Bankruptcy Law: Filings Rise

By: Joseph J. Wielebinski (Co-author) and Jay H. Ong (Co-author)
Texas Lawyer
December 22, 2008

In 2008, business and consumer bankruptcy filings are rising dramatically after a historic lull occasioned by the confluence of the 2005 overhaul of the U.S. Bankruptcy Code, unprecedented credit availability and an irrational perception of unending prosperity. To experienced bankruptcy practitioners, the current economic downturn has a unique feel and an ironic twist.

As to the former, the spike in bankruptcies is not (yet) commensurate with the severity of the problems facing the economy, albeit the current cycle already has witnessed the demise of Lehman Brothers Holdings Inc., a venerable Wall Street investment banking firm, and the possibility that the big three automakers are next. Business bankruptcies also are producing an unusually high percentage of liquidations. Widely reported examples include Linens 'n Things, Sharper Image, Whitehall Jewelers and Circuit City.

One reason for this change is that businesses and consumers became overleveraged and vulnerable to the extremely rapid evaporation of credit and accompanying devaluation of assets. Not only are they now unable to obtain credit to stave off bankruptcy, but also debtor-in-possession financing and deep-pocket buyers are almost non-existent. Moreover, the onerous requirements placed on debtors under the 2005 Bankruptcy Code amendments have undermined debtors’ and bankruptcy courts’ flexibility. Bankruptcy therefore becomes a less effective tool for the restructuring and repayment of debt.

The irony is that the champions of the 2005 amendments to the Bankruptcy Code were financial institutions and credit card companies. To them, bankruptcy was a too-convenient weapon for debtors to shed legitimate obligations, purportedly resulting from poor decisions, indefensibly risky behavior and rampant abuse. Despite the warnings of experienced practitioners and knowledgeable experts, a heavily lobbied Congress decided to enact broad changes that weakened bankruptcy relief, imposed unmanageable preconditions and removed discretion from a competent judiciary.

It appears these financial behemoths adopted the same conduct they argued had crippled the U.S. bankruptcy system: indefensible risk with inadequate controls, poor decisions and rampant abuse. However, even with bankruptcy being more onerous and less flexible, the debt burden has become so overwhelming that filings are rising significantly, according to a late November daily newsletter from the American Bankruptcy Institute. While these debtors have to deal with the consequences of their actions and a weakened safety net, the financial giants have collapsed but were rewarded with a $700 billion bailout by the federal government. The sponsors of the recent bankruptcy amendments purportedly designed to discourage unreasonable risk-taking and minimize the social impact of free rides for debtors just received the most expensive and lucrative free ride ever. The irony is sadly overwhelming.

Each day brings new financial challenges and a myriad of costly measures to attempt to address the growing economic problems. One simple, equitable and cost-effective approach that policymakers are only now seriously considering is to undo some of the ill-conceived changes to the Bankruptcy Code. Perhaps this time, Congress should take a less myopic, lobbyist-sponsored analysis and approve amendments that might actually help debtors who are attempting to repay their obligations without government handouts.