Bankruptcy Changes Could Harm Instead of Help

Keep promises you make and pay debts you incur--basic responsibilities, right?

Yet 1.3 million individuals and 52,000 businesses declared bankruptcy last year, most of them shirking their responsibilities by taking advantage of a sort of debtors’ no-fault zone, courtesy of our nation’s bankruptcy laws.

Small businesses, usually without the means to hire attorneys to go after debtors, often take it on the chin when a bankruptcy is declared. It’s a hot-button issue for most small-business owners.

Just ask Scott Hauge, owner of CAL Insurance in San Francisco and chairman of California Small Business Assn.

“I’ve been screwed about a half-dozen times and the last one owed me $23,000,” Hauge said. “What baffles me is reorganization. The courts put together some kind of plan that pays 10 cents on the dollar and the guy who filed bankruptcy goes merrily on in business.”

Change may be on the way.

Three bills that would dramatically revamp the nation’s bankruptcy laws are working their way through Congress.

The Bankruptcy Reform Act of 1998, HR 3150, proposed by Rep. George Gekas (R-Pa.), has passed through various committees and will be taken up by the full House next week.

The bill imposes a formula that individual debtors would use when they seek bankruptcy protection. The formula would evaluate their ability to repay debts based on current and future income. If they can repay their debts, they will be required to do so and prohibited from filing a Chapter 7 bankruptcy.

It is Chapter 7 that allows individuals to avoid paying their full debts once they’ve liquidated all their assets. An estimated 30% of those filing bankruptcy have the ability to repay their debts but instead go directly into Chapter 7, according to federal statistics.

Under the business bankruptcy provisions of the bill, small businesses with less than $5 million in debt would have to meet shorter deadlines for bankruptcy reorganization so that creditors such as Hauge could receive money more quickly from liquidated assets.

Two similar measures were proposed in the Senate: the Business Bankruptcy Reform Act of 1998, SB 1914, and the Consumer Bankruptcy Reform Bill, SB 1301, both proposed by Sen. Charles E. Grassley (R-Iowa) and Sen. Richard Durbin (D-Ill.). SB 1301 would require court action before the formula would be imposed, and SB 1914 contains provisions addressing health care and securities. These bills have also passed through committees, and action on them will probably occur in June.

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But don’t uncork the champagne yet. Some small-business advocates and bankruptcy experts say the bills would actually harm small businesses, not help them.

It turns out the bills are the work of banks and credit card companies, the very folks who send out 3 billion credit card applications annually. That’s enough for 30 applications per person nationwide.

These are the same folks who run those touching television ads with a father and son at a baseball game and a tally of the cost--game tickets, hot dogs, souvenirs--to conclude that sinking the family deeper in debt is OK because dad and the kid spent quality time together.

If we’re talking about responsibility, how about beginning with banks and credit card companies? They could certainly be more discriminating in issuing credit.

But banks and credit card companies want to continue spewing easy credit. With the new, stricter rules, they could more easily collect their 17% credit card interest rates, cut their losses and not have to change their business practices, said Ken Klee, a professor of bankruptcy law at UCLA.

“When you look at the legislation, it’s particularly hostile to small business,” said Klee, who also is a member of the National Bankruptcy Conference, a congressional advisory group that has taken a stance against the bills.

A lot of small businesses that get into trouble need bankruptcy protection, Klee said. The proposed legislation, while helping small businesses as creditors, would harm them significantly as debtors, he said.

As many as 200,000 of the 1.3 million individual bankruptcies last year were business-related, mainly self-employed consultants. Under current bankruptcy laws, these people can remain in business, paying business-related expenses. But under the proposed changes, they would be disallowed from paying those expenses and forced to file a business bankruptcy instead, Klee said. And under the new business bankruptcy proposals with shorter deadlines, small businesses and consultants could be forced into liquidation almost immediately, he said.

“My guess is that if it becomes law, venture capital dries up somewhat, the Small Business Administration has larger losses, small businesses generally will have more losses, banks and finance companies wind up having fewer losses, and entrepreneurs have a harder time starting over.”

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And that’s the most far-reaching argument against the proposed changes. Klee and other experts say the strength and flexibility of the U.S. economy is based, in part, on liberal bankruptcy laws that forgive debts and allow businesses to start over. Laws in Japan, South Korea and Taiwan punish bankers and business owners for failure, said Robert Broadfoot, managing director of Hong Kong-based Political & Economic Risk Consultancy Ltd.

As a result, private capital doesn’t flow freely through entrepreneurial ventures there, he said. Thailand and South Korea, recognizing the problem, have begun to create bankruptcy laws that allow business owners to start over. Ironically, the changes overseas are coming just when the United States is trying to tighten bankruptcy laws, which could ultimately harm the ability of small businesses to deal with economic downturns and hurt the economy in general.

“If we didn’t have the freedom to fail, we wouldn’t have the Silicon Valley,” Broadfoot said.

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Times staff writer Vicki Torres can be reached at (213) 237-6553 or at vicki.torres@latimes.com.