Businesses in the US, looking for a way out of their financial crisis through bankruptcy, must be aware of all the aspects governed by the business bankruptcy law. In most cases, filing for bankruptcy seems like the best option out of the debt trap, especially for businesses. Understanding the types of insolvency available for companies would help them in understanding how to be protected under the bankruptcy laws.
Business can become insolvent under Chapter 7 or Chapter 11 bankruptcy codes under the business bankruptcy law.
Under Chapter 7, the company applying for bankruptcy needs to stop all its operations and go out of function completely. The court appoints a trustee to liquidate all the assets. The proceedings are used to clear the debt. The stakeholders who have taken the minimum risk would be paid first. That is, secured creditors would be the first ones to get a pay off, as they are highly risk averse. Unsecured creditors (suppliers, bondholders, bank, etc.) follow the secured creditors in getting a settlement and the last would be the stockholders.
Under this bankruptcy code, a committee comprising of stakeholders and creditors reorganizes the assets and business affairs of the company in debt. The company is expected to gain sound financial standing and return to business in future. Chapter 11 is a good option for those companies that need to restructure their unmanageable debt. The company is allowed to carry on its operations, however, the major business decisions are approved only by the bankruptcy court.
Chapter 11 is an expensive affair, where the company is obligated to fulfill all its obligations as part of the reorganization to get a fresh start. For many of the public firms, this is the best option, as they can continue their business while working to be debt free. The business bankruptcy law does not prohibit the trading of the stocks of an insolvent company. However, the major stock markets do not list such companies.
Bankruptcy proceeding is much like a lawsuit proceeding, which commences without guaranteed outcome. The company filing for bankruptcy needs to follow a legal process with stakeholders, creditor and third parties regarding the restructuring or discharging of debts. One difference from the regular lawsuit is that, the business bankruptcy petition can get temporary automatic stay. This business bankruptcy law prevents the creditors from pursuing further steps in collecting their debts without the permission of the court.