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What Happens In Bankruptcy

What happens when a company like GM files for bankruptcy?

Here are some basic answers.

What is bankruptcy?

When an organization or individual is unable to pay their debts, they can file for bankruptcy. The filing can be voluntary, which means the debtor willingly goes into bankruptcy proceedings. The other is involuntary, where creditors petition the court to force bankruptcy proceedings.

How does bankruptcy work?

The objective of bankruptcy is an orderly and equitable settlement of obligations. In some cases, the assets are sold off—or liquidated—to settle debts. In other cases, the debtor is allowed to reorganize while it figures out a way to pay off creditors. There is no liquidation of assets and the debtor eventually emerges from bankruptcy proceedings.

There are several forms—or "chapters"—of the US Bankruptcy Code, but the three basic kinds are:

Chapter 7: The debtors' assets are liquidated to pay off creditors. If it's a business, the company ceases operations.

Chapter 11: The debtor, usually a business, is protected from creditor claims—and liquidation—while it reorganizes and tries to figure out a way to meet its obligations. Management continues to run the day-to-day operations, but all significant business decisions must be approved by a bankruptcy court. The reorganization plan must be approved by creditors and the court.

Chapter 13: This is for individuals who want to work out a way to pay their debts.

How would GM's bankruptcy work?

According to Bloomberg, GM may be considering a so-called "363 sale," which refers to a section of the Chapter 11 bankruptcy code.

Under the section, GM would create a new company from its assets and brands. According to Reuters, the new company would be made up of the most successful units, while the 'old company' would contain the less-profitable units. This option is gaining momentum and is seen as the company's best configuration for the future, a source familiar with the talks told Reuters.

The company, meanwhile, would continue to focus on even deeper cost-cutting measures and plans to hold discussions with officials in the U.S. Treasury Department, Bloomberg said.

What do creditors get in bankruptcy?

There is a hierarchy of creditors in all bankruptcy proceedings. Secured creditors, whose money is backed by a particular asset of the company, are at the top of the list. Then there are unsecured creditors, which can include suppliers and others who are owed money. They have no claim on any particular asset, so they are paid only after secured creditors are satisfied.

What about bond holders and stock holders?

Bondholders are usually considered secured creditors, although their bonds may not be tied to any particular asset. So other secured creditors may get paid first.

Stockholders are basically at the bottom of the list, since they are essentially owners of the company, not creditors.

In most cases when a company files for bankruptcy, the common shares are virtually worthless. Preferred shareholders, as the name implies, are put ahead of common holders in terms of getting any money back.

Sources: Reuters, Bloomberg and various government web sites.

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