The document provides information about bankruptcy including: 1. Definitions of bankruptcy and causes of bankruptcy such as unsuccessful newly established companies, ambitious growth companies that overestimated demand, companies that lost touch with their environment, and dazzled growth companies with unrealistic management. 2. The four main types of bankruptcy processes are described as relating fundamental causes to financial and non-financial consequences. 3. Specific bankruptcy causes are outlined for each type of failed company. Inadequate management, misinformation about market size, and unrealistic management are highlighted as primary causes.

1. BANKRUPTCY
Group 1
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2. Definition of Bankruptcy
• Bankruptcy is a legal proceeding under federal law that allows a debtor who is
having serious financial difficulties to obtain financial relief. Bankruptcy allows
debtors to either eliminate their debts or repay some or all of them under the
protection of the Bankruptcy Court.
• Is the status of a person that are unable to pay their debtors as they fold him /her.
• The term bankruptcy can only be used for a person or an individual. A company or
any other legal entity that cannot settle its debtors is known to be insolvent.

3. CAUSES OF BANKRUPTCY
Four main types of failure processes. These processes relate the fundamental causes
of bankruptcy to the financial and nonfinancial consequences,
•
• Unsuccessful newly established companies led by a management with a
significant lack of managerial and industry related experience.
• Ambitious growth of companies, which have (after a failed investment) insufficient
financial means to adjust their way of doing business to the changes in the
environment.
• Dazzled growth companies, led by an overconfident management without a realistic
view on the company’s financial situation.
• Gradual deterioration of established companies where management had lost
touch with the changing environment.
•
Source: CAUSES OF BANKRUPTCY IN EUROPE AND CROATIA, Branko
Novak and Domagoj Sajter

4. CAUSES OF BANKRUPTCY
1. Bankruptcy causes of newly established companies
This type of failure process is the most common. Many companies fail within five
years after their start-up; with no significant growth and no profits many have
almost no chance of survival.
• General environment:
- recession in the industry,
• Immediate environment:
- lack of customers / customer dissatisfaction,
- mistrust on many levels (banks, customers, suppliers, …),
• Characteristics of management or the entrepreneur:
- insufficient competences and skills in many areas,
- rashness, authoritarian leadership,

5. • Corporate policy:
- no strategic advances,
- inappropriate capital expenditures,
- lack of customers / customer dissatisfaction,
- insufficient financial planning,
- severe operational errors.
-
The most common bankruptcy cause in this particular failure process is
Inadequate Management Quality, as newly established
managements are deficient in knowledge and experience in many areas
of business.
•

6. CAUSES OF BANKRUPTCY
2. Bankruptcy causes of ambitious growth companies
Ambitious growth companies have a weaker financial structure, because their
failure process starts at the level when they are still new and/or small.
Therefore, those companies are more vulnerable to bankruptcy when the
expansion strategy has a worse outcome than expected.
• general environment:
- weak stock market,
- price increase of raw materials,
• Immediate environment:
- shortage of customers,
- mistrust,
• Characteristics of management or the entrepreneur:
- flawed turnover estimation,
- extensive risk takers,
- over-optimism,

7. • Corporate policy:
- exaggerated capital expenditures,
- overestimated sales,
- lack of expertise.
Specific to the second failure process is the large overestimation of the
demand for the company’s products despite the experience and
capabilities of management, as a consequence of over-optimism or
misinformation about the market size.
•

8. CAUSES OF BANKRUPTCY
3. Bankruptcy causes of dazzled growth companies
Dazzled growth companies have existed successfully for several years before
considering extreme expansion and have stronger financial structure.
These companies deploy a new strategy that initially becomes a success,
which overwhelms the management as it becomes extremely
overoptimistic and unrealistic.
Type 3 companies have more possibilities of outliving a catastrophic investment
plan, as a consequence of their financial reserves, and they only go bankrupt
if the management loses touch with reality.
Hence, this failure process is an example of the dangers of healthy companies
taking risks when there is no adequate management.

9. • General environment:
- weak stock market,
- recession in the industry,
• Immediate environment:
- mistrust,
- competitors as a consequence of inflexibility,
• Characteristics of management or the entrepreneur:
- too optimistic; dazzled / overwhelmed / astonished,
• Corporate policy:
- exaggerated capital expenditures,
- unadjusted management and operational structure.

