Printer Friendly

Bankruptcy and Entrepreneurs: In Search of an Optimal Failure Resolution System.


Who can forget the childhood thrill of going to the circus and watching the daring flying trapeze artists, as they soared through the air and made seemingly impossible flips, turns, and catches? But even the greatest trapeze acrobats sometimes miss, and when they do, they are saved by the net below--if they use one. When, in their Icarus-like hubris they have eschewed using the safety net, horrific accidents have resulted; recall the tragic deaths and paralyses suffered by the famed Flying Wallendas in 1962. (1) And they were perhaps the most talented trapeze artists in the world. One can only imagine the carnage if novice trapeze artists attempted to fly without a net.

Metaphorically, that is essentially what would happen if entrepreneurs embarked on business ventures without an efficient, fair, and economical system in place for the resolution of prospective failure. I call such a system a "failure resolution system" ("FRS"), a term I have coined. This paper proceeds on the premise that a legal regime best promotes entrepreneurial activity if it offers a viable FRS. I have identified what I believe are the core features of an optimal FRS. I then apply my general conclusions specifically to the United States context and propose concrete reforms. Note that I have not yet used the term "bankruptcy" to describe the failure resolution mechanism. A federal bankruptcy system, enacted pursuant to the authority of the Bankruptcy Clause in Article I, [section] 8 of the Constitution, might be the optimal means to resolve entrepreneurial failures in the United States and indeed, for reasons explained below, will in many cases be preferred. However, I want to consider first principles, unburdened by preconceived notions or by an assumption that a FRS needs to mirror anything we currently offer in the United States Bankruptcy Code. My inquiry is: what are the core aspects of an optimal failure resolution system for entrepreneurs?

For creditors and debtors alike, financial carnage, paralysis, and death often would ensue in the absence of a FRS. Inefficient legal rules in this context negatively affect ex ante bargaining between the entrepreneurial debtor and her creditors and also undermine ex post incentives. (2) In almost any endeavor, and certainly in entrepreneurial activity, some degree of failure is inevitable. Even the "unsinkable" Titanic hit an iceberg and sank. False assumptions that it was unsinkable led to the fatal decision not to carry enough lifeboats. When you roll the dice, you might roll a seven or an eleven and win, but you also might roll "snake eyes" or "box cars" and "crap out." Unfortunately, entrepreneurs hit icebergs and "crap out" at a relatively high rate. (3) Studies have shown that as many as half of all startups fail within four years. (4) And the reality is that it is very hard to predict in advance which entrepreneurs will fail and which will succeed. (5) Who will hit an iceberg and who will enjoy clear sailing is very uncertain; the crystal ball is cloudy indeed.

Given the inevitability of a significant percentage of failures, coupled with the inability to identify probable failures up front, the lack of a workable FRS would impose significant dead-weight losses and create potential distributional injustices among stakeholders. The failing entrepreneur, as well as many of the creditors and investors who backed her, might sink beneath the waves of business failure. Not only would the entrepreneurial debtor and her creditors and investors suffer losses ex post (often shared unequally), but the ex ante recognition that such losses are both (1) inevitable in a large number of cases, and yet (2) unpredictable as to which ones will fail, would chill entrepreneurial activity from the viewpoint of the prospective entrepreneur and her investor-creditors. Conversely, the perception that an effective FRS is in place would largely eliminate that chilling effect and encourage entrepreneurial activity and investment. (6)

While we use the more positive phrase "nothing ventured, nothing gained" to capture the intuitive premise underlying the value of entrepreneurism, we should not forget the darker side of that phrase. Perhaps "everything ventured, everything lost" would capture the depressing reality. A full and fair measure of the societal impact of entrepreneurism (7) must count the failures as well as the losses. We cannot have one without the other. An optimal legal system should account ex ante for those inevitable failures, provide satisfactory mechanisms to resolve them, and do so in a way that both minimizes inefficiencies and maximizes appropriate incentives, from both ex ante and ex post perspectives.

Before examining the necessary components of an optimal FRS, it is worth considering why we care. Obviously, for any particular entrepreneur and her creditors, having a workable FRS is better than not. But as a society, why do we or should we care? The reason is this: the harm from inevitable and unpredictable entrepreneurial failure is not purely private, affecting only those with "skin in the game." (8) Encouraging entrepreneurism, promoting investment, maximizing value, and preserving valuable human capital, by offering debtors a soft landing with an equitable distribution among creditors in the event of failure, directly impacts the economic well-being of the entire country. (9) Entrepreneurship is a driver of economic growth, (10) and an entrepreneur-friendly FRS encourages entrepreneurial ventures. (11) In short, the strictness of a FRS in a country correlates closely with the levels of entrepreneurship in that country. In countries with stricter regimes, (12) failed entrepreneurs are more likely to exit entrepreneurship entirely, and not return. (13) This has a concomitant negative effect on the country's economy. If, however, the consequences of failure are less severe, and new credit is accessible even for failed entrepreneurs, more entrepreneurs will be willing "to experiment with novel (and more risky) business ideas," (14) which could lead to greater economic growth.

I saw this phenomenon in action while consulting with the government of the People's Republic of China in 2002 in regard to modernizing their bankruptcy laws (which went into effect in 2007 (15). As China moved away from a purely socialist economy to a more market-based economy, (16) its leaders understood that China could not be a viable world economic power without a fair and efficient failure resolution system. They recognized that having such a system in place was necessary both to encourage entrepreneurs to pursue new ventures and to encourage investment in those enterprises.

It was precisely this same recognition--that bankruptcy laws serve the public good by encouraging entrepreneurial risk-taking--that led the evolving nation-states in the Renaissance period to enact the first modern bankruptcy laws. Sir William Blackstone (1765), writing about the then-extant English bankruptcy law (the Statute of George, 1732), observed that "the laws of bankruptcy are considered as laws calculated for the benefit of trade...." (17) National power depended upon economic strength; a strong economy required vibrant trade and commerce; trade and commerce necessitated the use of credit; once credit was used, failure and the inability to repay debts became possible; and when business failures occurred, the consequences of those failures had to be apportioned fairly. As Bruce Mann has observed: "Crops fail, prices fall, ships sink, warehouses burn, owners die, partners steal, pirates pillage, wars ravage, and people simply make mistakes." (18) The essential function of bankruptcy law as a necessary mechanism to account equitably for credit risk, and accordingly to encourage both entrepreneurial risk-taking and the extension of credit to such entrepreneurs, was brought into stark relief by the fact that the early English laws limited bankruptcy relief to "traders," for whom resort to credit was unavoidable. (19) Blackstone again captured the idea: "Trade cannot be carried on without mutual credit on both sides: the contracting of debts is therefore here not only justifiable but necessary. And if by accidental calamities ... a merchant or trader becomes incapable of discharging his own debts, it is his misfortune and not his fault." (20)

The United States finally recognized this public interest in a workable bankruptcy system when it adopted a permanent regime of federal bankruptcy legislation over a century ago, in 1898. (21) A House Report in 1897 answered the rhetorical question, "is a bankruptcy law needed?," by first noting the large number of business failures from 1879 to 1895. (22) It then observed that:
   This vast number constitutes an army of men crippled
   financially--most of them active, aggressive, honest men who have
   met with misfortune in the struggle of life, and who, if relieved
   from the burden of debt, would reenter the struggle with fresh hope
   and vigor and become active and useful members of society....

   [T]he passage of a bankrupt law ... will lift these terrible and
   hopeless burdens, and restore to the business and commercial
   circles of the country the active and aggressive elements that have
   met with misfortune and are now practically disabled for the battle
   of life....

   [W]hen an honest man is hopelessly down financially, nothing is
   gained for the public by keeping him down, but, on the contrary,
   the public good will be promoted by having his assets distributed
   ratably as far as they will go among his creditors and letting him
   start anew. (23)

In 1934, the United States Supreme Court confirmed that a bankruptcy system was "of public as well as private interest" (24) in freeing a hopelessly impoverished individual debtor from his debt burden so that he could have "a new opportunity in life and a clear field for future effort." (25) Today, even though the commercial world in many respects is quite different from the world of 1732, 1897, or 1934, that same truth holds--an effective FRS is needed to promote entrepreneurial activity, which will in turn benefit the nation as a whole.

