Going Bankrupt in the World

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g Bankrupt in the World

By: Sam Vaknin, Ph.D.

It all starts by defaulting on an obligation: Money owed to creditors or to suppliers is not paid on time, interest payments due on bank loans or on corporate bonds issued to the public are withheld. It may be a temporary problem - or a permanent one.

As time goes by, the creditors gear up and litigate in a court of law or in a court of arbitration. This is a technical or equity insolvency status.

But this is not the only way that a company can be rendered insolvent. It could also run liabilities which will outweigh its assets. This is bankruptcy insolvency. True, there is a debate raging as to what is the best method to appraise the assets and the liabilities. Should these appraisals be based on market prices - or on book value?

There is not one decisive answer. In most cases, there is strong reliance on the figures in the balance sheet.

If the negotiations with the creditors of the company (as to how to settle the dispute arising from the company's default) fails, the company itself can file (=ask the court) for bankruptcy in a "voluntary bankruptcy filing".

Enter the court. It is only one player (albeit, the most important one) in this unfolding, complex drama. The court does not participate directly in the script. To say its lines - court officials are appointed. They work hand in hand with the representatives of the creditors (mostly lawyers) and with the management and the owners of the defunct company.

They face a tough decision: should they liquidate the company? In other words, should they terminate its business life by (among other things) selling its assets?

The proceeds of the sale of the assets is divided (as "bankruptcy dividend") among the creditors. It makes sense to choose this route only if the (money) value generated by liquidation exceeds the (money) the company as a going concern, as a living, functioning, entity.

The company can, thus, go into "straight bankruptcy". The secured creditors will receive the value of the property which was used to secure their debt (the "collateral", or the "mortgage, lien"). Sometimes, they will receive the property itself - if it not easy to liquidate (=sell) it.

Once the assets of the company are sold, the first to be fully paid off will be the secured creditors. Only then will the priority creditors be paid (wholly or partially).

The priority creditors include administrative debts, unpaid wages (up to a given limit per worker), uninsured pension claims, taxes, rents, etc.

And only if there is any money left after all these payments, it will be proportionally doled out to the unsecured creditors.

The USA had many versions of its bankruptcy laws. There was the 1938 Bankruptcy Act, which was followed by amended versions in 1978, 1984 and, lately, in 1994.)

Each state has modified the Federal Law to fit its special, local conditions.

Still, a few things - the spirit of the Law and its philosophy are common to all the versions. Arguably, the most famous procedure is named after the chapter in the law in which it is described, Chapter 11.) Following is a small discussion of chapter 11 intended to demonstrate this spirit and this philosophy.

This chapter allows for a mechanism called "reorganization". It must be approved by two thirds of all classes of creditors and then, again, it could be voluntary (initiated by the company) or involuntary (initiated by one to three of its creditors).

The American legislator set the following goals, in writing the bankruptcy laws:

  • To provide a fair and equitable treatment to the holders of various classes of securities of the firm (shares of different kinds and bonds of different types)
  • To eliminate burdensome debt obligations, which obstruct the proper functioning of the firm and hinder its chances to recover and ever repay its debts to its creditors.
  • To make sure that new claims received by the creditors (instead of the old, discredited, ones) equal, at least, to what they would have received in liquidation.

Examples of such new claims: owners of debentures of the firm can receive, instead, new, long term bonds (known as reorganization bonds, whose interest is payable only from profits).

Owners of subordinated debentures will, probably, become stockholders and stockholders in the insolvent firm will receive no new claims.

The chapter dealing with reorganization (the famous "Chapter 11") allows for "Arrangements" to be made between debtor and creditors: an extension or reduction of the debts.

If the company is traded in a stock exchange, the Securities and Exchange Commission (SEC) of the USA advises the court as to the best procedure to adopt in case of reorganization.

What chapter 11 teaches us is that:

The American Law leans in favour of maintaining the company as a going concern. A whole is larger than the sum of its parts - and a living business is worth more than the sum of its assets, sold separately.

A more in-depth study of the bankruptcy laws shows that they allow for three ways to tackle a state of malignant insolvency which threatens the well being and the continued functioning of the firm:

Chapter 7 (1978 Act) - liquidation

A District court appoints an "interim trustee" with broad powers. Such a trustee can also be appointed at the request of the creditors and by them.

