The New York Times, July 2005
By Louis Witt

Listening to Rick Girard describe his bustling landscaping business outside Orlando, Fla., as one of the state's largest, you might not guess that his first lawn care venture was a bust.

He started it in 1989, when he was 19, and shut it six years later, letting 30 workers go and filing for bankruptcy protection from creditors. Though his company was growing, it could not pay its bills. Like many young entrepreneurs who lack a track record, he had personally guaranteed much of his company's debt. "Overcoming the stigma of bankruptcy was almost the hardest thing I had to do," he said.

Afterward, struggling on a $32,000 salary, Mr. Girard borrowed $1,000 from his father-in-law, bought a truck, and started another landscaping business with some partners. That one also ran into problems, and in 1998, he formed one with his brother Randy.

Learning from his mistakes, he has since built Girard Holdings into a $16 million operation, with 220 employees, garden centers, landscaping services and a pool-and-patio business. Along the way, he paid off his old tax bills and his debts to his grandfather (who had mortgaged his home) and his cousin.

He even paid back most of his creditors, although his debts to them had been discharged under Chapter 7; some of them are now his best clients. "I wasn't mature mentally to fight myself out of a hole," he said. "Bankruptcy allowed me to get out of that hole."

Mr. Girard's experience is apparently much more common than the policy makers in Washington might think. A study commissioned by the Ewing Marion Kauffman Foundation in Kansas City, Mo., which supports entrepreneurial education, found that almost one in five Americans who filed for personal bankruptcy protection in recent years had operated businesses - small companies, home enterprises or start-ups - within two years of filing for bankruptcy.

Many of them had incorrectly filled out their paperwork, so the government mistakenly counted them as individuals, not businesses. In many more instances, the study showed, they had been classified as individuals by a computer software oversight.

The study's findings raise the possibility that the bankruptcy law President Bush signed in April, and which is to take effect in October, may have damaging ramifications for the nation's entrepreneurial culture.
Instead of cracking down almost entirely on careless consumers who cannot pay credit card bills, the study indicates, the legislation threatens to hobble untold numbers of entrepreneurs and small-business owners caught in financial setbacks.

"All laws have unintended consequences," said Robert Litan, vice president for research and policy at the Kauffman Foundation. "The only question is how significant they are. In the case of the new bankruptcy law, all I can say is that it may turn out that one of the unintended consequences of the law will be to erect roadblocks for new business formation."

Congress wrote the Bankruptcy Abuse Protection and Consumer Protection Act of 2005 based on data from the Administrative Office of the United States Courts showing that individual filings as a percentage of all federal bankruptcies have steadily risen in the last 20 years, while business filings have precipitously declined from a peak of 18.3 percent in 1985 to 2.1 percent in 2004.

But the Kauffman study, written by Elizabeth Warren, a Harvard law professor, and Robert Lawless, a law professor at the University of Nevada, Las Vegas, concluded that if entrepreneurs and small-business owners had been properly classified, the rate of business bankruptcies in the United States would have remained steady at around 19 percent over the last two decades.

Bankruptcy lawyers and scholars have known that many individuals who file for bankruptcy are businessmen and women. "It's doesn't divide so neatly into consumer and business bankruptcies," said Jay L. Westbrook, a business law professor at the University of Texas at Austin.

Professor Westbrook's own studies show that as many as 20 percent of consumer filings may be business bankruptcies. "It's not just the Enrons of the world and the Jay Westbrooks," he said. "In the middle, hundreds of thousands of others go into bankruptcy starting their own businesses."

The Kauffman study discovered why the government had undercounted entrepreneurs to such a large degree: a computing error. In the mid-1980's, the bankruptcy court system's records began to be computerized, and the most common software programs defaulted to individual settings. The error often went uncorrected.
"The model that Congress used for writing the bankruptcy law - a growing number of consumers and a rapidly shrinking number of entrepreneurs and small-business owners - was simply wrong," said Professor Warren. "It's bad policy on lots of levels."

The new law will make it harder for all individuals who file for bankruptcy protection to discharge their debts and get a fresh start. It takes away some of the bankruptcy judges' discretion in settling cases and sets up a two-part means test.

Under the test, if a debtor's expenses are considered excessive, and his income is deemed to be high, then he will most likely have to file under Chapter 13 and enter into a five-year plan to pay back his creditors.
If an individual must drastically reduce expenses to pay off creditors, he may have to sell his home, sell his car and stop paying for his children's education. Some states have what are called "homestead exemptions," but they do not usually cover the full value of the house. "It's pretty draconian," said Harry Sommer, president of the National Association of Consumer Bankruptcy Attorneys.

That will be especially so for entrepreneurs who finance start-ups with credit card debt or home mortgages, or borrow money from family members and friends. Without profit - or sometimes even revenue - and no business track record, it is often next to impossible for them to secure traditional bank loans.

They often plunge ahead anyway because they hold a passionate belief in their products, a mark of the entrepreneurial personality.

Consider Chris Ashton, 35, and his wife Natasha, 31, who raised money from angel investors and expect to obtain venture capital to finance an insurance program for pets, to begin in October under the name Petplan USA.
They have been able to get nothing from the banks, however, and to cover expenses they have racked up $60,000 in debt on their credit cards.

"The reason that I'm prepared to do that is because I believe so strongly in the business, and I think that we'll be able to pay off the credit cards before we go bankrupt," Mr. Ashton said.

Greg Jordan, a bankruptcy lawyer with Dykema Gossett Rooks Pitts in Chicago, spelled out the implications of the new law for people like the Ashtons. "It's not going to stop people from starting their first business. Entrepreneurs tend to believe that they will beat the odds," he said. "But it will stop them dead from starting a second one."
It probably would have stopped Tom Lange from getting back into the game. To escape the debt he held after he and his brother sold two funeral homes to a Canadian company for stock that later became worthless, Mr. Lange filed for Chapter 7 protection against creditors six years ago.

With the debt written off, the move enabled him to start another funeral home, in Centerville, Iowa, in 2000. If he had been forced to pay off all his debts, Mr. Lange, 51, said he probably would have had to uproot his family to find work.

Today he has a full-time funeral director and seven part-time employees, and his business is thriving.
"If it wasn't for the bankruptcy law, I don't know what would have happened," he said. "I was able to clear off my debt and get back on my feet."

Proponents of the bankruptcy revisions are not concerned that many individuals who file for bankruptcy protection may be entrepreneurs or small-business owners.

"I support entrepreneurship, it's important to the foundation of America, but I also want to promote responsibility and fairness in the bankruptcy system for all parties," Senator Charles E. Grassley, Republican of Iowa and the legislation's sponsor, said in a statement.

Philip Corwin, a lobbyist for the American Bankers Association, said: "These folks chose to borrow as consumers and not as businesses. If they have the ability to pay a substantial amount of what they borrow, then why shouldn't they?"

Once politicians, business leaders and entrepreneurs realize the new bankruptcy law may hurt business formation, Professor Warren said, they might prod Congress for revisions.

"People may be on board when they don't have accurate information," she said. "But that doesn't mean that they will stay on board when they find out the truth."