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2006 described as the year of ‘bankruptcy holiday’

To date, the changes in the bankruptcy law that went into effect in October 2005 as a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) have had a far greater impact than Hurricane Katrina on bankruptcy filings in Mississippi. There was a large spike in bankruptcy filings in the U.S. in October 2005, but filings in 2006 were only about a third of those seen in 2005.
Nationwide, there were about 458,406 consumer bankruptcy filings in 2005 compared to 150,844 in 2006. U.S. Bankruptcy Courts in Mississippi saw a similar spike in filings in October of 2005 followed by big declines in 2006.

“There was a flood of filings before the law changed,” said Andy Phillips, a partner with Mitchell, McNutt & Sams, P.A., Oxford, who primarily practices in the area of creditors’ rights. “Thereafter, it has dropped off. With the advent of the bankruptcy reform act and its effective date of October 19, 2005, the year of ‘06 has been described as a ‘bankruptcy holiday.’ For the Northern District of Mississippi, and for most jurisdictions throughout our nation, filings are significantly down. The requirements to file are stringent and some, including me to a certain extent, would say some requirements are unnecessary and simply don’t work in the ‘real world’.”

Phillips said as debtors’ counsel becomes more familiar with the new act, which is occurring, he believes that there will be a gradual and steady increase in filings, but likely not close to the historical yearly averages of the past.

“The clear downside to the new act is the overly burdensome requirements laid at the steps of debtors’ counsel to insure the accuracy of information provided by debtors they represent,” Phillips said. “In fact, that burden is so heavy that it has pushed many practitioners out of the field of bankruptcy.

“From a practical and creditors’ perspective, the new act appears to have eliminated some ‘serial filers’ who have, in the past, filed multiple petitions on the eve of foreclosures and/or repossessions with only the goal to stop these events, but not seriously seeking the relief and protection that the bankruptcy court can provide to debtors seeking a fresh start or an opportunity to reorganize.”

Steve Rosenblatt, who heads the bankruptcy practice division of Butler, Snow, O’Mara, Stevens & Cannada, PLLC, Jackson, said bankruptcy filings may be down so much in part because of a lot of misinformation.

“Some people think they aren’t entitled to file bankruptcy any more because of publicity about the bankruptcy amendment and how much harder it was going to be to file bankruptcy,” Rosenblatt said. “The new amendments in consumer bankruptcies affect those above the median income. Most of the folks who file in Mississippi will be below the state median income so they are not going to be significantly affected by the bankruptcy amendment.”

Fallout from Katrina

Thus far, Hurricane Katrina has not had a big impact on bankruptcy filings. Some studies have shown that there is a lag time of about 12 to 24 months after a natural disaster until the full impact is felt on a consumer level.

“During 2007, we’ll start seeing some of the impacts on consumer bankruptcy filings,” Rosenblatt said. “There has been a moratorium in effect on foreclosures on residential mortgages, and people have been waiting to get insurance and grant issues resolved. As the federal disaster money tap gets turned off and insurance proceeds are paid, banks and other lenders are going to have to start addressing the situation on home mortgages. I think we will see a rise in the number of state consumer cases that are filed.”

Rosenblatt said there is currently a lot of liquidity in the marketplace; right now lenders of all different shapes and sizes are fighting to put money in the marketplace.

“Frankly, that may have kept a lot of businesses propped up that wouldn’t have been propped up,” Rosenblatt said. “It is not ‘if’ but ‘when’ we will see a tightening in the credit market. My impression is that lenders used to be more willing to work out problem loans with their borrowers. I sense less of a willingness to do that generally now, particularly with non-traditional lenders. Loan-to-own lenders loan to get a foot in the door when their real goal is to acquire a business rather than loan it money. Those folks are going to be more focused on performance. It will be much less relationship based than the local bank where there has been a long standing relationship.”

