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Some Thoughts on Bankruptcy

It's unfair, but ....

by Mike Hartnett (January 7, 2008)

Junkitz filed for Chapter 7 bankruptcy – liquidation – just before Christmas, and once again I've received complaints from suppliers venting about the unfairness of it all. I've written a lot about bankruptcy over the years and I've never figured out if the bankruptcy laws make sense or could be improved.

Retailers close their doors without paying vendors and vendors walk away leaving their suppliers in the lurch. Banks and credit card companies loan money to consumers and encourage them to spend, spend, spend, then scream when those customers are bankrupt.

And it's not just small companies. Rag Shop was a major chain in the East; a couple of years ago it told its vendors if they didn't take 25 cents on the dollar as payment, the company would shut down like Junkitz. The vendors reluctantly agreed, saving Rag Shop about $8 million. Then 14 months later Rag Shop shut down anyway, and this time vendors will probably get nothing.

1. It's unfair to creditors. Absolutely no question about that, but look at the larger picture: keeping a company afloat saves jobs. When Ames was in Chapter 11 (reorganization), it was reported that by staying in business, Ames was keeping as many as 10,000 people employed.

But the articles never checked to see how many employees of Ames' vendors were laid off because Ames only paid pennies on the dollar.

Ames emerged from bankruptcy, then went bankrupt again a few years later. This time it closed its doors and eventually led to the demise of Craft World, once the industry's largest distributor, whom Ames stiffed for $1.3 million.

2. Secured creditors and lawyers. It's unfair that they get paid in full before the unsecured creditors (the vendors) receive a penny. But stop and think: banks wouldn't loan money if they weren't assured they'd be first in line when a business fails.

The bankruptcy laws, like so many other laws, are endlessly complicated. No bankruptcy case would ever be resolved without lawyers, and no lawyer would take a case if he thought he wouldn't be paid.

Years ago when I was editor of Craftrends, I was asked to serve on the unsecured creditors committee for a large industry company, which owed Craftrends for some advertising. I thought serving on the committee would be interesting and agreed. It took an enormous amount of time, mostly conference calls, but what truly shocked me was the amount of paperwork. It seemed like any time someone sneezed, a lawyer would send us a report. By the time the case was resolved, I had a stack of paper almost a foot tall.

Bottom line: Craftrends received virtually nothing.

Occasionally a CLN subscriber has declared bankruptcy and listed CLN as a creditor because the company owed for its subscription. Then I receive letters from the court about the case. I'm sure it cost more for a lawyer to send me those letters than it would have been to pay for the subscription in the first place.

3. The 90-day payback is unfair. A portion of the law requires any vendor who received a payment within 90 days of the bankruptcy filing should pay that money back to the bankrupt company, even if the creditor is still owed thousands – or millions.

Here's the rationale: Suppose I have a business that's not going well and I'm afraid I'll end up in bankruptcy. I have a vendor, Vendor A, who is a good friend and I don't want to see him hurt any worse than possible. So I pay him what I can, and ignore Vendors B, C, and D. Then I file for bankruptcy. That's human nature, but is it fair?

So every creditor is supposed to return any payments received during that 90-day period. Then the court collects all that money, sells the company's assets, and then divides it among all of the creditors.

That's fair, but the poor vendor who was owed $10,000, received $50 prior to the bankruptcy, then received a letter from a lawyer demanding the vendor pay back the $50. "It's like they stick the knife in with the bankruptcy," one exasperated manufacturer told CLN, "then they twist the knife demanding the money back."

Meanwhile, the lawyer probably charged the court $50 to write the letter.

Years ago I wrote a column about the 90-day requirement and received a panicked phone call from a small vendor who somehow had received a payment from a chain in trouble. "If I have to pay that back, I'll lose my house," she said.

The chain hung on a few months longer before filing for bankruptcy, so the vendor's house was saved. Later the vendor sold her company, which today is one of the leading brands in its category.

So, any ideas about how to improve our bankruptcy laws? Email your thoughts to CLN at mike@clnonline.com. I'm all ears.

(Note: To read previous Business-Wise entries, click on the title in the right-hand column.)

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