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Bankruptcy Paper Essay

In this paper I would like to cover what bankruptcy really is and how the bankruptcy system operates in order to repay creditors. I will also discuss a few scholarship bankruptcy theories. People and businesses can erase all personal debt they are unable to pay by filling for bankruptcy. However, as everyone knows, this entire process is not only humiliating but also very difficult to go through.

The point of declaring bankruptcy is to allow a sincere and honest debtor to wipe the slate clean by clearing the majority of his debts and paying back the creditors as soon as the money is on hand, in a methodical manner. Debtors are permitted to pay back their debts by distirbution of their assets between hire creditors – the distribution is done on a pre-decided priority basis. If, after the assets are depleted and the debts are still not entirely paid, the bankruptcy system allows debtors to be free of the unpaid debts.

For the beginning (declaring bankruptcy) to the end (settling all financial commitments) debtors are given protection from creditors. The creditors aren’t allowed to harass the debtors by filing lawsuits against them, taking away their wages and calling to demand payment. “In

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Title 11 of the United States Bankruptcy Code there are six types of bankruptcy an individual or organization can file. They are:

  • This can be done by both businesses and individuals by liquidaton.
  • This is typiclly a civic bankruptcy
  • This kind doesn’t invovle liquidation of all the assests but rahter restructuring of the business, it can also be used by people as individuals whose debts run similar to those of businesses.
  • This kind of sepically desgined for those in the agriculture industry such as farmers and fishers. It involves reorginizing with an appropriate payment plan.
  • This type of bankruptcy case is the most frequently filed, it is filed by individuals who are knee high in debt but still have earn regularly.
  • This is a special kind, it can only be filed for cross-border cases”.

(Carruthers and Halliday, 1998, pg. 58)

Since the implementation of the new bankruptcy law on the 17th of October 2005 a staggering number of people believe that filing for bankruptcy is no longer possible. Because of this the number of filings for bankruptcy has reduced greatly, proof of this is the decline from the 70,860 debtors who filed bankruptcy petitions to only 1,304 bankruptcy filings in the last two months of 2005. It is not true that debt relief is no longer available.  It has just become tougher to simple wipe out debts and to fraud the system.

“The Bankruptcy Abuse Prevention and Consumer Protection Act’s most significant changes include:

– Prefiling credit counseling.

– Post-filing financial education for individuals with primarily consumer debts.

– A means test for filers of Chapter 7 bankruptcy, or liquidation, which allows debtors to wipe their slate clean of financial obligations. With some exceptions, Illinois filers must earn below the state median annual income, which is $70,357 for a family of four.

– If a debtor’s income is too high to qualify for Chapter 7, the person can still file a Chapter 13 bankruptcy that requires a repayment plan for at least part of the debts.” (Daily Herald, Miller, 2006).

The main purpose of business bankruptcy systems is to find an appropriate solution to the organization crisis which creditors of bankrupt firms have. A few of these firms can’t even earn enough to cover any non financing costs that arise and if the assets of these firms are useless as they are and can be put to better use somewhere else, common sense dictates that the assets should be sold off. On the other hand there are those firms which manage to earn enough form their revenues to cover the non financing and production costs but what they earn isn’t adequate to cover the insolvent firm’s debt.

These firms shouldn’t be liquidated and should be continued. Of course, a creditor isn’t concerned about such characteristic differences, creditors want to be paid and so would much rather maximize returns by attaching assets sufficient to pay its claim in full. If every creditor attempts to attach assets, the firm will be liquidated piecemeal, regardless of whether it is effective and economical not to liquidate the firm and reorganize it.

Creditors as a group only have a preference for liquidating the insolvent firm piecemeal, when and if restructuring and continuing with the firm wouldn’t raise more money as compared to gradual liquidation, to pay them back. Their best is to collaborate and coordinate all their efforts in one direction, rather than only thinking of themselves individually. However such alliances prove too expensive and the evidence for this is is several, for example private calisthenics after a firm has declared bankruptcy have been unsuccessful frequently.

 Typically the western bankruptcy system would try to solve this dilemma by endorsing coordination mechanisms. These mechanisms prohibit creditors from collecting debts individually so that the insolvent firm doesn’t liquidate piecemeal inefficiently and it also determines measures through which value-maximizing choices can be made between liquidation and reorganization.

“The value of the insolvent firm is then distributed to creditors who participate in the bankruptcy procedure according to a priority scheme. Western countries require the debtor and many (sometimes all) creditors to participate in the state-supplied bankruptcy system and restrict the ability of 4 parties to alter certain outcomes that the state system directs. To appreciate these peculiar bankruptcy features, recall that the typical commercial dispute is resolved by a court but parties can contract for a different dispute resolution procedure, such as arbitration.

