The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 affects small businesses at both ends of the spectrum. For growing companies, it gives them more power to recover bad debts. At the same time, it makes bankruptcy a larger liability for entrepreneurs and their investors.
"Any change that makes it harder to get out of debt makes life better for small businesses," says Luis Salazar, a bankruptcy attorney for Greenberg Traurig. "If you have a financially sound company, you are worried about collecting from other people. This law keeps them out of bankruptcy and makes them pay."
According to Mr. Salazar, the consensus opinion among bankruptcy specialists is that this is "the best bankruptcy act money can buy." During debate in the Capitol, Representative Bill Delahunt, a Democrat from Massachusetts, said the "act was written by and for the credit card industry, and they spent north of $40 million to make sure that they got what they wanted."
Lobbyists for the act included the American Bankers Association, the U.S. Chamber of Commerce, and credit card issuer MBNA. Congressman F. James Sensenbrenner Jr., Republican from Wisconsin and the act's main sponsor in Congress, called it "truly a bipartisan effort," although only eight Democrats appear among his 88 co-sponsors. However, the final 302-126 vote in the House and 74-25 in the Senate demonstrate support from both parties.
Under the new law, debtors who make the average income in their state won't be able to walk away from their debts easily. Also, the law restricts the wealth a bankrupt person can hide from creditors in home equity (see box, "New Regulations"). Currently, most people file Chapter 7 bankruptcy, which provides for a court-appointed trustee to divide the available assets among creditors. Chapter 13 bankruptcy covers people who own a home and may restructure the debt to pay off creditors.
"The new law drives people into Chapter13," says Mr. Salazar. "The underlying theory is that bankruptcy is abused, so the idea is to push people above the median income into Chapter 13. The court will decide if they are able to pay."
In general, the law focuses on consumer bankruptcies, which officially account for 98 percent of all filings. For example, of the 1.6 million bankruptcies filed last year, only 34,317 were business bankruptcies, according to the Administrative Office of the U.S. Courts. But a study released in June from the Ewing Marion Kauffman Foundation estimates the true number of business bankruptcies at 260,000 to 315,000. The discrepancy comes from the fact that nearly all small businesses start as sole proprietorships, meaning the business and the owner's personal finances are legally the same.
Rene Diaz, a California-based financial consultant affiliated with Fiducial, has seen many small business clients go under, and in every case they filed for Chapter 7 as sole proprietors. "When they order supplies, they might use personal credit cards. The vehicles for the business are in their names. So when the business defaults, they're still liable," he says.
The line between personal and business obligations often blur at the point of home ownership. Many state laws protect a person's home from creditors, but filers often abuse this so-called "homestead exception." Mr. Salazar says that Florida and Texas have reputations as homestead states. In the past, people have moved to these states, purchased mansions, and declared bankruptcy while protecting their wealth in the form of home equity.
