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Monday, March 29, 1999
 
Financing

Delaying the inevitable?

Chapter 11 bankruptcy can buy time for a struggling business, but the underlying problems must be solved

by Robert Marshall Wells
Seattle Times staff reporter

Many people dream of owning a small business. But sometimes things don't work out. When they don't, there are alternatives to closing up shop.

But none of these moves come without pain and consequences.

One option is filing for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code, designed to give financially troubled businesses a chance to reorganize and restructure their debts, preserve their employees' jobs and protect their shareholders' investments.

Some businesses eventually emerge from Chapter 11, but local bankruptcy attorneys say that more often than not, reorganization is little more than a last-ditch attempt to delay the inevitable.

"It's a business emergency room," Seattle bankruptcy attorney Dillon Jackson said of Chapter 11. "You don't want to be there. The question is, 'Does Chapter 11 help save a business?' The track record is not very good."

From the perspective of a troubled business, it's easy to understand why Chapter 11 can seem appealing.

Nearly all legal action and collection activities must stop when a company files for Chapter 11, giving businesses time to assess their situations and negotiate with their creditors.

Generally, a court-approved plan is worked out so the business can continue. A business eventually can emerge from Chapter 11 once it has shown it can fulfill the goals set in the reorganization plan.

But companies in Chapter 11 must keep up with their current debts and normal operating costs, and make quarterly compensation and reimbursement payments to their attorneys, accountants and others whose services they use.

In some cases, creditors whose interests are backed by tangible assets such as business equipment or vehicles can obtain court orders allowing them to foreclose on the property, sell it and use the proceeds to pay off debts.

For those reasons, Renton bankruptcy attorney Joy Lee Barnhart said, many businesses that find themselves in such situations are all but doomed, usually because they have waited too long to seek help.

"Small-business people tend to be fairly independent," Barnhart said, and "it's difficult for them to admit that they're over their head."

In general, Chapter 11 cases can take one to three years or more to resolve. Businesses that emerge intact from Chapter 11 still tend to fail in the long term, making it difficult to quantify successful reorganizations.

Rough estimates among local bankruptcy attorneys are that well less than 50 percent of Western Washington businesses that file for Chapter 11 ever return to viability.

"Unless the owner can solve the problem that caused the . . . insolvency," Jackson said, "Chapter 11 isn't going to help. They have to solve the problem that got them into Chapter 11."

If they don't, the next step could be liquidation.

One recent example of that was Kentucky-based retailer J. Peterman, which entered Chapter 11 in January but was soon forced into liquidation.

Ernst Home Center, which operated a chain of home-improvement stores, was another business that entered Chapter 11 but never emerged.

On the bright side, perhaps because the economy has been healthy, Chapter 11 filings in Western Washington have been in decline recently. In 1998, 189 Chapter 11 cases were filed out of more than 25,000 total bankruptcies in Western Washington. That represented nearly a 29 percent decrease from the 265 Chapter 11 cases filed in 1997.

Lawrence Engel, a veteran attorney who once clerked in Western Washington's bankruptcy court, noted that Chapter 11 does not allow businesses to get off cheap.

Court costs, attorneys fees and various other payments often can total from $10,000 to $25,000 or more, depending on the case.

Chapter 11 filings can be further complicated by such issues as unpaid back taxes, market pressures, poor management practices and personal problems, including divorce.

"Many of these cases fail. And a lot of them fail because a leopard can't change its spots that quickly," Engel said. "You're trying to engage in behavior modification and it doesn't always work. People try their best. But sometimes, that's not good enough."

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