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BANKRUPTCY DOs AND DON'Ts

On Apr. 14, 1997, bankruptcy attorney Kent Snyder, small-business chair of the American Bankruptcy Institute, participated in a BW Online Enterprise Chat on America Online on the topic of how to avoid bankruptcy -- and what to do if it comes. Here's the transcript of this BW Enterprise chat:


JackBW: Welcome to Business Week Online and another in our series of weekly BW Enterprise chats, presented in conjunction with America Online's Your Business Dinner program. Tonight's guest is attorney Kent Snyder, small-business chair of the American Bankruptcy Institute, talking about how to avoid bankruptcy -- and what to do if it comes. Good evening, Kent Snyder, and thanks for joining us.

I also want to welcome SmallbizBW, who is Fred Strasser, editor of BW Enterprise. BW Enterprise chats are presented by Enterprise, the edition of Business Week published eight times a year especially for small business and entrepreneurs.

JackBW: REYBOLO had his hand up for a question -- ask away.

REYBOLO: What are the pros and cons about filing bancrupcy?

JackBW: A good way to start off.

KentSnyder: The cons first. For a small business, there are three types of bankruptcy: Chapter 7, which is commonly referred to as "bankruptcy." It involves a trustee liquidating the business. So the con, in that kind of case, is that the business is closed, obviously. If the company wants to remain in business and reorganize, it would file a Chapter 11 (for a partnership or corporation) or a Chapter 13 (if the business is a sole proprietorship with unsecured debts less than $250,000 and secured debts less than $750,000). So the pro is that there you have a chance to restructure your debt and to stay in business.

REYBOLO: In regard to a personal bankruptcy, can I also include debts to the Uncle?

KentSnyder: Simply, income taxes can be discharged if they are more than three years old. The rules are complex, of course, but income taxes become dischargeable after three years.

JackBW: Meaning you forget about them?

KentSnyder: Dischargeable, meaning that you don't have to pay your debt anymore. That answer it, Jack? You can also use a Chapter 13 to force a payment plan down the IRS's throat. Payroll taxes are generally not dischargeable, but you still can force the IRS to make a payment plan if you are in Chapter 13.

REYBOLO: Thanks.

JackBW: Let's back up a bit and assume a small business is in serious financial trouble. What steps would you advise taking to avoid bankruptcy?

KentSnyder: First, make a realistic assessment of assets, liabilities, and future cash flow. Second, determine if the company is viable. Does it have a product or service it can sell to make money? If it was able to hold off its creditors, can it operate in the black looking forward? If it can't, forget it. Don't waste your time. You can try out-of-court workouts -- structured payments with creditors or Chapters 11 or 13.

SmallbizBW: Kent, we have a story running in the next Enterprise in which a lot of people say they think small-business owners have been borrowing on their personal cards and getting into big trouble. Do you have an opinion about that?

KentSnyder: Anecdotally, I have seen -- and most of the attorneys I know across the country have seen -- a lot of small-business owners financing their businesses through credit cards. Historically, they used to use banks and SBA-backed loans, which would require collateral and have more control over credit. But it's much easier to get credit lines because the credit-card companies are falling over one another trying to get you into debt. How many credit-card applications did you receive in the mail last month?

SmallbizBW: Two tonight!

KentSnyder: See how easy it is, Fred, to borrow money! The argument, of course, is whom to blame, the borrowers or the lenders?

JackBW: Before bankruptcy, should you go to creditors and your bank and try to work out a plan?

KentSnyder: Yes. And it's been our experience that most credit-card lenders do not participate in out-of-court restructurings. Even the Consumer Credit Counseling Service has problems getting credit-card companies to make workouts, and they're funded by creditors.

JackBW: In your experience, have you seen many successful comebacks by small business in -- or close to -- bankruptcy?

KentSnyder: Yes. Again, the most important thing to figure out first is whether or not the company has a product or service to sell on which it can make a profit. If the answer is yes, then there's usually a way to restructure your debts to allow the company to stay alive and the employees employed, and to contribute to the economy. The companies that succeeded out of bankruptcy took a hard look at liabilities and cash flow.

