Does Bankruptcy Spell Death for Business?
Bankruptcy on business, an odious phenomenon seems to be getting a grip on many banking sectors and businesses around the world. When bankruptcy materializes, it seems imperative that bankruptcy protection laws allow companies to effectively shed their debt.
This allows the banks to start anew and reinvent themselves. Among various invested facets of the banks, most ideally, it is found that creditors recover most of what they’re owed. This is due to the fact that as a restructured firm’s ability to garner profits that help in turning a profit in the organization, the banks give priority to the creditors of the business.
Yet, given the enticing mechanism of restructuring, we encounter liquidation in more and more companies. This emphatically violates the second chance at the success of reinvention that the banking law aims to encourage in the system. In fact, it is to be noted that in the cumbersome process of liquidation, these effectively and ultimately shortchange creditors by billions of dollars a year.
“Chapter 11 allows for reorganization, which sounds like such a great thing. People get to keep their jobs, the creditors get paid equity, and the customers don’t lose this business that they loved.
It should be emphatically noted here that at a serious time when the COVID-19 pandemic has been rampant and incessant, the chances or the propensity of bankruptcy hitting many companies hard has increased. This is merely due to supply chain constraints, incessant lockdowns to contain the spread and various macroeconomic factors that contribute to the debacle of a business.
Thus, where the law might highly encourage reconstruction, reorganization in the organization, where jobs are sustained and creditors get paid equity, such a scenario can be best described as a euphoric dream that remains miles from being achieved.
But what really contributes to the process of liquidation that is the most sought-after mechanism for bankruptcy? The trend has been recently seen with senior managers going for liquidation instead of reorganizing. The scenario that usually plays out in court is that of a manager usually trying to persuade the judge to approve a speedy asset sale.
This is due to the fact that managers usually prefer and priorities a fast resolution over a more long-drawn beneficial reorganization of the company. It is to be noted that such a hasty resolution often leads managers to steer firms into liquidations that perpetually harm the employees, junior creditors, and customers.
In fact, in the case of US bankruptcy laws is to be scrutinized, it can be known that under Section 363, judges can emphatically and powerfully grant the request of the managers without the consent of the creditors if a legitimate “business justification” for the aforementioned move has been provided.
This emphatically implies the fact that managers call major shots for the future of the company. The rationale behind the fast or warp speed sale is the fact that assets in the firm usually lose their value at a high speed if not sold in a definite small-time frame. Thus, in order to curb the losses in the firm, we encounter faster sales by the managers before little value is left of the firm.
But is this process or mechanism an effective way of dealing with the crisis? Many might believe that effectively rushing the process of liquidation may be short-sighted for many creditors and the companies and creditors. This is due to the huge costs that will be incurred by both parties in the long run.
A prime example of the same is Sears, which witnessed the most expensive retail bankruptcy in the history of retail. In this particular case, it was encountered that the firm had lost its value through its short-sighted, hasty asset sales in the market.
In fact, according to various analysts and researchers, it has been found that reconstruction of the company is a better way out of the bankruptcy debacle. According to the reports, creditors can effectively gain a potential 52 cents on each dollar owed when a company is strategically restructured.
Another study puts forward the fact that at least 60 percent of the liquidations cost the creditors more than a simulated reorganization would effectively or subsequently have. Talking about liquidation, more losses were recorded when some bankrupt company was effectively acquired. This is also true for the reorganization of the company, where creditors haven’t lost as much as in the liquidation criteria.
But why does a reorganized company offer better profits or returns for the creditors than liquidation? Firstly, hasty sales of the assets might lead to a lower valuation of the firm’s assets leading to losses. Secondly, the companies emerging from bankruptcy may perform quite well when reorganized.
This might serve as a boon for the firm if the idea or the mechanism is implemented. Here, again the managers play a huge role. If their charming personality, at least in the business, can convince all the creditors to agree to lower the specific debt load and to effectively accept a write-down, then the equity in that company has a great potential to become really valuable.
Reconstruction, on the other hand, is quite beneficial for the creditors themselves. This is due to the pertinent fact that the creditors can significantly negotiate equity stakes in the new firm. This negotiation can be carried out in the form of payment for outstanding debt.
Thus, in totality, for a firm that is going through bankruptcy, the best way out is negotiation and ideation. Before effectively heading for the court, the managers that are considering bankruptcy should strategically meet with key creditors. This can lead to the hammering of innovative ideation and stall risky warp speed sale of the assets.
Meanwhile, though managers should be cautious, the creditors too should be open to working more intently and closely with management. The discussion should be centered around the plan for reorganization before heading into court.
This should be done while keeping in mind that the firm is experiencing only temporary setbacks as a result of the pandemic that has made the conduction of business arduous. thus, in totality, communication between the management and the creditors is the key, which might not value, but is the most beneficial.
Terms related to the article:
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