When a company experiences financial problems, its focus often turns to cash conservation. If the problems are not too severe, instituting a hiring freeze or cutting back on nonessential business trips and expenses may be sufficient until the company finds itself on surer footing. However, sometimes more drastic measures are required. Such steps may include laying off non-essential employees, contracting with management consultants to identify additional cost savings or to overhaul the business plan, replacing existing management with persons experienced in business turnarounds, negotiating with creditors to restructure payment terms, or even liquidating parts of the company.
When all else fails, the final option may be filing for bankruptcy. While bankruptcy offers some advantages, such as an automatic stay of debts or an opportunity to reorganize, there are some trade-offs. For one, bankruptcy will impose numerous obligations on the company. Because the company must fully disclose its assets and liabilities, creditors will be able to review its financial records in depth. Company officials will also have to answer questions on every aspect of the business. Moreover, decisions outside the ordinary course of business will require court approval. For these reasons, bankruptcy should be the last resort in dealing with a financial crisis.
For a more in-depth understanding, excerpts from the Bankruptcy Basics pamphlet, published by the Bankruptcy Judges Division of the Administrative Office of the United States Courts, are provided below.
Under a Chapter 7 bankruptcy, the court will appoint a trustee to oversee the liquidation of a company's assets and the payment of creditors from these proceeds.
Under a Chapter 11 bankruptcy, a company is permitted to reorganize. This allows a financially troubled company to change the terms on its debts and propose a reorganization plan for the bankruptcy court to approve.
A Chapter 11 reorganization can also preserve the "going concern" value of a company. If a company is worth more than the sum of its parts, the court will more likely allow a company to remain intact rather than compel it to sell off its assets piecemeal.
Usually, the company's management will also retain control of company assets. Rather than appoint a trustee, the company usually maintains control as a "debtor in possession."
After filing for bankruptcy, a company is protected by an automatic stay from its creditors' collection efforts, including foreclosures, repossessions and contract terminations. However, a bankruptcy court can lift the stay for various reasons.