Bankruptcy Laws in America

Bankruptcy is the legal process by which financially distressed firms and individuals resolve their debts. The bankruptcy process plays a central role in economics, because competition tends to drive inefficient firms out of business, thereby raising the average efficiency level of those remaining. Consumers benefit because the remaining firms produce goods and services at lower costs and sell them at lower prices.

In evaluating how the new consumer bankruptcy laws will change business practices you must be able to differentiate between the types of business there are. You must see the laws impact on entrepreneurship, small business or partnerships, and corporate entities. Depending on the availability of funding, sources of funding, special provisions enact by Congress one can determine; if, when, or how a company could seek protection and a restart through

bankruptcy.

Entrepreneurship

The new laws enacted by Congress main objective was to holding Americans to be more responsible for paying off their consumer debts. However, it may have an unintended consequence: stifling the entrepreneurial spirit in the United States. It's not just debt-burdened consumers who end up in bankruptcy court, snowed under by medical bills and credit card debt, bedeviled by job loss and divorce. Entrepreneurs by the thousands file personal bankruptcy when their businesses go bad.

. Unfortunately, the new bankruptcy law, which goes into effect on Oct. 17, doesn't acknowledge that some individuals rack up debt not because they're irresponsible, profligate spenders, but because they're entrepreneurs, says Westbrook. In fact, business failures are a factor in as many as 17 percent of the 1.6-million consumer bankruptcies filed each year, according to a provocative new study

The changes, which took effect in October, could end up discouraging business formation, since it will be more difficult for the self-employed to wipe out their debts and make a fresh start. Many entrepreneurs finance their startups by maxing out their personal credit cards as well as taking out mortgages or equity lines of credit on their homes. Not an insignificant number of people who have excess debt also happen to be entrepreneurs.

Even if the credit card is in the name of the business, the fine print in the application is likely to say that the person opening the account is responsible for the debt. Many entrepreneurs never incorporate; often they're simply selling themselves, providing a service as an independent contractor. Others incorporate but remain on the hook for business debts.

"The corporate form gives some benefit in the way you can manage ownership of the business," said U.S. Bankruptcy Judge Michael Williamson in Tampa. "There's also a benefit for some types of liability: If a company truck driver has a major accident, tort liability stays with the corporation. But most small-business people have to guarantee bank debt or equipment financing debt personally because their corporations are only worth what they individually have."

By the time the case gets to court, often there's nothing to distinguish it from thousands of other bankruptcies. Although bankruptcy forms have a box for individuals to check that their debts are business debts, relatively few do. The current form forces a choice between consumer debts and business debts.

"All laws have unintended consequences," Litan says, referring to the new bankruptcy law that President Bush signed last month. "That's the rule in Washington. The only question is how significant they are. In the case of the (new) bankruptcy law, all I can say is that it may turn out that one of the unintended consequences of the law will be to erect roadblocks for new business formation."

SMALL BUSINESSES

President Bush in April signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The act, which applies (with some exceptions) to all bankruptcy cases filed on or after Oct. 17, 2005, represents the first major congressional overhaul of bankruptcy law in more than 25 years.

The act incorporates changes affecting small businesses, both as debtors and creditors. The most significant outcome from these changes is the amount of time companies have within the bankruptcy process. The bill aims to accelerate the process so companies don't have to languish there. Here are a few of the most significant changes.

1. The act streamlines the procedure for a small-business debtor seeking to confirm a plan of reorganization.

2. The new law will help assure small-business representation on creditors' committees in larger cases.

3. Revised section 546 of the Bankruptcy Code permits vendors to "reclaim" goods provided to a debtor during the 45 days preceding the start of the debtor's case (up from the current 10-day look-back period) as well as during the 20 days following the bankruptcy filing.

4. Commercial real estate lessors will benefit from an amendment shortening the period during which a debtor may assume or reject a commercial lease that the parties entered into before the bankruptcy filing.

5. The act includes several amendments to the preference provisions. Revised section 547(c)(2) eases the creditor's burden by permitting the creditor to prove either that the transfer was made in the ordinary course of business between the debtor and the creditor, or that it was made according to industry standards.

If a business decides to declare bankruptcy it can do so in three ways:

Voluntary Bankruptcy

This is the most common because it involves a thought through decision by a responsible business owner who has probably seen it coming for some time.

Creditor Bankruptcy

This often occurs when an insolvent business makes an offer to its creditors that they do not accept. After this, the business really has little choice but to go ahead and file bankruptcy.

Forced Bankruptcy

This is not a pretty thing. It occurs when the creditors begin to fear that they will never get their money back so they file a petition with the court to force the company into bankruptcy.

The proposed bankruptcy reform would have a chilling effect on incentives to start or own small businesses. Owners of failed businesses who have filed bankruptcy under Chapter 13 would not find it attractive to start new businesses because any future income would be heavily taxed to repay debts of the old businesses. Owners