Business Debt Exception to the Means Test

The means test only applies to individuals whose debts are primarily “consumer debts,” as opposed to business debts, pursuant to § 707 ofthe Bankruptcy Code.  Congress did not define the word “primarily,” but most courts have defined the word to mean more than half.  If more than 50% of the debtor’s debts are non-consumer debts or business debts, the debtor is automatically eligible to file for Chapter 7 bankruptcy without doing the means test, and the presumption of abuse does not apply,

What are consumer debts?  Section 101(8) of the Bankruptcy Code defines a consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.”  Many bankruptcy courts have developed a “profit motive” test.  If the debt was incurred with an eye towards making a profit, then the debt should be classified as business debt.  Accordingly, a mortgage on an individual’s home would be considered consumer debt; however, if a vacation home were purchased for investment purposes and rented out, then the mortgage would qualify as business debt.  If an individual uses credit cards for consumer purchases, then those debts are consumer debts; however, if an individual used the credit card for business purposes, then in all likelihood that debt would be deemed business debt.  If an individual guaranteed a debt for a business obligation, that personal guaranty would be deemed business debt, as would the investment losses.

With respect to tax debts, a number of bankruptcy courts outside the Second Circuit have held that those debts are business debts.  SeeIn re Brashers, 216 B.R. 59 (Bankr. N.D. Okla. 1998), which holds that the debtor’s income tax obligations do not constitute consumer debt, also see In re Westberry, 215 F.3d 589 (6^th Cir. 2000), which also holds that taxes are not consumer debt.  Taxes are not consumer debts, according to the Westberry Court for the following reasons:

I. Tax debt is incurred differently than consumer debt.  Consumer debt is incurred voluntarily and taxes are involuntary.

II. Consumer debt is incurred for personal or household purposes, while taxes are incurred for a public purpose.

III. Taxes arise from the earning of money, while consumer debts arise from consumption.

IV. Consumer debt normally involves the extension of credit from a credit card or from the seller of goods.

Notwithstanding the fact that business debt is an exception to the means test, if an individual files for Chapter 7 bankruptcy, their business debt exceeds their consumer debt and they do not have to take the means test, a creditor, the Office of the U.S. Trustee, or the Bankruptcy Trustee may move to dismiss the case if they find that the debtor was living an extravagant lifestyle (based on the details of their Schedule J expenses), and that if they reduced those expenses they could pay creditors a significant dividend via a Chapter 11 plan.  See In re Rahim and Abdulhussain, 442 B.R. 578 (Bankr. E.D. Mich. 2010).   

Notwithstanding the fact that this is a Michigan case, this author believes that this logic would also be applicable to cases in the Second Circuit and the Southern and Eastern Districts of New York.  In In re Rahim and Abdulhussain, the court held that under § 707(a) of the Bankruptcy Code, there is cause to dismiss a case for abuse of discretion, as well as under § 707(b) of the Code.  Relying on case law, the court held that Congress only intended to deny Chapter 7 relief to dishonest or non-needy debtors.  Relying on In re Krohn, the court held that among the factors to be considered is whether the debtor is needy is the debtor’s ability to repay debts out of future earnings.  The Sixth Circuit held that debtor’s continuing lavish lifestyle would support a finding of bad faith sufficient to warrant dismissal of a bankruptcy case under § 707(a), notwithstanding the fact that the individual’s debts were primarily business debts.  In In Re Rahim and Abdulhussain, the debtor’s monthly expenses exceeded $42,000, which the court described as extravagant and lavish.  The court indicated that the record indicated that the debtors had made no effort to reduce their expenses-they leased or owned expensive cars, owned property in Florida and sent their children to private schools.  Accordingly, the court dismissed the bankruptcy case.