subject: Financial Distress [print this page] In the last few months the number of companies facing the financial distress has increased at alarming rates. From small scale business entities to large companies like the General Motors, the companies that filed for bankruptcy under the Chapter 11 are enormous. So, what were the factors that contributed significantly to this financial distress and what was the solution that was offered to them?
Poor management of the companys restricted resources account for the major cause for insolvency. When the liabilities far exceed the assets, the company is considered insolvent. Negative economic net worth can be termed as insolvency. Insolvency also occurs when the external elements like the general economy, general economic policies related to the business, interest rates and similar factors turn unfavorable. When the debt problem turns acute, the company will become insolvent.
Generally, insolvency need not turn into bankruptcy or liquidation. Bankruptcy is when the legal authorities adjudge you as bankrupt. Bankruptcy always emerge from insolvency, but insolvency need not amount to bankruptcy if the management manages to pay the outstanding through the sale of the assets or employment of the cash reserves.
When a company files for bankruptcy under Chapter 11, the legal authorities examine the feasibility of continuing it as a going concern, before making the final verdict. The verdict can be for a formal or informal restructuring, or liquidation under Chapter 7. Formal restructuring calls for the services of an insolvency practitioner who is aware of the legalities and the best approach to be performed in the revival program. With his extensive knowledge and experience he will be in a better position to know the various options and can assist in the attainment of the best deal for restructuring. Restructuring under Chapter 11 will require the transfer of the control of the daily operations to a trustee. This dilution of the control is one of the major reasons why the companies and the shareholders refrain from formal restructuring.
The financially distressed companies may resort to informal reorganization wherein it enters into an informal arrangement with the creditors to postpone the payment required, which is known as extension, or an agreement with creditors to settle for partial payment termed as composition. Mergers also provide respite from the burden of bankruptcy.
But where the court feels the futility of continuing the business operations, it will demand liquidation under Chapter 7. Liquidation involves the sale of the assets and its redistribution to the creditors.
by: Paul Smythe
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