Most people think that bankruptcy is bad and try to avoid it. However, bankruptcy is a powerful legal tool and if using it the right way, it can solve your problems, whether you are a creditor or a debtor.
If you are a creditor, why should you file for bankruptcy?
Creditors often file normal lawsuits to collect the debts instead of using bankruptcy proceedings because (i) bankruptcy is very complicated and (ii) bankruptcy will invite other creditors to join the proceedings, so you may need to share the assets collected from the debtor with them1 . However, bankruptcy may be a good approach in the following situations:
1. You are late in comparison to other creditors in taking legal actions against the debtor
In a normal lawsuit, the court and enforcement agency often operate under a first come first served basis. Thus, if you are late in filling the lawsuit, the other creditors will get the judgments and seizing the assets before you. As a result, you may have nothing left to collect from the debtor.
In that situation, filing a bankruptcy can be a solution. After you file a bankruptcy request, the court will order the stay of all cases that may impact the assets of the debtor, regardless whether they are at the litigation stage or enforcement stage. After that, if your bankruptcy request is accepted and the court officially opens the bankruptcy proceedings, such cases will be transferred and merged into the bankruptcy case. Thus, filing for bankruptcy will effectively stop all other creditors from taking the assets and forcing them to come back and compete in the same proceedings with you. Furthermore, if the bankruptcy comes to the liquidation stage, unsecured creditors will have the same priority order in payment2 , so you may get a share from the assets, even if you are the last creditor to take the legal action.
2. The debtor has been hiding its assets
When facing the legal actions of the creditors, it is common that the debtor will transfer its assets to other entities (e.g. other companies of the same owner or relatives of the owner) to hide its assets. Prevention of such action is often difficult, as you do not know exactly what assets the debtor has; when, how and to whom they will be transferred. Though it is possible to ask the court for voiding those transactions, the proceeding may take significant time and by the time you can revert one transaction, the debtor may have already finished two or three more.
Bankruptcy proceedings can give you powerful legal measures to stop the asset dispersion and preserve the assets of the debtor. Accordingly, after the court agrees to officially open the bankruptcy proceedings, it will appoint an asset management agency or officer (“Asset Management Agency”) to inventory and supervise the assets of the debtor. Any asset transactions of the debtor must be reported to and approved by the Asset Management Agency, and any acts of hiding or unreasonably reducing the debtor’s assets are banned. Furthermore, suspicious transactions within 06-18 months prior to the opening of the bankruptcy proceeding can also be voided and reverted by the court. Voiding the transactions within the bankruptcy proceedings is often faster and easier than in normal lawsuits, because you will have a judge who clearly knows about the case be available for you, and ready to take actions to preserve the debtor’s assets.
If you are a debtor, should you file for bankruptcy?
1. It can save your business
Debtors usually do not consider bankruptcy filing, as it sounds like a suicide action. Nevertheless, bankruptcy proceedings do not always end in a bankrupted business, it can also help to restructure and recover the business.
If your business become insolvent, you must have been chased, or even sued, by multiple creditors. You may try to negotiate with the creditors for extension by explaining your difficult situation. However, the creditors may not listen to you story, they only see a long overdue debt that they must collect. In this situation, filing for bankruptcy can be a good solution. The first and immediate advantage is that, as mentioned above, the bankruptcy proceedings will make all lawsuits against your business be transferred and merged into the bankruptcy proceedings. This means that instead of facing multiple lawsuits in multiple courts, you only need to join a single bankruptcy case in a single court, which is less stressful.
After that, the court will hold a creditors’ meeting in which you can present a restructuring/payment plan. It may be easier to convince the creditors to approve your plan in this situation because:
(i) They can actually see your difficult situation, and understand that if they push too far, the business will be bankrupted, and they may not get their repayments.
(ii) If the restructuring/payment plan is approved, it will be supervised by the Asset Management Agency appointed by the court so it will be easier for the creditors to trust your plan.
(iii) You do not need to convince all creditors, you only need to meet the quorum required by the law, which is more than half of the creditors present in the meeting and 65% of the total unsecured debts. The approved plan, however, will be binding to all creditors.
2. It helps you to limit your liability if the business is declared bankrupted by the court
Under the law, the legal representative and some other officials3 of company is obligated to file for bankruptcy when the company becomes insolvent. If they fulfil such obligation, there is almost no personal liability4 . In the worst scenario that the company is declared bankrupt, all assets of the company will be liquidated to pay the creditors, the company will die and the legal presentative (and other officers) can move on with a new company. However, if the legal representative and the other officers are unreasonably late in filing for bankruptcy when the company has already become insolvent, they will be personally liable for any damage caused by such delay. Furthermore, they may even be banned from establishing any companies or holding any management position in any companies for 3 years.
Thus, the law encourages you to voluntarily file for bankruptcy when the company becomes insolvent. The longer you delay and hide the financial situation of the company, the more likely that you may have personal liability.