Bankruptcy in Business: The Positive and Negative Affects
The term “bankruptcy” is derived from the Italian word “banca rotta”, meaning broken bench. It is a process regulated by federal law which provides debtors –individuals and corporations – with a legal of seeking relief from their creditors.
Bankruptcy is becoming the most convenient and easy way out for people who are facing financial troubles. However, majority of them are not aware of two very important things: Bankruptcy is not a viable solution for all the people who have overwhelming debt. Bankruptcy has far reaching and long term consequences that can affect adversely on an individual’s life.
The Negative Effects of Bankruptcy
- Many debtors filing for bankruptcy get a feeling of being defeated and embarrassed. Your detailed financial affairs will be made available to the court and creditors.
- You as the debtor do not have much of any say in how much you will be required to payback to the creditors, this decision is no longer yours but that of the courts.
- You may lose valuable or treasured assets, and may even lose your business if you have one.
- Payments may be deducted from your paycheck for up to five years.
- Consumer debtors are required to attend credit counseling within 180 days of filing the petition for bankruptcy.
- Debtors must also complete a personal financial management education before they can obtain a discharge. In business, bankruptcy leads to recovery because bankruptcy law allows the business to shake off debt that it cannot repay and to break out of contracts that is detrimental to it while allowing the business to continue operating in the “business as usual” fashion.
As a result, the business is able to generate positive cash flow and eventually recovers. Without being able to get rid of debt and break out of contracts, the business has to use its cash to pay debt and honor contracts, instead of using the cash for operations and to generate a profit. After everything is said and done, a business has no business doing business if it cannot generate a profit at some point in time.
Thus, in bankruptcy reorganization, the sine quo non standard to successfully emerge from bankruptcy court is to convince the court that the business will be able to generate a profit within a short period of time if it is able to get rid of a significant portion of its debt and if it is allowed to dishonor particular contracts. If the business cannot show eventual recovery and profitability after debts and contracts are nullified, the court will liquidate the business instead of allowing it to reorganize.
The main advantages of bankruptcy are:
- The experience usually isn’t as traumatic as it is perceived by the public in general.
- While notice of your bankruptcy will be published in the newspaper; it’s usually not read or noticed by most people.
- Most Debt is written off and you gain a degree of freedom and a certain peace of mind.
- Most cases are automatically discharged from bankruptcy after one year.
- You are allowed to keep basic possessions and the tools of your trade if you are self employed
- Even though you may be issued with an IPO directing you to pay a proportion of your surplus income, this is only after generous living expenses have been deducted. Your living expenses budget allowed in bankruptcy are far more generous than in an IVA.
- For the person involved, bankruptcy provides relative peace of mind and possible automatic discharge after one year (or less in some cases).
- For the creditors, bankruptcy allows a full investigation of the debtor’s affairs to be carried out.
- Pressure is taken off you because you don’t have to deal with your creditors. Disadvantages of bankruptcy: Following are a few disadvantages of bankruptcy (Avoid Bankruptcy – Myths, Reality and Alternatives, n. d. )
- Ruined credit history: Bankruptcy creates ultimate damage to one’s Credit history. It remains in the Credit report for 10 years from the date it was discharged. Not only that, it also stays in Court Records for 20 years. The worst part of this is that it reduces the chances of getting loans and jobs in the future as creditors and employers judge a candidate first hand through their credit report.
- Property repossession: Declaring bankruptcy can result in losing valuable assets (non exempt property) or equivalent cash value. You may need to part with your most treasured property.
- Stained social status: Personal bankruptcy can spoil your social status.
- Damaged business: Filing of bankruptcy by a business owner can shatter all chances of a growing business. The damaged credit rating due to bankruptcy will not make him qualified for business loans.
- Serious financial crisis: After being declared a bankrupt you can expect all your bank accounts, credit cards etc to be closed. Anything that you might be leasing, or buying on hire purchase, such as your car will be immediately returned to the owner. This can however give birth to tremendous financial crunch.
- Hampered aspects of life: People who have declared bankruptcy may find it extremely difficult to buy or even rent a home; acquire insurance, security clearance and buying or leasing a car. This can lead to a lot of problems & put a big question mark on the chances of having a standard & secured living. It is thus advisable to avoid bankruptcy for a safer future.
- Expensive assets such as your house and car can be seized.
- Certain debts are not written off. These debts include student loans, child support, overpayment of benefits and court fines.
- If an IPO is issued, you will have to pay some of your surplus income towards your debts for three years.
- You are not allowed to obtain credit over ? 500 without disclosing your bankruptcy.
- Your career can be damaged and you may even lose your job. This applies only if you belong to certain professions including but not limited to the police, judiciary and certain financial positions. Check your contract of employment and/or contact your HR department if you are unsure.
- You are also restricted from being a company director or forming a limited company.
