When a company can no longer afford to pay its debts, it can either try to raise more money or go out of business. Many companies in this situation simply go bankrupt because they cannot secure any additional funding. In this situation, the business could file for chapter 7 or chapter 11 bankruptcy.
When a company goes through Chapter 11 bankruptcy, it continues to operate as a business. This type of bankruptcy allows the company to reorganize its debt structure and hopefully emerge from the situation. Many times, in this type of bankruptcy, the company will exchange debt for equity in the business. This makes the creditors of the business new business partners that have a stake in the company. Many companies have emerged from this type of bankruptcy successfully.
Another type of bankruptcy that a company could use is chapter 7. With chapter 7 bankruptcy, the company ceases to exist and liquidates its assets. If a company does not have enough income or assets to qualify for chapter 11, it may be forced into chapter 7 bankruptcy. With this kind of bankruptcy, a bankruptcy trustee will be appointed to liquidate the assets of the company and to try to repay creditors.
In many cases, the company that goes out of business has investors who put up money to get them started. When investors are involved, they may be able to be repaid from the assets of the company. The creditors of the company will be paid first, such as those with collateral. Then anyone who invested in corporate bonds will be repaid next. Investors who have preferred stock will be paid after the corporate bondholders and then investors with common stock get the last payments, if any are available.
If the company has intentions of remaining in business, they will try to file for chapter 11. If they meet the qualifications for this kind of bankruptcy, they will have to set up a repayment plan with their creditors. The bankruptcy trustee will be involved in the negotiation phase of this payment plan. The corporation will have to pay the trustee and then the trustee distributes the payments to the creditors according to the repayment plan.