What is Corporate Bankruptcy?

In these hard economic times, it seems like everyday newspapers carry front-page articles about companies on the verge of, or filing for, bankruptcy. Car companies in particular are at the center of these reports, closing dealerships, and, in the case of Chrysler, actually filing for Chapter 11 bankruptcy. But many people may not realize what bankruptcy actually is, and what happens to a company in the wake of filing for bankruptcy.

What Is Bankruptcy?

Contrary to popular notion, filing for bankruptcy is not necessarily the end for a company. Bankruptcy is a legal state in which a debtor is judged to be insolvent, after which his property is distributed amongst his creditors. This can apply to businesses as well, since businesses are in many ways considered to be legal individuals. Just as you can declare bankruptcy to protect yourself, so can a corporation.

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Types of Bankruptcy

There are two main types of bankruptcy for corporations in the United States:

Chapter 7. In Chapter 7 Bankruptcy, a company which is badly in debt ceases operation and its assets are sold and the proceeds from the sale are distributed to the company's creditors. For instance, if you ran a restaurant that was deep in debt to the point where you couldn't pay off your debts, you could file for Chapter 7 bankruptcy. All your stoves and pans and tables would be sold off, and the money raised by the sale of these items would go to lessen the financial loss of the people who loaned you the money for your restaurant whom you are no longer able to pay back. Chapter 11. In Chapter 11 Bankruptcy, a company files for bankruptcy in order to restructure its debt. Unlike in Chapter 7 bankruptcy, the debtor retains ownership of his possessions, subject to the supervision of the court that issued the bankruptcy. A debtor protected under Chapter 11 bankruptcy can secure loans with favorable terms, and most litigation against the debtor is put on hold until it can be resolved in bankruptcy court. So, if you had, say, a car company that could no longer pay its debts but you had significant means of producing more vehicles and many investors, you could file for Chapter 11 bankruptcy to restructure your debts and emerge as a smaller but more viable company.


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