Last fall I co-authored a design book for a publishing house operating under the umbrella of a larger corporation. Two weeks ago this larger entity shut its doors, taking my publishing company and at least three others down with it. Cora couldn't understand how a company could close doors without warning, leaving several dozen writers and other employees without pay. Frankly, I couldn't believe it, either.

However, businesses do close doors when the going gets rough. This particular company was in the U.K., so their term for the closing of doors is "insolvency," or an inability to pay debts as they come due. In this particular case, the company gave their employees and authors a cursory notice and immediately began the process of asset liquidation.

Since my literary efforts are part of their insolvency, I pay close attention to the liquidation of my intellectual property rights. As I follow threads of various newsgroups concerned authors created to keep up-to-date, I wondered how it would play out if I were an investor in this company. What would happen to my monetary investment if this overseas company - or a company in the U.S. - would close their doors or declare any other form of bankruptcy?

Cora and I decided to take a look at the various acts involved in the bankruptcy protection proceedings in the U.S. and overseas. We wanted to know how and why these actions were allowed, and why the bankruptcy was called a "protection" program against creditors.

Although bankruptcy laws have been around for centuries, U.S. companies were first given an option of creditor protection in 1898. These particular laws were developed to help a business in dire financial straits to reorganize. This reorganization effort was made more formal and extensive in the 1930s, during the Great Depression. The Chandler Act of 1938 included substantial provisions for business reorganization.

The Chandler Act sufficed until 1978, as bankruptcy from the Great Depression through the 1970s wasn't a huge topic. Very few companies needed or wanted a bankruptcy protection program during those decades. In 1978, The Bankruptcy Reform Act was created, and took effect on October 1, 1979. This act created what we now know as Chapters 11 and 13. This act also made it much easier than ever before for both businesses and individuals to file bankruptcy and reorganize.

Just one year after this act was created, Uncle Sam noticed the Act of 1978 didn't touch on tax related issues. Hence, the Bankruptcy Tax Act of 1980 was created. This act clarifies tax loss carry-forwards and taxation rules when there's an exchange of equities for debt.

In 1983, the Supreme Court challenged the ease in which companies could protect themselves from labor contracts while in bankruptcy. By 1984, new laws limiting the right of companies to terminate labor contracts emerged.

During the past two decades, record numbers of all types of bankruptcies have been filed. Some larger international companies include the complexity of involving insolvency rules of several different countries. There were so many bankruptcies during this time, new "prepackaged" and "pre-arranged" bankruptcies were developed to allow the court systems to efficiently handle all the caseloads.

Finally, on October 22, 1994, President Clinton signed the Bankruptcy Reform Act of 1994. This act contains numerous provisions for businesses and individuals, including an encouragement for all participants to use Chapter 13 to reschedule debts rather than use Chapter 7 to liquidate assets. This law also allowed the creation of a National Bankruptcy Review Commission. This commission was charged to further investigate changes in bankruptcy law. By 1997, the commission completed a report on bankruptcy reform.

Before we go any further, let's define current U.S. Bankruptcy Code chapters. Chapters 1, 3, and 5 cover matters of general application, and usually arise under one of the following five chapters:

Chapter 7: This chapter concerns liquidation proceedings, and is often referred to as "straight bankruptcy." Partnerships, corporations, and individuals may file a Chapter 7. Generally, the company or individual ceases operations, and a trustee is selected to collect and sell all assets. Supposedly, after the assets are sold, creditors are paid with the proceeds from the liquidation. This isn't always straight and clear, however. Sometimes, liens or mortgages are involved, which could reduce the company or individual's apparent value.

Chapter 9: This concerns bankruptcies of municipalities like towns, cities, school districts, or other collective physical districts. This chapter is much like reorganization under Chapter 11. We'll cover this chapter in more depth, as it involves a protection for investors under what's called the Securities Investor Protection Act, or SIPA.

Chapter 11: This Chapter concerns itself with reorganization proceedings, generally for business entities. The debtor maintains control of the business, unless the Court appoints a trustee. Under this bankruptcy chapter, a company has a chance to eliminate certain contracts and leases, and recover various assets. We'll cover this chapter more in depth to discover investment opportunities.

Chapter 12: Also known as "Adjustment of Debts of a Family Farmer with Regular Annual Income." This chapter is also a reorganization of debts, and often doesn't affect our investment strategies (unless you're a family farmer or the feed store down the road).

Chapter 13: This Chapter is also called, "Adjustment of Debts of an Individual With Regular Income." This allows an individual to readjust their debts so they aren't forced to lose valuable assets like their home. This chapter normally doesn't affect investment strategies, unless you're the investor filing Chapter 13, or you've invested in this individual.

Next week we'll see if we can protect ourselves from another entity's bankruptcy. We'll also see if a company's reorganization efforts might benefit our portfolios.

Until Then,
Linda Goin