Oct 16, 2017

New Bankruptcy Legislation Undercuts Important Safety Net for Entrepreneurs

Published Jun 17, 2005, 12:00pm

Kansas City - Kansas City - New bankruptcy legislation failed to account for hundreds of thousands of entrepreneurs, independent contractors and self employed individuals who traditionally have turned to bankruptcy relief as an important safety net in their effort to recover from a failed undertaking, according to a new research study.

In fact, large numbers of entrepreneurs use the bankruptcy system, despite official government statistics that say their presence in bankruptcy has declined sharply. A result of the faulty data is a skewed picture of the measurement and strength of the nation's small business economy. The new legislation, according to some experts on entrepreneurship, could also serve to deter would-be entrepreneurs from embarking on risky new business formation.

The study was conducted by professors at Harvard Law School and the University of Nevada, Las Vegas, with support from the Ewing Marion Kauffman Foundation.

According to the research, which appears in the most recent issue of California Law Review, owners of small businesses annually file an estimated 260,000 to 315,000 bankruptcies. Those numbers are about nine times higher than the government's official data, which lists only about 37,000 business cases.

Official government statistics report that business bankruptcies began a steady decline in the mid-1980s, when businesses comprised about 18 percent of all bankruptcy filings to their present-day total of only 2 percent of all filings (see Figure 1). Today, corporations and other legal entities comprise almost all of the business filings counted by the government. Entrepreneurs who take on the risk of a new business undertaking have essentially disappeared from the official business bankruptcy statistics.

The authors trace the problem of the faulty reporting to efforts in the mid-1980s to simplify the official bankruptcy reporting process and the advent of new computer software that changed the way attorneys completed forms used to compile the government statistics. This technological change has created a systematic bias in which entrepreneurs were reclassified as consumer cases rather than business cases.

In this new study, 19.5 percent of cases labeled as a consumer bankruptcy filing show some evidence of a connection to an underlying business. In interviews with bankruptcy filers, 13.5 percent reported self-employment at the time of bankruptcy or shortly before. Historically, these filings would have been counted as business bankruptcies.

As further evidence of the skewed data, the government's official statistics differ drastically from annual statistics compiled by both Dun & Bradstreet and the Small Business Administration, which both show a significant increase in small business failures since the mid-1980s.

"It is apparent that entrepreneurs continue to use the bankruptcy system in big numbers. The surprising thing is not so much that they are there but why it took so long for someone to notice that the government figures were so divorced from reality," commented Robert M. Lawless, a study co-author and the Gordon & Silver, Ltd., Professor of Law, at the William S. Boyd School of Law of the University of Nevada, Las Vegas. "Each year, the bankruptcy system provides a critical safety net for hundreds of thousands of entrepreneurs. Our findings again suggest that the popular image of the bankruptcy system as full of irresponsible, overspending consumers is myth."

The research is the first segment of an in-depth study about entrepreneurs in the bankruptcy system. With the support of bankruptcy judges in five judicial districts (California, Illinois, Pennsylvania, Tennessee and Texas), researchers administered questionnaires to 1,771 bankruptcy filers and reviewed their court records. Extensive telephone interviews, which included questions about owning a business and self-employment, were conducted with 911 of these bankruptcy filers.

"The data suggest that much of the measurement of the small business economy is simply wrong, and that errors affect every assessment of the strength, number and role of entrepreneurial businesses in the United States," said Elizabeth Warren, also a co-author of the study and Leo Gottlieb Professor of Law at Harvard Law School. "Our economic system needs to encourage entrepreneurs to make new investments. Sometimes these investments will fail through no fault of their owners, and when that happens, the owners need to be able to move to other businesses and create new jobs and investment opportunities."

Carl Schramm, president and CEO of the Kauffman Foundation, a national leader in advancing entrepreneurship, added that the new legislation could have the unintended effect of dampening the formation of new businesses. "Entrepreneurs deserve to know that they will have adequate support and information in all their activities--including the death and rebirth of their enterprises," said Schramm. "We need to appreciate the enormous risks that entrepreneurs take on, and the number of times many of them must try, fail, and try again until they hit the right idea at the right moment."

Schramm noted that the study serves as a great example of how legislation can positively or negatively affect America's high-impact entrepreneurs. "Before taking final action, America's decision makers should be sure to assess the impact of proposed legislation on the thousands and thousands of entrepreneurs who create jobs and innovations, and who fuel our country's economic growth."

###

The Ewing Marion Kauffman Foundation of Kansas City works with partners to advance entrepreneurship in America and improve the education of children and youth. The Kauffman Foundation was established in the mid-1960s by the late entrepreneur and philanthropist Ewing Marion Kauffman. Information about the Kauffman Foundation is available at www.kauffman.org.

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