Thus, from both an ex ante and an ex post perspective, any commercial society will benefit from a FRS that is responsive to the needs of entrepreneurs as well as their creditor-investors. So, what would an optimal FRS look like? It is to that central theme I now turn. As I elucidate the critical building blocks of an optimal FRS, I will examine how well the currently extant options in the United States measure up, and how they might be changed or modified to enhance optimality. For several reasons, I conclude that in many (but perhaps not all) cases, a federal law enacted under the authority of the Bankruptcy Clause (26) offers the best chance for efficacious relief. Given that, I focus in particular on how the current bankruptcy system, which offers different forms of relief (viz., chapters 7, 11, and 13) might be amended to provide entrepreneurs and their creditors with a FRS that would best encourage and promote ambitious, vibrant entrepreneurial activity. I suggest the possibility of creating a new bankruptcy chapter specifically designed for entrepreneurs.


The special nature of entrepreneurial activity must be taken into account in designing any FRS. Two aspects are critical: first, much of the value inheres in the entrepreneurs human capital; (27) and second, the entrepreneur often has difficulty diversifying risk. (28) Taken together, these factors leave entrepreneurs in an exposed, vulnerable position.

An optimal failure resolution system for entrepreneurs should be: (1) forgiving; (2) human-capital-preserving; (3) not morally hazardous; (4) value-maximizing; (5) equitable; (6) accessible; (7) controllable; (8) participatory; (9) binding; (10) inexpensive; (11) non-gluttonous (no incentive for bankruptcy administrators to extract excessive fees); (12) simple; (13) clear; and (14) speedy. The first three of these are especially critical. Therefore, I will focus my analysis on those three interrelated aspects.

A. Forgiving

The putative entrepreneur must not suffer so much from failure that she would be unwilling, or even less willing, to accept appropriate levels of risk ex ante and attempt another entrepreneurial venture. And yet debtors do suffer. As an extreme illustration, consider the puzzling historical practice of imprisonment for debt. (29) The prospect of being imprisoned if one's entrepreneurial venture fails--even if you act honestly--certainly would have a chilling effect on one's willingness to take an entrepreneurial risk. While we no longer imprison debtors, they still suffer more than financial hardship. Their distress includes discrimination, psychological trauma, stigma, a lack of credit standing, and other disabilities.

I have noted that "[a] debtor who will be fired from his job if he discharges his debts in bankruptcy, or who will lose his driver's license if he does not pay a discharged debt, may be hesitant to avail himself of the discharge privilege, and even if he does go through bankruptcy will not exit the bankruptcy process with a full financial fresh start." (30) Armour and Cumming observe: "a 'forgiving' personal bankruptcy law ... will increase the supply of would-be entrepreneurs." (31) This higher supply promotes economic growth. (32) In sum, it is essential for the promotion of optimal levels of entrepreneurship that the FRS be forgiving. Here I focus on two aspects of forgiveness: anti discrimination rules and exemption laws. Debt forgiveness (i.e., the bankruptcy discharge) is a core part of forgiveness, but it is sufficiently important in its own right that I discuss it under the second principle of preservation of human capital.

1. Anti-discriminatory

Under current United States law, [section] 525 of the Bankruptcy Code codifies a prohibition against certain types of discrimination against a debtor because she filed bankruptcy. (33) The genesis of [section] 525 (34) is the United States Supreme Court's 1971 decision in Perez v. Campbell, (35) striking down under the Supremacy Clause (36) an Arizona statute that required a driver to pay a tort judgment--even one that had been discharged in bankruptcy--as a condition of keeping his driver's license. (37) The Court concluded that this statute, which indisputably put pressure on a bankrupt to pay a discharged debt, undermined the federal bankruptcy "fresh start" policy. (38) In 1978, Congress added [section] 525 to codify the principle of Perez. (39) In its legislative history, Congress also made clear that the section was "not exhaustive" and that "[t]he enumeration of various forms of discrimination against former bankrupts is not intended to permit other forms of discrimination." (40) In short, Congress invited courts to extend the scope of prohibited forms of discrimination beyond the statutory listing. But unfortunately, the courts have not taken up this mantle and this is one of the major reforms necessary to optimize the United States' FRS for entrepreneurs.

Aside from state exemption laws discussed below, there is little outside of the bankruptcy system to protect a failed entrepreneur from either aggressive creditor collection efforts or blatant discrimination. Under the Fair Credit Reporting Act, most negative information stays on a person's credit report for seven years. (41) A bankruptcy filing remains on the report for ten years. (42) A defaulting debtor could be fired from her job, (43) denied admission as an attorney to the state bar, (44) lose her driver's license, (45) have credit denied, (46) and the list goes on and on. It is only through a bankruptcy filing that debtors are able to enjoy the protective harbor of [section] 525. I propose, however, that the anti-discrimination rule be moved out of the Bankruptcy Code, so that a debtor would not have to file bankruptcy just to take advantage of its protection.

Moreover, the protections of [section] 525 currently enumerated in the statute are too narrow in scope. (47) Specifically prohibited is discrimination: (1) by a governmental unit in licensing and related matters, and in hiring, firing, and other terms of employment; (2) by a private employer in firing or in the terms of employment; and (3) by a lender who makes student loans. (48) As previously mentioned, courts have ignored Congress's express invitation to expand the list of discriminatory practices as necessary. Instead they have narrowly construed it. (49) They have curiously and erroneously invoked the statutory interpretation maxim expressio unius est exclusio alterius (roughly, the expression of one thing is the exclusion of another). So, for example, courts have held that private employers are free to discriminate in hiring based on a bankruptcy filing, since only firing is specifically proscribed. (50) The Ninth Circuit even held that an employer could fire an employee who told them he was about to file bankruptcy, because he had not yet filed. (51) Courts have held that it is only illegal to discriminate with respect to student loans (52) because that is the only type of loan mentioned in the statute. Many more examples of this interpretive stinginess exist. (53)

Another way in which the courts have construed [section] 525 too narrowly is to impose a heightened standard of proof of causation. For discrimination by the government or private employers to be covered by the statute, courts have held that a violation only occurs if the debtor's bankruptcy was the sole basis for the discriminatory act. (54) Even if the debtor's bankruptcy filing was the primary factor and other factors had only a minimal impact on the decision, the discrimination is not illegal. (55)

Closely related is the willingness of courts to find justification for the discriminatory act. The non-debtor entity may be allowed to consider other factors, such as future financial responsibility, as a basis for discriminating against a debtor. (56) For example, debtors who have filed bankruptcy have been denied admission to the bar based solely on their prior bankruptcy filing. (57) The justification for this decision is that the erstwhile bankrupt might manage clients' money badly. But no proof beyond the mere fact of the bankruptcy filing is required. Similarly, other than with student loans, lenders are able to discriminate against former bankrupts based on a prior bankruptcy filing. Obviously, the inability to obtain credit, except under the most onerous of terms, will dramatically undercut a previously failed entrepreneur's efforts to try a new venture.

What, if anything, can be done? First, as noted above, I recommend that the anti-discrimination rule be enacted as federal law pursuant to the Commerce Clause, (58) not solely as part of the Bankruptcy Code. If that were done, then a failed entrepreneur would not have to file bankruptcy to obtain the benefit of its protection. If the failed entrepreneur were able to enter into a work-out arrangement with her creditors and had no other reason to file for bankruptcy relief, then she could start afresh without a bankruptcy filing and without fear of harmful discrimination.

Second, the anti-discrimination rule itself should be changed with respect to its scope and the requirements for causation and justification. Obviously, if my first suggestion is adopted to move the anti-discrimination rule from its current home in the Bankruptcy Code to federal law generally, then further modification would be necessary. Section 525 focuses on a bankruptcy filing or a bankruptcy debt discharge as the trigger for the anti-discrimination rule. (59) Moving the anti-discrimination rule out of the Bankruptcy Code would render the bankruptcy and discharge triggers nonsensical. In its place, I recommend a statutory provision that prohibits:

(1) any discrimination,

(2) by any entity,

(3) against an individual debtor,

(4) based materially on the failure to pay a debt when due, unless

(5) the non-debtor party proves that the discrimination was substantially justified.

This provision is narrower than current law in that it limits the universe of protected debtors to individuals. This change should be unobjectionable because if a business entity fails, its owner can simply liquidate it and then incorporate a new business unburdened by the prior company's debts. It is only individuals that cannot shed the stigma of insolvency. Individuals need to be able to reenter the marketplace with a new entrepreneurial venture unhampered by discrimination over past debts.

