Corporate bankruptcy is an essential event for a business that can no longer repay its debts.
It represents the legal process for a business to try to meet its financial obligations.
In the business landscape, where new businesses emerge and old ones close almost weekly, it’s critical to know these terms. Corporate bankruptcy is a good way to forfeit a company’s effort to meet its debt repayments.
Economic fluctuations and shifts in the market can often cause many businesses to consider bankruptcy. Exploring the definitions, implications, alternatives, and other legal considerations of bankruptcy is also essential for someone venturing into the business world.
In this article, we have simplified what corporate bankruptcy means. Keep reading to know more.
Understanding Corporate Bankruptcy
Corporate bankruptcy is the legal process initiated by a corporation incapable of repaying its debts. The U.S. Bankruptcy Code governs the proceedings and provides the legal proceedings mechanisms for businesses to choose from two ways out.
They can choose to liquidate their assets or recognize their debts. As per The U.S. Bankruptcy Code, there are two major types of bankruptcies to consider.
Chapter 7
This type of bankruptcy is also called liquidation bankruptcy, where the business must sell off its assets to repay its clients. When the business is done liquidating its assets, it is ready to settle its debts and cease its operations.
Chapter 11
Chapter 11 bankruptcy, also known as reorganization bankruptcy; it allows businesses to continue operating while restructuring their debts. This is a process that provides businesses with a fresh start through renegotiation. They have a different term for repaying their debts. Often it also potentially eliminates their liabilities as a business.
Common Reasons for Filing for Corporate Bankruptcy
Why does a business file for corporate bankruptcy? If you were wondering what the reasons behind a business considering bankruptcy as a way out, then the reasons can be one of the three below –
Financial Mismanagement
When a business has a poor financial budget, inadequate cash flow, and weakness in making better financial decisions, it’s common to choose bankruptcy. Poor management can drive insolvency.
Economic Downturns
Sometimes, broader and industrywide challenges like recession can also affect a business, causing it to consider bankruptcy. These industry-wide changes significantly impact the revenue and sales of a business. Then it leads to bankruptcy when the business cannot repay debt.
Increased Competition
Sometimes, the competitors in the business can erode market share and affect business profitability. The result? Corporate Bankruptcy. That’s when either Chapter 7 or Chapter 11 bankruptcy is required.
Steps Involved in Filing for Corporate Bankruptcy
So, what steps must a business take to file for corporate bankruptcy? Following are the steps a business must fulfill –
Step 1
First, the company must compile all the financial documents like its financial documents, balance sheets, income statements, and different assets and liabilities.
Step 2
Once the documents are ready, the business must go through the formal proceedings to file a petition to the specific court for corporate bankruptcy.
Step 3
Once a business files for bankruptcy, an automatic stay is enacted. It halts all the collective activities against the business for debt repayment. The company can file for temporary relief from its repayment liabilities through bankruptcy filing.
Role of the Bankruptcy Trustee
Whether a business is filing for a Chapter 7 or a Chapter 11 bankruptcy, a trustee is appointed to oversee the bankruptcy process. They are responsible for handling the assets, ensuring compliance with the legalities, and representing the interests of the creditors.
It’s needless to say, a creditor’s role in the entire process is crucial.
Timeline of the Process
The timeline for corporate bankruptcy can also vary significantly according to the complexity of the business bankruptcy case.
The resolution of the process can take a timeline that spans a few months to almost years, based on the level of complexity.
Chapter 7: this process only requires the assets to be liquidated. Once the assets are sold, the corporate bankruptcy process is as good as done.
Chapter 11: the reorganization or Chapter 11 bankruptcy can take different levels of time. It can often take a few months leading up to a year. This is because the company must come to terms with its repayment terms.
Implications of Corporate Bankruptcy
How do the stakeholder’s factor into the whole equation?
Before the company is ready to go bankrupt, it must address its effects on the employees, creditors, and shareholders. Here’s how it’s handled –
Employees: job security is jeopardized under corporate bankruptcy. Layoffs are common when the company is streamlining its operations or restructuring itself.
Creditors: secured creditors usually have priority to ensure their investment through the liquidation of the company assets.
Shareholders: the stockholders are commonly the ones facing a huge loss. Their investments go obsolete or become a waste as the company restructures.
Effects on Company Operations
After a business applies for bankruptcy, its regular and normal business operations are often run under strict supervision of the court. This type of operation applies to the Chapter 11 bankruptcy cases. For Chapter 7 bankruptcy, the business must sell off its assets and stop operations.
Long-term Consequences for Brand Reputation
Corporate restructuring also tarnishes a company’s reputation. Customers also lose trust in the brand that has declared itself bankrupt. This type of case impacts the business’ sales and revenue.
Alternatives to Corporate Bankruptcy
So, can a business choose a way out? Even with the business getting a reduced cash inflow, it may not always require a corporate bankruptcy to settle the debts.
Following are some corporate bankruptcy alternatives a business can choose –
Debt Restructuring Options
Before resorting to bankruptcy, businesses may explore debt restructuring:
First, they can negotiate with the creditors. They can start with an open communication with the creditors to change the repayment terms. Sometimes, having temporary relief from repayment can work wonders for businesses.
If the creditors are open to negotiation, companies can work to build favorable repayment structures and timelines. This way, they can better manage the debt management process and have some relief without resorting to bankruptcy.
Voluntary Liquidation as an Alternative
In many cases, businesses may choose for voluntary liquidation outside a formal bankruptcy process. This is a choice to have when they believe that off assets can yield better returns than going to the court for liquidation.
Seeking Financial Assistance or Investment
The other way to opt out of bankruptcy is by attracting investors to provide the business with the necessary capital. This is an approach where the company must present efficient business models to the angel investors who may consider an investment.
Conclusion
Whether running a small business or working in the business landscape, it’s essential to know these terms. The complex environment of running or managing a business comes with different levels of success and failure. It also includes incidents like corporate bankruptcy.
There are several reasons why an organization must go through this phase. This decision also includes rethinking the bankruptcy implications, processes, and legal considerations for fulfilling one. Hopefully, this article provided you with the necessary information on what small business corporate bankruptcy stands for and how to go through it.
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