Testing, Testing… Is This Thing On? How Means Testing Shapes The Bankruptcy Process

There is a common misperception among folks in the Milwaukee area that all personal bankruptcies are liquidation bankruptcies. Our clients often assume that all their assets will be sold off, their debts wiped out, and then they will have to rebuild their life from scratch. 

But it is also common knowledge that some companies file for bankruptcy, then continue operating as if nothing out of the ordinary was going on. David’s Bridal, for example, filed for bankruptcy last year, but is still selling dresses and otherwise outfitting bridal parties. Wisconsin-based Shopko attempted to follow a similar path but ultimately shut down. 

This doesn’t seem fair. Why should companies get to decide if they want to liquidate and shut down or try to keep operating while people are forced to sell off all their assets and start over with nothing? 

The reality is that people can choose to file for bankruptcy under a chapter of the bankruptcy law that allows them to hold on to many of their assets instead of being forced to liquidate them. 

Chapter 7 and Chapter 13 Bankruptcy

There are two main chapters of the bankruptcy code that people may file under — Chapter 7 and Chapter 13. 

A Chapter 7 bankruptcy is a traditional liquidation-style bankruptcy. Assets are sold off, the proceeds are used to pay off debtors, and most remaining debts are forgiven. 

If starting over with nothing is not appealing, or the debtor has an asset like a house or car that he or she really wants to hold on to, filing under Chapter 13 may be a better option. Chapter 13 is sort of like a corporate restructuring. The court presses the pause button on collections, figures out how much the debtor owes, then sets up a multi-year repayment process that allows the debtor to get caught up on their payments and get their finances under control. At the end of the process, most debts will be paid off rather than forgiven. 

Deciding which chapter to file under can be difficult. And that task is made more complicated by the fact that some people who want to file for bankruptcy under Chapter 7 are legally barred from doing so. 

Because the government wants to encourage people to pay off their debts rather than have them forgiven, the law tries to push people to file under Chapter 13 rather than Chapter 7 by forcing would-be Chapter 7 files to pass a means test

What is the means test?

The means test is a government-designed set of factors that measures a filer’s income, expenses, and family size to determine whether it thinks the filer has enough disposable income to repay his or her debts.

If a debtor “fails” the means test, it means the government thinks he or she should attempt to pay off his or her debts through the Chapter 13 bankruptcy process instead of having them forgiven through the Chapter 7 process. 

As bankruptcy attorneys, it is our job to help our clients figure out which chapter of the bankruptcy code would be better for them to file under. If they think getting a clean slate through the Chapter 7 process would be best, we help them through the means testing process.