When any city or municipality files for bankruptcy, it can raise eyebrows within the state since we expect our local governments to operate somewhat efficiently. But when a major metropolitan entity like Detroit files, the entire country takes note and experts argue and search for reasons for the massive public failure.
Detroit’s bankruptcy filing in 2013 was the largest municipal bankruptcy in American history. It was the climactic collapse of a once proud and thriving community that had its heyday in the 1950s. Home to the booming auto industry, African-Americans from the Jim Crow southern states flocked to the city. The civil rights movement, however, was still in its infancy and racial sensitivities were not much different in the North, though perhaps not as blatant or violent. White residents feared that housing prices would rise and many fled to the suburbs and city neighborhoods became segregated. Union disputes, racial unrest and rioting in the 1960s furthered the city’s deterioration as businesses relocated and unemployment rose along with crime rates. With a depleted tax base, schools were underfunded as well. Foreign competition and American auto manufacturers’ slow move to more fuel efficient cars caused further loss of jobs and added to the city’s increasing financial woes.
Detroit Is Bouncing Back
By filing for bankruptcy, Detroit was given an opportunity to redefine itself. Governor Rick Snyder appointed an emergency city manager whose overall authority was initially questioned as an unconstitutional power grab. But in the past two years, Detroit has been able to reorganize its debts, and reinvestment in the city’s core has been steadily growing. Shrinking the city has been a concern but planners see this a plus as worn out buildings and abandoned areas are being destroyed. Planners are enticing small businesses and startups into the area by establishing “renaissance zones” that offer tax relief. The city is also offering training for workers hired by incoming businesses. Overall, city officials are optimistic that although Detroit may never be the metropolis it once was, it will be an area that can be as productive as any other great American city and a city where people will once again want to live and work.
Small Businesses and Bankruptcy Protection
The ability of an entity the size of Detroit to emerge as a revitalized urban area should be instructive to small business owners who are facing overwhelming debt that prevents them from becoming profitable. Many such businesses are plagued by too much debt along with unfavorable lease agreements or vendor contracts, poor initial planning, illogical methods of operation or having to deal with the demands of unions and creditors, overdue taxes or unproductive workers.
A small business owner who wants to see his company become profitable and a growing business concern has two bankruptcy options: Chapter 13 or Chapter 11.
For many struggling small businesses with too much debt, Chapter 13 is an option. Called a wage earner’s plan, this is generally used for individuals who choose not to use Chapter 7 (so as to retain certain assets) or who do not qualify for Chapter 7, and for sole proprietors or small business owners. Your filing has to include all your debts, including personal ones. This includes contingency debts or an obligation that only comes due when an event occurs and thus has a determinable value.
When you file under any bankruptcy chapter, an automatic stay under 11 US Code Section 362 goes into effect. This means that all collection activity must cease and that any civil court proceedings are paused.
The Repayment Plan
As the business debtor, you and your attorney have to present a debt repayment plan that includes all the creditors who are categorized in order of priority. For example, unpaid taxes and wages to employees are a priority. Like a Chapter 7 filing, you do have to qualify to file and the amount of your income determines the duration of the plan as either 3 or 5 years.
The means test determines the duration of the plan. If your average income over the past 6 months is more than the monthly state median for your household size, your plan is 5 years. Otherwise, it is 3 years. Few of your unsecured creditors are usually paid 100% of your obligation to them.
Also, under Section 109(e) of the Bankruptcy Code, your secured debts cannot exceed $1,149,525 and your unsecured cannot exceed $383,175. If they do, you can only file under Chapter 11 or Chapter 7.
Retain Your Property
Chapter 13 is not a liquidation, so you retain all of your assets. You do have to maintain the payments you will have to make pursuant to the repayment plan or you risk being forced into Chapter 7. If that occurs, you could lose any non-exempt property and you will have to cease operations. With the protection afforded you and your business under Chapter 13, you and your business can slowly repay creditors over time while your business grows.
Chapter 11 is for corporations, partnerships, LLCs and even small businesses and individuals. Small business owners may have to choose this option if their debts go too high for Chapter 13.
Chapter 11 is a restructuring of your business pursuant to a reorganization plan. You may continue business operations as the debtor-in-possession wherein you are in a fiduciary position and have the authority of a bankruptcy trustee. A trustee normally has some oversight over the administration of your operations but in a small business case, the trustee will have more power in monitoring your operations including refinancing or negotiating contracts or leases.
Your restructuring includes paying back creditors but for less than the original obligations. You are also allowed, if not required, to initiate a plan to get your business back on track.
As debtor in possession, you can lay off employees, engage in litigation, sell off assets and secure new sources of funding. You can also seek and accept loans. Like any other bankruptcy, once you file the petition, an automatic stay goes into immediate effect under 11 US Code Section 362. The stay applies to any current lawsuits as well as ongoing collection activities by creditors.
Chapter 11 filings are usually very complicated and expensive and require extensive preparation and disclosure of all aspects of your business entity. However, if you are a small business, certain provisions normally required in a Chapter 11 are waived:
No Creditors’ Committee
In a typical Chapter 11, there is one or more creditors’ committees with their own attorneys and finance professionals who are paid by the bankruptcy estate who represent the unsecured creditors. These committees vote to approve the plan presented by the debtor-in-possession or submit competing plans. In a small Chapter 11 proceeding, the court can order that no committees be formed.
As a small business, you are required to submit certain reports during the duration of the process that include your most recent balance sheet, cash flow statement, statement of operations and tax return.
Submission of a Plan
You have the right to submit a plan within 300 days, which can be extended in some cases. In large cases, there is no deadline unless the court imposes one. You also have the exclusive right to submit one within 180 days after it files so as to avoid having to litigate competing plans proposed by creditors who generally want to liquidate or take control of your assets.
No Disclosure Statement
Another onerous requirement for larger businesses in a Chapter 11 that is waived for small businesses is that of issuing a Disclosure Statement. This is a complex document that contains comprehensive information about the company’s history, valuation of assets, why it is filing for protection, feasibility of the proposed plan and other data that can be very costly to prepare. A court can waive this requirement and save you potentially thousands of dollars.
Once the plan is approved, you must make a monthly payment to the trustee for the benefit of the unsecured creditors while maintaining your obligations to the secured ones. In the meantime, you can seek new sources of income or loans, terminate unproductive employees and find new ones and engage in a plan for advertising and finding clients or customers for your business to grow and become profitable.
The DCDM Law Group
If your sole proprietorship or business is struggling under mounting debt with no end in sight, call the DCDM Law Group to discuss if bankruptcy protection is a viable option for you. We have decades of experience in working with small businesses and helping them on the road to financial recovery.