Bankruptcy Bill Needs Reforming
President Bush these days likes to promote his vision of an “ownership society” in which citizens take more control of their lives from the government.
So why is he poised to sign what could be one of the most sweeping anti-ownership laws in years?
I’m speaking of the bankruptcy overhaul bill that is moving rapidly toward becoming law. The bill has been framed as a needed reform to get people to take more responsibility for their personal debts and make it harder to just walk away from them.
But what most people don’t realize is that it will hammer entrepreneurs and discourage small business formation, undermining a major pillar of an ownership society.
The proposed law passed the Senate a month ago and will be voted on by the House this week, and the president has indicated he will sign it. Unless some key changes are made, it will greatly increase the penalties for risk taking.
Under current law it is possible for an entrepreneur to take a chance and fail, then have the debts discharged and move on to a fresh start with new financing. But under this bill, an entrepreneur who fails would have those debts hanging over him or her for years, limiting opportunities to raise new capital. And wages could be garnisheed at any job the entrepreneur might take.
The message of this legislation is “don’t start your own business,” says Rep. Howard L. Berman (D-North Hollywood), a member of the congressional committee that worked on the bill.
The bill, the most dramatic overhaul of the bankruptcy code in 27 years, also would discourage a small company from expanding into a new field “for fear that failure could sink the whole enterprise and cost the owners all their property,” says Michelle White, economics professor at UC San Diego and an expert on bankruptcy.
Where did such a bill come from? Mainly from the credit card and banking lobbies, which have sought for years to stem what they describe as a rising tide of individual bankruptcies.
Last year, 1.6 million individuals declared bankruptcy, 1.1 million of them in Chapter 7, which allows discharge of debts and a fresh start. Creditors claim that people are using credit cards recklessly and escaping the consequences.
Consumer groups respond that debt problems are not surprising considering that “pre-approved” cards are distributed freely through the mail to practically anybody with a pulse.
Whatever the merits of those arguments, the problem for small companies is that 20% -- or 320,000 -- of those individual bankruptcies are actually small, unincorporated companies, financed by credit cards, home equity loans and borrowings from friends. The reality of small business, as White points out, is that an unincorporated company’s debts are personal liabilities of the firm’s owner.
If the bill becomes law in its present form, says bankruptcy attorney Robert Darby of the Fulbright & Jaworski law firm, “look for a rush of small companies to incorporate.”
Yet that won’t really protect small operators because lenders often require that owners personally guarantee the debts of small corporations. That’s understandable because “90% of all new companies fail within 48 months,” says Lloyd Chapman, a veteran Silicon Valley entrepreneur and founder of the American Small Business League, which represents the interests of small firms that do business with the government.
Chapman says the bankruptcy bill is “too broad” and should be amended to make a distinction between businesses and individual credit card users.
Good point. It is strange that there is no special clause in the bankruptcy bill to protect small companies. After all, with 22 million small firms in the U.S., according to Dun & Bradstreet, you’d think entrepreneurs would have some clout. But the small business lobby was split on this issue between companies that see themselves as creditors and others who are debtors.
For example, Michael Moore, a furniture store owner in Gainesville and Cornelia, Ga., testified as a creditor complaining that more of his customers were declaring bankruptcy and not paying back their furniture loans.
Also there was little chance for entrepreneurs to be heard because the Congress held almost no recent hearings on the legislation. The last time major hearings were held by the House Judiciary Committee, in 1999, credit card and banking groups were heavily represented. Small business voices were few.
One however, Jere Glover, chief counsel of the Advocacy Office of the Small Business Administration, nicely summed up the importance of second chances: “Our experience is that many entrepreneurs indeed do fail at their first attempts at business,” Glover testified. “But it is through their experience of failure that they find the right formula for success.”
The bankruptcy laws that allow this second chance have proved a strength of our economy from Henry Ford, who went bust a couple of times before getting it right, to Ray Kroc, who tried several businesses before achieving success with McDonald’s.
The bankruptcy bill is odd because it seems actively hostile to entrepreneurs.
That’s because it “would impose trustees to oversee small company owners and require extensive paperwork. It would be a disaster,” says Kenneth Klee, a UCLA law professor who worked as a congressional staff member on the 1978 bankruptcy law overhaul.
On top of that, the Congressional Budget Office estimates that the bill will add $400 million to the federal budget deficit because more federal bankruptcy trustees and judges will have to be hired.
Also, two states most friendly to entrepreneurs, Texas and Florida, where state laws protect homes from seizure for debt, would have that protection reduced to an upper limit of $125,000. In other words, a failed small business owner in Texas could lose the house to creditors and receive no more than $125,000 for it.
The great danger in this bankruptcy bill is that it would change American risk-taking culture to something closer to the European model, where entrepreneurs are suspect and a single business failure pretty much rules out any second chances.
If the bankruptcy “reform” bill is not itself reformed before becoming law, the hopeful words “ownership society” will become only an empty slogan standing for a vanished dream.
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James Flanigan can be reached at jim.flanigan@latimes.com.
