It’s very difficult to give a real look to the word ‘crisis’, it stays just underneath the carpet waiting to head up; one wrong decision and it’s there! It has got many faces; one being ‘Bankruptcy’, dubiously famous for its nod on any organisation (how small or large it may be!) at any time. Well, the name itself is quite significant and pointing towards a hardcore impact, and yes, it certainly can uproot any strong base provided all its necessities are met. Readers may wonder how a billion dollar organisation could go bankrupt. Examples like Lehman Brothers, General motors; makes it even more questionable as to how these giants went into this trap and became vulnerable to their own existence.
Here in this article we will be enumerating on the following points:
. What is bankruptcy?
. How does it play its role?
. The preventing rule
What is bankruptcy?
US bankruptcy law defines bankruptcy as “A federally authorized procedure by which a debtor—an individual, corporation, or municipality— is relieved of total liability for its debts by making court-approved arrangements for their partial repayment”. Putting this in more general Wikipedia terms “bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors”. [Note: India doesn’t have any specific law to define bankruptcy, though there are individual/organisational bankruptcy laws in place. The only law that gives a little insight into bankruptcy is Provincial Insolvency Act enacted in 1920 which involves chapter7 and chapter 13 US bankruptcies].
How does it play its role?
While thinking about bankruptcy a very basic question comes into mind; why would an organisation become bankrupt? We have seen organisations making millions yoy, qoq and a sudden downplay of the market at any time puts it on the verge of bankruptcy. Let’s try to find out the science behind this. We have seen many investment banks falling prey to this in last couple of recessions, so we will be taking a similar example under consideration to make it simple to understand. Suppose XYZ is an investment bank that is live in the European market for last couple of years. And it’s quite obvious that no organisation creates money for its own investment. There are share holders like banks, financial institutions, governments those play an active role in money laundering to the investment bank (in our example it’s XYZ investment bank) for its operations. Since these amounts are given in credit, these parties are called as creditors. And the investment bank owes some liability to these creditors or in other words the investment bank is in debt to these parties and hence called a debtor. So now we have established the relationship between creditor and debtor. Let’s move one step ahead; with the laundered money from different parties the XYZ bank invests the same amount on an infrastructure development project of ABC organisation with a defined interest rate with an annuity period of suppose 4 years. Hence as per this settlement, ABC organisation has to pay off the whole amount + interest in 4 years. Now this pay off truly depends on the health of ABC. Let’s suppose because of some reasons ABC couldn’t perform well in the market resulting in a fall out in paying back the investment amount to XYZ. Since the amount was taken by XYZ in credit from different third parties. With similar scenarios across multiple investments XYZ ceases to have any real cash flow in terms of return. This drags XYZ in to a situation where in it becomes impossible for it to convince the creditor for some more relief. Looking straight at the situation will make it even more understandable; issues in ABC’s performance made it difficult for it to return the invest amount to XYZ, XYZ being liable to the creditors was looking forward to this return from ABC which could not happen (With money being blocked as investments with minimal or…