In all other respects, the proposed anti-discrimination rule is broader than [section] 525. First, any form of discrimination would be prohibited, unless substantially justified. Second, the prohibited basis or trigger for the discrimination would be expanded to include any non-payment of a debt. Expanding the scope in these two ways would eliminate the nit-picking, narrow interpretative approach currently employed by courts and would shift the burden to the discriminating entity to justify the discrimination. In cases involving the extension of credit, the discriminating party's burden likely would be quite modest because past financial default bears on the risk to the lender with new financing, unless the debtor can prove changed circumstances. But in almost all other situations, what legitimate interest does the non-debtor party have for discriminating against a failed debtor? Why should an employer be allowed to fire an employee or refuse to hire someone simply because that person did not pay a debt? Why should anyone be deprived of a driver's license based on non-payment of debt? How does non-payment of debt bear on a person's fitness to practice law? In none of these cases is there any defensible reason to permit the discrimination, especially when we remember that a non-forgiving FRS is antithetical to the public interest, which benefits from increased entrepreneurial activity.

Another significant expansion would be to prohibit discrimination by any non-debtor entity, not only a governmental unit, private employer, or student loan lender. This is consistent with the expansion to cover any type of discrimination. Again, there is no evident reason why any entity should be permitted to discriminate without justification against an individual simply because that individual had not repaid her debts.

Finally, my proposal contemplates lessening the debtor's burden of proof in establishing causation. Under current law, the discrimination must be based solely on the debtor's bankruptcy. (60) This heightened standard is both illogical and damning for debtors. Instead the discriminatory act should be prohibited if it is materially based on the non-payment of debt. By changing the standard, the analysis would be: first, was there discrimination?; second, if so, was it based materially on the debtor's non-payment of a debt?; and third, if so, was there a sufficient justification for the discrimination?

2. Maximizing Exemptions

Exemption laws play an essential role in providing individual entrepreneurs with a fresh start. They allow an individual debtor to keep some of her current property even if she does not fully repay her creditors. (61) Every state has its own set of exemption laws. Most are available to debtors both inside and outside of bankruptcy, although they vary from state to state enormously in terms of their generosity, or lack thereof. In [section] 522(d), the Bankruptcy Code also offers a federal law source of exemptions. (62)

Exemptions serve both the private interests of a debtor and the debtor's family and the public interest of society (63) Without exemptions, creditors could reduce the debtor's family to becoming wards of the state or the objects of private charity. Only a pre-conversion Ebenezer Scrooge (64) could think that would be a good idea. Nor should creditors be able to strip a debtor of her means of earning a living in the future, taking away the proverbial "tools of the trade." If they could, it would reduce the debtor's future productive capacity, harming not only the debtor and her family, but also public interests. Furthermore, allowing creditors to take everything from a defaulting debtor would be inhumane and undermine the debtor's personal dignity. Imagine living in a world in which creditors could seize a debtor's Bible (65) her wedding ring, her bed, and the very clothes off her back. In such a harsh and unforgiving world, only the most intrepid (or foolish?) would be willing to risk an uncertain entrepreneurial venture. In short, promoting entrepreneurism demands that a country have adequate exemption laws.

But what constitutes "adequate" exemption laws? To avoid Goldilocks' dilemma, the property reserved as exempt should be neither too little nor too much. If a debtor is allowed to keep too little of her property, the negative consequences noted above would likely arise. Conversely, if a debtor could protect virtually all her existing property, creditors would likely be more reluctant to extend credit at all, or might increase the price of credit, either way hampering robust entrepreneurism.

Existing state exemption laws in the United States are notable for their extreme range, from wildly over-generous states like Texas and Florida, where a debtor can entirely exempt a homestead no matter how great its value (66) to stunningly stingy states, like Pennsylvania that offers no home stead exemption at all. (67) Neither extreme is optimal for a robust entrepreneurism (68) This dramatic state-by-state variation inspired the Uniform Law Commissioners to propose a Uniform Exemptions Act ("UEA") in 1976 (amended in 1979), with the hope that states would adopt it (69) The UEA sought to strike an appropriate balance in the exemptions allowed to debtors, neither too little nor too much, but "just right. " (70) However, states have largely ignored the UEA and instead stubbornly cling to their own views of what level of exemptions are "adequate." (71)

In 1978, the Bankruptcy Reform Act (72) modernized federal bankruptcy law. Under [section] 522(d), Congress offered bankruptcy debtors a well-balanced menu of exemptions, drawing heavily on the 1976 UEA, as an alternative to electing state exemptions. The idea was that a debtor could elect the more beneficial set of exemptions applicable to her own particular circumstances and, in stingy-exemption states, a debtor would have available a more acceptable floor of exemptions. However, Congress severely curtailed the usefulness of this federal option when it also allowed states to "opt out" of the federal exemptions. (73) "Opting out" means that a state may provide that bankruptcy debtors residing in the state may not elect the federal bankruptcy exemptions of [section] 522(d), and thirty-five states have done just that. (74) Therefore, since Illinois is an "opt-out" state, an Illinois debtor may only exempt $15,000 of equity under Illinois' homestead exemption and cannot take advantage of the more generous homestead exemption of $25,150 in [section] 522(d)(1)." (75)

The first change that needs to be made is to repeal the "opt out" provision in [section] 522. Other than political considerations, there is no justification for allowing a state to deprive its bankrupt residents of the option of electing the fairly balanced exemption laws set out in [section] 522(d). Indeed, I would recommend that the uniform exemption option be taken one step further. The same set of federal exemption laws should be offered to debtors both inside and outside of bankruptcy.

Under current law, the only way that a failed entrepreneur in an exemption-poor state can even possibly obtain sufficient exemptions is to file bankruptcy and even then she would be certain to have sufficient exemptions only if she lived in one of the fifteen states that has not opted out of the federal exemptions. What sense is there in forcing a debtor to file bankruptcy solely so she can have access to adequate exemptions? Assume that an entrepreneur owns a home with equity of $30,000 in Pennsylvania, which has no state homestead exemption law. Her entrepreneurial venture fails and she defaults on her debts. Unless she files bankruptcy and elects the federal homestead exemptions under [section] 522(d)(1), which she could do since Pennsylvania has not opted out, her creditors could get a judgment against her and seize her home. If something like [section] 522(d) were a federal law of general applicability, she could save most of the equity in her home. This would not be unfair to creditors, since they could price their credit with full cognizance of the federal exemption possibility. Or the putative creditor could demand a home mortgage as security for its extension of credit, including a typical waiver of the exemption, which would be enforceable against exempt property as a consensual lien. (76) In today's interconnected economic world, it is contrary to the public interest for debtors anywhere in the country to have inadequate exemptions.

On the flip side, preventing excessively generous exemptions by imposing a national cap is perhaps unnecessary. Knowing that the state has overly generous exemptions, most creditors can decide ex ante whether to extend credit in the first place and, if so, on what terms. (77) If the state of the debtors residence allows excessive exemptions, credit may be less readily available there, but at least the creditor can make an informed choice. The case is not beyond cavil, however; the argument can be made that chilling credit extensions to prospective entrepreneurs restricts the volume of entrepreneurial undertakings to a suboptimal level for society.

There is one remaining exemption-related issue to address to optimize the FRS. It involves the legality of conversions of nonexempt property to exempt property, which often occurs shortly before a debtor files bankruptcy. (78) For example, assume that exemption law allows a debtor to claim a $30,000 homestead exemption. The day before filing bankruptcy, the debtor takes $30,000 from her nonexempt bank account and uses it to pay down her home mortgage, creating $30,000 of equity in her home. Before that transaction, the debtors $30,000 in her bank account was subject to seizure by her general creditors. Now it is not. "Foul!" cry her creditors. What result?

The answer is, it depends. It depends on whether the court thinks the debtor was trying to defraud her creditors. Of course, fraud sounds bad; no one is in favor of fraud. But is it fraud for the debtor to claim the benefit of what the law allows? In practice, courts tend to disallow the exemption, or find fraud sufficient to defeat a bankruptcy discharge, if the debtor converts a lot of property to exempt status just before filing bankruptcy. (79) Courts are fond of repeating the folksy saying, "[W]hen a pig becomes a hog it gets slaughtered." (80) However, the problem lies less with the debtor's conversion of non-exempt property, and more with the legislature's decision to allow excessively generous exemptions. But courts should not second guess the legislature's setting of the proper exemption amount. And yet, it is human nature to do so when the amount seems overly generous. If, however, the exemption amount represents a more modest amount, then we as a society should want failed debtors to be able to claim that amount, even if the debtor obtains the exemption of the eve of filing bankruptcy. Thus, not only should Congress remove the "opt out" provision and offer exemptions to both bankrupts and non-bankrupts alike, but it should also expressly prohibit courts from disallowing exemptions based on supposedly "fraudulent" conversions.

