Why Formerly Successful Entrepreneurs Have No Viable Bankruptcy Option

By: Donald L Swanson

The well-being of our market economy, here in these United States, is dependent upon entrepreneurs. Here’s how:

–entrepreneurs, along with their families and friends, create businesses that provide and consume vast quantities of goods and services, provide meaningful work and income to lots of people, pay taxes that sustain all levels of government and provide leadership within local communities.

Entrepreneurial Risks

But it’s not all fun and roses for entrepreneurs. They face significant risks every day:

• Every business will face moments of crisis, from time to time, with the very existence of the business at stake; and
• Even a well-run business can fail, in a flash, from an unforeseen catastrophe, like a pandemic, a natural disaster, terrorism, product obsolescence, an economic downturn, emergence of a competitor, embezzlement by a trusted employee, an ill-advised (in retrospect) expansion, etc., etc., etc.

The risk of failure is an entrepreneur’s ever-present companion. It never goes away.

And the effects of failure, upon a formerly-successful entrepreneur, can be catastrophic: e.g., multiple-millions of dollars of guaranteed debt and liquidation taxes come due, for the entrepreneur, that can never be repaid.

No Viable Bankruptcy Relief

You’d think, in these United States, we’d be highly-equipped to help our entrepreneurs deal with business failure. But we aren’t.

Granted, there is a new Small Business Reorganization Act that’s now a part of Chapter 11 bankruptcy laws, in which the total-debt limit for eligibility stands at $7.5 million (it’s scheduled by statute to drop to $2.725 million in 2021).

But what about the formerly successful entrepreneur who has $8.0 million or $20 million of total guaranteed debt (or $3.0 million in 2021)?  There is no viable bankruptcy relief available for him/her.

Anchored in Ancient Prejudices

Our bankruptcy laws for entrepreneurs are anchored in prejudices and based on ancient images that no longer apply: e.g., from when an “act of bankruptcy” is defined as an entrepreneur’s action with fraudulent intent.

The U.S. Supreme Court, back in 1935, explains bankruptcy history like this: “Bankrupt laws have been in force in England for more than three centuries, and they had their origin in the Roman law.” [Fn. 1]

And early U.S. bankruptcy laws are modeled after England’s.  One such model is the “Acts of Parliament of England concerning Bankrupts,” enacted on April 4, 1800, which describes its targeted entrepreneurs like this:

• “divers and sundry persons” who “craftily obtained into their hands great substance of other men’s goods”;
• who then “suddenly flee to parts unknown” without “minding to pay or restore to any their creditors”; but
• “at their own wills and own pleasures consume” what they “obtained by credit of other men”; and
• they do so at “their own pleasure and delicate living” and “against all reason, equity, and good conscience.” [Fn. 2]

The image in this description, of an entrepreneur-as-fraudster, is still with us today.  That image may be in the background and unstated . . . but it has never gone away.  Such image  manifests itself in today’s bankruptcy laws, by treating all entrepreneurs (whether evil or honest) alike—i.e., badly.

Just like ancient times, we still treat formerly-successful entrepreneurs (with more than $7.5 million total debt) like fraudsters and swindlers—even when they aren’t.

How can this be?

Oliver Wendell Holmes, Jr., provides an explanation of how this happens. [Fn. 3]  Here it is:

• The customs, beliefs or needs of a primitive time establish a rule or a formula;
• In the course of centuries the custom, belief or necessity disappears, but the rule remains;
• The reason which gave rise to the rule has been forgotten, and ingenious minds set themselves to inquire how it is to be accounted for;
• Some ground of policy is thought of, which seems to explain it and to reconcile it with the present state of things;
• then, the rule adapts itself to the new reasons which have been found for it, and it enters on a new career; and
• The old form receives a new content, and in time even the form modifies itself to fit the meaning which it has received.

—An Illustration from Holmes

As an illustration, Holmes writes, “in Massachusetts today [back in 1881], . . . there are a great many rules which are quite sufficiently accounted for by their manifest good sense.”

But there are others which can only be understood by reference to the infancy of procedure among the German tribes, or to the social condition of Rome under the Decemvirs. Here is how such laws evolved over time:

• early forms of legal procedure were grounded in vengeance;
• Roman law started from the blood feud, as did the German law;
• The feud led to laws by which the feud was bought off and was broken up, though not extinguished, by the time of William the Conqueror;
• The house-burnings of an earlier day became actions for arson and trespass;
• Actions for arson and trespass are an alternative to vengeance—importing a feeling of blame and an opinion that a wrong has been done: “even a dog distinguishes between being stumbled over and being kicked.”

—A Need for Law to be Ever-Growing

The law is always approaching, and never reaching, consistency, Holmes writes:

• It is forever adopting new principles from life at one end;
• it always retains old ones from history at the other, which have not yet been absorbed or sloughed off; and
• It will become entirely consistent only when it ceases to grow.

Such process of law development, Holmes writes, involves the attempt to follow precedents, and to give good reasons for them. But, he adds:

• when policy grounds justifying rules are inventions to account for survivals from primitive times, we need to decide whether those grounds are adequate; and
• we must recognize that law is continually transmuting moral standards into objective ones, from which actual guilt is wholly eliminated.

Conclusion

What we have in today’s Bankruptcy Code, for formerly successful entrepreneurs, is a hold-over from ancient laws.  Those ancient laws deal, explicitly, with entrepreneurs who act with fraudulent intent. Unfortunately, that hold-over is a major problem for the needs of today’s entrepreneurs—especially for the formerly successful entrepreneurs who are honest but unfortunate.

We have failed to craft a bankruptcy relief that is viable for the needs of today’s formerly-successful entrepreneurs who have more than $7.5 million total debt.

Such failure needs to be remedied as soon as possible.

Footnote 1: Continental Illinois National Bank v. Chicago, Rock Island & Pacific Ry. Co., 294 U.S. 648, 674 (1935).

Footnote 2: “The Bankrupt Law of America: Compared with the Bankruptcy Law of England,” by Thomas Cooper (1801).

Footnote 3: All Holmes information is from Part 1, in his book, “The Common Law” (1881).

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