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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER THIRTY-NINE

Failure and Reorganization

When a company fails, it can be either reorganized or dissolved. Business failure can occur in a number of ways, including a poor rate of return, technical insolvency, or bankruptcy.

BUSINESS FAILURE

According to law, failure of a company can be technical insolvency, bankruptcy, or deficient rate of return. Creditors have recourse against the company’s assets. Some reasons for business failure include poor management, lawsuit, overexpansion, an economic downturn affecting the company and/or industry, and catastrophe. The types of business failure are defined next.

  • Technical insolvency. Technical insolvency means that the company cannot satisfy current obligations when due even if total assets exceed total liabilities.
  • Bankruptcy. In bankruptcy, liabilities exceed the fair market value of assets. There is a negative real net worth.
  • Deficient rate of return. A company may fail if its rate of return is negative or very low. If operating losses exist, the company may not be able to pay its debt. A negative return will cause a decline in the market price of stock. If a company’s return is less than its cost of capital, it is losing money. However, a poor return in and of itself does not constitute legal evidence of failure.

How does a voluntary settlement work?

By voluntarily settling out of court with creditors, the company saves the costs associated with bankruptcy. The settlement allows the company either to continue or to be liquidated ...

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