Corporate bankruptcy is a very complicated area of law because it incorporates elements from corporate law, contract law, tax law, and even real estate law. Around 98% of all filings are from personal bankruptcy but business bankruptcy generates a lot of publicity because of its big impact on the economy. For example, in recent years, WorldCom, Enron, and Adelphia have filed for bankruptcy and these developments were in news headlines for several days.
Corporate Bankruptcy
All corporate bankruptcy traces its root to the same problem: the organization has more debt that it can possibly pay. These filings will give the company legal protection from creditors. In this case, the company can either work out a repayment plan or through liquidation. But what exactly leads a company to file for bankruptcy?
How a Company Becomes Bankrupt
It is important to note that no business wants to go bankrupt. But it some cases, it becomes inevitable. Look at the case with Kmart; the company operates a relatively successful discount retail store chain until competition from other stores led to a decline in sales. Kmart began missing due payments to its suppliers and it was eventually forced to file for bankruptcy.
In some cases, companies might face the sudden loss of sales that prevents them from paying off due payments. For example, an advertising company might be getting 40% of its revenue from a single client. When the client suddenly decides to select another advertising firm, the company will lose a significant amount of its business. They still need to pay for their employees’ salaries, health plan, suppliers, and taxes despite the loss of their revenue though so they have no other recourse but bankruptcy.
Sudden financial loss also leads to an instant debt with no revenue to pay for it. When a company is forced to face a lawsuit or pay government fine in the billions of dollars, it is sometimes inevitable for it to declare illiquidity. Scandals can also cause the company’s stock prices to drop; this severely damages the company’s financial health and its ability to pay off debts.
As you can see, there are many scenarios that forces organizations to deal with a drastic loss of revenue. Sometimes, the company can get out of this problem through restructuring and massive lay-offs. But on other cases, the company will have no other recourse but to seek legal help and file for bankruptcy.
