MANY self-employed debtors resort to Chapter 13 to reorganize their financial affairs. However, most self-employed debtors operate a business that is losing money or just breaking even. The fact that the business is losing money creates an obstacle in a Chapter 13 case.
Why so? Imagine a rental property that is upside down and losing money. If debtor does not abandon the rental, what he is actually doing is paying creditors less to subsidize the loss, a proposal that will not sit well with the trustee. It’s like telling your creditors that you will pay them less because they need to help you finance the money you are losing on the rental every month.
To illustrate, if the rental is losing $500 a month while debtor proposes a plan payment of $300 a month for 60 months, he is actually telling creditors that he is going to pay them only $300 a month, instead of $800 a month, for 60 months because he wants to keep his rental property which is negative $500 a month. So, debtor is proposing to pay his creditors $30,000 less by keeping his rental. Why should his creditors accept $18,000 when debtor can actually pay $48,000 which is $30,000 more? Thus, trustee who represents all of debtor’s creditors, will certainly object to debtor’s proposed payment of $300 while keeping his rental. If debtor insists on keeping his rental, he would have to increase his plan payment to $800.
A business that is losing money is exactly the same as a rental that is losing money. If the debtor’s business is losing $500 a month, he faces the same problem as the rental in the foregoing example. Here, the self-employed debtor must show that his business is profitable, or his proposed plan payment must show that he is not asking his creditors to subsidize the loss. In Re Culcasi, the Chapter 13 debtors’ calculation of their monthly disposable income was too low because they included deductions for the repayment of a post-petition, unauthorized 401k loan, and for work expenses that were more than the income generated from that work. The court previously determined that debtors had monthly disposable income of $1,000 which they said they did not have. In response, debtors amended the petition and submitted a new plan. The amended schedules showed monthly disposable income of $239. The plan proposed a plan payment of $230 because $9 was needed for bird food. The trustee objected to confirmation, pointing out that after filing for bankruptcy, the debtors borrowed money from the wife’s 401k plan and used the money to pay off their student loans. They included the retirement loan’s repayment among their monthly expenses. The court agreed with the trustee that the loan payment was included in disposable income because the debt was incurred post-petition. In other words, the 401k loan payment was treated as disposable income. Debtors argued that the court should treat the loan repayment like the repayment of a separately classified student loan so that it would not be treated as disposable income. Debtors wanted to have their cake and eat it too.
But the court refused to do so because the debtors unilaterally decided to substitute the 401k loan for the student loan. By doing so, they made the possibility of separate classification of the student loan irrelevant. Further, the court said that debtors could not deduct the debtor husband’s work expenses to the extent they exceeded his income. Debtor was self-employed. He had monthly income of $4,000 and expenses of $4500. The court said the debtor’s employment was similar to situations in which debtors wish to keep investment property that is losing money. “Allowing Mr. Culcasi to stay employed in a losing business effectively forces the debtors’ creditors to subsidize his business while creditors receive less payment on their claims. Such a result would defeat the purpose of the Code which seeks to have debtor pay what they can to creditors.”
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite 1125 Unit 58 Alhambra, CA 91803.
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