The Bankruptcy Business Is Booming

The economic downturn and pending federal legislation are driving up filings before the consequences of failure become even more costly

The new year was only a few days old when Silicon Valley bankruptcy attorney Norma Hammes noticed that corporations were halting construction projects, letting incomplete buildings stand as towering monuments to the stalled economy. "That rippled down, says Hammes. "Of course it affected small-business people," says Hammes.

Many small companies and sole proprietorships that had been teetering on the edge of insolvency late last year also saw few bright spots when they surveyed 2001's economic landscape. Instead of hopeful signs pointing to a coming upturn, what caught their eye instead were headlines announcing corporate layoffs and the passage of tougher bankruptcy legislation.


  That legislation, which will make it more difficult for individuals to discharge some types of debt and for small businesses to reorganize, is stalled as a conference committee works out differences between the House and Senate versions. The grim prospect of a tougher law, however, was the catalyst for some businesses in financial trouble to file for bankruptcy sooner rather than later.

The bankruptcy business at Gold & Hammes law firm in San Jose, Calif., is nearly double what it was a year ago, Hammes says. In Seattle, "every bankruptcy attorney I know is swamped," notes attorney Deborah Crabbe of Betts, Patterson & Mines.

Nor is the wave of insolvency limited to high-tech neighborhoods or to the business community. Nationwide, individual bankruptcy filings in April were up 31% vs. a year ago. Meanwhile, the number of public-company bankruptcies in the first quarter is nearly 50% higher than it was in 2001. Many observers are predicting that records set in 1998 will be surpassed this year. The number of private-company bankruptcies nationwide during the first quarter won't be available for a few weeks, but many U.S. Bankruptcy Courts jurisdictions, including the Northern District of California, are reporting that filings have jumped more than 50%.


  Often, small-business bankruptcy is a prelude to the outfit's owner filing for personal bankruptcy, most often because he or she has tapped a credit card or home-equity loan to finance operations. Bankruptcy figures are only part of the insolvency picture for small companies: For every business ending its days in bankruptcy court, dozens of others close up quietly outside the court system.

The rising tide of insolvency is not expected to turn anytime soon. In addition to the 150,000-plus layoffs announced so far this year, more are on the way, warns Kenneth Posner, an analyst at Morgan Stanley Dean Witter, who predicts personal bankruptcies will increase by 20% this year and 15% next year.

Personal bankruptcy is often a direct consequence of small-business bankruptcy, lawyers say. A principal in a company "maybe has a bank loan or they signed a lease...if they have given a personal guarantee or used their credit card, they'll file, too," says Jeffrey G. Grody, lawyer at Day, Berry & Howard in Hartford, Conn.


  "I had almost zero insolvency-type issues during the first half of last year," Grody says. "Right now, half of the matters I'm dealing with have some sort of a solvency angle with them." It's not just the debtors and creditors who want advice, but also people who have contracts with bankrupt corporations. What if you were relying on, say, Northpoint Communications, to provide your DSL service so you, in turn, could provide for your customers? Or what if a big part of your business was providing trucks to Public Gas & Electric in California? Says Grody: "These people have business partners. It goes on down the line."

A year ago, Grody was working on contracts and startup-stage legal work for dot-coms, many of which couldn't raise their second or third rounds of financing when the IPO market disappeared. For those that came up empty-handed, the typical pattern has been to let employees go and become dormant for a couple of months, Grody says. "Now their questions are: We have creditors, we have some cash, what do we do? The answer is: You die," he adds.

For every small business going through bankruptcy, many more are quietly liquidating outside of the court system. Either way, the deaths of dot-coms tend to be quick rather than lingering because they often have little in the way of assets other than intellectual property, which is generally the software they developed. Such technology rarely has a lien against it because it's very difficult to establish a dollar value, lawyers say.


  In the Rio Grande Valley town of Brownsville, Tex., bankruptcy attorney John Ventura doesn't see many dot-com cases. But he does get a lot of small-business owners who've piled up personal debt to finance operations. His troubled mom-and-pop clients have a few things in common, though, with their high-tech counterparts: "I see them both doing the same things," Ventura says. "They spend their money on things that do not produce income, and they have no concept of profitability."

They probably share something else, too -- credit-card debt, which is a factor in most small-business bankruptcy cases, Hammes says, adding: "The effect that credit-card companies have in helping small businesses go under is something that should be looked at."

As the bankruptcy numbers rise, while cash may be in short supply, there's apparently no shortage of scolding to go around.

By Theresa Forsman in New York