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What is Bankruptcy?What is Bankruptcy?What is Corporate Recovery?What is Corporate Recovery?

Part 1Part 1

Dr. Clive Vlieland-BoddyDr. Clive Vlieland-Boddy

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Bankruptcy LawBankruptcy Law

The bankruptcy law facilitates debt relief toindividuals and corporations under various

provisions, called chapters.

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Personal Vs CorporatePersonal Vs Corporate

Two Kinds of Insolvency Laws:• Personal Insolvency, which deals with

individuals. • Corporate Insolvency – It results in winding

up of the company . • The process of insolvency triggers the

appointment of “Liquidator” or other independent court appointed officer.

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Initial TerminologyInitial Terminology

• Debtor – Is the name given to the Bankrupt

• Creditor – Is anyone who is owed money by the bankrupt.

• Trustee – Is a Court appointed officer who is responsible for the debtors estate.

• Liquidation – Means that the enterprise is terminated.

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OBJECTIVESOBJECTIVES• Overview of Personal and Corporate Bankruptcy• Consider the advantages disadvantages of

declaring bankruptcy

• List types of debts that are discharged in bankruptcy

• Distinguish between corporate and personal bankruptcy

• Summarise the different types of Bankruptcy

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The US Bankruptcy CodeThe US Bankruptcy Code

• The Bankruptcy Code provides for two definitive options under the protection of the bankruptcy court.

• These two alternatives are often known by the chapters of the Bankruptcy Code:– Chapter 11 Reorganization– Chapter 7 Liquidation.

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What is BankruptcyWhat is Bankruptcy

• Bankruptcy is a general term meaning that the liabilities are greater than the assets and the debts cannot be paid.

• Indeed the two tests of bankruptcy are….

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Objectives of BankruptcyObjectives of Bankruptcy

• To restore the debtor company to profitable trading where possible.

• To maximize the return to creditors • To establish a fair and equitable system for the

ranking of claims and the distribution of assets among creditors

• To provide a mechanism by which the causes of failure can be identified and those guilty of mismanagement brought to book.

To facilitate achievement of these objectives the insolvency law provides legal and administrative instruments and institutional structures.

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The Tests of BankruptcyThe Tests of Bankruptcy

• The Balance Sheet Test– The Liabilities are greater than the Assets

• The Liquidity Test– Unable to pay the debts as they fall due.

A debtor is classified as either solvent or insolvent.

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Personal or BusinessPersonal or Business

• Bankruptcy can be either personal or of a company.

• As we know bankruptcy for a company will be the end of it. For an individual they will not (NORMALLY) die from it….

• However, there are rescue procedures that are available which may avoid the death. ( we will deal with these later)

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Personal BankruptcyPersonal Bankruptcy

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PersonalPersonal• Most countries have a structure of laws to

allow an individual to me made bankrupt.

• Normally it requires the individual or a creditor to file a statement or declaration in a court.

• Once filed, the bankrupts estate (his assets) are taken over by the court or an appointed trustee.

• These assets are realised and used to discharge as much as possible of the bankrupts creditors.

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Personal BankruptcyPersonal Bankruptcy

• There are tow types of petitions for bankruptcy:

• One filed by the debtor where he seeks protection from creditors. This is called a voluntary petition.

• One filed by creditors who have not been paid monies due by the debtor. This is called a Involuntary petition.

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Voluntary PetitionVoluntary Petition

• The debtor must be insolvent.

• The courts are there to protect the debtor from the onslaught of creditors.

• The court makes an order after which all creditors are frozen.

• A court appointed officer takes over all the then assets of the debtor and discharges as far as possible the liabilities.

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Involuntary Petitions

Creditors initiate the action by filing a petition for liquidation or reorganization with the bankruptcy court.

The bankruptcy court will generally enter an order for relief against the debtor only if evidence indicates that the debtor is inslovent

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Length of Personal BankruptcyLength of Personal Bankruptcy

• Most countries discharge the bankrupt within a short period. Typically 1day or up to 3 years.

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Individual BankruptcyIndividual Bankruptcy• This is used by individuals with no steady income

and few assets. (In USA Chapter 7). • It eliminates most debts but also requires immediate

liquidation of most assets. • Cosigners to the debtor's accounts can be required

to pay off the contract by the creditor. • In most cases bankrupt people can keep a small

equity in their homes, an inexpensive car, and limited personal property.

• People who declare bankruptcy usually cannot file for bankruptcy again for at least 3-6 years.

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The Effect of the BankruptcyThe Effect of the Bankruptcy

• Once the Court has accepted the filed request and the bankruptcy order made, all creditors are no longer able to demand payment from the debtor.

• All the debtors assets are handed over to the trustee.

• All the debtors liabilities can only claim against the existing assets held by the trustee. (There are some exceptions which we will look at later)

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MAKING A FRESH STARTMAKING A FRESH START• Bankruptcy is designed for people and

businesses caught in severe financial circumstances beyond their control.

