Business Boom Is a Bust for Bankruptcy Lawyers

In the world of Valley business, things are looking up for just about everyone--except bankruptcy lawyers.

The number of Chapter 7 bankruptcies filed by San Fernando Valley firms stood at 26 in October, down 35% from the 40 cases filed the same month last year, according to U.S. Bankruptcy Court. Likewise, the year-to-year drop was 22% in September and an even bigger 51% in August.

At the Woodland Hills office of bankruptcy specialist Merritt & Hagen, the number of cases, after rising steadily for much of the 1990s, is down between 10% and 15% this year, said David Hagen, a partner in the firm.

“The shift is due to a couple of things,” he said. “The booming economy has now boomed not only across all regions but also across all strata in terms of upper and lower class. Also, property values are up, so people are refinancing [their properties] or taking out second mortgages to take care of their cash problems.”

The decline in Chapter 7 bankruptcies reflects a regional trend, according to the Bankruptcy Court.

Chapter 7 bankruptcies are liquidations that generally result in businesses closing their doors, as opposed to Chapter 11 reorganizations in which companies stay in business under Bankruptcy Court supervision.

As a result, companies that file for protection from creditors under Chapter 7 of the U.S. Bankruptcy Code tend to have little hope of ever turning a profit again.

Bankruptcies in the Valley have tended to be concentrated among certain industries at various times in the 1990s, according to local business experts.

In the early part of the decade, construction-related firms were hit hard as building activity in the Valley--and much of the country--came to a near standstill during the recession.

Aerospace and defense firms quickly followed during the defense downsizing of the post-Reagan era. And in the aftermath of the 1994 Northridge earthquake, real estate agents were hit hard after many damaged homes were removed from the market.

In fact, fallout from the earthquake probably represented a high water mark in Valley business failures, as many companies still reeling from defense downsizing and the weak property market were also forced to shut down, said professor John Rooney, of the Lloyd Greif Center for Entrepreneurial Studies at USC’s Marshall School of Business.

“The recession really started the beginning of the trend,” said Rooney, former president of the Valley Economic Development Center, a Van Nuys-based nonprofit that helps small business. “Defense downsizing increased the trend. But the earthquake peaked the trend. That was the catalyst for a lot of the bankruptcies. The earthquake was sort of like a forest fire--it burned a lot of the dying trees. The survivors were much stronger.”

While much of the Valley economy has rebounded in the last few years, small retailers--many of them unable to compete with national chains--have come increasingly under the gun in the late 1990s. And the most recent wave of troubles is in the entertainment industry, where work is dropping off for many small businesses that support the big studios, said Roberto Barragan, acting president of the Valley Economic Development Center.

“Movie-making is probably the one area that’s seeing retrenching right now because of the flight of activity to Canada and other overseas locations,” Barragan said. “You’re seeing some contractors and support companies to the movie industry start to hurt. We haven’t seen a lot of bankruptcies yet, but whatever employees they’ve brought on, they’ve had to lay them off.”

Of the bankruptcies that are occurring, many fall into one of several categories that seem to prevail regardless of the economic environment. Companies that lack capital to finance growth are probably the largest group, Hagen said.

He cited one of his clients, a North Valley nightclub that recently filed for bankruptcy as a case in point.

The club started to gain a clientele in its first six months but had too much debt, Hagen said. Growing antsy, one of its creditors decided to put a “keeper”--a retired marshal--in the club to take cash from the register for repayment of some of the owner’s debt.

“It was depriving them of their cash flow,” Hagen said. “It was very disruptive. The other problem is that having police in there for four to five hours at a time is not conducive to a nightclub. So the club filed for bankruptcy.

“He wouldn’t have had to do it if the creditor hadn’t come in.”

Another common scenario involves businesses that can’t adapt quickly enough to changing market conditions. In many of the cases, businesses see their revenues drop but aren’t quick enough to change their game plans, Rooney said.

“This is what a lot of businesses struggle with--trying to reduce their business in the face of lost revenues,” he said. “They can’t cut costs enough to save the business. For example, you’ll see a textile company that suddenly isn’t getting enough business as they were getting before because people are ordering from Mexico. Or you’ll see an aerospace subcontractor whose orders are reduced by 30%.”

Hagen cited one such case involving a client that installed cable in Valley apartment complexes.

“The work dried up, and they weren’t able to adapt into something else quick enough,” he said. “They really ran it past what they should have--probably put $400,000 of their own money into the corporation. They were looking to get into different kinds of installation.”

Another common case involves unforeseen catastrophic changes, such as the death of a business partner, breakup of a friendship or discovery of major environmental contamination at a company site.

Hagen recalled one such case in which a restaurant that was doing well had to file for bankruptcy after its two partners had a falling out, prompting the one who oversaw the culinary aspect of the business to leave.

“The relationship ended, and the [other partner] with the money just wasn’t a restaurateur,” Hagen said.

At the Valley Economic Development Center, meanwhile, the emphasis has shifted in the last few years from firms struggling to keep their business going to ones trying to finance expansion amid the booming economy, Barragan said.

“Right now, everyone coming to us is in expansion mode,” he said. “Usually those are businesses that had a hard time in the early ‘90s. Their cash flow [and] credit has been impacted in the past. Now their things are turning around, and they’re in growth mode.”