Know When to Declare Bankruptcy

Know When to Declare Bankruptcy

When closing a business, you may be left with a collection of debts and no ability to pay them. Though Bankruptcy can be a scary idea, declaring Bankruptcy may be a necessary step. The process is not as difficult as you may think.

Is Bankruptcy a Messy Affair?

Though a bankruptcy case dealing with the financial fallout of a closed business can be more complicated than a single consumer case, this is not necessarily the rule. In fact, business bankruptcy can be a simple process and an effective solution for your troubles.

What is a “Means Test”?

A “Means Test” is a standard step in the process of filing for bankruptcy. The purpose of this test is to identify people who have the ability to pay a significant amount back to their creditors over a reasonable period of time.

The Means Test disqualifies those who are unable to pay back their creditors, which allows most debts to be quickly discharged. In the event that one does not pass the Means Test, they may be stuck in a 3-to-5 year payback period, which requires strict payments back to the creditors.

The Challenge of Pass the Means Test

Passing a Means Test relies on the following conditions: (1) Having a relatively low income (or official median income for a debtor’s family size within their home state) or (2) Having little “disposable income” leftover after allowed expenses. If you do not meet these requirements, your debts will be allotted for payback in the previously mentioned 3-to-5 year period.

It is fairly common for a business owner seeking bankruptcy relief to fail a Means Test. There are a number of scenarios in which one may be forced into this 3-t0-5 year payback period. For example:

  • If closing a business, the owner may acquire a well-paying job prior to filing for bankruptcy. If the income for this job is greater than the median income for their state and family size, they would effectively fail a Means Test.
  • If the business in question was operated by only one spouse while the other earned a decent income at another job, that spouse’s income alone may bump the couple past the median income, causing them to fail the Means Test.
  • Another issue arises with surrendering business collateral—this includes vehicles or equipment, for example. If the former business owner earns above the median income, they cannot deduct monthly payments to secured creditors. Other business expenses such as renting a business premises, are also excluded from this application. Because a former owner cannot include these items in their “allowed expenses,” their income may still be too high and cause them to fail the Means Test.

Skip the Means Test in Business Bankruptcies

Don’t worry just yet—there are ways to bypass the Means Test. If debts owed are classified as primarily “consumer debts,” up to fifty percent of businesses are able to skip the Means Test altogether. So, what exactly is a “consumer debt”?

There are times when the line between a business debt and a consumer debt can be unclear. Given the stakes riding on these debts, the possibility of paying significant amounts for up to five years is intimidating. That’s why it is important to speak to your attorney and identify which debts can be classified in the “consumer” category. These debts are sustained by an individual for the purpose of paying for personal, family, or household expenses. For example, if you take out a second mortgage on a home with the intent of financing your business, this second mortgage would likely be considered a business debt, rather than a consumer debt. If you need more information on filing for bankruptcy, contact bankruptcy attorney Brad A. Woolley today.