Corporate Financial Distress: Default, Insolvency, and Liquidation

Corporate Financial Distress: Key Concepts

Understanding Insolvency Proceedings (Bankruptcy)

The term bankruptcy refers to the legal process initiated when a person or entity enters a state of insolvency, meaning they cannot cope with all payments due. This single administrative procedure covers situations of both temporary default (suspension of payments) and final liquidation.

Suspension of Payments (Default)

Definition of Suspension of Payments

Suspension of payments occurs when the company, despite having sufficient assets to cover all its debts, is unable to pay them upon maturity due to a temporary lack of liquidity.

Financial Indicators (Illustrative):

• Current Liabilities > Real Assets
• Current Assets > Total Liabilities

Process for Suspension of Payments

1. Application for Suspension of Payments: Performed by the employer in court, providing accounting records, a memory of creditors, stated causes, and a proposal for debt payment.
2. Creditors' Meeting and Agreement: A board meeting of creditors, headed by the judge, aims to reach an agreement with the employer. This agreement is called a "covenant" and can be:
   • Removable (Atonement): Involves debt reduction (i.e., a percentage write-off).
   • Delay: Involves increasing the payment period.

Effects of Suspension of Payments

The employer does not lose their status and continues their activity, overseen by an insolvency court, which must authorize all payments and collections.

Final Bankruptcy (Liquidation)

Definition of Final Bankruptcy

Final bankruptcy signifies the definitive failure of the business due to debts (Liabilities) exceeding real assets (Assets). It involves the liquidation of the company and the distribution of assets among creditors according to a predetermined order of preference.

Financial Indicator: Liabilities > Real Assets

Liquidation Process

1. Application by the company or any creditor to the court.
2. Disqualification of the employer by the judge.
3. Constitution of the collectivity of creditors and the mass of assets to be distributed (mass of bankruptcy).
4. Settlement based on an order of preference: Public Finance, Social Security, municipalities, mortgagees, etc. Note: Workers are typically paid the salary of the last month first.

Types of Bankruptcy

1. Fortuitous: Caused by circumstances beyond the employer's control, without any fault on their part.
2. Guilty: The employer is found responsible for the situation as a result of their behavior (e.g., undue expense, knowingly erroneous economic decisions).
3. Fraudulent: Results from actions such as distorting accounting records or hiding information. This may lead to the perpetual banning of the entrepreneur.