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Business bankruptcies hit pre-BAPCPA numbers: could reform send them even higher?

Much like consumer credit, consumer bankruptcies ultimately dominate any news coverage surrounding the subject of insolvency.

Reports have been dire. Consumer bankruptcies have trudged ever upward, since their initial fall in the wake of the 2005 passage of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). That fiscal year, ending on September 30, 2005, just two weeks before the BAPCPA's provisions went into effect, consumer filers rushed to take advantage of the old bankruptcy rules, which were considered far more lenient than the ones within BAPCPA, and filings topped out at 1,748,421. The following year showed a predictably precipitous decline, with only 1,085,209 consumer bankruptcies filed in the 2006 fiscal year.

They fell again in FY 2007, to 775,344, and then began to recover in FY 2008, when filings bounced back to 1,004,342, and finally peaked in FY 2009, when filings reached 1,344,095. Analysts have noted that should the increases continue, consumer filings could very easily reach the same heights as they did before the passage of what were considered to be the unforgiving reforms of BAPCPA. The first few months of 2010 have also supported such an outcome as the 149,268 consumer filings in March 2010 marked the highest monthly consumer total since the BAPCPA overhaul. This number was a 34% increase from February 2010's 111,693 filings and while January 2010 filings fell to 102,254 from 113,274 in December 2009, January traditionally has the least filings of any month of the year, and the 102,254 figure was still 15% higher than the same month in 2009.

"While January represented a drop in filings from the previous month, high unemployment rates, unsustainable mortgage burdens and other economic stresses will push more consumers to seek the financial relief of bankruptcy in 2010;' said American Bankruptcy Institute (ABI) Executive Director Samuel Gerdano. "The sustained economic pressures of unemployment coupled with high preexisting debt burdens are a formula for consumer filings to surpass 1.5 million filings [in 2010]. As consumers continue to look to bankruptcy for financial shelter, annual filings will likely equal those averaged in the years leading up to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005."


This steady increase in consumer bankruptcies and the return to pre-BAPCPA filing levels is certainly worrisome. In the meantime, however, business bankruptcies very quietly ascended to their pre-2005 heights, and then kept going a great deal further.

Business Debts

Despite the buzz about consumer filings and their return to higher levels, FY 2009 consumer filings were still a solid 23% below 2005 levels. Business filings, on the other hand, hit 58,721 in that same period, marking a 52% increase over FY 2008 and a full 72% above 2005 levels. Surges in the business bankruptcy world occurred in all chapters, but most notably Chapter 11, which grew by an enormous 69% in FY 2009. Chapter 7 filings continued to comprise the largest percentage of the filings, but only increased by 51%. Much of the rise in Chapter 11 filings came in March and April of 2009, and 44% of it took place in the three districts that handle the majority of Chapter 11 cases: the District of Delaware, the Southern District of New York and the Central District of California.

"The increase can be attributed to economic problems in a variety of industries, as communications firms, real estate companies, retail malls, automotive companies and construction companies all filed large numbers of Chapter 11 petitions" said the Administrative Office of the U.S. Courts in a recent newsletter. The office went on to note that business filings, as a percentage of total bankruptcy filings, have doubled since the passage of BAPCPA, suggesting a shift in certain filing patterns. "Business filings have not played as significant a role in the bankruptcy courts since the early 1990s, when overall filings were below one million," they added. "The increases may be related to continuing economic weakness--as evidenced by high unemployment and by continued instability in the housing market in many regions of the country--but the impact of BAPCPA cannot be ignored either."

Clearly, the changes that BAPCPA made to the bankruptcy filing process had little long-term effect on the occurrence of business filings. But it's also important to remember that despite the fact that business filings have skyrocketed back to levels not seen since the reform, they didn't have nearly as big of a hole to dig out of as consumer filings did, and still do. "The 2005 Act was aimed primarily at debtors who file consumer bankruptcy petitions, and it disproportionately affected the number of consumer bankruptcies filed post-BAPC-PA," said the Admin Office. "Both consumer and business filings dipped following the implementation of BAPCPA, but consumer filings dropped more severely, and the growth in consumer filings has been much slower than that of business filings. If the economy improves, it remains to be seen whether the current higher ratio of business filings will persist."

