If the company does not have an opportunity to pay-off an extensive amount of debts, filing for bankruptcy can be a good decision that helps to discharge the debts or find efficacious solutions for repaying them without putting a threat to the business.
The aim of this paper is to investigate how certain areas of bankruptcy law influence business decisions, determine the most impactful principles of the law, and explore the common fears related to the law. Proper investigation of these questions will help to understand the main specifics of the process of filing for bankruptcy in the United States and determine possible mistakes that should be avoided.
Law and Business Decisions
Bankruptcy in the United States is regulated under the Title 11 of the United States Code. The title consists of nine chapters presenting rules for the regulation of various situations related to bankruptcy. Particular areas of the law have a certain impact on the business decisions. The literature research has been conducted to understand the relation between the particular areas of law and business decisions.
Bankruptcy Exemption Laws and Business Decisions
It appears that the area of bankruptcy law dealing with exemption is directly related to business decisions on creating a company, as this area of law influences the entrepreneur’s vision of existing risks in case of negative tendencies in the development of the company. Mathur (2009) conducted a research to find out how the bankruptcy regulation influences the formation of small firms (p. 25).
The gained results revealed the fact that the predicted probability of starting a business is twenty-five percent higher in the states with higher bankruptcy exemptions compared to their neighbours than in the states with lower exemptions compared to their neighbours (Mathur, 2009, p. 25).
The results of the study demonstrate a direct relation between an increase in the dollar value of the entrepreneur’s own state exemption and an increase in the probability of a business start (Mathur, 2009, p. 45). Therefore, the area of law regulating the bankruptcy exemption influences the business decisions made by people willing to start a business.
Besides, the bankruptcy exemption laws influence the decisions of the entrepreneurs on declaring bankruptcy. Agarwal, Chomsisengphet, Liu, and Mielnicki (2005) used “loan-level panel data” to define the impact of state exemption laws on small business bankruptcy decisions (p. 620).
The results of the study demonstrated that the rise in the homestead exemptions increases the probability of the declaration of bankruptcy by the entrepreneurs. Therefore, exemptions laws directly influence the decisions of declaring bankruptcy by the owners of small companies.
The Severity of Particular Areas of Bankruptcy Law and Business Decisions
It appears that the severity of bankruptcy laws is one of the most influential factors in encouraging people to make business decisions aimed at giving preference to start own business instead of working for some company. Armour and Cumming (2008) conducted significant research aimed at investigating the relation between bankruptcy laws and the rates of self-employment across the countries (p. 303).
The results of the study revealed the importance of entrepreneur-friendly bankruptcy laws to the promotion of self-employment business decisions. The particular area of law that influences the positive or negative tendencies in self-employment is the one that identifies the number of years “a bankrupt must wait until he may be discharged (if ever) from prebankruptcy indebtedness” (Armour & Cumming, 2008, p. 337).
The researchers have come to the conclusion that bankruptcy laws have the most statistically and economically significant effect on the levels of self-employment (Armour & Cumming, 2008, p. 337). Their effect even overcomes the impact of real GDP growth and MSCI stock market returns. Therefore, the severity of bankruptcy laws, and the area regulating the procedure of discharging from prebankruptcy indebtedness, in particular, directly affect business decisions of people choosing between working for others or being self-employed.
The influence of the severity of bankruptcy laws regulating the relations between debtors and creditors on business decisions also cannot be underestimated. Blazy, Deffains, Umbhauer, and Weill (2013) investigated how legal sanctions related to bankruptcy influence debt contracting and financial and investing decisions (p. 129).
The study demonstrated the impact of bankruptcy law on renegotiable debt contracts. The researchers revealed the fact that legal environment plays an essential role in the process of making financial decisions at the time of credit granting (Blazy et al., 2013, p. 140). The level of bankruptcy severity has an impact on the price of debt. Therefore, legal sanctions related to bankruptcy directly influence the subsequent investing decisions made by the managers of business companies.
The studies mentioned above contribute to better understanding of the impact that certain areas of bankruptcy law have on business decisions. The studies show that high/low bankruptcy exemption affects the probability of starting a business and declaring bankruptcy by the existing companies.
