Bob Lawless remembers well the moment he realized he knew something no one else in law, business, or government had put together. It was May 2004, and the professor was poring over stacks of data in his office at the William S. Boyd School of Law when he realized that a single flaw in a computer form had skewed the data that was used to craft new federal bankruptcy law.
The discovery came as Lawless and Harvard law professor Elizabeth Warren were researching the discrepancy between their statistics and official government numbers. The administrative office of the U.S. Courts indicated that bankruptcy filings by small-business owners had dropped markedly — from 18 percent of all filings in the mid-1980s to less than 2 percent in 2004.
Lawless and Warren's research, conducted under grant funding from the Ewing Marion Kauffman Foundation, shows that small businesses still account for as much as 17 percent of bankruptcies filed, nine times what official government data showed. That discrepancy could amount to as many as 280,000 misfiled claims each year.
"It's the most rewarding part of doing this kind of research — looking at the findings and realizing I'm the only person in the world who knows this," Lawless says.
A defect in computer software used by many law firms to file bankruptcy paperwork is resulting in the skewed data, the researchers say. A box on the form's cover page defaults to a consumer bankruptcy unless otherwise noted.
"The cover sheet has no legal bearing, so most lawyers focused their attention on the parts of the cases affecting clients' legal rights, which is something any good lawyer would do," Lawless says. Because the error was so widespread, Lawless places the burden for detecting and correcting the problem on those compiling official statistics, the administrative office.
The findings are proving very important as new federal bankruptcy legislation is slated to go into effect this October. The legislation, which was meant to target consumers, will make it very hard for entrepreneurs to recover from bankruptcy and start new ventures, Lawless says.
"Although the new legislation will obviously hurt small-business owners more directly, it's going to affect everyone because we all live in the same society," he says. "It takes a nick out of every small business, which will be reflected in the job market that eventually touches us all."
The legislation will also likely cause existing small businesses to be more cautious about expanding, Lawless believes.
He fears the law will make it very hard for repeat bankruptcy filers to work through the system and start fresh. In the end, this will further damage the business climate, he says.
The long-held belief that small businesses are either successful or not, with no middle ground, is a myth, Lawless says. "Research shows that most small businesses fail three or four times before owners are successful," he says, noting that the bankruptcy system enables them to eventually find a venture that meets their skills.
Now that he and Warren have uncovered the reason for the disappearing business bankruptcy in government statistics, the next step is the "how and why" phase.
"Our goal now is to figure out why small-business owners filed for bankruptcy and how they're doing as a result," he says. "We want to look at how these entrepreneurs financed their businesses, through credit cards and home equity loans, for example, and see if there's a correlation."
In the meantime, Lawless hopes his findings prompt policymakers to reassess the new legislation, knowing the extraordinary risks taken by entrepreneurs.
"We hope the findings challenge lawmakers to question whether a bankruptcy system designed for consumers works in a system in which one in seven debtors is an entrepreneur."
