Bankruptcy Law: Created to Benefit Us All

United States law allows every person and/or legal entity, such as a business, to trade, borrow and lend as it sees fit. This right is fundamental to our free-market system. It gives those who sell goods and services the freedom to offer “terms” – at their own risk. It gives lenders the right to lend – at their own risk. And it allows businesses and individuals to borrow and make promises to pay – at their own risk.

Our system works pretty well, but it’s not perfect. One example is when a debtor becomes unable to repay – temporarily or permanently. What if the debtor is a business that has promise and employs many but, if forced to pay as originally agreed, would have to close? Should the creditors hold the fate of the employees entirely in their hands? Or what if the debtor is an individual who could never earn enough to repay? Should the individual face a lifetime of insolvency – in effect forever losing his or her freedom to peacefully exist and have normal debtor-creditor relationships?

U.S. bankruptcy law was created by Congress under its Constitutional authority to “establish … uniform laws on the subject of Bankruptcy throughout the United States.” The purpose was to protect the debtors, creditors and related parties (such as employees and communities) in these extreme cases. Bankruptcy proceedings are supervised by and litigated in the U.S. Bankruptcy Courts, part of the U.S. District Courts.

There are two basic types of bankruptcy proceedings. A filing under Chapter 7 is called liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the appointment of a trustee who collects the property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy proceedings under Chapters 11, 12 and 13 involve the rehabilitation of the debtor to allow him, her or it to attempt to “get back on their feet” so that they can use future earnings to pay off creditors, pay taxes, provide jobs, etc.

In almost all cases, a trustee is appointed to supervise the assets of the debtor. A bankruptcy proceeding can either be entered into voluntarily by a debtor or forced by creditors. And various provisions of bankruptcy law establish the priority of creditors’ interests (i.e., the process for determining who gets what, when).

After a bankruptcy proceeding is filed, creditors – for the most part – may not seek to collect payment or seize assets of the debtor outside of the proceedings (i.e., without the approval of the bankruptcy court). And the debtor is not allowed to transfer property that has been declared part of the estate subject to the proceedings. Furthermore, transactions that occur – such as transfers of property, secured interests and liens – before a bankruptcy filing may be subject to reversal or invalidation to protect the original creditors.

And so, as described here, bankruptcy law is logical and unemotional, and provides a valuable service to debtors, creditors and our greater society. But to the people involved, such as the business owner “losing his business,” it is emotional, painful and perhaps even humiliating. If you are in this position, understand that:

• Bankruptcy exists to bring order and fairness.
• The decision to seek bankruptcy “protection” can be a rational, mature and even compassionate choice.
• If your business is failing, or is having financial difficulty, it can be less a reflection on you than on the situation you’re in.
• Good people can “go bankrupt.” It does not mean that you are less of a human being.
• Of course, maybe in hindsight, you could have, or would have, done things differently, but you did not have the benefit of hindsight before.
• If you’ve been holding on to a belief that you are incredibly smart or perfect, maybe it’s time to come to grips with the fact that you are human, just like the rest of us!
• This too shall pass and, likely, you’ll end up in a much better place (even though you can’t see it now).

If you think you may be facing bankruptcy or could become “unable to keep the doors open,” you need to talk to your banker, accountant, legal advisor and, if you have one, an experienced and trusted “business expert.” The best thing you can do for yourself and for your business is to face reality, get some help and some objective points of view, gather information and options, and come up with the most rational means for dealing with the crisis.

You also need to deal with your considerable stress in healthy ways. That is, engage in activities that reduce your stress and enhance your ability to manage it and its potentially debilitating side effects. For example, exercise and “talking it through with your advisors” are obviously healthier than keeping your problems to yourself and drinking too much.

Yes, your business may be failing, and you might even be facing personal financial failure, and it may all seem out of your control, but you do have control of your response. You can choose to deal with it in a way you can feel proud of, with dignity, honesty, humility, fairness and diligence. What more could anyone ask of you? What more should you really ask of yourself?