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What happens when a business declares bankruptcy

When a company goes out of business or is trying to dig out from under tons of debt there are Federal bankruptcy lawsto govern how this is done. When the bankrupt company wants to reorganize its business and attempt to begin to make a profit again, they might choose to use Chapter 11 of the Bankruptcy Code. Chapter 11 allows management to continue performing the day to day business operations but a bankruptcy court must approve all important business decisions associated with the company.

A company that goes completely out of business and ceases all operations may choose to use Chapter 7 of the Bankruptcy Code. When a Chapter 7 is used, a trustee is selected to sell off the company's assets. The money from the liquidating of assets is then used to pay off debts to creditors and investors. Secured creditors such as a bank take less risk and are paid first. Secured creditors know they will get paid first if the company files bankruptcy because the credit that they extend is usually with collateral.
Unsecured creditors such as bond holders are the next to get paid. Bondholders have a better chance of recovering their losses than stockholders. This is because bonds represent the debt associated with the company and the company has agreed to pay bondholders interest along with returning their principal.
Those taking the greatest risk and the last to be repaid are stockholders. Stockholders are those who own the company. The owners make the majority of the money if the company succeeds, but they stand to lose the most if it fails. The order of payment is determined by the Bankruptcy laws.

The majority of publicly-held companies choose to file under Chapter 11 rather than Chapter 7 because they can still operate their business while in the Bankruptcy process. Chapter 11 gives a company that is deep in debt a chance to try to work out a successful plan and return to making a profit.

To enable the company to try to get back to profitability, there is one committee that must be formed and is called the "official committee of unsecured creditors." This committee represents all of the unsecured creditors, which also includes the bondholders. To represent stockholders there may be an additional committee appointed. The U.S. Trustee may also name another committee, which would represent a distinct class of creditors.

A company may choose tofile under Chapter 7 because they are so far in debt or have other serious problems they can no longer continue to operate their business. Under Chapter 7, it is likely they will liquidate all their assets. Their assets are sold by a trustee who was appointed by a court. The administrative and legal expenses are the first to be paid, the remaining amounts go to the creditors. Collateral will be returned to the secured creditors. Bondholders and other unsecured creditors should file a claim just in case there is by chance some money left for them.

Under Chapter 7, stockholders do not have to be notified, this is because they usually do not get anything in return for their investment. However, stockholders will be notified if by chance the creditors are paid in full and stockholders will then be given the opportunity to file claims.

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