§ 52.3     Debtors Engaged in Business after BAPCPA
Cite as:    Keith M. Lundin, Lundin On Chapter 13, § 52.3, at ¶ ____, LundinOnChapter13.com (last visited __________).
[1]

Except for one mistaken cross-reference,1 BAPCPA did not take aim directly at Chapter 13 debtors engaged in business.2 The forms drafters beefed up the notion of a debtor “in business” for purposes of Official Form 7, the Statement of Financial Affairs, without a nod to the term of art “engaged in business” in Chapter 13 cases.3 Changes to several general provisions of the Code may affect Chapter 13 debtors engaged in business more than ordinary consumer debtors. There is some evidence that the drafters of BAPCPA were not aware that a significant minority of Chapter 13 debtors are or were engaged in business.4 This is particularly apparent in the new calculation of disposable income at confirmation.

[2]

Detailed elsewhere,5 at confirmation of a Chapter 13 plan, upon objection by the trustee or an allowed unsecured claim holder, the disposable income test in § 1325(b) has dramatically different configurations depending on whether the debtor has current monthly income (CMI) over or under applicable median family income. For the under-median-income debtor, after calculating CMI,6 the debtor is allowed to deduct “reasonably necessary” expenses.7 Among the reasonable and necessary expenses deductible from CMI by an under-median-income Chapter 13 debtor the statute lists “if the debtor is engaged in business . . . expenditures necessary for the continuation, preservation and operation of such business.”8

[3]

For Chapter 13 debtors with CMI greater than applicable median family income, BAPCPA redefined “reasonably necessary” expenses that can be deducted from CMI to determine disposable income as follows: “Amounts reasonably necessary to be expended . . . shall be determined in accordance with subparagraphs (A) and (B) of section 707(b)(2).”9 This definition of amounts reasonably necessary to be expended for purposes of the disposable income test in § 1325(b)(2) intercepts the list of permitted deductions from CMI, including the reference to debtors engaged in business and the payment of expenditures necessary for the continuation, preservation and operation of the business, quoted above. In other words, as you read down through § 1325(b)(2) as amended by BAPCPA, for an over-median-income debtor, the allowable deduction for debtors engaged in business does not apply and instead amounts reasonably necessary to be expended are determined in accordance with § 707(b)(2)(A) and (B).

[4]

Unfortunately for Chapter 13 debtors engaged in business, the “abuse test” in § 707(b)(2)(A) and (B) was not conceived with business debtors in mind. The monthly expenses specifically identified in § 707(b)(2) nowhere mention the expenses of a business. Official Form B22C contains a single line for the debtor to deduct “ordinary and necessary business expenses” from gross receipts of a business without explanation of the source of this deduction or how it is to be calculated.10 This deduction is misplaced in Part I of the form, where it inappropriately reduces CMI for all debtors.11 It is worded without regard for the different, and broader, business expense deduction allowed under-median-income debtors by § 1325(b)(2).12

[5]

The IRS standards incorporated into § 707(b)(2)(A)(ii) address business expenses in a category of Other Necessary Expenses.13 In the Internal Revenue Manual under Other Necessary Expenses, there is a category for “unsecured debts.”14 The comments to this category explain: “Examples of unsecured debts which may be necessary expenses include: payments required for the production of income such as payments to suppliers and payments on lines of credit needed for business and payment of debts incurred in order to pay a federal tax liability.”15 The Other Necessary Expenses category for unsecured debts is the place where a taxpayer would claim deductions for business expenses in a negotiation with the IRS. The “unsecured debts” category of Other Necessary Expenses is one of the IRS categories the rules drafters chose to omit from Official Form B22C.16

[6]

Doubly unfortunately for Chapter 13 debtors engaged in business, § 707(b)(2)(A)(ii)(I) states that “notwithstanding any other provision of this clause, the monthly expenses of the debtor shall not include any payments for debts.”17 Are unsecured debts incurred by an over-median-income Chapter 13 debtor in the ordinary course of a business or trade deductible business expenses for purposes of the disposable income test or are business expenses “unsecured debts” that fall within a category of Other Necessary Expenses that cannot be deducted because of § 707(b)(2)(A)(ii)(I)? If prepetition business debts are not considered, then projected business expenses must be brought back into the calculation in Official Form B22C at some point else the disposable income calculation will be nonsensical for an over-median-income debtor engaged in business. Neither the drafters of BAPCPA nor the drafters of the new Official Form B22C seem to have thoroughly digested this issue.

