Bankruptcy: what is it and what is the procedure? Recommendations for preventing bankruptcy

Publication date: 19 January 2023.

You will learn from this article what bankruptcy is, how a company can go bankrupt and what happens to a bankrupt company. You'll also learn about the necessary procedures, how the process can be avoided, and how it affects employees.

Contents:

1. Bankruptcy: what it means and how a company can end up in this situation

1.1. What is bankruptcy? Legal framework in Romania

1.2. How a company can go bankrupt - the most common management mistakes

2. Company bankruptcy: what can you do to prevent it? 

3. What happens to employees when the company goes bankrupt

4. Useful information about the situation of a bankrupt company

1. Bankruptcy: what it means and how a company can end up in this situation

Bankruptcy of a company means that the business is insolvent and cannot pay its accumulated debts. If insolvency is the concrete situation where the company has debts above a certain value threshold and has no liquidity and undergoes a reorganisation process, bankruptcy is the legal process whereby the company in question is closed under the laws in force due to its inability to recover.

1.1. What is bankruptcy? Legal framework in Romania

Often confused with insolvency, the term bankruptcy actually refers to the final stage of the insolvency process. Specifically, when a company can no longer pay its invoices, employees, suppliers, etc., it is in a position to go through the insolvency process.

This provides the legal framework to try to remedy these particularly serious problems and protect a business that may still be economically viable. If, following this process, the competent authorities find that the situation has not improved according to plan, the second stage of insolvency - bankruptcy proceedings - will follow.

In Romania, the legal framework for insolvency and bankruptcy proceedings is regulated by Law 85/2014 on Insolvency Prevention Proceedings, as amended. According to Art. 45, "bankruptcy proceedings are insolvency proceedings, concursus, collective and egalitarian, which are applied to the debtor in order to liquidate its assets to cover its liabilities, followed by the debtor's removal from the register in which it is registered."

There are two types of procedure established by the legislator: the general procedure and the simplified procedure, detailed in the document referred to in Articles 46 and 47 respectively.

The general procedure is the insolvency procedure whereby "a debtor enters, after the observation period, successively into judicial reorganisation proceedings and bankruptcy proceedings or, separately, into judicial reorganisation proceedings only or bankruptcy proceedings only".

The simplified procedure provides that "the debtor shall enter directly into bankruptcy proceedings, either at the opening of insolvency proceedings or after an observation period of a maximum of 20 days."

It is important to note that bankruptcy proceedings liquidate the debtor's assets in order to pay off existing debts. Subsequently, the company in question is struck off the register in which it is registered.

1.2. How a company can go bankrupt - the most common management mistakes

When the insolvency process fails, there may be industry-specific reasons. Most of the time, however, these reasons boil down to a series of poor management, marketing and financial management decisions in the company.

A business often starts with a lot of enthusiasm and grand plans. Many professionals start a company with expertise in their field and relative experience in managing such an entity.

It undoubtedly requires effective management of several plans, from running the business itself and managing employees, to positioning against the competition and effectively promoting the products or services offered. Unfortunately, it is often the case that behind some small, start-up businesses there is a person or a small group of people without a full range of experience in running a business.

That's why independent business review can prove to be a lifesaver if a company starts to run into difficulties. Enlisting the support of an external partner with consulting experience and providing an objective perspective on business performance and appropriate solutions may be the best decision for business viability.

External factors that can lead to bankruptcy include: changing economic conditions and lack of predictability in some areas of business, increased competition and production costs, and other natural disasters or calamities.

2. Company bankruptcy: what can you do to prevent it?

Bankruptcy is generally seen as a last resort for entities that can no longer financially support their debts and cannot find viable options to resolve the situation. Before starting bankruptcy proceedings, there are alternatives worth exploring. In the long run, they may prove even less costly and more productive for the company's future.

At a difficult time for the economy, both amid the effects of the pandemic and the general recession, it is an increasing challenge to have a business that is sustainable in all respects. That's why there are a few key issues to consider before you start insolvency or even bankruptcy proceedings.