• It gives people with excessive debt an opportunity to make a fresh start by reducing or eliminating the debt.

• While some debts will be eliminated, others such as alimony and child support, will not be discharged.

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• Bankruptcy is a legal right, governed by each countries law.

• The court is asked to declare a person unable to pay his or her debts.

• If the court grants the petition, a court officer called a “Trustee” divides the debtor's property and pays each creditor as fully as possible.

• Bankruptcy is never a pleasant experience, but it does give individuals an opportunity to deal with severe debt problems.

More Facts

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• The bankruptcy procedure can temporarily prevent creditors from actions such as foreclosure on a home or repossession of a car.

• It can also stop wage garnishment, debt collection harassment and disconnection of utilities.

• The creditor cannot take further action against the person unless the creditor obtains permission from the bankruptcy court.

More FactsMore Facts

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DISADVANTAGES OF BANKRUPTCYDISADVANTAGES OF BANKRUPTCY• Bankruptcy information remains on a credit report

for up to 10 years, and a negative credit report can make it difficult to make major purchases, buy a house or rent an apartment.

• Future lenders know that people who have declared bankruptcy have difficulty paying debts and may regard them as poor credit risks.

• People who are considered poor credit risks must often pay higher interest rates or use a secured credit card.

• Finally there is a stigma about having been bankrupt.

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• Many people declare bankruptcy thinking that it is an easy way to deal with overwhelming debt problems.

• Credit counselors recommend that a person consider bankruptcy only if most or all of the following "ifs" apply.

• If all attempts to control spending and credit use have failed, even with the help of a credit counselor or a debt-consolidation plan.

• If the debtor is unable to meet debt obligations on current income.

The Bankruptcy Decision

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• rent and the rental agreement• utility bills • deficiency balances (the difference between the

amount you owe and the value of the property) • court judgments, such as property or liens • credit card debts • legal, medical and accounting bills • newspaper and magazine subscriptions • loans from friends and relatives

Dischargeable DebtsDischargeable Debts

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• alimony and child support

• some student loans

• certain taxes. (Depending on the Country)

• debts from fraud, larceny, theft

• fines and penalties for violating the law, such as traffic tickets

• debts not listed on bankruptcy papers (So long as omitted erroneously)

Non Dischargeable DebtsNon Dischargeable Debts

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Exempt PropertyExempt Property• home equity (In some Countries but often severely

restricted to say $15k)• disability and unemployment benefits • life insurance policy (Restricted in Some Countries to

say $8k) • alimony, child support & social security benefits.• qualified retirement benefits( In Some Countries

these are not exempt)• personal property such as clothing, household goods

to $400 per item, $800 total. • tools of the person's trade such as books and

computers. (Often restricted but could include a vehicle!)

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Non-Non-ExemptExempt Property PropertyThe following are examples of property that may be

used to pay debts when you file bankruptcy:• cash and bank account balances • stocks, bonds, investments • equity in a house (Above a certain amount) • luxury items such as fur coats, jewelry, coins, stamps,

family heirlooms • second house or motor vehicle • musical instruments, unless a professional • private pension plans

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Alternatives to Personal BankruptcyAlternatives to Personal Bankruptcy

• An informal agreement with the creditors.

• Some countries have a law that allows formal court approved agreements between the debtor and his creditors.

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Informal ArrangementsInformal Arrangements

• These are common but risky.

• What if some of the creditors agree and some don’t.

• They are however very common.

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Formal AgreementsFormal Agreements• Not all countries have these but they are

becoming popular.• The debtor obtains a court order freezing

all the creditors and any action that they can take to recover debts.

• The debtor then has a short time to make a proposal to all the creditors.

• Normally requires a majority of the creditors to agree.

• Once agreed it becomes binding on all.

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Arrangement with CreditorsArrangement with Creditors

These are Court protected arrangements by individuals.

A proposal is made to the Creditors to discharge as much of the debts as possible by way of contributions from future earnings.

To a great extent the arrangements require full disclosure and honesty.

In USA it is Chapter 13, in UK IVA

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More FactsMore Facts

• These Bankruptcy Arrangements recognizes

rather than liquidates the debtors assets. A debt repayment plan is designed to pay off as much of the debt as possible, usually within 3 to 5 years, under the supervision of a trustee.

• The person must maintain a strict budget and cannot obtain new credit without the trustee's approval.

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• Secured creditors ( against their security)

• Trustee’s administrative costs.

• Certain preferential debts.

• General (unsecured) creditors.

(More...)

Priority of ClaimsPriority of Claims

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• These are creditors who’s debt is secured against certain assets.

• They can claim the asset. Sell the asset and discharge their debt.

• If there is a surplus then it is returned to the trustee.