SmallbizBW: It seems sort of a conundrum: If you have a viable business, restructure. But how do people usually get in such trouble to start with if they have a business capable of making money?

KentSnyder: What happens is they're undercapitalized. If it takes $50,000 per month to cover overhead expenses -- not debt payments -- and they only make $30,000 on their product, restructuring isn't going to help. But if they're making $55,000 a month, they can use the $5,000 to make payments on the debt, as an example.

JackBW: Without violating anyone's privacy, can you give us some specifics of a situation where a turnaround was successful?

KentSnyder: Sure -- a small manufacturing company with half a million dollars of trade debt and a million dollars in secured debt, and whose product was being sold with sufficient income to cover overhead. We set a four-year payment plan to pay back 45% of the unsecured debt and restructured the secured debt with an eight-year payoff -- and paid all that with projected future cash flow.

JackBW: All bankruptcy matters are in federal court, right? So there are no state-to-state variations?

KentSnyder: Bankruptcy is a federal-court proceeding. The exemptions available to individual debtors vary by state. And there are local variations based on judge to judge, just the same as in all other courts.

BobABW: What's a bankruptcy lawyer do for clients, exactly? The range of possibilities?

KentSnyder: We help businesses and individuals reestablish financial stability. That's the simple answer. We get them relief from creditors -- and help advise them on strategies. Bottom line: We help people who are stressed out.

SmallbizBW: What is the impact on future borrowing of filing for bankruptcy protection?

KentSnyder: The stigma is much, much less now than it was even 10 years ago. With companies like TWA, Texaco, and people like Governor Connally, Burt Reynolds, and the fact that there were 1.1 million consumer bankruptcies in 1996, the stigma is just not there as much. Additionally, creditors are aggressively pursuing lower-rated debtors. They used to only go after A- or B-rated people. Now they're going after C- and D-rated borrowers. Why? They're trying to make money. They make the most money on people who carry a balance. And that's usually people with the least ability to pay. So that's who they market to.

JackBW: Is there much difference between a consumer bankruptcy and a bankruptcy of a really small business -- say, a sole proprietorship?

KentSnyder: It depends on whether you're liquidating (Chapter 7) or reorganizing (Chapter 13). If the goal is to keep the business alive, then it's a little more complicated for the business than it is for a straight consumer bankruptcy.

JackBW: How early in the game do bankruptcy attorneys get involved, usually?

KentSnyder: Not early enough.

JackBW: LOL.

KentSnyder: Unfortunately, most debtors wait until the last minute to see a qualified bankruptcy attorney. You should look at it more like a heart problem. If you have heart problems, you should see a doctor early. Don't wait until you wake up in the emergency room or don't wake up at all. We'd like to be more preventive-care lawyers, but we often end up as emergency-room lawyers (but not ambulance chasers!).

SmallbizBW: It sounds like there's really no downside to filing for protection, as long as you don't completely alienate supppliers?

KentSnyder: It's something you should only do if you have to. If you can work things out without filing, that's still the best way to go.

JackBW: How long does the typical small-business bankruptcy take to unwind?

KentSnyder: A small-business Chapter 11 will take between six months and one year in court, depending on complexity and where you are located. Which judge you have, for instance, matters. A Chapter 13 for a sole proprietorship will take about two to three months in court, and the business will then be operating under a plan for three to five years, with a trustee having some oversight. A Chapter 7 (liquidation) takes three to four months.

JackBW: How much does this cost, besides the debts you have to work out?

KentSnyder: First, prices vary across the country. Chapter 7 (liquidation) runs $175 filing fee, attorneys' fees of $800 to $2,000. Chapter 13 is $165 filing fee, attorneys' fees $1,500 to $5,000. Chapter 11 filing fee is $800, attorneys' fees probably $5,000 to $100,000 and up. Plus a U.S. trustee fee based on quarterly payments.

JackBW: Are the attorneys' fees included in the court settlement?

KentSnyder: Frequently, attorneys' fees are built into the workout plan. Again, it depends on local practice, the complexity of the case, the type of case -- meaning Chapters 11 or 13 -- because almost all competent bankruptcy lawyers are going to require a siginifcant retainer before starting a case, because of the restrictions on payment of attorneys' fees after a case is filed. That affects other professional fees, too, like accounting.

