What Is Bankruptcy?
Bankruptcy can be termed as a legal process by which entities or people who are not able to repay debts to their creditors can seek relief from the debts. Bankruptcy is often initiated by the debtor and imposed by a court order. However, insolvency and bankruptcy are different.
Difference Between Bankruptcy And Insolvency
A company or person is considered insolvent when they are not able to repay debts to the lenders on time. If a company or person becomes insolvent, they can opt to file for bankruptcy or go for other options like debt consolidation or consumer proposals.
On the other hand, bankruptcy is a legal process that helps a person who is not able to repay their debts to lenders to clear their debts. Here are the steps involved in filing for bankruptcy:
- Meet a licensed insolvency trustee or LIT (formerly called Trustee in Bankruptcy)
- File the paperwork
- Sell assets of the bankrupt person or entity if required
- Contact and meet the lenders if required
- Attend credit counseling services
- Get debts cleared / discharged by the Federal Government’s Office of the Superintendent of Bankruptcy (OSB).
Once the person or entity is discharged from bankruptcy, it means that they are relieved from the obligation to repay the debts, and they become solvent again.
Types Of Bankruptcies
There are 3 main types of bankruptcies. It is important to know which chapter to file, as each has its own options and objectives. Here are the 3 types of bankruptcies:
Chapter 7 Bankruptcy
Chapter 7 is also called liquidation bankruptcy as it calls for most of the debtor’s assets to be sold to pay the lenders. Almost all chapter 7 filers get at least some of their debts discharged. This can be used by both businesses and individuals.
It can be said that chapter 7 offers the fastest way through bankruptcy. A chapter 7 filing may take about 4 months from filing to the resolution, which is a lesser time. This is because there is no repayment plan involved in this chapter unlike other chapters.
Chapter 13 Bankruptcy
A chapter 13 filing is also termed as a wage earner’s plan. It lets the debtor keep more property at the cost of repaying the debts over a long period, about 3 to 5 years.
Chapter 13 lets the filers protect their homes from foreclosure. This type of bankruptcy halts the foreclosure and lets the debtor catch up to the late mortgage payments. Herein, the debt makes payments to the trustee, who distributes funds to the lenders so that the debtors don’t have to be in contact with the lenders while making payments.
Chapter 11 Bankruptcy
Chapter 11 can also be called reorganizing bankruptcy. It is usually related to business corporations and partnerships. Business individuals, like sole proprietors, may use this type of bankruptcy filing. Like chapter 13, this chapter also involves a repayment plan.
Chapter 11 helps the business to stay in operation while its debts get restructured, paying the lenders over time. This is a major asset for the filer, and even for the lenders who, otherwise, may not have any prospects of repayment.
When compared to chapter 7 and 13, chapter 11 is complex, lengthy, and costly. If a huge corporation goes bankrupt, it can seek bankruptcy protection with this chapter.
What Happens When A Company Goes Bankrupt?
When a company goes bankrupt, the most affected are its shareholders and the employees. When a company that is publicly listed ceases its operations and goes into liquidation, its shareholders may be entitled to a portion of the assets, depending on the types of shares that have. However, the stop is usually worthless.
Bankruptcy And Shareholders
There are different effects of different chapters of bankruptcy. If it is a chapter 11 bankruptcy, common stock shares become worthless and stop paying dividends to the shareholders. The stock may also get delisted on the major stock exchanges and a Q may be added to the stock’s symbol to indicate that the company has filed for bankruptcy.
It is possible that the company’s shares regain value as it emerges from bankruptcy. The company may also cancel old shares and issue new ones as a part of reorganization of debt, leaving little or nothing to the original shareholders.
If it is a chapter 7 bankruptcy, the stock is defunct. Herein, the common shareholders may get a portion of their value back when the company’s assets are distributed. However, they rarely get anything.
Bankruptcy And Employees
Apart from shareholders, if a corporation goes bankrupt then employees of the bankrupt company, too, are affected in the most negative way. At the time of bankruptcy, the employees are often seen as abandonable. During the process, their pensions and savings are spent on the survival of the company. It is the most difficult to deal with the employees’ salary, pension, and benefit schemes as they hold most of the money of the company. This does not only bring financial problems for the employees but also brings emotional turmoil. In India, there is no adequate safeguard for them when the company is liquidated.
However, the Insolvency and Bankruptcy Code, 2016 (IBC) has mechanisms that help employees claim their wages and salaries unpaid in the course of business up to 12 months before the initiation of the company’s liquidation process. However, workmen can claim their dues for 24 months as the court distinguishes between employees and workmen.
There are many aspects to a company. While businesses are big contributors to the economy, they also have their pros and cons. It is not necessary for a business to always earn profit, there can be situations where they can incur huge losses and reach the verge of bankruptcy.
Bankruptcy is a legal process by which entities or individuals who are not able to repay debts to their lenders can seek relief from the debts. However, many people confuse the term ‘insolvency’ with bankruptcy. The term insolvency is used for a company or person when they are considered insolvent and are not able to repay debts to the creditors on time. However, if a company or person becomes insolvent, they can file for bankruptcy as they are not able to repay their debts. Bankruptcy is the next step to insolvency; it is a legal process that helps a person or entity which is not able to repay their debts to the lenders.
The situation of bankruptcy may not be the same for every company. Therefore, there are 3 common types of bankruptcy, namely, chapter 7 bankruptcy, chapter 13 bankruptcy, and chapter 11 bankruptcy. While all the three operate differently, chapter 7 and chapter 11 are mostly preferred by the companies or individuals as per their situation.
There are provisions made for the company, its lenders, and affected parties so that they get their dues cleared without creating any mess. In case a company ends up bankrupt, it can simply file bankruptcy and get aid in repaying its creditors and recovering its shareholders’ and employees’ losses as much as possible.