[7]

Notice that the deductions allowed by § 1325(b)(2) for an under-median-income debtor include expenditures necessary for the “continuation, preservation and operation” of a business. The statute contemplates that an under-median-income Chapter 13 debtor engaged in business may not be operating the business, yet payments to preserve or continue the business are allowable deductions to determine disposable income at confirmation.18 The statute does not address whether this expansive notion of expenses necessary for a debtor engaged in business applies when the Chapter 13 debtor has CMI greater than applicable median family income. It is not clear from the IRS standards or from § 707(b)(2)(A) or (B) whether an over-median-income Chapter 13 debtor has the same business expense deductions as an under-median-income debtor. Does a debtor’s decision whether to continue operating a trade or business affect whether expenses of the business are deductible for purposes of § 1325(b)? Remember: the CMI calculation under § 101(10A) is historical—it computes average income during the six months before the month in which the petition is filed.19

[8]

Chapter 13 debtors may encounter other changes by BAPCPA that are more likely to affect business debtors than nonbusiness debtors. There is a new administrative expense in § 503(b)(9) for the value of goods received by a debtor in the ordinary course of business within 20 days before the petition.20 Coupled with the expanded 45-day period in which a seller can reclaim goods under amended § 546(c)(1),21 Chapter 13 business debtors with raw material or inventory needs could have new reclamation and administrative expense issues.

[9]

BAPCPA has simplified the ordinary course of business defense to preference recovery under § 547(c)(2).22 Chapter 13 debtors engaged in business and their standing trustees will be less likely to recover transfers to business creditors after BAPCPA.

[10]

BAPCPA created a new avoidance power with respect to transfers within two years of a bankruptcy petition to or for the benefit of an insider under an employment contract not in the ordinary course of business.23 A Chapter 13 debtor engaged or previously engaged in business could end up as the defendant in an action under this new section.

[11]

Chapter 13 debtors engaged in business may be impacted by BAPCPA amendments to the priorities in § 507. BAPCPA shuffled the priorities in § 507 to elevate domestic support obligations24 to first priority. As a result, administrative expenses were depressed to second priority under § 507(a)(2).

[12]

In a Chapter 13 case, to satisfy the mandate in § 1322(a)(2)25 the plan must provide for full payment of all claims entitled to priority under § 507, without regard to where the claim falls in the hierarchy of priorities.26 But in a Chapter 7 case, the new order of priorities in § 507(a) will make quite a difference if there are insufficient assets to pay all domestic support obligations and administrative expenses in full. The Chapter 7 trustee will be required to first pay domestic support obligations ahead of administrative expenses, respecting the statutory carve-out for the expenses of the trustee.27

[13]

This change in priorities may complicate the continued operation of a business by a Chapter 13 debtor engaged in business. By definition, a debtor engaged in business incurs trade debt in the production of income.28 Trade credit during a Chapter 13 case typically would classify as expenses of administration for purposes of the priorities in § 507(a).29 Trade creditors worried about viability of the debtor’s business or concerned whether the debtor will confirm and consummate a Chapter 13 plan face increased risk that extensions of credit during the Chapter 13 case will be administrative expenses that lose priority to domestic support obligations in the event of conversion. Willingness to extend trade credit to a Chapter 13 debtor engaged in business may be diminished.


 

1  See 11 U.S.C. § 1304(c) (reference to “704(8)” should probably be “704(a)(8)”).

 

2  See 11 U.S.C. § 1304, discussed in §§ 57.1 [ Operating a Chapter 13 Debtor Engaged in Business ] § 52.1  Operating a Chapter 13 Debtor Engaged in Business and 57.2 [ Additional Filing and Reporting Requirements ] § 52.2  Additional Filing and Reporting Requirements.

 

3  See § 383.1 [ Statement of Financial Affairs after BAPCPA ] § 36.23  Statement of Financial Affairs after BAPCPA. See also §§ 57.1 [ Operating a Chapter 13 Debtor Engaged in Business ] § 52.1  Operating a Chapter 13 Debtor Engaged in Business and 57.2 [ Additional Filing and Reporting Requirements ] § 52.2  Additional Filing and Reporting Requirements.

 

4  Robert M. Lawless & Elizabeth Warren, The Myth of the Disappearing Business Bankruptcy, 93 Cal. L. Rev. 743 (2005).

 

5  11 U.S.C. § 1325(b) is discussed beginning at § 92.1  In General.