Secured CreditorsSecured Creditors

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Corporate BankruptcyCorporate Bankruptcy

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Preferential CreditorsPreferential Creditors

• These depend on the country and the Law.

• Often small amounts of arrears of wages to employees. (Say one month)

• In some countries, certain taxes.

• Real argument that all creditors should be treated equally

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Unsecured CreditorsUnsecured Creditors

• All creditors who have no security.

• Normally these will all be treated equally.

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Corporate BankruptcyCorporate Bankruptcy

• Companies are formed under the laws of their country.

• They start with a birth certificate called a ‘certificate of incorporation’

• Companies are a separate legal entity.

• If they go bankrupt they will die. (Unless some rescue procedure can be made)

• This death is called liquidation.

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Recovery ProceduresRecovery Procedures

• Because bankruptcy will end a company, rescue procedures are essential.

• So to avoid liquidation, companies often seek a solution for their financial difficulties.

• We will deal with these in a few minutes.

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Types of BankruptcyTypes of Bankruptcy

• Chapter 11• Chapter 12• Chapter 13

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Bankruptcy of a CorporationBankruptcy of a Corporation

• If a company is unable to pay its debts as they fall due or fails the “Balance Sheet Test” of solvency then it is “INSOLVENT”.

• It should not continue to trade and shoyld declare bankruptcy.

• Failing to so do and trade on could expose the directors to a charge of fraud.

• It would mean that the veil of incorporation would be broken.

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The Effect of being InsolventThe Effect of being Insolvent

• The directors start to become personally liable for the debts of the company unless they take positive actions and seek advice.

• Most countries have laws that assist directors in such a situation.

• Most countries have a legal structure to allow companies in financial difficulty a way to trade out so long as there is a real prospect of so doing.

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So what must be done?So what must be done?

• Always seek professional advice/ That moves some of the responsibility away from the directors.

• Explore the options?

• If there is no business worth saving then LIQUIDATE

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LiquidationLiquidation• Usually the directors make a declaration

that the company is insolvent. File this in a court.

• A liquidator is appointed.• A Statement of Affairs is produced ( A

balance Sheet with only current values on It. We will return to this)

• A meeting of creditors is held.• The assets are realised and the creditors

paid off as best as possible.• The company is then dissolved.

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What is a winding-up?What is a winding-up?

• Process whereby a company is dissolved• At this point the company ceases to be a legal entity• Also referred to as a liquidation• Legal requirements contained in chapter 5 of

Corporations Act• Two modes of winding up a company:

– Winding-up in insolvency and by the court– Voluntary winding-up by members or creditors

• Accounting entries are the same in both cases

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Winding-up in Insolvency and by the courtWinding-up in Insolvency and by the court• Where a company is insolvent, application may be made to

the court for winding-up• Application to the court may be made by the company itself, a

creditor, a director and a contributory• Once an application is made, the court may order the

insolvent company to be wound up• Insolvency is presumed to exist under a number of

circumstances set out in the Corporations Act. These include where:

– A creditor serves a demand for unpaid debts over $2,000 and the debt remains unpaid after 3 months

– A receiver has been appointed under a floating charge on property

• A contributory refers to the holders or immediate past holders of shares in the company continued

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The ProcessThe Process

• Insolvency is the most common reason for liquidation – therefore the major accounting problem in liquidation is the apportionment of limited assets between creditors and shareholders

• A liquidator is appointed after the filing of the applications in order to see that the status quo of the company is maintained i.e. that the assets are not quickly drained from the company

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The Process ContinuedThe Process Continued• The directors and secretary of the company must

prepare and submit a Statement of Affairs to the liquidator within 14 days of the making of the order for winding-up

• The Statement of Affairs includes:– Summary of assets and liabilities– Details of charges over assets and secured liabilities

• Aim of the Statement of Affairs is to provide information concerning the company’s estimated realizable values of assets and any expected surplus or deficiency of assets after deducting creditors’ claims

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The Process ContinuedThe Process Continued

• After the liquidator has realized all the property, discharged the liability to creditors, and made a final return (if any) to contributories, he/she may apply to the court for the company to be disolved.

• After deregistration, the company ceases to exist

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Powers of the liquidator include:Powers of the liquidator include:

• Carry on the business of the company so far as is necessary for beneficial disposal or winding-up

• Pay any class of creditors in full• Make arrangements with creditors or parties

claiming to be creditors• Come to agreements regarding calls, liabilities

and claims existing, and take any security for the payment of such calls, liabilities and claims

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Other powersOther powers• Other powers include everything that is

necessary to wind up the affairs of the company and distribute the property

• Additional powers in relation to performing roles that are performed by the courts in court appointed liquidations (e.g. fixing a time when debts and claims must be proved)

• Finally to investigate any expected wrong doings by the directors.

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Bye for now!Bye for now! I’m ready forsome leisure time.

Please ensure you Prepare for next session