Experts in the field recommend some effective ways to implement in your business:

• Prioritise and streamline the budget. The main cause of bankruptcy is financial debt. That is why it is essential that debt repayment is a priority and is included as such in the implementation of the budget. When the first signs of difficulties in making any type of payment are observed, a professional financial audit and financial advisory services should be sought. This is perhaps the most important decision to prevent an imminent escalation of the internal crisis.
• Renegotiate loan repayment plans. In most situations, transparent communication with lenders can make them open to discussing repayment terms for the loans on which the business is based. After all, creditors don't want the company to default either, so they will work together to find solutions that work for both sides. In this case, an outsourced legal advisory service can provide the insight that is needed.
• Changing the business plan. It can be a pretty extreme solution, but business flexibility has proven to save many companies from bankruptcy. Certainly, no one wants to change their business plan, especially since this is a personal goal. But to prevent a financial crisis, it is necessary to streamline the company and differentiate it from the competition. This may involve a new sales and marketing strategy and better resource management. By using business management services, for example, you can get an objective view of how to reposition yourself in the market.

3. What happens to employees when the company goes bankrupt?

Ineffective management of human resources can be one of the reasons why a company may default. When a company has more employees than it really needs to run its business, the budget can be affected.

This is why every company needs to have a very clear vision of the role of human resources in the business, streamlining its tasks and automating some internal processes.

The bankruptcy of a company automatically means that employees are out of a job. For example, in the case of long-term non-payment of wages, it may be the employees themselves who can initiate insolvency proceedings. As an employer, you can turn to a collective redundancy or the Wages Claims Fund to protect your employees' rights. It is important to note that when the court determines the bankruptcy of a company, it becomes official that employees will no longer have a job.

In 2021, amidst a context where more and more people found themselves in a situation where they could not prove their employment with a company that had gone bankrupt, an extremely useful addition was made to the Labour Code. Thus, Article 34 specifies the following obligations for the employer in insolvency, bankruptcy or liquidation proceedings:

"If the employer is in insolvency, bankruptcy or liquidation proceedings in accordance with the legal provisions in force, the judicial administrator or, as the case may be, the judicial liquidator shall be obliged to issue to the employees a document certifying the work carried out by them, in accordance with the provisions of para. (5), to terminate and transmit to the general register of employees the termination of individual employment contracts."

Every company's team is, after all, the heart of the business and any leader must take this into account. No matter where you are in the process of starting insolvency or bankruptcy proceedings or if you are on the brink of an internal crisis, pay particular attention to how you communicate these issues to your employees.

4. Useful information about the situation of a bankrupt company

Sometimes, no matter how you run your business, there are factors (internal and/or external) that result in a company going bankrupt. Below is some information you need to know if your company is in this position or if the course of events leads to insolvency/bankruptcy.

• How long does bankruptcy last? In a first phase, according to Law no. 216/2022 of 14 July 2022 on amending and supplementing Law no. 85/2014 on insolvency prevention and insolvency proceedings and other regulatory acts, the insolvency process is started 60 days after the due date towards the debtor. Depending on the company's reorganisation plan and the monitoring of its fulfilment, after 3 years the bankruptcy proceedings start.
• Can a bankrupt company still operate? As soon as the court declares a company bankrupt, its activity ceases with immediate effect.
• What is the liability of a bankrupt company director? Ineffective management by directors often inevitably leads to the bankruptcy of a company. This is why many creditors try to recover damages by invoking the personal liability of the administrator. Even if creditors can justify their reasoning, under Law 85/2014 poor management is not clear evidence of personal interest, by default it cannot be invoked to hold the administrator liable.

Preventing bankruptcy will not happen overnight, as it is a long and complicated process that requires a total rethink of the business and the way you manage human and financial resources. Given the scale that such a situation can take, partnering with an exceptional company that offers integrated audit, tax and financial advisory services can mean a fresh start for your business.

*This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.