Bankruptcy, the legal proceeding instituted when a person or business is unable to pay consumer or business debts as they become due. Almost all a bankrupt’s assets will be handed over to a trustee to reimburse creditors. A bankrupt is forbidden by law from certain business activities, such as being a company director. However, bankrupts can obtain a legal discharge from bankruptcy, with only a limited proportion of debts being repaid.
II EARLY PROCEDURES
Debtors who were unable to meet their financial obligations were harshly treated under the legal systems of most countries until relatively recent times. During one period in ancient Rome, creditors were entitled literally to divide a debtor’s body or to enslave debtors and their families. Under the laws of England in the reign of James I, debtors who were unable satisfactorily to explain their inability to pay were placed in the public pillory. Debtors might be put to death if their failure to pay their creditors was due to fraudulent practices. Savage reprisals of this kind were eventually halted, but for many years British courts ruled that debtors who failed to pay a judgment against them were guilty of a breach of the peace and therefore subject to imprisonment. With the development of more sophisticated trade and commercial practices, steps were taken to ameliorate the condition of defaulting debtors. Since the late 19th-century bankruptcy legislation has evolved to permit people who are unable to pay their unsecured debts to be discharged from that responsibility if they were willing to liquidate their nonexempt property for distribution among unsecured creditors. Laws now usually allow a debtor to retain some exempt property in order to permit the debtor’s family to maintain a minimum standard of living. National exemption laws vary widely in their generosity.
III CURRENT PRACTICES
Bankruptcy practices differ from country to country. In the United Kingdom, for example, the main options in the case of a company that is insolvent are as follows. Liquidation entails the sale of all the company’s assets for cash, which is then disbursed to the claimants in order of their seniority (for example, bondholders before shareholders). In receivership, a receiver is appointed by a senior claimant (often a bank) to run the company. The receiver will decide whether to maintain the company, in order that it may be sold as a going concern or sold in part, or liquidate to realize funds with which to repay creditors. Administration, introduced in the 1986 Insolvency Act, entails the appointment of an administrator, who takes control of the company and works with the interests of all claimants in mind (rather than just the senior claimants). These options vary in their application: companies often put themselves into receivership to give themselves time to order their affairs, whereas liquidation is usually initiated by creditors or receivers.
The Bankruptcy Code in the United States allows insolvent individuals and business debtors to try to reorganize their finances in order to avoid full-scale bankruptcy proceedings under Chapter 13 (individual) or Chapter 11 (corporate) reorganization proceedings. A typical plan under Chapter 13 proceedings will require payment of outstanding debts from the debtor’s future income. Chapter 11 proposals may combine payments from sales of some business assets with income from future business operations. Shareholder interests may be restructured through the acquisition of more equity in the company in return for writing off some of the rest.