The ABCs of bankruptcy By Timothy Nixon News-Chronicle There are growing signs of economic recovery in the United States. Yet, at the same time, bankruptcy filings continue to increase both nationally and close to home. In fact, during the first eight months of 2003, the number of business bankruptcies in Eastern Wisconsin doubled over the same period in 2002. Can the increase be blamed solely on the economic troubles we may now be leaving behind? Probably not. While the general economy always will be a factor in the number of bankruptcies, it also is clear obtaining credit is easier than ever and overextending one's budget is a common problem in consumer bankruptcies. On the business side, the high cost of health care has had an impact. In addition, the "stigma" that once may have attached to filing for bankruptcy has been minimized somewhat because of the increasing numbers of corporate and consumer bankruptcies. Most people continue to fly United Airlines and shop at Kmart. The fact is more and more people and businesses now view bankruptcy courts as a way to right a listing if not sinking ship and save jobs. For those guiding struggling companies - and those dealing with customers or vendors that are struggling - it's critical to understand bankruptcy law basics. For more than 100 years, bankruptcy laws in the United States have served a dual purpose - to help those who cannot pay their debts or obligations and to help creditors from suffering total loss by creating an orderly and "equitable" method for recovering on debts. U.S. bankruptcy laws have a seemingly "pro-debtor" feel to them because many of our ancestors escaped Europe where "debtors' prisons" provided the only "fresh start" in town. The three primary forms of bankruptcy are - Chapter 7 - In a Chapter 7 bankruptcy case ("straight bankruptcy"), assets, if any, are liquidated by a Chapter 7 trustee and the proceeds are distributed pro rata to the unsecured creditors. - Chapter 13 - Chapter 13 bankruptcy is meant for individuals. In general, the trustee does not liquidate assets - there is a court-approved plan that is funded from future disposable income of the debtor that pays creditors some or all of the debt. - Chapter 11 - A Chapter 11 bankruptcy usually involves the reorganization of a business. A plan of reorganization sets forth how the debtor will pay its creditors (both secured and unsecured). Typically the business continues to operate while the case is pending. What can filing for bankruptcy mean for a company that is on the rocks? A Chapter 11 bankruptcy can buy time, giving the company's management a chance to reorganize and turn things around. But it must be done carefully, with solid advice and with a sufficient cash flow to permit a company to weather the financial storm. For many companies there is no prospect for reorganization, only an orderly liquidation. Once a company files a bankruptcy petition, an "automatic stay" takes effect. In essence, this statutory provision gives the company breathing space from its creditors. It prohibits creditors from commencing or continuing lawsuits of almost any nature against the debtor, prohibits any and all collection efforts and prohibits any act to obtain property of the bankrupt firm. In essence, it provides protection and time to give the company's management the opportunity to restructure and reorganize. After a company files bankruptcy, it generally obtains court permission to purchase goods and services. Companies doing business with a corporate debtor after the beginning of the bankruptcy have a high probability of being paid. Yet, the Bankruptcy Code prohibits the bankrupt company from paying virtually any debts that accrued before the start of the bankruptcy During the bankruptcy process, creditors file claims for the debt that is owed. Those claims fall into several categories - secured, unsecured, undersecured, priority and administrative and contingent. The type of claim and the reorganization plan are key factors in the percentage of the claims that are paid through the U.S. Bankruptcy Court. Generally, unsecured creditors receive little or no return. The real value of the process lies in "recycling" the assets so that the company can become, usually under new ownership, a profitable employer and player in the economy. While more and more companies are turning to bankruptcy court, it is not the answer for all businesses. It's critical to completely understand bankruptcy laws and seek expert advice on whether bankruptcy is a viable option for your company. Bankruptcy is a world where many commonly understood business rules do not apply. Make sure you have an expert to guide you. This is particularly true when you are drawn into large cases in New York, Chicago or Delaware as has happened this past year to many Northeastern Wisconsin businesses. Timothy Nixon is an attorney with Godfrey & Kahn S.C. in Green Bay and is head of the Business Finance & Restructuring team.