In early 16th century Italy, when a moneylender was unable to continue business, his bench or counter (banca) was broken (rotta) and he was spoken of as bancarotta, or bankrupt. Now, almost 500 years later, bankruptcy remains a fact of commercial life, and while benches may not be broken, the same cannot be said for dreams and wallets.

San Diego attorney Ali Mojdehi believes bankruptcy, or some other form of reorganization, is an inevitable part of a cycle in a capitalist system, a system that fosters the entrepreneurial spirit and encourages debt.

“You have to worry most when times are best,” Mojdehi says. As values go up people can borrow more, but when the “value bubble bursts,” the debt still has to be paid. Wall Street’s bubble burst some time ago, and the bankruptcy effect is now rippling through the U.S. economy. San Diego, so far, has not been hit as hard as other parts of the country, but even here “we’re seeing signs of distress,” he says.

Mojdehi is chairman of the financial restructuring, creditors’ rights and bankruptcy practice group at the Downtown offices of Baker & McKenzie. Like his counterparts in the region’s other major law firms, Mojdehi swims out to help rescue large, corporate clients caught in financial riptides rather than individuals who suddenly find themselves out of their depth.

He was practicing law in Oklahoma in 1984 when he came to San Diego as part of a team involved in the massive bankruptcy of Nucorp Energy Inc. The oil and gas conglomerate, with 27 affiliates across the country, was subject to more than 16,000 claims totaling about $1 billion. Mojdehi thinks this was the largest bankruptcy ever in San Diego and it was certainly a career highlight for a man who relishes the challenges thrown up by such major cases. “The bigger they are, the more complex and interesting the legal problems,” he says.

Sue Hodges, managing partner of the San Diego office of Pillsbury Winthrop, launched her career in the specialized world of bankruptcy law in Chicago in 1984 and moved to San Diego four years later. She says chapters 7, 11 and 13 of the bankruptcy code are lawyers’ main tools. More rarely used is Chapter 9, covering municipalities (among the most prominent recent cases was Orange County in the early ’90s), and 12, covering family farms.

Chapter 7 basically is a liquidation. Hodges says a trustee is appointed to collect and sell assets and distribute the money to creditors; secured creditors may be paid in full but unsecured creditors likely will receive only a fraction of what they are owed. Chapter 13 mostly is used in individual cases and effectively is a monthly payment plan, although again unsecured creditors are unlikely to get all their money back.

The majority of companies, especially large ones, that find themselves being sucked into a financial black hole file for Chapter 11, a protective umbrella under which they can reorganize and attempt to recover. Chapter 11 almost always offers a better option than Chapter 7 in the bigger cases, says Mojdehi. “Chapter 11 can result in the rebirth of the company and often does in the case of larger companies, for example, those $100 million or more in debt.”

The move buys time for a company to put its house in order through one of several strategies, Hodges explains. One is to raise additional cash by selling a subsidiary, division or other assets, sometimes even the company’s crown jewels. Management changes, in the executive ranks or on the board, may occur, Hodges says, but generally the key to long-term prosperity is restructuring debt.

Companies draw up survival plans which, subject to court and usually creditor approval, may include measures such as converting debt to equity, extending loans, reducing interest rates and possibly persuading lenders to write off part of their debt. Often a creditors’ committee is established at the company’s expense. Lawyers and other professionals are typically employed by these committees, which closely scrutinize the drafting and implementation of rescue packages.

Margaret Mann is a partner and lead litigator in the commercial, finance and insolvency practice group of Luce, Forward, Hamilton & Scripps. She draws upon extensive experience in large, complex Chapter 11 and Chapter 7 cases on behalf of creditors, trustees, debtors and other interested parties. Mann says while the pace of bankruptcies in San Diego is “certainly picking up,” it’s not as high as might be expected given the widespread gloomy economic news. Latest statistics confirm that view. Figures from the U.S. Bankruptcy Court, Southern District, show San Diego County casualties are slowly mounting again after a steady downward trend over the past three years.

