Recession
Bankruptcy – A Second Chance!
By Thomas O’Malley
May 25, 2010 - 3:22:00 PM

The current downturn and its impact on business activity have resulted in a high rate of business failure both personal and corporate. This is notwithstanding that the individuals and companies involved acted honorably and honestly in their business dealings. Traditionally there has been a greater stigma and sense of shame associated with financial failure in Ireland, the UK and other European countries.

In contrast if a business fails in the United States, the individual can move on with his or her life without living in shame or total poverty. The ability to start over is what makes Americans willing to take risks in business. This in turn is good for the economy. The US relies heavily on the use of credit by individuals and businesses to fuel its economy. The US has forgiving bankruptcy laws that protect individuals and businesses if they become financially insolvent. For individuals, there are two main types of bankruptcy Chapter 7 and Chapter 13. Chapter 7 allows people in financial trouble to “discharge” or “be forgiven” most debts for which there is no collateral security (property etc). This type of bankruptcy does not help a person where the borrower has pledged collateral, such as property.

Chapter 13, allows people in financial trouble to pay back a portion of their debts through a payment plan extending over three to five years. At the end of the period, assuming the debtor has contributed all of his or her disposable income to the payment plan, the remaining debts are forgiven and the collateral security retained.

For businesses Chapter 11 applies. This may allow the company to continue in business while they reorganise their debts. Thus, unlike most bankruptcy systems around the world, US laws allow a bankrupt company to continue in operation, with the same management, while it tries to restructure its debts. In other words, typically, no trustee or custodian (analogous to an Examiner) is appointed. Some people think this system, known as a debtor in- possession system, promotes economic and job growth because more companies remain in business and their assets are protected. Businesses can also avail of Chapter 7 to liquidate assets and use sale proceeds to pay creditors.

As such these laws support capitalism and the growth of small businesses by encouraging people to take business risks. The US regulatory framework encourages people to set up in business, with the hope that they will succeed, hire employees, pay taxes and benefit the economy as a whole. There is an acceptance that in the process some business ventures will fail. Culturally, the US values a person’s willingness to risk his or her job and money (including borrowed money) for the chance to succeed.

Examples of early failures include ketchup magnate John Henry Heinz and Henry Ford of Ford Motor Company. These men eventually became very rich, in part because they were given a chance to try a business, fail and start again. There is much less stigma associated with a failed business in the US. Employers may consider an employee from a failed company to be more valuable because of the lessons learned. It is the culture of being able to start again that makes Americans willing to take risks in business. Bringing this back to an Irish context means that we must revise our attitudes to and sanctions for business failure. If we are not prepared to adopt a more enlightened approach we will discourage entrepreneurs from starting up indigenous businesses which have potential to grow and provide employment in local communities and thus contribute to the recovery of the Irish economy.

The SME sector numbers 230,000 and it is this group which has borne the brunt of the recession. If we do not afford a second chance to those who have failed honestly in the current economic crisis, we will exclude those who have the courage to take risk. The Government through Nama has recognized the systemic importance of the banking system and however it is dressed up there is an element of “forgiveness”. Unless there is a more forgiving attitude to financial failure by society and reflective in the bankruptcy laws, existing and upcoming entrepreneurs will be loathe to take risks involved in establishing a new business. This will ultimately be to the detriment of the Irish economy and slow down recovery.

Thomas O’Malley
Managing Director
Property and Banking Unit
t: 01 828 0622
F: 01 8280614

mail: tomalley@mcdowellpurcell.ie
Website: www.mcdowellpurcell.ie