- A record of your bankruptcy will remain on your credit file for six years even after you’ve been discharged.
- The fact of your bankruptcy, name, address and occupation is published and this has a certain social stigma.
- You have to inform the OR of any windfalls such as inheritance or lottery money which are usually taken.
- You can be questioned about how you became bankrupt.
- Any Bankruptcy Restriction Order will be registered.
The effects of bankruptcy could be positive and even negative (Foster, 2007):
- If we declare bankruptcy, we need not pay the full debt, in most of the cases most of the debt is not repaid.
- When a person is in debts, and declares a bankruptcy then he won’t be under the risk of having his utilities or automobiles from being repossession. The person who declares bankruptcy will get rid of the phone calls and wage garnishments from the debt collectors.
- When a person declares bankruptcy then he will not be allowed to pay for some things like child support, student loans criminal fines etc.
- Bankruptcy will not eliminate the mortgage or any other collateral loans of the holder. Though bankruptcy can be an answer in getting out of the debt, still we should be trying to avoid this condition because the credibility would come under stake when bankruptcy is declared.
By having a proper financial planning, we can avoid this situation of bankruptcy. Even after having a good planning and maintenance, if the person comes under debts then certainly filing for bankruptcy is a nice option so that he can restart again financially. Analysis of Bankruptcy: There are a number of social effects from bankruptcy. The individual declared as bankrupt losses his or her previous status in society. The bankrupt person has to inform about the bankruptcy each and every time he tries to get a job, start a business or apply for financial assistance.
The psychological pain is an unfortunate effect of bankruptcy. From the beginning of the bankruptcy process until the end, the bankrupt person is subjected to mental pain, the feelings of guilt and failure, as well as tremendous stress. It is difficult to begin a new life under these conditions. Many people worry about the stigma of bankruptcy and how their friends will think of them. For some people the effect of publicity is very worrying. Advertised in the London Gazette and possibly a local paper people worry that the bankruptcy may be picked up by someone they know.
Although unlikely, the possibility of someone seeing is still a worry. All of the effects of bankruptcy can be too much for some people, sometimes culminating in problems such as stress, anxiety and depression. It is important to realize that bankruptcy can be a stressful time, which is often made worse by the uncertainty that bankruptcy brings. The key to tackling bankruptcy is to seek advice as early as possible, this will help remove the uncertainty and prepare you to get on with the rest of your life. A number of restrictions are imposed on the financial life of the bankrupt.
There are also the psychological effects of bankruptcy. The effects of bankruptcy cause major problems for the individual. Once a person is declared a bankrupt, the trustee takes possession of all personal assets. After selling the assets, the debts are cleared. The individual is also forced to start anew, although they are subjected to a number of financial restrictions. If investors perceive that a bankruptcy is an opportunity for competitors to improve profitability by increasing market share at the filing company’s expense, then a competitive effect would increase rivals’ share prices.
The bankruptcy court focuses on an equitable division of assets among claimants rather than increasing shareholders’ wealth. Finally, customers are reluctant to buy from bankrupt companies and shift their business to its competitors (Haensly et al, 2001). Bankruptcy is listed in the top five life-altering negative events that we can go through, along with divorce, severe illness, disability, and loss of a loved one. Very few people that have gone through bankruptcy would say that it is just a painless cleaning of your debts, where afterwards you can easily begin your new life (Long-term effects of Bankruptcy, n. d. )
Bankruptcy laws are generally written with reference to individual debtors. However, they often become a de facto set of bankruptcy rules for many entrepreneurs, because the debts of non-corporate firms are often the personal liabilities of the owner (Fan and White 2003). For example, entrepreneurs often finance their start-up efforts through personal sources of capital and often must provide personal guarantees for business debt. Assets that are protected from bankruptcy provide a form of wealth insurance for entrepreneurs by mitigating the personal financial risks of business ownership.
Though bankruptcy law is generally federal in nature, the type and amount of assets that are exempt from the process are often left to state law. As a result, differences in the exemptions between states create different levels of wealth insurance (Auken et al, 2009) Bankruptcy should be viewed as a last resort if nothing else can work. Debt settlement is by no means the magic bullet and does come with its respective pros and cons, however for many people it is a savior from going into bankruptcy.
A business in financial difficulties usually encounters a resistance from its business partners, financiers, creditors (who typically require guarantees) and the general public (who prefer to buy from another company) in continuing to do business. This mentality and negative reaction against businesses in distress should be changed into a more positive perception of the situation, since the continued support from business partners, financiers, creditors and consumers could contribute in a company avoiding bankruptcy.
In short, a bad situation may sometimes have good effects, and what is required now is to draw lessons from this crisis and the subsequent losses suffered. Therefore, bankruptcy should never be looked on as being an easy way to eliminate debt because it carries serious negative side effects on your credit rating, emotions, and personal circumstances.
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