B. Preserving Human Capital

To promote entrepreneurism, the single most important aspect of an optimal FRS is to establish conditions that will enable the entrepreneur to retain, tap into, and maximize her human capital again and again, without limit. Thus, any FRS proceeding should conclude with the entrepreneur able to reaccess her human capital without suffering unduly harsh consequences. After all, the value of an entrepreneur's "business" is typically not in the business itself, but the owner and operator herself, i.e., her human capital. Human capital is the central asset of an entrepreneur. (81) The FRS should help pre serve and promote the maximization of that asset. (82)

Consider the impact of a contrary system. In Canada, when there was no federal bankruptcy system, failed entrepreneurs fled in droves across the border to the United States. This mass exodus deprived Canada of much of its valuable human capital. (83)

Discharging past debts is the essence of human capital preservation. If the fruits of an entrepreneur's human capital must be devoted to paying old debts, the entrepreneur will have little incentive to produce those fruits. In the United States, due to the constitutional ban against states impairing the obligation of contracts, (84) debt discharge will likely always require a federal solution, like our current bankruptcy system. While the debts of the failed business may be the debts of a corporation or other entity, the present norm requires the entrepreneur to guarantee the business' debts. Thus, she will likely have to undergo bankruptcy or some other FRS solution to free herself of the business' debts. If for some reason, however, she were not personally liable, then access to debt discharge in bankruptcy would not be necessary; the debtor herself could simply walk away from the failed business and start anew, leaving her creditors to pick over the carcass of the dead enterprise. In that circumstance, a FRS under state law or even by private contract would be feasible.

Perhaps the most famous expression of the public interest in a bankruptcy system came in the iconic United States Supreme Court case of Local Loan Co. v. Hunt, (85) in which Justice Sutherland, writing in 1934 during the depths of the Great Depression, justified the discharge of debts for individuals in bankruptcy as follows:
   The power of the individual to earn a living for himself and those
   dependent upon him is in the nature of a personal liberty quite as
   much if not more than it is a property right. To preserve its free
   exercise is of the utmost importance, not only because it is a
   fundamental private necessity, but because it is a matter of great
   public concern. From the viewpoint of the wage-earner there is
   little difference between not earning at all and earning wholly for
   a creditor. Pauperism may be the necessary result of either.... The
   new opportunity in life and the clear field for future effort,
   which it is the purpose of the Bankruptcy Act to afford the
   emancipated debtor, would be of little value to the wage-earner if
   he were obliged to face the necessity of devoting the whole or a
   considerable portion of his earnings for an indefinite time in the
   future to the payment of indebtedness incurred prior to his
   bankruptcy. (86)

Unfortunately, in the United States today, the preservation of an entrepreneur's human capital through a bankruptcy debt discharge is suboptimal. An individual has two basic choices: proceed via an immediate liquidation and discharge under chapter 7 or enter into a multi-year repayment plan in either chapter 13 or chapter 11, which after the 2005 bankruptcy amendments are now so similar for individuals that I consider them to be essentially the same option. But both the liquidation and reorganization options have significant disadvantages when it comes to protecting the entrepreneur's human capital.

From 1898 until 1984, an entrepreneur could readily, easily, and often with little sacrifice obtain an immediate debt discharge under chapter 7, thereby preserving her human capital. (87) There were virtually no barriers to access chapter 7, other than payment of a modest filing fee. Entry of the discharge was almost immediate, and the debtor had no obligation to pay discharged debts out of future earnings post-bankruptcy. Some debts were excluded from discharge (88) and an uncooperative debtor could lose her discharge. (89) Debtors could not readily disadvantage secured creditors, who retained the right to realize the value of their collateral, but nothing more. Otherwise, the only meaningful quid pro quo for the immediate debt discharge was that the debtor had to relinquish to the trustee, for sale and distribution to her creditors, any of her nonexempt assets. Since few debtors had any nonexempt assets that were not fully collateralized, this did not pose a significant hurdle. In most cases, the opportunity to obtain a prompt discharge of debts entailed very little real sacrifice by the debtor. This made bankruptcy an appealing option.

Too appealing, argued the consumer credit industry. After several decades of intense lobbying, it succeeded in securing new legislation to dramatically limit the availability of the immediate debt discharge in chapter 7. (90) In 1984, the "substantial abuse" test was added to chapter 7, authorizing a bankruptcy judge to dismiss a chapter 7 case by an individual with primarily consumer debts if the filing constituted a "substantial abuse." (91) Courts looked at the "totality of the circumstances," including the debtor's ability to pay her debts out of future earnings (92) For the first time, an entrepreneur's ability to retain her human capital became compromised, but only if her debts were primarily consumer debts. The substantial abuse test did not screen out the chapter (7) filings of individuals with primarily business debts. (93)

However, the 1984 amendment was just the camel's nose under the tent. In 2005, an extremely harsh and draconian "abuse" test replaced the substantial abuse test (94) The heart of the new abuse test is a largely mechanical "means test." (95) Depending on the amount of debt a debtor has, if she can repay somewhere between approximately $135-$225 per month, she is kicked out of chapter 7; the case must either be dismissed or, with the debtor's consent, it must be converted to a chapter 13 payment plan. (96) Once in chapter (13), she must devote all her projected disposable income for three to five years to repay her past debts, (97) which obviously dramatically undermines her entitlement to the fruits of her human capital.

Admittedly, an entrepreneur might escape means test scrutiny if she has primarily business debts, given that the abuse test only applies to debtors with primarily consumer debts (98) But this insulation may be less secure than it would seem. For example, a debtor's home mortgage would likely count as consumer debt and, given its size, it might tip the scales to consider her filing a primarily consumer debt case. In addition, an entrepreneur might put a lot of her business debts on credit cards and those debts could potentially be classified as consumer debts. In short, a failed entrepreneur might still face scrutiny under the abuse test of [section] 707(b).

The risk that a failed entrepreneur could be subjected to the abuse test is unacceptable. The Hobson's choice of having her bankruptcy case dismissed, so she would not be able to discharge any of her debts, or of being coerced to convert to chapter 13, where she must pay her disposable income for three to five years, is anathema to the ideal norm of human capital preservation. My recommended solution, which is responsive also to the need to reduce moral hazard, is to provide a distinct and single bankruptcy option for individual entrepreneurs, which blends aspects of chapter 7 and 13. I will provide more details shortly, after explaining the shortfalls of the existing chapter 13 system and its now clone-like counterpart for individuals in chapter 11.

Explaining the shortfalls of chapter 13 does not take long. It outrageously confiscates and completely eviscerates a debtor's entitlement to her human capital for an unacceptably long period of time." Whether the default plan period is three years or five years depends on whether the debtor's family income is above or below the state median income based on the size of the family. (100) Unlike chapter 7, where at least the abuse test is limited to debtors with primarily consumer debts, the chapter 13 rules apply to all debtors; whether the debtor has primarily consumer or business debts does not matter. (101) Nor is there any respite to be found in chapter 11. With the 2005 amendments, chapter 11 now requires a five-year repayment plan for individual debtors. (102) Thus, there is no possible escape for an entrepreneur.

In short, chapter 13 only allows a failed entrepreneur her minimally necessary living expenses and then she must pay all her extra income to her creditors. To rub salt in her financial wounds, if she embarks on a new venture that proves unexpectedly successful, her unsecured creditors or the chapter 13 trustee may ask the court to modify the plan and force the debtor to hand over all of that additional income as well. (103) Thus, under the current chapter 13 and chapter 11 schemes, an entrepreneur is disincentivized to attempt a new business, as anything she earns will likely have to be turned over to her creditors. This is the equivalent of a 100% marginal tax rate on income above necessary expenses for the entire life of her reorganization plan.

The solution lies in designing a system under which the entrepreneur and her creditors share in her future earnings. This approach would both incentivize the debtor to start anew and guard against moral hazard, discussed in the next part. Thus, I propose adopting a bankruptcy proceeding for individual entrepreneurs that would essentially combine chapters 7 and chapter 13. Moral hazard would be averted in part by not allowing the entrepreneur who elects the new proceeding an immediate discharge. Incentives for maximizing human capital could be retained in two ways. First, it could be accomplished by allowing the entrepreneur to keep a significant percentage of her future earnings. The second way would be achieved by shortening the required repayment period. Specifically, I propose that the entrepreneur be given a choice between paying fifty percent of her projected disposable income for one year or twenty-five percent over two years. Discharge would be granted only upon completion of the required payments. While these specific percentages and the associated commitment periods might be adjusted, a new bankruptcy chapter for the entrepreneur should focus on the underlying goals of incentivizing the entrepreneur through greater profit retention and a shorter repayment period.

