Law Tips: Consumer versus Business Cases in Bankruptcy, Pt 1

A lawyer’s responsibility is to “make life as comfortable as possible for individuals who are forced into seeking protection under the Bankruptcy Code.” So goes the advice of this week’s Law Tips contributors, Samuel Hodson and Wendy Brewer, partners with Benesch, Friedlander, Coplan & Aronoff LLP, Indianapolis. During ICLEF’s Annual Bankruptcy Institute their presentation examines the issues that a skilled and competent practitioner works through in preparing an individual business owner for bankruptcy. They note that this exercise is as useful for settlement outside bankruptcy as it is for bankruptcy planning. 

Following is a sampling of their expert insights on “Consumer Versus Business Cases:” 

Congress has recognized the critical importance of the bankruptcy safety net for those who form new businesses. One local bankruptcy judge has often commented that personal bankruptcy for owners of failed businesses makes capitalism possible.  Without the bankruptcy safety net, fewer small businesses would be attempted and fewer jobs would be created. Congress recognized the social good of the fresh start for business owners when it exempted business debtors from the harsh means testing provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act  (BAPCPA) and the bad faith requirements of 11 U.S.C. § 707(b ).

Debtors whose debts are primarily for business may obtain a Chapter 7 discharge even if their incomes are substantially higher than the expenses allowed under the means test in 11 U.S.C.

§ 707(b ). It is important to be certain that business clients are not treated as consumer debtors when planning their personal bankruptcies.

A debtor’s status as a business debtor is determined by whether his business debt exceeds his consumer debt. For differing approaches on how courts determine whether consumer debts exceed business debts, see In re Hlavin, 394 B.R. 441 (Banlu. S.D. O.H. 2008) (outlining the various approaches); In re Stewart, 175 F.3d 796, 808 (lOth Cir. 1999) (illustrating the majority approach focusing on the aggregate value of each type of debt); In re Bell, 65 B.R. 575, 577-78 (Bankr. B.D. Mich. 1986) (noting that where the relative dollar amounts of consumer versus non-consumer debts are close to equal, it will also consider the relative number of each kind of debt); In re Vianese, 192 B.R. 61, 68 (Banlu. N.D. N.Y. 1996) (looking at whether the amount of the consumer debt actually being discharged and not reaffirmed exceeds fifty percent of the debtor’s total liabilities).

Consumer debt is defined as debt incurred for personal, family or household purposes. 11 U.S.C. 101(8); see also In re Thongta, 401 B.R. 363, 366 (Bankr. E.D. Wis. 2009) (explaining difference between personal, consumer and business debts); In re Millikan, 2007 WL 6260855 (Banlu. S.D. Ind. Sept. 4, 2008) (explaining history of definition and use of “profit motive” test to determine nature of debt).

Given the popularity of McMansions by entrepreneurs over the last decade, home mortgages are likely to be a major concern for small business owners. The amount of the obligation, not the probable deficiency controls. A home with a $1,000,000 mortgage and $1,100,000 market value counts as $1,000,000 in the consumer column despite the equity. If its owner had $900,000 of debt from personal guarantees of business obligations, he would be considered a consumer debtor and would be subject to means testing under 11 U.S.C. § 707(b ).

In re Stewart, 175 F.3d at 808. This result can be avoided by sale of the home, deed in lieu of foreclosure, or payments to reduce the mortgage balance. For example, if the debtor owned a Porsche and a boat worth more than $100,000, the problem could be corrected by selling these assets and applying the proceeds to the mortgage balance. If the home is in foreclosure, it may be prudent to allow the sale to complete prior to filing so that the balance is reduced by the credit bid of the lender.

While homes are generally the most common problem on the consumer side of the ledger, business owners often have personal property encumbered to secure consumer loans which can create problems. The ratio can easily be skewed towards consumer by a few German cars. Returning or selling luxury consumer goods to reduce the consumer side of the ledger prior to filing may save business owners from means testing purgatory.

We’ll continue this Consumer versus Business Case analysis by our Law Tips contributors next week with their advice on how to look at this equation from the business side of the ledger.  Join us again!

For a thorough update in this area, take advantage of ICLEF’s Annual Bankruptcy Institute CLE seminar by clicking here.


Thank you to Our Law Tips faculty contributors: 
Wendy Brewer, is a partner with Benesch Friedlander Coplan & Aronoff LLP, Indianapolis, where she is vice-chair of the firm’s Business Reorganization Practice Group. She primarily focuses her practice on the representation of creditors, debtors, trustees, and committees in bankruptcy cases and adversary proceedings and the representation of corporate and bank clients in commercial litigation.

Samuel Hodson, is a partner in Benesch Friedlander Coplan & Aronoff LLP, Indianapolis, Business Reorganization Practice Group. Mr. Hodson represents debtors, creditors, trustees, committees and receivers in proceedings under Chapters 7, 11, 12, and 13 of Bankruptcy Code, state and federal court commercial litigation, out-of-court workouts, and administrative collection matters with state and federal taxing authorities. Mr. Hodson also counsels business owners in wealth protection planning.

About our Law Tips blogger:
Nancy Hurley, Law Tips blogger, has long-standing connections with Indiana lawyers.  She was formerly a member of the ISBA and IBF staffs for over 30 years. Nancy’s latest lifestyle venture is with ICLEF. We plan to utilize her exceptional writing and interviewing skills while exploring how her Indiana-lawyer background fits with ICLEF’s needs.  When she isn’t ferreting out new topics for Law Tips, her work can be found in our Speaker Spotlight blogs, postings on the ICLEF Facebook page, Twittering and other places her legal experience lends itself.

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ICLEF • Indiana Continuing Legal Education Forum, Indianapolis, IN

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