Filings under chapters 7, 11 and 13 peaked at 19,282 in 1997, and they had dropped dramatically to 12,547 by the end of last year. However, in the first five months of this year the numbers reached 5,910; if maintained, that would haul the annual total back up around 14,180.

Mann, who has 20 years of experience in commercial litigation and bankruptcy law, says increasing use is being made of an out-of-court insolvency process known as “assignments for the benefit of creditors.” It’s a move she strongly supports, arguing that a company’s money can be better spent within the business than on legal fees. Mann says an out-of-court settlement means a bigger pot at the end of the day and is usually a better solution.

In a typical bankruptcy the bottom line is the interests of creditors and whether they are best served by a quick liquidation and distribution of funds or by a longer-term reorganization under Chapter 11. But not all creditors have equal status. The complexities of Chapter 11 include a hierarchy of claims and a complicated formula for representing a variety of competing interests, all interwoven with an intricate system of checks and balances and an overall monitoring process.

Trade debtors and employees often are trusting and supportive of management, says Mann. Each group likely will back a restructuring under Chapter 11 as the best way to preserve respectively their customers and their jobs. Mann believes “utter candor” is the best approach in a bankruptcy. “You have to be honest about the problem and suggest solutions, keep focused on the solution and avoid blame.”

David Osias agrees. “Sometimes we are our clients’ harshest critics at the start of a case,” says the man who heads the bankruptcy and creditors’ rights department at Allen Matkins Leck Gamble & Mallory. Osias joined the firm exactly 10 years ago this month (July) and among many high-profile cases he has handled since was the bankruptcy of publicly traded Telios Pharmaceuticals in the mid-90s. In every instance he believes it’s essential to know the real problem, such as bad management or bad products, admit it and find a solution that achieves the goal of recovering a company’s credibility.

Osias says one of the ironies of Chapter 11 is that many companies delay too long before filing. By that time they have run out of money and cannot afford to restructure and trade their way out of trouble. Filing for Chapter 11 draws a line under the company’s financial position at a certain date. But all obligations from then on, such as wages and accounts for suppliers, must be paid as they fall due.

At the same time, Osias says many companies should not file under Chapter 11 in the first place because they are never going to survive. He says most Chapter 11 cases fail and many revert to Chapter 7 where a trustee oversees the liquidation.

Jeff Davis, a partner at Gray Cary and a specialist in bankruptcy and insolvency issues, has been busy dealing with cases of faltering high-tech, software, dot-com and telecommunications companies — but mostly in the Bay Area, Austin, North Carolina and other parts of the country. “We have not seen that much of an increase in San Diego,” he says.

In the past Davis has worked on some huge San Diego cases. He represented the committee of investors in the $64 million Chapter 11 of pay telephone company Amtel; another $60 million was at stake about 10 years ago when a golf course and residential development faltered at Temecula; then there was a $42 million reorganization involving a multi-use development on La Jolla Village Drive.

Davis notes the reorganization process has tended to become much quicker in recent times. Retail or manufacturing cases once wound through the bankruptcy court in two to three years with revenue still coming in while debt was restructured, management reorganized and fat trimmed. Today, in contrast, a quick sale of assets is often the solution for many troubled tech companies which are backed by venture capital, have little debt financing, no established lending relationship with a supportive bank and minimal revenues.

Davis turns down more cases than he accepts, often after seeing telltale signs such as weak management, a lack of financing or an eroding customer base. Many high-tech companies, he says, are not viable even without debt.

Filing for bankruptcy has definite downsides. It can be an expensive, time-consuming and painful process; future credit may be harder to get and cost more; and management may lose a degree of control and privacy. They may even lose their jobs.

Another disadvantage is the stigma still attached to the word “bankrupt.” To counter this negative image, the system tries to emphasize that filing under the various chapters is not admitting defeat but is more about offering a fresh start for businesses and individuals.