State court filings fly below the radar
After a decline in recent years, the number of business and personal bankruptcies in southeast Wisconsin has been increasing. And from all indications, 2002 will produce a bumper crop of persons and companies seeking protection from creditors.
Small businesses in particular are being hit hard by cutbacks at the larger corporations they provide materials or services to.
The federal government tracks business and individual bankruptcies separately. Last year, there were 14,612 filings in Wisconsin Eastern District Bankruptcy Court – and 236 of those filings were for businesses. In, 2000 there were 12,075 filings, of which 172 were businesses.
For the first two months of the year, the trend is clear. In January and February of 2002, there were 1,856 filings as opposed to 1,600 the year before. Of filings the first two months of this year, 34 were for businesses – a watermark well ahead of 2001.
But according to some, there is an undeniable relationship between personal and business insolvency.
Even attorneys appointed to liquidate creditors’ assets are noticing not only an increase in cases, but a cycle of insolvency that encompasses both businesses and consumers.
"When we go down to do cases in Kenosha, we see people laid off from Motorola," said Douglas Mann, a Milwaukee-based court-appointed receiver. "Those people may not be buying a new snowblower that year. Later we go up to West Bend, and John Deere has just laid people off, and they may not be buying a cell phone. I’ve come to appreciate how inter-related the economy really is."
Mann, who works on state insolvency cases that do not show up in federal data, said he has seen an increase in receivership cases since early 2000. Attorneys representing debtors and creditors in several southeast Wisconsin counties echoed Mann’s observation. While there is no reliable statistic of companies going into receivership in state court, there are only a handful of court-appointed receivers, and they are all very busy.
"It got worse in the fall of 2001," Mann said. "There seems to be a lack of confidence in the economy. While in the past we would see small businesses avoid receivership by going back to their lenders and getting more money or putting in more personal resources, now people don’t want to invest more money or resources."
7-11 not just a convenience store
In federal court, the numbers of companies filing for bankruptcy under Chapter 7 and Chapter 11 of the bankruptcy code can be easily tracked. Mann’s observation about state filing is borne out by numbers on the federal level as numbers of filings increased between 2000 and 2001; the increase has largely come in the number of Chapter 7 filings. While filing under Chapter 11 involves reorganization and a potential continuation of a business once necessary changes have been made, Chapter 7 largely means the business is defunct.
Last year, 64 more businesses in the area filed in Eastern District federal court, and of that increase, only four more opted for Chapter 11 protection than the year before.
According to Andrew Wronski, an attorney who handles commercial reorganizations and workouts on a national level out of Foley and Lardner’s Milwaukee office, choosing between Chapter 7 and Chapter 11 has more to do with business dynamics than law.
"The primary determinant is whether there is a realistic expectation that the business could proceed after going through with reorganization," Wronski said. "Is it a failed business model, or a product that is not in demand? You couldn’t successfully reorganize a buggy whip company today."
But in some instances, product demand does not have to do with obsolescence, as is the case of the buggy whip, but with business and economic cycles. In cases like these, determining which way to jump can be tricky, according to Wronski.
"Under Chapter 11, you can retool your capital structure," Wronski said. "You can turn some of your long-term debt into equity in the company. You can stretch out your debt — confirm a plan that provides for a payment length longer than was agreed with your lender. You are lowering those obligations and not paying 100 cents on the dollar. The question becomes: Can this let the business survive until there is an uptick in that particular business cycle? It all has to do with cash flow and timing. Will the business have enough cash to survive this process?"
State vs. federal
According to Wronski, filing for Chapter 128 under state code can be a faster, less expensive way to go for businesses throwing in the towel.
"People choose a 128 because it is cheaper than Chapter 7," Wronski said. "The procedures are not as burdensome. They are not paying a Chapter 7 trustee fee and expenses — but they do have to pay the expenses of a receiver. Secured creditors like them because they are a little cheaper."
But even if a debtor files under state statute, creditors can file for an involuntary Chapter 7 bankruptcy in federal court because the federal code allows creditors more freedom to sue the debtor and other creditors. This federal filing trumps the state filing.
"When you are under state law in a Chapter 128, you don’t have the same chance to go back after preferential transfers," Wronski said. "Under the federal bankruptcy code, it allows creditors to recover payments on debts made in the 90 days prior to bankruptcy."
The rule, which is designed to prevent a debtor from favoring one creditor over another, allows one debtor to obtain a share of monies paid to other creditors just before the bankruptcy is filed.
"They take that money and put it all back in the pot," Wronski said. "Then it is divided among the creditors. It is a way to prevent preferential treatment of one creditor over another, but really it can be something that hurts creditors. There are provisions for preferences under state law but they are far narrower."
Wronski said he has seen quite a few of these cases pulled from state to federal court in this manner.
"The recent treatment of 128s in bankruptcy courts may deter some people from filing them because you essentially wind up wasting money," Wronski said.
Conversely, some Wisconsin businesses that are incorporated in Delaware may choose to file in that state’s federal bankruptcy courts. A case in point would be Dynamatic Corp., a Kenosha-based manufacturer of vehicle emission test equipment and electronic drives and controls that filed in Delaware in February.
"In Delaware, they have a reputation for having developed a lot of expertise," Wronski said. They are a little more debtor friendly. Lawyers representing debtors like to file in Delaware."
Bankruptcies in southeast Wisconsin
TOTALBUSINESS
200114,612236
200012,075172
199912,615213
199812,962267
January through February of 2002 vs previous years
20021,856
20011,600
20001,358
April 12, 2002 Small Business Times, Milwaukee
