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Bankruptcy

Definition

When a company declares bankruptcy, it says that it is incapable of meeting all of its financial commitments/ liabilities. All of its agreements with trade-unions are then also canceled.

The business’s assets can be liquidated (seized, valued and sold) to satisfy its liabilities. Also, the company may be taken over and restructured; and the new owner can repay outstanding debts.

Rescue

Motivation

The government is often motivated to rescue failing businesses to prevent negative consequences like job loss, reduction in national pride etc..

’Distress investors’ are motivated by the prospects of taking ownership of a well established enterprise cheaply, if they believe they can make it profitable.

Overpaying for bad assets

One way rescue can happen is by buying or by encouraging others in buying toxic assets/ investments of the business at a sufficiently high price to ensure that the company regains solvency - the drawback is that the investor (tax-payer/ government usually) is then stuck with an unsound investment.

Stock injection

Another way is to invest in the business - become one of its owners by replenishing the business’s capital.

As part of doing so, it is often essential to ensure that future investments are sounder, so the management is often to be replaced or stress tests are conducted, where businesses are allowed to fail if they fail to perform even after a rescue.

Disadvantages

Businesses which are rescued from collapse as a consequence of mistakes tend to make more bad moves in the future - especially if the management is not replaced. This happened with Japanese banks in 1990’s.