What Happens When a Company Files for Bankruptcy

09/10/2024

Understanding how bankruptcy affects businesses is crucial for financial success. Is your company familiar with the different types of bankruptcy?

Bankruptcy is a legal process that allows companies (or individuals) to resolve their debts under the protection of the court. When a company files for bankruptcy, it typically means it can no longer meet its financial obligations and needs legal relief to either liquidate its assets or restructure its debts. This move is often seen as a last resort, taken when all other options, such as securing new financing or renegotiating terms with creditors, have failed. Filing for bankruptcy can have significant implications not only for the company but also for its creditors, employees and stakeholders.

According to an article by S&P Global Market Intelligence, the U.S. experienced a significant spike in corporate bankruptcies in 2023, the highest number recorded since 2010.  December alone witnessed 50 new filings, capping a year marked by economic challenges such as high interest rates and inflation. 

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What types of bankruptcies are there?

There are three primary types of bankruptcy that a company might file for, each under different chapters of the Bankruptcy Code.

When you're doing business with another company, keeping an eye on their financial health is crucial. If they’re heading toward bankruptcy, it could impact your bottom line. Here's a quick rundown on what it means if the company you’re watching is heading for Chapter 7, Chapter 11, or Chapter 13.

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Chapter 1

Chapter 7 Bankruptcy: Shutting Down for Good

If the company files for Chapter 7, it's a sign they’re closing shop. Imagine a business that's hit a dead end—they can't pay their bills and there’s no way out.

  • What Happens: The company’s assets are liquidated. A trustee comes in, sells off whatever the company owns and uses that money to pay off debts. Once the assets are gone, so is the company.
  • What It Means for You: If they owe you money, you might get some of it back, but it's likely to be a fraction of what you're owed. And once the assets are liquidated, that's it—the business is done.

Chapter 7 is the end of the road. If a company you're dealing with files for this, expect them to disappear from your radar soon.

Bankruptcy
Chapter 1

Chapter 11 Bankruptcy: A Rebuilding Phase

Chapter 11 is different—it’s a sign that the company isn’t ready to give up just yet. They’re struggling, but they think they can turn things around with a little breathing room.

  • What Happens: The company keeps running, but with the court's oversight. They’ll come up with a plan to reorganize and pay off their debts over time, while continuing operations.
  • What It Means for You: If you’re a creditor, this could be a good sign—they’re not out of the game and you might still get paid, though it might take longer than expected. However, keep in mind that their financial stability is shaky during this period.

Chapter 11 is a chance for the company to pull itself together. If you’re relying on them, this could be a bumpy ride, but there’s hope for recovery.

Chapter 1

Chapter 13 Bankruptcy: Personal Restructuring

If the company is a small business run by an individual or sole proprietor, they might file for Chapter 13. This is a sign that they’re trying to stay in business while catching up on what they owe.

  • What Happens: The owner sets up a repayment plan, usually lasting three to five years. They’ll pay off debts gradually, while keeping the business running.
  • What It Means for You: You’re likely to see some payments come your way, but over time and only if the business stays afloat. The good news is that they’re trying to keep things going, which could mean stability in the long run.

Chapter 13 is about buying time. If a sole proprietor you’re working with files for this, it means they’re fighting to stay in business, which might work in your favor if they succeed.

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Spotting the signs of bankruptcy

It’s crucial to identify potential financial distress in a company before it reaches bankruptcy. By the time a company files for bankruptcy, recovering your owed funds becomes a lengthy and uncertain process that can severely impact your cash flow. Instead, focus on monitoring your customers and suppliers regularly to detect early warning signs.

Key indicators of potential bankruptcy include an increase in Days Beyond Terms (DBT) and a declining credit score. These could signal financial trouble, and you should proactively check in with the company to understand what’s happening. If you notice that payments are slowing down, it’s essential to re-prioritize your cash collections. Consider reducing your payment terms, or even requiring upfront payments if their credit score drops significantly.

By staying vigilant and utilizing credit monitoring tools, you can avoid the risk of being caught in a bankruptcy situation and protect your financial interests.

Spotting the signs of bankruptcy

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What happens after a company files for bankruptcy?

Once a company files for bankruptcy, the court will oversee the process to ensure that debts are managed or discharged appropriately. In Chapter 7 cases, the company’s assets are sold off, and the proceeds are used to pay creditors. The company then ceases to exist. In Chapter 11, the company continues operating while working on a reorganization plan, which may involve renegotiating contracts, downsizing, or selling parts of the business. Chapter 13, although rare for companies, involves a repayment plan over a set period.

During and after the bankruptcy process, the company’s creditworthiness will be severely impacted, making it difficult to secure future financing. Additionally, stakeholders like employees, shareholders, and creditors may face significant losses. For those doing business with the company, staying vigilant and regularly monitoring its financial health is crucial to avoid unexpected losses due to bankruptcy.

Understanding the nuances of bankruptcy is crucial for anyone doing business with a company facing financial challenges. Whether a company files for Chapter 7, Chapter 11, or Chapter 13, each type of bankruptcy carries its own implications for creditors, employees, and stakeholders. By staying informed and vigilant—through regular monitoring of business credit reports, payment behaviors, and legal filings—you can protect yourself from potential financial risks. Recognizing the warning signs early enables you to make better decisions, negotiate favorable terms, and safeguard your investments, ensuring the stability and success of your business relationships in an unpredictable financial landscape.

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Lina Chindamo

About the Author

Lina Chindamo 

Director, Enterprise Accounts, Creditsafe 

Lina Chindamo is currently Director, Enterprise Accounts at Creditsafe Canada, and a Certified Credit Professional (CCP) with over 25 years of experience in credit risk management.  She has held senior leadership roles with leading companies in multiple industries in the Canadian market such as Sony Electronics, Maple Leaf Foods, and Mondelez Canada. Her experience as a credit professional along with her current role as Director, Enterprise Accounts who works closely with c-suite partners and credit teams across all industries makes her a well-rounded credit professional who is well respected in our industry.

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