Who would be eligible to file under this new bankruptcy option? While I would be content to allow anyone to use this option, consumer or business debtor alike, I doubt that Congress would be similarly inclined. I suspect that Congress would want to limit its use to "business" debtors of some sort. The definition of a "business" debtor for this purpose might be two-pronged. First, it could include any individual debtor with primarily business debts. Second, even if the debtor did not have primarily business debts, it still could proceed under this chapter if it had a minimum floor amount of business debt. How much? I would propose perhaps a $50,000 floor, possibly a little higher. Thus, a debtor who did not have primarily business debts, but who had $50,000 in business debts, could file under the new chapter. A debtor with less than $50,000 in business debts, but whose debts were primarily business debts, would also be able to file under the new "entrepreneurs chapter."

A final thought on the need to preserve a debtors human capital: the student loan exception to discharge (104) should be repealed. In its current incarnation, a debtor is burdened by her student loans forever unless she can prove an undue hardship, (105) which is a very difficult standard to satisfy under current interpretations. As a result, the student loan exception is an unshakeable debt albatross burdening a putative entrepreneur for decades. Effectively, it serves as an ineradicable lien on a debtors human capital. The burden is all the more weighty given the extraordinarily high costs of higher education today. And barring discharge of student loans directly undermines a debtor's human capital, because the whole point of getting an education in the first place is to enhance one's human capital. Under current law, many people choose not to take on the educational debt burden in the first place, knowing that it is so high and cannot be shed. As a society, if we want to promote maximum utilization of human capital, it is necessary that education be affordable and that its costs not be inescapable.

C. Not Morally Hazardous

While the optimal FRS should be forgiving and maximize human capital, it also must not promote moral hazard. By that I mean, the FRS itself should not incentivize, skew, or promote inefficient risk-taking. For example, if a bankruptcy discharge were available without any limitations or restrictions whatsoever, a debtors incentive to assess appropriately the prospective risks of a venture would be lessened. If an entrepreneur knew that she had a totally safe and soft landing post-bankruptcy, and without question could keep all of her future earnings, she could roll the dice imprudently on a risky venture and still come out fine, with her creditors bearing all the loss. Under those circumstances, creditor-investors would become more aggressive in ex ante monitoring prospective loans to individual entrepreneurs and would skew their decision-making or would charge a higher rate to account for the increased risk, which would in turn reduce entrepreneurial activity. Thus, an ideal FRS must strive to strike an optimal balance that neither chills entrepreneurs' willingness to attempt new ventures nor the investors' willingness to invest in those enterprises.

In the preceding subsection, I offered a proposal that would ameliorate moral hazard. An entrepreneur would not be able to get an absolute and unconditional discharge under chapter 7, but she also would not be subjected to the 100% disposable income tax of chapter 13. Instead, she would have to pay a percentage of her future earnings to her creditors to have her debts discharged. The best balance between forgiveness and the preservation of human capital, on the one hand, and the avoidance of moral hazard, on the other, would be if the entrepreneur had to pay some of her future earnings to her creditors, but not so much as to discourage the incentive to undertake a new venture in the first place.

D. The Remaining Components of an Optimal FRS

Recall that the other aspects of my ideal FRS are that it be: value-maximizing; equitable (as between the debtor and her creditors, and between creditors inter se); accessible for the debtor; controllable by the debtor; participatory for stakeholders; binding on all creditors, whether they assent or not; inexpensive; non-gluttonous (i.e., no incentive for bankruptcy administrators to extract excessive fees); simple; clear; and speedy. (106) Several of these features need no explanation. A few justify further remarks and some lead to specific reform proposals.

1. Accessible

As a threshold matter, it is imperative that the entrepreneur have ready access to the FRS. The standards for eligibility must be fair, balanced, and clear. Likewise, entering the process should be inexpensive, simple, and speedy. The current bankruptcy system in the United States falls far short of these goals. Under chapter 7, the "abuse" test of [section] 707(b), along with the mountain of required paperwork after the 2005 amendments, significantly undercut these goals. Chapter 13 is restricted to debtors whose debts aggregate less than certain dollar amounts ($419,275 in unsecured debt and $1,257,850 in secured debt). (107) Only individuals, as opposed to entities and individuals, may file for chapter (13) relief. These two limitations shut the courthouse doors to many small business owners. (108) While access to chapter (11) does not suffer from these same restrictions, it is a more cumbersome and expensive process. Congress attempted to address these disadvantages by relaxing some requirements in chapter 11, but they did so only for the "small business debtor." Although those changes were a good start, they remain inadequate because they only apply to a debtor with debts less than $2,725,625. (109) An entrepreneur could easily have business debts greater than that amount.

For entrepreneurs, I would eliminate the debt ceiling of a small business debtor or at least significantly increase it to at least $10 million. I would allow any individual engaged in business to file under the new chapter, as well as the business entities controlled by these individual debtors. An optimal FRS would not require proof of insolvency nor anything resembling the chapter 7 abuse test. It would eliminate much of the excessive paperwork, other than the schedules of assets and liabilities, the statement of affairs, and the proposed plan of reorganization.

2. Debtor Controlled

An entrepreneur also needs assurance up front that she will retain control over the bankruptcy process. This is an essential requirement for the entrepreneur. If another entity can hijack the proceedings and take control, then the entrepreneur might be reluctant to seek redress in the FRS in the first place. She also might not be able to maximize the value of her human capital. Accordingly, the debtor should presumptively hold the position of a debtor in possession, in keeping with the current rules for chapters 11 and 13. (110) A trustee should be appointed only on proof of actual fraud or gross incompetence and mismanagement. Furthermore, only the debtor should have the power to propose a plan or effect a sale of assets. Nor should other parties be able to propose a modification of a confirmed plan.

Ordinarily in chapter 11, an unsecured creditors' committee is appointed (111) and creditors vote to approve the plan. (112) But to enable the debtor to maintain greater control, to enhance predictability, certainty, and speed, and to minimize costs, creditors' committees should be eliminated, and creditors should not get to vote on the debtor's plan of reorganization. Creditors may object to the plan if they believe it does not meet the statutory requirements for confirmation, but the debtor should not have to secure their votes. Thus, the chapter 13 model, in which there are no committees and creditors do not vote, is the preferred option for entrepreneurs.

Presently in a small business case, the court may order that no creditors' committee be appointed. (113) While this is a step in the right direction, it remains inadequate for two reasons. First, the definition of a small business debtor is restricted to those with debts less than about $2.7 million. Second, even when the debtor falls within the definition of a small business debtor, the debtor must specifically request exemption from the appointment of a committee and the court retains discretion in ruling on such a request. (114) The same is true with disclosure statements in chapter 11. The court has the discretion to hold that a disclosure statement is unnecessary in a small business case. (115) But again the debtor must first be a small business debtor and she is only released from this requirement at the discretion of the court. Likewise, securing the necessary votes on a plan is a major impediment to the entrepreneur's quick and certain resolution of her financial distress. As long as she complies with certain fundamental and fair financial standards, her creditors should have no cause to complain. It is also critical that the relevant legal standards be simple and clear. Enhancing predictability and minimizing uncertainty are especially important in fostering and sustaining entrepreneurial activity. (116)

3. Treatment of Unsecured Claims and Interests: The Absolute Priority Rule (APR)

In determining what financial standards should be applied to an entrepreneurial chapter, one of the existing chapter 11 confirmation requirements should be eliminated. Presently, a chapter 11 plan proponent must demonstrate that no junior class of unsecured claims or interests, in the bankruptcy priority scheme, will receive or retain anything under the plan on account of that junior claim or interest, unless all senior classes have been paid in full. (117) This is known as the "absolute priority rule" (APR). Professor Kenneth Ayotte has espoused the belief the APR should not be applied to individual entrepreneurs. (118) He found that "bankruptcy bargaining backed by APR produces less debt relief than is socially efficient" and would "weaken the prospects of a reorganized firm by reducing an owner-manager's incentive to succeed after bankruptcy." (119) Instead, only the "best interests" test (i.e., that the plan propose to pay creditors at least liquidation value (120)) should be required. Once again, a blend of chapter 13, which has no APR, with that of chapter 11, which has no debt limitations, is the preferred FRS for entrepreneurs.