 

6  See 11 U.S.C. § 101(10A), discussed in §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income and 468.1 [ Current Monthly Income: The Baseline ] § 92.3  Current Monthly Income: The Baseline.

 

7  See 11 U.S.C. § 1325(b)(2), discussed in §§ 165.1 [ Reasonably Necessary for Maintenance or Support ] § 91.3  Reasonably Necessary for Maintenance or Support and 470.1 [ Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Applicable Median Family Income ] § 93.1  Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Median Family Income.

 

8  11 U.S.C. § 1325(b)(2)(B), discussed in §§ 167.1 [ Debtor Engaged in Business ] § 91.6  Debtor Engaged in Business and 470.1 [ Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Applicable Median Family Income ] § 93.1  Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Median Family Income.

 

9  11 U.S.C. § 1325(b)(3), discussed in § 92.1  In General and beginning at § 94.1  Big Picture: Too Many Issues.

 

10  See Official Form B22C, Line 3, discussed in § 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income.

 

11  See §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income and 468.1 [ Current Monthly Income: The Baseline ] § 92.3  Current Monthly Income: The Baseline.

 

12  See §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income, 470.1 [ Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Applicable Median Family Income ] § 93.1  Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Median Family Income and 477.1 [ Other [Necessary] Expenses—In General; All Categories ] § 95.4  Other [Necessary] Expenses—In General; All Categories.

 

13  See 11 U.S.C. § 707(b)(2)(A)(ii)(I), discussed in § 477.1 [ Other [Necessary] Expenses—In General; All Categories ] § 95.4  Other [Necessary] Expenses—In General; All Categories.

 

14  See I.R.M. 5.15.1.10, at 3.

 

15  I.R.M. 5.1.5.1.10, at 3.

 

16  See §§ 380.1 [ Form B22C: Disposable Income Calculation ] § 36.21  Form 122C-2: Disposable Income Calculation and 477.1 [ Other [Necessary] Expenses—In General; All Categories ] § 95.4  Other [Necessary] Expenses—In General; All Categories.

 

17  11 U.S.C. § 707(b)(2)(A)(ii)(I), discussed in § 94.2  Netting Issues, Including Exclusion of Payments for Debts.

 

18  See § 167.1 [ Debtor Engaged in Business ] § 91.6  Debtor Engaged in Business.

 

19  11 U.S.C. § 101(10A), discussed in §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income and 468.1 [ Current Monthly Income: The Baseline ] § 92.3  Current Monthly Income: The Baseline.

 

20  See 11 U.S.C. § 546(c)(2), discussed in § 523.1 [ Miscellaneous Administrative Expenses and Priority Claims ] § 136.15  Miscellaneous Administrative Expenses and Priority Claims after BAPCPA.

 

21  See 11 U.S.C. § 546(c)(1), discussed in § 523.1 [ Miscellaneous Administrative Expenses and Priority Claims ] § 136.15  Miscellaneous Administrative Expenses and Priority Claims after BAPCPA.

 

22  See 11 U.S.C. § 547(c)(2), discussed in § 411.1 [ Preferences ] § 50.5  Preferences after BAPCPA.

 

23  See 11 U.S.C. § 548(a)(1)(B)(ii)(IV), discussed in § 412.1 [ Fraudulent Transfers ] § 50.6  Fraudulent Transfers after BAPCPA.

 

24  See 11 U.S.C. § 101(14A), discussed in § 440.1 [ New and Changed Priority Claims ] § 73.3  Priority Claims Added or Changed by BAPCPA.

 

25  11 U.S.C. § 1322(a)(2) is discussed in §§ 98.1 [ Plan Must Provide Full Payment ] § 73.1  Plan Must Provide Full Payment and 441.1 [ New and Changed Treatment of Priority Claims ] § 73.6  Treatment of Priority Claims Changed by BAPCPA.

 

26  See §§ 98.1 [ Plan Must Provide Full Payment ] § 73.1  Plan Must Provide Full Payment and 99.1 [ What Claims Are Priority Claims? ] § 73.2  What Claims Are Priority Claims?.

 

27  See 11 U.S.C. § 507(a)(1)(C).

 

28  See 11 U.S.C. § 1304(a), discussed in § 57.1 [ Operating a Chapter 13 Debtor Engaged in Business ] § 52.1  Operating a Chapter 13 Debtor Engaged in Business.

 

29  See 11 U.S.C. § 507(a)(2), which defines as administrative expenses the actual and necessary costs and expenses of preserving the estate under 11 U.S.C. § 503(b)(1)(A).