Bankruptcies

In the event of a bankruptcy, which means the company or the individual is incapable of meeting its debt obligations the assets of the concerned entity is transferred from the owners, i.e. the shareholders to the debt holders or the creditors. This is accordance with the norm that in case of bankruptcy the owners get their dues last from the residue, if any, after meeting the obligations of the creditors.

In the business world we find stages of bankruptcy denoted by various terms. We now take a look at those separately. When an ailing company formulates a plan for reorganization which has to be agreed and voted on by the creditors, debt holders and the share holders that it can file for bankruptcy. This is known as Pre-packaged Bankruptcy as it is predetermined to resurrect the fledgling fortunes of a company by shortening and simplifying the procedure, cutting costs in order to generate more funds for the creditors.

Technical Bankruptcy one of situation wherein the entity has defaulted on its debt obligation and would be declared bankrupt if a case is filed by the creditors. It can be said to be the previous step to complete bankruptcy with the difference that the entity is yet to be declared bankrupt by the courts.

There is one more term that is associated with bankruptcy and is known as accounting insolvency which only takes into account the state of the balance sheet where the liabilities are more than the assets.

Bankruptcy can be filed in the U.S. under various sections of the Bankruptcy Code. Prominent amongst them are bankruptcy filed under Chapter 11 which gives a chance to the entity to start afresh after restructuring its assets and debts but subject to fulfillment of certain mandatory obligations as specified. It is filed mainly to restructure the debts. However this category of bankruptcy filing is very complex and expensive.

Bankruptcy filing under Chapter 13 is another option which is used by entities having sufficient income generating capacity whereby the entity, under the supervision of the courts restructures its affairs and must pay back the creditors within a stipulated time period. This is a popular form of filing for bankruptcy. Then there is Chapter 7 under which an entity can opt for foreclosure.

In case of bankruptcy the company may go into liquidation and a receiver is then appointed by the courts to settle the affairs. When a receiver is appointed the creditors lose their rights to directly get their dues from the borrowing entity. The receiver takes stock of the assets and sells them in order to pay the creditors in proportion to their dues. It is to be noted that there are a type of debt known as the nondischargeable debts which do not get eliminated in case of bankruptcy. This occurs when the creditors refuse to discharge their particular debt.

Liabilities which arise prior to filing bankruptcy are known as pre petition liability. This distinction of pre and post petition liability has a significant bearing on the quantum the company must pay. A company can use what is known as 'turnaround financing' under Chapter 11 of the U.S. Bankruptcy Code. This type of financing though profitable to the lender carries very high risks. However a company can file for 'automatic Stay' which prohibits the creditors from suing the company which has filed for bankruptcy under Chapter 11 for debts till the stay is in force.