10. CAUSES OF BANKRUPTCY
4. Bankruptcy causes of established but deteriorating
companies
These types of companies have existed for several years and are
distinctive by the lack of motivation and commitment of rigid
company’s leaders, who keep believing in strategies that were
successful in the past. Their indifference and lethargy leaves them
unaware of gradual changes in the environment.

11. One can find causes of failure of gradually deteriorating companies
within these groups:
• General environment:
- change in legislation,
- economic changes in foreign countries,
• Immediate environment:
- competitors with strategic advantages,
• Characteristics of management or the entrepreneur:
- insufficient motivation & commitment,
- inertia,
• Corporate policy:
- no adjustments to changing environment,
- unadjusted capital expenditures,
- operational inefficiencies.

12. OTHER CAUSES OF BANKRUPTCY
• Ineffective sales force:
The end result of production is to sell the product. If the sales force is not properly trained and
developed, the company may find it difficult to sell its product especially if the product is sold
in a highly differentiated competitive market.
• High production costs:
This is a situation where the production cost of a firm makes its product not to compete
favourably with other differentiated products in the market. This could be due to over
employment of human and material resources or technical inefficiency in the production
process (Bowen, Morara and Mureithi, 2009).
• Poor financial management:
A firm whose financial manager is unable to take effective financial management decisions is
bound to experience acute liquidity problem. Such decisions include investment, financing
and dividend policy decisions (Richard and Steward, 1986) and (Preston and Post, 1975).
www.sciedu.ca/bmr Business and Management Research Vol. 2, No. 4; 2013
Published by Sciedu Press 22 ISSN 1927-6001 E-ISSN 1927-601X

13. • Risk assessment strategy: The risk associated with an investment decision should be
properly evaluated. The reason is that investments in assets constitute the most
important source of corporate earnings. Thus, if risk assessment is not properly done,
corporate income would be impaired (Mbat, 2001).
•
• Inappropriate commercial policy: Policies affecting sales especially credit sales
should be carefully evaluated since such could lead to debt build up and by implication
liquidity crises (Alo, 2003).
•
• Absence of manpower training and development policy: A firm that does not
have manpower training and development policy cannot make use of well trained and
specialized staff that can help in the achievement of corporate objectives.
•

14. Capital inadequacy: A firm that is undercapitalized is bound to fail sooner or latter. The
reason is that the firm will not have enough capital to buy the relevant fixed assets,
invest in enough income generating assets or enough working capital. Very often than
not, such firms experience underutilization of capacity.
Socio cultural factors: A firm that produces products which are not absorbed by the
immediate environment will have tough times selling its products. It will force the firm to
look for distant markets which will lead to higher marketing costs and inability to sell its
products (Hopenhayn, 1992).
Public policy: Public policy is a very important external source of corporate failure. When
government policy is against the interest of a firm within the short-term period, the firm
could go bankrupt. For example, if government places a ban on importation of a firm’s
input, production will be impossible when the existing stock inputs are exhausted
(Robson, 1996).

15. • Poor budgeting and spending habits.
• Personal disasters like death of providers and accidents
• Medical expenses.
• Divorce and its related expenses like alimony, child support and its
legal fees.
• Loss of a job.
• Student loans
•

16. Declaration of bankruptcy.
• According to section 20 of the insolvency act, there are two ways in which an
individual can be declared bankrupt and they include the following;
1. Through the creditor.
If someone who is owed money wants to be paid, he issues a statutory demand and
the person who owes money has 21 working days within which he should pay. If he
doesn’t then the creditor has 30 days to petition the court to declare him bankrupt.
If the 30 days elapse before the creditor petitions court then he starts this process
again.

17. 2. Through the debtor.
If the person owing money wishes to declare bankruptcy, he issues a state of
affairs which proves that he is unable to settle his debtors. Once the court has
proved that this is actually true, it then begins the bankruptcy proceedings.
Bankruptcy proceedings.
Once the court declares a person bankrupt, it appoints an official receiver as
an interim receiver of his/ her estate and property.
The receiver is supposed to oversee the liquidation of the bankrupts property
and ensure that he gets good value for all his/ her assets.
The receiver is also supposed to call for a creditors meeting with 14 days
notice once the declaration of bankruptcy has been made.
The creditor can also appoint a trustee to oversee the payments and
procedures of settling the debts.

