Corporate And Business Bankruptcy:
There are two ways for a company to declare bankruptcy. It is the federal bankruptcy laws that govern how a company goes out of business. A company can file for bankruptcy under Chapter 11 in which case the debtor company is given a chance to reorganize its business and try to become profitable. The company is allowed to operate on its own using its own staff for daily functioning. However, the court may appoint an overseer who must be consulted for major financial decisions.
A company that has no hope of recovering can file a Chapter 7 bankruptcy and stop all operations. It is completely out of business. The court appoints a trustee who is in charge of liquidating all assets of the company and distributes the money to creditors and investors.
What happens in Chapter 11 bankruptcy?
When a company files for Chapter 11 bankruptcy the U.S.Trustee appoints a committee of members who look into the interests of the creditors, stockholders and investors of the company.
A plan is created to help the company reorganize itself and make a profit to repay debts. This plan is put forth before all the creditors, bondholders and stockholders. If they accept the plan then the court finalizes it. If stockholders reject the plan, the court can still finalize it if it finds the plan to be feasible.
Once the plan has been finalized, a detailed report is filed with the SEC on Form 8-K. This report contains a summary of complete details of the plan for repayment as well.
Who gets paid first?
Once a company declares bankruptcy the credits are divided into three groups. Secured creditors like the banks are the first to recover their money. They are the investors who take the least amount of risk and their loan is generally backed by some collateral.
Unsecured creditors like bondholders, banks, and suppliers have the next claim to recovering their money. Since the company has agreed to pay bondholders their principle amount and some interest, they are given greater priority than stockholders.
Stockholders take the maximum amount of risk. They stand to gain a lot if the company does well. However, they also have to incur losses when the company declares bankruptcy.
What happens in Chapter 7 bankruptcy?
If a company files for bankruptcy under Chapter 7, it has gone for straight bankruptcy. The company is in fact belly-up and you can consider all your investments as gone.
The company’s assets are liquidated and the money is used to pay administrative and legal fees. Secured creditors are given their collateral and if it is not enough to repay all their loans then they are grouped with unsecured creditors. Bondholders and other creditors are notified of the bankruptcy and should file a claim for money owed to them.
Generally, stockholders are not notified of the company’s bankruptcy since they don’t receive anything. However, in the unlikely event that money is still left over after full repayment of all other creditors, the stockholders are notified and need to file a claim.
Thus, how huge the losses suffered by the company are and whether the company is capable of recovery determines whether the company will file Chapter 11 or Chapter 7 bankruptcy.
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