Question

2. What is Chapter 7 liquidation and Chapter 11 reorganization? When should each be used? Please choose one company that has gone through either type of bankruptcy proceeding and describe the circumstances leading up to the filing.

Answer 1

Chapter 7 Liquidation deals with bankrputcy events of the bank where the assets of the bank are liquidated that is sold to pay off the creditors. A trustee is appointed which looks after the events. Going into liquidation for a bank is result of some serious misadventures of the senior managers over the long period of time. Creditors are likely to incur losses in this. When left with no scope as to reorganise also, banks move to liquidation.

Chapter 11 Reorganization deals with the phase where bank gets into situation where it is needed to change the nature of their debts so as to reorganise their capital structure. In this assets are not sold and trustee is do appointed. However, rather than selling off all assets to pay back creditors, the trustee supervises the assets of the debtor and allows business to continue. It's important to note that debt is not absolved in Chapter 11. The restructuring only changes the terms of the debt, and the firm must continue to pay it back through future earnings.

In a recent past, Lehman Brothers, 4th largest Investment Bank of USA faced liquidation bankruptcy where around 25000 people lost their jobs and $ 46 Billion of wealth got wiped out. The fallout was mainly because of bubble burst of housing loans. Bank acquired company's which dealed with Alt A loans like BNC Mortgage and Aurora Loan Services. Acquisitions at start looked positives when they led to increase of revenues by 56% from 2004 to 2006, more than any of their competetitors. However, their lousy approach towards vigillance and over confidence over Alt A loans cracked in start of 2007 when defaults on subprime mortgages rose to a seven-year high. News that Lehman Brothers would be affected the most spread like fire and company had its biggest one-day drop in five years. Layers of mis management started to repeal which led to event of bank going to liquidation.