As previously explained, the plan confirmation rules should not require the debtor to pay her creditors all her projected disposable income, and the minimum term of the plan should be dramatically reduced. A 100% tax on the debtors human capital over the three to five years required by chapters 13 and 11 undermines her incentive to re-engage in productive entrepreneurial activity. At suggested, a fifty percent share in disposable income over a one-year period or twenty-five percent over two years should be sufficient deterrence against moral hazard.

4. Treatment of Secured Creditors

Another major flaw of current reorganization law is that secured creditors are given too much value in both chapters 13 and 11. When the debtor proposes to retain collateral in the plan, she should only have to pay the secured creditor the foreclosure or liquidation value of its collateral, not its going-concern or replacement value. Outside of a compulsory collective proceeding such as bankruptcy, the foreclosure value is all that the secured creditor could hope to recover. (121) Thus, the Supreme Court's 1997 decision in Associates Commercial Corp. v. Rash, (122) holding that the secured creditor is entitled to receive payments representing the replacement value when the debtor proposes to keep the collateral is fundamentally misguided and detrimental--not only to the entrepreneur who seeks to restructure her business, but to the other creditors as well. (123)

In addition, the debtor entrepreneur should also be able to bifurcate the secured creditor's claim into its secured and unsecured portions in accordance with [section] 506(a), paying only the secured portion over time, and lumping the unsecured portion into the unsecured creditor class, where unsecured creditors typically receive only pennies on the dollar for their claims, without exception. Chapter 11 already makes this possible. In chapter 13, the same general principle supposedly applies, but Congress has made major exceptions to it that render it of very little utility. (124) The home mortgage, most car loans, and the secured loan on "any other thing of value" acquired by the debtor in the year prior to bankruptcy are all excepted from the general rule. (125) This means that the chapter 13 debtor must pay the full amount of the loan on these items, regardless of their current fair market value. This leaves the secured creditor with too much value and both the debtor and the other creditors suffer as a result. With a blended chapter 13 and 11 chapter for entrepreneurs, there should be no exceptions to the general bifurcation rule.

Finally, some of the chapter 11 advantages given to secured creditors should also be eliminated in the new chapter. The secured creditor's right to make the [section] 1111(b) election (requiring the debtor to pay the full amount of the debt over time) should be among the first provisions to go. Nor should the secured creditor be allowed to credit bid. If the proposed sale price is set at or above the judicially appraised amount, no party should have an inside edge on bidding. (126)

5. Speedy and Inexpensive

It goes without saying that both chapters 13 and 11 are too expensive under the present system. One factor that impacts cost is the length of the proceeding. The faster the case proceeds to resolution, the less time professionals can bill against it. Chapter 13 is already a very streamlined process, but chapter 11 is not. Part of the length attributable to chapter 11 cases is tied to the disclosure and voting process. With the elimination of those steps, there is no reason that the case could not progress as quickly as a chapter 13 case.

An optimal FRS for entrepreneurs should be resolved quickly. It should function more like a chapter 13 case than a chapter 11. In chapter 13, the debtor must file the plan within fourteen days of the filing of the case. (127) The plan confirmation hearing must be held not earlier than twenty days or later than forty-five days after the first meeting of creditors, (128) which itself cannot be held earlier than twenty-one days or later than fifty days after the case is filed. (129) Thus, unless the court orders otherwise, the confirmation hearing cannot be held sooner than forty-one days after the filing. I would recommend that the plan confirmation hearing in an entrepreneurial chapter be held no later than thirty days after the filing of the case.

6. Non-Gluttonous

Only very modest fees should have to be paid for case administration. Unfortunately, under current law, the proverbial "pound of flesh" is extracted from debtors making payments under either chapter 13 or 11 plan, as well as in a chapter 7 liquidation. For example, in chapter 13, the trustee receives a fee of up to ten percent of the amounts paid under the plan. (130) This represents a significant additional financial hardship on chapter 13 debtors. And for what? Early in the case, the trustee actively participates in the case to ensure that the debtor is paying as much as she reasonably can to her creditors. But following confirmation, the chapter 13 trustee is little more than a disbursing agent: the debtor sends her payments to the trustee, who then issues checks to the creditors under the terms of the plan. In a new chapter for entrepreneurs, administrative fees should be dramatically reduced by allowing the debtor to make payments directly to her creditors (as is normally done in chapter 11). In the usual case, there should be no need for the appointment of a trustee. Creditors have every incentive to make sure they get paid; if the debtor fails to pay them under the plan, then creditors may move to have the case dismissed (131) or converted to chapter 7. (132) The added benefit of having a trustee in every case, who is paid an excessively large fee, is simply not worth the cost.


The United States should model for the rest of the world the importance of designing an optimal FRS tailored to the needs of entrepreneurs. Some of those needs should be reflected in federal legislation that applies both inside and outside of bankruptcy, such as anti-discriminatory laws and federal exemptions. Within the context of our bankruptcy system, a new chapter should be adopted for the entrepreneur that blends the best features of chapter 13 and 11. It should adopt chapter 13's streamlined confirmation process, eliminating disclosure statements and voting and the expense associated with a creditors' committee. On the other hand, it should eliminate chapter 13's provision for a trustee and the associated administrative costs by allowing the debtor to act as a debtor in possession. The length of the time during which the debtor entrepreneur is forced to repay creditors should be significantly shortened. Payment of the debtor's future income, above minimal living and business expenses, should be shared between the debtor and the creditors to encourage the debtor to re-engage in fruitful endeavors. In short, our current system needs substantial reform if we are to lead the world in promoting entrepreneurism. In turn, society as a whole would greatly benefit from the re-investment of human capital as quickly as possible, by giving entrepreneurs a better safety net.

(1) See, e.g., The Rich, Tragic History of Daredevil Wallendas, CBS News (June 15, 2012, 7:42 AM),

(2) Kenneth Ayotte, Bankruptcy and Entrepreneurship: The Value of a Fresh Start, 23 J.L. Econ. Org. 161 (2006).

(3) Mike W. Peng, Yasuhiro Yamakawa & Seung-Hyun Lee, Bankruptcy Laws and Entrepreneur-Friendliness, 2010 Entrepreneurship Theory & Prac. 517, 519 (2010).

(4) Douglas G. Baird & Edward R. Morrison, Serial Entrepreneurs and Small Business Bankruptcies, 105 Colum. L. Rev. 2310, 2329 (2005); see also Amy E. Knaup, Survival and Longevity in the Business Employment Dynamics Data, Monthly Lab. Rev, May 2005, at 51 ("[M]ost of the new establishments disappeared within the first 2 years after their birth, and then only a smaller percentage disappeared in the subsequent 2 years. These survival rates do not vary much by industry."); cf. H.G. Parsa, John T. Self, David Njite & Tiffany King, Why Restaurants Fail, 46 Cornell Hotel 8c Restaurant Admin. Q. 304, 304 (2005) ("[A] relatively modest 26.16 percent of independent restaurants failed during the first year of operation").

(5) Marco Caliendo & Alexander S. Kritikos, Is Entreprenurial Success Predictable? An Ex-Ante Analysis of the Character-Based Approach, 61 KYKLOS 189, 210-12 (2008); Michael Blanding, How to Predict Whether a Business Idea Will Succeed, Forbes (Oct. 21, 2015, 12:10 PM), sites/hbsworkingknowledge/2015/10/21 /how-to-predict-whether-a-business-idea-will-succeed/#263a2 ca858e9; see also David M. Townsend, Lowell W. Busenitz & Jonathan D. Arthurs, To Start or Tsfot To Start: Outcome and Ability Expectations in the Decision to Start a Tiew Venture, 25 J. Bus. Venturing 192, 200 (2010).

(6) John Armour & Douglas Cumming, Bankruptcy Law and Entrepreneurship, 10 Am. L. Econ. Rev. 303, 306-07, 309 (2008).

(7) For a discussion of the societal impact of entrepreneurism, see Sarah H. Alvord, L. David Brown & Christine W. Letts, Societal Entrepreneurship and Societal Transformation: An Explanatory Study, 40 J. Applied. Behav. Sci. 260 (2004).

(8) Deniz Ucbasaran, Dean A. Shepherd, Andy Lockett & S. John Lyon, Life After Business Failure: The Process and Consequences of Business Failure for Entrepreneurs, 39 J. Mgmt. 163, 175-82 (2013); see also Samuel Edwards, The Negative Side Effects of Entrepreneurial Failure, Inc. (Nov. 3, 2015), https://

(9) See, e.g., Seung-Hyun Lee et al. How Do Bankruptcy Laws Affect Entrepreneurship Development Around the World?, 26 J. Bus. Venturing 505, 517 (2011).

