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Chapter 27

MCS 3040 Chapter Notes - Chapter 27: Security Interest, Fiduciary, Secured Creditor

Marketing and Consumer Studies
Course Code
MCS 3040
Joseph Radocchia

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Chapter 27
Bankruptcy & Insolvency
Business Failure
When a business or economy experiences downturn, even healthy businesses run into difficulties
To ensure both the business in hard times and its creditors are treated fairly, s body of law, generically
called insolvency law, has evolved.
Law provides several options for debtors & creditors as well as a framework for the ultimate financial
failure - bankruptcy
Debtor Options
If a business isn’t able to cope with a specific debt or its obligations in general, there are several
possibilities to be explored ranging from informal negotiations to bankruptcy.
Informal Steps
Before considering bankruptcy, many business may 1st try to solve their financial distress by way of
negotiated settlement
Could try to convince creditors that business can be saved
A settlement can be formal/informal depending on the circumstances
Creditors may meet with debtors sometimes with a facilitator to try to reach an agreement that is
acceptable to both parties, and allows business to keep operating/terminate without expensive legal
One danger is that some creditors will attempt to push through an agreement that is unfair to others or
that simply ignores them
Good to have facilitator b/c they are trained to identify these risks
In hopeless cases, negotiations may not be a good option or may fail
Proceedings before bankruptcy
If informal negotiations fail to produce a settlement with creditors and pressure continues from cr
editors, formal proceedings may be required
Debtors should seek advice from a lawyer or accountant with insolvency expertise and will eventually
need a trustee in bankruptcy who has legal authority to administer legal proceedings.
Trustee in bankruptcy: The officer assigned legal responsibility for administering the affairs if bankrupt
corporations or individuals
Trustees choose to take on cases based on (1) is there any conflict of interest (maybe an existing
client) & (2) does the client have sufficient assets in the estate to pay for the trustee’s services?
If a debtor cant find trustee to accept appointment (which is common) the debtors only recourse
may be some form of debt counseling services
The 1st meeting of the trustee and the debtor, the trustee outlines the nature of the services offered
Trustee starts assessing the estate and prepares a preliminary statement of assets and obligations
Estate: The collective term for the assets of the insolvent or bankrupt
Insolvent: Unable to meet financial obligations as they become due or having insufficient assets to meet
Proposal: A contractual agreement between the debtor & creditors that allows an involvement debtor to
reorganize and continue in business
If proposal is successful, the debtor will benefit and the creditor will receive a greater portion of their
debts then they would if the business ceased
An alternative to a proposal is an arrangement under the Companies’ creditors arrangement act
(CCAA) which is used for corporations that have debt over 5 million $ and have broader impact on
greater business community
Both paths allow debtor to seek new bank financing to cover wages and other operating expenses
during the period of bankruptcy protection
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While the goal of a proposal is to allow the business to continue, this can occur only if the recovery is
feasible and creditors agree to such an arrangement
A proposal is designed to achieve 3 purposes…
1. Reduce amount paid to creditors while the debtor retains assets to carry out business
2. Extent the time payment of claims
3. To arrange for the trustee to control assets for the benefit of the creditors for the period of the
B/c of the risk of proposals being used as delaying tactics, they operate under rigid timelines
Proposals are contracts between debtor & creditors and can come in variety of forms
Creditors are divided into classes w/ common interests & within each class, a majority of creditors
who hold 2/3 of the debt in that class must approve the proposal
If any class doesn't approve, there is a deemed assignment in bankruptcy by the debtor
If approved by creditors it must then be approved by the court
Business will function in accordance w/ terms of proposal under the supervision of the trustee
All creditors are now bound
New debts aren’t covered by proposal
Any default on proposal terms can lead to bankruptcy
Assignment in bankruptcy: The debtor’s voluntary assignment to the trustee in bankruptcy of legal title to
the debtor’s property for the benefit of creditors
If proposal doesn't work, business can attempt to carry on, cease business or make an assignment in
bankruptcy (which means debtor assigns all property for the general benefit of his creditors, to the
trustee in bankruptcy
Bankrupt: The legal status of a debtor who has made an assignment or against whom a bankruptcy order has
been made
Creditor Options
If a debtor is late paying creditor, they have options
Creditor should 1st try to determine the extent of the businesses financial health
o Find out if it temporary lapse or serious difficulty
o Do they owe other creditors
A supplier can assert pressure and say they'll stop supplying if they aren’t paid
Creditors can negotiate ad create a formal proposal
Each creditor must then decide whether its proposal arrangement is likely to produce greater recovery
of debts in the long run than exercising legal remedies
Creditors may take formal action…
Any creditor can sue based on debt
A secured creditor can take private action against specific assets
Creditors may petition the debtor into bankruptcy
Action Taken by secured creditors against specific assets
Most common action taken by secured creditors since what happens to the balance of the estate really
is no concern to them
Contract may entitle the creditor to appoint a receiver to the purpose of seizing the assets & paying the
The recovered owes a fiduciary obligation not only to the secured creditor but also to all others with an
interest n the insolvent’s estate to make reasonable efforts to get the best price when selling the debtors
Petitioning the Debtor into Bankruptcy
If other options fail, a creditor (s) can petition the business into bankruptcy by meeting conditions
required by legislation
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