The Self-Employment Problem

Small business owners are, by nature, risk-takers.  For every business that succeeds, there are several that never get off the ground, and wind up with more debt than they can repay.

For those who are self-employed and need bankruptcy protection, a unique problem arises.  Under the Chapter 7 bankruptcy rules, only the trustee may operate an “estate business,” which often includes a self-employed debtor’s livelihood.  This applies to handymen, attorneys, shops, and restaurants.  In other words, the moment the bankruptcy petition is filed, the business must stop operating, even if it is profitable.

Fortunately, there are several way to fix this problem for self-employed debtors.

First, before filing the petition, the business owner can convert the self-employment into a business entity.  In California, we tend to prefer LLCs for small businesses.  They are relatively inexpensive to form, flexible in their rules, and most importantly, they can continue to operate even if the owner files for bankruptcy.

Second, the owner can file a motion with the bankruptcy court to “compel abandonment” of the business.  Essentially, this takes the business out of the bankruptcy estate, allowing the owner to resume operations.  The down-side is that, depending on the court’s local rules, it may take several weeks to obtain this relief, and in the meantime, the business cannot operate.  In the Sacramento region, these motions can be set on 14-days notice.

Third, the owner can close the business prior to filing, and after filing can start a new business.  The new business can be in the same line of work, as long as it does not make use of the old business’ property.  This can be a tricky analysis, since many business owners rely on certain assets, such as bank accounts, customer lists, and equipment.  However, for small businesses in the service industry, this can sometimes be a viable option.

For any of these three approaches, you should consult with a bankruptcy attorney to discuss the pros and cons, and which solution is best suited to your particular circumstances.  What you should NOT do is break the rules by continuing to operate your business while in bankruptcy without taking the appropriate steps to ensure you are complying with the law.



BAPCPA reaches its 7 year milestone

Seven years ago, Congress made some significant changes to the Bankruptcy Code in a law called the Bankruptcy Abuse Prevention and Consumer Protection Act, or BAPCPA.

This law dramatically altered the landscape of bankruptcy by, among other things, imposing a means test to prevent some high-income families from filing for relief.  It forced many people seeking protection from their creditors into a repayment plan under Chapter 13 by “disqualifying” them for Chapter 7 protection.

In the months after BAPCPA passed, but before it came into effect, there was an immense surge of filings as people tried to get their cases opened before the new standards made it more difficult to do so.  There were so many new filings that the Court Clerk had to open extra space for the overflow traffic of debtors filing for relief.

Of course, nobody knew at the time that we were in for the worst recession since the great depression of the 1930s just a few short years later.  It turns out a housing bubble and financial shenanigans were the real cause of economic trouble, not abusive bankruptcy filings.

However, for the folks who filed for bankruptcy back in 2005, there was a new dilemma.  Just like other people, they often got hit by job loss, income reduction, foreclosure, and the other trappings of the economic downturn.  Unfortunately, they were not always able to discharge their debts in bankruptcy, since the code only permits one chapter 7 discharge every eight years.

Over the coming twelve months, those original filers will once again be eligible for relief. I expect to see a large up-tick in filings as those who patiently waited for the time period to run once again seek relief from their debts.


The Student Loan Conundrum

This is one area of law where I have both a personal and professional interest.  Between my Jurisdoctorate and my wife’s Masters degree, we have significant student loans, even after half a decade of payments.  How significant?  Suffice it to say, bigger than yours.

This is also an issue for many of my clients.  They can wipe out their credit card debt, their judgments, and sometimes even their tax liability.  Student loans, however, are usually forever.  Even bankruptcy won’t do much for student loans unless you can pass the ill-conceived, sadistic standard known as the Brunner test (named after a case, of course):

1. You cannot maintain even a minimal standard of living while paying your student loan debt.

2. Additional circumstances suggest that this problem will persist for the majority of the payback period.

3. You have made a good faith effort to work with your student loan lender.

Courts have interpreted this test narrowly enough to mean that, while it is not technically impossible to pass, it usually is.  It is extremely rare for student loans to be discharged in bankruptcy.

Why?  For federally-backed student loans, the answer is obvious: the government will be left holding the bag if you discharge the debt.  As you might know if you pay even passing attention to the political news du jour, our government doesn’t have a ton of disposable income right now, so they don’t want to pick up the tab for billions of dollars in discharged student loans.

For private loans, the answer is more nuanced.  The lenders made the loans on favorable terms because they knew the risk was very small, since bankruptcy would not wipe away the debt.  That might change in the future, but is unlikely to change retroactively.

So, what do you do if you have significant student loan debt?  The best solution for most people is income-based repayment.  If you qualify for this option, depending on your type of loans, you are permitted to pay what the government has determined you can afford.  Here’s how you figure it out:

1. Take your gross income, usually from your last tax return.

2. Subtract 1.5 times the poverty level, based on your household size.

3. Take fifteen percent of the result, and divide by twelve (months in a year).  That is your monthly payment.

4. Re-apply each year, and after 25 years if you still owe, the remaining debt will be forgiven.

One small wrinkle: if you took out any loans after 2009, you take 10% rather than 15% in step 3, and the time period for forgiveness is shortened to 20 years instead of 25.  One additional issue that won’t come up for another two decades or so is whether the forgiven debt will be treated as taxable income; as it stands today, it will, and that can cause tax problems.

This is, in my opinion, the simplest way to deal with long-term student loan debt that you simply can’t pay.  It is far from the only option.  There is an attorney named Joshua Cohen who specializes in student loan issues, and you can check out his site for more information.


Opening Remarks

Yesterday afternoon, I was meeting with a client and caught myself in a re-run.  Of course, for the client, the information was new and shiny, but it occurred to me (after the fact) that I had given this same explanation, in basically the same words, about three dozen times.  No case is ever the same as another, but they frequently rhyme.

So, as a frequent “explainer of legal things” and occasional blogger, it occurred to me that maybe I should blog about the law.  Specifically, about consumer debt law, my area of focus.  If you read my other blogs, you will correctly predict that I will stray off-topic from time to time when the mood strikes me, but I plan to stick with this focus because of how important it is that people get actual information about debt, the law, and how one can affect the other.

My particular pet peeve in legal information sites is when they are basically sales pitches attached to small nuggets of truthiness (hat tip, Stephen Colbert): this will not be that.  If you want to hire me, go to my firm’s web site.  While I might link to it and other sources from time to time, my purpose in blogging is not to drum up business, it is to share information and ideas.

Finally, please be aware that this information is just that: general information.  Don’t mistake it for legal advice.  Yes, I’m an attorney, but without actually knowing you and asking you six thousand questions, I can’t tell you what to do.  If you need legal help, talk to an attorney one-on-one.  You should never rely on legal information without double-checking with a local attorney, and since the law changes and varies from time to time and place to place, this blog is no exception.

So, I hope you find this information useful, and I look forward to your questions and comments.