(10) Zoltan J. Acs & Laszlo Szerb, Entrepreneurship, Economic Growth and Public Policy, 28 Small Bus. Econ. 109, 109 (2006) ("A positive effect of entrepreneurial activity on economic growth is found for highly developed countries; a negative effect is found for developing nations.[TM]) (emphasis original).

(11) Id.

(12) While England's laws have created a what is often-described as a "debtor's paradise," English society views financial failure negatively. Joseph Spooner, Long Overdue: What the Belated Reform of Irish Personal Insolvency Law Tells Us About Comparative Consumer Bankruptcy, 86 Am. Bankr. L.J. 243, 248 (2012). "[E]ven today, English society is unforgiving about financial failure. The English generally consider financial failure a weakness of character, whether it is caused by business or personal financial missteps." Nathalie Martin, Common-Law Bankruptcy Systems: Similarities and Differences, 11 Am. Bankr. Inst. L. Rev. 367, 374 (2003). Both Canada and Australia have adopted England's laws. Id. at 367. See also Rafael Efrat, Global Trends in Personal Bankruptcy, 76 Am. Bankr. L.J. 81 (2002). In contrast, Ireland's bankruptcy laws are described as "inaccessible and unforgiving," prompting debtors to flock to the United Kingdom to file bankruptcy. Spooner, supra, at 246. Recently, however, Ireland has relaxed its requirements for personal bankruptcy. See Conor Pope, Q&A: What Does the Change in Bankruptcy Law Mean?, Irish Times (Dec. 1, 2015, 3:59 PM), q-a-whatdoes-the-change-in-bankruptcy-law-mean-1.2450293.

(13) Sharon A. Simmons et al. Stigma and Business Failure: Implications for Entrepreneurs Career Choices, 42 Small Bus. Econ. 485, 489-90 (2014).

(14) Heiner Schumacher, Kerstin Gerling & Michal Kowalik, Entrepreneurial Risk Choice and Credit Market Equilibria, 15 Econ. Analysis & Pol'y 1455, 1456 (2015).

(15) Kirkland & Ellis LLP, Alert: China's New Enterprise Bankruptcy Law 1 (2006), https://

(16) John Child & David K. Tse, China's Transition and Its Implications for International Business, 32 J. Int'l Bus. Stud. 5, 8 (2001).

(17) Charles Jordan Tabb, The History of the Bankruptcy Laws in the United States, 3 Am. Bankr. Inst. L. Rev. 5, 11-12 (1995) (quoting 1 William Blackstone, Commentaries *472).

(18) Bruce H. Mann, Republic of Debtors: Bankruptcy in the Age of American Independence 36 (2002).

(19) Charles Jordan Tabb, The Law of Bankruptcy 37 (4th ed. 2016) [hereinafter Tabb, The Law of Bankruptcy].

(20) 1 William Blackstone, Commentaries '474.

(21) Tabb, The Law of Bankruptcy, supra note 19, at 41.

(22) Charles Jordan Tabb, The Historical Evolution of the Bankruptcy Discharge, 65 Am. Bankr. L.J. 325, 365 n.321 (1991).

(23) H.R. Rep. No. 65, 55th Cong, 2d Sess. 30-32 (1897) (incorporating H.R. Rep. No. 1228, 54th Cong, 1st Sess.).

(24) Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934).

(25) Id.

(26) U.S. Const, art. I, [section] 8, cl. 4.

(27) Eli Gimmon & Jonathan Levie, Instrumental Value Theory and the Human Capital of Entrepreneurs, 43 J. Econ. Issues 715, 720-23, 727-28 (2009); Baird & Morrison, supra note 4, at 2331-32, 2342; see also Taye Mengistae, Competition and Entrepreneurs' Human Capital in Small Business Longevity and Growth, 42 J. Dev. Stud. 812, 834 (2006) ("[Entrepreneurial human capital is an important determinant of small business growth and survival. Our evidence for this is that the probability of business survival increases with the number of years of the entrepreneur's schooling, as does the average growth rate").

(28) Hui Chen et al. Entrepreneurial Finance and Nondiversifiable Risk, 23 Rev. Fin. Stud. 4248, 4248 (2010); see generally Robert E. Hall & Susan E. Woodward, The Burden of the Nondiversifiable Risk of Entrepreneurship, 100 Am. Econ. Rev. 1163 (2010).

(29) See generally Jay Cohen, The History of Imprisonment for Debt and Its Relation to the Development of Discharge in Bankruptcy, 3 J. Leg. Hist. 153 (1982).

(30) Tabb, The Law of Bankruptcy, supra note 19, at 1015 (2016).

(31) Armour & Cumming, supra note 6, at 304.

(32) Lee et al, supra note 9, at 506; see also Devin Bunten, Stephan Weiler, Eric Thompson & Sammy Zahran, Entrepreneurship, Information, and Growth, 55 J. Regional Sci. 560, 575-76 (2015); Heather M. Stephens and Mark D. Partridge, Do Entrepreneurs Enhance Economic Growth in Lagging Regions?, 42 Growth & Change 431, 458 (2011) ("[E]ven in remote rural regions, self-employment and the associated entrepreneurial capacity are positively linked to growth.").

(33) Douglass G. Boshkoff, Bankruptcy-Based Discrimination, 66 Am. Bankr. L.J. 387, 388-89 (1992) (providing examples from section 525). For further discussion of the history of [section] 525, see Terrence Cain, The Bankruptcy of Refusing to Hire Persons Who Have Filed Bankruptcy, 91 Am. Bankr. L.J. 657, 663-77 (2017).

(34) Future references to "section" or "[section]" will refer to Title 11, United States Code, unless expressly stated otherwise.

(35) 402 U.S. 637 (1971).

(36) U.S. Const., art. VI, cl. 2.

(37) Perez, 402 U.S. at 656.

(38) Charles J. Tabb & Ralph Brubaker, Bankruptcy Law: Principles, Policies, and Practice (2015); see also Tabb, The Law of Bankruptcy, supra note 19, at 1016.

(39) Tabb, The Law of Bankruptcy, supra note 19, at 1015-16.

(40) H.R. Rep. No. 95-595, 95th Cong. (1977).

(41) See 15 U.S.C. [section] 1681c(a) (2012).

(42) Id.

(43) Tabb, The Law of Bankruptcy, supra note 19, at 1017

(44) Matter of Anonymous, 549 N.E.2d 472, 473-74 (N.Y. 1989).

(45) Tabb, The Law of Bankruptcy, supra note 19, at 1015-16.

(46) Id. at 1016.

(47) Id. at 1015-20.

(48) 11 U.S.C. [section] 525 (2012).

(49) Tabb, The Law of Bankruptcy, supra note 19, at 1015-17.

(50) E.g., Myers v. Toojay's Mgmt. Corp, 640 F.3d 1278, 1285 (11th Cir. 2011); see 22 U.S.C. [section] 525(b) (2012); see also Tabb, The Law of Bankruptcy, supra note 19, at 1016-17

(51) In re Majewski, 310 F.3d 653, 656 (9th Cir. 2002).

(52) See, e.g., Ayes v. U.S. Dep't of Veterans Affairs, 473 F.3d 104, 109-11 (4th Cir. 2006).

(53) For further discussion, see Tabb, The Law of Bankruptcy, supra note 19, at 1018.

(54) Id. at 1016-17

(55) Id. at 1017

(56) Toth v. Mich. State Hous. Develop. Auth, 136 F.3d 477, 480 (6th Cir. 1998).

(57) See, e.g., Matter of Anonymous, 549 N.E.2d 472 (N.Y. 1989).

(58) U.S. Const, art. I, [section] 8, cl. 3.

(59) 11 U.S.C. [section] 525 (2012).

(60) Tabb, The Law of Bankruptcy, supra note 19, at 1016-17.

(61) Id. at 873.

(62) 11 U.S.C. [section] 522(d) (2012); see also Tabb, The Law of Bankruptcy, supra note 19, at 873-74.

(63) Tabb, The Law of Bankruptcy, supra note 19, at 874

(64) Charles Dickens, A Christmas Carol (1843).

(65) In re Robinson, 811 F.3d 267 (7th Cir. 2016).

(66) Fla. Const, art. X, [section]4; Fla. Stat. [section] 222.01-222.05 (2016); Tex. Prop. Code Ann. [section][section] 41.001-41.024 (West 2016).

(67) Pennsylvania Bankruptcy Exemptions, Pa. Bankr. L, exemptions.html (last visited Aug. 10, 2018).

