By John L. Duoba, Business Owner's Toolkit Staff Writer

Reform of the U.S. Bankruptcy code by lawmakers in the 107th Congress appears to be dead, or at least very barely breathing. This is a remarkable turn of events, given the efforts (read: money) expended by many special interest groups and the overwhelming support reform once had.

Both houses of Congress passed slightly different reform measures by rather large voting margins in 2001--making the rules stricter for debtors--and a conference committee was planning to unify the measures for the president's signature into law.

But it's clear now that the seeds of its eventual defeat were sown during the nation's economic downturn of 2001 and the aftermath of September 11. And recent acts by Congress seem to signal that now is not the right time to tighten the rules of bankruptcy.

A Sign of Things to Come?

The Senate on February 13, 2002, approved a federal farm aid bill (58-40) containing an amendment (passed 93-0) that would permanently reinstate special bankruptcy protections for farmers, under a provision called Chapter 12. The law granting these protections to farmers had expired in October of 2001.

Chapter 12, which used to be the only temporary chapter in the bankruptcy code, is tailored to help farmers reorganize debt. The newly passed bill also contains provisions that would reduce the capital gains tax for farm assets sold as part of a reorganization plan.

Lawmakers had previously addressed permanent extension of Chapter 12 in the larger bankruptcy reform packages passed in March of last year, but the conference committee designed to iron out the differences between the packages had been scheduled to meet September 12, 2001. It has been postponed indefinitely.

So, with no legislative activity on bankruptcy reform by Congress since early in 2001, and with less than nine months until the next national elections, Senate lawmakers moved quickly and tacked Chapter 12 onto the farm bill. It's likely they believed that overall reform of bankruptcy is too politically sensitive at this time, so they moved to fill the void created when Chapter 12 expired last October, waiting for the conference bill to emerge. The Chapter 12 extension bill now moves to the House of Representatives.

Reading between the lines, it appears a conference bill will not emerge before this Congress adjourns at year's end, otherwise the amendment to the farm bill would not have been necessary.

Reform's Long and Winding Road

This latest turn completes another "chapter" in the odyssey that is bankruptcy reform. Dating back to the mid-1990s, numerous reform efforts of the various types of bankruptcies have been attempted in Congress. At that time of great economic growth, bankruptcy filings had reached record numbers, and this fact made little sense to many, but especially the credit card industry. As unsecured creditors, credit card companies stood the most to lose from these record filings.

So during those boom days, the argument was easily advanced that we should crack down on those abusing the system, since most "everyday" people weren't in bad straits and, with times so good, didn't expect to be anytime soon. Intense lobbying and lots of cash got lawmakers' attentions, but repeated attempts were turned away by threatened or actual vetoes by then-President Clinton.

Then, with Clinton leaving office in 2000, those interested in bankruptcy reform saw an opportunity and launched an all-out assault on getting a measure rushed through a newly constituted Congress and signed by a new president early in 2002. Record amounts of campaign contributions funding record numbers of candidates poured in from the credit card, lending and banking communities.

They got their wish in March of 2001 when both houses of Congress passed bankruptcy reform measures, and new President George W. Bush pledged to sign the less debtor-friendly one. You know the rest of the story about the conference committee, the recession, September 11. . .up until now.

In the meantime, the support of those "everyday" people for reform has subsided, as many now find themselves facing uncertain economic futures; in fact, the number of U.S. bankruptcy filings in 2001 passed the all-time record set in 1998. Moreover, it seems many lawmakers and policy wonks have finally sat down to read the text of these measures, and a number of them are not happy about the reform measure they had once supported.

The Devil's in the Details

These reform bills would not have been good for small businesses--the backbone of our country's economy. Means-testing and mandatory repayment/reorganization of debts would all but eliminate the liquidation option of Chapter 7, the most common filing for small business owners. This leaves Chapter 13 forced reorganization as the only option. Effectively, this option would mandate that struggling businesses stay open, often ensuring more problems, when they likely should be liquidated.

This is because many debtors rarely complete Chapter 13. A five-year repayment plan just adds another bill to a debt load that the debtor has already admitted it can't handle. Yet, under the reform measure, the repayment plan stays intact--no matter whether your business eventually folds, your health deteriorates, or some other unforeseen problem occurs.

So unable to complete Chapter 13, and unable to choose liquidation because it's no longer readily available, a small business owner is often left with little protection under bankruptcy reform.

In addition, more and more entrepreneurs are using credit card debt to launch/fund their businesses. And the measure contained a provision that would allow credit card companies to get guarantees securing any balances before granting acceptance to potential customers, turning unsecured debt into secured debt. This type of leverage can be damaging to small businesses.

Moreover, this measure would have done little to improve prospects for small business creditors. Pursuing a claim on a bankrupt debtor is a time-consuming and expensive endeavor for a small-time operation without a staff of lawyers at its disposal. And usually, the small business creditor ends up at the back of the line with little chance of full collection, behind a number of secured creditors. The proposed reform would have added more secured creditors to the front of that line (such as credit card companies), pushing the unsecured small business creditors even further back.

On the other hand, as more details emerge, the measures would have been a boon to very large corporations, which certainly did their share of lobbying and giving when the language was being drafted. As an example, large corporate bankruptcies filing Chapter 11 (like the infamous Enron case) would be allowed to shield certain off-the-books transactions from bankruptcy courts under Section 912 of the House reform measure.

This section allows debtor-creditor deals to be struck without court supervision, giving preferential treatment to some creditors and reducing the overall collection of assets to be distributed among the other creditors. It also certainly would encourage more off-the-books transactions--precisely the type of accounting arrangement that brought down Enron.

And the Winner Is. . .

So, the previous year's negative national economic outlook, the current negative press coverage of the bills' details, and the soon-to-come negative election advertising have combined to snatch defeat from the jaws of victory for bankruptcy reform supporters. But regardless of the reasons, the good news is that important protections--designed as a last resort and a way out for those entrepreneurs willing to take a risk, start a business, employ workers, pay taxes--have been preserved.

It's also a win-win proposition for Washington's lawmakers. They avoid enacting what was sure to become a very unpopular measure, while at the same time they get to revisit lobbyists and contributors for more election money windfall in 2002. But be warned, after getting so close last time, those lobbyists and contributors are definitely going to want something in return next time.

Related items:

Record Bankruptcies Signal Changes To Come

Senate Passes Its Version of Bankruptcy Reform

House Approves Bankruptcy Reform Bill of 2001

President Vetoes Bankruptcy Reform Bill

Congress Agrees on Bankruptcy Reform Act; Veto Likely

Bankruptcy Reform Legislation of 1999 Stalls in Congress

Senate Approves Bankruptcy Reform Act of 1999, Includes Minimum Wage Increase

Decline in Personal Bankruptcies Downplays Need for Bankruptcy Reform Bill

House Passes Its Version of Bankruptcy Reform Act of 1999

Bankruptcy Reform Act of 1999 Introduced in the House

Bankruptcy Reform of 1998 Stalls in Senate

Senate Overwhelmingly Passes 1998 Bankruptcy Bill, Tough Conference Looms

Bankruptcy Reform Legislation of 1998 Approved by House; SBA Asked To Study Impact