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Chapter 7 Bankruptcy for Business Owners: When (and How) Do You Qualify?

No As a business owner, you take calculated risks. You make decisions that you think will help drive your business to success, but success is far from guaranteed. The current economic conditions have hit many small and medium-sized business owners particularly hard, and many are struggling despite making decisions that likely would have led to profitability under normal circumstances.

Due to the recent economic downturn, many business owners currently find themselves in the position of contemplating bankruptcy. While there are several types of bankruptcy filings, one of the most well-known types of bankruptcy is a “Chapter 7.” Filing for Chapter 7 bankruptcy allows business owners to eliminate their debts completely (with some exceptions), and it is a smart option in many cases.

But, not all business owners qualify to file for bankruptcy under Chapter 7. With this in mind, if you are considering a business bankruptcy and think a Chapter 7 filing may be your best option, your first step is to determine whether you are eligible to file.

Two Ways to Qualify for Chapter 7 Bankruptcy

There are two ways business owners can qualify to file for bankruptcy under Chapter 7. The first option involves filing to obtain relief from business debts, while the second involves filing as an individual debtor who satisfies the Chapter 7 “means test”.  

Option #1: Filing for Chapter 7 Bankruptcy to Eliminate Business Debts

Individuals, partnerships, corporations and other business entities are all eligible to file for bankruptcy under Chapter 7 to obtain relief from business debts. As the U.S. Courts explain:

“To qualify for relief under chapter 7 of the Bankruptcy Code, the debtor may be an individual, a partnership, or a corporation or other business entity. . . . Subject to the means test . . . for individual debtors, relief is available under chapter 7 irrespective of the amount of the debtor’s debts or whether the debtor is solvent or insolvent.”

This means that if you own a business entity that is in debt, or if you have personally incurred debts as a business owner or entrepreneur that are of a business nature, you are generally eligible to file for bankruptcy relief under Chapter 7. As noted by the U.S. Courts, the total value of your debt (or your business entity’s debt) is irrelevant, and you do not have to prove that you or your company is insolvent in order to make a Chapter 7 filing.

There are two more important facts about Chapter 7 eligibility based on business debts:

  • Chapter 7 Filers Must Have “Primarily” Business Debts – To qualify under Chapter 7, business owners must have “primarily” business debts. This simply means that greater than 50 percent of their debts must be of a business nature.
  • The Bankruptcy Courts Judge the Nature of Debts Using the “Profit Motive Test” – To determine whether a debt is of a business nature, the bankruptcy courts use the “profit motive test.” Under this test, a personal mortgage can qualify as a business debt if the mortgaged property was acquired for investment purposes (i.e., as a rental property), and debts incurred in the name of a business entity can qualify as non-business debts if they were incurred for personal purposes (i.e., using a business credit card to cover personal expenses).

If you are filing for Chapter 7 bankruptcy primarily (or exclusively) to eliminate business debts, then your ability to pay is not a deciding factor with regard to your eligibility. However, if you are filing to eliminate personal debts you have incurred as a business owner, then you must satisfy the Chapter 7 “means test”.

Option #2: Filing for Chapter 7 Bankruptcy Based on the “Means Test”

The means test applies when a business owner’s debts are primarily personal in nature. As the Legal Information Institute (LII) explains, “[t]he purpose of the means test is to see . . . if [a] debtor is abusing the bankruptcy system by filing . . . even though they could afford to pay at least some of their debts.” 

Under the means test, the ability to pay is judged based on the debtor’s monthly income. If a debtor’s monthly income falls below the median income for their state (according to the U.S. Census Bureau), then the debtor is automatically eligible to file. However, if the debtor’s monthly income is above the applicable state median, then additional calculations are necessary.

For some business owners, calculating their monthly income will be fairly straightforward. If you have never drawn a salary or taken a distribution from your company, for example, your monthly income may be $0 (assuming you do not have income from other sources). But, if you have paid yourself varying amounts, or if you have recently reduced (or eliminated) your own compensation, then performing the means test could be more challenging. In any case, conducting the test will be well worth the effort involved, as it will allow you to make informed decisions about your next steps.

Certain Debts are Ineligible for Discharge in Chapter 7 Bankruptcy

Regardless of whether you qualify to file for Chapter 7 bankruptcy as a business debtor or as an individual who satisfies the “means test,” there are certain debts you won’t be able to discharge through a Chapter 7 filing. These debts include:

  • Certain tax debts
  • Debts obtained by fraud or false pretenses
  • Debts owed to certain tax-advantaged retirement plans
  • Divorce-related debts
  • Student loans
  • Unpaid government fines and penalties

If you have any of these debts, you will need to carefully consider whether filing under Chapter 7 makes sense or whether you may be better off pursuing a reorganization bankruptcy under Chapter 11.

Speak with a Chapter 7 Bankruptcy Lawyer at Edelboim Lieberman Revah

To discuss your options with a Chapter 7 bankruptcy lawyer at Edelboim Lieberman Revah in confidence, please call 305-768-9909 or request a free initial consultation online. With offices in Miami and Fort Lauderdale, we represent business owners throughout Florida.

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