Last year a record number of Americans and American companies filed for bankruptcy.
The bad economy was the main reason: When sales declined, some companies didn't have enough money to pay all their expenses. People and companies also had borrowed too much money during the boom years of the 1990s, thinking that the good times would last forever. Some then found it impossible to keep up with interest payments or repay the loans on time.
What's unusual about the recent bankruptcies is how big and well-known some of the companies are -- including Enron, WorldCom, United Airlines and US Airways. Financial reporter Steven Pearlstein explains what happens when a company goes bankrupt.
What is bankruptcy?
Centuries ago, when people couldn't pay back their debts, they were thrown in jail. That didn't work out particularly well for anyone, since the person who owed the money had no way to work and pay back even some of the money owed. Finally, someone came up with the idea of bankruptcy: Debts are put on hold and the people who are owed money (the creditors) and the person who owes money (the debtor) go to a special court and try to work out a settlement.
What kind of settlement?
In the case of individuals filing for bankruptcy, it usually means the creditors agree to accept less money than they are owed, or agree to wait longer to get their money, or some combination of both.
In the case of companies, the idea is the same but it usually gets a lot more complicated.
If the bankruptcy court decides that the business has no chance of surviving, even with lower debt, then the judge will order the company to sell off whatever it can, often at an auction. Whatever money is collected from the sale is given to the creditors, with some creditors getting all of what they are owed and others getting only a fraction, if anything. It all depends on what kind of debt it was and who it was owed to, and there is a complicated set of rules that govern this. After all the money is given out, the company is closed and all remaining debts are canceled.
Many times, however, the judge decides that the business can survive and, in time, pay back at least some of the money it owes. This is called bankruptcy reorganization and it often takes a year or more to work out all the details and allow the company to come out of the bankruptcy process.
What happens to the company while it negotiates all that?
For most employees and customers, the company runs pretty much like it always did. That's why, for example, you can still fly on United or US Airways even though they are in bankruptcy. At the same time, the court often will order changes to make the company profitable and able to begin paying some of its debts. For instance, the managers might close money-losing stores or factories, fire workers or reduce salaries.
Do the creditors eventually get all their money back after a reorganization?
No, they usually get only a portion of what they are owed. For some, it can be as little as 10 percent.
Is that fair?
From the point of view of the creditors, it's not fair, but what alternative do they have? If there is not enough money, there is not enough money. That's why banks, credit card companies and other moneylenders check to see if a borrower is likely to make enough money to pay back loans.
Do some people borrow money they know they won't be able to repay, spend it and then file for bankruptcy?
Yes. That's why Congress is considering changes in the bankruptcy law. The changes would make it harder for people to simply wipe out their debts if they might someday be able to repay them.
Does the government sometimes help out companies that are bankrupt?
On very rare occasions, the government has stepped in to help a big and important company that is about to go bankrupt. That happened years ago with the Chrysler car company and airplane maker Lockheed. The government provided assistance to US Airways as part of its bankruptcy reorganization plan. So far, however, the government has refused to back loans to United Airlines out of concern that they would never get repaid.
Hasn't gotten government help.