Besides, entrepreneur-friendly bankruptcy laws influence the rates of self-employment, debt contracting, and financial decisions. In my opinion, these facts demonstrate the importance of thoughtful regulation of bankruptcy issues, as it has a huge impact on the tendencies in the business environment of the country.
Impactful Law Principles
The underlying principles of Bankruptcy Code reveal the specifics of regulating the process of paying off the debts and help to understand which chapter is the most suitable for a particular case.
Principles Identifying the Type of Bankruptcy Procedure
The particular chapters define the principles of identifying the type of bankruptcy procedure. These principles can be considered among the most impactful as they directly affect the destiny of the company declaring bankruptcy. The debtor eligible to Chapter 7 bankruptcy is supposed to pay the debts by liquidating all of the assets while the unpaid debts are discharged (Twomey & Jennings, p. 710). The chapter is named “Liquidation” and consists of five subchapters dealing with different aspects of the process.
Famous cases of successful filing for Chapter 7 bankruptcy include Western Pacific Airlines, Bank of New England, Kira Plastinina, Mars Music, etc. The debtor eligible for Chapter 11 can reorganize the business with protection from overwhelming debts. An example of successful results of filing for Chapter 11 bankruptcy is the United Airlines’ case. The United Airlines filed for federal bankruptcy court protection in 2002 after two years of heavy losses.
This step freed the company from the threat of creditors’ lawsuits while it focused on reorganizing the finances. In such way, United Airlines retained control of the business and was able to start “a new beginning” (United Airlines finally flies out of bankruptcy, 2006, par. 1). The debtor eligible for Chapter 13 can develop a plan of reorganization of business to repay the debt. An example of filing for Chapter 13 by a famous person is the case of Sammy Kershaw, a country music singer.
The Implications of the Bankruptcy Abuse Prevention and Consumer Protection Act
Due to numerous concerns about the misuse of Chapter 7, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was promulgated in 2005 as the most “substantial revision of bankruptcy law since the 1978 Bankruptcy Code” (Wedoff, 2007, p. 31). This act has become an impactful tool for controlling the process of liquidation, as it enables the individuals to go directly to Chapter 7 without presenting enough proof of their inability to pay the debts. The means tests were introduced to determine whether the debtor is eligible for Chapter 7 or Chapter 13 bankruptcies.
The first test determines the debtor’s ability to pay twenty-five percent of unsecured debt based on the particular formula. The second test measures the metric of median income. Only if the debtor’s income does not exceed the state median, he/she will be considered eligible for Chapter 7 bankruptcy. Otherwise, Chapter 13 bankruptcy will be applied, and the debtor will have to recuperate the debts through the repayment plan. After the promulgation of BAPCPA, the bankruptcy law became more advantageous for the lenders.
The Principles of Dealing with Different Types of Claims
Other impactful principles of the bankruptcy law regulate the order of dealing with secured, unsecured, and priority claims. Secured claims, such as mortgage or car loan, are not affected by the debtor’s bankruptcy. If filing for Chapter 7 bankruptcy, the debtor should determine his/her willingness to keep the property. In such situation, it is necessary to continue paying the credit on the regular basis.
If filing for Chapter 13 bankruptcy, the debtor willing to keep the assets should make regular payments with the help of the repayment plan or without it. Unsecured claims are directly affected by the debtor’s bankruptcy. There are two types of such claims: priority and nonpriority. Nonpriority debts, such as medical bills and personal loans, are dischargeable in bankruptcy. If filing for Chapter 7 bankruptcy, the debtor will pay nonpriority unsecured creditors in the last instance.
If filing for Chapter 13 bankruptcy, the debtor will pay nonpriority unsecured creditors depending on the disposable income. The unsecured priority claims, such as tax obligations or child support, cannot be discharged. If filing for Chapter 7 bankruptcy, the debtor will pay such debts prior to unsecured credits. If filing for Chapter 13 bankruptcy, the debtor will pay them through the repayment plan, which has to be large enough to cover them within the plan period.
Every person filing for bankruptcy has to be aware of the major principles of bankruptcy law, which directly affect the outcomes of the procedure.
Distrust of the Law and Misconceptions
As the bankruptcy law deals with delicate situations when people are at the risk of losing everything, the occurrence of numerous misconceptions related to distrust of the law appears to be rather natural. Most people are afraid of filing bankruptcy as they have certain fears that are in fact not well grounded enough.
