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Bankruptcy

is one of the most complex areas of law, incorporating elements of contract law, corporate law, tax law and real estate law. In recent years, several high-profile corporations like Enron, WorldCom and Adelphia have filed for bankruptcy. Although businesses only accounted for about 2 percent of all bankruptcy filings in the United States last year, commercial bankruptcies can have a big impact on the economy because there can be a lot of money at stake.

In this article, we'll explain the different types of bankruptcy filings under United States law, figure out who pays what to whom, and describe the process of reorganizing a company and running it under bankruptcy.

All of the different kinds of corporate bankruptcy amount to the same problem -- a company has more debt than it can pay. In this situation, a company files for bankruptcy. This gives it legal protection from its creditors. The company can either get out from under the debt or work out a repayment plan and continue operating. A bankruptcy filing prevents creditors from trying to collect on debts outside the process of the bankruptcy filing itself.

What circumstances lead a company to file for bankruptcy? Sometimes debt grows over time until the business owners realize they have no hope of paying it off. The 2002 bankruptcy of Kmart is an example of this. Competition from other discount store chains led to a steady decline in sales, and the company began missing payments to their suppliers.

Companies sometimes face a sudden loss of revenue that prevents them from paying their suppliers. For example, a printing company might draw 30 percent of its revenue from a single publisher. If that publisher moved its contract to a different company, the printer would lose almost a third of its revenue. However, it would still have to pay employee wages, health care plans, taxes, suppliers and all of its other bills.

A sudden, massive financial loss can result in instant debt without the revenue to pay for it. This is often the result of some wrongdoing on the company's part. A lawsuit or government fines can cost a company millions or billions of dollars. Scandals can also cause stock prices to drop. WorldCom was already struggling in 2002 when an accounting scandal became public. The scandal severely damaged the company and forced them into bankruptcy.

Creditors can also force a company into bankruptcy. They might do this if they discover that the owners are selling off all of the company's assets and preparing to dismantle the company without paying their debts. A creditor might also force a bankruptcy if the company is already making large payments to a different creditor.

Next, we'll take a look at the different terms used in bankruptcy filings and see how bankruptcy filings generally work.

 

Big Money

Kmart filed the largest United States retail bankruptcy in 2002, with over $17 billion in assets. Those numbers seem tiny compared to the top United States bankruptcies:
Filing Year
Company
Assets
2002
WorldCom
$104 billion
2001
Enron
$64 billion
2002
Conseco Corporation
$63 billion
2005
Delta Airlines
$21.8 billion
2002
Adelphia Communications
$21.4 billion
2005
Delphi
$16.5 billion
Source: BankruptcyData.com

Bankruptcy Basics
Although bankruptcy is complicated and the exact steps can vary from state to state, each chapter of bankruptcy uses the same terminology and follows the same basic process.

Two main parties are involved in bankruptcy filings -- the debtor and the creditor. The debtor is the party who has debt, or owes money, to the creditor. A debtor can be a company or an individual. The creditor is an organization or company that claims the debtor owes property, service, or money. Most bankruptcy cases involve several creditors.

Debtors can have two different types of debt – secured and unsecured. With secured debts, creditors have the legal right to something of yours if you fail to make the proper payments. Your mortgage, for example, is a secured debt. By loaning you the money to pay for your house, the bank gets a lien on it. If you stop making mortgage payments, the bank can foreclose and take possession of your house.

In business, secured debt can get very complicated. Various business loans may give creditors a lien against intangible aspects of the business, such as patents, trademarks or intellectual property. The creditor can still repossess property that has a lien against it, even if some portion of the debt has been discharged -- secured debt can't ever be fully discharged. The debtor can either make the payments and keep the item, or stop paying on the debt and have the item repossessed. Secured creditors are always paid first in a bankruptcy settlement.

 

bankruptcy filings nationwide 1994 - 2004
©2005 HowStuffWorks

Types of Bankruptcy 

The four types of bankruptcy are named for their respective chapters in the United States Bankruptcy Code. The type of bankruptcy that you file depends on several factors, including whether or not you are an individual or part of a corporation.

Chapter 7 is what most people mean when they say, "I'm filing for bankruptcy." This is a liquidation bankruptcy, which means that the trustee sells off all non-exempt assets held by the debtor so that the debts can be repaid to the fullest extent possible. Individuals, corporations and partnerships are all eligible for Chapter 7 bankruptcies. The portion of the debt that can't be repaid through liquidation is discharged. Businesses generally try to avoid Chapter 7, because it is impossible to conduct business operations. Income generated after the bankruptcy filing is not a part of the bankruptcy -- the debtor can keep it.

Chapter 11 is the most complex bankruptcy filing and the one that most troubled businesses file (although some individuals may file it as well). In a Chapter 11 bankruptcy filing, the debtor continues to function, maintains ownership of all assets, and tries to work out a reorganization plan to pay off creditors.

In the past, a business had an almost unlimited amount of time to come up with their reorganization and payment plan. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 imposes a 120-day time limit. If the debtor has not submitted a plan within that period, creditors can submit their own plans.

Chapter 12 is specifically for farm owners. The debtor still owns and controls his assets and works out a repayment plan with the creditors. Chapter 13 is like Chapter 11, but for individuals. The debtor retains control and ownership of assets. He also works out a three to five-year repayment plan. Some portion of the debt may be discharged, depending on the income of the debtor. There are also limits on the amount of debt involved.