How many bankrupt companies get a second chance?

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As Europe tries to recover from the recession, one lesson should quickly be learned: current bankruptcy laws in many countries will hamper thousands of entrepreneurs trying to get back on their feet and restart their businesses.

The second principle of the European Commission's Small Business Act is to "ensure that honest entrepreneurs who have faced bankruptcy quickly get a second chance".

This week, the Commission published its review of the Small Business Act and recommended that national governments limit the time to discharge and settle bankruptcy debts to a maximum of three years by 2013.

Half of new businesses don't survive more than five years, but only 15% of those end in bankruptcy. Yet those numbers can be skewed by tough economic times: last year, a record number of businesses filed bankruptcy in France, Spain, the Netherlands, Belgium, Switzerland, Austria, Finland, Ireland and Portugal.

In 2009, an estimated 1.7 million jobs were lost because of business failures, according to Creditreform Economic Research Unit. And yet, countries with more efficient bankruptcy laws tend to have lower unemployment rates, according to research by Businessdynamics, which is part of the Enterprise Education Trust in the UK.

"Most of the entrepreneurs that fail don't want to be an employee, they want to restart," said Inigo Urresti of the European Commission's department for enterprise and industry, adding: "Studies show that an entrepreneur who starts a second business fails far less often and grows faster."

Social stigma associated with bankruptcy

Cash-flow problems are the most common reason business owners can't pay their bills, and that's the main reason the European Union passed its Late Payments Directive last year. The legislation enforces a 30-day limit for most companies and government institutions to pay their bills. That will reduce the estimated €25 billion that companies spend each year chasing down tardy payers.

The move would be a seismic shift in Italy, Spain and Sweden, where a company's debts are never discharged until repaid. In Greece, debts can haunt a business owner for 15 years, while in Germany, Denmark and Bulgaria they don't fade for five years.

Plus, there's often a social stigma that shadows a failed entrepreneur.

"Bankruptcy is the least sexy word on the planet," Urresti said. "Unfortunately in Europe and elsewhere, there's a strong correlation [in people's minds] between failure and dishonesty," he said, although only roughly 5% of bankruptcies are due to dishonest behaviour.

Tax holidays in Sweden

Last month, the Commission published a two-year report from an expert group on bankruptcy and second chances, pooling information from 33 countries. The expert group compiled a series of conclusions that focused on the four stages of a business failure: early warning (prevention), pre-court settlements, in-court settlements, and post-bankruptcy recovery.

Urresti said countries should focus on the first two because, "The longer it takes to fold a company, the more value is lost. It takes longer for the entrepreneur to go back into the market."

To prevent more companies from closing their doors, the expert group said government intervention is crucial and active assistance should be offered to entrepreneurs in financial crisis.

In Sweden, for example, the most successful initiative has been 'Business Emergency Treatment', in the western region of the country, where entrepreneurs in financial distress can get advice and negotiation assistance, explained Wilhelm von Seth of the Swedish Agency for Economic and Regional Growth.

He also said during the financial crisis, the Swedish government made it possible for companies to have a "tax payment holiday," which was helpful for many companies, though no post-assessment has been done.

Refinancing debt in France and Italy

For business owners who are underwater financially, a repayment agreement with creditors to stave off bankruptcy is the next best thing. In France and Italy, for example, there are licensed insolvency practitioners to supervise the process and pay creditors.

The expert group stressed that a company that has signed a refinance agreement should be allowed to compete for government contracts on an equal footing with other companies.

Streamlined bankruptcy procedures in Ireland

When it's too late, and a business owner has thrown in the towel, at least temporarily, streamlined bankruptcy procedures are essential, especially for small companies with 10 employees or fewer, according to the report.

Simple and predictable in-court procedures not only result in faster proceedings, but also increase the chances that cases are resolved out-of-court, the group found.

In Ireland, for example, officials are considering a 'Pre-Action Protocol' which would require debtors and creditors to consider a debt settlement agreement or to negotiate a voluntary debt management plan before filing for bankruptcy.

The group recommended actions be taken to make a greater distinction between good and bad debtors. In the UK, for instance, officials look for reckless spending or borrowing, paying family members and disappearing assets close to the bankruptcy filing. Criminal actions are prosecuted.

And in the end, it's important to get as many honest entrepreneurs back on their feet.

"There is a massive pool of potential there," Urresti said.

The European Commission proposed a Small Business Act (SBA) for Europe in June 2008 and the initiative was backed by the EU heads of states in December that year (EURACTIV 02/12/08). 

The second of 10 principles of the act is to ensure that honest entrepreneurs who have faced bankruptcy quickly get a second chance.

The current financial and economic crisis has shifted the focus to measures aimed at securing the survival of small businesses, which have been severely hit by the collapse of banks and decreasing liquidity in the market.

There were a record number of bankruptcy filings last year in France, Spain, the Netherlands, Belgium, Switzerland, Austria, Finland, Ireland and Portugal.

In the review of the Small Business Act, the Commission recommended that national governments limit the time to discharge and settle bankruptcy debts to a maximum of three years by 2013.

  • By 2013: EU governments to limit the time to discharge and settle bankruptcy debts to a maximum of three years.

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