Many businesses that make it out of a Chapter 11 process are Left a shadow of their former selves.

After the Filing

While these statistics illuminate a harsh business environment that has sent the largest number of firms running for the courts since the late 1980s and early 1990s, one of the things they cannot illuminate is the result of these filings, whether or not they were successful, and, if successful, the financial condition of the firm in the wake of the proceedings. Many businesses that make it out of a Chapter 11 process are left a shadow of their former selves, a regular criticism of the process recently lobbed by Joseph Mason, professor of finance at Louisiana State University (LSU) and senior fellow at the Wharton School, during a hearing in the Senate Judiciary Committee. "We are still dealing with the fallout of changes to bankruptcy incentive in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. There, liberal rights granted to unsecured consumer creditors led to increased credit supply and rampant consumer borrowing," said Mason. "On the business side, 'BAPCPA's extension of safe harbor provisions to a seemingly unlimited universe of financial contracts ... dramatically increased the number of parties who could freely terminate or accelerate agreements, liquidate positions and set off claims against margin or collateral called in from a debtor without fear of interference by a bankruptcy court? As a result, failed firms had already been drained dry of cash and assets by margin calls on new financial products, leaving the firm a mere shell in the aftermath." By allowing certain creditors to more easily dominate the process, companies that even managed to exit bankruptcy were left with little hope for the future, and while evidence is scarce, high profile Chapter 11s that fold into Chapter 7 liquidations (i.e., Circuit City) have many in Washington, D.C. taking note of BAPCPA's failures.

As reported in previous editions of Business Credit magazine and NACM's weekly eNews, lawmakers on Capitol Hill are in the process of considering more reforms to the nation's Bankruptcy Code. While the intention is essentially to correct what isn't working in BAPCPA, the end goal is

to spur job growth and create a filing process for smaller businesses that allows them the chance to not only survive bankruptcy but return to the economy a leaner, vibrant company. "From an economic point of view, we want a small business bankruptcy law that smoothes the transition of the serial entrepreneur, allowing them to flow into and out of businesses in a way that preserves both creditor and entrepreneur value" said Mason. "Such a balance can, indeed, be struck."

An interesting issue, however, is that striking such a balance and creating an effective bankruptcy process that preserves value on both sides of the matter could wind up having what some would consider a negative side effect. "Some elements, however, remain counterintuitive to policymakers both in the judiciary and banking worlds;' Mason noted. "Economically, the simple key to retaining value is to intervene earlier than is currently the case. Of course, that means more bankruptcies."

While the negative stigma associated with bankruptcies has abated to some degree in recent years, the fact still remains that bankruptcy is still regarded as the admission of a business or consumer failure. Yet, if the goal is to preserve value for all firms, both creditor and debtor, and position fledgling companies for long-term success, this perception may be forced to change. As shocking as the speedy return of bankruptcies to pre-BAPCPA levels may be, should a reform package actually create a bankruptcy process that works properly and does what's best for the economy at large, these numbers could conceivably rise even higher. "As Michelle White famously wrote of personal bankruptcies even before BAPCPA, the surprising aspect of bankruptcy is not how many people use it, but how few," said Mason. "Overall, a leaner Chapter 11 system with simplified filing and streamlined procedures for quick recovery will help those who have the capacity get back to business while preserving collateral value and saving on legal bills for others. Such a system has the potential to be an important impetus for economic growth in the coming recovery."

Jacob Barton, NACM staff writer, can be reached at
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Title Annotation:SELECTED TOPIC; Bankruptcy Abuse Prevention and Consumer Protection Act
Author:Barron, Jacob
Publication:Business Credit
Geographic Code:1USA
Date:Jun 1, 2010
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