SmallbizBW: Regarding the card lenders, why are they less willing to reach terms out of court?

KentSnyder: I've been asking them for many years with no satisfactory answer. A lot of them just won't try it. And it causes more bankruptcies. That Neanderthal attitude exacerbates the problem.

BobABW: How devastating is the psychological effect of bankruptcy on most entrepreneurs? Or is it not that devastating in most cases?

KentSnyder: It actually works in reverse. The devastation is usually the stress that the entrepreneur is under before getting the relief of filing and setting up a reorganization plan. The first document you file is called a Petition for Relief. My experience is that people have a huge sense of relief, by (1) finding out what their options are or (2) actually filing for reorganization.

SmallbizBW: This isn't a practical question, but I'm wondering how, with nearly full employment and low interest rates, personal bankruptcies can be at an all-time high? What's going on?

JackBW: Credit cards again?

KentSnyder: There are several factors: (1) You and I both know a lot of people who, while employed, are now earning less than they used to make before they were laid off from prior employment. (2) That reduction of income causes many people to no longer afford their previous lifestyle and debt -- plus lots of uninsured and underinsured medical expenses. (3) Huge growth in consumer debt over the last 10 years. (4) Two-income families becoming one-income families -- one of them loses a job, and before one spouse gets back to work, they're in a huge pile of debt.

The default rate in consumer credit cards is much higher than banks admit publicly. They keep it artificially low by constantly signing up new credit-card customers. In other words, two people default and you have 100 customers -- that would be 2%. If you sign up another 100 customers, you now have a 1% default rate. The banks are constantly trying to sign people up to make their default rates look low. They have admitted that off the record.

BobABW: Earlier, you talked about preventive-care lawyers. What did you mean, exactly? What's the trigger point at which entrepreneurs should seek help, and should a lawyer always be the first person contacted?

KentSnyder: Anytime things start looking a little rocky, go talk to a good bankruptcy lawyer about what options there are if things take a turn for the worse, so you can prepare. Second, most good bankruptcy lawyers are working with a variety of turnaround managers and workout specialists who can help people keep a company out of bankruptcy. I'd say, yes, speak to a lawyer first. And the lawyer should be able to refer you to a solid finance person.... I've got several guys I know who are really good at it. They know the warning signs, and they help give the assistance early.

JackBW: Are there any estimates of small-business bankruptcies as a percent of the small-business universe?

KentSnyder: Eight out of ten businesses fail in the first five years. That's often quoted, but I don't know statistics beyond that.

JackBW: What does the American Bankruptcy Institute do? Any services that businesspeople can take advantage of?

KentSnyder: The ABI is an organization of people involved in the bankruptcy system -- judges, lawyers, accountants, trustees, creditors, etc. The focus of the organization is on the bankruptcy system and its efficiency. It does not take sides on issues -- i.e. creditor vs. debtor.

SmallbizBW: You mentioned size limits before. What are they, and what difference do they make in the way the proceeding is conducted?

KentSnyder: There are no size limits in Chapter 7 liquidations. Size merely has an effect on complexity and cost. In Chapter 13, it must be an individual -- i.e., a sole proprietorship, with unsecured debts under $250,000 and secured debts under $750,000. If you're over the limit, you have to file Chapter 11. LLCs [limited liability corporations] and partnerships must also file Chapter 11s -- which are more complex and expensive, and are really designed for publicly traded companies and for multiple shareholder companies, more than they are for closely held small businesses.

JackBW: Any more questions from my colleagues? Speak now -- or forever hold your peace. If not, we're grateful to Kent Snyder, bankruptcy attorney and small-business chair of the American Bankruptcy Institute, for this helpful discussion. Thanks for stopping by, Kent.

KentSnyder: Thanks for having me. It was a real pleasure.

JackBW: Be sure to visit BW Online's Small Business Center, full of useful information -- including all the Enterprise editions. Transcripts of this and all BW Online chats and conferences are available soon after the event. Look under Talk & Conferences on the BW Online opening screen. Thanks again, and goodnight to all!

Copyright 1997 Bloomberg L.P.



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