The Interim Trustee is empowered to do the following:

  • liquidate property and make distribution of liquidating dividends to creditors
  • make management changes
  • arrange unsecured financing for the firm
  • operate the debtor business to prevent further losses

By filing a bond, the debtor (really, the owners of the debtor) is able to regain possession of the business from the trustee.

Chapter 11 - reorganization

Unless the court rules otherwise, the debtor remains in possession and in control of the business and the debtor and the creditors allowed to work together flexibly. They are encouraged to reach a settlement by compromise and agreement rather than by court adjudication.

Maybe the biggest legal revolution embedded in chapter 11 is the relaxation of the ages old ABSOLUTE PRIORITY rule, that says that the claims of creditors have categorical precedence over ownership claims. From now on, the interests of the creditors have to be balanced with the interests of the owners and even with the larger good of the community and society at large.

And so, chapter 11 allows the debtor and creditors to be in direct touch, to negotiate payment schedules, the restructuring of old debts, even the granting of new loans by the same disaffected creditors to the same irresponsible debtor.

Chapter 10

Is sort of a legal hybrid, the offspring of chapters 7 and 11:

It allows for reorganization under court appointed independent manager (trustee) who is responsible mainly for the filing of reorganization plans with the court - and for verifying strict adherence to them by both debtor and creditors.

Despite its clarity and business orientation, many countries found it difficult to adopt to the pragmatic, no sentiments approach which led to the virtual elimination of the absolute priority rule.

In England, for instance, the court appoints an official "receiver" to manage the business and to realize the debtor's assets on behalf of the creditors (and also of the owners). His main task is to maximize the proceeds of the liquidation and he continues to function until a court settlement is decreed (or a creditor settlement is reached, prior to adjudication). When this happens, the receivership ends and the receiver loses his status.

The receiver takes possession (but not title) of the assets and the affairs of a business in receivership. He collects rents and other income on behalf of the firm.

So, British Law is much more in favour of the creditors. It recognizes the supremacy of their claims over the property claims of the owners. Honouring obligations - in the eyes of the British legislator and their courts - is the cornerstone of efficient, thriving markets. The courts are entrusted with the protection of this moral pillar of the economy.

Economies in transition were in transition not only economically - but also legally. Thus, each one adopted its own version of the bankruptcy laws.

In Hungary - Bankruptcy is automatically triggered. It is not allowed to swap debt for equity. Moreover, the law provides for a very short time to reach agreement with creditors about reorganization of the debtor. These features led to 4000 bankruptcies in the wake of the new law - a number which mushroomed to 30,000 by 5/97.)

In the Czech Republic- the insolvency law comprises special cases (over indebtedness, for instance ...). It delineates two rescue programs:

  • A Debt to Equity Swap (an alternative to bankruptcy) supervised by the Ministry of Privatization.
  • The Consolidation Bank (founded by the State) can buy a firm's obligations if it went bankrupt at 60% of par.

But the law itself is toothless and lackadaisically applied by the incestuous web of institutions in the country. Between 3/93 - 9/93 there were 1000 filings for insolvency, which resulted in only 30 commenced bankruptcy procedures. There hasn't been a single major bankruptcy in the Czech Republic since then - and not for lack of candidates.

Poland is a special case, always pitting horses against tanks, always losing the war, as a result. The pre-war (1934) law declares bankruptcy when confronted with a state of lasting illiquidity and excessive indebtedness. Each creditor can apply to declare a company bankrupt. An insolvent company is obliged to file a maximum of 2 weeks following cessation of debt payment. There is, indeed, a separate liquidation law which Allows for voluntary procedures.

Bad debts are transferred to base portfolios and have one of three fates:

  • Reorganization, debt-consolidation (a reduction of the debts, new terms, debt for equity swaps) and a program of rehabilitation.
  • Sale of the corporate liabilities in auctions
  • Classic bankruptcy (happens in 23% of the cases of insolvency).

No one is certain what is the best model. The reason is that someone has yet to come with answers to the questions: are the rights of the creditors superior to the rights of the owners? Is it better to rehabilitate than to liquidate?

