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Understanding the Bankruptcy Process

Understanding the Bankruptcy Process

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Author: Sophia Media
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Identify the basic features of the bankruptcy process in the United States.

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[MUSIC PLAYING] This is Dr. Bob Nolley with a discussion today on bankruptcy. Business entities, just like individuals that are undergoing financial distress, may be forced to consider bankruptcy. Bankruptcy is a legal status of a firm that is insolvent, meaning that they can't repay the debt they owe the creditors. Jurisdiction over bankruptcy cases lies with the US District Court. The Attorney General of the United States appoints trustees for each of the 21 districts, who in turn each manage their own panel of trustees to hear bankruptcy cases.

The bankruptcy code imposes an immediate stay once a bankruptcy petition is filed. This stay keeps creditors from starting collection actions, enforcing collection actions, or appealing actions or judgments against a debtor for a claim that arose during a prior filing. What this means is, as soon as the position is filed, the debtor has all the protection to provisions under the bankruptcy code.

There are different chapters of the bankruptcy code that address different petitions being filed. One is Chapter 7, which is filing for liquidation. This is the most common form when the trustee gathers all the assets and delivers all the proceeds to the creditors. Most Chapter 7 bankruptcy cases are those that involve no assets.

Chapter 11 bankruptcy allows an organization to reorganize. Businesses frequently take advantage of this by developing a bankruptcy plan, where they reorganize the debts, which then gets voted upon by the creditors. Chapter 11 bankruptcies can take years, depending on the complexity of the case.

The business develops a plan to reorganize, and it gets voted on for approval by all of the creditors involved. The disadvantages are, they face future higher capital cost. It can make it difficult, if not impossible, for an individual to borrow in the future, because companies that are reorganized are not dissolved and they face the higher value of a cost of capital for future operations after they emerge from bankruptcy.

So to avoid the negative impacts, companies in financial distress have some alternatives. They could try to decrease financial leverage. They could dispose of investments that are not producing a profit. They could stagger or extend debt payments.

They could lower earnings distributions, like dividends. They could diversify operations. And they could severely reduce costs where possible. They could moderate risky investments and improve efficiency.

During bankruptcy after a Chapter 11 agreement has been confirmed, the provisions are binding. And it prescribes how the details of operations are to be handled. Sometimes the organization may be able to acquire financing terms if they give new lenders first priority on the earnings. If the company's debts are greater than the sum of all the assets, the company owner, as well, in all likelihood, will be left with nothing.

So let's review. Bankruptcy arises for an organization when it is unable to pay its creditors. It could file for protection under Chapter 11, which provides for a reorganization of debts and restructuring that allows operations to continue. But it may be forced to file for Chapter 7, which leads to liquidation.

This is Dr. Bob Nolley. And I'll see you in the next lesson.

[MUSIC PLAYING]

Terms to Know
Bankruptcy

The legal status of an insolvent person or organization; one who cannot repay the debts they owe to creditors.