BANKRUPTCY IN BIG BUSINESSES
Bankruptcy refers to a state whereby a debtor is unable to meet his obligations to his creditors. As a result, debtors often file for bankruptcy to protect their assets from creditors. Therefore, bankruptcy law is meant to relieve debtors who are overburdened by debts and give them a fresh start. On the other hand, the law is supposed to assure the creditors of equitable and fair repayment of their debts. The law is therefore, supposed to balance the two obligations. The bankruptcy code has undergone several amendments, with last one being in 2005. This was to stop the misuse of the bankruptcy protection by debtors. Therefore, managers need to know the various causes of bankruptcy and the laws available, which the business can use to ensure an effective turnaround (Webster & Lauren, 2003).
Causes of bankruptcy in big businesses
Causes of bankruptcy refer to what leads to failures in businesses, which leads a business to be declared bankrupt. Although causes of bankruptcy are almost the same in all organizations, bankruptcy in big businesses has some few differences that separate them from other businesses. Some of the causes are examined as below
Poor economic conditions
The number of businesses failing increases when there is an economic downturn. These failures are as a result of contraction of economic activities. Recessions are always characterized with an increase in the number of businesses filing for bankruptcy. Although big businesses have a lot of resources to cushion them from economic shocks, the same resources can be the reason for their failure. During recession such as the great depression, many companies file for bankruptcy because they cannot meet their obligations, which result from large transactions (Norton, 2004).
Some causes of trouble may be completely beyond the control of the business. These causes are known as acts of God and can happen in any society. They include floods, earthquakes, hurricanes or fires. Such causes always destroy the resources of an organization, leading to their downfall. In large business, these causes must be of large magnitude. They do not include insignificant causes like illness of the owner or an employee. For instance, hurricane Katrina brought big businesses to their knees and although some of them were insured, they could not regain their previous state even after compensation. Most of their customers had shifted some of their markets had been taken by competitors. Therefore, big businesses find it hard to regain their previous state after such causes and this leads to their fall (Norton, 2004).
Inside underlying causes
These are causes that arise from within the organization, which could have been prevented by some action in the business. They mainly result from wrong decisions made in the past or lack of action from management when such was needed. They include over extension of credit and inefficient management, which are explained below as follows (Blanc, 2002).
Over extension of credit
Most businesses tend to over extend credit and subsequently are to collect unable to collect from their debtors in time to meet their own liabilities. Most large manufacturers end to overextend credit to their distributors in an attempt to maximize their sales. On the other hand, the distributors who receive the credit also sell their goods on credit to their customers. However, in most cases the distributors are also driven by the need to make more sales, as a result, they also overextend credit to their customers. Therefore, default by the distributor’s customers will; in turn result in default by the distributor. Considering that large manufacturers offer credit in large volumes defaults will often weaken the company’s financial structure. As a result, the operations of the business cannot continue, because it cannot meet its liabilities and this leads to a crisis. Hence, the business has to file for bankruptcy (Blanc, 2002).
Most businesses fail because of lack of management’s ability to make effective decisions for the organization. As the owners search for people to fill their top leadership positions, they often seek for those managers who have a good record of accomplishment in their previous positions. However, great performance in one sector does not guarantee success in all sectors. Without considering this fact, most large corporations employee people in their top leadership who end up failing because they were inexperienced in that particular field. Some of the wrong decisions made by inefficient managers include the following (Bush, 1915).
Failure to keep pace with changes in the market place
Most big businesses are often associated with conformity to their traditional way of doing things. However, in today’s business environment, changes occur within a very short period. For instance, a manufacturing firm can fail to adopt some technological changes in the market. Hence, leading to excessive costs compared to its competitors. On the other hand, some managers may become overly concerned with manufacturing innovations and they end up ignoring other important strategies of success (Norton, 2004).
Overexpansion is one of the main strategic causes of failure. Many large corporations believe that diversification will make them do better than businesses that concentrate on one line. This has led such companies to spend most of their resources in acquisitions and mergers. However, some businesses have ended up over diversifying in to unfamiliar areas. Some of these companies often discover their inability to operate in the new areas when failure is imminent and unavoidable. Therefore, they end up incurring a lot of costs without any significant returns, which leads them to bankruptcy (Blum, 2006).
