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Friday, 5 October, 2001, 07:11 GMT 08:11 UK
Q&A: Bankruptcy made simple
Bankruptcy, receivership and administration mean different things in different countries. BBC News Online explains.

What is a standard definition of bankruptcy?

In most countries there are two tests for bankruptcy:

  • a company that cannot pay its debts because there is not enough money in the bank

  • a company with liabilities (or what it owes) that exceed its assets (such as property, inventory or what it is owed).

In the UK or in Europe, the first scenario would usually tip a company into liquidation unless it was rescued.

Under the second scenario, which is sometimes called balance sheet insolvency, the company is more likely to avoid liquidation by negotiating with its creditors.

Confusingly, UK firms will not go bankrupt at all - here the term is reserved for personal bankruptcies.

Companies running out of money instead enter a Company Voluntary Arrangement (CVA), go into administration or receivership, or are wound up.

Why is bankruptcy in the US different?

In the US it is more common for a company to go into Chapter 11 bankruptcy, which gives it an opportunity to reorganise and emerge from bankruptcy.

Chapter 11 basically gives an ailing company a bit of breathing space and allows the management to stay in charge while negotiating with creditors.

For example, the US airline TWA filed for Chapter 11 bankruptcy before it was bought by American Airlines.

Do any other countries have this system?

Philip Wood, a partner at Allen & Overy and an expert in bankruptcy law, says that most OECD countries are slowly moving towards more of a Chapter 11 system.

France has a system called Judicial Composition , similar to Chapter 11, but only about 7% of bankrupt companies go down this route.

Most either negotiate with creditors before entering bankruptcy, or go straight into liquidation.

What happens when a company falls into liquidation?

A company is liquidated when the situation is hopeless and there is no plan to rescue it.

At this point an insolvency agent takes over the company from its management, sells the assets and returns any money to its creditors.

Unless it is a US company in Chapter 11 bankruptcy, shareholders have no hope of recovering any of their investment.

The liquidators themselves have first call on the company's assets to pay their fees.

After that there is usually a strict pecking order for the creditors.

Preferential creditors, such as tax authorities, have the first claim on the assets, followed by the banks that have lent money on a secured basis to the company.

Any remaining assets are then divvied up between lenders (who have no security for their loans) bond investors, suppliers and employees.

What is the difference between going into administration and going into receivership?

In the UK, the banks that have lent money on a secured basis have the right to call in a receiver to sort out the assets and look after their interests.

Many Commonwealth countries, including New Zealand, Australia and India, also follow this model.

In other countries, such as France, a court will appoint an administrator to act in everyone's interests, including the employees, although special regard is paid to the banks.

Under new reforms, the UK plans to move away from the receivership system to the administration model favoured by Continental Europe.

The UK parliament is due to debate a new bill on the subject next year.

How can a company avoid bankruptcy?

Obviously in the US, Chapter 11 is always an option.

In the UK and in Europe, a company can try to negotiate with its various creditors before it files for bankruptcy.

Sometimes a bank may see the logic of reducing its claims on the company in the hope of recovering more of its investment later.

For example, if the bank is owed 200m, it may only recover 100m once the company is liquidated.

However, if it allows the company to continue operating it could possibly recover 150m at a later date.

Other times a creditor might be persuaded to inject more money, as is the case with Swissair, for much the same reasons.

"Most business rescues in Europe are done outside of any formal insolvency process," says Mark Hyde, head of the insolvency practice at Clifford Chance in London.

Are directors of a bankrupt company liable?

In the UK, if directors continue to trade when their company is technically insolvent, they run the risk of being personally liable.

In France it is even more common for directors to be liable, but in the US they are not liable at all.

So countries have different attitudes to bankruptcy?

Yes. Many countries can be divided into the creditor-friendly camp or the debtor-friendly camp.

"It is a very hotly disputed issue," says Allen & Overy's Mr Wood.

The UK has traditionally been more creditor-friendly, but the government is keen to change that.

France, however, is more in favour of the debtor, particularly in seeking compensation for its employees.

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