Business failure or bankruptcy occurs when a firm cannot pay its debts on time or when liabilities exceed ASSETS. Bankruptcy is an ancient issue, critical to the development of an economic and social system. It is addressed both in the Old Testament of the Bible and the U.S. Constitution. The Bible states: “At the end of every seven years you shall grant a release and this is the manner of the release: every creditor shall release what he has lent to his neighbor . . .” The Constitution granted Congress the authority to establish “uniform laws on the subject of bankruptcies throughout the United States.” Business failure includes both legal and management issues. In the United States, The Bankruptcy Act, first passed in 1800 and amended numerous times since, serves several purposes:
• to ensure that the debtor’s property is fairly distributed to creditors
• to ensure that some creditors do not obtain an unfair advantage
• to protect creditors from actions by the debtor to not relinquish assets to which the creditors are entitled
• to protect debtors from demands for payment by creditors
The Bankruptcy Code includes two levels or chapters of business failure status: straight liquidation (Chapter 7) and reorganization (Chapter 11). There are also statutes for FAMILY FARM bankruptcy (Chapter 12) and CONSUMER BANKRUPTCY (Chapter 13). Under Chapter 7, known as “straight bankruptcy,” a firm must disclose all property owned and surrender the assets to a bankruptcy trustee. The trustee sets aside certain assets that the debtor is allowed to retain and then sells the remaining assets in order to pay off creditors. Either a voluntary or involuntary petition (filed by the debtor or the creditor, respectively) can initiate Chapter 7 proceedings. Individuals, PARTNERSHIPs or CORPORATIONs can file voluntary petitions. Involuntary petitions are sought by creditors seeking to have a debtor declared bankrupt and have their assets distributed to creditors. There are numerous legal details and exceptions in bankruptcy proceedings as well as attorneys that specialize in bankruptcy law. Under Chapter 11 of the Bankruptcy Act, a debtor is allowed to work out a plan to solve its financial problems under the supervision of a court-appointed representative. The debtor agrees to a reorganization plan, usually including some debt relief from creditors. The goal of Chapter 11 is to allow debtors, primarily businesses, to continue to exist and return to solvency. During the 1980s and 1990s many U.S. companies seeking to avoid major liability claims used Chapter 11 proceedings. Johns-Manville Corporation filed for bankruptcy because of asbestos claims. A. H. Robins filed for protection because of birth control device LIABILITY. Some companies have filed Chapter 11 to get out of COLLECTIVE BARGAINING agreements. As stated previously, business failure is also a management issue. As one official of the SMALL BUSINESS ADMINISTRATION (SBA) stated, “Poor management is the greatest single cause of business failure.” Some common management mistakes include hiring the wrong people, inadequate employee training, trying to do too much, and misuse of management time. The SBA’s Online Women’s Business Center lists 11 common causes of business failure:
• choosing a business that is not very profitable
• inadequate cash reserves
• failure to clearly define and understand one’s market, customers, and customers’ buying habits
• failure to price one’s PRODUCT or service correctly
• failure to adequately anticipate cash flow
• failure to anticipate or react to COMPETITION, technology, or other changes in the marketplace
• overgeneralization
• overdependence on a single customer
• uncontrolled growth
• believing one can do everything oneself
• putting up with inadequate MANAGEMENT