The new law cracks down on this practice, but legitimate businesses may get caught in the legal switch. Mr. Diaz says that when companies get in trouble, conventional financing often dries up. To keep the business afloat, the owner may tap his or her home equity. But in Mr. Diaz's experience, turnarounds never work for these firms, and both the house and the business debts become part of the bankruptcy.
The few business-specific sections of the new law deal with commercial real estate and international trade. "For small businesses with [commercial] real estate, the law will improve their control over recovering rent," Mr. Salazar says. In particular, the law sets time limits for a bankrupt tenant to decide on keeping a lease.
In international trade, the law brings the United States into alignment with a United Nations model for handling cross-border bankruptcies. Since Mexico was an early adopter of the U.N. model, this means "there will be certainty between the U.S. and Mexico in the resolution of disputes, because both nations have a similar statute," says Josefina Fernandez McEvoy, head of the Southern California bankruptcy and restructuring practice group at the law firm Squire, Sanders & Dempsey in Los Angeles. "I anticipate an influx of business and a lot of capital inflows to Mexico."
Operationally, "the new law changes the game because U.S. courts are authorized to cooperate and coordinate cross-border bankruptcies with foreign judges," which they could not do previously, according to Ms. McEvoy.
The new law makes it easier for small corporations to file under Chapter 11, the type of bankruptcy that allows firms to reorganize. "If you have debt below $2 million, you can do a small business Chapter 11 and it's easy," Mr. Salazar explains. He expects that the law will reduce the number of third-party lawsuits sur-rounding Chapter 11 bankruptcies, because the law requires these suits to be filed in the venue where the defendant exists rather than in Dela-ware, where most large companies incorporate.
While the new law gives businesses stronger collection rights, it might inadvertently discourage the formation of new businesses in the first place, according to the Kauffman study. "Our economic system needs to encourage entrepreneurs to make new investments. Sometimes these investments will fail through no fault of their owners, and when that happens, the owners need to be able to move to other businesses and create new jobs and investment opportunities," says Elizabeth Warren, co-author of the study and a professor at Harvard Law School.
"We need to appreciate the enormous risks that entrepreneurs take on, and the number of times many of them must try, fail, and try again until they hit the right idea at the right moment," explains Carl Schramm, CEO of the Kauffman Foundation. "Before taking final action, America's decision makers should be sure to assess the impact of proposed legislation on the thousands and thousands of entrepreneurs who create jobs and innovations, and who fuel our country's economic growth."
Despite the changes in bankruptcy code, one rule remains firm: You must pay your taxes, which Mr. Diaz says is often the largest single "debt" on the books. While individuals can escape with only paying three years of personal income taxes, businesses generally cannot avoid payroll and sales taxes. "I've seen cases with [unpaid] taxes over $1 million," he says. "You could have bills to pay for the rest
of your life."
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 contains these changes to current law:
RAISING THE BAR A new "means" test will determine if a debtor can afford to repay part of the debt. The test assumes people can repay if they make more than the median income in their state. (The national median household income equals $54,000 for a family of four.)
CREDIT EDUCATION To file for bankruptcy, a person must receive credit counseling within 60 days; to finalize the bankruptcy, the person must complete a financial literacy course. The idea is to help the debtor learn the U.S. financial system.
HOME EQUITY State laws protect from creditors some or all of the value of a primary residence, and debtors have taken advantage of this by buying big homes and then declaring bankruptcy. The new law restricts this "homestead exemption."
COMMERCIAL REAL ESTATE For commercial bankruptcies, the new law eliminates a $4-million cap on single-asset real estate cases, meaning that real estate holding companies or developers with large real estate holdings must put together a reorganization plan within 30 days or turn over properties to creditors.
TRUSTS Because debtors may use trusts to hide assets, the new law gives officials authority to void any transfer to a trust for up to 10 years prior to the bankruptcy filing.
Source: American Bankers Association
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