Why Companies Declare Bankruptcy

You’ve heard it all before, a company goes bankrupt and then closes; former big names like Radio Shack and Toys R Us are some of the most recent victims. But should you panic when you hear of a company declaring bankruptcy, or more importantly, if you have your own company are there times when you should consider bankruptcy?

Long answer short, don’t panic; there are instances where bankruptcy is in the best interest of the company. Not all cases are the same, and it will be crucial to evaluate your options to see how you can best help your company and eliminate debt. Primarily, there are 2 types of bankruptcy that companies go through: chapter 7 will sell off a company’s assets to pay off debt and close the company, and chapter 11 will be used to help re-structure debt and allow a company to return to normal operations.

Chapter 7 Bankruptcy

When a company opts to take chapter 7, this means that they are no longer viable and will be closing. The company will cease all operations and go out of business, then an appointed trustee will sell off assets to pay down debt. If you have invested in a public company that takes chapter 7, don’t worry. When you invest in a company have a significantly reduced exposure risk and typically, you will be paid off first from the sale of the company’s holdings. However, if you are an equity holder in such a company, you may lose money on your investment.

Taking chapter 7 can be a scary concept, but it may be the best option for your company. Often, companies find themselves in too much debt to manage, and profit margins are non-existent. Typically, chapter 7 is used by individuals, but in some cases, it can be in the best interest for a company to cease existing and declare bankruptcy.

Chapter 11 Bankruptcy

This is the most common form of bankruptcy taken by companies, as it allows for re-structuring then the resuming of business. Chapter 11 is the most complicated form of bankruptcy, but it can yield great results. Unmanageable debt will be consolidated this way and will allow the company to have a fresh start. Chapter 11 is highly recommended when the company is profitable or is worth saving, but still has a large amount of debt.

In this case, there will still be a trustee appointed to manage the bankruptcy proceedings, but the assets will not be sold off. In the case of a large, public company, there will typically be a board of shareholders that will be put in place to help right the company. They will be charged with making the company profitable and will make drastic changes to improve profitability. This does not eliminate a company’s debt entirely, rather it will re-structure and re-negotiate the terms of debt. There are instances that som of the debt is eliminated entirely, but that is on a case by case basis.

Chapter 11 is typically considered to be for larger companies, but it is possible to do for small businesses (500 or less employees). In fact, most chapter 11 filings are for small businesses. However, the courts tend to be stricter on the requirements for these and will maintain careful oversight which will require you to provide balance sheets and tax return statements through the process. In some cases, the court deems it necessary to move the company from chapter 11 to chapter 7, which shuts the company down. When you file for chapter 11, there will be a three-step process involved:

  1. A petition for bankruptcy must be filed
  2. A reorganization plan will be created
  3. A conformation of debt discharge

Companies have many reasons to declare bankruptcy, and not all of them spell doom. Remember that if you are considering this, going over the process and reviewing the situation with an attorney is of the upmost importance. There are times when companies will need to close their doors, and again having the right legal team will make all the difference and prevent losing everything. At the Holland Law Offices, we are experts in bankruptcy law, and are here to help. No matter what the situation of your business is, let us help you find a solution that works for you.

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