The Growing Bankruptcy Brigade

American companies are now failing at the rate of 500 a week

The wild cheering on the floor of the New York Stock Exchange and around the financial district last week did not spread much beyond Wall Street. Across the U.S. there is still deepening gloom about the economy, and no single group is more painfully aware of it than the beleaguered owners of American businesses. This year their ranks are being trimmed by bankruptcy faster than at any time since the Depression. Says Chairman of Eastern Air Lines Frank Borman, whose company has several times flirted with failure: “I’ve long said that capitalism without bankruptcy is like Christianity without hell. But it’s hard to see any good news in this.”

Companies are going into bankruptcy court and asking for protection from their creditors at the rate of about 500 every week. By the end of September, 18,572 companies had already filed for bankruptcy, more than in all of 1981. Wall Street’s Dun & Bradstreet predicts that the number of corporate and commercial failures will approach 24,000 by the end of the year.

That total does not include a far greater number of firms, perhaps as many as 4,000 weekly, that simply fold up and quit after paying off their debts. When a plant gate is padlocked or when the neighborhood dry cleaner shuts its doors, jobs are lost, investments vanish, and dreams turn into dust.

Despite the anguish corporate bankruptcy causes individuals, many economists agree with Eastern’s Borman that it is an inevitable, perhaps even healthy, aspect of capitalism. Like a forest fire that creates more productive land by burning off dead trees and scrub, the failure of one company often yields markets, capital and skilled labor that fuel the growth of another. Says Eugene Lerner, professor of finance at Northwestern University’s J.L. Kellogg Graduate School of Management: “For a long time, thanks to inflation, a lot of firms found it convenient to borrow a lot more than was prudent. If inflation had continued, these same guys would have been millionaires. But someone always gets caught when the merry-go-round stops.”

The flood of official bankruptcies may be temporarily stemmed this fall by a constitutional conflict between the Supreme Court and Congress. In June, the high court ruled that Congress had granted the nation’s 220 federal bankruptcy judges unconstitutionally broad powers in 1978 with the passage of the Federal Bankruptcy Reform Act. The court gave Congress a deadline of Oct. 4 to correct that defect. Since Congress could not or would not act in time, the court moved last week to prevent the bankruptcy courts from shutting down altogether by extending the deadline to Dec. 24. Meanwhile, many lawyers plan to delay filing any new bankruptcy petitions until after the court challenge is resolved.

The majority of bankruptcies involve small-scale enterprises, companies such as lumberyards and machine shops or retail stores with sales of less than $100,000. These firms operate on the cusp of the business community, and they traditionally suffer from inadequate capital, inexperienced management and pressures from larger, more established competitors. High interest rates and slow growth have wiped out the margin for error that these firms might have enjoyed in prosperous times, and only a few of the best-managed ones are surviving.

This year, however, the failed smaller companies have been joined by such large, well-capitalized corporations as Braniff Airways, Wickes Cos., Saxon Industries and De Lorean Motor Co. Says Purdue University Professor William Dunkelberg: “The recession is performing the age-old process of creating leaner, meaner and more efficient firms. Unfortunately, the recession has also cut heavily into the lean and mean. We’ve lost established companies to low demand and high debt.”

Financial institutions have been especially hard hit by the recession. So far this year, as many as 30 banks, from the Western National Bank in Santa Ana, Calif., to the National Security Bank in Tyler, Texas, have been forced to file for bankruptcy. By far the most spectacular failure was Oklahoma City’s Penn Square Bank. It had loaned many millions of dollars to risky oil and gas ventures. When falling oil prices threw dozens of those into bankruptcy, Penn Square was obliged to follow shortly afterward.

Some other familiar names in American business, including Pan American World Airways and Air Florida, are also potential candidates for bankruptcy. International Harvester Co. last week informed its shareholders that the company’s prospects for survival are “in substantial doubt.” The company, which piled up losses of $790.4 million during its 1980 and 1981 fiscal years, says that it could lose an additional $1.6 billion in its year ending Oct. 31, and that it is rapidly running out of ways to generate more cash or cut costs further.

While some failed firms simply disappear or see their assets parceled out to creditors, other companies manage to survive a formal declaration of bankruptcy. As a result of changes in the American bankruptcy law four years ago, such firms can now more easily reorganize their operations and try to become profitable again while they make partial payments on their debts. Perm Central Corp. has been able to emerge as a strong manufacturer and real estate operator after shedding the railroad operations that propelled it into bankruptcy court in 1970. Last week Joe B. Freeman Jr., chairman of AM International Inc., the Chicago-based business-equipment firm that filed for bankruptcy protection in April, announced that he now expects the company to turn a small profit during its 1983 fiscal year, after losing $245 million in fiscal 1981 and running up debts earlier this year that approached half a billion dollars.

As long as there remains a market for the product or service that a bankrupt company was providing, more efficient competitors can pick up the slack. Workers who manage to locate new jobs may even find themselves better off than before because they are employed by healthier firms. Says Barry Bosworth, an economist with the Brookings Institution in Washington: “It is not correct that bankruptcies in and of themselves destroy jobs.

