Getting your fiscal house in order - bankruptcy

Black Enterprise, Dec, 1992 by Steve Bergsman

The number of bankruptcies continues to rise at a heady pace. According to the American Bankruptcy Institute, Washington, D.C., Americans filed a record number of applications for bankruptcy protection during the first quarter of this year.

Indeed, the total number of bankruptcies was 252,733 compared with 230,723 for the same period last year. Of those first quarter filings, 18,760 were businesses, an increase of 5.3%, while 233,973 were nonbusiness filings, an increase of 9.8%. "Over the last two to three years, we have seen a tremendous number of our small business clients seek relief in bankruptcy protection," says Chester N. Watson, a certified public accountant and partner in the New York accounting firm, Mitchell/Titus & Co.

Now obviously, no one begins a business thinking it will fail, but in this tempestuous economic climate, more and more companies are finding it harder to stay afloat. Sometimes, businesses fail not because of mismanagement or cash flow shortage but extraneous circumstances. Recently, the drugstore chain Phar-Mor, Youngstown, Ohio, filed bankruptcy, alleging that two of its executives embezzled $350 million.

Lecount Davis, a certified financial planner and president of Washington, D.C.-based Financial Services Network, tells of a client whose wife left him with a mountain of bills. The small businessman couldn't take care of personal and business bills, so he took to the shelter of the bankruptcy court.

Bankruptcy should be a last resort. It affects the creditworthiness of that individual person or business for years. Although there is no longer a social stigma associated with bankruptcy, there is still a blot on the person's credit rating, which some credit reporting agencies keep on record for a minimum of 10 years. When starting another business, having filed bankruptcy could be "the kiss of death" in terms of trying to get conventional financing.

Some people are aware that they are headed into bankruptcy, yet, they may not really care. For them, bankruptcy is a way out. For the most part, however, professionals recommended that you choose any other alternative to getting out of debt (see "The Big Comeback," January 1992).

However, bankruptcy can't always be avoided. Before filing, one should understand what the process is all about. Bankruptcy is actually a body of federal law, and once a person or company is in bankruptcy, it's under the court's jurisdiction.

The system itself is designed to give the debtor breathing room. Once a person files for bankruptcy, creditors are prevented from taking any collection against the debtor.

There are two principal types of bankruptcy, Chapter 7 and Chapter 11. Succinctly put, Chapter 7 is a straight liquidation where the debtor shuts down operations and liquidates assets to pay off creditors. Chapter 11, on the other hand, is a reorganization, in the hope that the company can reshuffle itself and eventually emerge again as a surviving company--usually as a much smaller entity and often with a different form of ownership.

Which option should a troubled business owner choose? Most often, the circumstances of the business dictates that decision. "The best candidate to emerge from a bankruptcy is one that has a good core business, but the problem is that it is overleveraged--or has borrowed too much," says Thomas J. Salerno, a bankruptcy expert with the Phoenix law firm, Streich Lang, P.A.

"If you have a business that has sufficient revenues to cover operational expenses and a little left over to cover debt, that is a business that can [survive] bankruptcy." But if you have a business that can't meet operational expenses even after you have trimmed all that fat, then that is a candidate for liquidation, says Salerno.

But even if a business meets Salerno's requisites for a Chapter 11 filing, it won't be an easy road to walk. Only 17% of all businesses that file bankruptcy ever recoup.

Jeffrey Thompson of the Washington, D.C., accounting firm, Thompson, Curtis, Brazilio & Associates, P.C., says he had one client that came back from bankruptcy. The client, who was a contractor, was in fact felled by the government--its main customer. The company had a lot of government receivables, was slow in collecting and couldn't secure a line of credit. After the bankruptcy filing, the owners personally guaranteed loans and secured financing. They were able to hang in there until they got their money.

The successful return of the business was a gamble since a primary rule of bankruptcy is to keep personal assets out of the line of fire when the creditors start hunting for debt payment. Unfortunately, in most small businesses it is difficult to keep to that rule because of the format of the business.

If the small business is a corporation, for instance, then the individual is protected if the company goes bust. But many small businesses are sole proprietorships. Thus, the individual is responsible for the debt since it's hard to separate personal dollars from business dollars. Lenders are getting tough by suing for personal assets, claiming this is the only way to get repayment.