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ABM Teacher- Sta. Elena Senior High School
Submitted to: Prof. Danilo Tiamzon Part-Time Instructor – San Mateo Municipal College
 Every economic system needs mechanisms to ensure the
optimal utilization of resources.
 Bankruptcy is the primary instrument for reallocating
means of production from inefficient to efficient firms.
 Theoretically, bankruptcy shakes out the bad apples from
sectors in difficulty and allows profitable groups to
 Without efficient bankruptcy procedures, financial crises
are longer and deeper.

 The bankruptcy process can allow a company to
reorganize, often requiring asset sales, a change in
ownership and partial debt forgiveness on the part of
 In other cases, bankruptcy leads to liquidation, the death
of the company.

Companies do not encounter financial difficulties because
they have too much debt, but because they are not
profitable enough. A heavy debt burden does no more than
hasten the onset of financial difficulties.

• Financial difficulties result either from a market
problem, a cost problem or a combination of the two.
• The company may have been caught unaware by
market changes and its products might not suit market
• The market may be too small for the number of
companies competing in it.
• Ballooning costs compared with these rivals can also
lead to bankruptcy
Nevertheless, a profitable company can encounter financial
difficulties. For example, if a company’s debt is primarily
short-term, it may have trouble rolling it over if liquidity is
lacking on the financial markets. In this case, the most
rational solution is to restructure the company’s debt.

• One of the fundamental goals of financial analysis as it
is practiced in commercial banks, whose main
business is making loans to companies, is to identify
the companies most likely to go belly up in the near or
medium term and not lend to them.
• Rating agencies also estimate the probability that a
company will go bankrupt in the short or long term
Rating agencies also estimate the probability that a company will go bankrupt in the short or
long term. When US energy giant Enron filed for bankruptcy at the end of 2001, rating
agencies were criticized for not anticipating financial difficulties and warning creditors. In this
case, the rating system did not work properly.

The European Union regulation (issued 29 May 2000) on
bankruptcy merely defines the competence of the different
jurisdictions rather than effectively setting a bankruptcy
procedure applicable all across Europe.

The number of bankruptcy has
significantly increased in 2002 with
Germany being specifically impacted
Goals of Debtor-(company-) A creditor-oriented process sets
friendly clearly the reimbursement of
and Creditor-friendly
creditors as the main target of the
bankruptcy process.
• Pay down the liabilities of The seniority of debt is of high
the firm importance and is therefore
• Minimize the disruptive recognized in the procedure.
impact on the industry In this type of procedure,
• Minimize the social creditors gain control or at least
retain a great deal of power in the
That type of process results most
likely in the liquidation of the firm
Criteria to Help Define
Bankruptcy Procedures

• Does the procedure allow restructuring or does it systematically lead to

liquidation (most jurisdictions design two distinct procedures)?
• Does the management stay in place or not?
• Does the procedure include secured debts? In some countries, secured debts
(i.e., debts that are guaranteed by a specific asset) and related assets are
excluded from the process and treated separately allowing greater certainty or
repayment. In such countries, securing a debt by a pledge on an asset gives
strong guarantees.
• Do creditors take the lead, or at least have a word in the outcome of the process?
In most jurisdictions, creditors vote for the plan that is proposed to them as the
outcome of the bankruptcy process. Sometimes they even have greater power and
are allowed to name a trustee who will liquidate the assets to pay down debt. But
in some countries (e.g. France) they are not even consulted.
UK France Germany Sweden Spain Italy

Type Creditor Debtor- Creditor Creditor (lender) Creditor Debtor-

(lender) friendly (borrower-) (lender) friendly friendly (lender) friendly (borrower-)
friendly friendly

Possible Restructuring Rare after Yes Yes (rare) No Yes Yes

opening of a

Management can stay in place No Yes* Yes* Yes* ***

Creditors vote on restructuring/ Yes No Yes Yes Yes Yes***

liquidation plan

Priority value Proceeding Salaries; tax, Proceeding Secured debts; Secured debts; Proceeding
charges; other social charges; proceeding salaries; tax charges;
secured debts liabilities; part of secured debts ; charges; unpaid and social preferential
on specific secured debts; other debts secured debts; liabilities; creditors (inc. tax
assets; tax and proceeding tax and social creditor and social) and
social security; charges; other liabilities; other initiating secured creditors;
other secured secured debts; debts procedure unsecured
debts; other other debts (25%); creditors
debts unsecured

* Assisted by court-designated trustee

** Yes, in case of restructuring (pre-emptive arrangement) but only consultative committee in case of liquidation (fallimento)
*** No, in case of liquidation (fallimento)

Depending on the severity of the bankruptcy process and, in
particular whether it allows and promotes restructurings or not,
two opposite inefficiencies can be thought of:

• Allow restructuring of an inefficient firm, which destroys value.

This could be an issue because such restructuring may
destabilize the whole industry
• Lead to liquidation of efficient companies.
A firm can be caught in a bankruptcy procedure because
of a liquidity problem. In that case, liquidation could be