What is Bankruptcy - Chapter 11Bankruptcy Code

Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to any business, whether organized as a corporation or sole proprietorship, or individuals with unsecured debt of at least $336,900.00 or secured debt of at least $1,010,650.00, although it is most prominently used by corporate entities.

Definition :

When a troubled business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under chapter 11. A chapter 11 filing is usually an attempt to stay in business while a bankruptcy court supervises the "reorganization" of the company's contractual and debt obligations. The court can grant complete or partial relief from most of the company's debts and its contracts, so that the company can make a fresh start. Sometimes, if the business's debts exceed its assets, then at the completion of bankruptcy the company's owners all end up without anything; all their rights and interests are ended and the company's creditors are left with ownership of the newly reorganized company.

Rationale :

Sometimes the value of a business is greater if sold or reorganized as a going concern than the value of the sum of its parts if the business's assets were to be sold off individually. It follows that it may be more economically efficient to allow a troubled company to continue running, cancel some of its debts, and give ownership of the newly reorganized company to the creditors whose debts were canceled. In this way, jobs may be saved and the engine of profitability which is the business is maintained rather than being dismantled.

Who gets the money back?

Federal laws determine the laws of payment and further division of assets. Secured creditors are the first to get back their money. Bond holders are the next and shareholders of the company are the last to receive any kind of compensation. Though they make the maximum when the company is doing good business, they get the least preference in such situations. The owners may not get anything at all if the secured and the unsecured creditors' claims are not fulfilled. Bondholders stand a better chance of recovering their debt because of the commitment by the company to pay back the principal. Even after the company has filed for bankruptcy, the company's securities may continue to trade even after the company has filed for bankruptcy under Chapter 11. The company's securities may continue to trade on NASDAQ and NYSE. In most of the cases, the company's reorganization involves liquidating the equity shares and the management moving into the hands of creditors and bondholders; it is extremely risky for investors to trade in these stocks.

Companies follow this route mainly to have control over the reorganization process. In worst cases, the only option is to liquidate.

Source : Wikipedia and Economic Times

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