Bankruptcies, particularly business bankruptcies and reorganizations, have increased sharply in the first part of 1981, both nationally and in the Washington area.
"They're falling like flies -- and the real crunch hasn't hit a lot of business yet," said John W. Guinee Jr., former president of The Yeonas Co. and a trustee in several business reorganizations under federal bankruptcy law.
The culprit is the economy -- particularly high interest rates. The answer to who struck John's Lincoln-Mercury or John's Donut Stand or John's Roofing Service, more often than not, is "prime plus 2" or "prime plus 4," according to several area attorneys who specialize in bankruptcy cases.
"I think there were a lot of businesses last year with the high interest rates who decided to hang on, seeing the light at the end of the tunnel," said Nelson Cohen, a bankruptcy lawyer in Maryland. "Now that interest rates have gone up again, a lot of companies have just gone under."
The major victims are businesses related to real estate (including construction firms, mortgage companies, building-supply firms and others); service industries such as restaurants, automobile, boat and other dealerships that have to carry large inventories with borrowed money, and consulting firms.
"I see a general effect rippling out to all businesses, with small businesses hurt most," said Stanley Salus, another attorney.
For the nation has a whole, bankruptcy filings of all types have increased by approximately 21 percent from the first six months of 1980 to the first six months of 1981, rising from 216,745 to 262,345, according to the bankruptcy division of the administrative office of the U.S. Courts. Business reorganizations increased from 3,615 to 4,902 -- a 36 percent increase between the first half of 1980 and the first half of this year.
In the Washington area, which is covered by bankruptcy courts in Alexandria, the District of Columbia and Rockville, total bankruptcies increased about 28 percent from 1,068 in the first four months of 1980 to 1,371 in the first four months of 1981. Chapter XI reorganizations increased by almost 80 percent, from 24 to 43.
Chapter XI is designed to allow a company to reorganize and get out from under its debts in an orderly fashion rather than going out of business entirely. Many companies, however, choose a simple bankruptcy proceeding under Chapter VII in which its assets are distributed and the company is closed.
Still other businesses fade away without setting foot in bankruptcy court.
"I consult with a lot of people who never end up in bankruptcy court," Salus said. Instead, they simply go out of business. Because they have no assets to distribute, creditors get nothing.
"One of the things bankruptcy does is have a psychological impact," Salus said. "If you say a company has just closed down and that the Small Business Administration has taken all the assets under a lien," creditors sometimes find that harder to accept, he said.
Last year it was difficult to tell whether an increase in bankruptcy filings reflected a failing economy or changes in federal bankruptcy laws, which were rewritten substantially. Most of the changes went into effect in October 1979.
This year the courts are handling "many different companies all along the line, all of which may indicate a slowing of the economy," said Bankruptcy Court Judge Martin V.B. Bostetter of the Eastern District of Virginia. Bostetter added, and many lawyers noted as well, that increased advertising by bankruptcy lawyers may have contributed to the higher numbers.
"When the economy's so bad, it's hard to run a business," said Richard Gins, who represents several firms that found it difficult.
Under Chapter XI, firms have a chance to survive their economic difficulties. Management of the company is often allowed to retain control rather than be replaced.
"The debtor-in-possession approach is much better than the old approach," said Guinee, who is writing a book on bankruptcy. Retaining management often helps maintain confidence in business and between employes and customers, he said. "There's nothing to say that management in the first place is responsible for a business going downhill."
"What I hope you'll see is more XIs," Guinee said. "The unfortunate tendency in most parts of the U.S. is not to go all the way in an Eleven," he said. Many firms who initially file under that chapter later convert to a Chapter VII bankruptcy. "There is a tendency to give up too soon on reorganization," according to Guinee.
"By and large, Chapter XI is designed to help, and if you can get around the problem of what you're going to do with prime plus 2, then you can make a reorganization work," said Roy Zimmerman, an attorney in Virginia.
Zimmerman said he has a client who sells a type of recreational vehicle on a floor-plan arrangement -- an arrangement under which the client's inventory is financed by borrowed money. If the banks will not make loans to would-be customers, the dealer ends up paying high interest rates while the inventory sits on the floor. Soon the dealer's capital is eroded.
That is what happened to Zimmerman's client, now reorganizing under Chapter XI. "If we can ride this out for two or three years, we're going to make it," Zimmerman said.