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Jennifer Emens-Butler
Business Bankruptcy Filings Expected To Rise

At least that is what all the national headlines say. The conventional wisdom is that both business and consumer bankruptcies are expected to rise, despite the intended deterrent of the new bankruptcy laws. Statistically, when comparing the current filing rate to that of 2004, prior to the passing and enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), filings of any kind are down approximately 60% from 2004. Because of the onslaught of bankruptcy filings just before BAPCPA's effective date and the mixed reviews of BAPCPA's effectiveness as a deterrent, it is next to impossible to predict the future of the bankruptcy case.

Most scholars, either through extrapolating data or by relying on a hunch, believe that bankruptcies are on the rise. In a study conducted by the American Bankruptcy Institute, 71 percent of the respondents of lawyers, bankers and investors indicated that an increase in corporate filings is expected within the next 6 to 18 months. See Report: Corp. Bankruptcies Set to Rise (AP business wire 11/8/06). In their on-line poll, 72% of respondents believe that mid-market business bankruptcies will substantially increase in 2007. Hyper-liquidity is to blame for the current lull, Attorney John Penn states, because too much money is chasing after few good deals. Weaker companies are being propped up, merely deferring the inevitable demise of the companies who are extremely over-leveraged, cites Penn. The focus has been upon continually fixing liquidity, rather than focusing on the underlying causes of the company's financial difficulties.

The proliferation of hedge funds and second tier financing has created a false sense of security in many marginally operating companies. When interest rates increase and the liquidity drops, it creates a snowball effect. Second lien financing, too, has increased from approximately $57 million nationally in 2002 to a whopping estimated $30 billion in 2006. See In the (RED): The Business Bankruptcy Blog, (Bob Eisenbach), citing That's a significant amount of risky investment in a reportedly declining real estate market.

One historically reliable indicator of upcoming bankruptcy booms is the default rate on speculative grade bonds, currently at 1.8% compared to the historical average of 5%. See Forbes, A Bankruptcy Boom Cometh (Hannah Clark) 12/06. As Clark reports:

Most experts expect the default rate to rise in 2007, reaching 2.5% to 3% at the end of the year. That still won't be a boom by historic standards, but it will feel like one compared with the bankruptcy holiday that defined 2006. The following year, however, is a different story. [Wilbur L.] Ross expects default rates to rise as high as 7% or 8% in 2008, and many restructuring experts agree. 'I think when [a correction] comes, and it is coming, it's going to be a big one,' says Jay Goffman, a partner in the corporate restructuring department at law firm Skadden Arps.

As Clark summarized, the highly-leveraged companies will have further to fall.

Should the scholarly predictions be taken to the bank? Many law firms seem to think so. The National Law Journal reported in July that the New York office of Skadden Arps intends to add 35 restructuring attorneys to their current level of 85 over the next 14 months, bringing them closer to their 2003 peak of 120 attorneys. With filings at an all time low, however, timing is everything. Smaller firms will have a difficult time bridging the gap, potentially until 2008.

But what about business filings in Vermont? National trends, like the stalled real estate market, seem to take at least 6 months longer to reach Vermont. Chapter 11 filings have been rare birds indeed for the past several years, with 1 filing in 2006, 1 in 2005, 13 in 2004, 6 in 2003 and 5 in 2002. The bulk of business-related filings in Vermont end up being either liquidations or reorganizations by the company's principals after certain failure. Many average sized Vermont companies simply fold, rather than incur the prohibitive costs of a Chapter 11 reorganization. Negative factors such as rising insurance costs and costs of fuel, as well as increased outsourcing and international competition are not likely to decrease. The importance of strategic planning in dealing with these factors cannot be overemphasized.

While a Chapter 11 filing may be cost prohibitive for many Vermont companies, the goal of restructuring should be the same: regaining control. When a company is struggling, it starts to lose aspects of control, through C.O.D. demands, litigation and increased rates. With a solid vision as to how to improve the underlying causes of the downturn, the company may be reborn like a phoenix, with or without the protection of the Bankruptcy Code. It is most important to nip the bleeding in the bud by engaging in negotiations sooner and by hiring competent professionals to assist with potential workouts and exploration of options-both in and out of court.

The information provided in this article is offered for informational purposes only; it is not offered as and does not constitute legal advice. Every situation is unique— you are encouraged to seek legal consultation to address your individual circumstances.