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A Gift To Creditors


Whether you're cheered or chilled by passage of the new bankruptcy law depends on which side of the financial fence you're on. Small businesses that file for protection under Chapter 11 after the law takes effect in October may face a greater likelihood of liquidation than they would under the current law. But some small business creditors may have a better chance of hanging on to money they've received from companies that go bankrupt after making payments.

For debtors, says Elizabeth Warren, professor of law at Harvard Law School, the law "will be devastating." For the first time the bankruptcy code will treat small businesses -- those with debts of $2 million or less -- differently from large ones. The new law imposes stringent paperwork rules as well as requirements that debtors shell out more to utilities and other creditors before they can reorganize.

Small companies will have 300 days to file a plan, and extensions will be limited. Under the old law, judges had considerable flexibility to grant businesses more time.

A majority of companies that don't survive bankruptcy fail within six months of filing, according to research from Edward Morrison, an associate professor of law at Columbia Law School. Many of the rest survive, but Morrison says most of them need more than 10 months to reorganize.

The new law also "makes it more likely that small businesses as creditors will get repaid," says William R. Greendyke, a Houston attorney at Fulbright & Jaworski. Creditors would get "administrative claims priority" if they delivered goods to a company within 20 days of its bankruptcy filing. They would have to be paid before a company could reorganize, though they would stand in line behind secured creditors.

In addition, the law would make it easier for creditors to protect themselves against preference actions -- suits filed by creditors looking to reclaim payments made just before a bankruptcy filing. As it stands now, a bankruptcy court can demand that creditors return any money paid by the bankrupt company within the 90 days before it filed for bankruptcy. Now, payments of less than $5,000 per creditor will be exempted. And creditors that received more than $5,000 during the 90-day window will have an easier time proving that the payments were made in the "ordinary course of business." That would improve their chance of hanging on to the cash -- and, in extreme cases, decrease the chance that they'll end up in Chapter 11 themselves.

By Susan Garland


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