Born Again

The American Way of Failure

The bankruptcy laws-of which Chapter 11 is but one portion-help individuals and companies that have suffered a bad turn of events resolve their debt problems.

Although the court shields both businesses and individuals from their creditors, they are treated differently under bankruptcy. Individuals can absolve themselves of their debts completely and get on with their lives-albeit with ruined credit for seven years. Businesses don't get off so easy. They must either repay their debts, whether partially or in full, after winning approval of a plan for doing so (Chapter 11), or dissolve the business by selling its assets for what they can bring immediately and divvying up the proceeds among its creditors (Chapter 7).

Bankruptcy provides business owners an essential refuge to regroup. Creditors, however, can force bankruptcy on recalcitrant entrepreneurs. If the court is persuaded by the argument of creditors, it can force the sale of a company's assets under Chapter 7 or-in rare instances-displace the entrepreneur with new management to run the organization under Chapter 11 protection. That's why it's better to act before being acted upon.

But confronting bankruptcy head-on is no panacea. Ginsburg is one of the lucky ones. According to former U.S. bankruptcy judge Michael McConnell, less than 25 percent of the nearly 10,000 companies that enter into Chapter 11 each year receive approval for their reorganization plans. Those that win approval almost always move steadily through their bankruptcy under the watchful eye of a judge and a board of creditors. They exit the system with a new lease on life-and a bill for lawyers and other professionals that can run more than $100,000.

That means, however, that about 75 percent of firms that enter Chapter 11 quickly move to the dreaded Chapter 7-and destroyed credit. With the odds weighted toward dissolution, is it any wonder that bankruptcy carries such dread? Simon Scott calls the Chapter 7 filing that closed his 8-year-old Los Angeles lighting manufacturer Simon & Co. last year his hardest decision ever: "It's the end of your business and life as you've known it for years." Scott is now running a lighting design subsidiary of Everest Lighting Inc. He hopes to run his own business again in the future, but after the tumult of the past year, it won't be for a long time to come.

More entrepreneurs may be joining him. Although total business bankruptcy filings have fallen by more than half since their 1987 peak, much of the decline happened during the prosperous 1990s. With the economic clouds darkening, many experts expect bankruptcies to skyrocket this year.

Those looking for protection had better hurry to the courthouse. Congress is negotiating the final details of bankruptcy legislation that includes a host of provisions that make it less attractive to file. As of this writing, both the House and Senate versions of the bill delay implementation of the new laws for six months after President Bush signs it, which he has indicated is certain. Entrepreneurs should use those six months to weigh the merits of bankruptcy and other options.

The bankruptcy laws are broken down into "chapters"-each of which covers a different type of protection. The most common business filings occur under the following:

Chapter 7: Businesses use Chapter 7 to dissolve their enterprises and use the assets to cover a portion of their debts. You can either enter into Chapter 7 of your own free will or be forced into it by your creditors.

Chapter 11: Gives companies breathing room to reorganize their businesses and repay their debts in an orderly manner. Although a small-business provision under Chapter 11 can speed the process, many attorneys prefer to use as much time as possible to negotiate an agreement with creditors-more time makes creditors nervous and more willing to accommodate your terms. That's helpful because, after you file, creditors must approve your reorganization plan. A judge needs to approve all your major actions from the time you file until you exit Chapter 11.

Chapter 13: Only available to sole proprietors with relatively small debts, this provision works like Chapter 11 except that a judge approves your plan; creditors have no say. You can only have $269,250 in unsecured debt and $807,750 in secured debt. Businesses use Chapter 7 to dissolve their enterprises and use the assets to cover a portion of their debts. You can either enter into Chapter 7 of your own free will or be forced into it by your creditors.


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This article was originally published in the September 2001 print edition of Entrepreneur with the headline: Born Again.

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