Liquidation and Reorganization

Firms that cannot or choose not to make contractually required payments to creditors have two basic options: liquidation or reorganization. Liquidation means termination of the firm as a going concern, and it involves selling off the assets of the firm. The proceeds, net of selling costs, are distributed to creditors in order of established priority. Reorganization is the option of keeping the firm a going concern; it often involves issuing new securities to replace old securities. Liquidation or reorganization is the result of a bankruptcy proceeding. Which occurs depends on whether the firm is worth more "dead or alive."

Bankruptcy Liquidation Chapter 7 of the Federal Bankruptcy Reform Act of 1978 deals with "straight" liquidation. The following sequence of events is typical:

1. A petition is filed in a federal court. Corporations may file a voluntary petition, or involuntary petitions may be filed against the corporation by several of its creditors.

2. A trustee-in-bankruptcy is elected by the creditors to take over the assets of the debtor corporation. The trustee will attempt to liquidate the assets.

3. When the assets are liquidated, after payment of the bankruptcy administration costs, the proceeds are distributed among the creditors.

4. If any proceeds remain, after expenses and payments to creditors, they are distributed to the shareholders.

The distribution of the proceeds of the liquidation occurs according to the following priority list:

1. Administrative expenses associated with the bankruptcy

2. Other expenses arising after the filing of an involuntary bankruptcy petition but before the appointment of a trustee

3. Wages, salaries, and commissions

4. Contributions to employee benefit plans

5. Consumer claims

6. Government tax claims

7. Payment to unsecured creditors

8. Payment to preferred stockholders

9. Payment to common stockholders bankruptcy

A legal proceeding for liquidating or reorganizing a business.

The SEC has a good overview of the bankruptcy process in its "online publications" section: N

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