Illustration by Konani Chinn

Bankruptcy is the legal process that happens if you run out of money and can’t pay your bills. It can also be a way for companies and their managers to walk away from bad behavior, leaving other people holding the bag.

The Judge Will Work It Out

Most people think of bankruptcy as a really bad thing, to be avoided at all costs. But for many companies and individuals who go bankrupt, it can be a relief. Because it may let them wipe the slate clean by walking away from debts that would otherwise hang over their heads for a long time.

Bankruptcy used to be very harsh (resulting in prison, or worse), but today is more lenient. It’s a legal process of acknowledging the reality that there’s not enough money left to pay the bills. In business bankruptcies, it involves negotiating who gets dibs on what’s left over – often pitting shareholders against debt holders (e.g. banks) and employees (who’d been promised pensions).

Sometimes bankruptcy includes restructuring a company so it can come back to life. Say a chain of retail stores runs out of money, with millions in debt. A bankruptcy judge can decide how many stores to close, which ones to keep open, and how the remaining cash gets used.

The judge can decide how the reborn business will be run: who’ll own it (equity holders), who’ll manage it, how much they’ll get paid, and so on. Or she can just decide to shut it down entirely.

For individual bankruptcies, the process is similar. A bankruptcy court can negotiate a legal agreement with you about who to pay back, and who you won’t have to.

Bankruptcy tends to be harder on individuals than businesses. It affects their credit rating, lifestyle, and future ability to borrow money.

Whereas with business bankruptcies, the owners and managers who ran the business into the ground sometimes get to walk away with many millions of dollars, while employees and smaller shareholders and debt holders suffer the consequences.

Is this system fair? Probably not. But it’s unclear what the alternative would be… and a lot depends on the specifics of the case (and what the judge decides).