Bankruptcy as a Strategy – Part 1

When the word bankruptcy is used, the immediate image conjured is that of a company that is trying hard to stay afloat.

However, external parties such as creditors are pushing for the immediate repayment of debts causing the company to become insolvent.

The average person thinks of bankruptcy as an auction type event wherein the assets of the incumbent company will be sold to the highest bidder in order to pay back the dues previously owned by the company.

In other words, bankruptcy proceedings are often thought of as being involuntary. In fact, that was the case until some years ago.

However, as time has passed and laws have changed, companies have realized that bankruptcy need not be voluntary. Also, it need not be an adverse event for the company.

Many companies have started using bankruptcy as a strategic tool. This means that they have used bankruptcy laws in such a manner that the event is neither involuntary nor adverse.

The bankruptcy or the threat of filing bankruptcy is used by companies in order to negotiate deals that are more favourable for certain stakeholders of the company.

The voluntary and strategic implementation of bankruptcy laws has been explained in detail in this article.

Clearing the Title of the Assets

In many cases, the owners of the assets are unable to sell their properties because of liens and title disputes.

For instance, a particular company could be facing a court case related to succession, which causes the title of the assets owned by the company to be disputed.

In such cases, companies are unable to sell off these disputed assets.

However, if there is bankruptcy in such a case, then the interest of the shareholders and internal stakeholders takes a backseat.

Paying the external party on time becomes the first priority of the judge presiding over the bankruptcy proceedings.

Therefore, in such cases, courts order the title disputes to be solved within a short period of time, failing which the court intervenes in the matter.

Therefore, the strategic filing of a bankruptcy can be used to quickly sell assets that have been stuck in legal disputes over the years.

Lowering Tax Liability

The strategy of filing bankruptcy has also been used by many companies in the past to lower their tax liabilities effectively. For some businesses, tax liabilities can form a significant part of their overall liabilities. In such cases, filing bankruptcy may be advantageous.

It is a known fact that governments have largely excluded themselves from bankruptcy settlements. This means that they receive first priority in the repayment of debts.

Even the most secured higher level debts can only be paid back once the tax liabilities have been discharged.

Therefore, theoretically, filing of bankruptcy should not have any advantageous effect on the incumbent company.

However, there are several loopholes that allow companies to take advantage of bankruptcy laws to lower their tax liabilities.

For instance, taxes which have been due for more than three years are automatically discharged when bankruptcy is filed.

Also, the tax department generally charges a very high-interest rate on outstanding taxes.

However, companies that file bankruptcy do not have to pay this high-interest rate. Instead, the interest rate is lowered in order to enable the company to pay its other creditors as well.

Therefore, if a company owes the tax department a lot of money, they can voluntarily file for bankruptcy in order to obtain financial relief.

Increasing the Tenure of Debt

If a company has a lot of short term debt on its balance sheet, it can file bankruptcy in order to convert this short term debt into long term debt, which may have to be paid over many years.

For instance, if a company has a lot of trade payables i.e., bills to be paid within a year and do not have the money to pay the bills, they can file for bankruptcy.

In this case, bankruptcy law will ensure that the trade payables will not have to be paid immediately.

Instead, the court will help negotiate with the creditors, and the short term debt may be converted to a long term debt, which can be paid by the company over an extended period of time.

Also, if the company has other short term debt, which has to be paid within one to three years, the repayment of that debt will also have to be stopped. This is because, as per bankruptcy laws, companies are not allowed to repay debts to individual creditors until an entire reorganization plan has been worked out.

Often, filing bankruptcy scares the creditors and gives companies the bargaining power it needs in order to negotiate a lower rate, a longer tenure, or other more favourable terms.

The above-mentioned points are just some strategic ways of using bankruptcy laws. It is true that the reputation of the company takes a severe beating when it files for bankruptcy.

However, it is also true that sometimes the benefits reaped may be enough to justify this drastic step.

As a business person, it is important to understand that bankruptcy laws are an effective bargaining tool. The threat of filing bankruptcy is often persuasive enough to bring creditors to the bargaining table.