A Flood Of Bankruptcies
Local lawyers prepare for the worst
By John Cunningham
Special to the Worcester Business Journal
Consumers who have used home equity as a cash machine to pay for debts are in trouble, and bankruptcies are mounting as real estate values fall because of spiraling foreclosures.
"A lot of credit card debts were offloaded with home equity loans in recent years, but those days are over," said Worcester bankruptcy lawyer Carl D. Aframe of Aframe & Barnhill, who added that income-producing properties have also landed people in trouble. "It's not unusual to see a six-family on Vernon Hill with two tenants doing okay, two in trouble and two headed for housing court."
County Lines
Worcester County leads Massachusetts in foreclosures initiated in the last 60 days, and statewide there was a 148 percent increase in 2007 foreclosure deeds issued to purchasers of distressed properties.
Massachusetts bankruptcy filings correspondingly ticked up in 2007, registering a 64 percent increase over 2006, but remaining 25 percent below the pace of roughly 18,000 annually from 2002 to 2004 (See data-box). And recently, the Boston Globe reported that Massachusetts filings in US Bankruptcy Court increased to 2,493 between Jan. 1 and March 5, from 2,039 during the same period a year ago.
Local lawyers attributed a 2005 jump in filings to a courthouse rush prior to reforms in federal bankruptcy law that made it harder to discharge consumer debts. Some also speculated that the number of current bankruptcies, like the number of foreclosures, would be much higher if not for the 2005 gush and reforms that have since shut many consumer debtors out of the courthouse.
"Changes to the law in [late] 2005 pushed people who were even contemplating bankruptcy over the edge. That caused a flood of applications [before the changes took effect], but it's a whole new game now," said Aframe. He noted that the changes have subsequently forced many delinquent consumers to pursue loan workouts because of "means-testing" that prevents Chapter 7 relief.
"Lawyers are forced to do background checks on their own clients now," he added, noting that 2005 changes require attorneys to certify the accuracy of debtor disclosures regarding assets and liabilities.
As a result, Aframe must pull credit reports on his clients, and go through their pay stubs, check books and other records.
"As bankruptcy entails more work, lawyers have to charge more," he said, noting that many consumers shun the process and can no longer afford the retainers. "A lot of people now just go to a credit counselor who delays the inevitable, or they just stop paying on their home and stay until they're kicked out."
Outlook In '08
Lawyers have not observed any dramatic rise in business bankruptcies, and they noted that "means-testing" provisions don't apply to business filers, but they suggested that a rise in 2008 business bankruptcies is probable.
"In recent years, there was abundant cash available to businesses through banks, angel investors and equity investors," said Mark W. Powers of Worcester's Bowditch & Dewey. "Now inventory is high, credit is hard to get, and something has to give. Smaller businesses with less fat to cut and others with flawed business models will be severely tested," he added.
Kevin C.McGee of Seder & Chandler in Worcester agreed. "We're living in Darwinian times that will thin out the weakest in the business herd," he said.
He also pointed to recent drops in consumer spending as evidence that people are tapped out on their credit. If consumer spending is "not there, then businesses that cater to consumers are in trouble, especially if they're not selling necessities," said McGee.
Christine Devine of Worcester's Mirick O'Connell agreed, pointing to several national retailers with local stores who have filed for bankruptcy recently, including Bombay Company, Movie Gallery and Domain Furniture. She added that lawyers expect more regulatory scrutiny for lenders that will result in further credit-tightening.
Lenders must increase their cash reserves as property values fall to improve required debt-to-value ratios. Devine suggested that "a spike in business bankruptcies would not be surprising," noting that small business owners who have guaranteed their loans and cash-strapped developers with half-finished projects will be "particularly hard hit."
Lawyers also observed that many mortgage companies and residential home builders are already suffering.
"They are really in a depression in their segment of the economy," said Powers. But he also observed that business debtors are increasingly negotiating arrangements to avoid bankruptcy.
McGee affirmed that he has seen more negotiated settlements. "Some lenders are still aggressive, but others are entertaining workout proposals they wouldn't even consider a few years ago."
Even consumers are re-negotiating debts. "I'm helping some to compromise credit card debts and that rarely happened until recently," said Aframe.
John Cunningham is a freelance writer based in Natick.
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