Robert M. Lawless, a professor in the
U of I College of Law, says that the government has significantly
undercounted the number of bankruptcy filings arising from failed
businesses, leading to false assumptions about the profile of many
"The new bankruptcy law does not take into account the
phenomenon of the serial entrepreneur," he said in an interview.
"Most entrepreneurs go through several business models before they
are successful. Failure is part of being an entrepreneur. The harsh
provisions of the new law will discourage people from opening new
businesses and keep entrepreneurs who do fail in a business from
The Bankruptcy Abuse Prevention and Consumer Protection Act,
which went into effect last October, was designed to place
restrictions on thousands of debtors who allegedly filed for
bankruptcy in order to clear away debts that were caused by their
own overspending or self-indulgence.
"People should pay their debts to the extent that they are able,"
Lawless said, "but the evidence suggests that bankrupt debtors
already are paying as much as they could under the old law. The new
law simply sets up numerous roadblocks to the traditional bankruptcy
fresh start. Small-business owners therefore will not receive as
effective bankruptcy relief as they did before the new law, with the
result that they will be saddled with the debts of an old business
instead of starting a new one."
In a paper published in the California Law Review last year with
Elizabeth Warren, a professor at the Harvard Law School, Lawless
reported that much of the empirical data compiled by the government
regarding the cause of individual bankruptcy filings was inaccurate.
According to the bankruptcy courts, business-related filings
peaked at 18.3 percent of total cases in 1985 but have steadily
dropped to 2.3 percent in 2003. Advocates of the new law have cited
the "virtual disappearance" of business filings as proof that
responsible Americans do not need to resort to bankruptcy relief in
order to navigate the rapid changes in the economy.
"There is a significant problem with this story: It is not true,"
Lawless and Warren wrote in the paper. In fact, as many as nine
times more bankruptcies involve the failure of a business than
disclosed by the statistics of bankruptcy courts.
Why the discrepancy? A major reason turns out to be the software
programs used in filing bankruptcy cases, which typically have a
default setting that automatically classifies filings as "consumer"
rather than "business" cases.
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"Automated-form software has introduced a systematic bias into
the reported data," Lawless said. "As the filed forms shifted from
being filled out by hand to being filled out by computer programs
that presumed that individuals were always consumers, the proportion
of consumer filings rose, while the proportion of business filings
In addition to software bias, bankruptcy courts typically
classify debtors who are self-employed but have not incorporated
their business or established a legal partnership as consumer cases.
This underreports the expanding number of filers who work as
consultants or independent contractors.
Questioning a random sample of debtors in California, Illinois,
Pennsylvania, Tennessee and Texas, the researchers found that
between 13.5 and 17.4 percent of all debtors reported that they were
self-employed and that a business failure was a major reason for
"Our findings undermine the assumption that the bankruptcy system
deals with only two kinds of debtors, consumers and corporations,"
Lawless said. "Entrepreneurs are in bankruptcy court in substantial
numbers, even though the current classification system conceals most
of them and paints a rosier picture of the business climate than is
The scholar pointed out that government statistics are at odds
with data compiled by Dun & Bradstreet, the credit-reporting firm,
and the Small Business Administration. Both of their reports show an
increase in business failures.
Lawless and Warren estimated that bankruptcy courts misclassified
between 220,000 and 280,000 filings by independent contractors,
entrepreneurs and other small-business operators in 2003.
Lawless, who recently joined the Illinois law faculty, said that
there is a strong correlation between a bankruptcy system that
treats financial failure as a risk of the marketplace -- rather than
as a moral issue -- and a high level of entrepreneurial activity.
"Historically, this country has established a forgiving
bankruptcy system, compared to Europe, but the trend lines seem to
be crossing," he said. "We are adopting a more European attitude
toward bankruptcy, which traditionally favored creditors over
debtors, while Europeans, especially the Germans, are moving to a
system that offers debtors a fresh start by clearing away most
"The bottom line," Lawless continued, "is that this country needs
a safety net for entrepreneurs if it wants to foster conditions that
lead to the creation of new businesses, jobs and technologies."
The Lawless-Warren paper for the California Law Review is titled
"The Myth of the Disappearing Business Bankruptcy."
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