Choosing the Right Solution in a Closed-Business Bankruptcy Case

Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.

Hoping to File a Chapter 7 “Straight Bankruptcy”

Once you’ve closed down your business and are considering bankruptcy, it would be understandable if you preferred to file under Chapter 7 instead of under a Chapter 13 “adjustment of debts.”

After all you’ve been through the last few years trying to keep your business afloat, you just want a fresh, clean start, as quickly as possible. You likely feel like just putting the debts behind you. The last thing you likely want is to do is stretch things out for the next three to five years that a Chapter 13 case would usually take.

Likely Can File Under Chapter 7 Under the “Means Test”

The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. In my last blog I described how you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts.

But even if that does not apply to you, the “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.

Three Factors About Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt

The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:

1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.

If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them. Which option is better depends on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor. These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.

These three factors will be the topics of my next three blogs. After reviewing them you will have a much better idea whether your business bankruptcy case should be in a Chapter 7 or Chapter 13.