What is Bankruptcy? Definition of Bankruptcy, Bankruptcy Meaning

A bankruptcy or bankruptcy is the economic situation in which a company, organization or natural person finds itself when, due to the inability to face its debts with the available resources, it has to permanently cease its activity.

In other words, when the net worth is negative, a company is bankrupt. When this situation occurs it means that with all the assets they could not respond to the total debt they owe to the creditors.

It is necessary to distinguish the bankruptcy or bankruptcy situation from the suspension of payments situation. Thus, a company that suspends payments at a certain time cannot meet the payments at a certain time, but it is not necessarily bankrupt. This occurs in situations of absence of liquidity . But this does not mean that it receives sufficient liquidity the following month to continue meeting its payment obligations. Now, we should not confuse illiquidity with bankruptcy.

In contrast, bankruptcy is characterized by not being able to cope with current payments and not with future payments. As we have already indicated, it is a situation of permanent cessation of activity.

It is worth mentioning, before going deeper into the term bankruptcy, that the word bankruptcy, currently used as a synonym for bankruptcy, is not in a strict sense of the term.

Characteristics of a bankruptcy

Bankruptcy has some characteristics that make it a unique situation and, therefore, different from others. The characteristics of a bankruptcy are as follows:

  • It is an irreversible situation: Once a company declares bankruptcy, that company is doomed to disappear. Therefore, other new companies may be born, but that one will not work again. Bankruptcy is permanent.
  • Assets are less than liabilities: Total assets (furniture, buildings, cash, warehouses) are less than debts owed (loans, mortgages, outstanding payments).
  • It affects the entire company: Which means that in a bankruptcy, this legally affects the entire company. Regardless, of course, that subsidiaries can be sold that pass into the hands of other owners and avoid the situation of generalized bankruptcy.
  • It is legally typified: Since bankruptcy is a situation that could be used for fraudulent purposes, it is included in the law. In this way, the bankruptcy situation is intended to be an objective situation, not a subjective one.

Possible solutions to bankruptcy

In general, we can establish two possible solutions to bankruptcy:

  • Get a capital increase so that assets equal or exceed liabilities.
  • Let the creditors forgive the debts. That is, a debt relief .

As we can see, bankruptcy is a complex situation since by definition, the resources are not enough to cover the debts. In order to prioritize payment to creditors, a bankruptcy procedure is generally established in which an administrator is appointed who will be in charge of managing the available resources and determining the order of payment to creditors.

Types of bankruptcy

The importance of bankruptcy being included in the legal or commercial code of each country is fundamental. Thanks to that, we can distinguish three types of bankruptcy:

  • Fortuitous bankruptcy: Occurs when everything possible has been done to avoid this situation. However, due to market conditions, personal situation or otherwise, the company has declared bankruptcy.
  • Guilty bankruptcy: This case is condemned in all countries that have specific regulations in this area. It takes place when the administrator, owner or employer carries out activities without ensuring the proper functioning of the organization. In other words, it is poorly managed.
  • Fraudulent bankruptcy: It is an even more serious case. The administrator of the organization, knowing that he is carrying out activities that go against the stability and sustainability of the organization, performs them with malicious intent. This malicious intent is more technically known in law as a malicious attitude.

The difference between these types is very important, we said, since it can choose one result or another in favor or against the creditors. Many times, in cases where it is possible to prove that the bankruptcy was fraudulent, the creditors manage to recoup part of the investment, since they are compensated.