Why Should an Indebted Company Avoid Bankruptcy?

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Why Should an Indebted Company Avoid Bankruptcy?

Companies sometimes go through periods of distress and crises as a result of the risks surrounding them, which sometimes lead them to consider filing for bankruptcy. The declaration of bankruptcy is considered as a solution for the debtor to get rid of her/his debt, and for the creditor to recover her/his money. However, such a solution has to be the last choice which is used by the debtor to solve her/his stops paying problems, but why is that? And why it is better for debtor companies to reconcile with their creditors and solve problems related to debts in consensual ways? In other words, why should indebted companies avoid bankruptcy?

1. LOSS OF CONTINUITY
   The bankruptcy system was designed with the primary goal of restoring rights to creditors of corporations or traders who stopped paying their debts. In order to achieve this goal, it is necessary to dismantle the debtor company's business, by selling its assets and paying off its debts. For this, it is necessary to terminate some or all of the current and future contracts, as the case may be, including the employee contracts. Consequently, it becomes impossible for the company to be able to revive the business again, which makes it vulnerable to acquisition by large companies at best.
2. LOSS OF CONTROL
   One of the most important general principles of bankruptcy is: stopping the debtor from managing and disposing of her/his money, as well as supervising the judiciary over bankruptcy procedures. This means that the owners and managers will lose their control over the running of the business, and thus they will lose the ability to decide and choose which contracts they prefer to terminate and which contracts they want to keep, which will be up to the trustee and the bankruptcy court.This matter will negatively affect the company and the partners, if they wish to continue working after paying debts, whether in terms of securing new sources of funding, restoring the confidence of customers again, or even maintaining talented employees.
3. FULL DISCLOSURE AND LOSS OF PRIVACY
   As a result of the defaulted company being exposed to bankruptcy procedures, all creditors whose debt has come due or due in the future will be invited to join the process. The trustee will be obligated to have transparency and full disclosure of all financial information of the debtor company, including the names of creditors, the size of debts and the amount of liabilities, and all work-related affairs and all challenges that the company faces will be publicly disclosed.This, of course, will not be positively reflected on the reputation of the owners or managers of the debtor company. On the contrary, it will have economic and social impacts on them that are difficult to avoid and get rid of.
4. EXPOSING OWNERS AND MANAGERS TO HIGH RISKS
   The exposure of the debtor company to bankruptcy procedures will reveal the activities that the owners and managers have practiced, which include a high level of risk, such as participation in speculative operations in the past or unfair competition operations. This is not favored by the laws and regulations of countries. It will not only expose them to criminal accountability but rather they will be obligated to fill the shortfall in debts owed to the creditors, even if the company is a limited liability or public joint-stock company.
5. TIME PRESSURE
   One of the basic principles of bankruptcy is to expedite procedures, in order for creditors to recover their rights as quickly as possible, in a manner commensurate with the preservation of the commercial operations characteristics.Therefore, the exposure of the debtor company to bankruptcy procedures will put it under pressure, the short deadlines for procedures, and it will be difficult for it to find alternative solutions that enables it to fulfill its financial obligations.
6. NO PLACE FOR RETREAT
   Once the court accepts the bankruptcy declaration application and issues the decision to proceed with its procedures, there is no way to go backwards, and the official procedures must be completed to their end. And there will be no way for the debtor company to get out of this predicament except for immediate payment of all creditors in one go and full payment of their debt. This is impossible to achieve, unless there is another company that acquires the debtor company and pays off its debts.

⇨ In my opinion, these are the main reasons why bankruptcy procedures have to be avoided. Please, share more information or advices here.

References:
Essam Al Tamimi (2020), Ten Reasons why you should not consider filing for Bankruptcy, Al Tamimi & Company.
James A. Costantini (2009), Effects of Bankruptcy Procedures on Firm Restructuring: Evidence from Italy, working paper, INSEAD, P. 45.

		Comments Rating
		3 Warren D. Miller, CPA, CFA Strategy Consultant, United States
	Why Would a Company File for Bankruptcy?? (1 of 2) The short answer is that there are reasons a company would file for bankruptcy. They include: 1. An inability to meet its current obligations; 2. Unwillingness on the part of the owners of a company heavily in debt to persevere, struggle, and try to find ways to pay off what it borrowed; and 3. A belief on the part of the owners that, even if they liquidated some of their personal assets and put the proceeds into the company, their firm's future is such that it could not survive. In many parts of the United States, especially in smaller communities where almost everyone knows almost everyone else, character is everything. In that context, small-town citizens often believe that filing bankruptcy is the easy way out. More important, many of those who believe that might, in a given situation, be among the unsecured creditors who will not get paid 100 cents for every dollar they are owed. In working with some smaller companies struggling with a heavy burden of debt, I have emphasized to the owners that the first thing they must understand is the circumstances that led them to be in the jam they're in. In my experience, one, two, or all three of the following can put a company behind an eight-ball of debt: 1. Hiring too many people too fast - the metric to look at here is annual revenues per full-time-equivalent employee. In the United States, that figure will vary by industry for a simple reason: different industries have different underlying economic structures. Those structures affect a company's ability to repay its debt. 2. That is because, though paying the interest on debt is tax-deductible, repaying the principal is not tax-deductible. Therefore, the Net Income (on the CASH basis must throw off enough cash to pay debt AND to make capital investments in the company. 3. The thinner a company's gross margin is--that is, its gross profit as a percentage of its total revenue--the fewer people it can afford to hire because it will be unable to meet payroll.