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Why Bankruptcy Works

A U.S. bankruptcy judge fields questions from a senior Inc. writer and explains why bankruptcy laws work.
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When James A. Goodman graduated from Boston University Law School, in 1961, businesses were borrowing at rates of 30% and falling like flies. Goodman went back to his hometown of Bangor, Maine, and hung out his shingle as a solo practitioner. He took on whatever legal work came his way, including acting as a court-appointed trustee in an increasing number of bankruptcy cases. He was appointed a U.S. bankruptcy judge for the District of Maine in 1981 and has been the court's chief judge since 1990.

Q. The U.S. Constitution holds that Congress shall provide for a uniform bankruptcy act. Does it strike you as odd that We the People forgive debt as a national policy?

A. Not at all, considering this country was founded by debtors. They came from places where they were put in jail because they owed money. Our forefathers didn't want commoners like themselves thrown into debtors' prison if there was some other way out.

Q. And there is: Chapter 11. But statistics show that reorganizations aren't effective. Aren't you disappointed that 80% ultimately fail?

A. If a doctor had a 20% success rate with terminal cancer cases, you'd say, "That's incredible!" Well, that's what we've got--companies that are terminal. We take the nearly dead and show them how to operate better, and one-fifth survive. What's wrong with that?

Q. Yet people argue that Chapter 11 coddles poor management--that if a business is failing, let it.

A. There are many reasons why a business gets sick, but they don't necessarily mean it should be destroyed. Hundreds of thousands of businesses that at one time or another had financial difficulties survive today as the result of Chapter 11 proceedings. They continue to contribute to employment, to tax revenues, to overall growth. It's counterproductive to destroy the business value of an asset by liquidating it and paying it out in a Chapter 7 if that company shows signs of being able to recover in a reorganization. As for creditors, one of the provisions of the bankruptcy code is that in order for a reorganization to be confirmed, the creditor must get not less than he or she would have gotten in a Chapter 7 liquidation. So why not go through with the reorganization?

Q. In small businesses, most of the time, management is also ownership.

A. Then you take the owners, put them through a Chapter 11 case, and in the process try to train them to become better managers.

Q. How?

A. The Chapter 11 experience itself is the best teacher. The management is made to do things it never before knew it was supposed to do. Once people have gone through a Chapter 11 and been subject to the requirements of the U.S. Trustees Office--they have to file certain monthly reports, their accountants show them accounting processes, and their lawyers teach them about customer and employee relationships--those people are no longer such bad managers. Do you know how many businesses there are that if you walked in and asked if they had a profit-and-loss statement, they'd ask, "What does that mean?" Or a balance sheet? Or, how many have no idea how much inventory they should have? Maybe they have $100,000 in inventory, which they're turning over only once a year. You show them that if they had only $20,000 in inventory and turned it over five times, they'd make a lot more money. They don't understand the simplest concepts. The greatness of our system is that anyone can start a business. Sure, we have our failures, but so what?

Q. Occasionally, there are notices in the back of newspapers about entire companies up for bid in bankruptcy court. Can such a business be acquired relatively cheaply, as opposed to starting one from scratch?

A. Absolutely, if you're astute enough to know something about the industry. It's a way to make some very good money.

Q. Can an outsider buy the assets of a going business for as little as, let's say, a dime on the dollar?

A. I've seen it happen. But I've also seen that you can pay a dollar and a half on the dollar if another party has the same interest you do. There may be some reason why it's more valuable to that person than to somebody else. I had a case in which a party was trying to buy a business that serviced a certain airport. Another company in the same industry, one that didn't serve that airport, also wanted the business, and the two bid it up from $400,000 to $1.8 million!

Q. In your view from the bench over the past 15 years, what major change, if any, has struck small-business operations?

A. No question: easy credit.

Q. And that's what gets them into trouble?

A. No, it's absolutely favorable. From my recent experience teaching in Eastern Europe, I found the one thing that's holding back economies there is that no one can buy their goods because people don't have any money. No one can borrow money--not industry, not consumers.

Q. Are there things you see many small businesses do wrong?

A. My experience is that the largest percentage of bankruptcies are due not to poor business management but to outside conditions be-yond the owners' control. Take fuel prices. Everyone is aware that an increase in fuel prices affects airlines adversely, so you can expect a round of ticket increases. But what about small businesses that manufacture or sell snowmobiles? Or boat makers, who rely on reasonable prices for petrochemicals? What about greenhouses heated by oil? I had a greenhouse that went down the tubes the moment oil prices went up, but it had been a profit-making business until then.

Q. You say there are fewer small-business bankruptcies now. Is it possible that companies are simply giving up the ghost outside bankruptcy statistics?

A. That's possible. What bothers me about small corporations---many of them mom-and-pop operations---is that the remedy of a Chapter 11 is too expensive for them. I'm concerned that the changes have not kept up with the needs of the small debtor.

Q. Since you've been on the bench, have creditors gotten more tolerant of a small business's problems?

A. They've become amazingly understanding. They now accept that the law gives a debtor, as well as creditors, certain rights. They recognize that it can be more profitable to work with the debtor within the bounds of the law and that they're likely to receive more than they would if they pressed the debtor into foreclosure.

Q. Now there's enlightenment!

A. No question about it.

James A. Goodman was interviewed by senior writer Robert A. Mamis.

Last updated: Oct 1, 1996




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