Fear of Loosing a Credit Score
Many people think that after filing bankruptcy they will not be able to qualify for a mortgage loan for a house or any other type of credit. The reality is quite the opposite, as in many cases filing bankruptcy is the shortest way to qualify for a loan while trying to pay the impossible debt load often leads to very unsatisfying results.
Most people think that if bankruptcy is listed on your credit report, there is no possibility to get any credit for at least ten years (Johnston, 2012, par. 9). The truth is that bankruptcy can stay listed for this period, but it does not affect the person’s ability to receive credit. In fact, nearly two years after the discharge are needed to get a good credit score.
Fear of Being Condemned
Another concern is related to the belief that immediately after been qualified for bankruptcy the person will be judged by other members of the society. This belief is based on two false conceptions. The first one claims that it is wrong or shameful to find yourself unable to meet the obligations and file bankruptcy.
This belief is false, as filing bankruptcy is one of the most effective ways of dealing with problems that cannot be solved by applying other methods. It should not be regarded as a wrong act, as it appears to be the only wise solution in many cases. Another misconception is related to the belief that one’s bankruptcy will immediately be laid open to the public. In fact, the bankruptcy filings for individual consumers are not laid open to the public by any mass-medias or other sources of information.
Fear of Losing the Property
One more fear related to bankruptcy is the one of losing the house or apartment. In fact, the law provides bankruptcy exemptions protecting certain amounts of the debtor’s stuff. It means that there is a big possibility for saving a house, an apartment, or other belongings. The best way to overcome the false fear is to consult a bankruptcy lawyer and figure out the exact norms that apply to the particular case.
Fears Related to Complications in BAPCPA
After the promulgation of BAPCPA in 2005, some complicated areas of this act were often interpreted in the wrong way. Many people think that the act enabled most people to file for bankruptcy. The procedure indeed became more expensive and complicated, but there is still the same amount of chances to get a bankruptcy.
The first complicated aspect of BAPCPA is the means test. While the income aspect of the test is basic, the expense element is much more complicated (Smith et al., 2010, p. 10). Difficulties related to an extensive amount of documentation in bankruptcy case also cause a certain level of mistrust to the law. In fact, all of the problems mentioned above can be solved by addressing a competent professional counselor who can help the debtor to sort out the appropriate decisions.
In my opinion, the most common source of fear and distrust of the bankruptcy law is based on the lack of awareness of real implications of the law. Therefore, these misconceptions can be alleviated by presenting reliable information about the bankruptcy laws in mass media and encouraging the people to consult expert lawyers before making any decision related to filing bankruptcy.
The detailed analysis of certain areas and principles of the bankruptcy law helps to understand the main features of the process of filing bankruptcy and see the ways of making this process effective and beneficial.
Agarwal, S., Chomsisengphet, S., Liu, C., & Mielnicki, L. (2005). Impact of state exemption laws on small business bankruptcy decision. Southern Economic Journal, 71(3), 620-635.
Armour, J., & Cumming, D. (2008). Bankruptcy law and entrepreneurship. American Law & Economics Review, 10(2), 303-350.
Blazy, R., Deffains, B., Umbhauer, G., & Weill, L. (2013). Severe or gentle bankruptcy law: Which impact on investing and financing decisions? Economic Modelling, 34, 129-144.
Johnston, S. (2012). 5 bankruptcy myths debunked.
Mathur, A. (2009). A spatial model of the impact of bankruptcy law on entrepreneurship. Spatial Economic Analysis, 4(1), 25-51.
Smith, C., Stockton, G., Botes, B. W., Drew, W. P. III, Jurkiewiez, E. P., Weller, S. R., & Wilson, J. (2010). Understanding the effects of BAPCPA: Leading lawyers on examining BAPCPA changes, adopting new filing strategies, and analyzing consumer bankruptcy trends. New York: Thomson Reuters/Aspatore.
Twomey, D., & Jennings, M. (2011). Business law: Principles for today’s commercial environment (3rd ed.). Mason, Ohio: South-Western Cengage Learning.
Wedoff, E. R. (2007). Major consumer bankruptcy effects of BAPCPA.