Bankruptcy Terms

Absolute priority rule (APR): Hierarchical rule for the distribution of the firm's assets: payments go first to secured creditors, then to priority creditors (e.g., to cover taxes and bankruptcy costs), then to unsecured creditors (such as bondholders and bank depositors), then to subordinated-debt holders, and finally to stockholders. See also Chapter 19.

Automatic stay: In bankruptcy, a suspension of legal actions (other than the bankruptcy proceeding itself) until the bankruptcy case is over.

Bankruptcy: A legal process under which (1) a financially troubled debtor is declared to be insolvent, or incapable of meeting debt payments, (2) the assets of the debtor are distributed to creditors according to bankruptcy law, and (3) the debtor, if honest, is discharged from liabilities for remaining unpaid debt.

The word "bankruptcy" comes from the Italian banca rotta, or broken bench. The tradition was that when a medieval trader failed to pay his creditors, his trading bench was broken.

Liquidating proceeding: A bankruptcy proceeding in which the debtor's assets are converted to cash and distributed to creditors. In the United States, liquidation is covered under Chapter 7 of the U.S. Bankruptcy Code.

Reorganization proceeding: A bankruptcy proceeding in which the troubled firm may stay in business as it is reorganized in a process of financial rehabilitation. In the United States, reorganization is covered under Chapter 11 of the U.S. Bankruptcy Code. A majority of creditors and equity holders must approve the plan, otherwise liquidation proceeds under Chapter 7.

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