Chapter 11 of Bankruptcy law
The United States Bankruptcy Code defines the different types of bankruptcy that individuals and businesses can file depending on the various factors surrounding the situation. Most big businesses prefer to file chapter 11 of the law, yet it is the most complex. When a business files for bankruptcy under this chapter, it is allowed to maintain its assets and continue functioning. The managers are to work out a reorganization plan on how they will repay their creditors. One main reason why big businesses prefer this chapter is because they are allowed to retain the ownership of their assts. The second reason why big businesses choose chapter 11 is because, their revenue in the long-term is believed to be higher than the value of its liquidated assets. According to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the debtor is given up to 120 days to come up with the reorganization plan. If they fail to do so, the creditors are allowed to submit their plan (Swanson, Srinidhi & Seetharaman, 2003).
Big businesses that have applied for chapter 11 bankruptcy
The Lehman Brothers was a global provider of financial services, which was the fourth largest invest bank in the United States. The company filed for bankruptcy in September of 2008 after a massive exit of its customers. It is the largest bankruptcy that the US has ever witnessed, with assets valued at $693 Billion. An examiner appointed by the court found out that the Lehman executives had concealed the poor financial health of the company by applying cosmetic accounting gimmicks that showed that the company was doing well. Refco a financial services company based in New York dealing in brokerage of commodities and future contracts. The business entered in to financial crisis due fraud carried out by the CEO amounting to $430 million. The firm applied for bankruptcy in October 2005 wit pre-bankruptcy assets valued at $33.3 billion dollars (Marco, 2008).
Turn Around process
Big businesses are capable of turning around from the state of bankruptcy to state, where they can be able to produce and meet their obligations effectively. Most big businesses in bankruptcy would apply for Chapter 11 to protect them from creditors and to allow them to reorganize their balance sheet (Newton, 2009).
Stages of Turnaround
Management change is the first stage, which is meant to put in place leaders who are capable of leading a turnaround and to remove those leaders who might hinder the process. Often creditors will insist that the leadership be changed. Therefore, changing the leadership also include the board members who are not participating in the turn around process. The second stage is situation analysis, which is meant to identify how the downturn can be stopped, the viability of the business and the most appropriate turnaround strategy. This involves assessing the previous businesses processes and operations to determine those that can be retained, those to be eliminated and new ones that can be adopted (Newton, 2009).
Design and selection of turnaround strategy is the third stage, comes after analysis of the situation. Here the management outlines the specific goals and objectives to be achieved. It also comes up with sound corporate and business strategies, as well as detailed functional action plans. Some of the turnaround strategies that the management can choose include revenue increasing strategies, cost-reduction strategies, asset-reduction and redeployment strategies, competitive repositioning strategies as well as combination strategies. After determining the strategies to use, the management can then start the implementation plan as they monitor the progress (Newton, 2009).
The law of bankruptcy has evolved since the time it was first used in the in the 1880. Big businesses become bankrupt due to various reasons, which include poor economic conditions, casualties and inefficient management decisions. Most big businesses faced with bankruptcy always file for chapter 11 of the US bankruptcy code, which allows them to retain the ownership of their assets and reorganize their balance sheet in an attempt to repay their creditors. Some the big businesses that have filed for chapter 11 of bankruptcy includes the Lehman Brothers, which is the largest bankruptcy case in US history. Refco is another big company that filed for bankruptcy in the twenty first century with very high pre-bankruptcy asset value. However, its financial crisis resulted from a financial scandal. Businesses that go in to bankruptcy are able to turnaround and resume their normal operations. The turnaround process for big businesses involves four stages. Management change, situation analysis, choosing turnaround strategies and lastly there is implementation.
Blanc, D. E. (2002). Bankruptcy: a primer. Hauppauge, NY: Nova Publishers
Blum, B. A (2006). Bankruptcy and debtor/creditor: examples and explanations. New York, NY: Aspen Publishers Online
Bush, C. H. (1915). Uniform business law: with business forms and illustrative case. Baltimore, MD: The H. M. Rowe Company
Marco M. (2008). The 10 Biggest Chapter 11 Bankruptcies in US History. Retrieved 20, April 2011 from http://consumerist.com/2008/09/the-10-biggest-chapter-11-bankruptcies-in-us-history.html
Newton, G. W. (2009). Bankruptcy and Insolvency Accounting: Practice and Procedure. John Wiley and Sons
Norton, W L. (2004). Annual survey of bankruptcy law. Washington, DC: Callaghan.
Swanson Z., Srinidhi, B. N. and SeetharamanA. (2003). The capital structure paradigm: evolution of debt/equity choices. Westport, CT: Greenwood Publishing Group
Webster, P. K. and Lauren D. (2003). Practical Bankruptcy Law for Paralegals. Clifton Park, NY: Cengage Learning.
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