(68) Unif. Exemptions Act prefatory note at 3 (Nat'l Conference of Comm'rs on Unif. State Laws 1979).

(69) As of August 2018, Alaska is the only state that has adopted the UEA. Exemptions Act, Model, Unif. L. Comm'n, (,%20Model) (last visited Aug. 12, 2018). Alaska adopted the UEA in 1982. See Alaska Exemptions Act, Alaska Stat. [section][section] 09.38.010-09.38.510 (2018). For a discussion of Alaska's adoption of the UEA, see Eric H. Miller, From Accession to Exemption: A Brief History of the Development of Alaska Property Exemption Laws, 32 Alaska L. Rev. 273 (2015).

(70) See, e.g., Unif. Exemptions Act [section] 4 (Nat'l Conference of Comm'rs on Unif. State Laws 1979) (model homestead exemption).

(71) Lawrence Ponoroff, Exemption Limitations: A Tale of Two Solutions, 71 Am. Bankr. L.J. 221, 225 n.22 (1997).

(72) Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (1978) (codified as amended at 11 U.S.C. [section] 101).

(73) Eric A. Posner, The Political Economy of the Bankruptcy Act of 1978, 96 Mich. L. Rev. 47, 107 (1997); see also Tabb, The Law of Bankruptcy, supra note 19, at 878-79

(74) Tabb, The Law of Bankruptcy, supra note 19, at 878 n.33.

(75) 735 Ill. Comp. Stat. 5/12-901, 5/12-1201 (2016).

(76) 11 U.S.C. [section] 522(c)(2) (2012).

(77) Obviously, this would not be the case with involuntary creditors, such as tort victims.

(78) Alan N. Resnick, Prudent Planning or Fraudulent Transfer? The Use of Nonexempt Assets to Purchase or Improve Exempt Property on the Eve of Bankruptcy, 31 Rutgers L. Rev. 615 (1978); see also Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 275-78 (1986); Theodore Eisenberg, Bankruptcy Law in Perspective, 28 U.C.L.A. L. Rev. 953, 992-96 (1981); Steven L. Harris, A Reply to Theodore Eisenberg's "Bankruptcy Law in Perspective," 30 U.C.L.A. L. Rev. 327, 339-45 (1982); Lawrence Ponoroff & F. Stephen Knippenberg, Debtors Who Conuert Their Assets on the Eve of Bankruptcy: Villains or Victims of the Fresh Start?, 70 N.Y.U. L. Rev. 235 (1995); Tabb, The Law of Bankruptcy, supra note 19, at 893.

(79) Norwest Bank Neb, N.A. v. Tveten, 848 F.2d 871, 876-77 (8th Cir. 1988).

(80) Cf. Dolese v. United States, 605 F.2d 1146, 1154 (10th Cir. 1979) ("There is a principle of too much; phrased colloquially, when a pig becomes a hog it is slaughtered").

(81) Baird & Morrison, supra note 4, at 2330-32.

(82) Id. at 2314-18, 2366-68.

(83) Thomas G.W. Telfer, Ruin and Redemption: A Struggle for Canadian Bankruptcy Law 1867-1919 139 (2014).

(84) U.S. Const, art. I, [section] 10, cl. 1; see Sturges v. Crowninshield, 17 U.S. 122 (1819).

(85) 292 U.S. 234 (1934).

(86) Id. at 245.

(87) Charles Jordan Tabb, The Death of Consumer Bankruptcy in the United States, in International Perspectives on Consumers' Access to Justice 264 (Charles E.F. Rickett & Thomas G.W. Telfer eds, 2003).

(88) 11 U.S.C. [section] 523(a) (2012).

(89) 11 U.S.C. [section] 727(a) (2012) (examples included hiding assets from the bankruptcy trustee or filing false schedules).

(90) Charles J. Tabb, The Top Twenty Issues in the History of Consumer Bankruptcy, 2007 U. III. L. Rev. 9, 24.

(91) Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 98 Stat. 333, 355-56. But see Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 8, 119 Stat. 23, 27-28 (removing the "substantial abuse" language).

(92) See, e.g., In re Price, 353 F.3d 1135, 1139-40 (9th Cir. 2004) (interpreting [section] 707(b) prior to its 2005 amendment).

(93) See id. at 1138.

(94) 11 U.S.C. [section] 707(b) (2012).

(95) Id. [section] 707(b)(2).

(96) Tabb, The Law of Bankruptcy, supra note 19, at 171-72.

(97) Id. [section] 1325(b).

(98) Tabb, The Law of Bankruptcy, supra note 19, at 171.

(99) Id. [section] 1325(b)(1)(B).

(100) Id. [section] 1325(b)(4).

(101) Tabb, The Law of Bankruptcy, supra note 19, at 99.

(102) 11 U.S.C. [section] [section] 1115(a)(2) and 1129(a)(15)(B).

(103) 11 U.S.C. [section] 1329(a).

(104) Id. [section] 523(a)(8).

(105) Id.

(106) See supra Part II.

(107) 11 U.S.C. [section] 109(e) (2012).

(108) Id.; see also Tabb, The Law of Bankruptcy, supra note 19, at 1212-20.

(109) 11 U.S.C. [section] 101(5lD)(A) (2012).

(110) Id. [section][section] 1101(1), 1303, 1304.

(111) Id. [section] 1102(a)(1).

(112) Id. [section][section] 1126, 1129(a)(8).

(113) Id. [section] 1102(a)(3).

(114) Id. ("On request of a party in interest in a case in which the debtor is a small business debtor and for cause, the court may order that a committee of creditors not be appointed.") (emphasis added).

(115) Id. [section] 1125(f).

(116) Viktor Mayer-Sch?nberger, The Law as Stimulus: The Role of Law in Fostering Innovative Entrepreneurship, 6 I/S: J. L. & Pol'y for Info. Soc'y 153, 183 (2010). See also James E. Payne, The Role of Economic Policy Uncertainty in the US Entrepreneurship-Unemployment Nexus, 4 J. Entrepreneurship & Pub. Pol'y 352, 363 (2015).

(117) 11 U.S.C. [section] 1129(b)(2)(B), (C) (2012).

(118) Ayotte, supra note 2, at 180.

(119) Id. at 161-62.

(120) 11 U.S.C. [section] 1325(a)(4) (2012). See also Tabb, The Law of Bankruptcy, supra note 19, at 1252.

(121) Michelle M. Harner, The Value of Soft Variables in Corporate Reorganizations, 2015 U. Ill. L. Rev. 509, 530; Edward J. Janger, The Logic and Limit of Liens, 2015 U. Ill. L. Rev. 589, 595 n.32.

(122) 5 20 U.S. 953 (1997).

(123) Id. at 964-65.

(124) 11 U.S.C. [section][section] 1129(b)(2)(A)(i), 1325(a)(5)(B) (2012).

(125) 11 U.S.C. [section][section] 1322(b)(2), 1325(a)(9)*.

(126) Charles J. Tabb, Credit Bidding, Security, and the Obsolescence of Chapter 11, 2013 U. III. L. Rev. 103, 116.

(127) Fed. R. Bankr. P. 3015(b).

(128) 11 U.S.C. [section] 1324(b) (2012).

(129) Fed. R. Bankr. P. 2003(a).

(130) 28 U.S.C. [section] 586(e)(1)(B) (2012).

(131) Tabb, The Law of Bankruptcy, supra note 19, at 204.

(132) Id. at 218.

Charles J. Tabb, Mildred Van Voorhis Jones Chair in Law, University of Illinois College of Law; Of Counsel, Foley & Lardner LLP. This article has benefited from insights from my colleagues at the University of Illinois, especially Ralph Brubaker and Robert Lawless, and at Foley & Lardner LLP, especially Jill Nicholson, Rich Bernard, Victor Vilaplana, Geoffrey Goodman, and Harold Kaplan. I want to thank Soffia Kuehner Gray, Kaitlin Straker, Angela Torres, and Gabriela Zamfir for their invaluable research and editorial assistance.
COPYRIGHT 2019 National Conference of Bankruptcy Judges
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2019 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Author:Tabb, Charles J.
Publication:American Bankruptcy Law Journal
Date:Mar 22, 2019
Previous Article:Student Loan Bankruptcy and the Meaning of Educational Benefit.
Next Article:Choice of Law in Insolvency Proceedings: How English Courts' Continued Reliance on the Gibbs Principle Threatens Universalism.

Terms of use | Privacy policy | Copyright © 2019 Farlex, Inc. | Feedback | For webmasters