They shift the distribution of them.” Bosworth adds that this is often traumatic because employees must learn new skills or move their families to cities where work is available. But that means bankruptcies are as much a social problem as they are an economic one.

No single fact better demonstrates the dynamic effects of such self-correcting forces than the remarkable number of new companies that are now being formed. For every business that fails this year, 20 new ones will be started. During the first six months of this year, 281,458 enterprises were created. That rate is only a little below 1981, which was the best year ever for business starts.

Why are so many businesses being formed just when so many others are failing? Some risk takers see advantages in launching a new enterprise when business is slow because they can develop skills and plan strategy more slowly. They believe that they will then be able to cash in when the economy picks up. Many other founders of new businesses, however, come from the ranks of the unemployed. Says Ann Eskesen, the director of the Small Business Resource Development Center at Bentley College in Waltham, Mass.: “What precipitates going into business is often some sort of life crisis. When people are being laid off, ironically some of them decide to go into business for themselves.”

Many people turn to such businesses as retailing or restaurants, which are usually less complicated enterprises than manufacturing. More and more start-ups are in the growing field of computer-related business services, such as programming and word processing. In the Boston area, laid-off workers with technical skills are opening businesses in robotics, bio-medical research and other specialized areas.

In the nation’s economy, a new wine-and-quiche dining spot or another personal-computer store can hardly compensate for the economic loss of a failed Braniff, which provided jobs for about 10,000 people, or Wickes Companies, which operated 277 building and home supply stores in 38 states. Still, the sheer volume of new activity is encouraging. Says Economist Bosworth: “Although we worry about the high number of bankruptcies destroying incentives for people to take a chance, there are still a lot of people willing to go out and gamble that their idea will work.” —By Alexander L. Taylor III. Reported by J. Madeleine Nash/Chicago and Bruce van Voorst/New York

Two Tales of Tough Times

After 25 long years of selling wallpaper and paint in other people’s stores, Charles Trainito, 41, in November 1978 became his own boss. With $10,000 borrowed from his wife’s parents and a $15,000 bank loan, Trainito opened The Wallpaper Gallery on heavily traveled U.S. Route 1 in Saugus, Mass.

Though small and unimposing, the store offered a kaleidoscopic collection of paints and wallpapers for the do-it-yourself home decorator. Trainito put in 70-hour weeks. His wife Maria came in to work two days a week and kept the books. Thanks in part to its good location—next door to the huge Emerson Rug store and near Valle’s Steak House and the Kowloon, a popular Chinese restaurant—The Wallpaper Gallery did a brisk business. Although he was supporting three children, ages eleven to 17, Trainito paid himself only $420 a week, reinvesting the rest of the revenues in the store.

Last fall, Emerson Rug went out of business, and Trainito’s sales suddenly began to slide, in the midst of recession, potential customers decided that redecorating was a postponable luxury. By spring, Wallpaper Gallery revenues were off 45% from the same period in 1981. Trying to stay afloat, the Trainitos put up their house as security on a new $5,000 bank loan. Says Maria: “We desperately wanted this business to survive.” As sales continued to sag and debts to suppliers reached $63,000, the Trainitos were finally forced to declare bankruptcy and close their store.

The experience was shattering. “I haven’t had a full night’s sleep in six months,” says Charles Trainito. He swallowed his disappointment and last week began work as a site inspector for a construction firm. Trainito was lucky to get a job so quickly, but he will miss being his own boss.

Michael Clanton, 45, a black engineer, had a dream of becoming the largest minority employer on the West Coast and eventually in the U.S. A graduate of Pacific States University in Los Angeles who worked for many years for Rockwell International and Martin Marietta Corp., Clanton launched the Seattle Electronic Research Corp. in 1978. Working under contracts to such major companies as United Nuclear Corp. and Martin Marietta, the new firm did research and development on energy-conservation equipment. Clanton was particularly proud of one experimental product he designed: the Energy Minder was a small electronic meter that could tell homeowners how fast they were running up their electric bills. By 1980 Seattle Electronic Research had revenues of $300,000 and was on the verge of becoming profitable. Clanton had created jobs for 28 people, many of whom were blacks or refugees from Southeast Asia.

His company’s troubles started, Clanton asserts, with the election of Ronald Reagan. The new Administration began boosting defense spending and diverting funds away from areas like energy conservation. As a result, many of the companies that Clanton did work for lost Government funding for energy projects, and his firm did not get several contracts that he had hoped to win. “Our projections went out the window,” he says. After slashing the staff to 18, then to four and finally to two, he filed for bankruptcy, and will close his doors for the last time by the end of this month.

Clanton admits that poor financial planning was partly to blame for his firm’s demise. “When you talk about research and development, it takes a lot of money,” he says. “We needed at least $250,000, but we started out with $4,500.” Clanton has no worries about finding another job, but it will be hard to forget about his dashed dream. Says he: “You keep asking yourself, ‘What if I had done this or that?’ You look at it as a personal failure.”