The typical body of commercial law also is a set of defaults; the rules govern unless particular parties choose-different rules in their contract. In contrast, parties cannot contract in lending agreements to use a bankruptcy system other than the one the state supplies. Also, parties cannot modify many of the rules that constitute the system. For example, the Uniform Commercial Code (U.C.C.) permits a party to cancel a deal if its contract partner becomes insolvent, (7) and parties have commonly made the Code’s authorization explicit by contracting for a right to exit. Today, bankruptcy law permits the insolvent party (or its bankruptcy trustee) to keep a sales contract in force despite state law or private agreement”. (Schwartz, 1998, pg. 1817)

Bankruptcy systems don’t control the matter of transactions accounts for some of the differences between bankruptcy and commercial law generally, what they actually do is simply solve a synchronization problem. For instantance, if contracting were otherwise unregulated, a contractual term would allow creditors to collect their complete payment swiftly and if this couldn’t happen the creditors would be allowed acquire their money through piecemeal liquidation. There must be structural rules to ensure maximum payment to all creditors. The bankruptcy system doesn’t really carry structural rules, the rules of the bankruptcy systems can be described as mandatory. (Schwartz, 1998, pg. 1810)

Five of the 13 largest bankruptcies in terms of company assets were filed in 2002; they were WorldCom, Enron, Global Crossing, Conseco, and Kmart. Kmart filed for bankruptcy under Chapter 11, in New England in 2002. It is the largest American retailer to file for bankruptcy with US$ 37 billion in revenues in 2001; it had suffered weak sales and disastrous losses. Initially it let all 2114 Kmart stores to remain open and it terminated 350 leases for stores it had already closed and these assets gave them US$250 million. (Rouch, 2004, pg. 307)

Conseco Incorporated filed for bankruptcy under Chapter 11; it sold its “Conseco co Finance unit for more then $700 million to CFN Investment Holdings LLC and its Mill Creek Bank assets to GE Consumer Finance for $310 million.” (Rouch, 2004, pg. 322) The agreements were reached as part of its bankruptcy-court proceedings in an auction process and were approved by the bankruptcy judge over-seeing the case.

The firm reached an agreement in principle with the” bank and bondholder representatives to reduce the company’s leverage to a level that, together with the targeted operating performance”, will support the efforts by the Company’s insurance subsidiaries to reclaim an ‘excellent’ financial strength rating and restructuring the company. While negotiating with its major creditor constituents, Conseco worked closely with state insurance regulators during the bankruptcy process. (Rouch, 2004, pg. 323)

Just until a short while ago, the most prominent and most believed theory in bankruptcy scholarship was Professor Douglas Baird and Thomas Jackson’s “creditor’s bargain” theory  which stated that actually making a contract for the “bankruptcy procedure was not really possible because a debtor may have hundreds or even thousands of creditors whose interests will be interdependent at the time of insolvency and the contract by which they select a bankruptcy procedure optimal for the particular firm would have to be a contract among all of them, and it would have to be capable of changing over the years as the firm evolved”. So Baird and Jackson sought to discover and impose on all parties to bankruptcy cases the contract they would have chosen had contracting been possible. (Lopucki, 1999, pg 316)

Since the early 1990’s many have disagreed with this theory and have come up with new methods of their own. A prime example would be Rasmussen who suggested adjusting the contract as time passed by to make the required allowances. According to his method “the state would offer a “menu” of alternative bankruptcy regimes, and business debtors would select among them by inserting provisions in their corporate charters.

Changes in the election would be made by charter amendment. Prospective lenders could discover the debtor’s chosen bankruptcy regime from the public record and refuse to extend credit if they did not approve”. (Lopucki, 1999, pg 317)  This method wasn’t very practical because all the involved parties had to keep updating their information and keep making new contracts to suit the varying circumstances. Even though his idea wasn’t practically feasible, some of its facets had great potential and this stimulated others to develop and enhance the suggested proposal.

Schwartz came up with one scheme which was based on Rasmussen’s proposal. The design was such that it the debtor would reach a deal with only the latest creditor in the list and that creditor could not demand any information, he had to depend on any information the debtor would give him. Many scholars have regarded the assumptions this theory is based upon as unrealistic and improbable.

Any market economy has to have a certain degree of bankruptcy, it is a significant trait. As Carruthers and Halliday (1998) put it so eloquently, “it demarcates the limits of extending credit, confronting risk, entrepreneurial venture, and corporate self-determination; it engages all sectors of the economy; and it expresses fundamental conflicts at the heart of the capitalist political economy between labor and capital, owners and managers, debtors and creditors, and the state and the market.” (Carruthers and Halliday, 1998, pg 1)


 Carruthers, G, Bruce . Halliday, C,Terence.  Rescuing Business: The Making of Corporate Bankruptcy Law in England and the United States. Oxford University, 1998. Pg 1 & 58

Lopucki Lynn. A contract theory approach to the business of bankruptcy: Reply to Alan Schwartz. Yale Law Journal. (1999) Vol.109. Pg. 316 & 317

Miller, Karen,.  New Bankruptcy rules leaves debtors in doubt. Daily Herald. (22nd February 2006)

Rouch Chris. Show Me the Money: Writing Business and Economics Stories for Mass Communication. Lawrence Erlbaum Associates. Mahwah, NJ. (2004).  Pg# 309, 322 & 323

Schwart, Alan. A contract theory approach to the business of bankruptcy. Yale Law Journal. 1998. Vol.107, Pg 1817 & 1810

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