Wednesday, August 31, 2016

Involuntary Servitude? [Does the Business Debt Exception Mean Anything?]

In re Parvin, 549 B.R. 268 (W.D. Wash. 2016) is a case that scares me, a lot. The case is one where a doctor had a failed practice and of course had a ton of personal guarantees outstanding that could not be paid.  There appears to be no argument that there is not a Mean’s Test issue because the debtor would meet the business debt exception to the Test.  So as far as Mean’s Test qualification the doctor should be OK in filing a Chapter 7 case.  [For those of you that do not know the Mean’s Test was enacted by Congress to make it a little more difficult to file Chapter 7 bankruptcy if you made over a certain amount of income.]

The Court and United States Trustee appear to focus mainly on the debtor’s Schedule I & J where it shows he has a decent amount of money left over at the end of the month and thus, they believe, he should pay something back to his creditors.  They later argue he should pay 100% back (over a million dollars).  [Again for those of you that do not know I & J lists the debtor’s current income and expenses.]

You may say, why does this scare you?  I routinely deal with failed business fallout and in many of those cases the debtor does have some disposable income left over before paying all of the business guarantees.  It seems as though the business debt exception to the Mean’s Test is being completely ignored in this opinion.  It renders the exception meaningless. 

The debtor in this case will now be subject to the requirements of Chapter 11 bankruptcy where he is charged with being a fiduciary for his creditors.  He will be charged with using his future income to pay creditors apparently 100% of their claims over time.  If he now decides to quit his job or at least quit his second job in another state he will be accused of acting in bad faith and purposely under-working.  This result seems absurd.   

If this case stands it will now require failed business owners to not seek reemployment until after a case is filed.  In this case if the doctor would have simply quit working until after the case was filed he would have probably not came up against this argument by the United States Trustee and would thus not be forced into a Chapter 11 reorganization.

One of the pillars of the bankruptcy code has always been to allow entrepreneurs to take risks by opening a business.  If they fail with no criminal or fraudulent issues then the bankruptcy code has always allowed the individuals a fresh start.  It has not required them to be imprisoned with their debt.  It has been a tool to encourage the entrepreneurial spirit.  Without the fresh start of the bankruptcy the risks will begin to outweigh the potential.

I really hope the debtor in this case has the funds to appeal this decision.  The importance of this goes beyond one doctor and one business.  It may have an everlasting impact on all entrepreneurs.