Bankruptcy – Will reform hurt small businesses?

Will reform improve the system or spell the end for some small businesses?
Two areas affected by the proposed changes should pique business owners’ interests.
The first has to do with consumer debt whereby “means testing” or needs-based bankruptcy is being proposed. If passed, means testing would force many people out of Chapter 7 bankruptcy – where, after liquidation of the debtor’s assets, the balance of his or her debts are forgiven – and into Chapter 13 bankruptcy – where debtors use their future income to re-pay their debts.
“This is a fundamental change from the way bankruptcy’s been handled up until now,” says Randall Crocker, a shareholder and chair of the banking, bankruptcy and business litigation group at von Briesen, Purtell & Roper, a Milwaukee law firm. “Those who propose it say it’s only fair. If you have the ability to pay your debts, you shouldn’t be able to discharge them in bankruptcy.”
Crocker says the supporters of the proposed changes point to abusive cases where individuals with few assets, but large incomes or the potential for large future incomes, can run up their debts, declare bankruptcy, have the slate wiped clean and then go on to live extravagant lifestyles.
The biggest proponents of means testing are the credit card and banking lobbies “because they believe too many people charge up too much money on credit cards and then file bankruptcy. This will make it more difficult for them to file,” says Crocker.
Meat-cleaver approach
While abusive cases do exist, Assistant U.S. Trustee John Robert Byrnes sees the proposed remedies as being too broad.
“It’s not clear whether they’re going to address the specific abuses of Chapter 7 or take the meat-cleaver approach,” Byrnes says of the Bankruptcy Reform Act of 1999.
In Byrnes’ opinion, the laws being mulled over by Congress take the meat-cleaver approach to reform. “I think the fact it hasn’t been scheduled for a vote in the Senate says something,” Byrnes says, although the reform act has passed in the House.
The reforms that have alarmed local experts the most are those concerning small businesses.
The whole bankruptcy system, according to Crocker, was established to foster the entrepreneurial spirit.
“The assumption in bankruptcy is that relief should be provided to the honest, but overburdened debtor,” Crocker says.
The new law – while trying to prevent bankruptcy cases from wallowing in the system – pushes up filing dates for small businesses. Howard Schoenfeld, a shareholder in the Milwaukee law firm Godfrey & Kahn, says that could force more companies out of business rather than re-organizing under Chapter 11.
“In my opinion [the proposed reform] makes it much harder for small businesses to reorganize and succeed,” Schoenfeld says.
The new law would give businesses 90 days to file a plan and 60 days to get it confirmed by the court. Under current law, the debtor has the exclusive right to file a plan for the first 120 days of the case. After the 120-day limit, any creditor may file a plan. There is no set requirement as to when a plan needs to be filed, but failure to confirm a plan may constitute cause to dismiss or convert the case to Chapter 7, according to Crocker.
Bankruptcy, says Schoenfeld, is a three-stage process. “The first stage is akin to triage – there’s a crisis,” Schoenfeld says. “They wouldn’t be there [filing for bankruptcy] if there wasn’t. Here, you try to stop the bleeding.”
The second stage is restructuring the business. The court gives the business time to figure out what the problem is and how to fix it, whether it’s closing a store or discontinuing a product line.
The third stage is negotiating with creditors. “To negotiate with everyone just takes time and these proposals don’t give business the necessary time,” Schoenfeld says. “It forces companies to prematurely file a plan before they get the opportunity to negotiate.
Insufficient time
to reorganize
“Ninety days is not enough time to reorganize,” Schoenfeld says. “Cases that could succeed will fail. People will lose their jobs. This is a real Wisconsin issue.”
According to Crocker, Byrnes and Schoenfeld, the kind of cases that the reform act is targeting – small business bankruptcy cases that languish in the system – rarely occur in Wisconsin.
“These small business changes that seek to speed up the Chapter 11 proceedings for small businesses really are problematic for a district like Milwaukee,” Crocker says. “We have a very good court system. We have very aggressive, talented lawyers. Our cases don’t wallow, they go very quickly. And almost all the cases filed here we’d classify as small business cases.”
The reason the current system works, says Crocker, is because it balances the interests of both the creditors and debtors. With the Bankruptcy Reform Act of 1999, the law would shift the balance toward creditors. And it would make it more difficult to re-organize.
“When you go into bankruptcy, it’s usually because your company has a problem,” Crocker says. ” A turnaround means that you’re going to try to generate more revenue and less cost. If you’re limited in the amount of time you have to propose and confirm your plan, you’re limited in the amount of time that you can have your turnaround and, therefore, your likelihood of success goes down.”
The irony is that the bankruptcy reform acts fly in the face of the National Bankruptcy Review Commission which studied bankruptcy cases throughout the country and concluded the system, in general, is working well.
“This legislation gives new weapons to the creditor or the party who doesn’t want the company to be successful in its efforts to re-organize,” Crocker says. “And failure to re-organize is a bad thing because people lose jobs, the community loses a taxpayer, suppliers lose customers. Re-organization is really in the best interest for the entire community and the whole constituency if it can be accomplished.”
With major changes being proposed for personal bankruptcy, attorney Randall Crocker of von Briesen, Purtell & Roper summarized some of the changes being proposed in both the House (H.R. 833) and Senate (S. 625) bills.
General Provisions
Successive discharge – No Chapter 13 discharge if any prior discharge in a case filed within five years. No Chapter 7 discharge if any prior discharge in Chapter 7 filed within eight years.
Debtor education – Completion of education program made a condition of discharge; pilot programs run concurrent with mandatory programs.
Credit counseling – Counseling made a requirement of eligibility.
Improvements
Exemptions – Residency requirement for state exemptions; $250,000 homestead cap, waivable by state legislation.
Reaffirmations – Reaffirmations of unsecured debts require court hearing; waivable by state legislation.
Chapter 7
Means Testing – The biggest change being proposed in the Bankruptcy Reform Act of 1999. Through formulas, the court will determine whether a person is eligible to have their assets liquidated and their “debt” slate wiped clean. If debtors fail to qualify for Chapter 7, they will be forced to pay off the debts using future earnings under Chapter 13.
There is potential for abuses under the means testing, according to Crocker and Assistant U.S. Trustee John Robert Byrnes.
Byrnes: “Do you want to encourage people to go out and spend more to become eligible for Chapter 7?”
Crocker: “One of the expenses that every debtor is allowed is private school education for their children up to $10,000 per year. There aren’t a lot of debtors (now) who are facing Chapter 7 that are doing that but I can assure you that what will happen is they will put that in their budget because they’re planning to send their child to a private school – at least they’ll state that – in order to impact their means test.”
Chapter 13
Length of plan – Five year minimum plan required for debtors with more than
median income or debtors who convert from Chapter 7 to Chapter 13.