18. Settlement of debtors.
Once someone has been declared bankrupt and the proceedings have began, the
debtors are then settled in the order specified according to section 12 which starts
with the preferential debtors then the secured debtors and lastly the unsecured
debtors.
i. Preferential debtors.
These are the first debtors to be settled once the bankruptcy proceedings have
begun. These include the receiver, workers and employees, the court, taxes,
pension etc…
These debtors are settled in the following order;
• The receiver who is responsible for liquidating and overseeing the distribution of
the bankrupts estate and property is settled first. His/ her fees and any
liabilities incurred during the bankruptcy proceedings are paid off.

19. • The next thing to be paid are the expenses incurred during the court
proceeding, legal fees and any costs owed to the court.
• The salaries and wages of the employees are the next to be paid, if the
person had any.
• Taxes.
• NSSF
Once all these have been paid off, the next group of people to be settles are
the secured debtors.

20. ii. Secured debtors.
The secured debtors are supposed to be paid once the preferential debtors
have been fully settled.
These are those debtors that obtained security for their money before they
lent it out. The security could be inform of a car, land title or any property that
the bankrupt gave as surety for his loan.
These debtors can be an individual but in most cases is an organisation like
a bank or a loans organisation.
These debts in most cases are either paid off with the money from their
security or surety.
If the money from their security is not enough, then the balance of the debt is
then written in the unsecured debtors.

21. iii. Unsecured debtors
These are those debtors that didn’t obtain any surety or security for their loans
and these are usually settled last.
These are settled on the basis of “pari passu” which means equal footing. So a
percentage is establish with which these debtors are settled and therefore
those who were owed more money get more
Once all the debts have been settled and the court has certified that the
bankrupt has paid off all his debts to the best of his ability, the court then
discharges him.

22. • NB;
1. The matrimonial home (casual) of the bankrupt where he lives with his family is not
be taken or is not liable for liquidation and cannot be claimed for by the
debtors.
2. The clothes and the beddings of the bankrupt are also not liable for liquidation and
also cannot be taken away from the bankrupt.
3. The bankrupt does not lose his pension
4. Once the court proceeding for bankruptcy have begun, the court investigates if the
bankrupt entered in any of the following;
• Undervalue transactions
• Insider dealing
• Unlawful preferences
If the bankrupt entered any of these transactions or contracts prior to liquidation, these
transactions are said to be voidable

23. Rationale of bankruptcy
• To protect the bankrupt and his family from any harm that the debtors
may cause.
• Ensure orderly disposal of assets
• Enable someone to have a fresh start.

24. Disadvantages of bankruptcy
• It leaves someone in a state of total poverty
• The person who has been declared bankrupt cannot carryout transactions
• Person gets a stained reputation
• Cannot be appointed to some positions like financial managers or any other
kind of managerial post in a company.
• Cannot hold office
• Could also cause psycological torture.
•

25. Objectives of bankruptcy act
• Enables someone to have a fresh start after his cleared his debts
• To help protect the economy through proper disposal of assets.
• Minds the stakeholders that are involved in the bankrupts business
like the workers, employees and some business partners
• Allow for proper negotiations between the debtor and the creditors.
•

26. BANKRUPTCY RESTRICTIONS
There are some important rules about what you can or cant do once you
have been declared bankrupt. These rules are known as restrictions. If one
does one of these acts, they are offence according to the Bankruptcy Act.
They include:
•
Cannot act as director or get involved with setting up, promoting or
running a company without permission from the court
•
Cannot carryout a business in a different name from the one under
which you were declared bankrupt, without disclosing to
everyone the name of the business in which you were declared
bankrupt
•
Cannot act as an insolvency practitioner
•
Cannot hold a political office
•
Has no right to buy
If one does not abide by these restrictions, they commit an offence which is
punishable of up to 2 years in prison.

27. THE END
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