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The Means Test and Business Debt

The purpose of the bankruptcy means test is to determine whether the debtor has the ability to repay creditors during his or her bankruptcy case. After subtracting reasonable and necessary expenses (as determined by Congress using IRS guidelines), the means test calculates the disposable income of the debtor. If the debtor has disposable income of more than $182 each month, the debtor is presumed to be able to pay creditors through a Chapter 13 repayment plan. If not, the debtor is allowed to file under Chapter 7 and discharge creditors in four to five months.

The means test is generally required of all debtors filing bankruptcy, with a few exceptions. One of these exceptions is spelled out in 11 USC 707. A debtor with primarily business (non-consumer) debts is not subject to the means test calculation. In other words, if more than 50% of an individual’s debt is from business, the debtor is eligible to file and receive a Chapter 7 discharge without regard to the means test.

A recent example of this situation is found in the bankruptcy of University of Arkansas head football coach John Smith. Earlier this year Smith filed for bankruptcy and listed an $850,000 annual salary, $1.2 million in retirement accounts, personal property, and $25.7 million in debts. The majority of Smith’s debts are business debts from failed real estate ventures. Consequently, Smith has filed a Chapter 7 bankruptcy and claimed exception from the bankruptcy means test.

Coach Smith’s case falls in a gray area of bankruptcy law. On the one hand, the law excepts “business debtors” from the means test. On the other hand, he clearly can repay something to his creditors. The bankruptcy law imposes a “good faith” requirement on the Chapter 7 debtor which generally ensures that the debtor gets a fresh start, not a head start. However, is it “bad faith” to take advantage of the bankruptcy law that allows Smith to file Chapter 7 and avoid a Chapter 13 repayment plan? There will certainly be litigation over this high profile bankruptcy case.

The bankruptcy law is complex and is always evolving. An experienced bankruptcy attorney can guide you through this legal jungle and ensure you emerge on the other side with a bankruptcy discharge and a fresh financial start. Call today for a free consultation.