A debtor is someone who owes a financial obligation (a “debt”) to another, known as the creditor. An example of a debtor-creditor relationship is where a bank lends money to an individual or company, on the basis that the money has to be paid back at some point to the bank. The individual or company is therefore a debtor because it owes a debt to the bank, which is the creditor in this relationship. Another example is where a supplier provides goods or services to a company and sends the company a bill. The supplier is then owed money (and is thus a creditor) and the company owes money (and is thus the debtor in this relationship).
If a debtor is unable or unwilling to pay back money borrowed, creditors want to ensure that they are repaid or at least have a better chance of being repaid. For this reason, certain creditors will always take security over the assets of the debtor, which means that creditors may be able to take the debtor’s possessions, such as their house, car, machinery, etc. if the debtor doesn’t repay the loan. An example of this is where a family takes out a mortgage with a bank to buy a house. If the family fails to make repayments on time, the bank has the right to take possession of the house.
An individual or company that is unable to pay its debts when they fall due may be declared bankrupt/insolvent. In this situation, creditors such as banks who have lent money against security will have priority when it comes to getting their money back, particularly because they can take possession of the assets of the bankrupt individual or company. These creditors are known as “secured creditors”.
However, there may be many other creditors who are owed money by the individual or company but have not taken any security, such as suppliers. These creditors (known as “unsecured creditors”) also want to get their money back but will be lower down in the order of priority, generally being paid after the secured creditors have received what they are owed.
Certain creditors who are owed money and who have not taken any security are still given priority ahead of other creditors. They include tax authorities that are owed taxes and employees that are owed salaries. These creditors are known as “preferential creditors”.
A company that is insolvent or facing insolvency may be liquidated/wound up, which involves the company’s assets being sold, the money being used to pay off debts to creditors, and anything remaining being distributed to shareholders. The company will then be dissolved.
The company itself may decide to wind itself up, but also creditors, among others, may apply to the court to have the company liquidated. A liquidator will be appointed to carry out the liquidation process, bringing with it a certain amount of control over the company. The process involves selling the debtor’s assets, collecting any debts due to the company, and then paying off creditors in the proper order (i.e. usually preferential creditors first, then secured creditors, then unsecured creditors). Actually, the expenses of the actual liquidation are paid off first, so the liquidator makes sure his/her fees are paid!
Avoiding liquidation
A company in financial difficulties may employ a rescue mechanism to postpone or avoid liquidation. An administrator may be appointed by the company or a court whose job it is to reorganise the company or realise its assets within a limited period in order to achieve maximum benefit for the company and thereby save it from liquidation. During this period, the company benefits from the protection of a “moratorium”, which is effectively a freeze on creditors taking action against the company, such as filing for compulsory liquidation or enforcing security. The management of the company continues to run the day-to-day business operations but all significant business decisions must be approved by the administrator.
The administrator will put forward proposals to the shareholders and creditors for their approval as to how best to rescue the company. An arrangement must be approved by a certain majority of shareholders or creditors and often by a court as well, and will be binding on all creditors and shareholders if so approved. An example of such an arrangement is where creditors agree to convert the money that they are owed into shares in the debtor company (known as a “debt for equity swap”). This leaves the creditors without the money that they are owed, but they have the possibility of recouping the money at a later date if the company stays afloat and makes a profit, which can then be distributed to the shareholders (as well as being in possession of shares which can increase in value and then be sold to someone else for a profit).
Insolvency/ bankruptcy lawyers advise on numerous issues relating to the insolvency/bankruptcy of debtors. They can advise on rescue procedures for debtor companies that wish to avoid liquidation and dispute winding up proceedings on behalf of debtors. Lawyers can also advise creditors on enforcing security and stategies for recovering their debt. Insolvent companies often have assets in more than one country so advice on local insolvency/bankruptcy law from lawyers from different jurisdictions may be required.
UK Insolvency Service, a government agency
http://www.insolvency.gov.uk/
Information on the bankruptcy courts in the United States and other information on bankruptcy
http://www.uscourts.gov/bankruptcycourts.html
UK Insolvency Act
http://www.statutelaw.gov.uk/content.aspx?activeTextDocId=2519933
US Bankrupty Act
http://www.law.cornell.edu/uscode/usc_sup_01_11.html
how can we distinguish types of liens? ex. attachment, execution,garnishment and judgment liens