Until such time as these questions are answered and as long as the microeconomic debt crisis deepens -we will witness a flowering of versions of bankruptcy laws all over the world.

About The Author

Sam Vaknin is the author of "Malignant Self Love - Narcissism Revisited" and "After the Rain - How the West Lost the East". He is a columnist in "Central Europe Review", United Press International (UPI) and ebookweb.org and the editor of mental health and Central East Europe categories in The Open Directory, Suite101 and searcheurope.com. Until recently, he served as the Economic Advisor to the Government of Macedonia.

His web site: http://samvak.tripod.com


WHITE MINORITY In 2043 15.01.2013. 20:51

Why do Conservatives think we are going bankrupt? We are not going bankrupt. The World has a enough money and wealth to borrow from. Barack Obama has reduced the deficit and the debts in half as he promised.


Admin 15.01.2013. 20:51

Sure Obama has reduced the deficit and debt. How many of those flying pigs have you seen lately and is that herd on unicorns still hanging around your back yard.


Lady Catherine 01.08.2013. 03:07

Why are racists the mental midgets of society? I mean no offense, by the way. I respect everyone's right to think the way they see fit, so please don't take any offense to this.

But why are racists the mental midgets of society? Why are they so easily duped into accepting such an intellectually bankrupt world view?

Lady Catherine

Admin 01.08.2013. 03:07

They have under developed minds and are emotionally stunted.


umoza 29.10.2011. 21:36

Why is it that conservatives were extremely anxious to prosecute Bill Clinton? The George Bush Administration bankrupted the world causing financial chaos worldwide. Yet, no one from the conservative side called for hearings into his and those of his administration's actions.


Admin 29.10.2011. 21:36

Investigations were conducted and it was concluded that the community reinvestment act, the ACORN thugs, some greedy banks, greedy homeowners, and the failure of Fannie and Freddie were the root causes. During this time it was discovered that Dodd received a shady deal from Countrywide.


Man_Hat_Tan 25.09.2009. 12:22

Why the US boomed but the UK busted during WW2? Why is it the United Kingdom nearly went bankrupt during World War 2 fighting the Germans, but the United States experienced an economic boom during the war?

Weren't both of their industries working in full steam producing arms to fight the Nazis? Should the United Kingdom also become rich?

So why the difference?


Admin 25.09.2009. 12:22

UK's major cities such as London, Liverpool, Hull, Bristol, Birmingham, Sheffield, Glasgow and a lot more besides, were all bombed to blazes by the Nazi Luftwaffe.

I was born here in London in 1941 and grew up surrounded by the rubble and bombed out shells of houses that were once London.

Americans, thank God, have not had to suffer like we have in war, both in WW-One bombings and then again in WW-Two.

Britain at War

Edward R Murrow - reporting live by radio from Tafalgar Square during the London Blitz of 1940 to the folk back home in the USA.

So, to sum up. While British industry was working flat out - we were being bombed - so too were our railways (railroads) - by the end of WW-Two the country was a wreck.

It took us until the 21st Century to pay off our war debts to the USA and now we're in another mess. The so called credit crunch.

Laurel and Hardy doing war thing

In the Mood - Glenn Millar orchestra

but my own fave from WW2 is this. . .

The Andrew Sisters

Winston Churchill


longhaired freaky person 06.10.2009. 05:37

When they dump the dollar and America is a bankrupt 3rd world country, will Republicans finally be happy? We won't have any money to spend on education, so people will be less educated.
We will be at the mercy of forces we can't control, so people will turn to religion.
There will be less of everything to go around, so people will become less compassionate and generous.

Sounds like a bankrupt future is the only way the Republican Party can grow. Thanks, Bush!

longhaired freaky person

Admin 06.10.2009. 05:37

Lets look at the economy.
It started to turn down around early 2007...
Which happens to coincide with the Democrats taking control of Congress.

We can conclude Democratic Congress = poisoned economy.

I know you blame Bush for Gay Whorehouse Operator and Representative Barney Frank's deregulation of Fannie Mae and Freddie Mack. Learned people know it's Frank's fault (who coincidentally had a love interest with Fannie Mae leadership). Its funny to me that Democrats even mention morals after re-electing this gay pimp time and time again.

