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How do Bankruptcy Laws Help Revitalize US Businesses?

Recession, the September 11 attacks, a difficult holiday retail season, dramatic declines in demand, especially in the travel industry - all these factors have caused an unusually high number of U.S. firms to file for bankruptcy this year. That's why there are bankruptcy laws.

The failure rate for new businesses is extraordinarily high. A country like the United States that actively encourages people to create new businesses must have protective ways to handle the failures.

And that, says Temple University Law School professor Melissa Jacoby, is what U.S. bankruptcy laws are designed to do. The idea is to prolong the life of the company in hopes of resurrecting it, and, at the same time, protect those owed money.

The first thing that happens when a company declares bankruptcy, she says, is a shield goes up preventing creditors from collecting. "This provides both breathing room for the debtor as well as protecting each individual creditor, which otherwise would be engaged in some sort of race to the courthouse. Whoever could get there faster to collect their debts would get all. In bankruptcy law, all the creditors are protected under this injunction," she says.

Another important feature of bankruptcy law, Melissa Jacoby says, is that the debtor the owner of the bankrupt business stays in control.

"So the debtor continues to try to operate the business while negotiating with all the different parties in trying to come up with a reorganization plan. Many of these businesses do have a chance to reorganize and survive and we are all better off the parties involved and society at large if the business does get a chance to go on," she explains.

Arthur Abramowitz, an attorney at Philadelphia's Cozen O'Connor law firm, says declaring bankruptcy gives a business breathing room. It gives a firm time to restructure debt and rework the balance sheet. He says retailers, especially, tend to benefit from the bankruptcy system.

"Suppose you have 1,000 stores and maybe only 400 of them are making any money, but 600 are bringing the company down. The bankruptcy code allows you to close those 600 while keeping open the 400. While you will have to make an arrangement for creditors to pay something toward the balance, it allows you some flexibility that you wouldn't normally have," he says.

And now the bad news: Only about 10 percent of the firms that file for bankruptcy in the United States recover and become profitable again.

But, Mr. Abramowitz says, declaring bankruptcy gives even those firms that ultimately fail an opportunity to maximize their assets, deal with their creditors and forewarn their employees.