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Chapter 11 Not Abused--A Commentary by G. Eric Brunstad

(This essay was originally published in the September 18, 2005, edition of USA Today.)

The sobering truth is that most businesses ultimately fail, and the ideas that executives deliberately steer their firms into bankruptcy as an ordinary planning technique and that Chapter 11 coddles them are unfortunate myths. Most businesses that file for bankruptcy end up liquidating their assets. Most managers that bring their companies into Chapter 11 end up losing their jobs. Bankruptcy is not a particularly happy place, and executives typically strive to avoid it.

Cases like Enron and other spectacular corporate failures have helped fuel the misperception that bankruptcy is most often a self-inflicted wound, brought about by gross incompetence, corruption or greed. But cases like Enron are hardly the norm. Largely unreported are the vast majority of Chapter 11 proceedings involving far less dramatic tales of economic ruin. The reality is that many businesses run by perfectly ordinary people taking perfectly ordinary business risks just cannot make a go of it. For the vast majority of these businesses, insolvency is an accident brought about by such diverse events as a tragic hurricane, unforeseen market shifts, or changes in the law that alter how the company must conduct its business.

A good example of a sector pummeled by regulatory change is the airline industry. The major carriers built their basic structures years ago under a climate of heavy regulation. They acquired a mature workforce and large pension obligations, paid competitive salaries and built large infrastructures to handle designated routes. Then Congress changed the rules. Competitors were allowed to enter the playing field with younger employees (and correspondingly lower benefit costs), no pension obligations, lower wages and smaller infrastructures to handle only the routes they wanted to serve. Chapter 11 offers ways unavailable outside of bankruptcy for older carriers to adjust to a changed marketplace.

Not every business that encounters financial difficulty should be salvaged in bankruptcy. But those that can be should be. When a business is forced to close, this can spawn other bankruptcies among displaced employees, suppliers and others. The price of entrepreneurial risk-taking should not be the automatic destruction of a salvageable business simply because misfortune strikes.

G. Eric Brunstad chairs the Business Bankruptcy Committee of the American Bar Association; he's a partner at Bingham McCutchen LLP and a visiting lecturer at Yale Law School.