One of the biggest mistakes businesses make is not getting help early. A lot of business problems out there could be addressed if the business owner went to a CPA or bankruptcy lawyer and said: “Here is my problem. Help me through this.”
“The problem often is when you get a case, it is pretty well messed up,” Rosenblatt said. “It is much harder to solve problems after the fact than prevent them. Problem loans can be restructured. Leases can be modified. I don’t know if it is a cost issue or a reluctance to address reality issue, but the fact is that most businesses wait too long to really seek help. And that help is not necessarily filing of bankruptcy. Usually that is a last resort.

“It is expensive process. It exposes the businesses to the scrutiny of creditors. There is a huge administrative burden in terms of money and the amount of time. Here is a company that is struggling to be profitable and run its business, so the owner is putting in a full day’s work. When he files for bankruptcy, in addition, to a full-day of work he must attend bankruptcy hearings, meet with creditors and with the Office of the U.S. Trustee. There is a time and administrative burden as well as costs that have to be paid as part of the restructuring of the company.”

Identifying problems

But sometimes bankruptcy is the only option when a business has too many creditors with divergent interests, and can’t get agreement from creditors outside of bankruptcy.

Doug Noble, a partner with Phelps Dunbar, LLP, Jackson, said when making a decision about filing for bankruptcy, it is important for businesses to look for indicators suggesting that problems exist in their operations.

“Examples of such problems are the lack of sufficient cash to effectively operate the business, the potential for an adverse ruling in pending litigation, a deteriorating customer base or increased operational costs and increased reliance upon borrowed funds,” Noble said. “It is human instinct to resist admitting that there may be problems in the business and to try to salvage the situation, but overcoming this instinct is the crucial first step.”

Noble said many times the circumstances that led to the necessity of filing bankruptcy were not in the control of the individuals running the business. The timing of when to file bankruptcy is different for each business. However, involving professionals (attorneys, accountants and consultants) early in the process and recognizing existing problems best positions a business for preparing for a bankruptcy filing.

“The important thing is to take a candid and honest assessment of your business, to remain apprised of the company’s true operational performance and to recognize that restructuring may be necessary,” Noble said.

Noble said their law firm has not seen a significant increase in business bankruptcies as a result of Hurricane Katrina. Chapter 11 filings on the Mississippi Gulf Coast — and across the country — are down from prior years, which have been attributed to the new bankruptcy act.

“The relief provided by government agencies and other groups has assisted in preventing the failure of businesses during the recovery process,” Noble said. “Consequently, the relief has prevented the prevalence of insolvency-related actions such as bankruptcies and foreclosures. The continued rising real estate values on the Mississippi Gulf Coast and the response of governmental authorities in the region have worked to chill insolvency-related procedures.

“Similarly, the ready availability of cash in the market from both banks and private equity firms is believed by many to be masking certain indicators that a business may be in need of considering a bankruptcy filing and this applies all across the country, not just our Gulf Coast. When these forms of relief are no longer available, we do expect to see some activity. But how much is unknown at this time.”

Another partner at Phelps Dunbar, Chris Maddux, said the first thing that any business operating in bankruptcy needs to understand is that they operate in a “fish bowl.”

“All business planning, expenditures and corporate decisions are subject to the scrutiny of creditors, the United States Trustee and the court in the bankruptcy process,” Maddux said. “It is important for the leaders of the company to be committed to seeing the bankruptcy process through. It is much more difficult to work in a troubled environment than it is in a positive, growing environment, particularly when so much time must be devoted to the restructuring process.”

He adds that while the bankruptcy process is subject to hard and fast rules, there is the opportunity to be creative if debtors will keep their options open and remain flexible.

“You never know which way a case will go, what opportunities may present themselves, or how the business climate may change during the course of the bankruptcy,” Maddux said.
Maddux agrees the new bankruptcy act has made it more costly and difficult for businesses to operate under Chapter 11.

“Certain creditor-friendly provisions, such as limiting a debtor’s options related to its real property leases and the time during which the debtor can formulate a reorganization plan, will make the process more difficult,” Maddux said. “The changes to the bankruptcy code also increase the cost of successfully completing the restructuring of the business. It has curbed the number of business bankruptcies filed because it is simply a more difficult process now.”

Contact MBJ contributing writer Becky Gillette at bgillette@bellsouth.net.


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