Business bankruptcies on rise in N.M.

Last year’s 6 percent increase in Chapter 11 petitions from 48 in 2010 runs counter to two major national trends in bankruptcies: a drop in filings of all types in 2011 and, more specifically, an even steeper drop in the filing of Chapter 11s.

“It’s a sign of a lingering recession,” said Tom Walker, who is chairman of the State Bar’s bankruptcy law section, about the increase in New Mexico.

The last time filings surpassed the 50 mark was in 2002, when 52 Chapter 11s were filed in the aftermath of the 2001 recession. The pace of business reorganizations through Bankruptcy Court tends to rise and fall with the economy.

A form of bankruptcy in which a business continues to operate, Chapter 11 filings used to be far more common in New Mexico. The state averaged 116 Chapter 11 filings a year in the late 1980s and early 1990s, then the pace dropped by more than half in the mid- and late 1990s as the economy flourished.

Aside from the blip with the comparatively mild 2001 recession, Chapter 11s remained at a modest level both here and around the country until the Great Recession. Filings nearly tripled nationwide between 2007 and 2010. In New Mexico, filings only jumped by two-thirds from 29 in 2007 to 48 in 2010.

Although actual federal statistics aren’t available yet for 2011, Kansas City, Kan.-based Epiq Systems Inc. projects a 17 percent drop in Chapter 11 filings nationwide for the year.

‘New Mexico lag’

Last year’s 6 percent increase in New Mexico, which bucks the national trend, is generally viewed as reflecting the so-called “New Mexico lag,” which is loosely defined as an 18- to 24-month delay in national economic trends working there way down to the state level.

A Chapter 11 petition is often an optimistic move on the part of a business owner, Walker said. It buys time for the business to continue in operation while negotiations get under way with creditors to come up with a business reorganization plan. A critical component of the plan is repaying the debt.

“People think they can save all or part of their business,” Walker said. “Too often we see people waiting, hoping that business is going to turn around. They think, ‘I’ll get the big order,’ or, ‘I’ll get the government contract,’ but it just doesn’t happen.”

Fellow bankruptcy lawyer Bill Davis expressed a similar view, saying, “I see over and over again an optimism, a ‘can-do’ spirit, that they will work hard and succeed. Although admirable, when a business is failing, it can be the worse thing you can do.”

A company needs enough positive cash flow to pay its employees, its tax obligations and at least most of its suppliers to have a shot at a successful Chapter 11, Walker said. In other words, filing a Chapter 11 petition is not the last resort for a financially struggling business, he said.

“A Chapter 7 is the last resort,” he said.

Personal bankruptcies

In a Chapter 7 case in Bankruptcy Court, the business shuts down and its assets are sold off in a liquidation sale. More often than not with small businesses, a business failure leads to the personal bankruptcy of its owner, Walker said.

“They provided a personal guarantee of the debt owed by their failing business,” he said. “That makes them personally liable for the repayment.”

In 2011, 31 percent of the Chapter 11 petitions were filed by individuals, said Norman H. Meyer Jr., clerk of the Bankruptcy Court for the District of New Mexico. In the majority of those individual cases, the debt was likely business-related, he said.

Chapter 13 is the more common route for an individual to seek a reorganization of his or her finances, but the bankruptcy code sets limits of $336,900 on unsecured debts and $1,010,650 on secured debt for a person to qualify. As a result, individuals filing for a Chapter 11 reorganization typically have a high net worth.

Chapter 11 bankruptcy petitions often end in failure, typically with a liquidation that puts more cash into the pockets of creditors. As few as 10 percent nationwide result in the resurrection of the business, a failure rate that Walker said probably holds true in New Mexico.

Attempts at a Chapter 11 often fail when the financial numbers are crunched to come up with a plan of reorganization and the owner realizes the business is beyond salvaging. Job losses and a reduced local tax base are a common outcome.

Chapter 11s made up less than 1 percent of the 5,674 bankruptcy petitions filed in New Mexico last year. In fact, bankruptcies involving primarily business debt account for less than 5 percent of all filings both here and around the country in any given year.

Bankruptcies are by and large a consumer phenomenon. Despite the prolonged economic slump, bankruptcy petitions of all types dropped 12 percent nationwide in 2011 compared to 2010. In New Mexico, the drop was a slightly steeper 14 percent.

The most common reasons given for the unexpected drop in bankruptcies have been the changing landscape of consumer credit and a slight improvement in the employment picture.