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Bankruptcy by Example: You Can File a Chapter 7 Case without Qualifying under the “Means Test” if You Don’t Have “Primarily Consumer Debts”

Nov. 24, 2014

If your income has you concerned about passing the “means test,” you can skip that test when you owe more business debt than consumer debt.

The Purpose of the “Means Test”

To file and successfully go through a Chapter 7 “straight bankruptcy,” you must pass the “means test.” It’s essentially an income and expenses test with the purpose of determining if you have the “means” to pay a meaningful portion of your debts. If so, you could not proceed with a Chapter 7 case, and likely would be required to file a Chapter 13 “adjustment of debts” case instead. In contrast to discharging (legally writing off) many or all of your debts in a matter of 3 or 4 months in a Chapter 7 case, you would be required to pay as much as you could to your creditors through a 3-to-5-year Chapter 13 payment plan.

The first step of the “means test” is to determine whether your income is no more than the “median income” for your family size in the State of Oregon. If it’s not more, you pass the test. If your income is more than the “median” amount, then your “allowed expenses” are subtracted from your income to see how much “disposable income” you have. That amount is put through a calculation, comparing it to the amount of your debts, to see if you have sufficient “means” to pay a meaningful amount to your creditors.

“Primarily Consumer Debts”

The “means test” was intended for consumer bankruptcies not business ones. So you can avoid taking the “means test” altogether if your debts are not “primarily consumer debts.” If not, you would be eligible for a Chapter 7 case with much less regard for the amount of your income and expenses.

Your debts are not “primarily consumer debts” simply if the total amount of your “consumer debt” is less than the total amount of your debts that are NOT “consumer debts” (which are essentially business debts).

So you have to decide (with the help of your attorney) separately for each one of your debts whether it is a “consumer debt” or not, and then add up those which are and which are not.

The Bankruptcy Code says “consumer debt” is debt “incurred by an individual primarily for a personal, family, or household purpose.” (Emphasis added.) The distinction is on the purpose for which you initially incurred the debt, regardless that the debt might otherwise seem like a consumer debt. Small business owners often finance at least some of their start-up and ongoing operational costs through their consumer credit—credit cards, home equity lines of credit and such. So these might nevertheless qualify as non-consumer debts in calculating whether you have “primarily consumer debts.”

After adding up your debts which are and which are not consumer debts, if the total of those that are not “consumer debts” is larger than the total for those that are “consumer debts,” then you do not owe “primarily consumer debts.” You can skip the “means test.”

Don and Debra’s Bankruptcy

After 30 years fighting Home Depot and Lowe’s, Don closed his independent hardware store, owing a heck of a lot of business and personal debt. His wife, Debra, had for years been working as a buyer for national grocery store, so she had a decent and steady income, which had kept the couple afloat during the last decade or so as the profits from Don’s store kept dwindling lower and lower. Don finally threw in the towel six months ago when he was offered and he accepted a job as a manager for the Ace Hardware store in the next town. The pay isn’t great, but since his health isn’t good and it’s not hard work, he knew it was the best he could do. Don and Debra are both approaching retirement age. They need to get their financial lives in order as best and as quickly as they can.

Don and Debra’s new combined income is higher than the “median income” for a family of two in Oregon (currently $57,182). Since their expenses are relatively modest, after their attorney ran the numbers they did not pass the “means test,” based on the way “allowed expenses” and “disposable income” and the rest of the “means test” is calculated. It looked like they would have to go through a Chapter 13 case instead of getting the fast financial fresh start of a Chapter 7 case that their circumstances cried out for. They had no self-interested reason to do a Chapter 13 case—none of its many potential benefits would have done them any good. Instead it would have tied up financial lives for the next 5 years.

But their attorney added up all of their consumer debts and all of their business debts to find out that the latter were substantially higher. So Don and Debra were able to file a Chapter 7 case after all. A few months later all the business and personal debts that they needed to discharge were gone. So they could move on with their lives and prepare for their retirement years without being burdened by the debts from Don’s failed business.