Corporate bankruptcy is a legal process whereby the business entity declares that it is unable to meet its obligations, and is seeking protection from legal action by its creditors. In the US, there are two options for businesses under the bankruptcy act; chapter 7 and chapter 11. Any business, from a sole proprietorship to a corporation, can file under either of these two chapters.
Chapter 7 provides the guidelines for a business to cease operations and liquidate assets. The ownership of the business is signed over to the bankruptcy lawyer. The lawyer is then responsible for shutting down operations, selling off assets and dividing the proceeds between the creditors.
Chapter 11 allows the business to continue to operate while attempting to restructure under the guidance of the bankruptcy court. In this type of corporate bankruptcy, the court is able to grant full or partial relief from the company’s debts and contractual obligations. In a chapter 11 corporate bankruptcy, the company is reorganized and may emerge from bankruptcy able to continue business operations.
Under corporate bankruptcy proceedings, the court can set aside binding contracts, such as labor union agreements, real estate leases, supply purchasing and operating contracts. This option is most frequently used by large corporations who are in a recurring cash deficit position and unable to reorganize due to the expense of these binding contracts. Changes in the economic climate, low product sales or increasing operating expenses can all trigger a corporate bankruptcy.
In both chapters 7 and 11, all legal proceedings against the company are halted to give the business time to reorganize and settle its debts. In chapter 11, the debtors have the right to propose reorganization plans. If these plans are accepted by the majority of the creditors, and meet the criteria of the court, they will be imposed on the company.
If a plan cannot be agreed upon, the company either enters chapter 7 or returns to normal operations. Should the company return to normal operations, the creditors can resume legal action against the company. Unless financing is obtained quickly, the firm usually ends up back in bankruptcy.
Not all creditors are viewed equally in a corporate bankruptcy. Secured creditors have priority over all unsecured creditors. A secured creditor is a creditor whose debt was supported by an asset, or is considered classified as such under US law. Employees are considered the highest ranked secured creditor.
Publicly traded companies shares are removed from the stock exchange or delisted as soon as the company files for bankruptcy. News of economic troubles tends to lower the value of these shares in advance of any actual filing of corporate bankruptcy. As a result, the shares have usually lost a significant amount of value during the period just before filing for corporate bankruptcy.