In this lesson, you will learn about the main features of bankruptcy law in the United States and how companies manage finances before, during, and after filing. You’ll explore the key differences between Chapter 7 liquidation and Chapter 11 reorganization and the strategies firms use to avoid or recover from insolvency. Specifically, this lesson will cover:
1. Features of Bankruptcy in the United States
Business entities, just like individuals that are undergoing financial distress, may be forced to consider bankruptcy. Bankruptcy is the legal status of a firm that is insolvent, meaning that it cannot repay the debt it owes its creditors.
The United States District Court has jurisdiction over bankruptcy cases. The attorney general of the United States appoints trustees for each of the 21 districts; these trustees, in turn, 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. As soon as the position is filed, the debtor has all the protection provisions under the bankruptcy code.
There are different chapters of the bankruptcy code that address the different petitions being filed.
- Chapter 7 bankruptcy addresses filing for liquidation. This is the most common form of bankruptcy, in which the trustee gathers all the assets and delivers all the proceeds to the creditors. Most Chapter 7 bankruptcy cases are considered “no asset” cases.
- Chapter 11 bankruptcy allows an organization to reorganize. Businesses frequently take advantage of this by developing a bankruptcy plan to reorganize their debts, which is then voted upon by the creditors. Chapter 11 bankruptcies can take years, depending on the complexity of the case.
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- Bankruptcy
- The legal status of insolvent persons or organizations that cannot repay the debts they owe to creditors.
2. Financial Management Before and During Bankruptcy
Financial management before and during bankruptcy is critical for companies to remedy financial distress and insolvency. During a Chapter 11 bankruptcy, the business develops a plan to reorganize; then, this plan gets voted on for approval by all the creditors involved. The disadvantage here is that the company faces higher capital costs in the future. It can make it difficult, if not impossible, for an individual to borrow in the future because companies that are reorganized are not dissolved. They may face a higher value cost of capital for future operations after they emerge from bankruptcy.
To avoid the negative impacts of bankruptcy, companies in financial distress have some alternatives. They can do the following:
- Decrease the amount of financial leverage
- Dispose of investments that are not producing a profit
- Stagger or extend debt payments
- Lower earnings distributions like dividends
- Diversify operations
- Severely reduce costs where possible
- Make moderately risky investments
- Improve efficiency
During bankruptcy, after a Chapter 11 agreement is confirmed, its 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 it gives new lenders first priority on the earnings. If the company’s debts are greater than the sum of its assets, the company owner, in all likelihood, will be left with nothing.
In this lesson, you explored features of bankruptcy in the United States, which applies when a company becomes insolvent and unable to pay its debts. You examined Chapter 7 bankruptcy, which leads to liquidation of assets, and Chapter 11 bankruptcy, which allows businesses to reorganize and continue operations under court supervision. You also considered financial management before and during bankruptcy, such as reducing leverage, selling unprofitable assets, cutting costs, and diversifying operations.
Together, these elements highlight how firms manage financial distress, balance creditor and stakeholder interests, and attempt to recover stability while navigating the legal and financial challenges of bankruptcy.