I know you want to blame Bush for it, its completely understandable, you guys blamed a hurricane on him too.

Dumping the dollar would make all their exports un-salable in the USA. Your post doesn't make any sense.


slither37 28.01.2009. 13:04

What other things should obam-uh apologize to the world for? I of course would like to apologize to the world as well. I am sorry that my tax dollars go to paying dues to the useless UN. I am sorry that we are not feeding hungry Americans with that money. I am sorry that my tax dollars go to disaster relief to ungrateful countries. I am sorry that the US gives any military aid to the misogynistic theocracy that is saudi arabia.


Admin 28.01.2009. 13:04

How about, being sorry for sending abortion money to kill premature babies in Mexico and Africa?

How about stealing the futures of American children and bankrupting the world with his "housing for everyone" scheme?"


Don 22.03.2009. 12:03

What dangers and problems would the world have faced if Hitler managed to take over England? I saw documentaries and they shown how England was struggling so badly and drained economically. In what ways would the world have been a more dangerous place if England had been taken by Nazis?
Would more countries have been put into more danger?


Admin 22.03.2009. 12:03

Edit i keep reading Britain was bankrupt by 1940 show me the Link How about it is Rubbish Britain paid the US 700 Million in GOLD for Ships in 1940 Before Lend lease Yes she was in debit but with Russia's help could have beaten Germany without a single member of the US Military entering the battle in Europe

it is a Fact the USA extended the War past 1943 see link an American link


this link is what Britain had to put up with Eisenhower's Incompitence


End edit

to answer your question the USA would not have a base to attack Hitlers Germany Hitler would have an unlimited oil supply and finish building his Military Machines Like the new tanks so good Paton used one for target practise and Only scratched the paint he would have also finished building aircraft with a range of 15000 Kilometres France to New York and back without refuelling

and I have never seen any document that showed anything but that the UK with Russia's help were going to win WW2

even Rommel Acknowledged in 1942 the War is Lost that's why he was involved in the assignation of Hitler

Fact the German Navy Blockaded Montgomery beat the Africa Corps after the US failure at Kaserense Pass

and Germany had lost the War after Failing to Take El Alamain twice

and of course the NAZI'S were beaten in the battle Of Britain so the UK was safe from Sept 1940 before Lend lease and before the USA entered any war

It was Difficult winning when the USA was selling to Both sides as late as 1944


jezebel 08.10.2009. 02:21

Will immigration from the Third World bankrupt the First World? My state is broke and others are on the way. The burden of the social services is massive and it's probably worse in Europe. Is it even possible for the First World to absorb the entire Third World? A lot of immigrants seem to believe the US and Europe are bottomless pits of money. Where do they get the idea that the resources are limitless?


Admin 08.10.2009. 02:21

the third world mentality is instead of stayng and striving for their
own country to prosper, they abandon it(especially professionals)
and head for the nearest easy money.
numerous third world countries are resource rich and
sqaunder that wealth. their intellectual capital flees
to the nearest pot of gold.
japan and germany were smoking wrecks after ww2 with
no real resources.they used intelligence and hard work to re-establish and revitalise their countries into economic superpowers.


zk 2 25.11.2007. 13:16

Can a bankrupt get early discharge under medical ground? Can a bankrupt get early discharge under medical ground? Can anyone show me a link of such standing order or government gazzette?

zk 2

Admin 25.11.2007. 13:16

maybe.. go to google.com and type in legalhelpers... there is a world of information there and phone numbers...good luck


Rich 27.05.2012. 18:39

How did World War II pull us out of the Great Depression? We were always taught that World War II pulled us out of the Depression. How did this happen? Was it just the increased government spending? If that was the case, why wait for a war to get out of economic turmoil? It just doesn't quite make sense to me. Just spend the money and improve the economy (without the killing, of course). I am not a liberal but I just want someone to explain to me why our entrance into World War II ended the Depression and everything improved after the war. Are there any lessons for our current situation?


Admin 27.05.2012. 18:39

Lend lease created demand for manufactured goods and armaments and American industry expanded rapidly and with it there was a massive increase in the country's economic infrastructure and transport etc. so for a period of five years the US was the arsenal of the free world. Europe was bankrupt and the US was the wealthiest country on the planet.


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