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Tess Vigeland: It’s easy to get lost in financial statistics, but here’s one that stands out even in this economic era: Last month an average of 5,000 a day filed for bankruptcy. They asked for either chapter 7 or chapter 13 protection.
Meanwhile, just this week the Tribune Company, KB Toys, EZ Lube and the Baltimore Opera, among others, filed for chapter 11.
Someday we’ll be able to turn the page on all this, close the book on the crisis of ’08, but until then, it might be helpful to know just what we’re talking about when we cite the B word.
Here’s Marketplace’s Sean Cole with chapter and verse.
Sean Cole: To sort through all of this chapter business, I paid a visit to Richard Gottlieb. He’s a bankruptcy lawyer in Boston and he showed me a big thick red book.
Richard Gottlieb: This is the Bankruptcy Code and Rules.
Cole: Good God.
Gottlieb: That’s the ’07 edition. This is the compact version.
Cole: Oh wow.
Open it up and there’s a bunch of weirdly numbered chapters.
Gottlieb: 1, 3, 5, 7, 9, 11, 12, 13, 15.
The first few chapters define and lay out the provisions of bankruptcy. 7, 11 and 13 are the most common forms of bankruptcy, and if you study them closely, they tell a story:
Once upon a time, in a town called Horrible Recession, there was a three-story building, also known as…
Gottlieb: Mrs. Jones’s house, where Mrs. Jones lives on the second floor. She has a tenant living on the third floor.
Gottlieb: Saul! Yeah. Saul lives on the third floor.
And he was no stranger to misfortune: Laid off. His unemployment had run out.
Gottlieb: He says, “I owe $2,000 to my landlady for two months worth of rent. I’m being sued also by the Bank of No Equity Visa for their $15,000.”
Plus he owed the IRS a few thousand bucks for… let’s just skip ahead to chapter 7.
Gottlieb: In a Chapter 7 bankruptcy case, what drives the distribution of money to creditors is the liquidation — turning into cash — those assets of the debtor that have a substantial value.
So Saul files Chapter 7 even though he has no substantial assets — most chapter 7 filers don’t. He has some money left in his IRA, but the government lets him keep that so he can make a meaningful fresh start. So, but for the lawyer fees, Saul pays nothing, his debtors get nothing and over the next year his credit score is actually likely to rise. After all, he’s debt free now.
Now this might sound like an overly rosy portrait of bankruptcy, but Gottlieb says too many people think of bankruptcy as a disaster.
Gottlieb: Bankruptcy is not the Mark of Cain. It’s not the Scarlet Letter. Nobody puts a “B” on your forehead and says, “Ooh, there goes the bankrupt person.” No, bankruptcy is nothing more and nothing less than a form of financial redemption for both individuals and for businesses.
Which brings us to Chapter 11.
Gottlieb: Chapter 11 is a business reorganization.
And on the first floor of Mrs. Jones’s building there was a business called…
Gottlieb: Teddy’s Internet Cafe
Cole: And Haberdashery.
Gottlieb: And Haberdashery, Inc.
No stranger to misfortune was Teddy, in part because his business was ridiculous.
Gottlieb: Many people, they would come there just to try on the clothes but not use the computers and…
…he was delinquent on his business loan, owed his vendors money, and like Saul, he hadn’t paid the rent in months. Chapter 11 is like a time out. It means his creditors can’t take action against him while he reorganizes.
Cole: So does he have to stop business while he’s in Chapter 11?
Gottlieb: No, just the opposite. He continues the exact same way he did — well, hopefully not the exact same way he did — beforehand.
Meanwhile, he has to come up with a repayment plan which the creditors then vote on. All of this is supervised by the court. And if all goes well, Teddy’s will emerge from Chapter 11 leaner, meaner, and less insane. However…
Gottlieb: Most Chapter 11 cases fail.
The numbers are hard to come by, but from what I gather only a quarter to a half of Chapter 11 plans every year are approved by the courts and/or the creditors. Gottlieb says a lot of companies file too late, long after their creditors have thrown up their hands. Usually, the failed cases lead to liquidation.
Cole: So then we skip ahead to Chapter 13.
Gottlieb: Chapter 13 is my favorite chapter of bankruptcy.
Cole: You have a favorite chapter of bankruptcy?
Gottlieb: Absolutely! It’s the most fun chapter of bankruptcy.
Like Chapter 7, Chapter 13 is for individuals, or in this case the landlady of our fictional house, Mrs. Jones. She’s way behind on her mortgage and the lender is threatening to foreclose. She’s got credit card and tax debt too, so goes to see lawyer Rick, who asks her…
Gottlieb: “Are you earning anything?”
Mrs. Jones replies…
Gottlieb: “Yeah, I’m getting money now from Saul. He’s finally got himself working.”
And Teddy’s finally paying her too, plus she’s got a little Social Security money coming in, so lawyer Rick says…
Gottlieb: “I’m gonna recommend a Chapter 13 case for you.” “Why?” “Well, Chapter 13, unlike Chapter 7, is an income-based form of bankruptcy.”
Cole: As opposed to asset-based?
It’s more like a payment plan, and how much you pay depends on how much you earn. The fun part is telling the creditors that they’re only getting a fraction of what’s owed them. So the IRS will get its money in installments, but without interest and penalties.
Gottlieb: The credit card companies they keep banging on the door; “We wanna be paid in full!” No, no, no, you’re paying them 10 cents on the dollar on the principle balance. Bye bye.
Unfortunately, most Chapter 13 cases fail too. People just don’t keep up with their payments, in which case the creditors can swoop in. But if they do keep up, Gottlieb says, Chapter 13 can have a happy ending, as can the other chapters in our story.
Gottlieb: Does that mean everyone should file a Chapter 7 case or a bankruptcy case? Absolutely not. That would be foolish. Bankruptcy is like financial streaking. You don’t want to do this sort of thing every day of the week.
And that, boys and girls, is as good a moral as any.
In Boston, I’m Sean Cole for Marketplace Money. The end.
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