Debt Financing and Bankruptcy Grade April, 18, Debt Financing and Bankruptcy The term bankruptcy was coined by Roman creditors who would immediately break the work bench of an aberrant debtor after they had confiscated and divided up all of his or her assets. The archaic practice was replaced by a more humane mode of settling financial disputes. The Bankruptcy act of 1978 merged chapters of previous law thereby strengthening company reorganizations by restructuring the way courts administered bankruptcy. The chapter that is most frequently used by companies is chapter 11 since it preserves assets better by allowing the company to reorganize, thereby allowing creditors to recover relatively more. Chapter 11 protects the company from the creditors who might seek to recover their assets by demanding for immediate liquidation under chapter 7.
It also gives the company a two years grace period that could enable it to take advantage of any recovery opportunity that may arise during the time. That is, the company will be capable of reorganizing itself. Chapter 11 reorganizations allow companies to self select the procedure for bankruptcy. The size of the company will not necessarily be equated to the amount of bankruptcy expenses that it has to pay, the rates to be recovered by creditors and time needed to come out of bankruptcy.
However, if the company has an elaborate management structure, then it might take too long to file for a reorganization plan (Peter, 2002). Assets sold under this chapter do not yield anymore value than they would have through chapter 7. It would be fairly easy to persuade unsecured creditors provided the fact that they are likely to benefit from chapter 11 schemes which allows them to get up to one half of their claims unlike in chapter 7 where they get nothing.
Under this chapter, managers have much equity than chapter seven and there are more secured creditors. The unsecured creditors are represented by a committee appointed by the court. The committee which is composed of people with seven largest claims against the debtor can hire the team of professionals (Warner, 2009). The costs incurred by the committee are reimbursed later by the company through a courts directive.
This helps the company to save money that is very much needed during this period. Chapter 11 gives the company a chance to be successful once again should it manage to come out of bankruptcy. This chapter gives the company a chance to negotiate with the debtors. The company can put forth the argument of continuation to the bankruptcy committee to resist seizure of its assets unlike in chapter 7 liquidation. The managers of the company are protected from living office under this chapter should the company recover.
Also, given that managers are part of the secured creditors; this chapter gives them an advantage in that the lien of secured creditors is not dissolved once the company emerges. Companies exiting bankruptcy through chapter 11 often have their assets intact. This is so because it is possible to overstate the company’s assets to allow the courts to give it time to recover. This gives the company a chance to regain its value to ensure its survival. In this chapter, the likelihood of the company of incurring zero expenses is very high since unsecured creditors do not receive any reimbursements and the debtors are unlikely to ask for reimbursements in case the company recovers. References Warner, J.
(2009). Bankruptcy cost: Some evidence, Journal of Finance 3 (20), 337–347. Peter, M. (2002). Bankruptcy, Liquidation, and Reorganization. New York, NY: Arcade Publishing.