know.

The concept behind the means test is pretty straightforward: debtors who have the means to pay a meaningful amount to their creditors over a reasonable period of time should be required to do so. But putting that concept into law resulted in maddeningly complicated and unclear rules. Not surprisingly, trying to apply those rules to real life has been challenging.

The expense rules got really complicated by trying to be objective. Congress assumed that it couldn’t trust debtors to list their anticipated expenses because they’d just show they had no money left over for their creditors. For a more objective standard, Congress could have picked between either the actual expenses a debtor in fact pays for food, clothing, etc., or else used some standard amount for expenses.

Well, Congress chose…  BOTH—a mix between actual and standard expenses. So now for some expenses we must use standard amounts, based on Internal Revenue Service tables. But this gets complicated quickly because some of those expense standards are national, some vary by state, and some even vary among specific metropolitan areas within a state. Then some other “necessary” expenses can be the actual amounts expected to be spent. And there are even some expenses which are partly standard and partly actual (certain components of transportation expenses). Add in deductions for secured debt payments (vehicle, mortgage) and priority debts (income taxes, accrued child support), and trying to figure out when they can and can’t be claimed, and you get an idea why I’m not going to get any deeper into this “black box.”

I WILL tell you in my next blog what happens at the other end of this “black box” of expenses—what happens if you have some disposable income after deducting expenses.

I’ll close today by emphasizing that the expense rules are not clear how they are to be applied to many common situations. The result is that different courts have interpreted these rules in inconsistent ways, requiring the U.S. Supreme Court to resolve these disputes one at a time.

So this is a prime example of why you want to have an attorney who fully understands these often confounding rules, and is also on top of the pertinent local and national court interpretations of these rules. There’s a lot riding on it—whether or not you qualify for Chapter 7, and how much and how long you have to pay into a Chapter 13 case. In other words, what’s potentially at stake is years of your life, and thousands, if not tens of thousands, of dollars.

Waiting just one day to file your Chapter 7 bankruptcy case can make qualifying for it much easier—or much harder!

How could such a small delay make such a big difference?

One of the main goals behind the huge amendment to the bankruptcy law in 2005 was to force more people to pay a portion of their debts through Chapter 13 payment plans instead of writing them off in a Chapter 7 “straight bankruptcy.” And the primary tool that is supposed to accomplish this is the means test. The rationale behind this test was that instead of allowing judges to make judgment calls about who was or was not abusing the bankruptcy system, a rigid financial test would ferret out who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case.

But in real life rigid rules can have unintended consequences. An experienced and conscientious lawyer will work to turn these consequences to your advantage, and avoid their disadvantages. Here’s an idea how this plays out with the means test.

In my last blog I explained the first part of the means test, which essentially compares the income you received during the six FULL CALENDAR months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you get to file a Chapter 7 case (except in very unusual circumstances, which I’m not going to get into here). If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. And there’s a risk that you will be forced to go through a Chapter 13 payment plan.  So you can see that having income below the median income amount makes your case much simpler and less risky.

But how can filing the case a day earlier or later matter so much? Because of the means test’s fixation on those six prior full calendar months. And because the means test includes ALL income during that precise period (other than social security).  Virtually all money that comes into your hands during that period is counted, not just taxable income. 

So imagine that you received some irregular chunk of money, say an income tax refund, a few catch-up child support payments, or an insurance settlement or reimbursement.  Not a huge amount, say $3,000, received on July 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s say that the median annual income for your state and family size is $43,000.

So now we’re getting close to the end of January, your Chapter 7 bankruptcy paperwork is ready to file, and you’re anxious to get it filed so that you get protection from your aggressive creditors. BUT, if your case is filed on or before January 31, then the last six full calendar month period will be from July 1 through December 31 of last year, which includes that $3,000 extra money you received in mid-July. Your work income of 6 times $3,500 equals $21,000, plus that $3,000 totals $24,000 received during that 6-month period. Multiply that by 2 to make that an annual amount, and that equals $48,000, higher than the $42,000 median income. So you’d have failed the income portion of the means test.

But if you just wait to file until February 1, then the applicable 6-month period jumps forward by 1 full month to the period from August 1 of last year through January 31 of this year. Now that new period does NOT include the $3,000 you received in mid-July. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. So now you’re under the $43,000 median income amount. You’ve passed the income portion of the means test, and you get to skip the awkward and risky expenses part of the means test. So you’re much more likely to breeze through your Chapter 7 case. Hooray!

Last thing: what if that $3,000 chunk of money was not conveniently received almost 6 months ago, but rather only a 2 or 3 months ago, and you’re desperate to file your case? You need to stop a garnishment or foreclosure and simply can’t wait another few months to file. Well if you file now, then you will be over the median income, and will need to go through the expenses part of the means test. You may still be saved there, or there may even be other ways of qualifying for Chapter 7. More about those in my next blog or two. But if you are concerned about this now, please call to set up a consultation with me right away. This blog should make clear that careful pre-bankruptcy planning is critical. The sooner we start, the more likely time will be on your side.

Are you among the large majority of people whose income easily qualifies them for Chapter 7 “straight bankruptcy”? You can find out right here and now.

As you’ve likely heard, a few years ago Congress passed a major set of changes to the bankruptcy laws intended to make it harder for some people to file Chapter 7.  The idea was that those who have the means to pay a meaningful amount of their debt to their creditors in a three-to-five-year Chapter 13 payment plan ought to do so. So they shouldn’t be able to just write off all their debts in a Chapter 7 case. At least that’s the theory behind the means test.

In practice, for many people it’s quite an easy hurdle to step right over.  Most people who want to file a straight bankruptcy can still do so.

The means test is truly an odd one. It has two parts. The income part—the one I’m addressing here today—is relatively easy to figure out.

But the second part, involving living expenses, is one of the most complicated formulas imaginable. This law was worded so poorly that more than six years after it became effective there’s still a lot of debate about how it’s supposed to work. Fortunately, most people don’t need to get to that part of the test, and we won’t here.

That’s because if you pass the income part of the test, you can totally skip the expenses part.

So, the income part of the means test compares your income to a published “median income” for a household of your size in your state. If your income is no more than that median, then right away you’ve passed the test—you get to file a Chapter 7 case.

But even this easy part of the test has its quirkiness.

1. It is NOT based on your taxable income for the previous calendar year, or anything that simple. Instead it is based on the precise amount of income you received during the six full calendar months before your case is filed. So, for example, if your case is filed on January 25, 2012, we look at every dollar you received during the six-month period from July 1 through December 31, 2011. Then take that six-month total and divide it by six to come up with a monthly average.

2.The income included for this purpose is not just your “taxable income,” but rather every bit of income you’ve gotten from all sources during that period of time, including irregular ones like child and spousal support payments, insurance settlements, unemployment benefits, and bonuses. The exception: exclude all social security income.

Then multiply your six-month average monthly income by 12 to come up with your annual income. The last step is to compare that amount to the median income for your state and your size of family. You can find that median income in the table that you can access through this website. (This median income information gets updated every few months, so make sure you’re using the current table.)

If your income, as calculated in this precise way, is no more than the median income applicable to your state and family size, then you can file a Chapter 7 case. Congratulations—you’ve cleared the means test hurdle!

If your income is MORE than the applicable median amount, don’t despair. You may well still be able to file a Chapter 7 case. More on that in my next blog.